Urologix 10K 2005 Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2005.

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number 0-28414

UROLOGIX, INC.

(Exact name of registrant as specified in its charter)


Minnesota		41-1697237
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

14405 21st Avenue North, Minneapolis, MN 55447

(Address of principal executive offices)

Registrant’s telephone number, including area code: (763) 475-1400

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

(1) Common Stock, $.01 par value.

(2) Series A Junior Participating Preferred Stock Purchase Rights

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes x No ¨

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No

The aggregate value of the Company’s Common Stock held by non-affiliates of the Company was approximately $89.0 million as of the last day of the Company’s most recently completed second fiscal quarter, when the last reported sales price was $6.47.

As of September 1, 2005, the Company had outstanding 14,310,444 shares of Common Stock, $.01 par value.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information is incorporated into Part III of this report by reference to the Proxy Statement for the Registrant’s 2005 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.

TABLE OF CONTENTS


PART I

Item 1.	Business	4
Item 2.	Properties	17
Item 3.	Legal Proceedings	17
Item 4.	Submission of Matters to a Vote of Security Holders	17

PART II

Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	18
Item 6.	Selected Financial Data	19
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	29
Item 8.	Financial Statements and Supplementary Data	30
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	49
Item 9A.	Controls and Procedures	49
Item 9B.	Other Information	50

PART III

Item 10.	Directors and Executive Officers of the Registrant	51
Item 11.	Executive Compensation	51
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	51
Item 13.	Certain Relationships and Related Transactions	51
Item 14.	Principal Accountant Fees and Services	51

PART IV

Item 15.	Exhibits and Financial Statement Schedules	52

SIGNATURES		53

PART I

Forward-Looking Statements

Statements included in this Annual Report on Form 10-K that are not historical or current facts are forward-looking statements. In addition, our officers may make forward looking statements in the future. We wish to caution readers that these statements are not predictions of actual future results. Our actual results could differ materially from any such forward-looking statements as a result of risks and uncertainties, including those set forth below in “Risks Related to Our Business” and in other documents we file from time to time with the Securities and Exchange Commission, including our Quarterly Reports on Form 10-Q. Any such forward-looking statements reflect management’s opinions only as of the date of this Annual Report on Form 10-K, and we undertake no obligation to revise or publicly release the results of any revisions to any such forward-looking statements.

ITEM 1. BUSINESS

Overview

Urologix has developed and offers non-surgical, catheter-based therapies that use a proprietary cooled microwave technology for the treatment of benign prostatic hyperplasia (BPH), a disease that affects more than 23 million men worldwide. We market our products under the Targis^® and Prostatron^® names. Both systems utilize the Company’s Cooled ThermoTherapy^™, a targeted microwave energy combined with a unique cooling mechanism that protects healthy tissue and enhances patient comfort while providing safe, effective, lasting relief from the symptoms of BPH. Cooled ThermoTherapy can be performed without anesthesia or intravenous sedation and can be performed in a physician’s office or an outpatient clinic. We believe that Cooled ThermoTherapy provides an efficacious, safe and cost-effective solution for BPH with results clinically superior to medication and without the complications and side effects inherent in surgical procedures.

We maintain a website at www.urologix.com. Our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our periodic reports on Form 8-K (and any amendments to these reports) are available free of charge on our website as soon as reasonably practical after we file these reports with the SEC. To obtain copies of these reports, go to www.urologix.com.

Benign Prostatic Hyperplasia

BPH is a non-cancerous disease in which the prostate enlarges and constricts the urethra causing adverse changes in urinary voiding patterns. The prostate is a walnut-size gland surrounding the male urethra (the channel that carries urine from the bladder out of the body) that is located just below the bladder and adjacent to the rectum. While the actual cause of BPH is not fully understood, it is known that as men reach middle age, cells within the prostate begin to grow at an increasing rate. As the prostate expands, it compresses or impinges upon other portions of the prostate gland and the urethra, thereby restricting the normal passage of urine. BPH patients typically suffer from a variety of troubling symptoms that can have a significant impact on their quality of life. Symptoms of BPH include frequent urination during the day and night, urgency and painful urination. A delay in treatment can have serious consequences, including complete obstruction (acute retention of urine), urinary tract infections, loss of bladder functions and, in extreme cases, kidney failure.

BPH generally affects men after the age of 50, and medical experts suggest that nearly every man will be affected by this condition at some time in his life. The BPH market is large and can be expected to continue to grow due to the general aging of the world’s population, as well as increasing life expectancies.

Due in part to the side effects and complications associated with traditional BPH therapies, many patients diagnosed with BPH are regularly monitored by their physicians but elect not to receive active intervention. This course of inaction is known as “watchful waiting.” If symptoms persist or worsen, drug therapy or surgical

intervention has historically been recommended. Drug therapy is usually the first line of treatment. It is estimated that more than 20% of patients who initially pursue drug therapy discontinue treatment within 12 months due to various reasons including cost, ineffectiveness, side effects and the burdens of compliance. Patients may also try multiple drugs or combinations of drugs to improve effectiveness. This leads to a more costly treatment and often, more side effects. Traditionally, the most common surgical procedure has been Transurethral Resection of the Prostate (TURP), an invasive surgery in which portions of the prostatic urethra and surrounding tissue are removed, thereby widening the urethra and improving urinary flow. While TURP results in a dramatic improvement in urine flow and reduction in symptoms, the procedure can require a lengthy recovery time and is reported to have a high rate of side effects and complications. Because the TURP procedure requires a highly skilled surgeon with extensive training, the incidence of complications are affected by the experience of the surgeon performing the TURP.

Cooled ThermoTherapy

Both our Targis and Prostatron systems utilize Cooled ThermoTherapy, a catheter-based treatment for BPH that is clinically superior to medication and less invasive than surgery. Cooled ThermoTherapy was developed to be the treatment of choice for patients who have tried drugs unsuccessfully and wish to avoid surgery. Today, some patients choose Cooled ThermoTherapy before trying medications.

Cooled ThermoTherapy utilizes a proprietary microwave technology, delivered through a flexible catheter that targets energy into the enlarged area of the prostate to a temperature sufficient to cause cell death, while simultaneously cooling and protecting the healthy, pain-sensitive urethral tissue. During a Cooled ThermoTherapy procedure, a catheter is inserted into the urethra, and a rectal thermosensing unit is placed into the rectum. Chilled water is then circulated through the catheter in order to lower the temperature of the urethra and protect it from heat and discomfort during the treatment. Temperatures in the urethra and rectum are monitored continuously during the treatment while microwave energy is delivered into the prostatic tissue, ultimately resulting in a reduction in the size of the prostate and relief of symptoms, as the body re-absorbs the destroyed tissue during the months following treatment.

Cooled ThermoTherapy provides significant advantages over other BPH therapies, producing lasting results that are clinically superior to drug therapy while avoiding the complications associated with surgery. Because Cooled ThermoTherapy does not require punctures or incisions and protects the urethra during treatment, it can be performed in the physician’s office or other outpatient environments without the need for anesthesia or intravenous sedation and results in fewer complications.

Clinical Studies

Clinical trials of the Cooled ThermoTherapy procedure have been performed to obtain data to support new indications and marketing claims, to obtain long-term durability data, and to gather data for Medicare and other reimbursement approvals in various markets. We continue to monitor multi-center, multi-year studies to evaluate the long-term durability of Cooled ThermoTherapy procedures. In our published results from multi-center clinical trials, conducted both in the United States and internationally, the majority of Cooled ThermoTherapy patients for whom follow-up data are available show significant long-term relief from the symptoms of BPH, without significant post-procedure complications.

Sales and Marketing

Our goal is to grow Cooled ThermoTherapy as a standard of care for the treatment of BPH. Our business strategy to achieve this goal is (i) educate both patients and physicians on the benefits of Cooled ThermoTherapy compared to other treatment options, (ii) increase the use of Cooled ThermoTherapy by physicians who already have access to a Cooled ThermoTherapy system, (iii) increase the number of physicians who provide Cooled ThermoTherapy to their patients, and (iv) satisfy demand for Cooled ThermoTherapy systems through the efficient use of both new systems and systems already in use.

United States

We have a sales and marketing team consisting of sales and marketing management, marketing communications, clinical and reimbursement specialists, and direct sales representatives, all of whom are dedicated to marketing our Cooled ThermoTherapy products. Our direct sales force and marketing efforts are targeted at urologists who treat BPH patients in their office. In addition to our direct sales force, we utilize independent third-party mobile service providers to provide hospitals and urology clinics with cost-effective access to our Cooled ThermoTherapy treatment. The mobile service providers transport the Cooled ThermoTherapy systems between sites, making the treatment available to physicians and patients on a rotating basis. In September 2005, we began offering a company-owned mobile service option, similar to that offered by the third-party mobile service providers, to customers in select markets in the United States. Depending on the success of this initiative, we may expand this offering to other areas of the United States. We also continue to provide an equipment delivery system to bring Cooled ThermoTherapy systems to physicians who choose not to utilize a full service mobile provider. As of June 30, 2005, we employed a total of 37 individuals in our sales and marketing department.

We offer our Cooled ThermoTherapy systems to our customers on a direct purchase or on a trial basis. Pricing for single-use treatment catheters varies based upon volume and the specific terms of the contract.

International

We have distribution agreements with Nihon Kohden Corporation and EDAP Technomed Co. Ltd. for the market development and sale of the Targis and Prostatron systems, respectively, in Japan. Our efforts outside of Japan remain relatively modest and are focused primarily on Western Europe and other parts of Asia where we use local distributors and independent agents experienced in selling products to hospitals and urologists.

Manufacturing

We manufacture the Targis system control unit and single-use treatment catheters at our suburban Minneapolis facility. We outsource all other manufacturing.

We had previously entered into a supply agreement for the production of the Prostatron control unit with EDAP TMS S.A., a French corporation; Technomed Medical Systems S.A., a French corporation and EDAP Technomed Inc., a Delaware corporation (collectively EDAP) that ended on October 1, 2003. At this time, we do not have plans to enter into another supply agreement for the manufacture of Prostatron control units, as we believe our current inventory of Prostatron control units combined with Company owned control units located at customer sites will adequately support future customer requirements.

We have a supply agreement with Accellent Corp. (formerly Venusa) for the production of the Prostatron disposable treatment catheter that extends through April 2006 with an automatic renewal term.

We assemble Targis control units and procedure kits using materials and components supplied by various subcontractors and suppliers, as well as components we fabricate. Several of the components are currently available to us through a single vendor. Wherever possible we attempt to develop alternative sources for critical components. Where alternative sourcing is not possible, we attempt to enter into supply agreements with each component provider. Nevertheless, failure to obtain components from these providers or delays associated with any future component shortages, particularly as we increase our manufacturing level, could have a material adverse effect on our business, financial condition and operating results.

Our manufacturing operations and the operations of our third-party suppliers must comply with the U.S. Food and Drug Administration’s (FDA) quality system regulation, which includes, but is not limited to, the FDA’s Good Manufacturing Practices (GMP) requirements, and with certain requirements of state, local and foreign governments for assuring quality by controlling components, processes and document traceability and retention, among other things.

In June 1997, July 1998, September 2000, September 2002 and March 2004, the FDA completed inspections of our facility, documentation and quality systems with no significant deficiencies of GMP noted. Our facility will continue to be subject to periodic inspections by the FDA and by other auditors. We believe that our manufacturing and quality control procedures meet the requirements of these regulations and that we have established training and self-audit systems designed to ensure compliance.

We have received ISO 13485 certification indicating compliance of our manufacturing facilities with European standards for quality assurance and manufacturing process control. We also have received CE mark certification, which allows us to affix the CE Mark to our products and market them in the European Union. In addition, the Targis and Prostatron systems have been approved for marketing by the Japanese Ministry of Health and Welfare. As of June 30, 2005, we employed 33 individuals in our manufacturing department.

Research and Development

We intend to build upon our scientific and clinical knowledge and relationships to develop innovative future generations of BPH and other urology products. Our research and development efforts are currently focused on improving the function and features of our Cooled ThermoTherapy systems, improving the treatable population and clinical response to Cooled ThermoTherapy treatment and reducing the production cost of the components in our products. During fiscal year 2005 we received seven new pre-market approved (PMA) Supplement approvals from the FDA resulting in expansion of our BPH labeling for our Targis, CTC^™ and Prostatron therapies, new and improved catheter material components and a new product, the CTC 4.5+ treatment catheter. The labeling expansion approvals included removals of contraindications for patients with severe BPH or who are in “retention,” patients wearing active stimulators (such as defibrillators/pacemakers) outside of 2.6 inches from the prostatic urethra, and patients diagnosed with a “median lobe.”

During the fiscal years ended June 30, 2005, 2004 and 2003, we spent $3.1 million, $2.4 million, and $3.7 million, respectively, on our research and development efforts. As of June 30, 2005, we employed 13 individuals in our research and development department.

Reimbursement

We believe that third-party reimbursement is essential to the continued adoption of Cooled ThermoTherapy, and that clinical efficacy, overall cost-effectiveness and physician advocacy will be keys to obtaining such reimbursement. We estimate that 60% to 80% of patients who receive Cooled ThermoTherapy treatment in the United States will be eligible for Medicare coverage. The remaining patients will either be covered by private insurers, including traditional indemnity health insurers and managed care organizations, or they will be private-paying patients. As a result, Medicare reimbursement is particularly critical for widespread market adoption of Cooled ThermoTherapy in the United States.

The level of Medicare reimbursement for Cooled ThermoTherapy is dependent on the site of service. Beginning on August 1, 2000, the Centers for Medicare and Medicaid Services (CMS) replaced the reasonable cost basis of reimbursement for outpatient hospital-based procedures, including Cooled ThermoTherapy, with a new fixed rate or prospective payment system. Under this method of reimbursement, a hospital receives a fixed reimbursement for each Cooled ThermoTherapy treatment performed in its facility, approximately $2,100 in calendar year 2005, although the rate varies depending on a wage index and other factors for each hospital. The urologist performing the Cooled ThermoTherapy treatment receives reimbursement of approximately $500 per procedure.

In January 2001, CMS began to reimburse for Cooled ThermoTherapy treatments performed in the urologist’s office. The reimbursement rate (inclusive of the physician’s fee) in calendar year 2005 for Cooled ThermoTherapy procedures performed in the urologist’s office is approximately $3,900 compared to $4,000 in calendar 2004, which is subject to geographic adjustment. Reimbursement rates for calendar year 2006 will be published in the November 2005 edition of the Federal Register.

In July 2003, CMS added the CPT Code covering Cooled ThermoTherapy to the ASC list of Medicare approved procedures providing a reimbursement rate for ambulatory surgical centers (ASC). As a result, procedures performed in an ASC were reimbursed under a two-part system similar to hospitals: the ASC received a fixed fee of approximately $1,300, the highest amount allowable under this system, while the urologist performing the procedure was reimbursed the same amount as if the treatment occurred in a hospital, approximately $500. The relatively low facility reimbursement relative to the cost of the procedure potentially limited the number of Cooled ThermoTherapy treatments done in an ASC. Effective July 2005, the CPT code covering Cooled ThermoTherapy was deleted from the ASC list of Medicare approved procedures. As a result, effective with that change, urologists who perform Cooled ThermoTherapy procedures in an ASC are reimbursed at the office-based reimbursement rates, approximately $3,900 (inclusive of the physician’s fee) in calendar year 2005, subject to geographic adjustment.

Private insurance companies and HMO’s make their own determinations regarding coverage and reimbursement based upon “usual and customary” fees. To date, we have received coverage and reimbursement in various geographies from private insurance companies and HMOs throughout the United States. We intend to continue our efforts to gain coverage and reimbursement across the United States. There can be no assurance that we will receive favorable coverage or reimbursement determinations for Cooled ThermoTherapy from these payers or that amounts reimbursed to physicians for performing Cooled ThermoTherapy procedures will be sufficient to encourage physicians to use Cooled ThermoTherapy.

Internationally, reimbursement approvals for the Cooled ThermoTherapy procedure are awarded on an individual-country basis.

Patents and Proprietary Rights

We currently own 46 U.S. and 13 non-U.S. patents. We also have 2 patent applications pending in the United States and in a number of non-U.S. jurisdictions, and we intend to file additional patent applications in the future.

Several of our United States patents claim methods and devices that we believe are critical to providing a safe and efficacious treatment for BPH. There can be no assurance that our patents, or any patents that may be issued as a result of existing or future applications, will offer any degree of protection from competitors or that any of our patents or applications will not be challenged, invalidated or circumvented in the future. In addition, there can be no assurance that our competitors, many of which have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with our ability to manufacture or market Cooled ThermoTherapy in the United States or in international markets. Further, there can be no assurance that our Cooled ThermoTherapy system does not infringe upon the patent rights or other intellectual property rights of other companies, that we will not be required to seek licenses from other companies or that other companies will not pursue claims of infringement against us.

In addition to patents, we also rely on trade secrets and proprietary know-how that we intend to protect, in part, through proprietary information agreements with employees, consultants and other parties. Our proprietary information agreements with employees and most of our consultants contain standard industry provisions requiring that the individuals assign to us, without additional consideration, any inventions conceived or reduced to practice while employed by or under contract with us, subject to customary exceptions. Our officers and other key employees also agree not to compete with us for a period following termination. There can be no assurance that proprietary information or non-compete agreements with employees, consultants and others will not be breached, that we will have adequate remedies for any such breach, or that third parties will not otherwise gain access to our technology.

Competition

Competition in the market for the treatment of BPH comes from invasive surgical therapies, such as TURP and side-firing lasers (Laserscope and Lumenis), drug therapy and other minimally invasive, office-based

treatments. There are six well-recognized prescription drugs available in the United States for treating the symptoms of BPH: Flomax (Boehringer Ingelheim International GmbH), Hytrin (Abbott Laboratories), Cardura (Pfizer Inc.), UroXatral (Sanofi-Synthelabo), Proscar (Merck & Co., Inc.) and Avodart (GlaxoSmithKline). Drug therapy is currently the first-line therapy prescribed by most physicians in the United States for BPH. Due to the large yet still uninformed marketplace of men suffering from BPH, we do not consider the drug manufacturers as major threats, but more as alternative therapies that have significant resources to bring awareness to this quality of life condition for which we believe our Cooled ThermoTherapy can provide a safe, effective and long-lasting treatment.

Competition in the market for minimally invasive office-based treatments for BPH continues to grow. Competitive devices include radio frequency (Medtronic); interstitial laser (Johnson & Johnson); non-cooled, low energy microwave (American Medical Systems); low energy microwave combined with balloon dilatation (Boston Scientific/Celsion); high energy microwave with limited cooling (ProstaLund/ACMI); and hot water therapy (ACMI). Additional competitors may enter the market. We believe Cooled ThermoTherapy provides significant advantages over other office-based BPH therapies. Because Cooled ThermoTherapy does not require punctures or incisions, it can be performed in the physician’s office or other outpatient environments without the need for anesthesia or intravenous sedation. Further, by combining microwave energy with cooling, we can drive more energy deep into the prostate, creating lasting results while preventing damage to the urethra, enhancing patient comfort and reducing complications.

Government Regulation

Governmental regulation in the United States and other countries is a significant factor affecting the research and development, manufacture and marketing of our products. In the United States, the FDA has broad authority under the Federal Food, Drug and Cosmetic Act and the Public Health Service Act to regulate the distribution, manufacture and sale of medical devices. Foreign sales of medical devices are subject to foreign governmental regulation and restrictions that vary from country to country.

Medical devices intended for human use in the United States are classified into one of three categories. Such devices are classified by regulation into either class I (general controls), class II (performance standards) or class III (pre-market approval or PMA) depending upon the level of regulatory control required to provide reasonable assurance of the safety and effectiveness of the device. Good Manufacturing Practices, labeling, maintenance of records and filings with the FDA also apply to medical devices.

Our Cooled ThermoTherapy systems have received FDA clearance for sale in the United States as a class III medical device. In addition, we have obtained CE Mark certification for distribution in Europe and product registration for distribution in Canada and Japan.

The FDA’s regulations require agency approval of a PMA supplement for a class III medical device when certain changes are made to a product if the changes affect the safety and effectiveness of the device. Such changes include, but are not limited to, new indications for use; the use of a different facility or establishment to manufacture, process or package the device; changes in manufacturing methods or quality control systems; changes in vendors used to supply components of the device; changes in performance or design specifications; and certain labeling changes. Any such changes will require FDA approval of a PMA supplement prior to marketing of the device. There can be no assurance that the required approvals of PMA supplements for any changes will be granted on a timely basis or at all, and delays in receipt of, or failure to receive such approvals, or the loss of the approval of the PMA for either of our Cooled ThermoTherapy systems would have a material adverse effect on our business.

The process of obtaining FDA and other required regulatory clearances or approvals is lengthy and expensive. There can be no assurance that we will be able to obtain or maintain the necessary clearances or approvals for clinical testing or for manufacturing or marketing of our products. Failure to comply with

applicable regulatory approvals can, among other things, result in warning letters, fines, suspensions of regulatory approvals, product recalls, operating restrictions and criminal prosecution. In addition, government regulation may be established that could prevent, delay, modify or rescind regulatory clearance or approval of our products.

Medical device laws are also in effect in many of the countries outside of the United States in which we do business. These laws range from comprehensive device approval and quality system requirements for some or all of our medical device products to simple requests for product data or certifications. The number and scope of these requirements are increasing. All medical devices sold in Europe must meet the European Medical Device Directive standards and receive CE Mark certification. CE Mark certification involves a comprehensive Quality System program and submission of data on a product to the Notified Body in Europe.

Health Care Regulatory Issues

The health care industry is highly regulated, and there can be no assurance that the regulatory environment in which we operate will not change significantly in the future. In general, regulation of health care related companies is increasing. We anticipate that Congress and state legislatures will continue to review and assess alternative health care delivery and payment systems. We cannot predict what impact the adoption of any federal or state health care reform measures may have on our business.

We regularly monitor developments in laws and regulations relating to our business. We may be required to modify our agreements, operations, marketing and expansion strategies from time to time in response to changes in the statutory and regulatory environment. Although we plan to structure all of our agreements, operations, marketing and strategies in accordance with applicable law, there can be no assurance that our arrangements will not be challenged successfully or that required changes will not have a material adverse effect on operations or profitability.

Product Liability and Insurance

Our business exposes us to potential product liability claims that are inherent in the testing, production, marketing and sale of medical devices. Like other participants in the medical device market, we are from time to time involved in lawsuits, claims and proceedings alleging product liability and related claims such as negligence. If product liability claims become substantial, our reputation could be damaged significantly, thereby harming our business. We may be required to pay substantial damage awards as a result of any successful product liability claims. Any product liability claim against us, whether with or without merit, could result in costly litigation, and divert the time, attention, and resources of our management.

As a result of our exposure to product liability claims, we currently carry product liability insurance covering our products with policy limits per occurrence and in the aggregate that we have deemed to be sufficient. We cannot predict, however, whether this insurance is sufficient, or if not, whether we will be able to obtain sufficient insurance to cover the risks associated with our business or whether such insurance will be available at premiums that are commercially reasonable. In addition, these insurance policies must be renewed annually. Although we have been able to obtain liability insurance, such insurance may not be available in the future on acceptable terms, if at all. A successful claim against us or settlement by us in excess of our insurance coverage or our inability to maintain insurance in the future could have a material adverse effect on our business, financial condition and results of operations.

Employees

As of June 30, 2005, we employed 90 individuals on a full-time basis. We also had several part-time employees and consultants. Although we believe that we have been successful in attracting experienced and

capable personnel, there can be no assurance that we will continue to attract and retain qualified personnel. None of our employees are covered under a collective bargaining agreement. We consider our relationship with our employees to be good.

Seasonality

We believe that holidays, major medical conventions and vacations taken by physicians, patients and patient families may have a seasonal impact on our sales. We continue to monitor and assess the impact seasonality may have on demand for our products.

Backlog

As of June 30, 2005, we maintained a minimal backlog of product orders. Our policy is to stock enough inventory to be able to ship most orders within a few days of receipt or as requested by our customers. Therefore, we rely on orders placed during a given period for sales during that period. Backlog information as of the end of a particular period is not necessarily indicative of future levels of our revenue.

Risks Related to Our Business

The occurrence of any of the following risks could harm our business. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our operations. If any of these risks materialize, the trading price of our common stock could decline, and investors may lose all or part of their investment.

We are faced with intense competition and rapid technological and industry change.

The medical device industry is characterized by rapid technological change, changing customer needs and frequent new product introductions. Our products may be rendered obsolete as a result of future innovations. We face intense competition from other device manufacturers and surgical manufacturers, as well as from pharmaceutical companies. Nearly all of our competitors are significantly larger than we are and have greater financial, technical, research, marketing, sales, distribution and other resources than we do. We believe that price competition will continue among products developed in our markets. Our competitors may develop or market technologies and products, including drug-based treatments that are more effective or commercially attractive than any we are developing or marketing. Our competitors may succeed in obtaining regulatory approval and introducing or commercializing products before we do. Such developments could have a significant negative effect on our business, financial condition and results of operations. Even if we are able to compete successfully, we may not be able to do so in a profitable manner.

Our products may not achieve market acceptance, which could limit our future revenue.

Physicians will not recommend Cooled ThermoTherapy procedures unless they conclude, based on clinical data and other factors, that it is an effective alternative to other methods of enlarged prostate treatment, including more established methods. Patient acceptance of the procedure will depend in part upon physician recommendations and on other factors, including the degree of invasiveness and the rate and severity of complications associated with the Cooled ThermoTherapy procedure compared with other therapies. Patient acceptance of the Cooled ThermoTherapy procedure also will depend upon the ability of physicians to educate these patients on their treatment choices. Health care payer acceptance of our procedure will require, among other things, evidence of the cost effectiveness of Cooled ThermoTherapy compared to other BPH therapies. Our marketing strategy must overcome the difficulties inherent in the introduction of new technology to the medical community. If our Cooled ThermoTherapy procedure is not widely accepted by physicians, patients or payers, or is accepted more slowly than expected, our business will be harmed.

Third-party reimbursement is critical to market acceptance of our products.

Our future revenues are subject to uncertainties regarding health care reimbursement and reform. In the United States, health care providers, such as hospitals and physicians, generally rely on third-party payers. Third-party reimbursement is dependent upon decisions by the CMS, contract Medicare carriers, individual managed care organizations, private insurers, foreign governmental health programs and other payers of health care cost. Failure to receive or maintain favorable coding, coverage and reimbursement determinations for Cooled ThermoTherapy by these organizations could discourage physicians from using our products. We may be unable to sell our products on a profitable basis if third-party payers deny coverage, provide low reimbursement rates or reduce their current levels of reimbursement.

The continuing efforts of government, insurance companies, health maintenance organizations and other payers of health care costs to contain or reduce costs of health care may affect our future revenues and profitability. With recent federal and state government initiatives directed at lowering the total cost of health care, the United States Congress and state legislatures will likely continue to focus on health care reform including the reform of Medicare and Medicaid systems, and on the cost of medical products and services. Additionally, third-party payers are increasingly challenging the prices charged for medical products and services. Also, the trend toward managed health care in the United States and the concurrent growth of organizations such as HMO’s that could control or significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care or reduce government insurance programs, may also result in lower prices for, or rejection of, our products. The cost containment measures that health care payers and providers are instituting and the effect of any health care reform could cause reductions in the amount of reimbursement available, and could have a materially adverse effect on our revenues and ability to operate profitably.

We have only attained profitability recently.

Although we produced net earnings of $2.8 million for the year ended June 30, 2005 and $356,000 for the year ended June 30, 2004, we have incurred losses of approximately $77.1 million since our inception. If physicians do not continue to purchase and use our Cooled ThermoTherapy systems to treat patients with BPH, we may not be able to maintain profitability. Because we will continue to incur additional expenses relating to sales and marketing activities and research and development activities, we will need to increase the revenues we receive from sales of our products in order to continue to operate in a profitable manner. We cannot assure you that we will be able to increase our revenues, maintain profitable operations, or successfully implement our business plan or future business opportunities.

We depend upon our Cooled ThermoTherapy products for all of our revenues.

All of our revenues are derived from sales of our Cooled ThermoTherapy system control units and single-use treatment catheters. As a result, our success is solely dependent upon the success of our Cooled ThermoTherapy products. To date, our Cooled ThermoTherapy systems have not achieved widespread market adoption. If we are unable to widely commercialize the use of these systems successfully, our business, financial condition and results of operations will be materially and adversely affected. Further, higher than expected manufacturing, marketing and distribution costs, lower than expected reimbursement levels, lower than expected usage by physicians, and/or other competitive forces may require us to alter our pricing or marketing structure in a manner that could have a material and adverse effect on us.

We have limited manufacturing experience and are dependent upon a limited number of third-party suppliers to manufacture our products.

We produce the single-use treatment catheters for the Targis system and in January 2004 we began manufacturing the Targis system control unit. Our success will depend upon our ability to cost-effectively

manufacture a reliable product and deliver that product in a timely manner. Because we lack extensive manufacturing experience, we may encounter difficulties in maintaining production efficiencies, quality control and assurance, component supply and qualified personnel. We cannot assure you that we will be able to manufacture a reliable product and deliver that product to customers in a timely fashion. Our failure to maintain a reputation among our customers as a timely, responsive manufacturer or higher than expected manufacturing costs would adversely affect our business.

Other than the Targis system control unit and procedure kits, we outsource all other manufacturing for our products. We assemble Targis control units and procedure kits using materials and components supplied by various subcontractors and suppliers, as well as components we fabricate. We rely on single sources for several components, one of which is obtained from a source that has a patent for the technology. Our reliance on outside suppliers for our components involves risks including limited control over the price and uncertainty regarding timely delivery and quality of parts. Additionally, we currently have a supply agreement with Accellent Corp. (formerly Venusa) for the production of the Prostatron single-use treatment catheter that extends though April 2006 with an automatic renewal term.

The termination or interruption of any of these relationships, or the failure of these manufacturers or suppliers to supply products or components to us on a timely basis or in sufficient quantities, likely would cause us to be unable to meet customer orders for our products and harm our reputation with customers and our business. Identifying and qualifying alternative suppliers of components or manufacturers of products takes time and involves significant additional costs and may delay the production of our products. Further, if we obtain a new supplier for a component, manufacture our product with an alternative component or if our products are manufactured by an alternative manufacturer, we may need to obtain FDA approval of a PMA supplement to reflect changes in product manufacturing and the FDA may require additional testing of any component from new suppliers prior to our use of these components. Further, if FDA approval of a PMA supplement is required, any delays in delivery of our product to customers would be extended and our costs associated with the change in product manufacturing would increase.

The failure of our third-party manufacturers to manufacture the products for us, and the failure of our components suppliers to supply us with the components, consistent with our requirements as to quality, quantity and timeliness would materially harm our business.

We are dependent on adequate protection of our patent and proprietary rights.

We rely on patents, trade secrets, trademarks, copyrights, know-how, license agreements and contractual provisions to establish and protect our intellectual property rights. However, these legal means afford us only limited protection and may not adequately protect our rights or remedies to gain or keep any advantages we may have over our competitors.

We cannot assure you that others may not independently develop the same or similar technologies or otherwise obtain access to our technology and trade secrets. Our competitors, many of which have substantial resources and may make substantial investments in competing technologies, may apply for and obtain patents that will prevent, limit, or interfere with our ability to manufacture or market our products. Further, while we do not believe that any of our products or processes interfere with the rights of others, third parties may nonetheless assert patent infringement claims against us in the future.

Costly litigation may be necessary to enforce patents issued to us, to protect trade secrets or “know-how” we own, to defend us against claimed infringement of the rights of others or to determine the ownership, scope, or validity of our proprietary rights and the rights of others. In connection with the settlement of a patent infringement suit we filed in March 2002, we granted ProstaLund AB, ProstaLund Operations AB and Circon Corporation (a/k/a ACMI Corporation) a non-exclusive, royalty free license under certain of our patents to sell the ProstaLund transurethral microwave thermotherapy system marketed in the United States by ProstaLund and ACMI Corporation as the CoreTherm device.

Any claim of infringement against us may involve significant liabilities to third parties, could require us to seek licenses from third parties, and could prevent us from manufacturing, selling, or using our products. The occurrence of this litigation or the effect of an adverse determination in any of this type of litigation could have a material adverse effect on our business, financial condition and results of operations.

Our business of the manufacturing, marketing, and sale of medical devices involves the risk of liability claims and such claims could seriously harm our business, particularly if our insurance coverage is inadequate.

Our products may be subject to product recalls even after receiving FDA clearance or approval, which would harm our reputation and our business.

The FDA and similar governmental authorities in other countries in which our products are sold, have the authority to request and, in some cases, require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government-mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects. Any recall of product would divert managerial and financial resources, harm our reputation with our customers and damage our business.

In December 2003, we determined that a component of one of our Cooled ThermoTherapy system control units may not perform properly under certain conditions. We advised our customers who are using the affected units of an appropriate product protocol to follow pending our implementation of a software solution to resolve the performance issue. We submitted the software update addressing the problem to the FDA and have received its approval. We completed the installation of the approved software update during the third quarter of fiscal 2005.

We have limited inventory of Prostatron control units and if customer demand exceeds our expectations, we will experience delays and expense in meeting customer demand that could be significant.

We have previously contracted with third parties for the production of the Prostatron product line pursuant to written supply agreements. Our supply agreement for the production of the Prostatron control unit with EDAP ended on October 1, 2003. At this time, we do not have plans to enter into another supply agreement for the manufacture of Prostatron control units, as we believe our current inventory of Prostatron control units combined with Company owned control units located at customer sites will adequately support future customer requirements. If, for any reason, customer demand exceeds our current projections, we could experience significant delays and expend significant resources in obtaining a new supply agreement with EDAP or another manufacturer to meet this customer demand. Therefore, we are likely to experience significant delays in fulfilling unexpected, significant customer demand for our Prostatron control units.

We are dependent on key personnel.

Failure to attract and retain skilled personnel could hinder our research and development as well as our sales and marketing efforts. Our future success depends to a significant degree upon the continued services of key sales, technical and senior management personnel, including Fred B. Parks, our Chairman of the Board and Chief Executive Officer. We have an employment agreement with Mr. Parks that provides that Mr. Parks will serve as our Chairman and Chief Executive Officer and that either party may terminate Mr. Parks’ employment at any time with or without cause. If we terminate Mr. Parks’ employment without cause, however, we would be required to make specified payments to him as described in his employment agreement. We do not have key person life insurance on Mr. Parks. Our future success also depends on our continuing ability to attract, retain and motivate highly qualified managerial, technical and sales personnel. Our inability to retain or attract qualified personnel could have a significant negative effect and thereby materially harm our business and financial condition.

Government regulation can have a significant impact on our business.

Government regulation in the United States and other countries is a significant factor affecting the research and development, manufacture and marketing of our products. In the United States, the FDA has broad authority under the federal Food, Drug and Cosmetic Act and the Public Health Service Act to regulate the distribution, manufacture and sale of medical devices. Sales of medical devices outside the United States are subject to government regulation and restrictions that vary from country to country. The process of obtaining FDA and other required regulatory approvals is lengthy and expensive.

We may not be able to obtain necessary approvals for clinical testing or for the manufacturing or marketing of our products in the United States or in other countries. Failure to comply with applicable regulatory approvals can, among other things, result in fines, suspension of regulatory approvals, product recalls, operating restrictions and criminal prosecution. In addition, government regulations may be established that could prevent, delay, modify or rescind regulatory approval of our products. Any such position or change of position by the FDA may adversely impact our business and financial condition. Regulatory approvals, if granted, may include significant limitations on the indicated uses for which our products may be marketed in the United States or in other countries. In addition to obtaining such approvals, the FDA and foreign regulatory authorities may impose numerous other requirements on us. The FDA prohibits the marketing of approved medical devices for unapproved uses. In addition, product approvals can be withdrawn for failure to comply with regulatory standards or the occurrence of unforeseen problems following initial marketing. We may not be able to obtain regulatory approvals for our products on a timely basis, or at all, and delays in receipt of or failure to receive such approvals, the loss of previously obtained approvals, or failure to comply with existing or future regulatory requirements would have a significant negative effect on our financial condition and results of operations. In addition, the health care industry in the United States is generally subject to fundamental change due to regulatory, as well as political, influences. We anticipate that Congress and state legislatures will continue to review and assess alternative health care delivery and payment systems. Potential approaches that have been considered include controls on health care spending through limitations on the growth of private purchasing groups and price controls. We cannot predict what impact the adoption of any federal or state health care reform measures may have on our business.

We, along with our distributors and health care providers who purchase our products and services, are subject to state and federal laws prohibiting kickbacks or other forms of bribery in the health care industry. We may be subject to civil and criminal prosecution for violations of any of these laws by our agents or us.

We have limited cash resources and may not have additional financing available to us.

We generated approximately $2.9 million of net cash from operating activities in the year ended June 30, 2005 and ended that period with approximately $10.8 million of cash, cash equivalents, and available-for-sale

investments. We believe our $10.8 million in cash, cash equivalents, and available-for-sale investments, together with the funds generated from product sales, will be sufficient to fund our working capital and capital resources needs for the next 12 months. Our business plan and financing needs are subject to change depending on, among other things, success of our efforts to continue to effectively manage expenses, market conditions, business opportunities and cash flow from operations, if any. We may require additional financing to continue our business, the receipt of which cannot be assured. Such additional financing could be sought from a number of sources, including possible sales of equity or debt securities or loans from banks or other financial institutions. We may not be able to obtain additional financing from any source on reasonable terms, if at all. Any future capital that is available may be raised on terms that are dilutive to our shareholders.

Fluctuations in our future operating results may negatively affect the market price of our common stock.

Our operating results have fluctuated in the past and can be expected to fluctuate from time to time in the future. Some of the factors that may cause these fluctuations include but are not limited to:

•

the timing, volume and pricing of customer orders for both control units and single-use treatment catheters,

•

the impact to the marketplace of competitive products and pricing,

•

costs and expenses related to our effort to protect our intellectual property,

•

the timing of expenditures related to sales and marketing, and research and development, and

•

product availability.

If our operating results are below the expectations of securities analysts or investors, the market price of our common stock may fall abruptly and significantly.

Our stock price may be volatile and a shareholder’s investment could decline in value.

Our stock price has fluctuated in the past and may continue to fluctuate significantly, making it difficult for an investor to resell shares or to resell shares at an attractive price. The market prices for securities of emerging companies have historically been highly volatile. Future events concerning us or our competitors could cause such volatility, including:

•

actual or anticipated variations in our operating results,

•

technological innovations or new commercial products introduced by us or our competitors,

•

developments regarding government and third-party reimbursement,

•

changes in government regulation,

•

government investigation of us or our products,

•

changes in reimbursement rates or methods affecting our products,

•

developments concerning proprietary rights,

•

litigation or public concern as to the safety of our products or our competitors’ products,

•

investor perception of us and our industry,

•

general economic and market conditions including market uncertainty,

•

national or global political events,

•

public confidence in the securities markets and regulation by or of the securities markets, and

•

changes in senior management.

In addition, the stock market is subject to price and volume fluctuations that affect the market prices for companies in general, and small-capitalization, high-technology companies in particular, which are often unrelated to the operating performance of these companies. Any failure by us to meet or exceed estimates of financial analysts is likely to cause a decline in our common stock price.

Future sales of shares of our common stock may negatively affect our stock price.

Future sales of our common stock could have a significant negative effect on the market price of our common stock. In addition, upon exercise of outstanding options, the number of shares outstanding of our common stock could increase substantially. This increase, in turn, could dilute future earnings per share, if any, and could depress the market value of our common stock. Dilution and potential dilution, the availability of a large amount of shares for sale, and the possibility of additional issuances and sales of our common stock may negatively affect both the trading price of our common stock and the liquidity of our common stock. These sales also might make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we would deem appropriate.

Anti-takeover provisions in our articles of incorporation may have a possible negative effect on our stock price.

Certain provisions of our articles of incorporation and bylaws may make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, control of us. We have in place several anti-takeover measures that could discourage or prevent a takeover, even if an acquisition would be beneficial to our shareholders. Our stock option plans contain provisions that allow for the acceleration of vesting or payments of awards granted under the plans in the event of specified events that result in a “change in control.” In addition, we have adopted a shareholder rights plan that would cause substantial dilution to any person or group attempting to acquire our company on terms not approved in advance by our board of directors.

ITEM 2. PROPERTIES

We lease approximately 37,000 square feet of office, manufacturing and warehouse space in a suburb of Minneapolis, Minnesota, pursuant to a lease that expires in March 2008. We believe our facilities will be sufficient to meet our current and future requirements and that additional space at or near the current location will be available at a reasonable cost if additional space is required in the future.

ITEM 3. LEGAL PROCEEDINGS

Our business exposes us to product liability claims that are inherent in the testing, production, marketing and sale of medical devices. Management believes any losses that may occur from these matters are adequately covered by insurance, and the ultimate outcome of these matters will not have a material effect on the financial position, liquidity or results of operations of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

PART II

ITEM 5.

MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the National Market System of the Nasdaq Stock Market under the symbol ULGX. The following table sets forth quarterly high and low last-sale prices of our common stock for the past two years.


		Quarter
Fiscal Year		First		Second		Third		Fourth
2005	High	$	15.58	$	7.37	$	6.52	$	5.44
	Low		6.32		4.84		4.54		3.81

2004	High	$	5.99	$	6.80	$	9.04	$	15.55
	Low		2.96		4.15		6.37		7.99

The foregoing prices reflect inter-dealer prices, without dealer markup, markdown or commissions, and may not represent actual transactions.

Dividends

To date, we have not declared or paid any cash dividends on our common stock, and we do not intend to do so in the foreseeable future.

Equity Compensation Plan Information

The table below presents our equity compensation plan information as of June 30, 2005:


	(a)	(b)		(c)
Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders	1,349,800	$	7.24	1,244,504
Equity compensation plan not approved by security holders	225,000	$	2.75	None

Total	1,574,800	$	6.60	1,244,504

The “equity compensation plans approved by security holders” listed above represent shares issuable under the Urologix, Inc. 1991 Stock Option Plan, an “employee benefit plan” as defined by Rule 405 of Regulation C of the Securities Act of 1933. Shareholders approved the most recent amendment to the 1991 Stock Option Plan, which, among other things, increased the number of shares of common stock available under the plan by 1,000,000 shares, in November 2004.

The 225,000 shares listed under “equity compensation plans not approved by security holders” represent a 225,000 share option granted to Fred B. Parks, the Company’s Chairman and Chief Executive Officer. The option was granted to Mr. Parks in connection with his original employment agreement dated May 21, 2003. The option is a non-qualified option exercisable at a price of $2.75. The 225,000 share grant began vesting over the period commencing on May 27, 2003 and ending on May 27, 2007, with 56,268 shares vesting on May 27, 2004, and 1/36th of the remaining 168,732 shares vesting on the 27th of each of the 36 months following May 27, 2004.

ITEM 6. SELECTED FINANCIAL DATA


	Years ended June 30,
	2005			2004			2003			2002			2001(1)
	(in thousands, except per share data)
Statements of Operations Data:
Sales	$	25,813		$	24,324		$	18,775		$	22,742		$	15,337
Cost of goods sold(2)		7,810			9,047			8,442	(3)		8,344			6,179

Gross profit		18,003			15,277			10,333			14,398			9,158

Costs and Expenses:
Selling, general and administrative		11,643			12,338			15,390			12,046			10,799
Research and development		3,073			2,390			3,675			4,073			3,533
Amortization of goodwill and other intangible assets(4)		164			164			164			164			707
Restructuring(5)		—			(200	)		1,275			—			—

Total costs and expenses		14,880			14,692			20,504			16,283			15,039

Operating earnings (loss)		3,123			585			(10,171	)		(1,885	)		(5,881	)
Interest income, net		138			57			123			234			746

Net earnings (loss) before income taxes		3,261			642			(10,048	)		(1,651	)		(5,135	)
Provision for income taxes		(424	)		(286	)		(286	)		(286	)		—

Net earnings (loss)	$	2,837		$	356		$	(10,334	)	$	(1,937	)	$	(5,135	)

Basic:
Earnings (loss) per common share	$	0.20		$	0.03		$	(0.74	)	$	(0.14	)	$	(0.40	)
Weighted average shares used in computing net earnings (loss) per share		14,279			14,015			13,915			13,810			12,760
Diluted:
Net earnings (loss) per common share	$	0.19		$	0.02		$	(0.74	)	$	(0.14	)	$	(0.40	)
Weighted average shares used in computing net earnings (loss) per share		14,759			14,649			13,915			13,810			12,760

	2005			2004			2003			2002			2001
Balance Sheet Data:
Cash, cash equivalents and available-for-sale investments	$	10,770		$	7,604		$	4,619		$	12,713		$	14,921
Working capital		13,174			8,556			5,023			15,534			16,690
Total assets		39,106			36,172			35,862			46,437			46,860
Total liabilities		5,961			6,312			7,329			7,776			7,351
Shareholders’ equity		33,145			29,860			28,533			38,661			39,509

(1)	Includes the acquisition of the Prostatron product line from EDAP on October 1, 2000.

(2)

Effective July 1, 2004, the company began including amortization expense relating to developed technologies within cost of goods sold. This expense was previously reported within amortization of other intangible assets. Consistent with this change, the Company re-classified this expense to cost of goods sold for the periods prior to this change. For the years ended June 30, 2004, June 30, 2003, and June 30, 2002 the reclassification adjustment was $500,000. For the year ended June 30, 2001 the reclassification adjustment was $375,000. The reclassification adjustment had no impact on net earnings for those periods.

(3)	Includes a $610,000 lower of cost or market write-down of control unit inventory and future control unit purchase commitments.

(4)	The Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” effective July 1, 2001, which eliminated the systematic amortization of goodwill and other indefinite lived intangible assets.

(5)	Represents a fiscal 2003 fourth quarter restructuring charge related to a workforce reduction and facilities consolidation and subsequent $200,000 recovery in fiscal 2004 due to a reduction in the severance related liabilities.

SELECTED QUARTERLY FINANCIAL DATA


	Year Ended June 30, 2005
	First Quarter			Second Quarter			Third Quarter		Fourth Quarter
	(in thousands, except per share data)
Sales	$	6,051		$	6,350		$	6,524	$	6,888
Gross profit		4,213			4,439			4,522		4,829
Net earnings		720			725			686		706
Basic net earnings per share	$	0.05		$	0.05		$	0.05	$	0.05
Diluted net earnings per share	$	0.05		$	0.05		$	0.05	$	0.05

	Year Ended June 30, 2004
	First Quarter			Second Quarter			Third Quarter		Fourth Quarter
	(in thousands, except per share data)
Sales	$	5,061		$	5,619		$	6,668	$	6,976
Gross profit(1)		2,954	(2)		3,430			4,177		4,716
Net earnings (loss)		(562	)		(279	)(3)		430		767	(4)
Basic net earnings (loss) per share	$	(0.04	)	$	(0.02	)	$	0.03	$	0.05
Diluted net earnings ( loss) per share	$	(0.04	)	$	(0.02	)	$	0.03	$	0.05

(1)

Effective July 1, 2004, the Company began including amortization expense relating to developed technologies within cost of goods sold. This expense was previously reported within amortization of other intangible assets. Consistent with this change, the Company has re-classified this expense to cost of goods sold for the periods prior to this change. For each of the quarters of fiscal year 2004 the re-classification was $125,000 and had no impact on the net earnings for those periods.

(2)	Includes a $160,000 charge for commitments to purchase control unit inventory at prices that exceeded the expected future sales value.

(3)	Includes a $175,000 restructuring benefit related to a reduction in previously accrued severance related liabilities.

(4)	Includes a $25,000 restructuring benefit related to a reduction in previously accrued severance related liabilities.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements and related notes contained elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of selected factors, including those set forth under “Risks Related to Our Business” in Item 1. All forward-looking statements included herein are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statements.

OVERVIEW

Urologix, Inc., based in Minneapolis, develops, manufactures and markets minimally invasive medical products for the treatment of urological disorders.

We have developed and offer non-surgical, catheter-based therapies that use a proprietary cooled microwave technology for the treatment of BPH, a disease that dramatically affects more than 23 million men worldwide by causing adverse changes in urinary voiding patterns. We market our products under the Targis and Prostatron names. Both systems utilize Cooled ThermoTherapy, a targeted microwave energy combined with a unique cooling mechanism that protects healthy tissue and enhances patient comfort while providing safe, effective, lasting relief from the symptoms of BPH. Cooled ThermoTherapy can be performed without anesthesia or intravenous sedation and, as a result, can be performed in a physician’s office or an outpatient clinic. We believe Cooled ThermoTherapy provides an efficacious, safe and cost-effective solution for BPH that is clinically superior to medication and is without the complications and side effects inherent in surgical procedures.

We believe that third-party reimbursement is essential to the adoption of Cooled ThermoTherapy, and that clinical efficacy, overall cost effectiveness and physician advocacy is key to obtaining this reimbursement. We estimate that 60% to 80% of patients who receive treatment in the United States will be eligible for Medicare coverage. The remaining patients will either be covered by private insurers, including traditional indemnity health insurers and managed care organizations, or they will be private-paying patients. As a result, Medicare reimbursement is particularly critical for widespread market adoption of Cooled ThermoTherapy in the United States.

a fixed fee of approximately $1,300, the highest amount allowable under this system, while the urologist performing the procedure was reimbursed the same amount as if the treatment occurred in a hospital, approximately $500. The relatively low facility reimbursement relative to the cost of the procedure potentially limited the number of Cooled ThermoTherapy treatments done in an ASC. Effective July 2005, the CPT code covering Cooled ThermoTherapy was deleted from the ASC list of Medicare approved procedures. As a result, effective with that change, urologists who perform Cooled ThermoTherapy procedures in an ASC are reimbursed at the office-based reimbursement rates, approximately $3,900 (inclusive of the physician’s fee) in calendar year 2005, subject to geographic adjustment.

We expect to continue to invest in sales and marketing programs and research and development projects as we focus on growing our revenues, continue clinical trials in support of regulatory and reimbursement approvals, and continue improving our therapy. Our future profitability will be dependent upon, among other factors, our success in achieving increased treatment volume and market adoption of the Cooled ThermoTherapy procedures in the physician’s office, our success in obtaining and maintaining necessary regulatory clearances, our ability to manufacture at the volumes and quantities the market requires, the extent to which Medicare and other health care payers continue to reimburse costs of Cooled ThermoTherapy procedures performed in physicians’ offices, hospitals, and ambulatory surgery centers and the amount of reimbursement provided.

Critical Accounting Policies:

In accordance with Securities and Exchange Commission guidance, we set forth below those material accounting policies that we believe are the most critical to an investor’s understanding of our financial results and condition, and require complex management judgment.

Revenue Recognition

We recognize revenue from the sale of Cooled ThermoTherapy system control units upon delivery to the customer. In addition to our sales of Cooled ThermoTherapy system control units, we place our Cooled ThermoTherapy system control units with customers under a variety of programs for both evaluation and long-term use. We retain title to these control units and do not recognize any revenue on these control units until title has transferred. These programs are designed to expand access to our technology, and thus expand the market for our single-use treatment catheters. Revenue from the sale of single-use treatment catheters is recognized at the time of shipment. Revenue for warranty service contracts is deferred and recognized over the contract period. We record a provision for estimated sales returns on product sales in the same period as the related revenue is recorded. The provision for estimated sales returns is based on historical sales returns, analysis of credit memo data and other known factors.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is a significant estimate and is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customer’s ability to pay. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Product Warranty

We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the product failure rates, material usage and service delivery costs, the historical length of time between the sale and resulting warranty claim and other factors. Should actual product failure rates, material usage or repair costs differ from our estimates, revisions to the estimated warranty liability would be required.

Inventories and Related Allowance for Excess and Obsolete Inventory

We value our inventories, consisting primarily of control units, single-use treatment catheters, and raw materials to produce the control units and treatment catheters, at the lower of cost or market value on the first-in, first-out (“FIFO”) basis. The inventory cost includes both merchandise and freight. A periodic review of the inventory on hand is performed to determine if the inventory is properly stated at the lower of cost or market. In performing this analysis we consider, at a minimum, the following factors: average selling prices, reimbursement changes, and changes in demand for our products due to competitive conditions or market acceptance. Each type of inventory is analyzed to determine net realizable values. A provision is recorded to reduce the cost of inventories to the estimated net realizable values, if required.

We also analyze the level of inventory on hand on a periodic basis, in relation to estimated customer requirements to determine whether write-downs for excess, obsolete, or slow-moving inventory are required. Any significant or unanticipated change in the factors noted above could have a significant impact on the value of our inventories and on our reported operating results.

Valuation of Intangible Assets and Goodwill

At June 30, 2005, the net carrying value of goodwill was $10.2 million. Goodwill is tested for impairment annually or more frequently if changes in circumstance or the occurrence of events suggests an impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. Our estimates associated with the impairment test are considered critical, due to the amount of goodwill recorded on our balance sheet and the judgment required in determining fair value amounts, including projected future cash flows.

As of June 30, 2005 other intangible assets consist of developed technologies, customer base and trademarks of $5.1 million, $1.5 million and $1.2 million, respectively. Developed technologies and customer base are amortized using the straight-line method over their estimated useful lives of 15 and 14 years, respectively. The trademark asset is considered to be an intangible asset with an indefinite useful life, and it will not be amortized until its useful life is determined to be no longer indefinite. We review intangible assets for impairment as changes in circumstance or the occurrence of events suggests the remaining value is not recoverable.

Income Taxes

We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax bases of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance. If we determine it is more likely than not that we will realize all or part of our deferred tax assets, we will adjust our earnings for the deferred tax in the period we make the determination. We continue to assess the need for a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. We consider factors such as having a cumulative pretax loss of $6.1 million in the past three fiscal years. The valuation allowance at June 30, 2005 was $32.2 million. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets.

Results of Operations

Fiscal Years Ended June 30, 2005 and 2004

Net Sales

Net sales increased to $25.8 million in fiscal 2005 from $24.3 million in fiscal 2004. The sales growth resulted primarily from increased revenues from the sale of our single-use treatment catheters in the United States partially offset by a decrease in the number of Cooled ThermoTherapy system control units sold during the period as well as lower revenues internationally. Sales of single-use treatment catheters accounted for 95% of revenue in fiscal 2005, compared to 93% in fiscal 2004. Average per unit selling prices of our single-use treatment catheters increased over fiscal 2004 prices primarily due to our price standardization initiative implemented in the second half of fiscal 2004 as well as a stronger mix of sales to our direct office accounts. We expect demand for our treatment catheters to increase in fiscal 2006 over fiscal 2005 as we continue to focus on increasing the utilization rates of our existing customers while continuing to develop new direct accounts and re-invigorate the mobile channel.

At June 30, 2005, we had a domestic installed base of 498 Cooled ThermoTherapy systems, including the units that are being used by customers pursuant to our evaluation and long-term use programs, compared to an installed base of 427 units at June 30, 2004.

Cost of Goods Sold and Gross Profit

Cost of goods sold includes raw materials, labor, overhead, and royalties incurred in connection with the production of our Cooled ThermoTherapy system control units and single-use treatment catheters, and amortization expense related to developed technologies. Effective July 1, 2004, we began including amortization expense related to developed technologies within cost of goods sold. This expense was previously reported within amortization of other intangible assets. Consistent with the change, we re-classified $500,000 of amortization expense to cost of goods sold for the fiscal year ended June 30, 2004. Cost of goods sold for fiscal 2005 decreased to $7.8 million from $9.0 million in fiscal 2004, due primarily to a decrease in the number of Cooled ThermoTherapy system control units sold during the year, combined with lower per unit manufacturing costs of our single-use treatment catheters, as well as a $160,000 charge we incurred in fiscal 2004 related to a commitment to purchase additional control unit inventory at prices which exceeded the expected future sales value.

Gross profit as a percentage of sales increased to 70% in fiscal 2005 from 63% in the prior fiscal year. The increase in the gross profit rate resulted primarily from an increase in the average per unit selling prices of our single-use treatment catheters combined with a reduction in their average per unit manufacturing costs. Additionally, fiscal 2004 gross profit rates were negatively impacted by the $160,000 charge described above.

Selling, General & Administrative

Selling, general and administrative expenses in fiscal 2005 decreased to $11.6 million from $12.3 million in fiscal 2004. The decrease in expense is due primarily to a reduction in legal expenses related to the patent infringement suit we filed to protect our intellectual property that was settled in January 2004, as well as a reduction in corporate overhead and variable selling expenses, partially offset by an increase in expenses related to Sarbanes-Oxley Section 404 compliance. We expect selling, general and administrative expenses in fiscal 2006 to increase as we continue to invest in sales and marketing programs and resources designed to generate awareness and further acceptance of Cooled ThermoTherapy with both physicians and patients.

Research and Development

Research and development expenses, which include expenditures for product development, regulatory compliance and clinical studies, increased to $3.1 million in fiscal 2005 from $2.4 million in the prior fiscal year.

The increase in expenses resulted primarily from increased expenditures on product development activities related to our next generation Coolwave control unit partially offset by lower clinical trial expenses. We expect research and development expenses to increase modestly in fiscal 2006 as we invest in development programs and clinical research aimed at further improving our technology and treatment outcomes.

Amortization of Other Intangible Assets

Effective July 1, 2004, we began including amortization expense related to the developed technologies acquired from EDAP within cost of goods sold. Consistent with this change, we re-classified $500,000 from amortization of intangibles to costs of goods sold for the fiscal year ended June 30, 2004.

Amortization of other intangible assets was $164,000 for both fiscal 2005 and 2004. This amortization expense is related to the acquired customer base that resulted from the purchase of the Prostatron Cooled ThermoTherapy product line from EDAP in October 2000.

Restructuring

In May 2003, we announced plans for organizational restructuring that eliminated 28 positions within the Company and also resulted in our vacating a portion of our leased facility. During the fourth quarter of fiscal 2003, we recorded a $1.3 million restructuring charge to cover the expenses associated with these items. All of the targeted headcount reductions were completed by June 2003, and we sublet the vacated space beginning in the second quarter of fiscal 2004.

There were no restructuring charges in fiscal 2005. During fiscal 2004, we recorded a $200,000 restructuring benefit, which resulted from a reduction in our severance obligations related to the May 2003 workforce reduction. All severance obligations have been paid. The lease term on the vacated space runs through fiscal 2008.

Net Interest Income

Net interest income for fiscal 2005 increased to $138,000 from $57,000 in the prior fiscal year. The increase is due to higher cash and investment balances, higher interest rates, as well as a reduction in interest expense associated with the lease obligation assumed as part of the Prostatron acquisition in October 2000. The lease obligation was completed during the third fiscal quarter of 2004.

Provision for Income Taxes

Income tax expense increased to $424,000 for fiscal 2005 from $286,000 in the prior year. The majority of income tax expense represents the increase in the deferred tax liability resulting from the amortization of goodwill and trademarks for tax purposes. The deferred tax liability related to the indefinite lived intangible assets cannot be offset against deferred tax assets with finite lives. The increase in income tax expense in fiscal 2005 is due to federal alternative minimum taxes and state taxes. Income tax expense is expected to be approximately $450,000 in fiscal 2006.

Fiscal Years Ended June 30, 2004 and 2003

Net Sales

Net sales increased to $24.3 million in fiscal 2004 from $18.8 million in fiscal 2003. The sales growth was primarily attributable to increased sales of single-use treatment catheters at moderately higher average per unit selling prices, partially offset by a decrease in revenue from sales of Cooled ThermoTherapy system control units. Although the number of control units sold increased slightly in fiscal 2004 compared to fiscal 2003, a decrease in the average per unit sales price of these systems more than offset the increased unit volume. Sales of single-use treatment catheters accounted for 93% of revenue in fiscal 2004, compared to 88% in fiscal 2003. We believe that our sales and marketing efforts focused on improving office based utilization through physician education on the clinical benefits of Cooled ThermoTherapy combined with the increased Medicare reimbursement rate for Cooled

ThermoTherapy procedures performed in the urologist’s office, which went into effect January 1, 2004, resulted in increased interest and demand for our products in fiscal 2004.

At June 30, 2004, we had a domestic installed base of 427 Cooled ThermoTherapy systems, including the units that are being used by customers pursuant to our evaluation and long-term use programs, compared to an installed base of 381 units at June 30, 2003.

Cost of Goods Sold and Gross Profit

Cost of goods sold increased to $9.0 million in fiscal 2004 from $8.4 million in fiscal 2003, due primarily to higher sales volumes of both single-use treatment catheters and control units, partially offset by lower per unit manufacturing costs. Additionally, fiscal 2003 cost of goods sold included a charge of $610,000 for a lower-of-cost or market write-down of control unit inventory and fiscal 2004 cost of goods sold included a $160,000 charge for a commitment to purchase additional control unit inventory at prices which exceeded the expected future sales value.

Gross profit as a percentage of sales increased to 63% in fiscal 2004 from 55% in the prior fiscal year. The increase in the gross profit rate resulted primarily from the increased volume of higher margin single-use treatment catheters sold in fiscal year 2004, combined with a modest increase in the average per unit selling prices and a reduction in the average per unit manufacturing cost of single-use treatment catheters, partially offset by a decrease in the average per unit selling price of Cooled ThermoTherapy system control units. Additionally, fiscal 2003 gross profit rates were negatively impacted by the $610,000 charge described above.

Selling, General & Administrative

Selling, general and administrative expenses decreased to $12.3 million in fiscal 2004 from $15.4 million in fiscal 2003. The decrease in expense is attributable to the organizational restructuring and workforce reduction that occurred in the fourth fiscal quarter of 2003, and a reduction in legal expenses related to the patent infringement suit we filed to protect our intellectual property that was settled in January 2004.

Research and Development

Research and development expenses decreased to $2.4 million in fiscal 2004 from $3.7 million in the prior fiscal year. The decrease in expenses resulted primarily from the organizational restructuring and workforce reduction that occurred in the fourth fiscal quarter of 2003, and decreased expenditures on product development activities and clinical trial expenses.

Amortization of Other Intangible Assets

Amortization of other intangible assets was $164,000 for both fiscal 2004 and 2003. Effective July 1, 2004, we began including amortization expense related to the developed technologies acquired from EDAP within cost of goods sold. Consistent with this change, we re-classified $500,000 from amortization of intangibles to costs of goods sold for the fiscal years ended June 30, 2004 and 2003.

Restructuring

During fiscal 2004, we recorded a $200,000 restructuring benefit, which resulted from a reduction in our severance obligations related to the May 2003 workforce reduction. All severance obligations have been paid. The lease term on the vacated space runs through fiscal 2008.

Net Interest Income

Net interest income for fiscal 2004 decreased to $57,000 from $123,000 in the prior fiscal year. The decrease was due to lower interest income resulting from lower cash and investment balances, partially offset by lower interest expense.

Provision for Income Taxes

Income tax expense was $286,000 for fiscal 2004 and fiscal 2003. Income tax expense represents the increase in the deferred tax liability resulting from the amortization of goodwill and trademarks for tax purposes. The deferred tax liability related to the indefinite lived intangible assets cannot be offset against deferred tax assets with finite lives.

Liquidity and Capital Resources

We have financed our operations since inception through sales of equity securities and, to a lesser extent, sales of our Cooled ThermoTherapy system control units and single-use treatment catheters. As of June 30, 2005, we had total cash, cash equivalents and available-for-sale investments of $10.8 million compared $7.6 million as of June 30, 2004. The increase in cash, cash equivalents, and available-for-sale investments resulted primarily from improvements in operating results in fiscal 2005, as well as proceeds from the exercise of stock options of approximately $452,000.

Cash Provided by Operating Activities

During fiscal 2005, we generated $2.9 million of cash from operating activities. Our net earnings of $2.8 million combined with depreciation and amortization of $1.9 million were partially offset by an increase in accounts receivable of $1.6 million and a decrease in accrued expenses and deferred income of $1.1 million. The increase in accounts receivable was driven by a number of factors, including higher sales volume in June 2005 versus June 2004, and lower fourth quarter cash collections in fiscal 2005 due to turnover in collections staff and increased focus of accounting personnel on Sarbanes-Oxley 404 compliance. The significant decreases in accrued expenses and deferred income resulted primarily from a decrease in accrued compensation expense related to annual employee bonuses earned in fiscal 2005 but not paid as of June 30, 2005. Increases in accounts payable and decreases in prepaid and other assets of $584,000 and $498,000, respectively, were partially offset by an increase in inventory of $502,000.

Cash Provided by Investing Activities

We generated $2.2 million from investing activities, resulting from the maturity of $2.3 million of available-for-sale investments partially offset by the purchase of $91,000 of property and equipment.

Cash Provided by Financing Activities

During fiscal 2005 we generated $348,000 from financing activities as a result of $452,000 of proceeds from the exercise of stock options, partially offset by the $104,000 principal payment to EDAP for the retirement of the promissory note associated with the Prostratron acquisition. The final payment on the promissory note was made to EDAP on December 31, 2004.

We plan to continue offering customers a variety of programs for both evaluation and long-term use of our Cooled ThermoTherapy system control units in addition to purchase options. As of June 30, 2005, our property and equipment, net, included approximately $2.0 million of control units used in evaluation or long-term use programs. Depending on the growth of these programs, we may use additional capital to finance the units used by these customers.

Future contractual commitments, including interest, that will affect cash flows are as follows (in thousands):


	Total		2006	2007	2008
Building and equipment leases	$	956	341	351	264

We have no contractual commitments beyond fiscal year 2008.

Based upon our financial performance in fiscal 2005, we believe our $10.8 million in cash, cash equivalents, and available-for-sale investments at June 30, 2005, together with the funds generated from operations, will be sufficient to fund our working capital and capital resources needs for at least the next 12 months. There can be no assurance, however, that we will not require additional financing in the future or that any additional financing will be available to us on satisfactory terms, if at all.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements.

Recently Issued Accounting Standards

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and we adopted this standard on July 1, 2005 using the modified prospective method. Beginning in fiscal year 2006, our results of operations will reflect compensation expense for new stock options granted under our stock incentive plan, and for the unvested portion of previous stock options granted. While we cannot precisely determine the impact on net earnings as a result of the adoption of SFAS No. 123R, we estimate our equity-based compensation expense will be between $1.5 million and $1.6 million for fiscal year 2006. The decrease in the expected expense of $1.5 million to $1.6 million in fiscal 2006 compared to the pro-forma expense of $2.4 million in fiscal 2005 is due primarily to the reduction in unvested options as of the beginning of fiscal 2006 versus earlier years and to the final vesting of options granted in fiscal 2001 and fiscal 2002 with weighted average fair values of $4.76 and $8.99, respectively, compared to the continuing vesting and expense associated with options granted in fiscal 2003 and fiscal 2004 with lower weighted average fair values of $2.72 and $2.70, respectively. The ultimate amount of equity-based compensation expense will be dependent on the number of option shares granted during the year, as well as the timing, the vesting period, and the determined fair value of the awards, and other factors such as future forfeitures.

In November 2004, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which clarifies the types of costs that should be expensed rather than capitalized as inventory. This statement also clarifies the circumstances under which fixed overhead costs associated with operating facilities involved in inventory processing should be capitalized. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005 and we adopted this standard on July 1, 2005. No material impact on our financial statements resulted from the adoption of this standard.

In May 2005, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections”, which replaces Accounting Principles Board (APB) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. This Statement changes the requirements for the accounting for and reporting of a change in accounting principle, and

applies to all voluntary changes in accounting principles, as well as changes required by an accounting pronouncement in the unusual instance it does not include specific transition provisions. Specifically, this Statement requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the effects of the change, the new accounting principle must be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and a corresponding adjustment must be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of the change, the new principle must be applied as if it were adopted prospectively from the earliest date practicable. This Statement is effective for the Company for all accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. This Statement does not change the transition provisions of any existing pronouncements.

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our financial instruments include cash, cash equivalents, and available-for-sale investments. Our financial investment portfolio at June 30, 2005 is carried at market value. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of these instruments. Also, fair values of interest rate sensitive instruments may be affected by the credit worthiness of the issuer, prepayment options, relative values of alternative instruments, the liquidity of the instrument and other general market conditions.

Market risk was estimated as the potential decrease in fair value resulting from a hypothetical 1% change in interest rates for the issues contained in the available-for-sale investment portfolio and was not materially different from the year-end carrying value. Due to the nature of our short-term investments, we have concluded that we do not have a material market risk exposure.

Our policy is not to enter into derivative financial instruments. We do not have any significant foreign currency exposure since we do not generally transact business in foreign currencies. Therefore, we do not have significant overall currency exposure. In addition, we do not enter into any futures or forward commodity contracts since we do not have significant market risk exposure with respect to commodity prices.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements are included in the Form 10-K.


Reports of Independent Registered Public Accounting Firm		31
Balance Sheets as of June 30, 2005 and 2004		34
Statements of Operations for the years ended June 30, 2005, 2004 and 2003		35
Statements of Shareholders’ Equity for the years ended June 30, 2005, 2004 and 2003		36
Statements of Cash Flows for the years ended June 30, 2005, 2004 and 2003		37
Notes to Financial Statements		38

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Urologix, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report On Internal Control Over Financial Reporting (Item 9A.(b)), that Urologix, Inc. did not maintain effective internal control over financial reporting as of June 30, 2005 because of the effect of the material weakness identified in management’s assessment, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Urologix, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management identified, and included in its assessment, a material weakness in internal control over financial reporting related to the Company’s accounting for income taxes as of June 30, 2005. Specifically, management did not have adequate technical expertise with respect to income tax accounting to effectively oversee and review the Company’s accounting over this area. This lack of adequate technical expertise resulted in a material error in the Company’s accounting for income taxes, which was identified during the course of the Company’s 2005 audit. This error related to the Company not providing a sufficient valuation allowance against deferred tax assets that are not more likely than not to be realized. The Company had incorrectly netted deferred tax liabilities related to intangibles with indefinite lives against deferred tax assets related to net operating loss carryforwards with finite lives in determining the amount of allowance necessary.

In our opinion, management’s assessment that Urologix, Inc. did not maintain effective internal control over financial reporting as of June 30, 2005, is fairly stated, in all material respects, based on criteria established in

Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Urologix, Inc. has not maintained effective internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets of Urologix, Inc. as of June 30, 2005 and 2004, and the related statements of operations, shareholders’ equity and cash flows for each of the years in the three-year period ended June 30, 2005. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 financial statements, and this report does not affect our report dated September 28, 2005, which expressed an unqualified opinion on those financial statements.

KPMG LLP

Minneapolis, Minnesota

September 28, 2005

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Urologix, Inc.:

We have audited the accompanying balance sheets of Urologix, Inc. as of June 30, 2005 and 2004, and the related statements of operations, shareholders’ equity and cash flows for each of the years in the three-year period ended June 30, 2005. These financial statements are the responsibility of the Company’s management.

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Urologix, Inc. as of June 30, 2005 and 2004, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Urologix, Inc.’s internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated September 28, 2005 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.

KPMG LLP

Minneapolis, Minnesota

September 28, 2005

Urologix, Inc.

Balance Sheets

(In thousands, except per share data)


	June 30,
	2005			2004
ASSETS
Current Assets:
Cash and cash equivalents	$	10,599		$	5,142
Available-for-sale investments		171			2,462
Accounts receivable, net of sales and bad debt allowances of $167 and $299		4,243			2,689
Inventories, net		1,742			2,144
Prepaids and other current assets		252			371

Total current assets		17,007			12,808

Property and equipment:
Property and equipment		9,977			9,256
Less accumulated depreciation		(7,526	)		(6,583	)

Property and equipment, net		2,451			2,673
Other assets		1,670			2,049
Goodwill, net		10,193			10,193
Other intangible assets, net		7,785			8,449

Total assets	$	39,106		$	36,172

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,533		$	949
Accrued compensation		811			1,425
Other accrued expenses		1,175			1,407
Note payable		—			165
Deferred income		314			306

Total current liabilities		3,833			4,252

Deferred tax liability		1,152			858
Deferred income		896			1,077
Other accrued expenses		80			125

Total liabilities		5,961			6,312

COMMITMENTS AND CONTINGENCIES (Note 9)
Shareholders’ equity:
Common stock, $.01 par value, 25,000 shares authorized; 14,308 and 14,194 shares issued and outstanding		143			142
Additional paid-in capital		110,110			109,653
Accumulated deficit		(77,107	)		(79,944	)
Accumulated other comprehensive (loss) income		(1	)		9

Total shareholders’ equity		33,145			29,860

Total liabilities and shareholders’ equity	$	39,106		$	36,172

The accompanying notes to financial statements are an integral part of these statements.

Urologix, Inc.

Statements of Operations

(In thousands, except per share data)


	For the Years Ended June 30
	2005			2004			2003
SALES	$	25,813		$	24,324		$	18,775

COST OF GOODS SOLD		7,810			9,047			8,442

Gross profit		18,003			15,277			10,333

COSTS AND EXPENSES
Selling, general and administrative		11,643			12,338			15,390
Research and development		3,073			2,390			3,675
Amortization of other intangible assets		164			164			164
Restructuring		—			(200	)		1,275

Total costs and expenses		14,880			14,692			20,504

OPERATING EARNINGS (LOSS)		3,123			585			(10,171	)

INTEREST INCOME		147			110			289
INTEREST EXPENSE		(9	)		(53	)		(166	)

EARNINGS (LOSS) BEFORE INCOME TAXES		3,261			642			(10,048	)
PROVISION FOR INCOME TAXES		(424	)		(286	)		(286	)

NET EARNINGS (LOSS)	$	2,837		$	356		$	(10,334	)


NET EARNINGS (LOSS) PER COMMON SHARE—BASIC	$	0.20		$	0.03		$	(0.74	)


NET EARNINGS (LOSS) PER COMMON SHARE—DILUTED	$	0.19		$	0.02		$	(0.74	)

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING—BASIC		14,279			14,015			13,915

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING—DILUTED		14,759			14,649			13,915

The accompanying notes to financial statements are an integral part of these statements.

Urologix, Inc.

Statements of Shareholders’ Equity

(In thousands)


	Common Stock			Additional Paid-In Capital		Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	Shares	Amount		Additional Paid-In Capital		Accumulated Deficit						Total Shareholders’ Equity
Balance, June 30, 2002	13,902	$	139	$	108,449	$	(69,966	)	$	39		$	38,661
Change in unrealized gains (losses) on investments	—		—		—		—			48			48
Net loss	—		—		—		(10,334	)		—			(10,334	)

Comprehensive loss	—		—		—		—			—			(10,286	)
Stock options exercised	57		1		149		—			—			150
Common shares issued under employee stock purchase plan	3		—		8		—			—			8

Balance, June 30, 2003	13,962		140		108,606		(80,300	)		87			28,533
Change in unrealized gains (losses) on investments	—		—		—		—			(78	)		(78	)
Net earnings	—		—		—		356			—			356

Comprehensive earnings	—		—		—		—			—			278
Value of options issued to consultants	—		—		5		—			—			5
Stock options exercised	220		2		1,012		—			—			1,014
Common shares issued under employee stock purchase plan	12		—		30		—			—			30

Balance, June 30, 2004	14,194		142		109,653		(79,944	)		9			29,860
Change in unrealized gains (losses) on investments	—		—		—		—			(10	)		(10	)
Net earnings	—		—		—		2,837			—			2,837

Comprehensive earnings	—		—		—		—			—			2,827
Stock options exercised	114		1		451		—			—			452
Income tax benefit related to employee stock options	—		—		6		—			—			6

Balance, June 30, 2005	14,308	$	143	$	110,110	$	(77,107	)	$	(1	)	$	33,145

The accompanying notes to financial statements are an integral part of these statements.

Urologix, Inc.

Statements of Cash Flows

(In thousands)


	For the Years Ended June 30
	2005			2004			2003
OPERATING ACTIVITIES
Net earnings (loss)	$	2,837		$	356		$	(10,334	)
Adjustments to reconcile net earnings (loss) to net cash provided by (used for) operating activities:
Depreciation and amortization		1,881			2,001			2,073
Value of options issued to consultants		—			5			—
Provision for bad debts		63			1			58
Deferred income taxes		294			286			286
Change in operating assets and liabilities:
Accounts receivable		(1,617	)		(561	)		2,367
Inventories		(502	)		665			(2,192	)
Prepaids and other assets		498			681			455
Accounts payable		584			(322	)		(846	)
Accrued expenses and deferred income		(1,119	)		(220	)		626

Net cash provided by (used for) operating activities		2,919			2,892			(7,507	)

INVESTING ACTIVITIES
Purchase of property and equipment		(91	)		(112	)		(280	)
Purchase of investments		—			—			(12,364	)
Proceeds from sales or maturities of investments		2,281			1,352			19,629

Net cash provided by investing activities		2,190			1,240			6,985

FINANCING ACTIVITIES
Proceeds from issuance of common stock		452			1,044			158
Payments made on capital lease obligations		—			(351	)		(513	)
Payments made on note payable		(104	)		(410	)		—

Net cash provided by (used for) financing activities		348			283			(355	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		5,457			4,415			(877	)

CASH AND CASH EQUIVALENTS
Beginning of year		5,142			727			1,604

End of year	$	10,599		$	5,142		$	727

Supplemental cash-flow information

Cash paid during the period for interest	$	16		$	157		$	130
Income taxes paid during the period	$	130		$	9		$	9
Net value of inventory transferred to (from) property and equipment	$	904		$	84		$	1,723

The accompanying notes to financial statements are an integral part of these statements.

UROLOGIX, INC.

Notes to Financial Statements

1. Nature of Business

Description of Operating Activities

Urologix, Inc. (Urologix or “the Company”) designs, develops, manufactures and markets medical devices for the treatment of benign prostatic hyperplasia (BPH), a disease that affects more than 23 million men worldwide by causing adverse changes in urinary voiding patterns. We have developed a catheter-based therapy that uses a proprietary cooled microwave technology for the treatment of BPH. We market our products under the Targis and Prostatron names. Both systems utilize Cooled ThermoTherapy, a targeted microwave energy combined with a unique cooling mechanism that protects healthy tissue and enhances patient comfort while providing safe, effective, lasting relief from the symptoms of BPH. Cooled ThermoTherapy can be performed without anesthesia or intravenous sedation and can be performed in a physician’s office or an outpatient clinic. Although we began actively selling our products in 1997, we operated profitably for the first time in fiscal 2004.

2. Significant Accounting Policies

Cash and Cash Equivalents

We classify highly liquid investments with original maturities of 90 days or less as cash equivalents. Cash equivalents are stated at cost, which approximates market value.

Available-for-Sale Investments

We invest in money market funds and U.S. government and investment-grade corporate debt investments with original maturities ranging from 91 days to two years. These investments are considered to be available for sale and are stated at market value, with the resulting unrealized gains or losses reported as a component of comprehensive earnings (loss) in the statements of shareholders’ equity. The gross realized gains and losses on sales of available-for-sale investments were not material for the years ended June 30, 2005, 2004 and 2003. Available-for-sale investments consist of corporate and governmental bonds and are quoted at their estimated fair value based on market quotes at June 30, 2005, 2004 and 2003 (in thousands) as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Market Value
2005	$	172	$	—	$	(1	)	$	171
2004	$	2,453	$	9	$	—		$	2,462
2003	$	3,805	$	87	$	—		$	3,892

Revenue Recognition

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

Trade Accounts Receivable

Trade accounts receivable are recorded at fair value upon the sale of goods or services to customers. They are stated net of allowances for doubtful accounts and estimated sales returns.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We consider factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customer’s ability to pay when determining the adequacy of the allowance. Accounts receivable are charged off after management determines they are uncollectible.

Bad debt provisions and accounts receivable write-offs for the years ended June 30, 2005, 2004 and 2003 were as follows (in thousands):


Years Ended	Beginning Balance		Provisions		Write-offs			Ending Balance
June 30, 2005	$	262	$	63	$	(168	)	$	157
June 30, 2004	$	294	$	1	$	(33	)	$	262
June 30, 2003	$	392	$	58	$	(156	)	$	294

Inventories

Inventories are stated at the lower of first-in, first-out cost or market, and consist of (in thousands):


	June 30, 2005		June 30, 2004
Raw materials	$	1,153	$	1,304
Work-in-process		320		163
Finished goods		269		677

Total inventories	$	1,742	$	2,144

Goodwill and Other Intangible Assets

At June 30, 2005, the net carrying value of goodwill was $10.2 million. Goodwill is tested for impairment annually or more frequently if changes in circumstance or the occurrence of events suggest an impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. We completed our fiscal 2005 assessment as of May 31, 2005 and have concluded that no impairment existed.

As of June 30, 2005 other intangible assets consist of developed technologies, customer base and trademarks of $5.1 million, $1.5 million and $1.2 million, respectively. Developed technologies and customer base are amortized using the straight-line method over their estimated useful lives of 15 and 14 years, respectively. The trademark asset is considered to be an intangible with an indefinite useful life, and it will not be amortized until its useful life is determined to be no longer indefinite. We review intangible assets for impairment as changes in circumstance or the occurrence of events suggests the remaining value is not recoverable.

Property and Equipment

Property and equipment are stated at cost. Company owned Cooled ThermoTherapy system control units located at customer sites for evaluation and long-term use programs are classified as property and equipment,

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

valued at net realizable value and depreciated over a useful life of four years. Repairs and maintenance are charged to expense as incurred. Depreciation for machinery, equipment and furniture is provided using the straight-line method based upon estimated useful lives of three to seven years. Leasehold improvements are amortized over the shorter of the useful life of the assets or term of the lease. Improvements that extend the useful lives of property and equipment are capitalized at cost and depreciated over their remaining useful lives.

Property and equipment, net, consisted of the following (in thousands):


	June 30, 2005		June 30, 2004
Leasehold improvements, equipment and furniture	$	388	$	539
Computer equipment		60		70
Control units		2,003		2,064

Total property and equipment, net	$	2,451	$	2,673

Other Assets

Other assets consist primarily of prepaid royalties resulting from patent licensing agreements. The agreements require us to pay a royalty on sales of Cooled ThermoTherapy products. Royalties are charged to cost of goods sold as sales are recognized.

Warranty Costs

Certain of our products are covered by warranties against defects in material and workmanship for periods of up to twenty-four months. We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the historical ratio of product failure rates, material usage and service delivery costs to sales, the historical length of time between the sale and resulting warranty claim and other factors.

Warranty provisions and claims for the years ended June 30, 2005, 2004 and 2003 were as follows (in thousands):


Years Ended	Beginning Balance		Warranty Provisions		Warranty Claims			Ending Balance
June 30, 2005	$	215	$	313	$	(387	)	$	141
June 30, 2004	$	159	$	252	$	(196	)	$	215
June 30, 2003	$	203	$	224	$	(268	)	$	159

Income Taxes

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

Net Earnings (Loss) Per Common Share

Basic net earnings (loss) per common share was computed by dividing the net earnings (loss) by the weighted average number of shares of common stock outstanding during the periods presented. Diluted net earnings (loss) per common share was computed by dividing the net earnings (loss) by the weighted average number of shares of common stock outstanding plus all potentially dilutive common shares that result from stock options. The number of shares used in earnings per share computations is as follows (in thousands):


	For the years ended June 30,
	2005	2004	2003
Weighted average common shares outstanding—basic	14,279	14,015	13,915
Dilutive effect of stock options	480	634	—

Weighted average common shares outstanding—diluted	14,759	14,649	13,915

The dilutive effect of stock options in the above table excludes 445,000 and 261,000 of options for which the exercise price was higher than the average market price for the years ended June 30, 2005 and June 30, 2004, respectively.

As a result of our net loss for the year ended June 30, 2003, potentially dilutive common shares of 47,000 from stock options have been excluded from the calculation of diluted earnings per share for that period as the effect would be antidilutive.

Stock-Based Compensation

We account for stock-based employee compensation arrangements in accordance with the provisions and related interpretations of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and have elected to follow the “disclosure only” alternative prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123).

Had compensation cost for stock-based compensation been determined consistent with SFAS No. 123, the net earnings (loss) and net earnings (loss) per share would have been adjusted to the following pro-forma amounts (in thousands, except for per share data):


	2005			2004			2003
Net earnings (loss), as reported	$	2,837		$	356		$	(10,334	)
Add: Stock-based employee compensation expense recognized in statement of operations		—			—			—
Less: Stock-based employee compensation expense determined under fair value based method, net of tax		(2,387	)		(2,590	)		(2,508	)

Pro forma net earnings (loss)	$	450		$	(2,234	)	$	(12,842	)

Net earnings (loss) per share:
Basic—as reported	$	0.20		$	0.03		$	(0.74	)
Basic—pro forma	$	0.03		$	(0.16	)	$	(0.92	)

Diluted—as reported	$	0.19		$	0.02		$	(0.74	)
Diluted—pro forma	$	0.03		$	(0.16	)	$	(0.92	)

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

The weighted average fair value of our options at their grant date was approximately $6.56 in 2005, $2.70 in 2004, and $2.72 in 2003. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, with the following assumptions:


	2005		2004		2003
Volatility	88.4	%	87.4	%	98.4	%
Risk-free interest rates	2.9	%	3.3	%	1.7	%
Expected option life	4 years		4 years		4 years
Stock dividend yield	—		—		—

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123 and supersedes APB 25, and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and we adopted this standard on July 1, 2005 using the modified prospective method. Beginning in fiscal year 2006, our results of operations will reflect compensation expense for new stock options granted under our stock incentive plan, and for the unvested portion of previous stock options granted. The ultimate amount of equity-based compensation expense will be dependent on the number of option shares granted during the year, as well as the timing, vesting period, and the determined fair value of the awards, and other factors such as future forfeitures.

Research and Development Costs

Research and development costs are charged to expense as incurred.

Financial Instruments

The carrying amounts of our financial instruments approximate fair value, as the majority of these instruments are short-term in nature.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recently Issued Accounting Standards

In November 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which clarifies the types of costs that should be expensed rather than capitalized as inventory. This statement also clarifies the circumstances under which fixed overhead costs associated with operating facilities involved in inventory processing should be capitalized. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005 and we adopted this standard on July 1, 2005. No material impact on our financial statements resulted from the adoption of this standard.

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

In May 2005, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections”, which replaces APB Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. This Statement changes the requirements for the accounting for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principles, as well as changes required by an accounting pronouncement in the unusual instance it does not include specific transition provisions. Specifically, this Statement requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the effects of the change, the new accounting principle must be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and a corresponding adjustment must be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of the change, the new principle must be applied as if it were adopted prospectively from the earliest date practicable. This Statement is effective for the Company for all accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. This Statement does not change the transition provisions of any existing pronouncements.

3. Other Intangible Assets, Net

Balances of other intangible assets, net, were as follows (in thousands):


	As of June 30, 2005						As of June 30, 2004
	Carrying Amount		Accumulated Amortization		Net		Carrying Amount		Accumulated Amortization		Net
Amortizing intangibles:
Developed technologies	$	7,500	$	2,375	$	5,125	$	7,500	$	1,875	$	5,625
Customer base		2,300		780		1,520		2,300		616		1,684

Subtotal	$	9,800	$	3,155		6,645	$	9,800	$	2,491		7,309

Non-amortizing intangibles:
Trademarks						1,140						1,140

Total other intangible assets, net					$	7,785					$	8,449

Effective July 1, 2004, we began including amortization expense related to developed technologies within cost of goods sold. Consistent with this change, we re-classified $500,000 from amortization of intangibles to costs of goods sold for the fiscal years ended June 30, 2004 and 2003.

Future annual amortization expense for other intangible assets is expected to be approximately $664,000 for each of the next five fiscal years.

4. Other Accrued Expenses

Other accrued expenses were comprised of the following as of June 30, (in thousands):


	2005		2004
Accrued vacation	$	251	$	220
Other		1,004		1,312

Total other accrued expenses	$	1,255	$	1,532

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

5. Income Taxes

The components of income tax expense consist of the following (in thousands):


	For the years ended June 30,
	2005						2004						2003
	Current		Deferred		Total		Current		Deferred		Total		Current		Deferred		Total
Federal	$	46	$	206	$	252	$	—	$	262	$	262	$	—	$	262	$	262
State		84		88		172		—		24		24		—		24		24

Total	$	130	$	294	$	424	$	—	$	286	$	286	$	—	$	286	$	286

A reconciliation of our statutory tax rate to the effective rate is as follows:


	For the years ended June 30,
	2005		2004		2003
Federal statutory rate	34.0	%	34.0	%	(34.0	%)
State taxes, net of federal tax benefit	3.5		2.4		0.2
Nondeductible expenses	1.9		5.7		0.5
General business credits	1.2		(7.8	)	(1.0	)
Valuation allowance	(27.6	)	10.2		37.1

	13.0	%	44.5	%	2.8	%

The components of our net deferred tax assets and liabilities are as follows (in thousands):


	June 30,
	2005			2004
Deferred Tax Assets:
Net operating loss carry forward	$	31,528		$	31,874
Charitable contribution carry forward		98			113
Federal and state general business credits		568			618
AMT credit		42			—
Accrued expenses		523			722

Gross deferred tax assets		32,759			33,327

Deferred Tax Liabilities:
Amortization of customer base and developed technologies		(411	)		(525	)
Amortization of goodwill and trademarks		(1,194	)		(858	)
Property, plant and equipment		(117	)		(288	)

Gross deferred tax liabilities		(1,722	)		(1,671	)

Net deferred tax asset before valuation allowance		31,037			31,656
Less: valuation allowance		(32,189	)		(32,514	)


Total non-current deferred tax liability	$	(1,152	)	$	(858	)

A valuation allowance equal to the full amount of the related gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period has been established due to the uncertainty of their realization. As of June 30, 2005 and June 30, 2004, the valuation allowance was $32.2 million and $32.5 million, respectively. Of these amounts, $529,000 as of June 30, 2005 and $469,000 as of June 30, 2004 was

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

attributable to increases in the net operating loss carry forwards resulting from the exercise of stock options. These amounts will be recorded as an increase to additional paid-in capital if it is determined in the future that this portion of the valuation allowance is no longer required.

In fiscal year 2005, the tax benefit related to stock option exercises, after the application of the valuation allowance, resulted in $6,000 recorded as an increase to additional paid-in capital.

At June 30, 2005, the expiration dates and amounts of our carryforward losses and credits for federal income tax purposes are as follows:


Years expiring (in thousands)	Net Operating Losses		Research Credits
2008 - 2010	$	3,476	$	132
2011 - 2015		35,764		156
2016 - 2020		15,555		—
2021 - 2024		25,125		115

	$	79,920	$	403

We also have a credit for alternative minimum tax of $42,000 which has no expiration date.

Utilization of the net operating losses and credits may be subject to an annual limitation due to the ownership change rules provided by the Internal Revenue Code of 1986 and similar state provisions.

6. Deferred Income

Deferred income as of June 30 consisted of the following (in thousands):


	2005		2004
Deferred royalty income	$	1,077	$	1,261
Deferred warranty service income		133		122

Total deferred income	$	1,210	$	1,383

Deferred royalty income consists of a prepaid non-exclusive license previously granted to a third party for the use of technologies. Deferred royalty income is recognized as the greater of amounts due based on actual sales or amortization of the license fee over the remaining license period of six years.

Deferred revenue for prepayments made to us on warranty service contracts is recognized over the contract period ranging from 12 to 24 months.

7. Restructuring

In May 2003, we announced plans for organizational restructuring that eliminated 28 positions within the Company and also resulted in our vacating a portion of our leased facility. During the fourth quarter of fiscal 2003, we recorded a $1.3 million restructuring charge to cover the expenses associated with these items. All of the targeted headcount reductions were completed by June 2003, and we reached an agreement to sublet the vacated space beginning in the second quarter of fiscal 2004.

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

Restructuring activity was as follows (in thousands):


	Severance			Lease			Total
Balance, June 30, 2002	$	—		$	—		$	—
Expense accruals		1,000			275			1,275
Cash payments		(364	)		(11	)		(375	)

Balance, June 30, 2003		636			264			900
Expense accruals (reversals)		(210	)		10			(200	)
Cash payments		(426	)		(105	)		(531	)

Balance, June 30, 2004		—		$	169		$	169
Cash payments		—			(44	)		(44	)

Balance, June 30, 2005	$	—		$	125		$	125

8. Stock Options

We have a stock option plan that provides for the granting of incentive stock options to employees and nonqualified stock options to employees, directors and consultants. As of June 30, 2005, we had reserved 4,450,910 shares of common stock under this plan, and 1,244,504 shares were available for future grants. Options expire seven to ten years from the date of grant and are subject to varying vesting schedules. Under the current terms of our stock option plan, persons serving as non-employee directors at the date of the annual shareholder meeting automatically receive a grant to purchase 10,000 shares of common stock at a price per share equal to fair market value on the date of grant. Such options are immediately exercisable on the date of grant, and expire 10 years from the date of grant, subject to earlier termination one year after the person ceases to be a director of the Company.

In addition to the stock option plan described above, Fred B. Parks, the Company’s Chairman and Chief Executive Officer, received an option to purchase 225,000 shares in connection with his original employment agreement dated May 21, 2003. The option is a non-qualified option exercisable at a price of $2.75. The 225,000 share grant began vesting over the period commencing on May 27, 2003 and ends on May 27, 2007, with 56,268 shares vesting on May 27, 2004, and 1/36th of the remaining 168,732 shares vesting on the 27th of each of the 36 months following May 27, 2004.

The following tables summarize our option activity:


	For the years ended June 30,
	2005				2004				2003
	Number of Options		Weighted - Avg. Exercise Price Per Option		Number of Options		Weighted - Avg. Exercise Price Per Option		Number of Options		Weighted - Avg. Exercise Price Per Option
Outstanding, beginning of year	1,655,041		$	5.70	1,453,391		$	6.72	1,676,091		$	8.06
Options granted	363,500		$	10.46	776,000		$	4.33	923,335		$	4.06
Options canceled	(330,505	)	$	7.22	(354,183	)	$	7.58	(1,088,959	)	$	6.75
Options exercised	(113,236	)	$	4.00	(220,167	)	$	4.61	(57,076	)	$	2.62

Outstanding, end of year	1,574,800		$	6.60	1,655,041		$	5.70	1,453,391		$	6.72

UROLOGIX, INC.

Notes to Financial Statements—(Continued)


Options Outstanding						Options Exercisable
Range of Exercise Prices		Outstanding as of June 30, 2005	Weighted-avg. Remaining Contractual Life	Weighted-avg. Exercise Price		Exercisable as of June 30, 2005	Weighted-avg. Exercise Price
$	— - $ 2.43	3,834	7.6	$	2.14	1,541	$	2.14
$	2.44 - $ 4.86	939,841	7.5	$	3.82	512,033	$	3.83
$	4.87 - $ 7.29	210,702	7.6	$	6.13	166,316	$	6.23
$	7.30 - $ 9.72	39,688	5.7	$	8.95	35,937	$	9.04
$	9.73 - $12.15	17,500	6.5	$	11.85	13,854	$	12.03
$	12.16 - $14.58	285,900	7.4	$	12.80	99,930	$	13.79
$	14.59 - $17.01	57,000	5.9	$	15.59	57,000	$	15.59
$	17.02 - $19.44	10,335	5.7	$	18.10	9,605	$	18.14
$	19.45 - $21.87	10,000	5.6	$	20.28	10,000	$	20.28

		1,574,800	7.4	$	6.60	906,216	$	6.77

Employee Stock Purchase Plan

We established an Employee Stock Purchase Plan (the Plan) and reserved 100,000 common shares for issuance under the Plan. Under the terms of the Plan, employees may purchase common shares at prices to be determined by the Company’s board of directors, ranging from 85% to 100% of the shares’ fair market value. Eligible employees elect to participate through payroll deductions at the maximum level established by the board of directors, but not to exceed 10% of the participant’s base pay, as defined. As of June 30, 2005, all shares have been issued under the Plan.

9. Commitments and Contingencies

401(k) Plan

The Company provides a 401(k) savings plan to which eligible employees may make pretax payroll contributions up to IRS allowed limits. Company matching contributions are discretionary, and none have been made to date.

Leases

The Company leases its facility and certain equipment under noncancelable operating leases that expire at various dates through fiscal 2008. Rent expense related to operating leases was approximately $328,000, $311,000, and $309,000, for the years ended June 30, 2005, 2004 and 2003, respectively. Future minimum annual lease commitments under noncancelable operating leases with initial terms of one year or more are $341,000 in fiscal 2006, $351,000 in fiscal 2007, $264,000 in fiscal 2008, and none thereafter. The future minimum lease payments under noncancelable operating leases have not been reduced by sublease rentals under a noncancelable sublease. As of June 30, 2005, future minimum rentals to be received under a noncancelable sublease were approximately $383,000.

Note Payable

On December 30, 2003, a final payment of $705,000, including interest, was due to EDAP under a promissory note dated October 1, 2000 in the original principal amount of $575,000 issued to EDAP by us pursuant to an Asset Purchase Agreement dated the same date (the “Note”). Pursuant to the terms of the Note, on December 30, 2003 we paid EDAP $130,000 of accrued interest and $410,000 of principal and deferred payment

UROLOGIX, INC.

Notes to Financial Statements—(Continued)

of $165,000 for offset against future anticipated product claims against EDAP. On December 31, 2004 we settled the remaining note balance by paying EDAP $120,000, consisting of $104,000 of principal and $16,000 of accrued interest.

Contingencies

10. Geographic Segment Data

Our business activities include the design, development, marketing and sales of Cooled ThermoTherapy products and have been organized into one operating segment. Our domestic operations primarily consist of product development, sales and marketing. Our foreign operations consist of a network of distributors. There were no long-lived assets located outside of the United States. Revenue attributed to geographic areas based on the location of the customers for the years ended June 30 is as follows (in thousands):


	2005		2004		2003
United States	$	25,578	$	23,867	$	18,089
Europe		124		204		419
Asia		103		253		267
Other		8		—		—

Total	$	25,813	$	24,324	$	18,775

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

Item 9A.

CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer, Fred B. Parks, and Chief Financial Officer, Todd E. Paulson, have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this report and due to the identification of a material weakness in internal control over financial reporting, related to the Company’s accounting for income taxes, as described below in Management’s Report on Internal Control Over Financial Reporting, concluded that the Company’s disclosure controls and procedures were not effective, at the reasonable assurance level, in ensuring that information required to be disclosed by the Company in reports filed with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. Due to this material weakness in internal control over financial reporting, the Company performed other procedures in preparing its financial statements as of and for the year ended June 30, 2005, to ensure that such financial statements were presented fairly, in all material respects, in accordance with U.S. generally accepted accounting principles.

(b) Management’s Report On Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

A material weakness (within the meaning of PCAOB Auditing Standard No. 2) is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

In conducting the aforementioned evaluation, management identified a material weakness in internal control over financial reporting related to the Company’s accounting for income taxes as of June 30, 2005. Specifically, management did not have adequate technical expertise with respect to income tax accounting to effectively oversee and review the Company’s accounting over this area. This lack of adequate technical expertise resulted in a material error in the Company’s accounting for income taxes, which was identified during the course of the Company’s 2005 audit. This error related to the Company not providing a sufficient valuation allowance against deferred tax assets that are not more likely than not to be realized. The Company had incorrectly netted deferred tax liabilities related to intangibles with indefinite lives against deferred tax assets related to net operating loss carryforwards with finite lives in determining the amount of allowance necessary. As a result of the error, the Company has restated its previously issued annual financial statements for each of the years in the three-year period ended June 30, 2004 and interim financial statements for the quarters ended March 31, 2005, December 31, 2004, September 30, 2004 and all the quarters in the year ended June 30, 2004.

Accordingly, management concluded that the Company’s internal control over financial reporting was not effective as of June 30, 2005.

KPMG LLP, the independent registered public accounting firm that audited the financial statements in this Form 10-K, has issued an auditors’ report on management’s assessment of the effectiveness of the

Company’s internal control over financial reporting, which report is included in this Form 10-K under Item 8.

(c) Changes in Internal Controls over Financial Reporting

There was no change in the Company’s internal control over financial reporting during the last completed quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Regarding the material weakness described in Management’s Report On Internal Control Over Financial Reporting above, the Company is taking steps to ensure that the material weakness is remediated by implementing enhanced control procedures over accounting for income taxes which include education and training of Company management and staff to improve technical expertise with respect to income tax accounting. The Company is also evaluating whether to engage additional independent tax consulting resources to assist with the Company’s evaluation of complex issues concerning tax accounting and tax reserves and to assist management in developing its judgments with respect to such issues. The Company expects to have the remediation completed no later than December 31, 2005.

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that its disclosure controls and procedures and its internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

Item 9B.

OTHER INFORMATION

None

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required under this item with respect to directors is contained in the sections “Election of Directors,” “Information Regarding Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance,” and “Code of Ethics” in the Company’s Proxy Statement for the 2005 Annual Meeting of Shareholders (the “2005 Proxy Statement”), a definitive copy of which will be filed with the Commission within 120 days of the end of the fiscal year covered by this Annual Report on Form 10-K and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information required under this item is contained in the sections entitled “Executive Compensation and Other Information,” “Compensation of Directors,” and “Employment and Change in Control Agreements” in the Company’s 2005 Proxy Statement and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information required under this item is contained in the section entitled “Security Ownership of Principal Shareholders and Management” in the Company’s 2005 Proxy Statement and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information required under this item is contained in the section entitled “Independent Registered Public Accountants” in the Company’s 2005 Proxy Statement and is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K

(a)Documents filed as part of this report.

(1)Financial Statements.

The financial statements of the Company are listed at Item 8 of this Form 10-K.

(2)Financial Statement Schedules for years ended June 30, 2005, 2004 and 2003.

None.

(3)Exhibits.


Exhibit Number	Document	Incorporated by Reference To:
3.1	Amended and Restated Articles of Incorporation.	Exhibit 3.1 of the Company’s Registration Statement on Form S-1 (File No. 333-03304) filed on May 28, 1996 (the “1996 Registration Statement”).

3.2	Amended and Restated Bylaws of the Company.	Exhibit 3.2 of the Company’s Form 10-K for the year ended June 30, 2003 (the “2003 Form 10-K”).

4.1	Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock	Exhibit 1 of the Company’s Registration Statement on Form 8-A (File No. 000-28414) filed on January 16, 1997 (the “1997 Registration Statement”).

4.2	Form of Rights Agreement dated January 14, 1997, between Urologix, Inc. and Norwest Bank Minnesota, N.A. as Rights Agent	Exhibit 1 of the Company’s 1997 Registration Statement.

10.1	* Amended and Restated Urologix, Inc. 1991 Stock Option Plan	Exhibit 4.1 of the Company’s Registration Statement on Form S-8 (File No. 333-124939) filed on May 13, 2005.

10.2	Lease Agreement dated January 20, 1992, between the Company and Parkers Lake Pointe I Limited Partnership, including Addendum to Lease Agreement dated April 5, 1995	Exhibit 10.5 of the Company’s 1996 Registration Statement.

10.3	* Form of Change In Control Agreement between the Company and its Executive Officers dated as of July 19, 2004.	Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the year ended June 30, 2004

10.4	* Letter between Urologix, Inc. and Fred B. Parks dated as of May 21, 2003.	Exhibit 10.5 of the 2003 Form 10-K

10.5	* Letter between Urologix, Inc. and Fred B. Parks dated as of July 19, 2004.	Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the year ended June 30, 2004

10.6	* Stock Option Agreement with grant date of May 27, 2003 between the Company and Fred B. Parks.	Exhibit 10.6 of the 2003 Form 10-K

10.9	Amendment of Lease Agreement dated October 4, 2002 between Parkers Lake I Realty Corp. and the Company.	Exhibit 10.9 of the 2003 Form 10-K.

23.1	Consent of KPMG LLP	Attached hereto.

31.1	Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 of the Exchange Act.	Attached hereto.

31.2	Certificate of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 of the Exchange Act.	Attached hereto.

32	Certification pursuant to 18 U.S.C. § 1350.	Attached hereto.

*	Indicates a management contract or compensatory plan or arrangement.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


UROLOGIX, INC.

By:		/s/ FRED B. PARKS
		Fred B. Parks, Chairman and
		Chief Executive Officer

Each person whose signature appears below hereby constitutes and appoints Fred B. Parks and Todd E. Paulson, and each of them his or her true and lawful attorney-in-fact and agent, with full power of substitution, to sign on his or her behalf, individually and in each capacity stated below, all amendments and post-effective amendments to this Form 10-K and to file the same, with all exhibits thereto and any other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as each might or could do in person, hereby ratifying and confirming each act that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Registration Statement has been signed below by the following persons in the capacities indicated on September 28, 2005.


Signature		Title

/s/ FRED B. PARKS Fred B. Parks		Chairman of the Board and Chief Executive Officer (Principal executive officer)

/s/ TODD E. PAULSON Todd E. Paulson		Vice President, Finance and Chief Financial Officer (Principal accounting officer)

/s/ SUSAN BARTLETT FOOTE Susan Bartlett Foote		Director

/s/ BOBBY I. GRIFFIN Bobby I. Griffin		Director

/s/ DANIEL STARKS Daniel Starks		Director

/s/ GUY C. JACKSON Guy C. Jackson		Director

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Urologix (ULGX) Inactive 10-K2005 FY Annual report

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