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| ULGX > SEC Filings for ULGX > Form 10-K on 21-Sep-2009 | All Recent SEC Filings |
21-Sep-2009
Annual Report
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 certain events could differ materially from those anticipated in these forward-looking statements as a result of risks and uncertainties, including those set forth under "Risk Factors" in Item 1A. All forward-looking statements included herein are based on information available to us as of the date hereof, and we undertake no obligation to update any such forward-looking statements.
OVERVIEW
Urologix develops, manufactures, and markets 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 control units under the Targis® and CoolWave® names and our procedure kits under the recently approved CTC Advance™, CTC™, Targis and Prostaprobe™ names. All systems utilize the Company's Cooled ThermoTherapy™ technology, 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 general 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 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 maintaining 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. In calendar year 2009 the reimbursement rates for a hospital performing our treatment on an outpatient basis is $3,026, and the reimbursement for the urologist performing the Cooled ThermoTherapy treatment is $587 per procedure. The reimbursement rate (inclusive of the physician's fee) in calendar year 2009 for Cooled ThermoTherapy procedures performed in the urologist's office is $2,551, which is subject to geographic adjustment. Urologists who perform Cooled ThermoTherapy procedures in an ASC are reimbursed under the two-part system in which the ASC receives a fixed fee of $1,849 for calendar year 2009, while the urologist performing the treatment is reimbursed $587 for calendar year 2009.
For calendar 2010, CMS is proposing additional reductions in the physician fee schedule covering Cooled ThermoTherapy. The exact amount of the reduction has not yet been determined. We are actively participating in the comment process related to the proposed reductions, have an active reimbursement strategy, and have retained consultative experts to assist us with dealing with the proposed reimbursement rate reductions.
Private insurance companies and HMOs 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.
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) 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) provide more physicians with access to Cooled
ThermoTherapy through the use of our own Cooled ThermoTherapy mobile service or
third party mobile providers in the United States.
We expect to continue to invest in research and development and clinical trials to improve our products and our therapy, while focusing on growing revenues through our sales and marketing teams and our Cooled ThermoTherapy mobile service. These investments are intended to broaden our product offering and expand the clinical evidence supporting our proprietary Cooled ThermoTherapy treatment for BPH. In April 2009 at the American Urological Association annual meeting we launched our newest Cooled ThermoTherapy treatment catheter in the CTC Advance family, and had two separate presentations of our clinical data. The presentations highlighted our 5 year durability data and the ability of physicians to customize the treatment for patients with our system.
Critical Accounting Policies and Estimates:
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 free of charge under a variety of programs for both evaluation and long-term use, and also provide access to Cooled ThermoTherapy treatments via our Cooled ThermoTherapy mobile service. We retain title to the control units placed with our customers for evaluation and longer-term use. These programs, as well as our Cooled ThermoTherapy mobile service, are designed to expand access to our technology, and thus expand the market for our single-use treatment catheters. Revenue for the free use of our Cooled ThermoTherapy system control units are bundled with the sale of single-use treatment catheters and are considered a single unit of accounting. Revenue from the bundled sales are recognized as the single-use treatment catheters are shipped to our customers. Revenue from our mobile service is recognized upon treatment of the patient. 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 specific customer-based circumstances. Should actual sales returns differ from our estimates, revisions to the sales return reserve would be required. Sales and use taxes are reported on a net basis, excluding them from revenue.
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 written-off after management determines they are uncollectible. 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
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.
Sales Tax Accrual
We maintain an accrual for sales tax liabilities we discover. The amount of the accrual is based on finding from sales tax audits and correspondence with state taxing authorities which indicate we may owe sales tax on items previously considered exempt, charged at incorrect tax rates, or for items which were not taxed by our vendors and we failed to self assess the sales tax. The accrual amount also includes interest and penalties which will result from these finding. Any unanticipated changes in the factors used to determine the amount of the accrual based on continued discussions and negotiations with the various state taxing authorities could result in changes to the amount of sales tax accrual required.
Based on a sales tax audit and new information obtained by the Company in the fourth quarter of fiscal 2008, we believed we may have additional sales tax exposure in some states related to our mobile service business. As a result, we believed that a liability was probable under Statement of Financial Accounting Standard (SFAS) No. 5 "Accounting for Contingencies" and increased our sales tax accrual by approximately $755,000 in the fourth quarter of fiscal 2008 for sales we previously believed to be exempt. This change in accounting estimate resulted in an increase to our fiscal year 2008 selling, general and administrative expense and net loss of $755,000 or $0.05 per diluted share. As a result of new information obtained subsequent to June 30, 2008, which indicated that we would not owe as much sales tax as previously estimated, we reduced our sales tax accrual by approximately $396,000 at September 30, 2008, resulting in a reduction in our selling, general and administrative expenses for that period. During the remainder of fiscal 2009 the sales tax accrual was further reduced by a net amount of $145,000, principally due to the resolution and settlement of other state sales tax liabilities, resulting in a sales tax accrual of $221,000 at June 30, 2009.
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 basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in
assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. 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 necessary to offset our deferred tax assets that will not be recoverable. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. 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. At June 30, 2009, we carried a valuation allowance of $39.9 million against our remaining net deferred tax assets.
Stock-Based Compensation
On July 1, 2005, we adopted the fair value recognition provisions of SFAS No. 123R "Share-Based Payment" using the modified prospective method. Under the modified prospective method, we recognize compensation expense on all stock option awards granted subsequent to July 1, 2005, as well as on any awards modified, repurchased or cancelled after July 1, 2005, and on the unvested portion of stock options granted prior to July 1, 2005. The amount of compensation expense is based on the fair value of the option award at the date of grant and is recognized over the requisite service period which corresponds to the option vesting period. Options typically vest 25 percent after the first year of service with the remaining vesting 1/36th each month thereafter. Generally, options granted to non-employee directors are immediately exercisable at the date of grant. Options are priced based on the closing price of a share of our common stock at the date of grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. To determine the inputs for the Black-Scholes option pricing model, we use historical data to estimate expected volatility and the period of time that option grants are expected to be outstanding. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The range of these assumptions and the range of option pricing and number of options granted at the different grant dates will impact our calculation of the fair value of the awards and will therefore impact the amount of expense reflected in our statement of operations for any given period.
Results of Operations
Fiscal Years Ended June 30, 2009 and 2008
Net Sales
Net sales decreased 14 percent to $12.8 million in fiscal 2009 from $14.9 million in fiscal 2008. The decrease in sales from fiscal 2008 is primarily due to reduced orders for procedure kits as well as a reduction in the number of Urologix mobile treatments performed due to fewer accounts treating, partially offset by an increase in orders for procedure kits to our third-party mobiles, as well as an increase in the mobile service average selling price (ASPs).
During fiscal 2009, revenue from catheter sales to direct accounts constituted 35 percent of sales compared to 43 percent in the prior fiscal year, while catheter sales to third party mobiles constituted 14 percent of revenue in the current fiscal year compared to 10 percent in fiscal 2008. Revenue derived from the Urologix mobile service constituted 48 percent of total sales in fiscal 2009 compared to 45 percent in the prior year. The remaining three percent of our sales in fiscal 2009 were from sales of our control units and warranty service contracts.
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, as well as costs associated with the delivery of our Cooled ThermoTherapy mobile service. Cost of goods sold for fiscal 2009 decreased to $6.4 million or 8 percent from $6.9 million in fiscal 2008. This decrease in cost of goods sold is a result of the 14 percent decrease in sales year over year, as well as fiscal year 2008 non-recurring charges related to the impairment of developed technologies of $65,000 and a $131,000 provision for Prostaprobe inventories, purchase commitments and warranties as a result of the projected decline in sales as a result of the decision to end-of-life the Prostatron product line. These decreases were partially offset by higher manufacturing expense per unit and increased unabsorbed manufacturing expense due to lower production volume in fiscal year 2009.
Gross profit as a percentage of sales decreased to 50% in fiscal 2009 from 54% in the prior fiscal year. The four percentage point decrease in fiscal 2009 as compared to fiscal 2008 is a result of higher manufacturing expense per unit and lower production volume of our treatment catheters, which provide a smaller base to absorb our fixed manufacturing overhead costs. In addition, the number of mobile unit treatments as a percentage of sales increased, which have lower overall margins.
Selling, General & Administrative
Selling, general and administrative expenses in fiscal 2009 decreased $3.2 million or 27 percent to $8.5 million from $11.8 million in fiscal 2008. The decrease in selling, general and administrative expense is largely the result of a $755,000 increase to our sales tax accrual in fiscal 2008, of which approximately $396,000 was reversed in the first quarter of fiscal 2009 as a result of new information obtained which indicated that we would not owe as much sales tax as previously estimated. In addition, the decrease in expenses from fiscal year 2008 to 2009 reflects a $496,000 decrease in legal and audit fees, a $383,000 decrease in consulting and professional fees due to certain one-time expenses in fiscal 2008 that were not repeated in fiscal 2009, a $230,000 decrease in commission expense due to lower sales, a $155,000 decrease in stock option expense due to lower grant date fair values, a $146,000 decrease in advertising and promotion expense, a $104,000 decrease in wages and benefits as a result of severance accruals recorded during fiscal 2008 for former Company executives, as well as smaller decreases in several other areas. Much of the decrease in selling, general and administrative expenses in fiscal 2009 is a result of our continuing efforts to manage expenses.
Research and Development
Research and development expenses, which include expenditures for product development, regulatory compliance and clinical studies, decreased to $2.4 million, or 15 percent for fiscal 2009 from $2.8 million for fiscal 2008. The decrease in research and development is due to a $557,000 decrease in product testing and project materials as we launched our newest catheter, CTC Advance at the end of the prior year. In addition, wages and benefits decreased by approximately $247,000 as a result of a reduction in headcount. These decreases were partially offset by an increase in consulting expenses of $450,000 as a result of research and development employee turnover.
Amortization and Impairment of Identifiable Intangible Assets
Amortization and impairment of identifiable intangible assets decreased to $24,000 in fiscal 2009 compared to $71,000 in fiscal 2008. The decrease in amortization and impairment expense is the result of the implementation of an end-of-life plan in fiscal year 2007 for the Prostatron control units and Prostaprobe catheters in connection with our strategy to develop a next generation catheter. As a result of this plan, in fiscal year 2008 we wrote-off the remaining balance of our trademark intangible asset of $16,800, as well as recorded an additional write-down of the customer base intangible asset of $24,000 due to a decrease in projected sales of
this end-of-life product line. The current year amortization expense relates to the amortization of our remaining customer base intangible asset over its remaining useful life of 5.25 years.
Net Interest Income
Net interest income for fiscal 2009 decreased to $53,000 from $400,000 in the prior fiscal year. The decrease is due to lower cash and investment balances and lower interest rates.
Provision for Income Taxes
We recorded $7,000 of income tax expense for the fiscal year ended June 30, 2009 compared to a $1.5 million income tax benefit for the fiscal year ended June 30, 2008. The $7,000 of income tax expense at June 30, 2009 was the result of the recording of $55,000 of income tax expense related to state taxes, partially offset by $48,000 of an income tax benefit related to research and development credits. The income tax benefit for the fiscal year ended June 30, 2008 is a result of a $1.6 million reversal of the deferred tax liability balance related to goodwill which was no longer necessary after the impairment of goodwill at December 31, 2007. This was partially offset by approximately $18,000 of tax expense mainly related to state taxes.
Fiscal Years Ended June 30, 2008 and 2007
Net Sales
Net sales decreased 30 percent to $14.9 million in fiscal 2008 from $21.3 million in fiscal 2007. The decrease in sales from fiscal 2007 was primarily due to reduced orders for procedure kits as a result of lost accounts, both direct and mobile, a reduction in the average order size of accounts, as well as our inability to meet demand for Prostaprobes as we awaited an end-of-life build from our supplier. Sales were also down as a result of continued turnover in our sales force, as well as disruptions in our mobile business from employee turnover.
During fiscal 2008, revenue from catheter sales to direct accounts constituted 53 percent of sales compared to 65 percent in the prior fiscal year, while our mobile treatments comprised 45 percent of total sales in fiscal 2008 compared to 33 percent in the prior year. The remaining one percent of our sales in fiscal 2008 was from sales of our control units and warranty service contracts.
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, amortization related to developed technologies, as well as costs associated with the delivery of our Cooled ThermoTherapy mobile service. Cost of goods sold for fiscal 2008 decreased to $6.9 million or 50 percent from $13.9 million in fiscal 2007, and was primarily due to the 30 percent decrease in sales from fiscal 2007 to fiscal 2008. Fiscal year 2007 includes $4.2 million in asset impairment charges related to developed technologies and Prostatron fixed assets, and a $213,000 write-down of Prostatron inventory as a result of the implementation of an end-of-life plan for our Prostatron control units and Prostaprobe catheters.
Gross profit as a percentage of sales increased to 54% in fiscal 2008 from 35% in the prior fiscal year. Gross profit margin rates were lower by 21% in the prior fiscal year as a result of the asset impairment charges and inventory write-down in fiscal 2007 mentioned above. Excluding the asset impairment charges and inventory write-downs, gross profit as a percentage of sales was down approximately 2% in fiscal 2008 as compared to fiscal 2007 as a result of lower sales and production volume of our treatment catheters, which provide a smaller base to absorb our fixed manufacturing overhead costs and an increase in the number of mobile unit treatments as a percentage of sales, which have lower overall margins.
Selling, General & Administrative
Selling, general and administrative expenses in fiscal 2008 increased $681,000 or 6 percent to $11.8 million from $11.1 million in fiscal 2007. The increase in selling, general and administrative expense was largely the result of a $755,000 increase to our sales tax accrual as a result of a sales tax audit and new information obtained by the Company in the fourth quarter of fiscal 2008, in which we determined we may have additional sales tax exposure in some states related to our mobile service business. As a result, we felt it was probable under Statement of Financial Accounting Standard (SFAS) No. 5 "Accounting for Contingencies" to increase our sales tax reserve by approximately $755,000 in the fourth quarter of fiscal 2008 for sales we previously believed to be exempt. In addition, there was a $568,000 increase in wages and benefits as a result of $520,000 of severance accruals recorded during the year for former Company executives, and a $258,000 increase in legal and audit expenses for special projects. These increases were partially offset by a $940,000 decrease in sales and marketing expenses largely as a result of a $478,000 decrease in sales and marketing wages and a $224,000 decrease in travel and entertainment due to an average decrease in headcount during fiscal 2008, as well as an $189,000 decrease in commission expense as a result of reduced sales.
Research and Development
Research and development expenses, which include expenditures for product development, regulatory compliance and clinical studies, decreased to $2.8 million, or 8 percent at June 30, 2008 from $3.0 million at June 30, 2007. The decrease in research and development was mainly due to a $223,000 decrease in wages and benefits as a result of reduced headcount and a $57,000 decrease in consulting, partially offset by an approximate $101,000 increase in product testing and project materials related to our newest catheter, CTC Advance.
Amortization and Impairment of Identifiable Intangible Assets
Amortization and impairment of identifiable intangible assets decreased to $71,000 in fiscal 2008 compared to $2,244,000 in fiscal 2007. The decrease in amortization and impairment expense was the result of the implementation of an end-of-life plan at June 30, 2007 for the Prostatron control units and Prostaprobe catheters in connection with our strategy to develop a next generation catheter. The fiscal year 2008 impairment and amortization expense was a result of the write-off of our trademark intangible asset of $16,800, as well as the additional write-down of the customer base of $24,000 in December 2007, and continued amortization of our remaining customer base intangible asset over its remaining useful life of 6.25 years, as compared to asset impairment charges of $991,000 related to the Prostatron customer base and $969,000 related to the Prostatron trademarks in fiscal 2007.
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