-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UvjDlK5Aq5j3fqL0zVbTrhczyj9E39TQdgK3aY/HM37MgczPN1HxW1sOFdhQSdU2 Xh7vC087jWZqnVRm9rkcww== 0001045969-03-001568.txt : 20030514 0001045969-03-001568.hdr.sgml : 20030514 20030514163451 ACCESSION NUMBER: 0001045969-03-001568 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20030331 FILED AS OF DATE: 20030514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UROLOGIX INC CENTRAL INDEX KEY: 0000882873 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 411697237 STATE OF INCORPORATION: MN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-28414 FILM NUMBER: 03699558 BUSINESS ADDRESS: STREET 1: 14405 21ST AVE N CITY: MINNEAPOLIS STATE: MN ZIP: 55447 BUSINESS PHONE: 6124751400 MAIL ADDRESS: STREET 1: 14405 21ST AVENUE NORTH CITY: MINNEAPOLIS STATE: MN ZIP: 55447 10-Q 1 d10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-Q --------------- [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction 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 (I.R.S. Employer incorporation or organization) Identification No.) 14405 21st Avenue North, Minneapolis, MN 55447 (Address of principal executive offices) Registrant's telephone number, including area code: (763) 475-1400 --------------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2) of the Exchange Act. Yes [_] No [x] 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 [_] As of April 30, 2003, the Company had outstanding 13,915,968 shares of common stock, $.01 par value. ================================================================================ PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Urologix, Inc. Condensed Balance Sheets (In thousands, except per share data)
March 31, June 30, 2003 2002 - ------------------------------------------------------------------------ ----------- ---------- ASSETS (unaudited) (*) Current assets: Cash and cash equivalents $ 603 $ 1,604 Available-for-sale investments 5,573 11,109 Accounts receivable, net of allowance of $370 and $483 2,111 4,554 Inventories, net 4,670 2,424 Prepaids and other current assets 503 880 - ------------------------------------------------------------------------ --------- ---------- Total current assets 13,460 20,571 - ------------------------------------------------------------------------ --------- ---------- Property and equipment: Machinery, equipment and furniture 9,708 8,227 Less accumulated depreciation (5,823) (5,007) - ------------------------------------------------------------------------ --------- ---------- Property and equipment, net 3,885 3,220 Other assets 2,480 2,676 Goodwill, net 10,193 10,193 Other intangible assets, net 9,279 9,777 - ------------------------------------------------------------------------ --------- ---------- Total assets $ 39,297 $ 46,437 ======================================================================== ========= ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,804 $ 2,117 Accrued compensation 578 686 Other accrued expenses 1,405 1,357 Current portion of lease obligation 489 513 Deferred income 1,703 1,891 Term debt 575 - - ------------------------------------------------------------------------ --------- ---------- Total current liabilities 6,554 6,564 - ------------------------------------------------------------------------ --------- ---------- Long-term liabilities: Term debt - 575 Long-term lease obligation - 351 - ------------------------------------------------------------------------ --------- ---------- Total long-term liabilities - 926 - ------------------------------------------------------------------------ --------- ---------- COMMITMENTS AND CONTINGENCIES (Note 10) Shareholders' equity: Common stock, $.01 par value, 25,000 shares authorized; 13,916 and 13,902 shares issued and outstanding 139 139 Additional paid-in capital 108,504 108,449 Accumulated deficit (75,988) (69,680) Accumulated other comprehensive income 88 39 - ------------------------------------------------------------------------ --------- ---------- Total shareholders' equity 32,743 38,947 - ------------------------------------------------------------------------ --------- ---------- Total liabilities and shareholders' equity $ 39,297 $ 46,437 ======================================================================== ========= ==========
(*) The Balance Sheet at June 30, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying notes to financial statements are an integral part of these statements. 2 Urologix, Inc. Condensed Statements of Operations (In thousands, except per share data) (Unaudited)
Three Months Ended Nine Months Ended March 31, March 31, ----------------------------- --------------------------- 2003 2002 2003 2002 - -------------------------------------------------------------------------------------------------------- Sales $ 4,558 $ 6,027 $ 13,606 $ 16,468 Cost of goods sold 1,802 2,114 5,162 5,763 - -------------------------------------------------------------------------------------------------------- Gross profit 2,756 3,913 8,444 10,705 - -------------------------------------------------------------------------------------------------------- Costs and expenses: Selling, general and administrative 3,739 2,962 11,509 8,548 Research and development 927 930 2,864 3,127 Amortization of intangible assets 166 166 498 498 - -------------------------------------------------------------------------------------------------------- Total costs and expenses 4,832 4,058 14,871 12,173 - -------------------------------------------------------------------------------------------------------- Operating loss (2,076) (145) (6,427) (1,468) Interest income, net 8 50 119 170 - -------------------------------------------------------------------------------------------------------- Net loss $(2,068) $ (95) $ (6,308) $ (1,298) ======================================================================================================== ======================================================================================================== Basic and diluted net loss per common share $ (0.15) $ (0.01) $ (0.45) $ (0.09) ======================================================================================================== Basic and diluted weighted average number of common shares outstanding 13,916 13,867 13,914 13,785 ------------------------- ---------------------------
The accompanying notes to financial statements are an integral part of these statements. 3 Urologix, Inc. Condensed Statements of Cash Flows (In thousands) (Unaudited)
Nine Months Ended March 31, ---------------------- 2003 2002 - --------------------------------------------------------------------- ---------- ---------- Operating Activities: Net loss ($6,308) ($1,298) Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization 1,510 1,246 Value of options issued to consultants - 38 Provision for bad debts 10 151 Change in operating items: Accounts receivable 2,433 (1,587) Inventories (3,651) (1,674) Prepaids and other assets 377 (57) Accrued expenses and accounts payable (561) 345 - --------------------------------------------------------------------- ---------- ---------- Net cash used for operating activities (6,190) (2,836) - --------------------------------------------------------------------- ---------- ---------- Investing Activities: Purchase of property and equipment, net (76) (156) Proceeds from sale of available-for-sale investments, net 5,585 3,195 - --------------------------------------------------------------------- ---------- ---------- Net cash provided by investing activities 5,509 3,039 - --------------------------------------------------------------------- ---------- ---------- Financing Activities: Payments made on capital lease obligations (375) (306) Proceeds from exercise of stock options 55 898 - --------------------------------------------------------------------- ---------- ---------- Net cash (used for) provided by financing activities (320) 592 - --------------------------------------------------------------------- ---------- ---------- Net increase (decrease) in cash and cash equivalents (1,001) 795 Cash and cash equivalents: Beginning of period 1,604 26 - --------------------------------------------------------------------- ---------- ---------- End of period $ 603 $ 821 ===================================================================== ========== ========== Supplemental cash-flow information Cash paid during the period for interest $ 108 $ 204 Net transfer of inventory to property and equipment $ 1,405 $ 594
The accompanying notes to financial statements are an integral part of these statements. 4 Urologix, Inc. Notes to Condensed Financial Statements March 31, 2003 (Unaudited) 1. Basis of presentation The accompanying unaudited condensed financial statements of Urologix, Inc. (the "Company" or "Urologix") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet as of March 31, 2003, the statements of operations for the three and nine months ended March 31, 2003 and 2002, and the statements of cash flows for the nine months ended March 31, 2003 and 2002, are unaudited but include all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position at such dates and the operating results and cash flows for those periods. Certain information normally included in financial statements and related footnotes prepared in accordance with generally accepted accounting principles has been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying financial statements should be read in conjunction with the financial statements and notes included in Urologix' annual report on Form 10-K for the year ended June 30, 2002, filed with the Securities and Exchange Commission. Results for any interim period shown in this report are not necessarily indicative of results to be expected for any other interim period or for the entire year. Certain prior year amounts have been reclassified to conform to current year presentation. 2. New Accounting Pronouncements In July 2002, Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," (SFAS No. 146) was issued and is effective for activities beginning after December 31, 2002. SFAS No. 146 requires, among other things, that costs associated with an exit activity (including restructuring and employee and contract termination costs) or with a disposal of long-lived assets be recognized when the liability has been incurred and can be measured at fair value. We adopted the provisions of SFAS No. 146 on January 1, 2003. SFAS No. 146 will have an impact on any restructuring activities initiated after December 31, 2002. In December 2002, the FASB issued SFAS No. 148, Stock Compensation. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We are making the required interim disclosures effective with the quarter ended March 31, 2003. 3. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. 5 Urologix, Inc. Notes to Condensed Financial Statements March 31, 2003 (Unaudited) 4. Basic and diluted net loss per share Basic and diluted net loss per common share was computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the periods presented. The following table summarizes the common stock equivalents that were excluded from the calculation of diluted earnings per share as the effect would be antidilutive. March 31, 2003 March 31, 2002 -------------- -------------- Three Months Ended 8,647 879,261 Nine Months Ended 56,712 967,652 5. Inventories Net inventories consisted of the following as of (in thousands): March 31, 2003 June 30, 2002 - ----------------------------------------------------------------------------- Raw materials $ 1,511 $ 936 Work in process 484 415 Finished goods 2,675 1,073 - ----------------------------------------------------------------------------- Total inventories $ 4,670 $ 2,424 ============================================================================= 6. Goodwill and other intangible assets Intangible assets consisting of acquired developed technologies and customer base are amortized over useful lives of 15 years and 14 years, respectively. We do not amortize the acquired trademarks as they are considered indefinite-lived intangible assets. Long-lived assets, including amortizing intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. Following a review, if such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. With the adoption of SFAS 142, goodwill is no longer being amortized against earnings and goodwill balances are subject to an impairment review on an annual basis or sooner if indicators of potential impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on total market capitalization as compared to the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets for several quarters, it may prompt us to engage a third party valuation firm to perform a valuation to assess whether our goodwill is impaired. Amortization of intangible assets was $166,000 and $498,000 for the three and nine-month periods ended March 31, 2003. Future annual amortization expense for acquired intangible assets is expected to be $664,000 for each of the next five fiscal years. 6 Urologix, Inc. Notes to Condensed Financial Statements March 31, 2003 (Unaudited) Balances of acquired intangible assets were as follows (in thousands):
As of March 31, 2003 ------------------------------------------ Carrying Accumulated Amount Amortization Net - -------------------------------------------------------------------------------------------------- Amortizing intangibles: Developed technologies $7,500 $1,250 $6,250 Customer base 2,300 411 1,889 ----- --- ----- Subtotal 9,800 1,661 8,139 Non-amortizing intangibles and goodwill: Goodwill 10,716 523 10,193 Trademarks 1,200 60 1,140 ----- -- ----- Subtotal 11,916 583 11,333 - -------------------------------------------------------------------------------------------------- Total acquired intangible assets $21,716 $2,244 $19,472 ==================================================================================================
7. Comprehensive Loss Comprehensive loss includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. Our comprehensive loss represents net loss adjusted for unrealized gains (losses) on available-for-sale investments. 8. Warranty Sales of our procedure kits and Cooled ThermoTherapy systems are subject to limited warranty guarantees. Procedure kit guarantees are limited to the disposable's printed date of expiration and system guarantees typically extend for one year after the date of installation or 15 months after the date of delivery, whichever is earlier. Standard warranty terms are included in customer contracts. Under the terms of these warranties, we are obligated to repair or replace any components or parts we deem defective in workmanship or materials. We reserve the right to reject warranty claims where we determine that failure is due to normal wear, customer modifications, improper maintenance or misuse. We record warranty provision monthly based on an estimated warranty expense percentage applied to current period revenue. The percentage applied reflects historical warranty incidence over the preceding twelve-month period. Both the experience percentage and the warranty liability are evaluated on an ongoing basis for adequacy. Warranty provisions and claims for the nine-month period ended March 31, 2003 were as follows (in thousands): Nine Months Beginning Warranty Warranty Ending Ended Balance Provisions Claims Balance ----------------- --------------- --------------- -------------- ----------- March 31, 2003 $203 $124 ($183) $144 7 Urologix, Inc. Notes to Condensed Financial Statements March 31, 2003 (Unaudited) 9. Stock Options We account for stock options under the provisions of Accounting Principles Board Opinion 25, under which no compensation cost has been recognized. The following pro forma net loss and net loss per share have been determined as if we had used the fair value method of accounting for our stock option grants and employee stock purchase plan share elections consistent with the method of SFAS 123, "Accounting for Stock-Based Compensation". Under this method, compensation expense is recognized over the applicable vesting periods and is based on the shares under option and their related fair values on the grant date.
(in thousands, except per share data) ------------------------------------------------------------ Three months ended Nine months ended March 31, March 31, ------------------------------ --------------------------- 2003 2002 2003 2002 ----------- ------------- ----------- ------------- Net loss (as reported) $ (2,068) $ (95) $ (6,308) $ (1,298) Non-cash compensation expense (730) (815) (2,073) (2,067) ------ ---- ------ ------ Pro forma $ (2,798) $ (910) $ (8,381) $ (3,365) Net loss per share (as reported) $ (0.15) $ (0.01) $ (0.45) $ (0.09) Non-cash compensation expense (0.05) (0.06) (0.15) (0.15) ------ ----- ------ ------ Pro forma $ (0.20) $ (0.07) $ (0.60) $ (0.24)
10. 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 or results of operations of the Company. In addition, the Company is involved in the litigation set forth below. Urologix v. ProstaLund AB et al. In March 2002, we filed a patent infringement action against ProstaLund AB, ProstaLund Operations AB, and Circon Corporation a/k/a ACMI Corporation in the United States District Court for the Eastern District of Wisconsin (and by a later amended complaint) alleging that the defendants' products infringed two United States Patents that were assigned to us: U.S. Patent No. 5,234,004 ("004 Patent") and U.S. Patent No. 5,509,929 the ("929 Patent"). We sought a preliminary injunction prohibiting the manufacture, use, sale, or offer for sale of the "ProstaLund Feedback Treatment" and an unspecified amount of damages. The defendants counterclaimed, alleging that they do not infringe our patents, that our patents are invalid and that we have "marked" our products as "patented" in a manner that violates patent law. The defendants are also seeking recovery of their attorneys' fees. In October 2002, the Court issued two separate Orders in this case. In an Order dated October 10, 2002, the Court determined that the `004 patent was not entitled to the benefit of an earlier filing date of a parent application and as a result was invalid. In an Order dated October 16, 2002, the Court denied our motion for a preliminary injunction on the `929 patent. 8 Urologix, Inc. Notes to Condensed Financial Statements March 31, 2003 (Unaudited) Subsequent to the Court Action, in November 2002 in response to our request, the United States Patent and Trademark Office ("PTO") issued an office action granting Urologix the benefit of the earlier office action on the `004 patent. In light of the PTO office action, we filed a motion with the Court in November 2002 requesting that the Court vacate the October 10, 2002 Order determining the `004 patent was invalid. In April 2003, the Court denied our motion to vacate the October 10, 2002 Order. We are evaluating our options in connection with the lawsuit and are preparing for a trial on the merits of the infringement claims of the `929 patent which has been scheduled by the Court for January 2004. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of Urologix' financial condition and results of operations for the three and nine-month periods ended March 31, 2003 and 2002. This section should be read in conjunction with the condensed financial statements and related notes in Item 1 of this report and Urologix' Annual Report on Form 10-K for the year ended June 30, 2002, which has been filed with the Securities and Exchange Commission. Cautionary Note Regarding Forward-Looking Statements This Management's Discussion and Analysis of Financial Condition and Results of Operations contains, in addition to historical information, forward-looking statements that are based on our current expectations, beliefs, intentions or future strategies. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements, including the extent to which the physicians performing Cooled ThermoTherapy procedures are able to obtain third-party reimbursement, changes in the reimbursement environment, market acceptance and the rate of adoption of Cooled ThermoTherapy for the treatment of benign prostatic hyperplasia (BPH) by the medical community, our ability to successfully protect our intellectual property rights, the ability of our key suppliers to provide product, the impact of competitive treatments, products and pricing, and the effectiveness of our sales and marketing organization. We caution readers not to place undue reliance on any of these forward-looking statements, which speak only as of the date made. A detailed discussion of risks and uncertainties may be found below in "Factors That May Affect Our Future Results and The Trading Price of Our Common Stock" and in our Annual Report on Form 10-K for the year ended June 30, 2002. OVERVIEW Urologix, Inc., based in Minneapolis, Minnesota, 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 superior to medication without the complications and side effects inherent in surgical procedures. We generate revenue from the sale of Cooled ThermoTherapy systems and the related disposable procedure kits. Third-party reimbursement is essential to acceptance of the Cooled ThermoTherapy procedure. We estimate that more than 50% of patients who receive treatment in the United States are eligible for Medicare coverage, making Medicare reimbursement critical for widespread market acceptance in the United States. 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. The rate of Medicare reimbursement for Cooled ThermoTherapy is dependent on the site of service. Medicare reimburses outpatient hospital-based procedures with a fixed rate under a "prospective payment system." Under this method of reimbursement, a hospital receives a fixed reimbursement for each procedure performed in its facility. Medicare began to reimburse for Cooled ThermoTherapy procedures performed in a physician's office on a fixed-rate basis on January 1, 2001. The change was a significant milestone, as it marked the first time patients were covered directly by Medicare for in-office Cooled ThermoTherapy procedures. 10 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 to (i) increase market awareness of Cooled ThermoTherapy, (ii) create access to Cooled ThermoTherapy through both the sale and long-term use arrangements of Cooled ThermoTherapy systems and (iii) increase the use of Cooled ThermoTherapy by physicians who already have access to a Cooled ThermoTherapy System. We expect to continue to incur operating losses as we fund marketing and sales activities and invest in our effort to protect our intellectual property. Our future profitability will be dependent upon, among other factors, our success in achieving market acceptance 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, and the extent to which Medicare and other health care payers continue to reimburse costs of Cooled ThermoTherapy procedures performed in hospitals, ambulatory surgery centers and physicians' offices and the amount of reimbursement provided. Critical Accounting Policies: 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 in accordance with Securities and Exchange Commission Staff Accounting Bulletin 101. We recognize revenue from the sale of Cooled ThermoTherapy systems upon acceptance by the customer. We recognize revenue from disposable product sales at the time of shipment. In addition to sales of our Cooled ThermoTherapy systems, we place our Cooled ThermoTherapy systems with urology groups under a variety of programs for both evaluation and long-term use. These programs are designed to expand our installed base, and thus increase the market for our disposable catheters. Under these programs, we generally charge a higher price for each disposable to include the use of our Cooled ThermoTherapy system by the urology group. Revenue for warranty service contracts is deferred and recognized on a straight-line basis 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. If the historical data we use to calculate this estimate does not properly reflect future returns, our revenues could be overstated. 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 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. Should actual product failure rates, material usage or repair costs differ from our estimates, revisions to the estimated warranty liability would be required. Inventory Carrying Value and Related Allowance for Excess and Obsolete Inventory. On a periodic basis we analyze the level of inventory on hand, its cost in relation to market value and estimated customer requirements to determine whether write-downs for shrinkage, excess, obsolete or slow moving inventory are required. The amounts of these reserves are based upon average selling prices, historical experience and forecasted demand. Our reserve requirements could be materially different if average selling prices decline or demand for our products decreased because of competitive conditions or market acceptance, or if products become obsolete because of advancements in the industry. 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 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. 11 Valuation of Long-Lived and Intangible Assets and Goodwill In fiscal 2002, we adopted Statement of Financial Accounting Standards (SFAS) 142, "Goodwill and Other Intangible Assets," and as a result, we have ceased to amortize approximately $10.2 million of goodwill and $1.1 million of trademarks. Goodwill is tested for impairment annually or more frequently if changes in circumstance or the occurrence of events suggests impairment may exist. 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 goodwill impairment tests 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. Other intangible assets consist of developed technology, customer base and trademarks. Developed technology 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 these definite and indefinite-lived intangible assets for impairment annually or as changes in circumstance or the occurrence of events suggests the remaining value may not be recoverable. RESULTS OF OPERATIONS Net Sales Net sales decreased to $4.6 million and $13.6 million for the three and nine-month periods ended March 31, 2003, from $6.0 million and $16.5 million during the same periods in the prior fiscal year. The decrease in revenue in both the three and nine-month periods was caused by a decrease in the number of Cooled ThermoTherapy systems sold as well as a decrease in the average per unit selling price of these systems and a decrease in the number of procedure kits sold. Sales of disposable procedure kits accounted for nearly 90% of total revenue in the first nine months of fiscal 2003, compared to approximately 75% in the same period in fiscal 2002. Both the volume of equipment sold and the sale price of our equipment were affected by competitive offerings in our marketplace. In addition, our effort to expand our domestic sales force during the first six months of fiscal 2003 has limited the growth of procedure kit sales. During the expansion, both our sales management and our experienced sales representatives invested a significant amount of time recruiting and training new team members which slowed work with existing customers and the effort to generate new business. We completed the expansion of our sales organization in December 2002 and have refocused efforts on maintaining and increasing sales. At March 31, 2003, we had an installed base of 346 Cooled ThermoTherapy systems, including the units that are being used by customers pursuant to our evaluation and long-term use programs. In January 2003, Medicare published new rates for office-based microwave treatments, including Cooled ThermoTherapy. These rates became effective for office based microwave treatment claims processed by Medicare on or after March 1, 2003. The new rates published by Medicare reflect a decrease of approximately 30% from previous office-based reimbursement rates. We do not know what impact this rate change will ultimately have on our business. See "Factors That May Affect Our Future Results and The Trading Price of Our Common Stock-Third-party reimbursement is critical to market acceptance of our products." 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 control units and disposable procedure kits. Cost of goods sold for the three and nine-month periods ended March 31, 2003 were $1.8 million and $5.2 million, down from $2.1 million and $5.8 million during the same periods of fiscal 2002. The decrease resulted from a decrease in the number of Cooled ThermoTherapy systems sold as well as a decrease in the number of procedure kits sold. Gross profit as a percentage of sales for the three and nine-month periods ended March 31, 2003 decreased to 60% and 62% respectively, from 65% in both the three and nine-month periods ended March 31, 2002. The decreases have resulted primarily from the drop in the average per unit selling price of our Cooled ThermoTherapy systems. 12 Selling, General & Administrative Selling, general and administrative expenses increased to $3.7 million and $11.5 million for the three and nine-month periods ended March 31, 2003, from $3.0 million and $8.5 million in the same periods of fiscal year 2002. The increased expenses are primarily attributable to legal expenses related to a patent infringement suit we filed to protect our intellectual property as well as the expansion of our direct sales force. We expect to continue to incur legal expenses in connection with our efforts to protect our intellectual property. Research and Development Research and development expenses, which include expenditures for product development, regulatory compliance and clinical studies, decreased to $927,000 and $2.9 million from $930,000 and $3.1 million for the three and nine-month periods ended March 31, 2003 and 2002, respectively. The decrease in expenses in both periods resulted primarily from decreased expenditures on product development activities, partially offset by increased clinical trial expenses. We expect quarterly research and development expenses for the fourth quarter of the fiscal year to be lower than the current quarter. Amortization of intangible assets Amortization of intangible assets was $166,000 and $498,000 for both the three and nine-month periods ended March 31, 2003 and 2002, respectively. The amortization of intangible assets is a result of the purchase of the Prostatron Cooled ThermoTherapy product line from EDAP in October 2000. Net interest income Net interest income decreased to $8,000 and $119,000 for the three and nine-month periods ended March 31, 2003 from $50,000 and $170,000 during the same period of the prior fiscal year. The decrease is primarily attributable to lower interest income due to lower cash and investment balances, partially offset by lower interest expense. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations since inception through sales of equity securities and sales of product. As of March 31, 2003, we had total cash, cash equivalents and available-for-sale investments of $6.2 million and working capital of $6.9 million. During the nine months ended March 31, 2003, we used $6.2 million of cash in operating activities, primarily as a result of our net loss of $6.3 million and an increase in inventory of $3.7 million that was partially offset by a net decrease in accounts receivable of $2.4 million and depreciation and amortization of $1.5 million. Our inventory increased due to the receipt of a large number of control units from our third-party suppliers. We expect inventory balances to decrease over the next several quarters as inventory purchases are scheduled to decrease and inventory is sold or transferred into property and equipment for use in our evaluation and long-term use programs. We generated $5.5 million from investing activities, resulting from the net sale of $5.6 million of available-for-sale investments partially offset by the purchase of $76,000 of property and equipment. We used $320,000 in financing activities as a result of $375,000 of payments on capital lease obligations offset by $55,000 from the exercise of stock options. We expect to continue to incur additional losses and we plan to continue offering customers a variety of programs for both evaluation and long-term use of our Cooled ThermoTherapy equipment in addition to purchase options. As of March 31, 2003, our property and equipment, net, included approximately $2.8 million of equipment used in an evaluation or long-term use program. Depending on the growth of these programs, we may use additional capital to finance the units used by these customers. We are exploring ways to reduce our expenses and efficiently use working capital to preserve cash while we focus on maintaining and increasing sales and continue to provide high quality support to our customers. Third party financing may also present opportunities to leverage the equipment used by our customers under evaluation and long-term use programs. 13 Based upon these factors, we believe our $6.2 million in cash, cash equivalents, and available-for-sale securities, together with funds generated from product sales, will be sufficient to fund our working capital and capital resources need for 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. 14 FACTORS THAT MAY AFFECT OUR FUTURE RESULTS AND THE TRADING PRICE OF OUR COMMON STOCK 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 affect our operations. The occurrence of any of the following risks could harm our business. In that case, the trading price of our common stock could decline, and investors may lose all or part of their investment. We have a limited operating history and expect to continue to generate losses. We have incurred substantial losses since our inception and, if physicians do not purchase and use our Cooled ThermoTherapy systems to treat patients with BPH, we may never achieve or maintain profitable operation. We incurred a net loss of approximately $6.3 million for the nine month period ended March 31, 2003, and have incurred losses of approximately $76 million since our inception. We expect to continue to incur operating losses in the near future as we continue our investment in sales and marketing activities to increase sales, continue to incur costs and expenses to protect our intellectual property, and fund research and development activities. We will need to significantly increase the revenues we receive from sales of our products to fund these operating expenses. We may be unable to do so, and therefore may never achieve profitability. Even if we do achieve profitability, we cannot be certain that we will be able to sustain or increase profitability on a quarterly or annual basis. 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 accepted by physicians, patients or payers, or is accepted more slowly than expected, we may never operate profitably. 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. Many of our competitors are significantly larger than we are and have greater financial, technical, research, marketing, sales, distribution and other resources than we do. There is intense price competition for 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. These developments could have a significant negative effect on our financial condition. Even if we are able to compete successfully, we may not be able to do so in a profitable manner. 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. 15 Third-party reimbursement is dependent upon decisions by the Center for Medicare and Medicaid Services (CMS), contract Medicare carriers, individual managed care organizations, private insurers, foreign governmental health programs and other payers of health care costs. 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. On January 17, 2003, Medicare published new rates for office-based microwave treatments, including Cooled ThermoTherapy. These rates became effective for office based microwave treatments claims processed by Medicare on or after March 1, 2003. The new rates published by Medicare reflect a decrease of approximately 30% from previous office-based reimbursement rates. We do not yet know what impact this rate change will ultimately have on our business. The rate change may discourage some physicians from using our products or could limit our future growth. 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 HMOs 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 affect on our revenues and ability to operate profitably. Our intangible assets and goodwill could become impaired. Intangible assets consisting of acquired developed technologies and customer base are amortized over useful lives of 15 years and 14 years, respectively. We do not amortize the acquired trademarks as they are considered indefinite-lived intangible assets. Long-lived assets, including amortizing intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. Following a review, if such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. With the adoption of SFAS 142, goodwill is no longer being amortized against earnings and goodwill balances are subject to an impairment review on an annual basis or sooner if indicators of potential impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on total market capitalization as compared to the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets for several quarters, it may prompt us to engage a third party valuation firm to perform a valuation to access whether our goodwill is impaired. Amortization of intangible assets was $166,000 and $498,000 for the three and nine-month periods ended March 31, 2003. Future annual amortization expense for acquired intangible assets is expected to be $664,000 for each of the next five fiscal Our inventory could become impaired. At March 31, 2003, our inventory had a carrying value of $4.7 million, including finished goods of $2.7 million. As we discussed in Management's Discussion and Analysis in this Form 10-Q, during the nine months ended March 31, 2003, we experienced a decrease in the average selling price of our Cooled ThermoTherapy systems as a result of increased competition in our market. Although we believe that our Cooled ThermoTherapy system has demonstrated superior results to those of our competitors, if we continue to experience significant price competition that results in a need to decrease the selling prices of our Cooled ThermoTherapy system, we may 16 determine that our inventory of Cooled ThermoTherapy systems is impaired and be required to revalue it, thereby incurring a charge. 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. These legal means afford us only limited protection, however, and may not adequately protect our rights or remedies to gain or keep any advantages we may have over our competitors. In March 2002, we filed a patent infringement action against ProstaLund AB, ProstaLund Operations AB, and Circon Corporation a/k/a ACMI Corporation in the United States District Court for the Eastern District of Wisconsin (and by a later amended complaint) alleging that the defendants' products infringed two United States Patents that were assigned to us. The defendants raised counterclaims against us and are seeking recovery of their legal fees. In October 2002, the Court issued orders invalidating one of our patents and denied our motion for a preliminary injunction. See "Legal Proceedings" for a discussion of developments in these proceedings. Although we continue to believe that we will prevail in the trial, there can be no assurance that we will be successful. In addition, because we lost our request for injunctive relief, we are currently unable to prevent the defendants from selling their products in the United States. Although we believe that our products have demonstrated superior results to the defendants' products, there can be no assurance that the defendants will not be able to capture a significant part of the market for less invasive BPH treatments, which could have an adverse effect on our future results of operations and profitability. In addition, this litigation has resulted in substantial expense and we anticipate that there may be additional substantial expense involved in this litigation. Furthermore, the existence of this litigation may divert our attention from implementing our business strategy. Additional litigation against other parties may be necessary in the future to enforce our intellectual property rights, to protect our patents and trade secrets, and to determine the validity and scope of our proprietary rights. Furthermore, we cannot be assured that others have not developed or will not develop similar products or manufacturing processes, duplicate any of our products or manufacturing processes, or design around any of our patents. We depend upon our Cooled ThermoTherapy systems for all of our revenues. All of our revenues are derived from sales of our Cooled ThermoTherapy systems and single-use disposable treatment catheters. As a result, our success is solely dependent upon the success of our Cooled ThermoTherapy systems. To date, our Cooled ThermoTherapy systems have not received widespread market acceptance. If we are unable to commercialize the use of these systems successfully, our business, financial condition and results of operations will be materially and adversely affected. We have limited manufacturing experience and are dependent upon a limited number of third-party suppliers to manufacture our products. We have contracted with third parties for the production of the Prostatron product line and the Targis system control unit pursuant to written supply agreements. If, for any reason, any of our third-party manufacturers are unable or unwilling to manufacture the products for us in the future, we could incur significant delays in obtaining a substitute contract manufacturer. Also, we purchase additional components used in our products from various suppliers and rely on single sources for several components. One such component is obtained from a source that has a patent for the technology. Delays could result if supply of this component or other components were interrupted. These delays could be extended in certain situations in which a substitute contract manufacturer or a component substitution would require approval by the FDA of a PMA supplement. 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 business. 17 We produce the disposable treatment catheter for the Targis system. We have limited experience in rapidly scaling up production. Manufacturers often encounter difficulties in scaling up production of new products, including problems involving production yields, product recalls, quality control and assurance, component supply and lack of qualified personnel. If we or any of our third-party manufacturers or suppliers experience production problems, we may not be able to locate an alternate manufacturer promptly. Identifying and qualifying alternative suppliers of components takes time and involves significant additional costs and may delay the production of our products. The FDA requires us to identify any supplier we use. The FDA may require additional testing of any component from new suppliers prior to our use of these components. The termination of our relationships with these single source suppliers or the failure of these parties to supply us with the components on a timely basis and in sufficient quantities likely would cause us to be unable to meet customer orders for our products in a timely manner or within our budget and harm our business. We are dependent on distributors for international sales. To date, a majority of our revenues outside the United States have been derived from sales through third-party distributors. Although we intend to work with our distributors and agents to improve international revenue, we expect a decline in fiscal 2003 over fiscal 2002, driven primarily by a decrease in reimbursement for Cooled ThermoTherapy in Japan. Further, the failure of our distributors to market our products in the international markets effectively or our failure to locate and establish relationships with reputable distributors could have an adverse effect on our ability to achieve penetration of these markets and establish long-term acceptance of Cooled ThermoTherapy. We are dependent on key personnel. Failure to attract and retain skilled personnel could hinder our sales and marketing and research and development efforts. Our future success depends to a significant degree upon our ability to attract and retain qualified sales personnel and the continued services of key technical and senior management personnel. The 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 drugs and 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. 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 addition to obtaining such approvals, the FDA and foreign regulatory authorities may impose numerous other requirements on us. 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 18 would have a significant negative effect on our financial condition. 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, as well as 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 and penalties if we or our agents violate any of these laws. We may be required to pay damages that exceed our insurance coverage for product liability claims. Our business exposes us to potential product liability claims that are inherent in the testing, production, marketing and sale of medical devices. While we believe that we are reasonably insured against these risks, we may not be able to obtain insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Currently, we maintain product liability insurance in amounts we deem to be reasonable. Some plaintiffs have sought punitive or exemplary damages against us, which damages, if awarded, may not be covered by insurance pursuant to state law or the provisions of our insurance policies. A product liability claim in excess of our insurance coverage or outside the scope of our coverage would have to be paid out of cash reserves and would harm our reputation in the industry and our business. 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 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 and harm our reputation with customers and our business. 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 and volume of customer orders for both equipment and single-use treatment catheters, . the impact of reimbursement changes . costs and expenses related to our effort to protect intellectual property, . the timing of expenditures related to sales and marketing, and research and development, and . product availability. Our business is exposed to risks related to acquisitions and mergers. As part of our strategy to commercialize our products, we may acquire one or more businesses. On October 1, 2000, we purchased the Transurethral Microwave ThermoTherapy (TUMT or Cooled ThermoTherapy) product line and related patents and technologies from EDAP TMS S.A., a French corporation and its affiliates. We may not be able to integrate our business effectively with any other business we may acquire. The failure to integrate an acquired company or acquired assets into our operations may cause a drain on our financial and managerial resources, and thereby have a significant negative effect on our business and financial results. 19 These difficulties could disrupt our ongoing business, distract our management and employees or increase our expenses. Furthermore, any physical expansion in facilities due to an acquisition may result in disruptions that seriously impair our business. We are not experienced in managing facilities or operations in geographically distant areas. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for other intangible assets. Finally, in connection with any future acquisitions, we may incur debt or issue equity securities as part or all of the consideration for the acquired company's assets or capital stock. We may be unable to obtain sufficient additional financing on favorable terms or at all. Equity issuances would be dilutive to our existing shareholders. Our stock price may be volatile and a shareholder's investment could decline in value. Our stock price has fluctuated in the past and is likely to continue to fluctuate significantly, making it difficult to resell shares at an attractive price when an investor wants to. 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, . 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, . technological innovations or new commercial products by us or our competitors, . investor perception of us and our industry, and . general economic and market conditions including market uncertainty. 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. 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. Future sales of shares of our common stock may negatively affect our stock price. Future sales of our common stock, including shares issued upon the exercise of outstanding options or hedging or other derivative transactions with respect to our stock, could have a significant negative effect on the market price 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 certificate 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 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK Our financial instruments include cash and cash equivalents. The fair value of our financial investment 20 portfolio at March 31, 2003, approximated carrying 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 investment portfolio and was not materially different from the March 31, 2003 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 contracts and, therefore, do not have significant market risk exposure with respect to commodity prices. 21 ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. The Company's Chief Executive Officer, Michael M. Selzer, Jr., and Chief Financial Officer, Christopher R. Geyen, have reviewed the Company's disclosure controls and procedures within 90 days prior to the filing of this report. Based upon this review, these officers believe that the Company's disclosure controls and procedures are effective in ensuring that material information related to the Company is made known to them by others within the Company. (b) Changes in Internal Controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls during the quarter covered by this report or from the end of the reporting period to the date of this Form 10-Q. 22 PART II - OTHER INFORMATION ITEM 1. 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 or results of operations of the Company. In addition, the Company is involved in the litigation set forth below. Urologix v. ProstaLund AB et al. In March 2002, we filed a patent infringement action against ProstaLund AB, ProstaLund Operations AB, and Circon Corporation a/k/a ACMI Corporation in the United States District Court for the Eastern District of Wisconsin (and by a later amended complaint) alleging that the defendants' products infringed two United States Patents that were assigned to us: U.S. Patent No. 5,234,004 ("004 Patent") and U.S. Patent No. 5,509,929 the ("929 Patent"). We sought a preliminary injunction prohibiting the manufacture, use, sale, or offer for sale of the "ProstaLund Feedback Treatment" and an unspecified amount of damages. The defendants counterclaimed, alleging that they do not infringe our patents, that our patents are invalid and that we have "marked" our products as "patented" in a manner that violates patent law. The defendants are also seeking recovery of their attorneys' fees. In October 2002, the Court issued two separate Orders in this case. In an Order dated October 10, 2002, the Court determined that the `004 patent was not entitled to the benefit of an earlier filing date of a parent application and as a result was invalid. In an Order dated October 16, 2002, the Court denied our motion for a preliminary injunction on the `929 patent. Subsequent to the Court Action in November 2002, in response to our request, In November, 2002, the United States Patent and Trademark Office ("PTO") issued an office action granting Urologix the benefit of the earlier office action on the `004 patent. In light of the PTO office action, we filed a motion with the Court in November 2002 requesting that the Court vacate the October 10, 2002 Order determining the `004 patent was invalid. In April 2003, the Court denied our motion to vacate the October 10, 2002 Order. We are evaluating our options in connection with the lawsuit and are preparing for a trial on the merits of the infringement claims of the `929 patent which has been scheduled by the Court for January 2004. See "Factors that may affect our future results and the trading price of our Common Stock - We are dependent on adequate protection of our patent and proprietary rights." ITEM 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 23 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Report on Form 8-K a. No reports on Form 8-K were filed during the period ended March 31, 2003 24 SIGNATURES Pursuant to the requirements 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. Date May 14, 2003 Urologix, Inc. (Registrant) /s/ Michael M. Selzer, Jr. - -------------------------- Michael M. Selzer, Jr. President and Chief Executive Officer (Duly Authorized Officer) /s/ Christopher R. Geyen - ------------------------ Christopher R. Geyen Vice President and Chief Financial Officer (Principal Financial Officer) 25 CERTIFICATIONS I, Michael M. Selzer, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Urologix, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Michael M. Selzer, Jr. -------------- -------------------------- Michael M. Selzer, Jr. President and Chief Executive Officer 26 I, Christopher R. Geyen, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Urologix, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Christopher R. Geyen ------------- ------------------------ Christopher R. Geyen Vice President and Chief Financial Officer 27 EX-99.1 3 dex991.txt CERTIFICATION OF CEO Exhibit 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with this quarterly report on Form 10-Q of Urologix, Inc. I, Michael M. Selzer, Jr, President and Chief Executive Officer of Urologix, Inc., certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: . The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and . The information contained in this report fairly presents, in all material respects, the financial condition and results of operations of Urologix, Inc. Date: May 14, 2003 /s/ Michael M. Selzer, Jr ------------------------- Michael M. Selzer, Jr President and Chief Executive Officer EX-99.2 4 dex992.txt CERTIFICATION OF CFO Exhibit 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with this quarterly report on Form 10-Q of Urologix, Inc. I, Christopher R. Geyen, Chief Financial Officer of Urologix, Inc., certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: . The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and . The information contained in this report fairly presents, in all material respects, the financial condition and results of operations of Urologix, Inc. Date: May 14, 2003 /s/ Christopher R. Geyen ------------------------ Christopher R. Geyen Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----