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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(x) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended June 30, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the transition period from ___________________ to
____________________.
Commission File Number 0-28414
UROLOGIX, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-1697237
(State or other jurisdiction of (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: (612) 475-1400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
(1) Common Stock, $.01 par value.
(2) Series A Junior Participating Preferred Stock Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes (x) No ( )
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
As of September 14, 1999, the aggregate value of the Company's Common Stock held
by non-affiliates of the Company was approximately $35,891,000 based on the last
reported sales price on that date.
As of September 14, 1999 the Company had outstanding 11,485,170 shares of
Common Stock, $.01 par value.
1
DOCUMENTS INCORPORATED BY REFERENCE
Certain information is incorporated into Part III of this report by reference to
the Proxy Statement for the Registrant's 1999 annual meeting of stockholders to
be filed with the Securities and Exchange Commission pursuant to Regulation 14A
not later than 120 days after the end of the fiscal year covered by this Form
10-K.
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INDEX
PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation
Item 7A Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
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PART I
ITEM 1. BUSINESS
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Forward Looking Statements
Statements included in this Annual Report on Form 10-K that are not historical
or current facts are forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995 and are
subject to certain risks and uncertainties that could cause actual results to
differ materially. These risks and uncertainties include, but are not limited
to: competition from other BPH treatments; the ability of the Company's sales
representatives and distributors to successfully market and sell the Targis(TM)
System; the Company's ability to manufacture the Targis System in sufficient
quantities; the Company's ability to maintain intellectual property protection
for its proprietary products and to defend its existing intellectual property
rights from challenges by third parties; and the extent to which the physicians
performing the Targis System procedures are able to obtain third-party
reimbursement. In addition, a detailed discussion of risks and uncertainties may
be found in the Section entitled "Business - Risk Factors" in this Form 10-K.
Overview
Urologix develops, manufactures and markets minimally invasive medical
devices for the treatment of urological diseases. The Company's initial product,
the Targis System, is designed to treat benign prostatic hyperplasia ("BPH"),
commonly known as "enlarged prostate." BPH dramatically affects the quality of
life of millions of men by causing adverse changes in urinary voiding patterns.
The Targis System has been approved for marketing in the United States, the 15
European Union countries, Japan and Canada.
The Targis procedure is a non-surgical, catheter-based treatment that uses
a proprietary microwave technology that preferentially heats diseased areas of
the prostate to a temperature sufficient to cause cell death, while
simultaneously cooling and protecting the pain-sensitive urethral tissue.
Because the urethra is protected from heat and is not punctured or penetrated, a
Targis procedure can be performed without general or regional anesthesia or
intravenous sedation. Accordingly, the procedure can be performed in a low cost
setting such as a physician's office or an outpatient clinic. The Company
believes that the Targis System provides an efficacious, safe and cost effective
procedure for the treatment of BPH without the complications and side effects
inherent in most current treatments, and as such, is well positioned to address
the needs of physicians, patients and payors.
The Company's clinical studies demonstrated that most patients who received
the Targis therapy experienced a significant improvement in BPH symptoms and
urine flow rates, minimal complications and post-treatment discomfort, and were
able to return to normal activities within a few days. The Company submitted
results of its clinical studies to the United States Food and Drug
Administration (the "FDA") in its premarket approval application ("PMA") in
February 1997 and subsequently received FDA approval to market the Targis System
in August 1997.
The Company markets the Targis System in the United States through a direct
sales force and its co-marketing partner, Boston Scientific Corporation ("Boston
Scientific"), a worldwide developer, manufacturer and marketer of medical
devices. Urologix' direct sales force has sole responsibility for completing and
transacting the sales of the Targis System, while Boston Scientific, through
selected members of its Microvasive Urology sales force, assists Urologix'
direct sales force in the promotion and marketing of the Targis System procedure
among urologists throughout the United States.
Outside the United States, the Company has developed a relationship with
Nihon Kohden Corporation ("Nihon Kohden"), a major Japanese developer,
manufacturer and marketer of medical devices, for market development and sales
of the Targis System in Japan. The Company has a distribution agreement with
Boston Scientific covering all countries outside the United States except
Japan. Under the agreement, which was amended in February of 1999, Urologix has
responsibility for market development of the Targis System and works with Boston
Scientific to sell Targis
4
Systems from Boston Scientific's inventory through Urologix' direct sales force
in Europe. Boston Scientific compensates Urologix for Urologix' market
development services.
Benign Prostatic Hyperplasia
BPH is a non-cancerous urological disease in which the prostate enlarges
and constricts the urethra. Symptoms associated with BPH affect the quality of
life of millions of sufferers worldwide and BPH can lead to irreversible bladder
or kidney damage. The prostate is a walnut-size gland surrounding the male
urethra (the channel that carries urine from the bladder out of the body) that
is located just below the bladder and adjacent to the rectum. The prostate
produces seminal fluid and plays a key role in sperm preservation and
transportation. While the actual cause of BPH is not fully understood, it is
known that as men reach middle age, cells within the prostate that are located
primarily lateral, medial and anterior to the urethra (the "transition zone")
begin to grow at an increasing rate. As the transition zone of the prostate
expands, it compresses or impinges upon other portions of the prostate gland and
the urethra, thereby restricting the normal passage of urine. This constriction
of the urethra may require a patient to exert excessive bladder pressure to
begin urination. If the patient cannot generate sufficient force to adequately
void urine from the bladder, the possibility of infection and bladder and kidney
damage increases. BPH patients also typically suffer from a variety of troubling
symptoms, which primarily relate to changes in urinary voiding, many of which
can have a significant impact on a patient's quality of life.
The American Urological Association ("AUA") has developed and statistically
validated a system of evaluating and monitoring BPH symptom severity called the
AUA Symptom Score. This score is composed of the sum of the patient's responses
to seven questions generally relating to the symptoms described above. The
patient ranks a symptom on a scale of 0-5, with 5 being most severe. The Agency
for Health Care Policy and Research ("AHCPR") has recommended that patients with
a total score of less than 8 not be considered candidates for BPH treatment of
any kind. A patient with a total score of 8 to 19 is considered to have moderate
symptoms of BPH, and a patient with a total score of 20 or greater is classified
as having severe symptoms. Other methods of diagnosing BPH and its severity
include measuring urinary flow rates (a ratio of the volume of urine voided to
duration of voiding expressed in milliliters per second), pressure flow data
(intravesical pressure required to urinate) and residual urine in the bladder
after voiding.
Evidence of BPH typically begins to appear in men in their 50s, and by age
70, the quality of life of most men is negatively affected by BPH symptoms.
Medical sources estimate that the percentage of men suffering from symptoms of
BPH is approximately 30% for men in their 50s and increases to more than 75% for
men over age 80. The BPH market is large and can be expected to continue to grow
due to the general aging of the world's population, as well as increasing life
expectancies. For example, the population of men 50 years of age and older in
the United States is growing approximately 25% annually and is expected to reach
approximately 39 million in 2005. Improved education on healthcare issues may
also encourage more men to seek treatment of their BPH symptoms.
Medicare, which covers approximately 80% of BPH patients in the U.S. is
under increasing budget pressures. The rising cost of healthcare in the United
States has also influenced public support for managed care in order to control
spending. Hospitals and doctors are now forced to compete for the managed care
dollars. Urologix believes it is well positioned to provide patients, payors and
physicians a cost-effective alternative to drug therapy, invasive surgery, and
other less invasive surgical procedures, and the Company intends to leverage
this position to capture market share. The Targis Procedure has clinically
proven durability over a four year period, low complications rates, shorter
recovery time and greater cost effectiveness than other therapies for treating
BPH. The Company believes that the cost of treatment with the Targis Procedure
will be less than the cost of most other BPH therapies due to the long term
durability of the procedure and a design that allows the Targis procedure to be
performed in an office or outpatient setting and results in fewer complications.
5
Other BPH Therapies and Their Limitations
Watchful Waiting
Historically, over 70% of men suffering moderate to severe symptoms of BPH
in the United States have elected to live with the discomfort and inconvenience
of the disease, an approach known as "watchful waiting." This has been due
primarily to a lack of understanding of the disease and limitations of existing
therapies. For many BPH sufferers, watchful waiting may represent only a
temporary option due to the significant impact BPH has on a patient's quality of
life. Of those receiving treatment in the United States, approximately 85% elect
drug therapy and approximately 15% elect surgical intervention.
Drug Therapy
Drug therapy for BPH has been available in the United States since the FDA
approved marketing of four orally administered pharmaceutical products--
Proscar(R) (sold by Merck & Co., Inc.) in 1992, Hytrin(R) (sold by Abbott
Laboratories) in 1993, Cardura(R) (sold by Pfizer Inc.) in 1995 and FLOMAX(R)
(sold by Boehringer Ingelheim Pharmaceuticals, Inc.) in 1997. Approximately 1.5
million men currently receive drug therapy in the United States for the
treatment of BPH symptoms. The Company believes the dramatic acceptance of drug
therapy in the short period since FDA approval is due to extensive drug company
marketing, resulting in increased patient awareness, and the desire of these
patients for treatments which have less severe complications and side effects
than currently available surgical procedures. The annual cost of drug therapy is
approximately $1,300 to $1,400 in the first year, and the typical total cost
ranges from $12,000 to $17,000, depending on the age of the patient when drug
therapy is initiated.
Alpha blockers, such as Hytrin, Cardura, and FLOMAX treat BPH by relaxing
the muscles in the prostate and bladder neck to relieve urethral obstruction.
While alpha blockers have demonstrated some ability to relieve a patient's BPH
symptoms and improve urine flow rates, they still carry the potential for
significant side effects such as dizziness, headache, asthenia (shortness of
breath) and fatigue. Proscar is designed to treat BPH by shrinking the prostate.
As much as six months of Proscar treatment may be necessary to determine
efficacy and, after 12 months, at least 40% of patients taking Proscar do not
experience an increase in urine flow rate or improved AUA symptom scores. Side
effects for Proscar include impotence and decreased libido. An estimated 30% to
40% of those patients who initially pursue drug therapy discontinue treatment
within 12 months due to various reasons including ineffectiveness, side effects,
the burden of compliance and the cost of the therapy.
Surgical Treatments for BPH
The most common surgical procedure for the treatment of BPH is Transurethal
Resection of the Prostate ("TURP"), whereby a rigid instrument is inserted into
the patient's urethra through which the surgeon passes an electrosurgical loop
that is used to remove the urethra and the diseased tissue within the prostate.
While TURP has been the established standard for treating BPH since the 1930s,
this procedure requires general or spinal anesthesia and almost always requires
post-treatment hospitalization. During the past several years, the number of
TURPs performed in the United States has been decreasing from approximately
450,000 in 1992 to 150,000 in 1998, which the Company believes is due to
increased awareness of the complications of surgery and the availability of
drugs as an alternative treatment.
While TURP results in a dramatic improvement in urine flow in 90% of the
patients and a reduction in the AUA Symptom Score in 85% of the patients, a
significant number of patients experience serious complications. Virtually all
patients experience a burning sensation upon urination that lasts for up to
three weeks following the procedure. Other complications, as reported by AHCPR,
include retrograde ejaculation--the reverse flow of semen--(73.4% of patients),
infection (15.5%), impotence (13.6%), excessive hemorrhaging requiring
transfusion (12.5%), immediate surgery to stop the bleeding (2.0%), long-term
incontinence (3.1%) and urethral stricture (3.1%). In addition, approximately
1.5% of TURP patients die as a result of the procedure and related
complications. The TURP
6
procedure requires a highly skilled surgeon with extensive training, and the
incidence of these complications may be affected by the experience of the
surgeon performing the TURP.
Other surgical techniques have been developed in an attempt to address the
complications and side effects of TURP. The three most prevalent procedures are:
(i) transurethral incision of the prostate ("TUIP"); (ii) transurethral
vaporization of the prostate ("TVP"); and (iii) laser assisted prostatectomy.
TUIP is a surgical procedure performed under general or spinal anesthesia,
whereby a surgical cutting tool is passed through a cystoscope in the urethra to
make one or more incisions in the prostatic urethra near the bladder neck,
thereby reducing urethral obstruction. TVP is a surgical procedure performed
under general or spinal anesthesia, similar to a TURP, except the
electrosurgical element is a tissue vaporizing cylinder or ball rather than a
loop. TVP removes the prostatic urethra and vaporizes and coagulates prostatic
tissue, thereby widening the channel for urinary flow. Laser assisted
prostatectomy includes two similar procedures--visual laser ablation of the
prostate ("V-LAP") and contact laser ablation of the prostate ("C- LAP"), in
which a laser fiber catheter is guided through a cystoscope and used to ablate
and coagulate the prostatic urethra and prostatic tissue. Studies have been
conducted using holmium lasers to surgically remove the prostatic urethra and
tissue. While these alternative surgical treatments have been effective in
reducing some side effects associated with a TURP, such as reduced risk of blood
loss, they still remove or damage the urethra, require general or regional
anesthesia and are performed in an operating room.
Less-Invasive BPH Treatments
In an effort to eliminate hospitalization and the complications arising
from surgical treatments, other technologies have been developed or are under
development for the treatment of BPH. Two of these technologies being marketed
in the United States are interstitial radio frequency therapy ("RF") and
interstitial laser therapy. In an interstitial therapy procedure, a rigid scope
is inserted into the patient's urethra and either needle electrodes or laser
fibers pierce the urethra and are advanced into the lobes of the prostate. RF or
laser energy is then delivered, causing necrosis of the surrounding tissues. Due
to the limited amount of tissue necrosis caused by each electrode or laser
fiber, multiple punctures of the urethra are required during this procedure in
order to coagulate a sufficient amount of tissue. The Company believes that a
highly trained and skilled physician is required to make judgments regarding the
number and depth of punctures and to effectively perform the procedure. While
these procedures are designed to be performed in approximately 30 to 45 minutes
using local anesthesia, the Company believes that intravenous sedation or
regional anesthesia will be required in addition to local anesthesia in most
patients due to the need to repeatedly puncture the urethra and manipulate the
large, rigid instrument within the urethra. As a result, the Company believes
that it will be difficult to consistently perform interstitial therapies in an
office setting.
Several companies, including Urologix, have developed or are developing
transurethral microwave thermotherapy technology for the treatment of BPH. See
"Competition." Other technologies to treat BPH have been developed or are under
various stages of development, including stents, dilatation balloons,
transurethral and transrectal hyperthermia and high intensity focused
ultrasound.
The Urologix Approach
The Targis System is one-time, non-surgical, catheter-based technology to
treat BPH. The Targis System utilizes a proprietary microwave technology,
delivered through a flexible catheter, that preferentially heats the diseased
area of the prostate to a temperature sufficient to cause cell death, while
simultaneously cooling and protecting the pain sensitive urethral tissue. The
Targis procedure does not require punctures or incisions, thereby leaving the
urethra intact. As a result, the procedure can be performed without general or
regional anesthesia or intravenous sedation. Consequently, the procedure has
been, and is expected to be performed in an outpatient setting and does not
require an overnight hospital stay. Unlike other FDA-approved microwave-based
systems, the Company's Targis System employs proprietary preferential heating to
target energy away from the rectum and impedance matching to maximize energy
delivery to the diseased prostatic tissue.
7
The Company's clinical studies demonstrated that most patients who received
the Targis procedure experienced a significant improvement in AUA Symptom Scores
and urine flow rates, minimal complications and post-treatment discomfort, and
were able to return to normal activities within a few days.
Targis System
The Company's Targis System consists of the Targis Control Unit and the
Targis Procedure Kit, which includes the Targis Catheter, Cooling Bag and Rectal
Thermosensing Unit ("RTU"). The Targis Control Unit contains a microwave
generator, a solid-state refrigeration device, a circulation pump and
electronic circuitry to monitor therapy. The Targis Control Unit supplies
microwave energy and coolant to the Targis Catheter and collects and processes
data from the Targis Catheter and the RTU. The Targis Catheter contains a
microwave antenna for delivering microwave energy to the prostate and a
thermosensor for monitoring the urethral temperature. The Coolant Bag holds the
coolant that is circulated during therapy. The RTU monitors rectal temperatures.
The Targis Catheter, Coolant Bag and RTU are single-use devices.
In a Targis procedure, the Targis Catheter is inserted into the urethra and
the RTU is inserted into the rectum. Chilled water is then circulated through
the catheter. The coolant is designed to lower the temperature of the urethra to
protect it from heat and discomfort. When the urethra is sufficiently cooled,
microwave energy is turned on. Temperatures in the urethra and rectum are
monitored continuously to ensure that the appropriate level of energy is
supplied. The targeted prostatic tissue that is sufficiently heated by the
microwave energy is necrosed. Following treatment, a small catheter is inserted
and the patient is released. The small catheter is typically left in place for
two to four days to drain urine while swelling subsides. During the period
following the treatment, pressure on the urethra is decreased and BPH symptoms
are reduced.
The exposure time required to produce cell death decreases exponentially
with increasing temperatures. Virtually all cells heated to above 45 degrees C
for one hour will die. As temperatures increase above 45 degrees C, the time
required for cell death decreases. The challenge to providing effective
microwave therapy relates to producing and maintaining adequate temperature
elevation in the diseased tissue while, at the same time, preventing excessive
thermal exposure to the urethra and the rectum, as well as the internal and
external urinary sphincters. Protection against injury to the rectum is
particularly important, as serious complications could occur should the rectum
be thermally damaged. Protection of the urethra is important because it
decreases the pain associated with the procedure and shortens recovery time. In
addition, protection of the external and internal urinary sphincters maintains
urinary continence and may preserve ejaculatory function.
Continuous energy delivery is required to most effectively necrose diseased
tissue in the prostate and thereby relieve BPH symptoms. The prostate is highly
vascularized and, in response to increased temperature, blood flow within the
prostate is dramatically increased during therapy. This produces an efficient
heat sink which reduces the temperature in the prostate beneath the temperature
threshold required for cell death within only a few minutes after microwave
energy is discontinued. In order to prevent damage to the rectum, FDA guidelines
provide that rectal temperatures not exceed 42.5 degrees C. If this temperature
is exceeded, microwave energy is discontinued to allow the rectal temperature to
decrease. Because of the time/temperature relationship to cell death, a decrease
in temperature in the prostate below the threshold for cell death during the
treatment has a diminished effect on treatment outcome.
The Company's Targis System addresses these challenges through a unique
integration of the following proprietary technologies.
Transurethral Microwave Heating and Catheter Cooling
A specially designed antenna within the Targis Catheter radiates microwave
energy, at approximately 915 MHz, preferentially into the prostatic tissue. The
tissue absorbs this energy, and heat is inductively generated to increase tissue
temperature above 45 degrees C. Meanwhile, chilled water is circulated through
outer channels in the catheter to draw heat away from the surface of the
urethra, thereby cooling it and protecting it from damage. This combination of
inductive microwave heating and conductive urethral cooling results in a
temperature pattern which varies in a
8
predictable and controllable way within the prostate, starting relatively low at
the urethral surface, increasing in temperature rapidly within the prostate and
then decreasing toward the capsule at the perimeter of the gland.
The Company's human clinical studies demonstrated that the Targis procedure
produced and maintained an extensive zone within the prostate which exceeded 45
degrees C and consistently produced tissue necrosis in all patients evaluated.
Because of urethral cooling, however, the temperature close to the urethra was
only slightly elevated. The Targis System is designed to maintain urethral
temperatures below 45 degrees C during the Targis procedure, thus providing a
crucial barrier to pain and allowing the procedure to be accomplished in a
physician's office or outpatient setting without the need for general or
regional anesthesia or intravenous sedation. In addition, post-therapy recovery
is improved as compared to existing surgical procedures because the urethra
remains intact.
Preferential Heating and Continuous Energy Delivery
Because the rectum is located close to the prostate, some of the thermal
energy from the heated prostate conducts into the rectal tissue. Serious
complications could result from significant temperature increases to the rectal
tissue; therefore, the prostate tissue closest to the rectum must be prevented
from reaching temperatures that could be damaging. The Company has a patented
technology that enables the delivery of microwave energy in a radially
preferential fashion. This is employed to direct a greater amount of energy
toward the anterior and lateral regions of the prostate than toward the rectum.
With the use of preferential heating, limitations on heat delivery into the
prostate imposed by the proximity of the prostate to the rectum are minimized.
The Company's Targis System is designed to continuously deliver greater amounts
of energy to the diseased areas of the prostate, resulting in sustained higher
temperatures in these areas, a larger area of cell death and thus a more
effective treatment.
The Targis System is designed to maintain rectal temperatures beneath the
FDA's guideline of 42.5 degrees C. Only on rare occasions in the Company's
clinical trials or subsequent treatments has a patient's rectal temperature
reached 42.5 degrees C. In the event that this limit is reached, the Targis
System is designed to automatically shut off microwave power until the rectal
temperature returns to an acceptable level. Attempts by others to use microwave
energy non-preferentially to heat the prostate have been hindered by frequent
elevation of rectal temperatures which cause treatment to be temporarily
suspended until rectal temperatures decrease.
Impedance Matching and Heat Generation
Transfer of microwave energy from the antenna in the Targis Catheter to the
prostate tissue is affected by the balance between the electrical impedance of
the antenna and the tissue surrounding it. Without adequate matching of the
antenna to its environment, a large portion of the electrical energy can be
reflected back through the antenna cable instead of being radiated to the
prostate as intended, which may cause two compromising effects. The reflection
of microwave energy may cause radiant emissions to occur along the transmission
cable and could result in temperature elevation to areas outside the target
tissue in the prostate. More importantly, a mismatched system may result in the
antenna generating resistive heat. This heat is absorbed by the cooling channels
within the catheter, thereby diminishing the catheter's heat carrying capacity.
This can be important because changes to the temperature of the catheter's
cooling fluid result in urethral temperature changes. The Targis System
addresses these problems by diminishing the amount of energy reflected and
therefore maximizing the radiation of energy in the prostate by matching the
electrical impedance of the antenna with the surrounding tissue for each patient
prior to treatment.
Controlled Energy Delivery
The Targis Catheter utilizes a helical antenna design, which produces an
electrical field that is confined to a region of the prostate gland closely
related to the antenna length. Beyond the antenna's boundaries, the electrical
field strength drops rapidly, thus little microwave heating occurs beyond the
length of the antenna. Within its length, the field is generally uniform,
resulting in uniform heat generation along the antenna length. This ensures
effective control over the zone of tissue damage and provides better assurance
against injury to the internal or external urinary sphincters, which could
affect ejaculation and urinary control.
9
Clinical Status
The combined results of the Company's clinical trials indicate that the
Targis System was effective in reducing AUA Symptom Scores by 56% at three
months and that the results were maintained for at least four years. The data
also demonstrated that the Targis procedure increased peak flow rates for
patients with a mean increase of 4 ml/sec at six months and that the flow rate
increase was maintained to the four year time point. The Company has patient
quality of life data from the 491 patients from whom the Company has received
one-year follow-up data. These patients were asked a statistically validated
quality of life assessment question to evaluate how they would feel living the
rest of their life with their current BPH symptoms. At 12 months following their
Targis procedures, 75% of these patients indicated they were satisfied, an
increase from only 4% giving the same response prior to treatment. There can be
no assurance that future clinical results will be consistent with those achieved
to date.
Of the 714 patients from whom the Company has received follow-up data, no
patient required an anesthetist or anesthesia services during the treatment, and
88% of the patients spent one day or less in bed following the Targis treatment.
Of these 714 patients, there were no cases of long-term incontinence or
significant bleeding resulting from the Targis procedure. Twelve percent of
patients experienced urinary retention which required catheterization for more
than one week. All of these cases were resolved within 30 days. Additionally, 7%
of the patients experienced an episode of urinary tract infection which was
treated and resolved with routine antibiotic therapy, and less than 1%
experienced urethral stricture requiring intervention. Other minor complications
included epididymitis (4%), loss of ejaculate (4%), and transient urinary
incontinence (3%).
Sales and Marketing
The Company's marketing strategy includes (i) increasing market awareness
of the Targis System, (ii) creating access to the Targis System through the
placement and sale of Targis System control units, (iii) enhancing the use of
the Targis System by physicians who have access to the Targis System, and (iv)
demonstrating the cost effectiveness of the Targis System to governmental and
commercial payors.
United States
The Company has developed a sales and marketing team consisting of sales
and marketing management, product managers, communication specialists and direct
sales representatives, who are all dedicated to marketing the Targis System. The
domestic sales force is divided into two tiers. The first tier is composed of
business development managers who are primarily responsible for increasing the
installed based of Targis control units. The second tier is composed of account
development specialists who are dedicated to educating urologists and BPH
patients on the safety, efficacy and other benefits of the Targis System leading
to increased utilization of the Targis treatment. The Company has hired and
trained 10 sales representatives and is actively recruiting additional sales
representatives. As of September 10, 1999, the Company employed a total of 26
individuals in its sales and marketing department.
The Company targets its sales to urologists who practice in high-volume
prostate treatment groups and urologists who are opinion leaders in BPH
treatment methods. The Company currently has 56 Targis Control Units in
operation in the United States. The Company believes that the demographics of
urologists and their practices in the United States will allow for an effective
direct selling strategy.
The Company offers urologists and hospitals the option to either purchase
the Targis System Control Unit or to rent the Targis System on a per use basis.
The list prices for the purchase of a Control Unit and Procedure Kit are
$150,000 and $1,200 respectively. Rental fees vary depending on the length and
terms of the arrangement.
International
The Company has developed broad-based relationships with Nihon Kohden and
Boston Scientific for market development and sales of the Targis System in Japan
and all other foreign countries outside Japan, respectively.
10
The Company entered into a distribution agreement with Boston Scientific in
1996. Under the agreement, Boston Scientific was granted exclusive distribution
rights for the Company's Targis System in all countries outside the United
States excluding Japan for a period of five years ending in 2001. Under the
agreement, which was amended in February of 1999, Urologix has responsibility
for market development of the Targis System and works with Boston Scientific to
sell Targis Systems from Boston Scientific's inventory through Urologix' direct
sales force in Europe. Boston Scientific compensates Urologix for Urologix'
market development services. Prior to entering into this distribution agreement,
Boston Scientific made equity investments in the Company.
In 1994, the Company entered into a distribution agreement with Nihon
Kohden which granted Nihon Kohden exclusive distribution rights for the
Company's Targis System in Japan for a term ending in the year 2000. Under the
agreement, Nihon Kohden agreed to purchase certain minimum numbers of the
Company's Control Units and Procedure Kits. The Company is currently working
with Nihon Kohden to refine certain provisions of the agreement. Nihon Kohden
made an equity investment in the Company concurrently with entering into this
distribution agreement.
Although the Company intends to work with these distributors to improve the
Company's international sales, in light of the significant inventory levels of
Boston Scientific and Nihon Kohden of the Company's products, the Company
expects minimal fiscal 2000 international sales.
Manufacturing
The Company's Targis System consists of the Targis Control Unit and the
Targis Procedure Kit, which includes the Targis Catheter, Cooling Bag and Rectal
Thermosensing Unit.
The Targis Control Unit is currently manufactured by a third party
manufacturer to the Company's specifications under a supply agreement that
expires in February 2000. Currently, the Company manufactures a key component of
the Targis Control Unit, the microwave generator, and provides it to the third
party manufacturer for incorporation into the final Targis Control Unit.
Although the Company expects that the third party manufacturer will be able to
adequately meet demand for the Targis Control Unit on a timely basis, there can
be no assurance that this will be the case.
The Targis Procedure Kits are assembled by the Company, using materials and
components supplied to the Company by various subcontractors and suppliers, as
well as components fabricated by the Company. Several of the components are
currently available to the Company through a single vendor. Wherever possible
and practical, the Company intends to develop alternative sources for every
critical component. Where alternative sourcing is not possible, the Company
intends to enter into supply agreements with each component provider.
Nevertheless, failure to obtain components from such providers or delays
associated with any future component shortages, particularly as the Company
increases its manufacturing level, could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company's manufacturing operations must comply with the FDA's quality
system regulation, which includes, but is not limited to, the FDA's GMP
requirements, and with certain requirements of state, local and foreign
governments, which establish requirements for assuring quality by controlling
components, processes and document traceability and retention, among other
things. In June 1997 and July 1998, the FDA conducted inspections of the
Company's manufacturing facility, in which the Company's facility, documentation
and quality control systems were determined to be satisfactory and no
significant deficiencies of GMP were raised with the Company. The Company's
facilities will also be subject to periodic inspections by the FDA and by other
auditors. The Company believes that its manufacturing and quality control
procedures meet the requirements of these regulations, and has established
training and self-audit systems designed to ensure compliance.
The Company has received ISO 9001 certification indicating compliance of
the Company's manufacturing facilities with European standards for quality
assurance and manufacturing process control. The Company has also received CE
mark certification, which allows it to affix the CE Mark to its products and
market them in the European
11
Union. In addition, the Targis System has been approved for marketing by the
Japanese Ministry of Health and Welfare. As of September 10, 1999, the Company
employed 26 individuals in its manufacturing department.
Research and Development
The Company intends to build upon its clinical knowledge and relationships
to develop innovative future generations of BPH and other urology products. The
Company's research and development efforts are currently focused on reducing the
production cost of the components in the Targis System, improving the function
and features of the Targis System and investigating other applications for its
technologies. The Company also believes that its core technologies may have
other medical applications for prostatic diseases, including malignancies.
During the fiscal years ended June 30, 1999, 1998 and 1997, the Company
spent $5.1 million, $6.7 million and $5.0 million, respectively, in its research
and development efforts. As of September 10, 1999, the Company employed 27
individuals in its research and development department.
Third-Party Reimbursement
The Company believes that third-party reimbursement will be essential to
commercial acceptance of the Targis procedure, and that overall cost
effectiveness and physician advocacy will be keys to obtaining such
reimbursement. The Company believes that the Targis procedure can be performed
for a substantially lower total cost than surgical treatments for BPH or
continuous drug therapy. Consequently, the Company believes that third-party
payors seeking procedures that provide quality clinical outcomes at a lower cost
will reimburse the Targis procedure.
The Company's strategy for obtaining reimbursement in the United States has
been to obtain appropriate reimbursement codes and perform outcome studies in
conjunction with clinical studies to establish the cost effectiveness of the
Targis procedure as compared to surgical and drug treatments for BPH. The
Company plans to use this information when approaching health care payors to
obtain reimbursement authorizations.
The Company estimates that 60% to 80% of patients who receive a Targis
treatment in the United States are eligible for Medicare coverage. The remaining
patients will either be covered by private insurers, including traditional
indemnity health insurers and managed care organizations, or be private-paying
patients.
The United States Health Care Financing Administration ("HCFA"), which
establishes coverage policies for Medicare carriers, can either make national
coverage reimbursement determinations or allow local Medicare carriers to adopt,
modify or ignore model reimbursement policies. Because HCFA has not made a
national coverage determination regarding transurethral microwave therapy, local
Medicare carriers have each made their own coverage decisions and Medicare
coverage for transurethral microwave therapy for BPH is currently available in
all 50 states. Despite these decisions, there can be no assurance that
reimbursement will be available to providers.
For those states where coverage is available from the Medicare carrier,
physicians' professional fees will be reimbursed for performing a Targis
procedure based on a Current Procedural Terminology ("CPT") code. CPT codes are
established by the American Medical Association's CPT Editorial Panel. This
Panel approved the addition of a CPT code and relative value for physicians to
use when submitting claims for performing transurethral microwave therapy. This
code has been published in the 1998 CPT book, which became available in November
1997. The Company believes that the existence of this code makes it easier for
physicians to adopt the Targis procedure. Reimbursement for hospitals by
Medicare fiscal intermediaries (Medicare administrators for hospitals) for the
cost of the Targis System and other costs related to a Targis procedure (other
than the physician's professional fee) is cost-based when submitted by hospitals
to the Medicare fiscal intermediary.
Currently, Medicare reimbursement of transurethral microwave therapy is
limited to procedures performed in an outpatient hospital environment. The
Company believes that the Targis procedure can be performed safely and at a
lower cost in an office-based environment. The Company continues to dedicate
significant effort to gain Medicare coverage for the Targis procedure in an
office-based environment.
The Company has been advised that Medicare will most likely consider
office-based reimbursement for the Targis procedure during the year 2000, with
implementation possible in 2001. There can be no assurance, however, that
office-based reimbursement will be implemented or if implemented, that amounts
reimbursed for performing the Targis procedure will be adequate to encourage use
of the Targis System in an office-based environment.
HCFA has recently proposed and published in the Federal Register new rules
for reimbursement of certain procedures in Ambulatory Surgery Centers ("ASCs")
and hospital outpatient departments. The proposed hospital outpatient rules
create a system known as Ambulatory Patient Classifications ("APCs") for
procedures performed in hospital outpatient departments. This system is similar
in some respects to Diagnostic Related Groups ("DRGs") used
12
by HCFA to reimburse for hospital inpatient surgical procedures. If the
reimbursement amounts proposed for the categories of procedures that would
include the Targis procedure are adopted as proposed, however, they could have a
negative impact on the Company's current list selling prices and gross margins.
The Company submitted comments to HCFA on the proposed rules prior to the close
of the comment period on July 31, 1999, and believes that a number of other
affected organizations also submitted comments on the proposed rules. In
addition to commenting on the proposed rules, the Company is currently assessing
other actions to influence the proposed rules.
The Company has been advised that the proposed rules, if adopted, would
most likely not take effect until the year 2001. There can be no assurance,
however, that the rules will not be implemented or that they will not take
effect earlier than the year 2001.
Private insurance companies and HMOs make their own determinations
regarding coverage and reimbursement based upon "usual and customary" fees
established for CPT codes.
There can be no assurance that the Company will receive favorable coding,
coverage and reimbursement determinations for its Targis System from Medicare
and other payors or that amounts reimbursed to physicians for performing a
Targis procedure will be sufficient to encourage physicians to use the Company's
Targis System.
Internationally, reimbursement approvals for the Targis procedure will be
sought on an individual country basis. Some countries currently have established
reimbursement authorizations for transurethral microwave therapy. Reimbursement
approvals have been obtained through Nihon Kohden Corporation for the Targis
System in Japan. The Company is actively pursuing reimbursement approvals on a
country-by-country basis throughout Western Europe. Clinical studies and
physician advocacy will be used to support reimbursement requests in countries
where there is currently no reimbursement for such procedures.
Patents and Proprietary Rights
The Company aggressively pursues protection of its intellectual property
and has been issued a number of United States patents. The Company also has
patent applications pending in the United States and in a number of foreign
jurisdictions and intends to file additional patent applications in the future.
The majority of the United States patents issued to the Company claim
methods and devices that the Company believes are critical to providing a
safe and efficacious treatment for BPH. Several of the claims under these
patents relate to devices and methods for preferentially limiting the amount of
microwave energy directed toward the rectum. Because cell death is a function of
time and temperature and because the rectum is in close proximity to the
prostate, the Company believes preferential heating is critical to enable
continuous delivery of energy to achieve an adequate zone of necrosis to durably
treat BPH while not endangering the rectum.
The Company also has several issued patents and pending applications
relating to its gamma-matched, helical-dipole microwave antenna. For a
microwave antenna to radiate energy efficiently, it must be impedance matched to
its environment. Further, the antenna design controls the evenness of the
heating and the area to be heated. The Company has been issued patents covering
various designs and methods of its helical microwave antenna with impedance
matching.
There can be no assurance that these patents, or any patents that may be
issued as a result of existing or future applications, will offer any degree of
protection from competitors or that any of the Company's patents or applications
will not be challenged, invalidated or circumvented in the future. In addition,
there can be no assurance that competitors, many of which have substantial
resources and have made substantial investments in competing technologies, will
not seek to apply for and obtain patents that will prevent, limit or interfere
with the Company's ability to manufacture or market its Targis System in the
United States or in international markets. Further, there can be no assurance
the Company's Targis System does not infringe upon the patent rights or other
intellectual property rights of other companies, that the Company will not be
required to seek licenses from other companies or that other companies will not
pursue claims of infringement against the Company.
13
Other companies have developed or are in the process of developing medical
methods and devices to transurethrally treat BPH with microwave energy. Several
companies have applied for, and in some cases received, patents related to such
medical methods and devices. One company, BSD Medical Corporation ("BSD"),
initiated a patent infringement lawsuit against the Company in 1992. The Company
chose to settle that lawsuit in March 1994 by entering into a settlement
agreement with BSD ("the 1994 BSD Settlement Agreement"), under which BSD
granted the Company a license for the patent at issue, as well as several other
patents. In May 1998 the Company entered into a settlement agreement ("1998
Agreement") with BSD Medical Corporation and TherMatrx, Inc. which resolved a
dispute about the 1994 BSD Settlement Agreement. Under the terms of the 1998
Agreement, the Company paid a total of $5.0 million and now holds a fully-paid,
non-cancellable, non-exclusive, worldwide license from BSD Medical and
TherMatrx, Inc. with respect to patents relating to the microwave treatment of
BPH and other urological diseases.
In August 1996, the Company entered into a non-exclusive, worldwide patent
license agreement with EDAP TMS S.A., a French corporation, and its subsidiary,
EDAP Technomed, Inc. (collectively referred to as "EDAP") for certain EDAP
patents relating to the microwave treatment of BPH.
The Company also relies on trade secrets and proprietary know-how, which it
seeks to protect, in part, through proprietary information agreements with
employees, consultants and other parties. The Company's proprietary information
agreements with its employees and most of its consultants contain industry
standard provisions requiring such individuals to assign to the Company, without
additional consideration, any inventions conceived or reduced to practice while
retained by the Company, subject to customary exceptions. The Company's
officers and other key employees also agree not to compete with the Company for
a period following termination. There can be no assurance that proprietary
information or non-compete agreements with employees, consultants and others
will not be breached, that the Company would have adequate remedies for any
breach, or that third parties will not nonetheless gain access to the Company's
technology.
Competition
Competition in the market for BPH treatments is intense and is expected to
increase. The Company believes that its principal competition will come from
both surgical and non-surgical therapies. Surgical therapies include TURP, TUIP
or alternative surgical procedures for vaporization of the prostate tissue using
laser or RF energy. Non-surgical alternatives include drug therapy and emerging
less invasive technologies.
The Company expects that competition in the BPH field will be based, among
other things, on the ability of the therapy to provide safe, effective and
lasting treatment, cost effectiveness of the therapy, acceptance of the
procedure by physicians, health care payors and patients, patent position,
marketing and sales capabilities, and third-party reimbursement policies.
Another factor in competition may be the timing of market introduction of
competitive products.
Government Regulation
United States
Government regulation in the United States and other countries is a
significant factor in the development and marketing of the Company's Targis
System and in the Company's ongoing manufacturing and research and development
activities. The Company and the Targis System are regulated in the United States
by the FDA under a number of statutes including the Federal Food, Drug and
Cosmetic Act ("FDC Act"). Pursuant to the FDC Act, the FDA regulates the pre-
clinical and clinical testing, manufacturing, labeling, distribution, sale,
marketing, advertising and promotion of medical devices in the United States.
Failure to comply with applicable requirements can result in fines, recall or
seizure of products, total or partial suspension of production, distribution,
sales and marketing, suspension or withdrawal of existing product approvals or
clearances, refusals to approve or clear new applications or notices and
criminal prosecution of a company and its officers and employees.
14
Prior to commercial sale in the United States, most medical devices,
including the Company's products, must be cleared or approved by the FDA. In
general, the regulatory process can be lengthy, expensive and uncertain, and
securing FDA clearances or approvals may require the submission of extensive
clinical data together with other supporting information to the FDA. Medical
devices such as the Targis System are classified into one of three classes,
Class I, II or III, on the basis of the controls necessary to reasonably ensure
their safety and effectiveness. Generally, Class III devices are those that must
receive approval of a PMA by the FDA to ensure their safety and effectiveness.
They are generally life-sustaining, life-supporting or implantable devices and
also include most devices that were not on the market before May 28, 1976 and
for which the FDA has not made a finding of "substantial equivalence" based upon
a 510(k).
Before a new device can be introduced to the market, the manufacturer
generally must obtain FDA clearance of a 510(k) or approval of a PMA. Following
submission of the 510(k), the manufacturer may not market the new device until
an order is issued by the FDA finding the device to be "substantially
equivalent" to a legally marketed medical device, i.e., a legally marketed Class
I or Class II medical device or a legally marketed Class III medical device that
does not itself require pre-market approval ("predicate device"). The FDA has no
specific time limit by which it must respond to a 510(k). It generally takes
from three to twelve months from the date of submission for the FDA to respond
to a 510(k) application depending on the complexity of the technology and the
level of review the FDA employs for evaluating the 510(k), but it may take
longer. The FDA may determine that the proposed device is not substantially
equivalent, or that additional clinical or other data are needed before a
substantial equivalence determination can be made.
If a new device is not found to be substantially equivalent to a legally
marketed predicate device, a PMA must be filed with and approved by the FDA
before the product may be marketed. The PMA process is significantly more
complex than the 510(k) process. The PMA process requires the performance of at
least two independent, statistically significant clinical studies that must
demonstrate the safety and effectiveness of the device in order to obtain FDA
approval of the PMA. The PMA process is expensive and often lengthy, typically
requiring several years, and may never result in approval. If the device
presents a "significant risk", the manufacturer or the distributor of the device
must obtain approval of an IDE from the FDA prior to commencing human clinical
trials in support of the PMA. The IDE application must be supported by data,
typically including the results of animal and laboratory testing. If the IDE
application is approved by the FDA (or the FDA does not notify the sponsor 30
days after receipt of the application that the trials may not begin) and one or
more appropriate institutional review boards approves the study protocol,
clinical trials may begin at a specified number of investigational sites with a
specific number of patients, as approved by the FDA. The FDA has the authority
to re-evaluate, alter, suspend or terminate clinical testing based on its
assessment of data collected throughout the trials. An IDE supplement must be
submitted to, and approved by, the FDA (or the FDA does not notify the sponsor
30 days after receipt of the supplement that the change may not be implemented)
before a sponsor or an investigator may make a change to the investigational
plan that may affect its scientific soundness or the rights, safety or welfare
of human subjects. Sponsors of clinical trials are permitted under FDA
regulations to sell the devices distributed in the course of the clinical study,
provided that such compensation does not exceed recovery of the costs of
manufacturing, research, development and handling.
In 1993, the FDA issued a policy statement indicating that medical devices
seeking to be labeled for use in treatment of BPH would be classified as Class
III devices which will require FDA approval of a PMA before marketing may begin.
The FDA approved the PMA for the Targis System by a letter (order) dated
August 22, 1997. In July 1998, the FDA approved expanded claims for the product
allowing treatment for obstruction of the urethra caused by BPH. The FDA made
the Targis System a restricted device which means that its labeling specifies
requirements for the training of physicians who may use the device and that the
FDA has greater control over advertising for the Targis System.
The FDA imposed a number of post approval requirements, including a study
to collect 5-year follow-up data to evaluate the long-term effects of the Targis
System treatment in at least 100 patients. This post approval study must assess
the rates of adverse events that occurred during the 5-year follow-up period, as
well as the rate of repeat and alternative treatments that were administered. As
with all such medical devices, the Targis System will be subject to
15
continual FDA and other regulatory agency review and regulation. Subsequent
discovery of previously unknown problems or failure to comply with applicable
requirements can result in severe administrative, civil, and criminal sanctions.
The FDA's regulations require agency approval of a PMA supplement for
certain changes if they affect the safety and effectiveness of the device. Such
changes include, but are not limited to: new indications for use; the use of a
different facility or establishment to manufacture, process or package the
device; changes in manufacturing methods or quality control systems; changes in
vendors used to supply components of the device; changes in performance or
design specifications, and certain labeling changes. Any such changes will
require FDA approval of a PMA supplement before marketing. There can be no
assurance that the required approvals of PMA supplements for any changes to the
Targis System will be granted on a timely basis or at all, and delays in receipt
of, or failure to receive such approvals, or the loss of the approval of the PMA
for the Targis System, would have a material adverse effect on the business,
financial condition and results of operations of the Company.
Advertising and promotional activities are subject to regulation by the FDA
and, in certain instances, by the Federal Trade Commission. Other applicable
requirements include the FDA's medical device reporting regulations, which will
require that the Company provide information to the FDA on deaths or serious
injuries alleged to have been associated with the use of its marketed devices,
as well as product malfunctions that would likely cause or contribute to a death
or serious injury if the malfunction were to recur. Failure to meet these
pervasive FDA requirements could subject the Company and/or its employees to
injunction, prosecution, civil fines, seizure or recall of products, prohibition
of manufacturing, distribution, sales or marketing or suspension or withdrawal
of any previously granted approvals.
The FDC Act regulates the Company's quality control and manufacturing
procedures by requiring the Company to demonstrate and maintain compliance with
quality system including GMP requirements as specified in the FDA device quality
system ("QS") regulation. This regulation requires, among other things, that
(i) the manufacturing process be regulated and controlled, and documented by the
use of written procedures and (ii) the ability to produce devices which meet the
manufacturer's specifications be validated by extensive and detailed testing of
every aspect of the process. The regulation also requires investigation of any
deficiencies in the manufacturing process or in the products produced and
detailed record keeping. In addition, the QS regulation requires preproduction
design controls, purchasing controls and maintenance of service records. The QS
regulation is expected to increase the cost of complying with the FDA GMP and
related requirements. The FDA monitors compliance with QS including GMP
requirements by conducting periodic inspections of manufacturing facilities. If
violations of applicable regulations are noted during FDA inspections of
manufacturing facilities, the FDA or the government through court enforcement
action can prohibit further manufacturing, distribution, sale and marketing of
the device until the violations are cured, and in that circumstance the
continued marketing of the Company's products would be adversely affected. Such
regulations are subject to change and depend heavily on administrative
interpretations. There can be no assurance that future changes in regulations or
interpretations made by the FDA or other regulatory bodies, with possible
retroactive effect, will not adversely affect the Company.
International
Sales of medical devices outside of the United States are subject to United
States export requirements and foreign regulatory requirements. Exportation of
a device that complies with FDA requirements for commercial distribution in the
United States is not subject to any FDA export permit requirement so long as the
device is exported for the indication(s) for which commercial distribution in
the United States is lawful under the FDA Act.
The Company has met the necessary registration requirements in the European
Union, Japan and Canada to commercialize the Targis System. In addition, the
Company's distributors have obtained the necessary registration requirements to
commercialize the Targis System in a number of different countries. Legal
restrictions on the sale of imported medical devices vary from country to
country. The time required to obtain approval by a foreign country may be longer
or shorter than that required for FDA approval, and the requirements may differ.
The Company has
16
implemented ISO 9001, a certification showing that the Company's procedures and
manufacturing facilities comply with standards for quality assurance and
manufacturing process control. The ISO 9001 certification, along with the
European Medical Device Directive ("MDD") certification, received in early
fiscal 1997, evidences compliance with the requirements and enables the Company
to affix the CE Mark to its current products. The CE Mark denotes conformity
with European standards for safety and allows certified devices to be placed on
the market in all EU countries. Medical devices may not be sold in European
Union countries unless they display the CE Mark. There can be no assurance that
the Company will be able to obtain regulatory approvals or clearances for its
products in other foreign countries.
The Company's distributor in Japan, Nihon Kohden, is responsible for
obtaining regulatory and reimbursement approvals for the Targis System in Japan.
In February 1997, the Company's Targis System received regulatory approval from
the Japanese Ministry of Health and Welfare.
Product Liability and Insurance
The business of the Company entails the risk of product liability claims.
Although the Company has not experienced any product liability claims to date,
any such claims could have an adverse impact on the Company. The Company
maintains product liability insurance with coverage of $1.0 million per
occurrence and an annual aggregate maximum of $2.0 million. The Company also
carries a $15.0 million umbrella insurance policy. The Company evaluates its
insurance requirements on an ongoing basis. There can be no assurance that
product liability claims will be covered by such insurance, will not exceed such
insurance coverage limits or that such insurance will be available on
commercially reasonable terms, or at all.
Employees
As of September 10, 1999, the Company employed 87 individuals on a full-
time basis. The Company also has several part-time employees and consultants.
The Company believes that it has been successful in attracting experienced and
capable personnel, although there can be no assurance that the Company will
continue to attract and retain qualified personnel. None of the Company's
employees is covered under a collective bargaining agreement. The Company
considers relations with its employees to be good.
Backlog
Although the Company has received orders for future delivery of its
products, the Company did not have a significant backlog at September 10, 1999.
Risk Factors
Uncertainty of Market Acceptance
The Targis procedure represents a new therapy for BPH, and there can be no
assurance that the Targis System will gain any significant degree of market
acceptance among physicians, health care payors or patients. Physicians may
elect not to perform the procedure unless adequate reimbursement from health
care payors is available. Health care payor acceptance of the Targis procedure
will require, among other things, evidence of the cost effectiveness of the
Targis procedure as compared to other BPH therapies. Patient acceptance of the
procedure will depend in part on physician recommendations, as well as other
factors, including the degree of invasiveness, the rate and severity of
complications and other side effects associated with the procedure as compared
to other therapies.
Dependence on Third-Party Reimbursement
The Company's success will be largely dependent upon the extent to which
satisfactory reimbursement for the Targis procedure can be obtained from health
care payors for physicians performing the Targis procedure and for costs of the
Targis System procedure. In the United States and in international markets,
third-party reimbursement is
17
generally available for certain existing therapies used for treatment of BPH.
Third-party reimbursement is dependent upon decisions by the Health Care
Financing Administration ("HCFA") and contract Medicare carriers for Medicare,
individual managed care organizations, private insurers, foreign governmental
health programs and other payors. Any failure to receive favorable coding,
coverage and reimbursement determinations for the Targis System by these
organizations could discourage physicians from using the Targis System.
Dependence on Patents and Proprietary Rights
The Company's success depends in part on its ability to protect its Targis
System and technology under United States and international patent laws and
other intellectual property laws and to operate without infringing upon the
proprietary rights of third parties. The validity and breadth of claims covered
in medical technology patents involve complex legal and factual questions and,
therefore, may be highly uncertain. Companies in the medical device industry
have employed intellectual property litigation to gain a competitive advantage.
Other companies have developed or are in the process of developing medical
methods and devices to transurethrally treat BPH with microwave energy.
Reliance on Single Product
The Targis System is the Company's sole product. As such, the Company's
future success is entirely reliant upon its ability to market the Targis System
commercially in the United States and elsewhere. If the Company is unable
to commercialize the Targis System successfully, the Company's business,
financial condition and results of operations would be materially adversely
affected.
Limited Manufacturing Experience; Scale-Up Risk; Product Recall Risk.
The Company has limited experience in manufacturing its products in
commercial quantities. 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. Any products manufactured or distributed by the Company
pursuant to FDA clearances or approvals are subject to pervasive and continuing
regulation by the FDA, including record keeping requirements and reporting of
adverse experience with the use of the device. The Company's manufacturing
facilities are subject to periodic inspection by the FDA, certain state agencies
and foreign regulatory agencies. The Company requires that its key suppliers
comply with International Standards for production of medical devices, and
performs audits to ensure that the Company's suppliers meet both recognized
standards and the Company's own stringent quality standards. The failure of the
Company or its suppliers to comply with regulatory requirements could have a
material adverse effect on the Company's business. There can be no assurance
that the Company will not be required to incur significant costs to comply with
laws and regulations in the future or that laws or regulations will not have a
material adverse effect upon the Company's business.
Dependence on Third-Party Distributors for International Sales
To date, a majority of the Company's revenues outside the United States
have been derived from sales of its Targis System through third-party
distributors. Boston Scientific has exclusive distribution rights for the Targis
System in all countries outside the United States, except Japan, and Nihon
Kohden has exclusive distribution rights in Japan. Although the Company intends
to work with these distributors to improve the Company's international sales, in
light of the current significant inventory levels of Boston Scientific and Nihon
Kohden of the Company's products, the Company expects minimal fiscal 2000
international sales. The failure to effectively market the Company's Targis
System in the international markets could have an adverse effect on the
Company's ability to achieve penetration of these markets and establish long-
term acceptance of the Targis System.
18
Contract Manufacturing; Dependence Upon Key Suppliers
The control unit for the Targis System is assembled by a third party
manufacturer pursuant to a supply agreement with the Company. If for any reason
the third party manufacturer is unable or unwilling to manufacture the control
unit for the Company in the future, the Company could incur significant delays
in obtaining a substitute contract manufacturer. In addition, the Company
purchases additional components used in the Targis System from various suppliers
and relies on single sources for several components. One such component is
obtained from a source that has a patent for the technology. Delays could be
caused if supply of this component or other components were interrupted. These
delays could be extended in certain situations where a substitute contract
manufacturer or a component substitution would require approval by the FDA of a
PMA supplement.
Year 2000 Issue Risks
The Company is evaluating the potential impact of what is commonly referred
to as the Year 2000 issue, concerning the inability of certain information
systems to properly recognize and process dates containing the year 2000 and
beyond. Although the Company believes that the Year 2000 issue will not have a
significant effect on the Company, there can be no assurance that the Company
will not be affected by this issue. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Year 2000 Issue" in Item 7 of
this Form 10-K for a detailed discussion of the Company's preparation for the
year 2000 issue.
Possible Volatility of Stock Price.
The stock market has from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies. These broad market fluctuations may adversely affect the
market price of the Company's Common Stock. In addition, the market price of the
shares of Common Stock is likely to be highly volatile. Factors such as
fluctuations in the Company's operating results, announcements of technological
innovations or new products by the Company or its competitors, FDA and
international regulatory actions, actions with respect to reimbursement matters,
developments with respect to patents or proprietary rights, public concern as to
the safety of products developed by the Company or others, changes in health
care policy in the United States and internationally, changes in stock market
analyst recommendations regarding the Company, other medical device companies or
the medical device industry generally and general market conditions may have a
significant effect on the market price of the Common Stock.
19
ITEM 2. PROPERTIES
- --------------------
The Company leases approximately 37,000 square feet of office,
manufacturing and warehouse space in a suburb of Minneapolis, Minnesota. The
lease expiration date is March 31, 2003. The Company believes its facilities
will be sufficient to meet the Company's current requirements and that
additional space at or near the current location will be available at a
reasonable cost if such space is required in the future.
ITEM 3. LEGAL PROCEEDINGS
- ---------------------------
The Company is not involved in any material pending litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------------
Not applicable.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
- ------- ---------------------------------------------------- ---------------
MATTERS
-------
The Company's Common Stock is traded on the Nasdaq Stock Market under the
symbol ULGX. The following table sets forth quarterly high and low last sales
prices of the Company's Common Stock for the past two years.
Quarter
Fiscal Year First second Third Fourth
- ----------- -----------------------------------------
1999 High 8 15/16 6 5 3 11/16
Low 4 1/2 3 1/2 3 2 1/4
1998 High 23 1/4 25 1/4 19 7/8 11 3/8
Low 16 16 1/4 8 1/4 8 1/4
On September 1, 1999, the Company had 348 shareholders of record. The Company
has never paid cash dividends on its Common Stock. The Board of Directors of the
Company currently intends to retain any and all income for use in the Company's
business and does not anticipate paying any cash dividends in the foreseeable
future.
21
ITEM 6. SELECTED FINANCIAL DATA
- ---------------------------------
Years Ended June 30,
- ---------------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
Statements of Operations Data: (in thousands, except per share data)
Sales.................................................... $ 6,110 $ 11,194 $ 5,504 $ 362 $ 489
Cost of goods sold....................................... 5,910 9,162 4,866 1,177 785
----------- -------- -------- -------- --------
Gross profit (loss)................................... 200 2,032 638 (815) (296)
Costs and Expenses:
Research and development.............................. 5,106 6,676 5,049 4,811 4,099
Sales and marketing................................... 6,838 6,765 3,430 1,007 477
General and administrative............................ 4,018 2,284 2,226 1,192 884
Total costs and expenses................................. 15,962 15,725 10,705 7,010 5,460
----------- -------- -------- -------- --------
Operating loss........................................... (15,762) (13,693) (10,067) (7,825) (5,756)
Interest income, net..................................... 1,746 2,056 1,833 232 329
Litigation expense....................................... -- (3,376) -- -- --
Net loss................................................. $ (14,016) $(15,013) $ (8,234) $ (7,593) $ (5,427)
============= ======== ======== ======== ========
Basic and Diluted Loss:
Net loss per common share................................ $(1.24) $ (1.44) $ (0.90) $ (1.22) $ (0.91)
Shares used in computing net
loss per share (1)....................................... 11,346 10,429 9,173 6,235 5,996
June 30,
- ---------------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
Balance Sheet Data: (in thousands)
Cash, cash equivalents and
available-for-sale securities.......................... $ 28,036 $ 36,500 $ 26,101 $ 40,844 $ 3,571
Working capital.......................................... 28,803 41,375 27,013 39,940 3,372
Total assets............................................. 38,988 53,489 35,582 42,368 4,876
Total liabilities........................................ 3,521 4,152 3,185 1,780 899
Accumulated deficit...................................... (55,796) (41,780) (26,767) (18,534) (10,940)
Total shareholders' equity............................... $ 35,467 $ 49,337 $ 32,397 $ 40,588 $ 3,977
- ---------------------------------
(1) Restated to reflect impact of preferred share conversion to common shares
in May 1996.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- ---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Overview
Urologix, Inc., incorporated in 1991, develops, manufactures and markets
minimally invasive medical devices for the treatment of urological diseases. The
Company has developed the Targis System, a one-time, minimally invasive
treatment, that uses a proprietary microwave technology to treat benign
prostatic hyperplasia ("BPH"), a disease that affects over 23 million men
worldwide. In August 1997, the Company received FDA approval to market the
Targis System in the United States. Regulatory approvals necessary to market the
Targis System in Japan and the European Union countries were obtained in fiscal
1997. The Company's Targis System consists of a control unit and a procedure kit
that includes the microwave delivery system incorporated in a catheter, a
cooling bag and a rectal thermosensing unit.
The Company markets the Targis System in the United States through a direct
sales force and its co-marketing partner, Boston Scientific Corporation, a
worldwide developer, manufacturer and marketer of medical devices. Urologix'
direct sales force has sole responsibility for completing and transacting the
sales of the Targis System, while Boston Scientific, through selected members of
its Microvasive Urology sales force, assists in the promotion and marketing of
the Targis System procedure among urologists throughout the United States. The
Company has developed a sales and marketing team consisting of sales and
marketing management, product management, communication specialists and direct
sales representatives, all of whom are dedicated to marketing the Targis System.
Outside the United States, the Company has developed a relationship with
Nihon Kohden Corporation ("Nihon Kohden"), a major Japanese developer,
manufacturer and marketer of medical devices, for market development and sales
of the Targis System in Japan. The Company has a distribution agreement with
Boston Scientific covering all countries outside the United States except Japan.
Under the agreement, which was amended in February 1999, Urologix has
responsibility for market development of the Targis System and works with Boston
Scientific to sell Targis Systems from Boston Scientific's inventory through
Urologix' direct sales force in Europe. Boston Scientific compensates Urologix
for Urologix' market development services.
Since inception, the Company has experienced operating losses and
anticipates that its operating losses will continue for the foreseeable future.
Expenditures will be related primarily to the continuing market development in
the United States, scale-up of commercial manufacturing, and research and
development activities.
Results of Operations
Fiscal Years Ended June 30, 1999 and 1998
Sales decreased to $6.1 million in fiscal 1999 from $11.2 million in fiscal
1998 due to a decrease in international sales. Sales in the United States
represented approximately 92% of revenue in fiscal 1999, compared to 27% of
revenue in fiscal 1998, representing growth in United States sales of 87% from
fiscal 1998 to fiscal 1999. The Company anticipates United States sales to
increase in fiscal 2000 compared to fiscal 1999; however, international sales
are expected to be minimal due to existing inventory levels of Targis Systems at
the Company's international distributors.
23
Cost of goods sold includes raw materials, labor, overhead and royalties
incurred in connection with the production of the Targis System control units
and disposable procedure kits. Cost of goods sold decreased to $5.9 million in
fiscal 1999 compared to $9.2 million in fiscal 1998. The decrease in cost of
goods sold is attributable primarily to decreases in sales volume. Excluding the
impact of a $1.3 million reserve for excess inventory established in fiscal 1999
and a $700,000 inventory write down related to a bad component recorded in
fiscal 1998, gross profit as a percentage of sales was 25% in 1999, relatively
unchanged compared to fiscal 1998. The Company expects gross profit as a percent
of sales to increase in the future as a result of higher sales in the United
States and from benefits realized from reductions in product and operating costs
and improvements in the manufacturing process.
Research and development expenses include those costs associated with
product development, protection of the Company's intellectual property,
treatment of patients participating in clinical trials, the accumulation of
outcome data to substantiate clinical results and the preparation and submission
of applications for regulatory approvals. Research and development expenses
decreased to $5.1 million in fiscal 1999 from $6.7 million in fiscal 1998, due
primarily to the conclusion of several clinical studies, lower regulatory
expenses and the settlement of litigation. Research and development expenses in
fiscal 2000 are expected to decrease due to lower clinical study expenses,
reduced staffing levels and lower regulatory expenses.
Sales and marketing expenses for fiscal 1999 were $6.8 million, which is
consistent with fiscal 1998. Additional sales and marketing costs incurred in
1999, including fees paid to Boston Scientific in connection with the domestic
co-marketing agreement, were offset by payments received from Boston Scientific
for international market development services provided by Urologix. These
payments were recorded as a reduction to sales and marketing expense. Sales and
marketing expenses were primarily related to sales and marketing personnel,
recruitment of field sales representatives, advertising and promotion, and
efforts related to obtaining third-party reimbursement for the Targis System.
The Company expects sales and marketing expenses to increase as it increases its
sales efforts in the United States and continues to support its international
market development efforts.
General and administrative expenses increased to $4.0 million in fiscal
1999 compared to $2.3 million in fiscal 1998. General and administrative
expenses for fiscal 1999 reflect a non-recurring charge of $1.6 million incurred
in connection with a reduction in workforce in October 1998 that resulted from
the downward revision of the Company's sales forecast. The charge included
severance costs paid to employees, future lease costs related to facilities no
longer occupied and the impairment of assets no longer used as a result of the
reduction in work force.
Interest income decreased to $1.7 million for fiscal 1999 from $2.1 million
in fiscal 1998. Interest income decreased due primarily to lower cash and
investment balances.
Fiscal Years Ended June 30, 1998 and 1997
Sales increased to $11.2 million in fiscal 1998 from $5.5 million in fiscal
1997, due to initial sales in the United States resulting from FDA commercial
marketing approval and an increase in shipments of the Targis System to the
Company's international distributors resulting from regulatory marketing
approvals obtained in the European Union and Japan. Sales in the United States
represented 27% of total sales in fiscal 1998.
Cost of goods sold increased to $9.2 million in fiscal 1998 from $4.9
million in fiscal 1997, due primarily to the significant increase in sales and
production. Cost of goods sold were impacted by two events in fiscal 1998.
First, the Company wrote down finished goods inventory by $700,000 during the
third quarter as a result of a component that caused an occasional failure of
the Targis System catheter. Second, during the fourth quarter, the Company
reduced its current production schedule in anticipation of introducing an
upgraded catheter in July 1998.
Research and development expenses in fiscal 1998 increased to $6.7 million
from $5.0 million in fiscal 1997, primarily due to costs related to new and on-
going clinical studies of the Targis System, product development activities
related to Targis System improvements and alternative applications for the
Company's technology, and the Company's settlement of litigation concerning its
rights under a previous settlement agreement.
24
Sales and marketing expenses in fiscal 1998 increased to $6.8 million from
$3.4 million in fiscal 1997, due primarily to costs associated with the
Company's United States marketing launch of the Targis System and marketing
support of the Targis System in Europe and Japan. These costs included the
hiring of sales and marketing personnel, preparation of promotional materials,
and efforts related to obtaining third-party reimbursement for the Targis
System.
General and administrative expenses in fiscal 1998 increased slightly to
$2.3 million from $2.2 million in fiscal 1997, due to administrative costs
associated with an increase in employees in connection with the Company's growth
and commencement of United States sales activities.
Interest income was relatively unchanged for fiscal 1998 compared to fiscal
1997, primarily as a result of similar average invested balances.
Liquidity and Capital Resources
The Company has financed its operations since inception through sales of
equity securities and, to a lesser extent, sales of the Targis System. As of
June 30, 1999, the Company had total cash, cash equivalents and available-for-
sale securities of $28.0 million and working capital of $28.8 million.
During fiscal 1999, the Company used $7.6 million in operating activities,
primarily as a result of the Company's net loss, a decrease in inventories of
$1.9 million and accounts receivable of $2.7 million. The Company generated $7.3
million in investing activities, primarily reflecting the net sale of $8.3
million in investment securities less purchases of $1.0 million of property and
equipment. The Company financed its fiscal 1999 operating and investing
activities primarily through a November 1997 secondary offering that raised net
proceeds of $31.5 million.
At June 30, 1999, the Company did not have any significant purchase
commitments.
The Company expects to continue to incur additional losses and will use
its working capital as it incurs substantial expenses related to the Targis
System market development in the United States, clinical trials and research and
development activities. In addition, the Company has commenced a program to rent
Targis System control units on a per procedure basis to customers. Depending on
the success of this program, the Company may use substantial capital to finance
the units rented by customers.
Although the Company believes that existing cash, cash equivalents and
available-for-sale securities will be sufficient to fund its operations for at
least the next 24 months, there can be no assurance that the Company will not
require additional financing in the future or that any additional financing will
be available to the Company on satisfactory terms, if at all.
Interest Rate Risk
The fair value of the Company's investment portfolio at June 30, 1999
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 10% increase in interest rates for the issues contained in
the investment portfolio and was not materially different from the year-end
carrying value.
25
Year 2000 Issue
Many currently installed computer systems and software products are coded
to accept, store or report only two-digit year entries in date code fields.
Beginning in the Year 2000 (Y2K), these date code fields will need to accept
four-digit entries to distinguish 21st century dates from 20th century dates.
The Y2K issue is a result of these programs being written with two digits
instead of four. As a result, computer systems and software used by companies,
including Urologix and its vendors and customers, will need to comply with the
Y2K requirements.
The Company is aware of the Y2K issue and has been proactive in addressing
the issue internally and externally. The Company's primary software system is
currently Y2K compliant. The Company does not depend on in-house custom systems
and generally purchases off-the-shelf software from reputable vendors who have
tested their software for Y2K compliance. The Y2K issue is being considered for
all future software purchases. Although the Company believes the Y2K issue will
not pose material operational problems for its computer systems, there can be no
assurance that problems arising from the Y2K issue will be completely
eliminated.
The Company is evaluating significant suppliers' and large customers'
systems to determine the extent to which the Company's interface with these
systems is vulnerable to the Y2K issue. This process is in progress and should
be completed prior to 2000.
Urologix products are Y2K compliant and are able to operate in the Year
2000 and beyond. The Company believes it has an effective program in place to
resolve Y2K issues in a timely manner. The Company also has contingency plans
for certain critical applications and is working on such plans for others. These
contingency plans involve, among other actions, manual workarounds, increasing
inventories and adjusting staffing strategies. In the event that the Company
does not completely resolve all of the Y2K issues, the Company's business
operations could be adversely affected, although the resulting costs and loss of
business cannot be reasonably estimated at this time.
26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------- ----------------------------------------------------------
Information with respect to Disclosures about Market Risk is contained in
the Section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations- Interest Rate Risk" under Item 7 of this
Report of Form 10-K and is incorporated herein by reference.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------
The following financial statements are included in the Form 10-K.
Page
----
Report of Independent Public Accountants............................ 29
Balance Sheets as of June 30, 1999 and 1998......................... 30
Statements of Operations for years ended June 30, 1999, 1998 and
1997................................................................ 31
Statements of Shareholders' Equity for years ended June 30, 1999,
1998 and 1997....................................................... 32
Statements of Cash Flows for years ended June 30, 1999, 1998 and
1997................................................................ 33
Notes to Financial Statements....................................... 34
28
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Urologix, Inc.:
We have audited the accompanying balance sheets of Urologix, Inc. (a Minnesota
corporation) as of June 30, 1999 and 1998, and the related statements of
operations, shareholders' equity and cash flows for each of the three fiscal
years in the period ended June 30, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Urologix, Inc. as of June 30,
1999 and 1998, and the results of its operations and its cash flows for each
of the three fiscal years in the period ended June 30, 1999, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
July 23, 1999
29
UROLOGIX, INC.
Balance Sheets
As of June 30
1999 1998
---------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 657,596 $ 882,801
Available-for-sale securities 27,378,692 35,616,726
Accounts receivable, net of allowance of $171,216 and $0 1,260,810 4,013,533
Inventories 2,436,418 4,313,895
Prepaids and other current assets 588,355 691,102
---------------- --------------
Total current assets 32,321,871 45,518,057
---------------- --------------
PROPERTY AND EQUIPMENT:
Leasehold improvements 742,923 1,001,934
Machinery, equipment and furniture 4,029,743 3,900,839
Less- Accumulated depreciation and amortization (2,521,479) (1,703,293)
---------------- --------------
Property and equipment, net 2,251,187 3,199,480
OTHER ASSETS 4,414,974 4,771,222
---------------- --------------
$ 38,988,032 $ 53,488,759
================ ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of capitalized lease obligations $ 8,924 $ 28,138
Accounts payable 836,999 1,960,768
Accrued liabilities 2,672,743 2,154,078
---------------- --------------
Total current liabilities 3,518,666 4,142,984
CAPITALIZED LEASE OBLIGATIONS, less current maturities 2,723 8,871
---------------- --------------
Total liabilities 3,521,389 4,151,855
---------------- --------------
COMMITMENTS AND CONTINGENCIES (Note 5)
SHAREHOLDERS' EQUITY:
Undesignated stock, 5,000,000 shares authorized; none issued or
outstanding - -
Series A Junior Participating Preferred Stock, 250,000 shares
authorized; none issued or outstanding - -
Common stock, $.01 par value, 25,000,000 shares authorized; 11,428,937
and 11,239,892 shares issued and outstanding 114,289 112,399
Additional paid-in capital 91,149,858 91,016,366
Accumulated deficit (55,796,123) (41,780,353)
Accumulated other comprehensive loss (1,381) (11,508)
---------------- --------------
Total shareholders' equity 35,466,643 49,336,904
---------------- --------------
$ 38,988,032 $ 53,488,759
================ ==============
The accompanying notes to financial statements are an integral part of these
balance sheets.
30
UROLOGIX, INC.
Statements of Operations
For the Years Ended June 30
-----------------------------------------------------
1999 1998 1997
-----------------------------------------------------
SALES $ 6,109,890 $ 11,194,212 $ 5,503,800
COST OF GOODS SOLD 5,909,826 9,161,708 4,866,082
----------------- ----------------- -----------------
Gross Profit 200,064 2,032,504 637,718
----------------- ----------------- -----------------
COSTS AND EXPENSES:
Research and development 5,106,379 6,676,716 5,048,917
Sales and marketing 6,837,544 6,764,832 3,429,443
General and administrative 4,018,339 2,283,817 2,226,012
----------------- ----------------- -----------------
Total costs and expenses 15,962,262 15,725,365 10,704,372
----------------- ----------------- -----------------
OPERATING LOSS (15,762,198) (13,692,861) (10,066,654)
INTEREST INCOME, net 1,746,428 2,056,014 1,832,798
LITIGATION SETTLEMENT EXPENSE (Note 5) - (3,376,144) -
----------------- ----------------- -----------------
NET LOSS $(14,015,770) $ (15,012,991) $ (8,233,856)
================= ================= =================
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (1.24) $ (1.44) $ (0.90)
================= ================= =================
BASIC AND DILUTED WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING (Note 2) 11,346,148 10,428,520 9,173,419
================= ================= =================
The accompanying notes to financial statements are an integral part of these
statements.
31
UROLOGIX, INC.
Statements of Shareholders' Equity
Accumulated
Additional Other
Common Stock Paid-In Accumulated Comprehensive Shareholders'
Shares Amount Capital Deficit Income (Loss) Equity
----------------------------------------------------------------------------------
BALANCE, June 30, 1996 9,128,433 $ 91,284 $59,030,559 $(18,533,506) - $ 40,588,337
Change in unrealized losses
on investment - - - - (59,258) (59,258)
Net loss - - - (8,233,856) - (8,233,856)
------------
Comprehensive loss - - - - - (8,293,114)
------------
Stock options exercised 128,161 1,282 100,538 - - 101,820
----------------------------------------------------------------------------------
BALANCE, June 30, 1997 9,256,594 92,566 59,131,097 (26,767,362) (59,258) 32,397,043
Change in unrealized losses
on investment - - - - 47,750 47,750
Net loss - - - (15,012,991) - (15,012,991)
------------
Comprehensive loss - - - - - (14,965,241)
------------
Stock options exercised 240,562 2,406 198,142 - - 200,548
Shares issued through
public offering, net 1,725,000 17,250 31,509,851 - 31,527,101
Shares issued pursuit to
employee stock purchase plan 17,736 177 177,276 - 177,453
----------------------------------------------------------------------------------
BALANCE, June 30, 1998 11,239,892 112,399 91,016,366 (41,780,353) (11,508) 49,336,904
Change in unrealized losses
on investment - - - - 10,127 10,127
Net Loss - - - (14,015,770) - (14,015,770)
------------
Comprehensive loss - - - - - (14,005,643)
------------
Stock options exercised 159,224 1,592 68,986 - - 70,578
Stock awards net of related
amortization 29,821 298 64,506 - - 64,804
----------------------------------------------------------------------------------
Balance, June 30, 1999 11,428,937 $114,289 $91,149,858 $(55,796,123) $ (1,381) $ 35,466,643
==================================================================================
The accompanying notes to financial statements are an integral part of these
statements.
32
UROLOGIX, INC.
Statements of Cash Flows
For the Years Ended June 30
-----------------------------------------------
1999 1998 1997
-------------- ------------- ----------------
OPERATING ACTIVITIES:
Net loss $(14,015,770) $(15,012,991) $ (8,233,856)
Adjustments to reconcile net loss to net cash used for operating
activities-
Depreciation and amortization 1,469,355 1,619,940 431,223
Loss on disposal of assets 773,191 - -
Change in operating items:
Accounts Receivable 2,752,723 (2,194,522) (1,703,453)
Inventories 1,877,477 (2,740,539) (1,237,928)
Prepaids and other assets 155,609 29,278 (301,617)
Accounts payable and accrued liabilities (605,104) 987,058 1,424,064
------------- ------------ ------------
Net cash used for operating activities (7,592,519) (17,311,776) (9,621,567)
------------- ------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment (990,867) (2,222,112) (1,901,246)
Purchase of securities (37,535,450) (57,164,738) (83,807,022)
Proceeds from sale of securities 45,783,611 47,421,001 98,701,702
Purchase of intangible assets, net - (2,000,000) (3,244,620)
------------- ------------ ------------
Net cash provided by (used for) investing activities 7,257,294 (13,965,849) 9,748,814
------------- ------------ ------------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net 135,382 31,905,102 101,820
Payments made on capital lease obligations (25,362) (20,247) (18,538)
------------- ------------ ------------
Net cash provided by financing activities 110,020 31,884,855 83,282
------------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (225,205) 607,230 210,529
CASH AND CASH EQUIVALENTS:
Beginning of year 882,801 275,571 65,042
------------- ------------ ------------
End of year $ 657,596 $ 882,801 $ 275,571
============= ============ ============
Supplemental Cash Flow Disclosures:
============= ============ ============
Cash paid for interest: $ 3,346 $ 5,863 $ 8,706
============= ============ ============
The accompanying notes to financial statements are an integral part of these
statements.
33
UROLOGIX, INC.
Notes to Financial Statements
1. Nature of Business:
Description of Operating Activities
Urologix, Inc. (Urologix or the Company) was organized to research, develop,
manufacture and market innovative devices for the treatment of benign prostatic
hyperplasia (BPH) and other urological disorders. Since inception (May 29, 1991)
through June 30, 1996, the Company was a development stage enterprise, having
devoted substantially all of its efforts to proprietary product development and
selling the Targis System to international distributors. These efforts also
included raising capital, performing clinical trials and developing commercial
markets. The Company received regulatory approvals necessary to market the
Targis System in the European Union Countries, Japan and Canada prior to fiscal
1998 and, in August 1997, received United States Food and Drug Administration
approval to market the Targis System in the United States.
Although the Company began actively selling its products during 1997 and no
longer considers itself to be in the development stage, it has not operated
profitably to date and there are no assurances that it will operate profitably
in the future.
2. Significant Accounting Policies:
Cash and Cash Equivalents
The Company classifies highly liquid investments with original maturities of 90
days or less to be cash equivalents. Cash equivalents are stated at cost, which
approximates market value.
Available-for-Sale Securities
The Company invests in money market funds and U.S. government and investment-
grade corporate securities with original maturities ranging from 90 days to two
years. These investments are considered to be available-for-sale and are stated
at market value, with the resulting unrealized gains or losses reported as a
component of comprehensive income in the statement of shareholders' equity.
Inventories
Inventories are stated at the lower of first-in, first-out cost or market and
consist of:
June 30
--------------------------------------------
1999 1998
---- ----
Raw materials $ 783,091 $2,349,717
Work-in-process 1,180,443 132,559
Finished goods 472,884 1,831,619
---------- ----------
$2,436,418 $4,313,895
========== ==========
Recently Issued Accounting Standards
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income in the financial statements. Comprehensive income
includes all changes in equity during a period except those resulting from
investments by and distributions to owners. For the Company, comprehensive
income represents net income adjusted for unrealized gains/losses on available-
for-sale securities.
The Company adopted the provisions of SFAS No. 131, "Disclosures
34
about Segments of an Enterprise and Related Information." SFAS No. 131
establishes new accounting standards for segment reporting. No operational
segment or customer information is required for the Company.
Property and Equipment
Property and equipment are stated at cost. Improvements that extend the useful
lives of property and equipment are capitalized at cost and depreciated over the
remaining useful lives. Repairs and maintenance are charged to expense as
incurred. Depreciation is provided using the straight-line method based upon
estimated useful lives of three to seven years for machinery, equipment,
furniture and leasehold improvements.
Other Assets
Other assets consist primarily of license fees and prepaid royalties resulting
from patent licensing agreements. The agreements require the Company to pay a
royalty on sales of certain catheters and related systems. The license fees and
amounts prepaid by the Company have been charged to expense as sales are
recognized.
Research and Development Costs
Research and development costs are charged to expense as incurred.
Net Loss Per Common Share
Basic and diluted net loss per common share is computed by dividing net loss by
the weighted average number of shares of common stock outstanding during each
period. The impact of common stock equivalents has been excluded from the
computation of weighted average common shares outstanding, as the effect would
be antidilutive.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles 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 revenues and expenses during the reporting period.
Ultimate results could differ from those estimates.
Financial Instruments
Management believes that the carrying amount of the Company's financial
instruments, including cash, available-for-sale securities, accounts payable and
accruals, approximates fair value as the majority of these instruments are
short-term in nature.
3. Income Taxes:
A reconciliation of the Company's statutory tax rate to the effective rate for
the years ended June 30 is as follows:
1999 1998 1997
-------- -------- ----------
Federal statutory rate 34% 34% 34%
State taxes, net of federal tax benefit 6 6 6
Valuation allowance (40) (40) (40)
-------- -------- ----------
-% -% -%
======== ======== ==========
As of June 30, 1999, the Company had net operating loss carryforwards of
approximately $55,000,000 for federal income tax purposes that are available to
offset future taxable income through the year 2014. Certain restrictions
35
caused by the change in ownership resulting from sales of stock will limit
annual utilization of the net operating loss carryforwards.
The components of the Company's deferred tax assets for the years ended June 30
is as follows:
1999 1998 1997
--------------------------------------------------------
Net operating loss carryforwards $ 22,082,000 $ 16,762,000 $ 10,151,000
Temporary deductible differences 720,000 228,000 160,000
Valuation allowance (22,802,000) (16,990,000) (10,311,000)
--------------------------------------------------------
$ - $ - $ -
========================================================
4. Shareholders' Equity:
Secondary Public Offering
In November 1997, the Company completed a secondary public offering of 1,725,000
shares of common stock, which generated net proceeds of $31,527,101 to be used
primarily to fund the commercial launch of the Company's Targis System in the
United States.
Stock Options
The Company has a stock option plan (the 1991 Stock Option Plan) which provides
for the granting of incentive stock options to employees and nonqualified stock
options to employees, directors and consultants. As of June 30, 1999, the
Company has reserved 2,450,910 shares of common stock under this plan. As of
June 30, 1999, 821,798 shares were available for future grants under this plan.
Options expire seven to ten years from the date of grant and are subject to
varying vesting schedules. Under the current terms of the Company's 1991 Stock
Option Plan, persons serving as non-employee directors at the date of the annual
shareholder meeting automatically receive a grant to purchase 5,000 shares of
common stock at a price equal to fair market value on the date of grant. The
options are immediately exercisable on the date of grant and expire 10 years
from the date of grant, subject to earlier termination one year after the person
ceases to be a director of the Company. In May 1998 and October 1998, the
Company repriced certain stock options previously granted to $8.81 and then to
$3.65, the fair market value on the date of repricing.
36
Shares subject to option are summarized as follows:
Weighted
Average
Stock Options Exercise Price
---------------- ---------------
Balance at June 30, 1996 907,918 $ 3.93
Options granted 196,000 16.35
Options canceled (2,020) .60
Options exercised (128,161) .81
---------------- ---------------
Balance at June 30, 1997 973,737 5.47
Options granted 447,234 10.51
Options canceled (159,635) 8.27
Options exercised (240,562) 1.19
---------------- ---------------
Balance at June 30, 1998 1,020,774 8.23
Options granted 1,359,421 3.69
Options canceled (939,585) 8.64
Options exercised (159,224) .44
---------------- ---------------
Balance at June 30, 1999 1,281,386 $ 3.81
================ ===============
Options exercisable at June 30, 1999 270,839 $ 4.07
================ ===============
The Company accounts for stock options under the provisions of Accounting
Principles Board Opinion No. 25, under which no compensation cost has been
recognized. Had compensation cost for these options been determined consistent
with SFAS No. 123, "Accounting for Stock-Based Compensation," the net loss and
loss per share would have been increased to the following pro forma amounts:
1999 1997 1997
------------- ------------- ------------
Net loss As reported $ (14,015,770) $ (15,012,991) $ (8,233,856)
Pro forma (15,850,908) (16,942,225) (9,872,331)
Net loss per share As reported $ (1.24) $ (1.44) $ (0.90)
Pro forma (1.40) (1.63) (1.08)
For purposes of calculating the above required disclosure, the fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions used for
grants in 1999, 1998 and 1997, respectively: risk-free interest rates of 6.16%,
5.52% and 6.87%, no expected dividend yield, expected volatility of 70.83% in
1999 and 54.25% in 1998 and 1997, and expected lives of seven years.
The weighted average fair value of options granted during 1999, 1998 and 1997
was $2.62, $10.51 and 16.35, respectively. Options outstanding at June 30, 1999,
have an exercise price between $0.40 and $14.00, a weighted average exercise
price of $4.07 and a weighted average remaining contractual life of 8.6 years.
37
1996 Employee Stock Purchase Plan
In 1996, the Company adopted the 1996 Employee Stock Purchase Plan (the Plan)
and reserved 100,000 common shares for issuance under the Plan. Under the terms
of the Plan, employees may purchase common shares at prices to be determined by
the Company's board of directors, ranging from 85% to 100% of the shares' fair
market value. Eligible employees elect to participate through payroll deductions
at the maximum level established by the board of directors, but not to exceed
10% of the participant's base pay, as defined. As of June 30, 1999, 22,557
shares had been purchased under the Plan for gross proceeds of $187,394.
5. Commitments and Contingencies:
Sales Commitments
The Company has signed agreements granting Boston Scientific Corporation and
Nihon Kohden Corporation exclusive distribution rights of the Targis System in
all geographic areas other than the United States. Nihon Kohden Corporation has
exclusive distribution rights for Japan. Boston Scientific Corporation has
exclusive distribution rights for the rest of the world, outside Japan and the
United States.
Litigation
In May 1998, the Company entered into a settlement agreement resolving
litigation with BSD Medical Corporation (BSD) and TherMatrx, Inc. (TherMatrx)
regarding a dispute about a previous settlement agreement. Pursuant to the
settlement agreement, the Company paid $5 million to BSD and TherMatrx and will
maintain its non-exclusive license to certain patents owned by BSD and
TherMatrx pertaining to transurethral insertable applicators and systems for
the treatment of BPH and other urological conditions. Of the $5 million
settlement amount, $2 million is included in other assets and is amortized
against future sales and the remaining $3 million plus related legal expenses
were recorded as litigation settlement expense for the year ended June 30, 1998.
401(k) Plan
The Company provides a 401(k) savings plan to which eligible employees may make
pretax payroll contributions of up to 15% of their compensation. Company
matching contributions are discretionary, and none have been made to date.
Leases
The Company leases its facility and certain equipment under noncancelable
operating leases which expire at various dates through fiscal 2003. Rent expense
related to operating leases was approximately $195,500, $139,700 and $102,500
for the years ended June 30, 1999, 1998 and 1997, respectively. Future minimum
lease commitments under noncancelable operating leases with initial remaining
terms of one year or more are as follows as of June 30, 1999:
Operating Leases
--------------------
Fiscal year:
2000 $ 280,409
2001 280,409
2002 296,763
2003 205,632
----------
$1,063,213
===========
38
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
- --------------------------------------------------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
Information required under this item with respect to directors is contained
in the section "Election of Directors" in the Company's Proxy Statement for the
1999 Annual Meeting of Shareholders (the "1999 Proxy Statement"), a definitive
copy of which will be filed with the Commission within 120 days of the close of
the past fiscal year, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
Information required under this item is contained in the sections entitled
"Executive Compensation and other Information" and "Employment Agreements" in
the Company's 1999 Proxy Statement, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
Information required under this item is contained in the section entitled
"Security Ownership of Principal Shareholders and Management" in the Company's
1999 Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
Information required under this item is contained in the section entitled
"Certain Transactions" in the Company's 1999 Proxy Statement and is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
- ----------------------------------------------------------------------------
(a) Documents filed as part of this report.
--------------------------------------
(1) Financial Statements. The financial statements of the Company are
--------------------
listed at Item 8 of this Form 10-K.
(2) Financial Statement Schedules for years ended June 30, 1999, 1998 and
---------------------------------------------------------------------
1997. No schedules are required in connection with the filing of this
----
Form 10-K.
(3) Exhibits
--------
3.1 Amended and Restated Articles of Incorporation. (1)
39
3.2 Amended and Restated Bylaws of the Company. (1)
10.1* Urologix, Inc. 1991 Stock Option Plan (2)
10.2* Employment Agreement dated November 10, 1998 between the
Company and Michael M. Selzer, Jr.
10.2.1* Restricted Stock Agreement between the Company and Michael M.
Selzer Jr. (2)
10.2.2* Stock Option Agreement between the Company and Michael M.
Selzer Jr. (2)
10.3* Employee Agreement dated February 18, 1994 between the Company
and Ward Allen Putnam(1)
10.4 Supply Agreement dated August 24-25, 1995 between the Company
and SeaMED Corporation(1)
10.5 Lease Agreement dated January 20, 1992, between the Company
and Parkers Lake Pointe I Limited Partnership, including
Addendum to Lease Agreement dated April 5, 1995(1)
10.6 Investor Rights Agreement dated December 5, 1996 between the
Company and certain of its shareholders(1)
10.7* Agreement dated November 5, 1993 between the Company and Dr.
David C. Utz, including supplemental letter agreements dated
November 2, 1994 and July 31, 1995 (1)
10.7.1* Letter agreement dated August 4, 1999 between the Company and
Dr. David C. Utz
10.8* Letter Agreement dated October 10, 1994 between the Company
and Mitchell Dann (1)
10.9 International Distribution Agreement made as of June 26, 1996
between the Company and Boston Scientific Corporation. (3)(4)
10.9.1 Amendment to the International Distribution Agreement between
the Company and Boston Scientific Corporation. (4)(5)
10.10 License Agreement dated August 7, 1996 between the Company and
EDAP International, S.A. and Technomed Medical Systems, S.A.
(3)(4)
10.11 Co-Marketing Agreement dated August 9, 1999 between the
Company and Boston Scientific Corporation(4)
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule
* Indicates Compensation Plan
(1) Incorporated by reference from the Urologix, Inc. Registration
Statement on Form S-1, File No. 333-3304.
(2) Incorporated by reference from the Urologix, Inc. Registration
Statement on Form S-8, File No. 333-84869.
(3) Incorporated by reference from the Urologix, Inc. Form 10-K for the
year ended June 30, 1996.
(4) Certain information has been deleted from this exhibit and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment under Rule 24b-2.
(5) Incorporated by reference from the Urologix, Inc. Form 10Q for the
quarter ended March 31, 1999.
(b) Reports on Form 8-K. There were no reports on Form 8-K filed during the
-------------------
fourth quarter of the fiscal year ended June 30, 1999.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duty caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
UROLOGIX, INC.
By: /s/ Michael M. Selzer, Jr.
---------------------------
Michael M. Selzer, Jr., President and
Chief Executive Officer and Director
Each person whose signature appears below hereby constitutes and appoints
Michael M. Selzer, Jr. and Christopher R. Geyen, and each of them his or her
true and lawful attorney-in-fact and agent, with full power of substitution, to
sign on his or her behalf, individually and in each capacity stated below, all
amendments and post-effective amendments to this Form 10-K and to file the same,
with all exhibits thereto and any other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully and to
all intents and purposes as each might or could do in person, hereby ratifying
and confirming each act that said attorneys-in-fact and agents may lawfully do
or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Registration Statement has been signed below by the following persons in the
capacities indicated on September 24, 1999.
Signature Title
- --------------------------------------------------------------
/s/ Mitchell Dann Chairman of the Board
- -----------------------------
Mitchell Dann
/s/ Michael M. Selzer, Jr. Director, President and
- ----------------------------- Chief Executive Officer
Michael M. Selzer, Jr.
/s/ Christopher R. Geyen Vice President, Finance and
- ----------------------------- Administration and Secretary
Christopher R. Geyen
/s/ Susan Bartlett Foote Director
- -----------------------------
Susan Bartlett Foote
/s/ Robert I. Griffin Director
- -----------------------------
Robert I. Griffin
/s/ Paul A. LaViolette Director
- -----------------------------
Paul A. LaViolette
/s/ Robert R. Momsen Director
---------------------------
Robert Momsen
/s/ David C. Utz Director
- ----------------------------
David C. Utz, M.D.
41