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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended September 30, 2003



OR



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



For the transaction period from
 to



Commission File Number 0-28414



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UROLOGIX, INC.

(Exact name of registrant as specified in its charter)



|Minnesota                                                      |  | 41-1697237                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



14405 21st Avenue
North, Minneapolis, MN 55447

(Address of principal executive offices)



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



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



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



As of November 7, 2003, the Company had outstanding 13,966,421 shares of common stock, $.01 par value.



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PART I  FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



Urologix, Inc.

Condensed Balance
Sheets

(In thousands, except per share data)



|                                                                                                        |  | September 30,2003 |         |   | June 30,2003 |  
|------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ------------ | -
|                                                                                                        |  | (unaudited)       |         |   | (*)          |  
|ASSETS                                                                                                  |  |                   |         |   |              |  
|Current assets:                                                                                         |  |                   |         |   |              |  
|Cash and cash equivalents                                                                               |  | $                 | 576     |   |              | $
|Available-for-sale investments                                                                          |  |                   | 3,296   |   |              |  
|Accounts receivable, net of allowance of $370 and $365                                                  |  |                   | 2,406   |   |              |  
|Inventories, net                                                                                        |  |                   | 2,682   |   |              |  
|Prepaids and other current assets                                                                       |  |                   | 507     |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|Total current assets                                                                                    |  |                   | 9,467   |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|Property and equipment:                                                                                 |  |                   |         |   |              |  
|Machinery, equipment and furniture                                                                      |  |                   | 9,955   |   |              |  
|Less accumulated depreciation                                                                           |  |                   | (6,302  | ) |              |  
|                                                                                                        |  |                   |         |   |              |  
|Property and equipment, net                                                                             |  |                   | 3,653   |   |              |  
|Other assets                                                                                            |  |                   | 2,330   |   |              |  
|Goodwill, net                                                                                           |  |                   | 10,193  |   |              |  
|Other intangible assets, net                                                                            |  |                   | 8,947   |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|Total assets                                                                                            |  | $                 | 34,590  |   |              | $
|                                                                                                        |  |                   |         |   |              |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                    |  |                   |         |   |              |  
|Current liabilities:                                                                                    |  |                   |         |   |              |  
|Accounts payable                                                                                        |  | $                 | 1,118   |   |              | $
|Accrued compensation                                                                                    |  |                   | 451     |   |              |  
|Other accrued expenses                                                                                  |  |                   | 2,101   |   |              |  
|Current portion of lease obligation                                                                     |  |                   | 208     |   |              |  
|Current portion of long-term debt                                                                       |  |                   | 575     |   |              |  
|Deferred income                                                                                         |  |                   | 1,539   |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|Total current liabilities                                                                               |  |                   | 5,992   |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|                                                                                                        |  |                  
|COMMITMENTS AND CONTINGENCIES (Note 11)                                                                 |  |                   |         |   |              |  
|Shareholders equity:                                                                                   |  |                   |         |   |              |  
|Common stock, $.01 par value, 25,000 shares authorized; 13,966 and 13,962 shares issued and outstanding |  |                   | 140     |   |              |  
|Additional paid-in capital                                                                              |  |                   | 108,618 |   |              |  
|Accumulated deficit                                                                                     |  |                   | (80,218 | ) |              |  
|Accumulated other comprehensive income                                                                  |  |                   | 58      |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|Total shareholders equity                                                                              |  |                   | 28,598  |   |              |  
|                                                                                                        |  |                   |         |   |              |  
|Total liabilities and shareholders equity                                                              |  | $                 | 34,590  |   |              | $
|                                                                                                        |  |                   |         |   |              |  



|(*) | The Balance Sheet at June 30, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



2



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Urologix, Inc.

Condensed Statements of Operations

(In thousands, except per share data)

(Unaudited)



|                                                                       |  | Three Months EndedSeptember 30, |       
|---------------------------------------------------------------------- |  | ------------------------------- | ------
|                                                                       |  | 2003                            |       
|Sales                                                                  |  | $                               | 5,061 
|Cost of goods sold                                                     |  |                                 | 1,982 
|                                                                       |  |                                 |       
|Gross profit                                                           |  |                                 | 3,079 
|                                                                       |  |                                 |       
|Costs and expenses:                                                    |  |                                 |       
|Selling, general and administrative                                    |  |                                 | 2,825 
|Research and development                                               |  |                                 | 584   
|Amortization of intangible assets                                      |  |                                 | 166   
|                                                                       |  |                                 |       
|Total costs and expenses                                               |  |                                 | 3,575 
|                                                                       |  |                                 |       
|Operating loss                                                         |  |                                 | (496  
|Interest income, net                                                   |  |                                 | 6     
|                                                                       |  |                                 |       
|Net loss                                                               |  | $                               | (490  
|                                                                       |  |                                 |       
|Basic and diluted net loss per common share                            |  | $                               | (0.04 
|                                                                       |  |                                 |       
|Basic and diluted weighted average number of common shares outstanding |  |                                 | 13,965
|                                                                       |  |                                 |       



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



3



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Urologix, Inc.

Condensed Statements of Cash Flows

(In thousands)

(Unaudited)



|                                                                             |  | Three MonthsEndedSeptember 30, |      
|---------------------------------------------------------------------------- |  | ------------------------------ | -----
|                                                                             |  | 2003                           |      
|Operating Activities:                                                        |  |                                |      
|Net loss                                                                     |  |                                | ($490
|Adjustments to reconcile net loss to net cash used for operating activities: |  |                                |      
|Depreciation and amortization                                                |  |                                | 439  
|Provision for bad debts                                                      |  |                                | 25   
|Change in operating items:                                                   |  |                                |      
|Accounts receivable                                                          |  |                                | (302 
|Inventories                                                                  |  |                                | 121  
|Prepaids and other assets                                                    |  |                                | 264  
|Accrued expenses and accounts payable                                        |  |                                | (622 
|                                                                             |  |                                |      
|Net cash used for operating activities                                       |  |                                | (565 
|                                                                             |  |                                |      
|Investing Activities:                                                        |  |                                |      
|Purchase of property and equipment, net                                      |  |                                | (22  
|Proceeds from sale of available-for-sale investments, net                    |  |                                | 567  
|                                                                             |  |                                |      
|Net cash provided by investing activities                                    |  |                                | 545  
|                                                                             |  |                                |      
|Financing Activities:                                                        |  |                                |      
|Payments made on capital lease obligations                                   |  |                                | (143 
|Proceeds from exercise of stock options                                      |  |                                | 12   
|                                                                             |  |                                |      
|Net cash used for financing activities                                       |  |                                | (131 
|                                                                             |  |                                |      
|Net decrease in cash and cash equivalents                                    |  |                                | (151 
|Cash and cash equivalents:                                                   |  |                                |      
|Beginning of period                                                          |  |                                | 727  
|                                                                             |  |                                |      
|End of period                                                                |  | $                              | 576  
|                                                                             |  |                                |      
|Supplemental cash-flow information                                           |  |                                |      
|Cash paid during the period for interest                                     |  | $                              | 18   
|Net transfer of inventory to property and equipment                          |  | $                              | 90   



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



4



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Urologix, Inc.

Notes to Condensed Financial Statements

September 30, 2003

(Unaudited)



|1. | Basis of presentation
|-- | ---------------------



The accompanying unaudited condensed financial statements of Urologix, Inc. (the Company or Urologix) have been prepared in
accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet as of September 30, 2003 and the statements of operations and cash
flows for the three months ended September 30, 2003 and 2002, are unaudited but include all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position at such dates and the operating results
and cash flows for those periods. Certain information normally included in financial statements and related footnotes prepared in accordance with generally accepted accounting principles has been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. The accompanying financial statements should be read in conjunction with the financial statements and notes included in Urologix annual report on Form 10-K for the year ended June 30,
2003, filed with the Securities and Exchange Commission.



Results for any interim period shown in this report are not necessarily indicative of results to be expected for any other interim period or for the entire year. Certain prior year amounts have been reclassified to conform to current year
presentation.



|2. | New Accounting Pronouncement
|-- | ----------------------------



In December 2002, the Emerging Issues Task Force (EITF) issued EITF 00-21, Revenue Arrangements with Multiple Deliverables. EITF 00-21
addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable,
and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently
functional, or there is not sufficient evidence of their fair values to account for them separately. EITF 00-21 addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. EITF
00-21 does not change otherwise applicable revenue recognition criteria. We adopted EITF 00-21 effective July 1, 2003, and it did not have an impact on our current revenue recognition policy.



|3. | Use of Estimates
|-- | ----------------



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



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Urologix, Inc.

Notes to Condensed Financial Statements

September 30, 2003

(Unaudited)



|4. | Basic and diluted net loss per share
|-- | ------------------------------------



Basic and diluted net loss per common share was computed by dividing the net loss by the weighted average number of shares of common stock outstanding
during the periods presented. The following table summarizes the common stock equivalents that were excluded from the calculation of diluted earnings per share as the effect would be antidilutive.



|                   |  | September 30,2003 |  | September 30,2002
|------------------ |  | ----------------- |  | -----------------
|Three Months Ended |  | 161,120           |  | 294,118          



|5. | Inventories
|-- | -----------



Net inventories consisted of the following as of (in thousands):



|                  |  | September 30,2003 |       | June 30,2003
|----------------- |  | ----------------- | ----- | ------------
|Raw materials     |  | $                 | 1,676 |             
|Work in process   |  |                   | 371   |             
|Finished goods    |  |                   | 635   |             
|                  |  |                   |       |             
|Total inventories |  | $                 | 2,682 |             
|                  |  |                   |       |             



|6. | Other intangible assets
|-- | -----------------------



Other intangible assets consist of developed technologies, customer base and trademarks. Developed technologies and customer base are amortized using the
straight-line method over their estimated useful lives of 15 and 14 years, respectively. The trademark asset is considered to be an intangible with an indefinite useful life, and it will not be amortized until its useful life is determined to be no
longer indefinite. Amortization of intangible assets was $166,000 for each of the three-month periods ended September 30, 2003 and 2002. Future annual amortization expense for acquired intangible assets is expected to be approximately $664,000 for
each of the next five fiscal years.



6



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Urologix, Inc.

Notes to Condensed Financial Statements

September 30, 2003

(Unaudited)



Balances of acquired intangible assets were as follows (in thousands):



|                                         |  | As of September 30, 2003
|---------------------------------------- |  | ------------------------
|                                         |  | CarryingAmount          
|Amortizing intangibles:                  |  |                         
|Developed technologies                   |  | $                       
|Customer base                            |  |                         
|                                         |  |                         
|Subtotal                                 |  |                         
|Non-amortizing intangibles and goodwill: |  |                         
|Goodwill                                 |  |                         
|Trademarks                               |  |                         
|                                         |  |                         
|Subtotal                                 |  |                         
|                                         |  |                         
|Total acquired intangible assets         |  | $                       
|                                         |  |                         



|7. | Comprehensive Loss
|-- | ------------------



Comprehensive loss includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. Our
comprehensive loss represents net loss adjusted for unrealized gains (losses) on available-for-sale investments.



|(In thousands)                                                           |  | Three MonthsendedSeptember 30, |     
|------------------------------------------------------------------------ |  | ------------------------------ | ----
|                                                                         |  | 2003                           |     
|Net loss                                                                 |  | $                              | (490
|Change in net unrealized gains (losses) on available-for-sale securities |  |                                | (29 
|                                                                         |  |                                |     
|Comprehensive loss                                                       |  | $                              | (519
|                                                                         |  |                                |     



|8. | Warranty
|-- | --------



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



Warranty provisions and claims
for the periods ended September 30, 2003 and 2002 were as follows (in thousands):



|Three Months Ended |  | Beginning Balance |     | Warranty Provisions |   | Warranty Claims |  |      | Ending Balance
|------------------ |  | ----------------- | --- | ------------------- | - | --------------- |  | ---- | --------------
|September 30, 2003 |  | $                 | 159 |                     | $ | 71              |  | ($68 | )             
|September 30, 2002 |  | $                 | 203 |                     | $ | 27              |  | ($42 | )             



7



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Urologix, Inc.

Notes to Condensed Financial Statements

September 30, 2003

(Unaudited)



|9. | Stock-Based Compensation
|-- | ------------------------



We account for stock-based employee compensation arrangements in accordance with the provisions and related interpretations of Accounting Principles Board
Opinion 25, Accounting for Stock Issued to Employees and elected to follow the disclosure only alternative prescribed by SFAS 123, Accounting for Stock-Based Compensation.



Had compensation cost for stock-based compensation been determined consistent
with SFAS 123, the net loss and loss per share would have been increased to the following pro-forma amounts (in thousands, except per share data):



|                                          |  | Three months endedSeptember 30, |       
|----------------------------------------- |  | ------------------------------- | ------
|                                          |  | 2003                            |       
|Net loss (as reported)                    |  | $                               | (490  
|Stock-based employee compensation expense |  |                                 | (638  
|                                          |  |                                 |       
|Pro forma                                 |  | $                               | (1,128
|                                          |  |                                
|Net loss per share (as reported)          |  | $                               | (0.04 
|Stock-based employee compensation expense |  |                                 | (0.04 
|                                          |  |                                 |       
|Pro forma                                 |  | $                               | (0.08 



|10. | Restructuring Expense
|--- | ---------------------



In May 2003, we announced plans for an organizational restructuring which eliminated 28 positions within the Company and also resulted in our vacating a
portion of our leased facility. All of the targeted headcount reductions were completed by June 2003, and we have reached an agreement to sublet the vacated space beginning in the second quarter of fiscal 2004. The lease term on the vacated space
currently runs through fiscal 2008. All severance obligations will be paid in their entirety prior to the conclusion of fiscal 2004.



Restructuring expense activity for three-month period ended September 30, 2003 was as follows (in thousands):



|                  |  | Severance |      |   | Lease |   |     | Total | 
|----------------- |  | --------- | ---- | - | ----- | - | --- | ----- | 
|Beginning balance |  | $         | 636  |   |       | $ | 264 |       | 
|Expense accruals  |  |           |     |   |       |   |    |       | 
|Cash payments     |  |           | (319 | ) |       |   | (49 | )     | 
|                  |  |           |      |   |       |   |     |       | 
|Ending balance    |  | $         | 317  |   |       | $ | 215 |       | 
|                  |  |           |      |   |       |   |     |       | 



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Urologix, Inc.

Notes to Condensed Financial Statements

September 30, 2003

(Unaudited)



|11. | Legal Proceedings
|--- | -----------------



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



Urologix v.
ProstaLund AB et al.



In March 2002, we filed a patent
infringement action against ProstaLund AB, ProstaLund Operations AB, and Circon Corporation a/k/a ACMI Corporation in the United States District Court for the Eastern District of Wisconsin (and by a later amended complaint) alleging that the
defendants products infringed two United States Patents that were assigned to us: U.S. Patent No. 5,234,004 (004 Patent) and U.S. Patent No. 5,509,929 (929 Patent). We sought a preliminary injunction prohibiting the
manufacture, use, sale, or offer for sale of the ProstaLund Feedback Treatment and an unspecified amount of damages. The defendants counterclaimed, alleging that they do not infringe our patents, that our patents are invalid, that we
have marked our products as patented in a manner that violates patent law and that we have engaged in inequitable conduct. The defendants are also seeking recovery of their attorneys fees.



In October 2002, the Court issued two separate Orders in this case. In an
Order dated October 10, 2002, the Court determined that the 004 patent was not entitled to the benefit of an earlier filing date of a patent application and as a result was invalid. In an Order dated October 16, 2002, the Court denied our
motion for a preliminary injunction on the 929 patent.



Subsequent to the Court Action in November 2002, in response to our request, the United States Patent and Trademark Office (PTO) issued an office action granting Urologix the benefit of the earlier office action on the 004
patent. In light of the PTO office action, we filed a motion with the Court requesting that the Court vacate the October 10, 2002 Order determining the 004 patent was invalid. In April 2003, the Court denied our motion to vacate the October
10, 2002 Order.



On September 5, 2003, the Court denied the
defendants motion for summary judgment on our claims that they are directly infringing and infringing under the doctrine of equivalents, our 929 patent. The Court, however, did grant the defendants motion for summary judgment on
our claim of indirect infringement by inducement or contributory infringement of the 929 patent. We are evaluating our options in connection with the lawsuit and are preparing for a trial on the merits of the infringement claims of the
929 patent, which we believe will occur early in calendar year 2004. Although we believe we will prevail at trial on these claims and further, do not believe the defendants remaining counterclaims have merit, an adverse determination on
any of these matters could have a material adverse effect on our business, financial condition, and results of operations. In addition, any determination that we are obligated to pay the defendants legal fees could also have a material adverse
effect on us.



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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following is a discussion and analysis of Urologix financial
condition and results of operations for the three-month periods ended September 30, 2003 and 2002. This section should be read in conjunction with the condensed financial statements and related notes in Item 1 of this report and Urologix
Annual Report on Form 10-K for the year ended June 30, 2003, which has been filed with the Securities and Exchange Commission.



Cautionary Note Regarding Forward-Looking Statements



This Managements Discussion and Analysis of Financial Condition and Results of Operations contains, in addition to historical information,
forward-looking statements that are based on our current expectations, beliefs, intentions or future strategies. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements,
including the extent to which the physicians performing Cooled ThermoTherapy procedures are able to obtain third-party reimbursement, changes in the reimbursement environment, market acceptance and the rate of adoption of Cooled ThermoTherapy for
the treatment of benign prostatic hyperplasia (BPH) by the medical community, our ability to successfully protect our intellectual property rights, the ability of our key suppliers to provide product, the impact of competitive treatments, products
and pricing, and the effectiveness of our sales and marketing organization. We caution readers not to place undue reliance on any of these forward-looking statements, which speak only as of the date made. A detailed discussion of risks and
uncertainties may be found below in Factors That May Affect Our Future Results and The Trading Price of Our Common Stock and in our Annual Report on Form 10-K for the year ended June 30, 2003.



OVERVIEW



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



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



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



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



In January 2001, CMS began to reimburse for Cooled
ThermoTherapy treatments performed in the urologists office. The reimbursement rate (inclusive of the physicians fee) in calendar year 2003 for Cooled ThermoTherapy



10



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procedures performed in the urologists office is approximately $2,700, which is subject to geographic adjustment. Reimbursement rates for calendar 2004
were recently published and the comparable rate is expected to be approximately $3,800 .



Our goal is to grow Cooled ThermoTherapy as a standard of care for the treatment of BPH. Our business strategy to achieve this goal is to (i) increase the use of Cooled ThermoTherapy by physicians who already have
access to a Cooled ThermoTherapy system, (ii) satisfy additional demand for Cooled ThermoTherapy systems through the efficient use of existing systems in the field and (iii) increase market awareness of Cooled ThermoTherapy.



We expect to continue to incur operating losses as we focus on growing our
revenues, continue clinical trials in support of regulatory and reimbursement approvals, and continue to invest in our effort to protect our intellectual property. Our future profitability will be dependent upon, among other factors, our success in
achieving increased treatment volume and market acceptance of the Cooled ThermoTherapy procedures in the physicians office, our success in obtaining and maintaining necessary regulatory clearances, our ability to manufacture at the volumes and
quantities the market requires, the extent to which Medicare and other health care payers continue to reimburse costs of Cooled ThermoTherapy procedures performed in hospitals, ambulatory surgery centers and physicians offices and the amount
of reimbursement provided.



Critical Accounting Policies:



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



Revenue Recognition



We recognize revenue from the sale of Cooled ThermoTherapy system control
units upon delivery to the customer. We recognize revenue from disposable product sales at the time of shipment. In addition to our sales of Cooled ThermoTherapy system control units, we place our Cooled ThermoTherapy system control units with
customers under a variety of programs for both evaluation and long-term use. We retain title to these control units and do not recognize any revenue on these control units until title has transferred. These programs are designed to expand our
installed base, and thus expand the market for our disposable catheters. Under these programs, we generally charge a higher price for each disposable procedure kit to include the use of our Cooled ThermoTherapy system control unit by the customer.
We recognize revenue on these disposable procedure kits at the time of shipment. Revenue for warranty service contracts is deferred and recognized over the contract period. We record a provision for estimated sales returns on product sales in the
same period as the related revenue is recorded. The provision for estimated sales returns is based on historical sales returns, analysis of credit memo data and other known factors. If the historical data we used to calculate these estimates does
not properly reflect future returns, our revenues could be overstated.



Allowance for Doubtful Accounts



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



Product Warranty



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



11



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Inventories and Related Allowance for Excess and Obsolete Inventory



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



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



Valuation of Long-Lived and Intangible Assets and Goodwill



In fiscal 2002, we adopted Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, and as a result, we
have ceased to amortize approximately $10.2 million of goodwill and $1.1 million of trademarks. Goodwill and trademarks are tested for impairment annually, or more frequently if changes in circumstance or the occurrence of events suggests an
impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. Our estimates associated with the impairment tests are considered critical, due to the amount
of goodwill and trademarks recorded on our balance sheet and the judgment required in determining fair value amounts, including projected future cash flows.



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



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RESULTS OF OPERATIONS



Net Sales



Net sales increased approximately 13% to $5.1 million for the three-month period ended September 30, 2003, from $4.5 million during the same period in the
prior fiscal year. The increase in revenue was primarily attributable to an increase in the number of disposable procedure kits sold, partially offset by a decrease in revenue from the sale of our Cooled ThermoTherapy system control units caused by
a decrease in their average per unit selling price. Sales of disposable procedure kits accounted for 93% of total revenue in the first three months of fiscal 2004, compared to 88% in the same period in fiscal 2003. At September 30, 2003, we had an
installed base of 390 Cooled ThermoTherapy systems, including the units that are being used by customers pursuant to our evaluation and long-term use programs.



Cost of Goods Sold and Gross Profit



Cost of goods sold includes raw materials, labor, overhead and royalties incurred in connection with the production of our Cooled ThermoTherapy system
control units and disposable procedure kits. Cost of goods sold for the three months ended September 30, 2003 increased to $2.0 million from $1.5 million during the first three months of fiscal 2003. The increase resulted primarily from the higher
volume of disposable procedure kits sold in the first quarter of fiscal 2004 compared to fiscal 2003 and a $160,000 charge to cost of goods for a commitment to purchase additional control unit inventory at prices which exceed the expected future
sales value. Delivery of these control units will occur in the second half of fiscal 2004.



Gross profit as a percentage of sales for the three-month period ended September 30, 2003 decreased to 61% from 66% in the three-month period ended September 30, 2002. The decrease resulted primarily from the drop in
the average per unit selling price of our Cooled ThermoTherapy systems and the $160,000 charge for the commitment to purchase additional control unit inventory.



Selling, General & Administrative



Selling, general and administrative expenses decreased to $2.8 million for the three-month period ended September 30, 2003, from $3.6 million in the same
period of fiscal year 2003. The decreased expenses are primarily attributable to the organizational restructuring and workforce reduction that occurred in the fourth fiscal quarter of 2003, and a reduction in legal expenses related to the patent
infringement suit we filed to protect our intellectual property.



Research and Development



Research and
development expenses, which include expenditures for product development, regulatory compliance and clinical studies, decreased to $584,000 from $974,000 for the three-month periods ended September 30, 2003 and 2002, respectively. The decrease in
expenses resulted primarily from the organizational restructuring and workforce reduction that occurred in the fourth fiscal quarter of 2003, and decreased expenditures on product development activities and clinical trial expenses.



Amortization of intangible assets



Amortization of intangible assets was $166,000 for both the three-month
periods ended September 30, 2003 and 2002. The amortization of intangible assets is a result of the purchase of the Prostatron Cooled ThermoTherapy product line from EDAP in October 2000.



Net interest income



Net interest income decreased to $6,000 for the three-month period ended September 30, 2003 from $71,000 during the same period of the prior fiscal year.
The decrease is primarily attributable to lower interest income due to lower cash and investment balances, partially offset by lower interest expense.



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LIQUIDITY AND CAPITAL RESOURCES



We have financed our operations since inception through sales of equity securities and, to a lesser extent, sales of our
Cooled ThermoTherapy system control units and single-use treatment catheters. As of September 30, 2003, we had total cash, cash equivalents and available-for-sale investments of $3.9 million and working capital of $3.5 million.



During the three months ended September 30, 2003, we used $565,000 of cash in
operating activities, primarily as a result of our net loss of $490,000, a decrease in accrued expenses and accounts payable of $622,000, and a net increase in accounts receivable of $277,000 that was partially offset by depreciation and
amortization of $439,000, a decrease in prepaids and other assets of $264,000 and a decrease in inventory of $121,000.



We generated $545,000 from investing activities, resulting from the net sale of $567,000 of available-for-sale investments partially offset by the
purchase of $22,000 of property and equipment. We do not expect to make significant capital expenditures during the remainder of fiscal 2004.



We used $131,000 in financing activities as a result of $143,000 of payments on capital lease obligations, offset by $12,000 from the exercise of stock
options.



We expect to continue to incur additional losses. We
plan to continue offering customers a variety of programs for both evaluation and long-term use of our Cooled ThermoTherapy system control units in addition to purchase options. As of September 30, 2003 our property and equipment, net, included
approximately $2.9 million of control units used in evaluation or long-term use programs. Depending on the growth of these programs, we may use additional capital to finance the units used by these customers.



We believe the recently completed restructuring and cost reduction initiative
will enable us to reduce our annual operating expenses by approximately 20% from fiscal 2003 levels, while we focus on increasing sales and providing high quality support to our customers. Third party financing may also present opportunities for us
to finance the equipment used by our customers under evaluation and long-term use programs.



Based upon these factors, we believe our $3.9 million in cash, cash equivalents, and available-for-sale investments at September 30, 2003, together with the funds generated from product sales, will be sufficient to
fund our working capital and capital resources needs, including the $575,000 plus interest debt payment due to EDAP in December 2003, for the next 12 months. There can be no assurance, however, that we will not require additional financing in the
future or that any additional financing will be available to us on satisfactory terms, if at all.



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FACTORS THAT MAY AFFECT OUR FUTURE RESULTS AND THE TRADING PRICE OF OUR COMMON STOCK



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



We have a limited operating history and expect to continue to generate losses.



We have incurred substantial losses since our inception and, if physicians do not purchase and use our Cooled ThermoTherapy systems to treat patients with
BPH, we may never achieve or maintain profitable operation. We incurred a net loss of $490,000 for the three months ended September 30, 2003, and have incurred losses of more than $80 million since our inception. We expect to continue to incur
operating losses in the near future as we continue to invest in sales and marketing activities to increase sales, continue to incur costs and expenses to protect our intellectual property, and fund research and development activities. We will need
to increase the revenues we receive from sales of our products as a result of these operating expenses. Even if we do achieve profitability, we cannot be certain that we will be able to sustain or increase profitability on a quarterly or annual
basis or that our profits will be significant enough to enable us to implement all aspects of our business plan to take advantage of business opportunities.



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



We used approximately $565,000 of cash and cash equivalents on operating activities in the three-month period ended
September 30, 2003 and ended that period with approximately $3.9 million of cash, cash equivalents, and available-for-sale investments. In the fourth quarter of fiscal 2003, we implemented a restructuring and cost reduction initiative that
eliminated 28 positions and vacated approximately 9,200 square feet of our leased facility that we have sublet. We believe that these actions will result in a reduction of annual operating expenses of approximately 20% from fiscal 2003 levels.
Although we expect to continue to use existing cash resources to fund our operations in the near future, we believe these actions will reduce the amount of cash used. As a result, we believe our $3.9 million in cash, cash equivalents, and
available-for-sale investments, together with the funds generated from product sales, will be sufficient to fund our working capital and capital resources needs for the next 12 months. There can be no assurance, however, that we will not require
additional financing in the future or that any additional financing will be available to us on satisfactory terms, if at all.



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



Physicians will not recommend Cooled ThermoTherapy procedures unless they conclude, based on clinical data and other
factors, that it is an effective alternative to other methods of enlarged prostate treatment, including more established methods. Patient acceptance of the procedure will depend in part upon physician recommendations and on other factors, including
the degree of invasiveness and the rate and severity of complications associated with the Cooled ThermoTherapy procedure compared with other therapies. Patient acceptance of the Cooled ThermoTherapy procedure also will depend upon the ability of
physicians to educate these patients on their treatment choices. Health care payer acceptance of our procedure will require, among other things, evidence of the cost effectiveness of Cooled ThermoTherapy compared to other BPH therapies. Our
marketing strategy must overcome the difficulties inherent in the introduction of new technology to the medical community. If our Cooled ThermoTherapy procedure is not accepted by physicians, patients or payers, or is accepted more slowly than
expected, we may never operate profitably.



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



Our
future revenues are subject to uncertainties regarding health care reimbursement and reform. In the United States, health care providers, such as hospitals and physicians, generally rely on third-party payers.



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Third-party reimbursement is dependent upon decisions by the Centers for Medicare and Medicaid Services
(CMS), contract Medicare carriers, individual managed care organizations, private insurers, foreign governmental health programs and other payers of health care cost. Failure to receive or maintain favorable coding, coverage and reimbursement
determinations for Cooled ThermoTherapy by these organizations could discourage physicians from using our products. We may be unable to sell our products on a profitable basis if third-party payers deny coverage, provide low reimbursement rates or
reduce their current levels of reimbursement.



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



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



The medical device industry is characterized by rapid technological change, changing customer needs and frequent new product introductions. Our products may be rendered obsolete as a result of future innovations. We
face intense competition from other device manufacturers and surgical manufacturers, as well as from pharmaceutical companies. Many of our competitors are significantly larger than we are and have greater financial, technical, research, marketing,
sales, distribution and other resources than we do. We have experienced intense price competition over the past 15 months which resulted in a significant decrease in the average per unit sales price of our control units. We believe that this price
competition will continue among products developed in our markets and that the average per unit sales price of our control units could decline further. Our competitors may develop or market technologies and products, including drug-based treatments
that are more effective or commercially attractive than any we are developing or marketing. Our competitors may succeed in obtaining regulatory approval and introducing or commercializing products before we do. Such developments could have a
significant negative effect on our financial condition. Even if we are able to compete successfully, we may not be able to do so in a profitable manner.



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



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



In March 2002, we filed a patent infringement action against ProstaLund
AB, ProstaLund Operations AB, and Circon Corporation a/k/a ACMI Corporation in the United States District Court for the Eastern District of Wisconsin. See Legal Proceedings. We are evaluating our options in conjunction with the lawsuit
and are preparing for a trial on the merits of the infringement claims of the 929 patent, which we believe will occur early in calendar year 2004. This litigation has resulted in substantial expense and may divert our attention from
implementing our business strategy.



Additional litigation
against other parties may be necessary in the future to enforce our intellectual property rights, to protect our patents and trade secrets, and to determine the validity and scope of our proprietary rights. Future litigation may require us to incur
substantial litigation expense and may divert substantial time and attention of our personnel. The occurrence of this litigation or the effect of an adverse determination in the current litigation or similar future litigation could have a material
adverse effect on our business, financial condition and results of operations.



Furthermore, we cannot ensure that others have not developed or will not develop similar products or manufacturing processes, duplicate any of our products or manufacturing processes, or design around any of our
patents.



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



All of our revenues are derived from sales of our Cooled ThermoTherapy
system control units and single-use disposable treatment catheters. As a result, our success is solely dependent upon the success of our Cooled ThermoTherapy systems. To date, our Cooled ThermoTherapy systems have not received widespread market
acceptance. If we are unable to commercialize the use of these systems successfully, our business, financial condition and results of operations will be materially and adversely affected.



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



We have contracted with third parties for the
production of the Prostatron product line and the Targis control unit pursuant to written supply agreements. Our supply agreement for the production of the Prostatron control unit with EDAP ended on October 1, 2003. At this time, we do not have
plans to enter into another supply agreement for the manufacture of Prostatron control units, as we believe our current inventory of Prostatron control units combined with Company owned control units located at customer sites and current purchase
commitments with EDAP will adequately support future customer requirements If, for any reason, customer demand exceeds our current projections, we could experience significant delays and expend significant resources in obtaining a new supply
agreement with EDAP or another manufacturer. If, for any reason, any of our third-party manufacturers are unable or unwilling to manufacture the products for us in the future, we could incur significant delays in obtaining a substitute contract
manufacturer. Also, we purchase additional components used in our products from various suppliers and rely on single sources for several components. One such component is obtained from a source that has a patent for the technology. Delays could be
caused if supply of this component or other components were interrupted. These delays could be extended in certain situations in which a substitute contract manufacturer or a component substitution would require approval by the FDA of a PMA
supplement. The termination or interruption of any of these relationships, or the failure of these manufacturers or suppliers to supply products or components to us on a timely basis or in sufficient quantities, likely would cause us to be unable to
meet customer orders for our products and harm our business.



We produce the disposable treatment catheter for the Targis system. We have limited experience in rapidly scaling up production. Manufacturers often encounter difficulties in scaling up production of new products, including problems
involving production yields, product recalls, quality control and assurance, component supply and lack of qualified personnel.



If we or any of our third-party manufacturers or suppliers experience production problems, we may not be able to locate an alternate manufacturer
promptly. Identifying and qualifying alternative suppliers of components takes time and involves significant additional costs and may delay the production of our products. The FDA requires us to identify any supplier we use. The FDA may require
additional testing of any component from new suppliers prior to our use of these components. The termination of our relationships with these single source suppliers or the failure of these parties to supply us with the components on a timely basis
and in sufficient quantities likely would cause us to be unable to meet customer orders for our products in a timely manner or within our budget and harm our business.



We are dependent on distributors for international sales.



To date, a majority of our revenues outside the United States have been derived from sales through third-party distributors.
We expect international sales to continue to decline in fiscal 2004 from fiscal 2003, as we focus on building the United States market. Although we will continue to sell internationally through distributors, the failure of our distributors to market
our products in the international markets effectively or our failure to locate and establish relationships with reputable distributors could have an adverse effect on our ability to achieve penetration of these markets and establish long-term
acceptance of Cooled ThermoTherapy.



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We are dependent on key personnel.



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



Government regulation can have a significant impact on our business.



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



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



We, as well as our distributors and health care providers who purchase our products and services, are subject to state and federal laws prohibiting
kickbacks or other forms of bribery in the health care industry. We may be subject to civil and criminal prosecution and penalties if we or our agents violate any of these laws.



We may be required to pay damages that exceed our insurance coverage for product liability claims.



Our business exposes us to potential product liability claims that are
inherent in the testing, production, marketing and sale of medical devices. While we believe that we are reasonably insured against these risks, we may not be able to obtain insurance in amounts or scope sufficient to provide us with adequate
coverage against all potential liabilities. Currently, we maintain product liability insurance in amounts we deem to be reasonable. A product liability claim in excess of our insurance coverage would have to be paid out of cash reserves and would
harm our reputation in the industry and our business.



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



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



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



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



| |  | the timing, volume and pricing of customer orders for both equipment and single-use treatment catheters,
| | - | --------------------------------------------------------------------------------------------------------



| |  | costs and expenses related to our effort to protect intellectual property,
| | - | --------------------------------------------------------------------------



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



| |  | product availability.
| | - | ---------------------



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



Our business is exposed to risks related to acquisitions and mergers.



As part of our strategy to commercialize our
products, we may acquire one or more businesses. On October 1, 2000, we purchased the Transurethral Microwave ThermoTherapy (TUMT or Cooled ThermoTherapy) product line and related patents and technologies from EDAP. We may not be able to integrate
our business effectively with any other business we may acquire. The failure to integrate an acquired company or acquired assets into our operations may cause a drain on our financial and managerial resources, and thereby have a significant negative
effect on our business and financial results.



These
difficulties could disrupt our ongoing business, distract our management and employees or increase our expenses. Furthermore, any physical expansion in facilities due to an acquisition may result in disruptions that seriously impair our business. We
are not experienced in managing facilities or operations in geographically distant areas. In addition, our profitability may suffer because of acquisition-related costs, amortization costs, and potential impairment of acquired goodwill and other
intangible assets. Finally, in connection with any future acquisitions, we may incur debt or issue equity securities as part or all of the consideration for the acquired companys assets or capital stock. We may be unable to obtain sufficient
additional financing on favorable terms or at all. Equity issuances would be dilutive to our existing shareholders.



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



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



| |  | actual or anticipated variations in our operating results,
| | - | ----------------------------------------------------------



| |  | developments regarding government and third-party reimbursement,
| | - | ----------------------------------------------------------------



| |  | changes in government regulation,
| | - | ---------------------------------



| |  | government investigation of us or our products,
| | - | -----------------------------------------------



| |  | changes in reimbursement rates or methods affecting our products,
| | - | -----------------------------------------------------------------



| |  | developments concerning proprietary rights,
| | - | -------------------------------------------



| |  | litigation or public concern as to the safety of our products or our competitors products,
| | - | -------------------------------------------------------------------------------------------



| |  | technological innovations or new commercial products by us or our competitors,
| | - | ------------------------------------------------------------------------------



| |  | investor perception of us and our industry
| | - | ------------------------------------------



| |  | general economic and market conditions including market uncertainty,
| | - | --------------------------------------------------------------------



| |  | national or global political events, and
| | - | ----------------------------------------



| |  | public confidence in the securities markets and regulation by or of the securities markets.
| | - | -------------------------------------------------------------------------------------------



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



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



Future sales
of our common stock, including shares issued upon the exercise of outstanding options or hedging or other derivative transactions with respect to our stock, could have a significant negative effect on the market price of our common stock. These
sales also might make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we would deem appropriate.



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



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



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ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK



Our financial instruments include cash and cash equivalents. The fair value
of our financial investment portfolio at September 30, 2003, approximated carrying value. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of these instruments. Also, fair values
of interest rate sensitive instruments may be affected by the credit worthiness of the issuer, prepayment options, relative values of alternative instruments, the liquidity of the instrument and other general market conditions.



Market risk was estimated as the potential decrease in fair value resulting
from a hypothetical 1% change in interest rates for the issues contained in the investment portfolio and was not materially different from the September 30, 2003 carrying value. Due to the nature of our short-term investments, we have concluded that
we do not have a material market risk exposure.



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



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ITEM 4. CONTROLS AND PROCEDURES



(a) Evaluation of Disclosure Controls and Procedures.



The Companys Chief Executive Officer, Fred B. Parks, and Vice
President, Finance and Controller, Todd E. Paulson, have evaluated the Companys disclosure controls and procedures as of the end of the period covered by this report. Based upon this review, these officers believe that the Companys
disclosure controls and procedures are effective in ensuring that material information related to the Company is made known to them by others within the Company.



(b) Changes in Internal Controls.



There were no significant changes in internal control over financial reporting that occurred during the fiscal quarter
covered by this report that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



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PART II - OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



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



Urologix v.
ProstaLund AB et al.



In March 2002, we filed a patent
infringement action against ProstaLund AB, ProstaLund Operations AB, and Circon Corporation a/k/a ACMI Corporation in the United States District Court for the Eastern District of Wisconsin (and by a later amended complaint) alleging that the
defendants products infringed two United States Patents that were assigned to us: U.S. Patent No. 5,234,004 (004 Patent) and U.S. Patent No. 5,509,929 (929 Patent). We sought a preliminary injunction prohibiting the
manufacture, use, sale, or offer for sale of the ProstaLund Feedback Treatment and an unspecified amount of damages. The defendants counterclaimed, alleging that they do not infringe our patents, that our patents are invalid, that we
have marked our products as patented in a manner that violates patent law and that we have engaged in inequitable conduct. The defendants are also seeking recovery of their attorneys fees.



In October 2002, the Court issued two separate Orders in this case. In an
Order dated October 10, 2002, the Court determined that the 004 patent was not entitled to the benefit of an earlier filing date of a patent application and as a result was invalid. In an Order dated October 16, 2002, the Court denied our
motion for a preliminary injunction on the 929 patent.



Subsequent to the Court Action in November 2002, in response to our request, the United States Patent and Trademark Office (PTO) issued an office action granting Urologix the benefit of the earlier office action on the 004
patent. In light of the PTO office action, we filed a motion with the Court requesting that the Court vacate the October 10, 2002 Order determining the 004 patent was invalid. In April 2003, the Court denied our motion to vacate the October
10, 2002 Order.



On September 5, 2003, the Court denied the
defendants motion for summary judgement on our claims that they are directly infringing and infringing under the doctrine of equivalents, our 929 patent. The Court, however, did grant the defendants motion for summary judgement on
our claim of indirect infringement by inducement or contributory infringement of the 929 patent. We are evaluating our options in connection with the lawsuit and are preparing for a trial on the merits of the infringement claims of the
929 patent, which we believe will occur early in calendar year 2004. Although we believe we will prevail at trial on these claims and further, do not believe the defendants remaining counterclaims have merit, an adverse determination on
any of these matters could have a material adverse effect on our business, financial condition, and results of operations. In addition, any determination that we are obligated to pay the defendants legal fees could also have a material adverse
effect on us.



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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) | Exhibits
|--- | --------



Exhibit 10.11 Letter between Urologix, inc. and Fred B. Parks dated September 29, 2003, as amended and restated.



Exhibit 31.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



Exhibit 31.2 Certification of Vice President of Finance Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002



Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350



|(b) | Report on Form 8-K
|--- | ------------------



| | a. | On August 6, 2003, the Company furnished a Form 8-K reporting under Items 7 and 12 information regarding the Companys results of operations for the quarter and fiscal year
ended June 30, 2003.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.



Date November 14, 2003



|Urologix, Inc.  (Registrant)                                                
|----------------------------------------------------------------------------
|                                                                            
|/s/ Fred B. Parks.                                                          
|                                                                            
|Fred B. Parks Chairman and Chief Executive Officer (Duly Authorized Officer)



|                                                                                    
|------------------------------------------------------------------------------------
|/s/ Todd E. Paulson                                                                 
|                                                                                    
|Todd E. Paulson Vice President, Finance and Controller (Principal Financial Officer)



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