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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended July 3, 2004
 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: 00030733 AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
  Delaware
    
    41-1978822(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 10700 Bren Road West, Minnetonka, Minnesota
    
    55343(Address of principal executive offices)
    
    (Zip Code)
 952-930-6000 
  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. [X] Yes [   ] No Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [X] Yes [   ] No As of July 30, 2004, there were 33,650,476 shares of the registrants $.01
par value Common Stock outstanding.




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##### Table of Contents



INDEX Page(s)Part I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited)Consolidated Balance Sheets as of July 3, 2004 and January 3, 2004
    
    3Consolidated Statements of Operations for the three and six month periods ended July 3, 2004 and June 28, 2003
    
    4Consolidated Statements of Cash Flows for the six month periods ended July 3, 2004 and June 28, 2003
    
    5Notes to Consolidated Financial Statements
    
    6  9Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    10  18Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    20Item 4.
    
    Controls and Procedures
    
    20Part II.
    
    OTHER INFORMATIONItem 5.
    
    Submission of Matters to a Vote of Security Holders
    
    21Item 6.
    
    Exhibits and Reports on Form 8-K
    
    21SIGNATURES
    
    
    
    22EXHIBIT INDEX
    
    23Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification Pursuant to Section 906
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS (Unaudited) American Medical Systems Holdings, Inc. 
 Consolidated Balance Sheets
  July 3, 2004
    
    January 3, 2004AssetsCurrent assetsCash and cash equivalents
    
    $
    65,891
    
    
    $
    58,953Short term investments
    
    
    11,349
    
    
    
    Accounts receivable, net
    
    
    36,922
    
    
    
    33,507Inventories, net
    
    
    17,600
    
    
    
    18,402Deferred income taxes
    
    
    6,126
    
    
    
    5,637Other current assets
    
    
    1,904
    
    
    
    2,896Total current assets
    
    
    139,792
    
    
    
    119,395Property, plant and equipment, net
    
    
    23,471
    
    
    
    25,489Goodwill, net
    
    
    98,989
    
    
    
    98,989Intangibles, net
    
    
    15,215
    
    
    
    17,466Deferred income taxes
    
    
    12,783
    
    
    
    12,991Investment in technology and other assets
    
    
    5,260
    
    
    
    4,997Total assets
    
    $
    295,510
    
    
    $
    279,327Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    3,648
    
    
    $
    4,621Accrued compensation expenses
    
    
    10,290
    
    
    
    9,886Accrued warranty expense
    
    
    1,319
    
    
    
    1,338Income taxes payable
    
    
    
    
    
    
    1,667Other accrued expenses
    
    
    5,459
    
    
    
    5,105Current portion of notes payable
    
    
    7,363
    
    
    
    7,159Total current liabilities
    
    
    28,079
    
    
    
    29,776Long-term notes payable
    
    
    5,523
    
    
    
    9,205Stockholders equityCommon stock, par value $.01 per share; authorized
95,000,000 shares; issued and outstanding: 33,637,605 shares at July 3, 2004
and 33,135,354 shares at January 3, 2004
    
    
    336
    
    
    
    331Additional paid-in capital
    
    
    208,201
    
    
    
    202,341Deferred compensation
    
    
    
    
    
    
    (24
    )Accumulated other comprehensive income
    
    
    584
    
    
    
    1,367Retained earnings
    
    
    52,787
    
    
    
    36,331Total stockholders equity
    
    
    261,908
    
    
    
    240,346Total liabilities and stockholders equity
    
    $
    295,510
    
    
    $
    279,327
 The accompanying notes are an integral part of the consolidated financial statements. 3




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American Medical Systems Holdings, Inc. 
 Consolidated Statements of Operations
  Three Months Ended
    
    Six Months EndedJuly 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2003Net sales
    
    $
    49,093
    
    
    $
    42,224
    
    
    $
    96,406
    
    
    $
    81,571Cost of sales
    
    
    9,047
    
    
    
    7,381
    
    
    
    17,977
    
    
    
    14,324Gross profit
    
    
    40,046
    
    
    
    34,843
    
    
    
    78,429
    
    
    
    67,247Operating expensesMarketing and selling
    
    
    17,250
    
    
    
    16,984
    
    
    
    33,743
    
    
    
    31,781Research and development
    
    
    3,577
    
    
    
    3,483
    
    
    
    7,161
    
    
    
    7,274General and administrative
    
    
    5,210
    
    
    
    3,845
    
    
    
    10,086
    
    
    
    7,915Amortization of intangibles
    
    
    1,058
    
    
    
    1,039
    
    
    
    2,119
    
    
    
    2,104Total operating expenses
    
    
    27,095
    
    
    
    25,351
    
    
    
    53,109
    
    
    
    49,074Operating income
    
    
    12,951
    
    
    
    9,492
    
    
    
    25,320
    
    
    
    18,173Other income (expense)Royalty income
    
    
    430
    
    
    
    687
    
    
    
    921
    
    
    
    1,464Interest income
    
    
    172
    
    
    
    112
    
    
    
    310
    
    
    
    242Interest expense
    
    
    (248
    )
    
    
    (698
    )
    
    
    (449
    )
    
    
    (1,424
    )Other income (expense)
    
    
    (31
    )
    
    
    286
    
    
    
    (187
    )
    
    
    321Total other income (expense)
    
    
    323
    
    
    
    387
    
    
    
    595
    
    
    
    603Income before income taxes
    
    
    13,274
    
    
    
    9,879
    
    
    
    25,915
    
    
    
    18,776Provision for income taxes
    
    
    4,845
    
    
    
    3,542
    
    
    
    9,459
    
    
    
    6,985Net income
    
    $
    8,429
    
    
    $
    6,337
    
    
    $
    16,456
    
    
    $
    11,791Net income per shareBasic
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    0.49
    
    
    $
    0.36Diluted
    
    $
    0.24
    
    
    $
    0.19
    
    
    $
    0.47
    
    
    $
    0.35Weighted average common shares used in calculationBasic
    
    
    33,384
    
    
    
    32,800
    
    
    
    33,313
    
    
    
    32,673Diluted
    
    
    35,037
    
    
    
    34,077
    
    
    
    35,004
    
    
    
    34,057
 The accompanying notes are an intergral part of the consolidated financal statements. 4




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American Medical Systems Holdings, Inc. 
 Consolidated Statements of Cash Flow
  Six Months EndedJuly 3, 2004
    
    June 28, 2003Cash flows from operating activitiesNet income
    
    $
    16,456
    
    
    $
    11,791Adjustments to reconcile net income to
net cash provided
by operating activitiesDepreciation
    
    
    3,466
    
    
    
    2,865Loss on asset disposals
    
    
    (5
    )
    
    
    Amortization of intangibles
    
    
    2,119
    
    
    
    2,104Amortization of deferred financing costs
    
    
    112
    
    
    
    135Non-cash compensation
    
    
    3
    
    
    
    88Income tax benefit related to stock option plan
    
    
    1,294
    
    
    
    892Change in net deferred taxes
    
    
    (618
    )
    
    
    (992
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    (3,693
    )
    
    
    (1,270
    )Inventories
    
    
    704
    
    
    
    (2,166
    )Accounts payable and accrued expenses
    
    
    (1,866
    )
    
    
    (3,039
    )Other assets
    
    
    727
    
    
    
    1,320Net cash provided by operating activities
    
    
    18,699
    
    
    
    11,728Cash flows from investing activitiesPurchase of property, plant and equipment
    
    
    (1,443
    )
    
    
    (1,599
    )Purchase of investments
    
    
    (11,349
    )
    
    
    Purchase of business
    
    
    
    
    
    
    (43,069
    )Net cash used in investing activities
    
    
    (12,792
    )
    
    
    (44,668
    )Cash flows from financing activitiesIssuance of common stock
    
    
    4,590
    
    
    
    1,269Payments on long-term debt
    
    
    (3,478
    )
    
    
    (3,319
    )Net cash provided by (used in) financing activities
    
    
    1,112
    
    
    
    (2,050
    )Effect of exchange rates on cash
    
    
    (81
    )
    
    
    (40
    )Net increase (decrease) in cash and cash equivalents
    
    
    6,938
    
    
    
    (35,030
    )Cash and cash equivalents at beginning of period
    
    
    58,953
    
    
    
    79,429Cash and cash equivalents at end of period
    
    $
    65,891
    
    
    $
    44,399Supplemental disclosureCash paid for interest
    
    $
    299
    
    
    $
    1,301Cash paid for taxes
    
    $
    9,820
    
    
    $
    6,641
 The accompanying notes are an integral part of the consolidated financial statements. 5




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  1. Basis of Presentation The consolidated financial statements included in this Form 10-Q have been
prepared by American Medical Systems Holdings, Inc. (the Company), without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to these rules
and regulations. The year-end balance sheet was derived from audited financial
statements, but does not include all disclosures required by generally accepted
accounting principles. These unaudited consolidated interim financial
statements should be read in conjunction with the Companys consolidated
financial statements and related notes included in its Annual Report on Form
10-K for fiscal 2003. All amounts are in thousands, except per share data. These statements reflect, in managements opinion, all adjustments (which
include only normal, recurring adjustments) necessary for a fair presentation
of the financial position and the results of operations and cash flows for the
periods presented. The results of operations for any interim period may not be
indicative of results for the full year. The Company has a 52 or 53 week fiscal year ended on the Saturday nearest
December 31. Accordingly, the second fiscal quarters of 2004 and 2003 ended on
July 3, 2004 and June 28, 2003, respectively. The second fiscal quarter and
the first half of the fiscal year are identified respectively herein as our
three and six month periods of fiscal 2004 and 2003. 2. Stock-Based Compensation The Company has one stock-based employee compensation plan. The Company
accounts for this plan under the recognition and measurement principles of APB
Opinion 25, Accounting for Stock Issued to Employees, and related
interpretations. The exercise price of the Companys employee stock options
generally equals the market price of the underlying stock on the date of grant
for all options granted, and thus, under APB 25, no compensation expense is
recognized. However, during 2000, the Company recognized deferred compensation
of $1.4 million, reflecting the excess of the fair value of the underlying
stock on the date of grant over the exercise price. The deferred compensation
was being amortized over vesting periods of two to four years, and was fully
amortized as of the end of the first fiscal quarter of 2004. The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of SFAS 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation. Three Months Ended
    
    Six Months Ended(in thousands, except per share data)
    
    July 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2003Net income, as reported
    
    $
    8,429
    
    
    $
    6,337
    
    
    $
    16,456
    
    
    $
    11,791Stock-based employee compensation
expense included in reported income, net of tax
    
    
    
    
    
    
    36
    
    
    
    15
    
    
    
    72Total stock-based employee compensation
expense determined under fair-value based
method for all awards, net of tax
    
    
    (1,019
    )
    
    
    (1,104
    )
    
    
    (1,835
    )
    
    
    (2,080
    )Pro forma net income
    
    $
    7,410
    
    
    $
    5,269
    
    
    $
    14,636
    
    
    $
    9,783Net income per shareAs reportedBasic
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    0.49
    
    
    $
    0.36Diluted
    
    $
    0.24
    
    
    $
    0.19
    
    
    $
    0.47
    
    
    $
    0.35Pro formaBasic
    
    $
    0.22
    
    
    $
    0.16
    
    
    $
    0.44
    
    
    $
    0.29Diluted
    
    $
    0.21
    
    
    $
    0.15
    
    
    $
    0.42
    
    
    $
    0.29
 6




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During the second fiscal quarter of 2004, stock options were exercised to
acquire 316,785 shares and 12,297 shares were purchased under the employee
stock purchase plan. During the first six months of fiscal 2004, stock options
were exercised to acquire 478,891 shares, and 23,360 shares were purchased
under the employee stock purchase plan. 3. Earnings per Share The following table presents information necessary to calculate basic and
diluted net income per common share and common share equivalents for the three
and six month periods of fiscal 2004 and 2003. Three Months Ended
    
    Six Months Ended(in thousands, except per share data)
    
    July 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2003Net income
    
    $
    8,429
    
    
    $
    6,337
    
    
    $
    16,456
    
    
    $
    11,791Weighted-average shares
outstanding for basic net income per share
    
    
    33,384
    
    
    
    32,800
    
    
    
    33,313
    
    
    
    32,673Dilutive effect of stock options
    
    
    1,653
    
    
    
    1,277
    
    
    
    1,691
    
    
    
    1,384Adjusted weighted-average shares outstanding and
assumed conversions for diluted net income per share
    
    
    35,037
    
    
    
    34,077
    
    
    
    35,004
    
    
    
    34,057Net income per shareBasic
    
    $
    0.25
    
    
    $
    0.19
    
    
    $
    0.49
    
    
    $
    0.36Diluted
    
    $
    0.24
    
    
    $
    0.19
    
    
    $
    0.47
    
    
    $
    0.35
 4. Inventories Inventories consist of the following: (in thousands)
    
    July 3, 2004
    
    January 3, 2004Raw materials
    
    $
    4,811
    
    
    $
    5,001Work in process
    
    
    3,113
    
    
    
    2,817Finished goods
    
    
    9,676
    
    
    
    10,584Net inventories
    
    $
    17,600
    
    
    $
    18,402
 5. Investments During fiscal 2004, the Company invested in certain tax-advantaged municipal
debt that is classified as available-for-sale securities. As of July 3, 2004,
the value of the investments was $11.3 million. Cost approximates market value
for the investments, which mature between January 2005 and June 2005. 6. Warranties Many of the Companys products are sold with warranty coverage for periods
ranging from one year up to the patients lifetime. The accrued warranty
allowance is the Companys estimate of the expected future cost of honoring
warranty obligations. Factors influencing this estimate include historical
claim rates, surgical infection rates, changes in product performance, the
frequency of use by the patient, the patients performance expectations, and
changes in the terms of our policies. The warranty allowance was adjusted down
in the fourth quarters of 2003 and 2002 by $3.1 million and $2.9 million,
respectively. This was based on a reduction in managements estimate of the
future cost of honoring the Companys warranty obligations resulting from
improvements in the quality and durability of its products and changes in its
claims processing. Changes in warranty allowances during the six month periods
of fiscal 2004 and 2003 were as follows: Six Months Ended
    
    Six Months Ended(in thousands)
    
    July 3, 2004
    
    June 28, 2003Balance, beginning of period
    
    $
    1,338
    
    
    $
    4,591Provisions for warranty
    
    
    147
    
    
    
    150Claims processed
    
    
    (166
    )
    
    
    (150
    )Balance, end of period
    
    $
    1,319
    
    
    $
    4,591
 7




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7. Comprehensive Income Comprehensive income for the Company is net income adjusted for changes in the
value of derivative financial instruments designated as hedges, unrealized
gains and losses on marketable securities, and foreign currency translation. Comprehensive income for the three and six month periods in fiscal 2004 and
2003 was: Three Months Ended
    
    Six Months Ended(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2003Net income
    
    $
    8,429
    
    
    $
    6,337
    
    
    $
    16,456
    
    
    $
    11,791Net loss on hedges, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Amounts reclassified to interest
expense during the period from
derivative and hedging activities, net of taxes
    
    
    
    
    
    
    201
    
    
    
    
    
    
    
    464Translation gain (loss), net of taxes
    
    
    (362
    )
    
    
    594
    
    
    
    (783
    )
    
    
    1,072Comprehensive income
    
    $
    8,067
    
    
    $
    7,132
    
    
    $
    15,673
    
    
    $
    13,322
 8. Recent Accounting Pronouncements The Medicare Prescription Drug, Improvements and Modernization Act of 2003 (The
Act) was signed into law in December 2003. The Act introduces a prescription
drug benefit under Medicare (Medicare Part D), as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a prescription drug
benefit that is at least actuarially equivalent to Medicare Part D. In May
2004, the FASB issued Staff Position
(FSP) No. 106-2, Accounting and Disclosure Requirements Related to the

Medicare Prescription Drug, Improvement and Modernization Act of 2003. This
FSP is effective for interim or annual periods beginning after June 15, 2004.
We have not yet concluded whether the benefits provided by our plan are
actuarially equivalent to Medicare Part D under The Act. 9. Industry Segment Information and Foreign Operations Since its inception, the Company has operated in the single industry segment of
developing, manufacturing, and marketing medical devices. The Company distributes its products through its direct sales force and
independent sales representatives in the United States, Canada, Australia, and
most of Europe. Additionally, the Company distributes its products through
foreign independent distributors, primarily in Europe, Asia, and South America,
who then sell the products to medical institutions. No customer or distributor
accounted for five percent or more of the Companys net sales during 2004 or
2003. Foreign subsidiary sales are predominantly to customers in Western
Europe, Australia, and Canada. Substantially all of the Companys foreign
subsidiary assets are located in Western Europe, Australia, and Canada. The following table presents net sales and long-lived assets by geographical
territory. No individual foreign countrys net sales or long-lived assets are
material. Three Months Ended
    
    Six Months Ended(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2003United StatesNet sales
    
    $
    37,643
    
    
    $
    33,919
    
    
    $
    74,241
    
    
    $
    66,266Long-lived assets
    
    $
    130,685
    
    
    $
    155,312
    
    
    $
    130,685
    
    
    $
    155,312Outside United StatesNet sales
    
    $
    11,450
    
    
    $
    8,305
    
    
    $
    22,165
    
    
    $
    15,305Long-lived assets
    
    $
    12,250
    
    
    $
    12,667
    
    
    $
    12,250
    
    
    $
    12,667
 8




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10. Goodwill and Intangible Assets There were no changes in the carrying amount of goodwill during the second
fiscal quarter of 2004. It is the Companys practice to assess goodwill
impairment under the annual requirement of SFAS 142 or when impairment
indicators arise. The following table presents the Companys intangible assets and accumulated
amortization as of July 3, 2004: Gross carrying
    
    Accumulated
    
    Net book(in thousands)
    
    amount
    
    amortization
    
    valueAmortizedPatents
    
    $
    10,122
    
    
    $
    (6,022
    )
    
    $
    4,100Licenses
    
    
    2,791
    
    
    
    (1,235
    )
    
    
    1,556Deferred financing
    
    
    1,611
    
    
    
    (1,273
    )
    
    
    338Developed technology
    
    
    17,853
    
    
    
    (10,407
    )
    
    
    7,446Non-compete agreements
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    Total amortized intangible assets
    
    
    33,488
    
    
    
    (20,048
    )
    
    
    13,440UnamortizedTrademarks
    
    
    1,775
    
    
    
    
    
    
    
    1,775Total intangible assets
    
    $
    35,263
    
    
    $
    (20,048
    )
    
    $
    15,215
 Three months ended
    
    Six months ended(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2004Amortization expense
    
    $
    1,058
    
    
    $
    1,039
    
    
    $
    2,119
    
    
    $
    2,104
 Estimated amortization expense for the years 2004 through 2008 is $4.2 million,
$2.7 million, $2.2 million, $1.3 million and $1.3 million, respectively,
excluding additional amortization that may arise from the acquisition in July
2004 of TherMatrx, Inc. as further described in Note 11. 11. Subsequent Events Repayment of Debt On July 8, 2004, the Company repaid the entire outstanding balance of $12.9
million under its senior credit facility and terminated the credit facility.
The original maturity of the term notes required quarterly principal payments
through September 2005. We have plans to reestablish a new credit facility
during 2004. TherMatrx Acquisition On July 15, 2004, the Company completed the acquisition of TherMatrx, Inc. As a
result of the merger, holders of shares of TherMatrx stock which were
outstanding as of the merger were initially paid cash proceeds, after all
adjustments made at closing, in the amount of $40.5 million. The Company
deposited $4.0 million of this initial consideration in escrow to be held for
six months after closing of the merger to cover certain contingencies, and the
balance was distributed to holders of TherMatrx stock. The Company used cash
on hand to make the initial payment of $40.5 million. In addition to the initial closing payment, the Company will make contingent
payments based on the net product revenues attributable to sales of the
TherMatrx Dose Optimized Thermotherapy product. These payments will equal four
times such sales over a period of six consecutive Company fiscal quarters
(which began on July 5, 2004, and will end on December 31, 2005), minus $40.0
million. The maximum amount of the purchase price is $250.0 million. 9




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. Words such as may,
expect, believe, anticipate, or estimate, identify such forward-looking
statements. These statements by their nature involve substantial risks and
uncertainties, and actual results may differ materially from those expressed in
such forward-looking statements. Some of the factors that could cause such
material differences are identified in Risk Factors. We undertake no
obligation to correct or update any forward-looking statements, whether as a
result of new information, future events, or otherwise. You are advised,
however, to consult any future disclosures we make on related subjects in
future filings with the SEC. Critical Accounting Policies and Estimates We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. Managements
discussion and analysis of financial condition and results of operations are
based upon the consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect (1) the reported amounts of assets, liabilities,
revenues, and expenses; and (2) the related disclosure of contingent assets and
liabilities. At each balance sheet date, we evaluate our estimates, including
but not limited to, those related to accounts receivable and sales return
obligations, inventories, long-lived assets, warranty, legal contingencies, and
income taxes. The critical accounting policies that are most important in fully
understanding and evaluating the financial condition and results of operations
are discussed in our Form 10-K on file with the SEC. Overview American Medical Systems develops, manufactures, and markets medical devices
for physician customers, primarily urologists, gynecologists and
urogynecologists. Our products are utilized by physicians to treat male
disorders such as erectile dysfunction, incontinence, and prostate disease; and
also female disorders such as incontinence, excessive uterine bleeding, and
pelvic organ prolapse. Our strategy has been to develop innovative products
that provide our customers with therapy options to better, and/or less
invasively, manage under-treated urological and gynecological conditions. Our product offering includes a full line of erectile restoration products
including both inflatable and non-inflatable prostheses to replace
non-functioning penile erectile tissue. For male urinary control we sell our
AMS 800 Artificial Urinary Sphincterand the InVancesling system. For
urethral stricture and benign prostatic hyperplasia (BPH) symptoms we sell
urethral stents and surgical resection loops. The ProstaJect®chemical prostate
ablation system is currently available outside of the U.S. and is in clinical
trials in the U.S. Our womens health products include several products for
stress urinary incontinence (InFast, SPARC, Monarcand BioArc). Through the
acquisition of CryoGen, Inc. in January 2003, we added the
Her Option®therapy
to our womens health portfolio for excessive menstrual bleeding. On July 15, 2004, we acquired TherMatrx, Inc., a privately held company focused
on providing physicians an in-office alternative for BPH. Each year in the
United States, over three million men seek treatment for the non-cancerous
enlargement of the prostate gland known as BPH. Current invasive therapies
offered for BPH include surgically removing the entire prostate, resecting a
portion of the prostate, or performing a transurethral incision of the
prostatic tissue. Other less invasive procedures performed in the hospital
include prostatic stenting, laser-based resection, radio-frequency energy
ablation, and the delivery of microwave energy. While some of these therapies
may be performed under certain circumstances in a physicians office, they are
neither as comfortable for the patient nor as appropriate for the office
setting as the TherMatrx microwave therapy for BPH symptoms. 10




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##### Table of Contents



Results of Operations The following table compares net sales by product line and geography for the
three and six month periods of fiscal 2004 and 2003: Three Months Ended
    
    $ Increase
    
    % Increase(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    (Decrease)
    
    (Decrease)SalesProduct LineMens healthErectile restoration
    
    $
    17,919
    
    
    $
    17,966
    
    
    ($
    47
    )
    
    
    -0.3
    %Continence
    
    
    12,266
    
    
    
    10,471
    
    
    
    1,795
    
    
    
    17.1
    %Prostate treatment
    
    
    1,089
    
    
    
    1,312
    
    
    
    (223
    )
    
    
    -17.0
    %Total mens health
    
    
    31,274
    
    
    
    29,749
    
    
    
    1,525
    
    
    
    5.1
    %Womens health
    
    
    17,819
    
    
    
    12,475
    
    
    
    5,344
    
    
    
    42.8
    %Total
    
    $
    49,093
    
    
    $
    42,224
    
    
    $
    6,869
    
    
    
    16.3
    %GeographyUnited States
    
    $
    37,643
    
    

    $
    33,919
    
    
    $
    3,724
    
    
    
    11.0
    %Outside United States
    
    
    11,450
    
    
    
    8,305
    
    
    
    3,145
    
    
    
    37.9
    %Total
    
    $
    49,093
    
    
    $
    42,224
    
    
    $
    6,869
    
    
    
    16.3
    %Percent of total salesProduct LineMens healthErectile restoration
    
    
    37
    %
    
    
    42
    %Continence
    
    
    25
    %
    
    
    25
    %Prostate treatment
    
    
    2
    %
    
    
    3
    %Total mens health
    
    
    64
    %
    
    
    70
    %Womens health
    
    
    36
    %
    
    
    30
    %Total
    
    
    100
    %
    
    
    100
    %GeographyUnited States
    
    
    77
    %
    
    
    80
    %Outside United States
    
    
    23
    %
    
    
    20
    %Total
    
    
    100
    %
    
    
    100
    %
   [Continued from above table, first column(s) repeated] Six Months Ended
    
    $ Increase
    
    % Increase(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    (Decrease)
    
    (Decrease)SalesProduct LineMens healthErectile restoration
    
    $
    35,384
    
    
    $
    35,818
    
    
    ($
    434
    )
    
    
    -1.2
    %Continence
    
    
    24,432
    
    
    
    20,503
    
    
    
    3,929
    
    
    
    19.2
    %Prostate treatment
    
    
    2,255
    
    
    
    2,511
    
    
    
    (256
    )
    
    
    -10.2
    %Total mens health
    
    
    62,071
    
    
    
    58,832
    
    
    
    3,239
    
    
    
    5.5
    %Womens health
    
    
    34,335
    
    
    
    22,739
    
    
    
    11,596
    
    
    
    51.0
    %Total
    
    $
    96,406
    
    
    $
    81,571
    
    
    $
    14,835
    
    
    
    18.2
    %GeographyUnited States
    
    $
    74,241
    
    
    $
    66,266
    
    
    $
    7,975
    
    
    
    12.0
    %Outside United States
    
    
    22,165
    
    
    
    15,305
    
    
    
    6,860
    
    
    
    44.8
    %Total
    
    $
    96,406
    
    
    $
    81,571
    
    
    $
    14,835
    
    
    
    18.2
    %Percent of total salesProduct LineMens healthErectile restoration
    
    
    37
    %
    
    
    44
    %Continence
    
    
    25
    %
    
    
    25
    %Prostate treatment
    
    
    2
    %
    
    
    3
    %Total mens health
    
    
    64
    %
    
    
    72
    %Womens health
    
    
    36
    %
    
    
    28
    %Total
    
    
    100
    %
    
    
    100
    %GeographyUnited States
    
    
    77
    %
    
    
    81
    %Outside United States
    
    
    23
    %
    
    
    19
    %Total
    
    
    100
    %
    
    
    100
    %
 Net Sales.Net sales increased by 16.3 percent in the second fiscal quarter of
2004 as compared to the same period in 2003. Net sales year to date through
the second quarter of 2004 grew 18.2 percent as compared to the same period of
2003. Sales in our second fiscal quarter grew broadly worldwide, contributing to our
total net sales of $49.1 million. International sales, which this quarter
represented over 23 percent of our net sales, grew 37.9 percent over last the
second quarter of 2003 (27.6 percent before favorable currency effects). U.S.
sales grew 11.0 percent from the year ago period. Growth in the U.S.,
excluding erectile restoration sales, was 21.5 percent. Further detail on the
erectile restoration business and its growth follows. Worldwide erectile restoration revenues decreased .3 percent and 1.2 percent
during the three and six month periods of fiscal 2004, respectively. We
believe that the overall erectile restoration market has been impacted by the
trialing of new drug therapies which tends to delay implant decisions by our
physician and patient customers. We also believe that our market share is
stable and could improve in future quarters as a result of an important new
product launch later this year. We have received clearance from the Food and
Drug Administration for our new AMS 700 Tactile Pumpproduct. Clinical trials
of this new erectile restoration product, designed to improve patients ease of
use in activating the pump, have generated early enthusiasm within the
prosthetic urology community. We anticipate worldwide availability of the new
pump in October 2004. Aided by the launch of this product, and a declining
effect of new drug trialing, we anticipate our erectile restoration business
will resume modest growth in the second half of 2004. 11




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##### Table of Contents



Our male urinary continence products increased 17.1 percent and 19.2 percent in
the three and six month periods of fiscal 2004, respectively, in second quarter
over the year ago period, primarily due to unit sales growth. Both the AMS
Artificial Urinary Sphincter 800and InVancesling were implanted in more
patients in the second quarter than at any time in our history. Prostate product sales declined by 17.0 percent and 10.2 percent in the three
and six month periods of fiscal 2004, respectively, as we continue to
reposition the UroLume®product toward obstructive urethral conditions such as
urethral stricture. Our second half sales of prostate treatment products will
include the sales of TherMatrx BPH products as of that companys July 15th,
2004 acquisition date. TherMatrx sales (not included in our reported first
half sales) were $9.7 million in the first half of 2004, a 45 percent increase
over the first half of 2003. Sales of womens health products increased 42.8 percent and 51.0 percent in the
three and six month periods of fiscal 2004, respectively. The market for
female incontinence products continues to expand rapidly driven by the
acceptance of minimally invasive therapies. The SPARCsling system continues
to be our number one selling female incontinence product in the U.S., although
we expect it will be surpassed by the end of the year with continued adoption
of Monarc. Monarcsales grew significantly in our second quarter of 2004, its
sixth quarter of availability in Europe and fourth quarter of use in the U.S.
We are continuing Monarctraining and proctoring for gynecologists and
urologists worldwide. Our BioArcsling system continued to grow sequentially
during the second quarter of 2004. BioArcis the only product available which
offers physicians the choice of a biologic graft material attached to the
self-fixating sling. We plan to further expand the BioArcseries from the
BioArcSP, (suprapubic surgical approach) to include also the BioArcTO
(transobturator surgical approach). This expansion of the BioArcseries is
anticipated during our third fiscal quarter of 2004. We expanded our female pelvic prolapse product portfolio during the second
fiscal quarter with the FDAs clearance of the Apogeeand Perigee. Although
we have received regulatory clearance for these products, our physician
training only began in early June 2004. We will continue to train physicians
in the third quarter of 2004 for purposes of post-market studies which we
believe will support wider product availability in 2005. Sales growth in the three and six month periods of fiscal 2004 were driven
primarily by unit volume growth of new products and, to a lesser degree, by
pricing increases and the positive impact of foreign exchange rates. Changes in currency exchange rates, primarily the Euro, increased sales for the
three and six month periods of fiscal 2004 by $.9 million and $2.2 million,
respectively. If these currency exchange rates in fiscal 2004 had been the
same as fiscal 2003, total sales during the three month period of fiscal 2004
would have been $48.2 million, an increase of $6.0 million, or 14.3 percent,
and total sales during the six month period of fiscal 2004 would have been
$94.2 million, an increase of $12.7 million, or 15.5 percent. 12




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##### Table of Contents



The following table compares revenue, expense, and other income accounts for
the three and six month periods of fiscal 2004 and 2003: Three Months Ended
    
    $ Increase
    
    % Increase(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    (Decrease)
    
    (Decrease)Net sales
    
    $
    49,093
    
    
    $
    42,224
    
    
    $
    6,869
    
    
    
    16.3
    %Cost of sales
    
    
    9,047
    
    
    
    7,381
    
    
    
    1,666
    
    
    
    22.6
    %Gross profit
    
    
    40,046
    
    
    
    34,843
    
    
    
    5,203
    
    
    
    14.9
    %Operating expensesMarketing and selling
    
    
    17,250
    
    
    
    16,984
    
    
    
    266
    
    
    
    1.6
    %Research and development
    
    
    3,577
    
    
    
    3,483
    
    
    
    94
    
    
    
    2.7
    %General and administrative
    
    
    5,210
    
    
    
    3,845
    
    
    
    1,365
    
    
    
    35.5
    %Amortization of intangibles
    
    
    1,058
    
    
    
    1,039
    
    
    
    19
    
    
    
    1.8
    %Total operating expenses
    
    
    27,095
    
    
    
    25,351
    
    
    
    1,744
    
    
    
    6.9
    %Operating income
    
    
    12,951
    
    
    
    9,492
    
    
    
    3,459
    
    
    
    36.4
    %Royalty income
    
    
    430
    
    
    
    687
    
    
    
    (257
    )
    
    
    -37.4
    %Interest income
    
    
    172
    
    
    
    112
    
    
    
    60
    
    
    
    53.6
    %Interest expense
    
    
    (248
    )
    
    
    (698
    )
    
    
    450
    
    
    
    64.5
    %Other income (expense)
    
    
    (31
    )
    
    
    286
    
    
    
    (317
    )
    
    
    -110.8
    %Income before income taxes
    
    
    13,274
    
    
    
    9,879
    
    
    
    3,395
    
    
    
    34.4
    %Provision for income taxes
    
    
    4,845
    
    
    
    3,542
    
    
    
    1,303
    
    
    
    36.8
    %Net income
    
    $
    8,429
    
    
    $
    6,337
    
    
    $
    2,092
    
    
    
    33.0
    %
   [Continued from above table, first column(s) repeated] Six Months Ended
    
    $ Increase
    
    % Increase(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    (Decrease)
    
    (Decrease)Net sales
    
    $
    96,406
    
    
    $
    81,571
    
    
    $
    14,835
    
    
    
    18.2
    %Cost of sales
    
    
    17,977
    
    
    
    14,324
    
    
    
    3,653
    
    
    
    25.5
    %Gross profit
    
    
    78,429
    
    
    
    67,247
    
    
    
    11,182
    
    
    
    16.6
    %Operating expensesMarketing and selling
    
    
    33,743
    
    
    
    31,781
    
    
    
    1,962
    
    
    
    6.2
    %Research and development
    
    
    7,161
    
    
    
    7,274
    
    
    
    (113
    )
    
    
    -1.6
    %General and administrative
    
    
    10,086
    
    
    
    7,915
    
    
    
    2,171
    
    
    
    27.4
    %Amortization of intangibles
    
    
    2,119
    
    
    
    2,104
    
    
    
    15
    
    
    
    0.7
    %Total operating expenses
    
    
    53,109
    
    
    
    49,074
    
    
    
    4,035
    
    
    
    8.2
    %Operating income
    
    
    25,320
    
    
    
    18,173
    
    
    
    7,147
    
    
    
    39.3
    %Royalty income
    
    
    921
    
    
    
    1,464
    
    
    
    (543
    )
    
    
    -37.1
    %Interest income
    
    
    310
    
    
    
    242
    
    
    
    68
    
    
    
    28.1
    %Interest expense
    
    
    (449
    )
    
    
    (1,424
    )
    
    
    975
    
    
    
    68.5
    %Other income (expense)
    
    
    (187
    )
    
    
    321
    
    
    
    (508
    )
    
    
    -158.3
    %Income before income taxes
    
    
    25,915
    
    
    
    18,776
    
    
    
    7,139
    
    
    
    38.0
    %Provision for income taxes
    
    
    9,459
    
    
    
    6,985
    
    
    
    2,474
    
    
    
    35.4
    %Net income
    
    $
    16,456
    
    
    $
    11,791
    
    
    $
    4,665
    
    
    
    39.6
    %
 Percent of Sales
    
    Percent of SalesFor the Three Months Ended
    
    For the Six Months Ended(in thousands)
    
    July 3, 2004
    
    June 28, 2003
    
    July 3, 2004
    
    June 28, 2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    18.4
    %
    
    
    17.5
    %
    
    
    18.6
    %
    
    
    17.6
    %Gross profit
    
    
    81.6
    %
    
    
    82.5
    %
    
    
    81.4
    %
    
    
    82.4
    %Operating expensesMarketing and selling
    
    
    35.1
    %
    
    
    40.2
    %
    
    
    35.0
    %
    
    
    39.0
    %Research and development
    
    
    7.3
    %
    
    
    8.2
    %
    
    
    7.4
    %
    
    
    8.9
    %General and administrative
    
    
    10.6
    %
    
    
    9.1
    %
    
    
    10.5
    %
    
    
    9.7
    %Amortization of intangibles
    
    
    2.2
    %
    
    
    2.5
    %
    
    
    2.2
    %
    
    
    2.6
    %Total operating expenses
    
    
    55.2
    %
    
    
    60.0
    %
    
    
    55.1
    %
    
    
    60.2
    %Operating income
    
    
    26.4
    %
    
    
    22.5
    %
    
    
    26.3
    %
    
    
    22.2
    %Royalty income
    
    
    0.9
    %
    
    
    1.6
    %
    
    
    1.0
    %
    
    
    1.8
    %Interest income
    
    
    0.4
    %
    
    
    0.3
    %
    
    
    0.3
    %
    
    
    0.3
    %Interest expense
    
    
    -0.5
    %
    
    
    -1.7
    %
    
    
    -0.5
    %
    
    
    -1.7
    %Other income (expense)
    
    
    -0.1
    %
    
    
    0.7
    %
    
    
    -0.2
    %
    
    
    0.4
    %Income before income taxes
    
    
    27.1
    %
    
    
    23.4
    %
    
    
    26.9
    %
    
    
    23.0
    %Provision for income taxes
    
    
    9.9
    %
    
    
    8.4
    %
    
    
    9.8
    %
    
    
    8.6
    %Net income
    
    
    17.2
    %
    
    
    15.0
    %
    
    
    17.1
    %
    
    
    14.4
    %
 Cost of sales.Cost of sales as a percentage of sales increased by .9
percentage point and 1.0 percentage point during the three and six month
periods of fiscal 2004, respectively. Over half of this increase was due to a
greater portion of our revenues consisting of sales of womens health products
and sales in international markets, both of which carry a lower margin than our
consolidated average. Inventory reserves for lesser-used product sizes were
also increased during the first and second quarters of fiscal 2004 as we
prepare to 13




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phase out older products in favor of anticipated new product releases later in
the year. These unfavorable increases were partially offset by the favorable
foreign exchange impact on our gross profit. Future cost of goods sold will
continue to depend on product phase-ins, production levels and product mix. Marketing and selling.Marketing and selling expense increased in the three
and six month periods of fiscal 2004 due to greater sales volume, but declined
by 5.1.and 4.0 percentage points relative to sales, respectively. This decline
as a percent of sales resulted from our ability to leverage the investment made
during 2003 in our marketing and training programs for womens health products.
Accordingly, our objective remains to increase sales and marketing expenses in
absolute dollars, but to decrease as a percentage of sales. Research and development.Research and development expense was 7.3 percent and
7.4 percent of sales during the three and six month periods of fiscal 2004,
respectively. We expect total spending in research and development over the
longer term, to be in the range of 8 to 10 percent of sales. General and administrative.General and administrative expenses during the
three and six month periods of fiscal 2004 increased 35.5 percent and 27.4
percent, respectively, and increased as a percentage of net sales over fiscal
2003. Over half of the increase in the three and six month periods of fiscal
2004 was attributable to external Sarbanes-Oxley Act related spending, combined
with legal costs related to intellectual property matters and bad debt expense. Amortization of intangibles.Amortization of intangibles includes amortization
expense on our definite-lived intangible assets, consisting of patents,
licenses and developed technology. We expect amortization of intangibles to
remain at approximately $1.1 million per quarter for the remainder of 2004,
excluding additional amortization that may arise from our acquisition of
TherMatrx in July 2004. Royalty income.Our royalty income is primarily from the license of our
stent-delivery technology for medical use outside of urology. This exclusive
worldwide license was entered into during 1998, with expiration immediately
following the term of the various licensed patents. We receive a royalty equal
to 2.625 percent of net sales of licensed products on a quarterly basis. We do
not directly influence sales of the products on which this royalty is based and
cannot give any assurance as to future income levels. Interest income.Interest income increased during the three and six month
periods of fiscal 2004, due to higher levels of investments resulting from
greater cash generated from operations in fiscal 2004 than in fiscal 2003. Interest expense.Interest expense declined during the three and six month
periods of fiscal 2004, due to the expiration of our interest rate swap
agreement as well as a decline in our long term debt balance. We hedged a
portion of our original $65.0 million variable rate term note, as required by
our senior credit facility, by entering into an interest rate swap agreement in
which we agreed to exchange, at specified intervals, the calculated difference
between the fixed interest rate of the swap and the variable interest rate on a
portion of our debt. This interest rate swap agreement expired June 30, 2003.
We did not renew the swap agreement and do not expect swap-related expenses
going forward. On July 8, 2004, we repaid the entire outstanding balance of
$12.9 million under our senior credit facility and terminated the credit
facility. Accordingly, we expect our interest expense to decrease in future
periods. Other income.Other income and expense primarily represents gains and losses
as a result of remeasuring foreign short-term denominated inter-company
receivables, mainly the euro, to current rates. The three and six month
periods of fiscal 2004 reflect losses due to the weakening of the euro by 1.2
percent and 2.2 percent, respectively, to the U.S. dollar from the beginning of
the period, while the three and six month periods of fiscal 2003 reflect gains
due to the strengthening of the euro by 6.8 percent and 10.2 percent,
respectively, to the U.S. dollar from the beginning of the period. Income taxes.Our effective tax rate for the three and six month periods of
fiscal 2004 was 36.5 percent. We believe our utilization of research and
development tax credits and the extraterritorial income exclusion will result
in an effective tax rate of 36.5 percent for the remainder of fiscal 2004. The effective tax rate for the three and six month periods of fiscal 2003 was
35.9 percent and 37.2 percent respectively. During the third quarter of fiscal
2003, the Company applied for and began to recognize the tax benefits related
to research and development tax credits and extraterritorial income exclusions. 14




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Liquidity and Capital Resources Cash and cash equivalents were $65.9 million as of July 3, 2004, compared to
$59.0 million as of January 3, 2004. This increase is due primarily to the
continued strong growth in revenues and net income, and other factors described
below. Cash flows from operating activities.Net cash from operations was $18.7
million for the six month period of fiscal 2004, driven by net income of $16.5
million and increased for certain non-cash expenses including depreciation and
amortization of $5.6 million. Working capital impacts included an increase in
accounts receivable of $3.7 million resulting primarily from higher revenues by
our foreign subsidiaries, and a decrease of $1.9 million in accounts payable
and accrued expenses. Net cash from operations was $11.7 million for the six
month period of fiscal 2003, resulting from net income of $11.8 million,
depreciation and amortization of $5.0 million, offset by other changes in
assets and liabilities. Cash flows from investing activities.Cash used in investing activities was
$12.8 million and $44.7 million for the six month periods of fiscal 2004 and
2003, respectively. During the six month periods of fiscal of 2004 and 2003,
we purchased equipment totaling $1.4 million and $1.6 million, respectively.
We expect capital expenditures to be in the range of $5.0 to $7.0 million for
the full year of fiscal 2004. During the six month period of fiscal 2004, we
purchased investments of $11.3 million. During the first fiscal quarter of
2003, we had a cash outlay of $43.1 million related to the acquisition of
CryoGen Inc. Cash flows from financing activities.Cash flows generated from financing
activities was $1.1 million during the six month period of fiscal 2004,
compared to $2.1 million used during the six month period of 2003. Cash
received under our stock option and employee stock purchase plans was $4.6
million and $1.3 million during the six month periods of fiscal 2004 and 2003,
respectively. Payments made under our senior credit facility were $3.5 million
and $3.3 million during the six month periods of fiscal 2004 and 2003,
respectively. On July 8, 2004, we repaid the entire outstanding balance of $12.9 million
under our senior credit facility and terminated the credit facility. The
original maturity of the term notes required quarterly principal payments
through September 2005. We were in compliance with all required financial
covenants both during the six month periods covered, as well as through the
date the debt was repaid in full. During the six month period of fiscal 2004, we received $4.6 million from the
exercises of options under our 2000 Equity Incentive Plan and for issuing
common stock under our Employee Stock Purchase Plan. Cash Commitments.Pursuant to our acquisition of CryoGen, Inc. on January 2,
2003, we have agreed to pay CryoGens former shareholders an earnout payment
contingent upon sales of CryoGen products. The earnout payment will be equal
to three times our net sales of CryoGen products during four consecutive
quarters, less our $40.0 million initial acquisition payment. The earnout
period expires December 31, 2005. If our net CryoGen product sales do not
exceed $13.3 million during any consecutive four-quarter period prior to
December 31, 2005, no earnout payment will be required. The maximum amount of
the earnout payment is $110.0 million. This transaction is more fully
described in our Form 8-K filed with the SEC on January 6, 2003. We do not
currently anticipate an earnout payment to the former CryoGen shareholders. On July 15, 2004, we completed the acquisition of TherMatrx. As a result of
the merger, holders of shares of TherMatrx stock which were outstanding as of
the merger were initially paid cash proceeds, after all adjustments made at
closing, in the amount of $40.5 million. We used cash on hand to make the
initial payment of $40.5 million. In addition to the initial closing payment,
we will make contingent payments based on the net product revenues attributable
to sales of the TherMatrx Dose Optimized Thermotherapy product. These payments
will equal four times such sales over a period of six consecutive fiscal
quarters (which began on July 5, 2004, and will end on December 31, 2005),
minus $40.0 million. Sales of the TherMatrx Dose Optimized Thermotherapy were
$5.0 million in TherMatrxs second quarter of 2004. Accordingly, if product
sales remained flat during the contingent payment period, the total amount of
the contingent payments would be $80.0 million. The maximum amount of the
purchase price is $250.0 million or $210.0 million of
contingent payments. We believe that funds generated from operations, together with our balances in
cash and cash equivalents, as well as short term investments and our plans to
add a new credit facility will be sufficient to finance current operations,
planned capital expenditures, and our commitment to TherMatrx shareholders. 15




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Risk Factors There are several factors that could cause our actual results to differ
materially from our anticipated results. Some of these factors, and their
impact on the success of our operations and our ability to achieve our goals,
are discussed below. Supplier Risks Many of our products are dependent on raw materials from one or two suppliers
who may not be able to meet our demands or who may decide to stop supplying us
because of their concerns about product liability claims or other reasons.
Losing any of these raw material suppliers could have a material adverse effect
on our sales and income. As a result of supplier consolidations, we now rely
on only one source for the silicone elastomer used in some of our implantable
products; the loss of this supplier would have a material adverse effect on our
cost of sales and income, as we would be required to qualify an additional
supplier. We procure human cadaveric dermis through two processors, and we
have one supplier of porcine dermis. Potential Product Recalls In the event that any of our products were defective, we could voluntarily
recall, or the FDA or an international regulatory body could require us to
redesign or recall, any defective product. There is a possibility that we may
recall products in the future and that future recalls could result in
significant costs to us and in significant negative publicity which could harm
our ability to market our products in the future. Continued Physician Use and Endorsement of our Products For us to sell our products, physicians must recommend and endorse them. We
may not obtain the necessary recommendations or endorsements from physicians.
Many of the products we acquired or are developing are based on new treatment
methods. Acceptance of our products is dependent on educating the medical
community as to the distinctive characteristics, perceived benefits, clinical
efficacy, and cost-effectiveness of our products compared to competitive
products, and on training physicians in the proper application of our products.
We believe our products address major market opportunities, but if we are
unsuccessful in marketing them, our sales and earnings might be below
expectations. Successful Introduction of New Products and Product Improvements As part of our growth strategy, we intend to introduce a number of new products
and product improvements. If we do not introduce these new products and
product improvements on schedule, or they are not well-accepted by the market,
our growth may be reduced. Continued Use of Non-Invasive Treatment Alternatives We predominantly sell devices and kits for invasive or minimally invasive
surgical procedures. If patients do not accept our products, our sales may
decline. Patient acceptance of our products depends on a number of factors,
including the failure of non-invasive therapies, the degree of invasiveness
involved in the procedures using our products, the rate and severity of
complications, and other adverse side effects from the procedures using our
products. Patients are more likely to first consider non-invasive alternatives
to treat their urological disorders. The introduction of new oral medications
or other less-invasive therapies might cause our sales to decline. Actions Related to Reimbursement for Procedures Using our Products Our physician and hospital customers depend on third party government and
non-government entities for reimbursement for services provided to patients.
The level of such third party reimbursement may influence whether or not
customers purchase our products. Effective January 1, 2004, the Centers for Medicare and Medicaid Services (CMS)
increased reimbursement for certain procedures utilizing inflatable penile
prostheses and urinary sphincter devices. This increase partially reverses
reductions in such reimbursement rates in 2001 and 2002. Our sales history of
these devices does not evidence an obvious correlation with changes in CMS
reimbursement rates. In March of 2004 we were informed by the American Medical Association that the
organizations Current Procedural Terminology (CPT) Editorial Panel had
approved a CPT code for our Her Optioncryoablation system to treat excessive
uterine bleeding. The receipt of this CPT code is the first step toward the
availability of standard reimbursement for Her Option.A noticeable effect on
sales of Her Optionis not 16




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expected until such reimbursement is established (currently anticipated to be
January 2005). We can offer no assurances that a new code for Her Option
procedures will be in place by January 2005 or that the reimbursement will
adequately cover the costs of performing the procedure. Intellectual Property Lawsuits The medical device industry is litigious with respect to patents and other
intellectual property rights. Companies in the medical device industry have
used intellectual property litigation to gain a competitive advantage. We are
currently involved in an intellectual property lawsuit with Mentor Corporation
relating to our Monarcsub-fascial hammock for the treatment of female
incontinence. If Mentor were to obtain a favorable ruling in this lawsuit, the
court could require us to pay significant damages to Mentor, prevent us from
selling our Monarcsub-fascial hammock for the treatment of female
incontinence, or both. The occurrence of any of these would have a negative
impact on our business. In the future, we may become a party to other lawsuits involving patents or
other intellectual property. A legal proceeding, regardless of the outcome,
could drain our financial resources and divert the time and efforts of our
management. If we lose one of these proceedings, a court, or a similar foreign
governing body, could require us to pay significant damages to third parties,
require us to seek licenses from third parties and pay ongoing royalties,
require us to redesign our products, or prevent us from manufacturing, using or
selling our products. In addition to being costly, protracted litigation to
defend or prosecute our intellectual property rights could result in our
customers or potential customers deferring or limiting their purchase or use of
the affected products until resolution of the litigation. Product Liability Lawsuits The manufacture and sale of medical devices exposes us to significant risk of
product liability claims. In the past, we have had a number of product
liability claims relating to our products. In the future, we may be subject to
additional product liability claims, some of which may have a negative impact
on our business. If a product liability claim or series of claims is brought
against us for uninsured liabilities or for amounts in excess of our insurance
coverage, our business could suffer. We are not currently involved in any
material product liability litigation. Costs of Physician Malpractice Insurance Most of our products are used by physicians who are required to maintain
certain levels of medical malpractice insurance to maintain their hospital
privileges. As the cost of this insurance increases, certain physicians who
have used our products to treat their patients may stop performing surgeries.
Unless these patients who would have been treated by these physicians are
referred to other physicians, sales of our products will decline. Acquisition Integration We have acquired businesses in the past, and we may acquire other businesses in
the future. Failure to successfully retain critical employees of an acquired
company, gain FDA approval for the products of an acquired company, or
establish and maintain appropriate communications, performance expectations,
regulatory compliance procedures, accounting controls, and reporting procedures
could have a material adverse affect on our business. Our CryoGen acquisition
has now been fully integrated into our business as we obtained FDA approval for
manufacturing and product service on March 31, 2004. We are currently
integrating TherMatrx, which we acquired in July 2004. International Sales During the three and six month periods of fiscal 2004, approximately 23 percent
of our sales were to customers outside the United States. Some of these sales
were to governmental entities and other organizations with extended payment
terms. A number of factors, including political or economic instability in the
countries where we do business, could affect payment terms and our ability to
collect foreign receivables. We have little influence over these factors and
changes could have a materially adverse impact on our business. In addition,
foreign sales are influenced by fluctuations in currency exchange rates, mainly
in the Euro. In recent periods, our sales have been positively impacted by
increases in the value of the Euro relative to the U.S. Dollar. Decreases in
the value of the Euro relative to the U.S. dollar would negatively impact our
sales. 17




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Manufacturing Facility We are currently operating with one manufacturing shift and have adequate
physical capacity to serve our business operations for the foreseeable future.
We do not have a back up facility, and the loss of our Minnetonka facility
would have a materially adverse effect on our sales, earnings, and financial
condition. 18




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ADDITIONAL INFORMATION ON AMS We are currently subject to the informational requirements of the Securities
Exchange Act of 1934, as amended. As a result, we are required to file
periodic reports and other information with the SEC, such as annual, quarterly,
and current reports, and proxy and information statements. You are advised to
read this Form 10-Q in conjunction with the other reports, proxy statements,
and other documents we file from time to time with the SEC. If you would like
more information regarding AMS, you may read and copy the reports, proxy and
information statements and other documents we file with the SEC, at prescribed
rates, at the SECs public reference room at 450 Fifth Street, NW, Washington,
DC 20549. You may obtain information regarding the operation of the SECs
public reference rooms by calling the SEC at 1-800-SEC-0330. Our SEC filings
are also available to the public free of charge at the SECs website. The
address of this website is http://www.sec.gov. We also make all of our SEC filings, such as our annual, quarterly and current
reports and proxy statements, available to the public free from charge on our
website www.AmericanMedicalSystems.com. Our website is not intended to be, and
is not, a part of this Quarterly Report on Form 10-Q. We place our SEC filings
on our website on the same day as we file such material with the SEC. In
addition, we will provide electronic or paper copies of our SEC filings
(excluding exhibits) to any AMS stockholder free of charge upon receipt of a
written request for any such filing. All requests for our SEC filings should
be sent to the attention of Investor Relations at American Medical Systems,
Inc., 10700 Bren Road West, Minnetonka, Minnesota 55343. 19




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rates We do not believe that our interest rate risk is material given the low
volatility of interest rates in recent years and the low level and relatively
short-term nature of our outstanding debt and our short term investments. On
July 8, 2004, we repaid the entire outstanding balance of $12.9 million under
our senior credit facility and terminated the credit facility. Currency Our operations outside of the United States are maintained in their local
currency. All assets and liabilities of our international subsidiaries are
translated to U.S. dollars at period-end exchange rates. Translation
adjustments arising from the use of differing exchange rates are included in
accumulated other comprehensive income in stockholders equity. Gains and
losses on foreign currency transactions and short-term inter-company
receivables from foreign subsidiaries are included in other income (expense). During the three and six month periods of fiscal 2004, revenues from sales to
customers outside the United States were 23.2 percent and 23.0 percent of total
consolidated revenues, respectively, and international accounts receivable,
inventory, cash, and accounts payable were 36.3 percent, 5.8 percent, 9.9
percent, and 22.2 percent of total consolidated accounts for each of these
items as of July 3, 2004. The reported results of our foreign operations will
be influenced during their translation into U.S. dollars by currency movements
against the U.S. dollar. The result of a uniform 10 percent strengthening in
the value of the U.S. dollar in fiscal 2004 levels relative to each of the
currencies in which our revenues and expenses are denominated would have
resulted in a decrease in net income of approximately $0.6 million and $1.2
million during the three and six month periods of fiscal 2004, respectively. At July 3, 2004, our net investment in foreign subsidiaries translated into
dollars using the period end exchange rate was $19.4 million, and the potential
loss in fair value resulting from a hypothetical 10 percent strengthening in
the value of the U.S. dollar currency exchange rate amounts to $.07 million.
Actual amounts may differ. Inflation We do not believe that inflation has had a material effect on our results of
operations in recent years and periods. There can be no assurance, however,
that our business will not be adversely affected by inflation in the future. 
 ITEM 4. CONTROLS AND PROCEDURES Our chief executive officer and chief financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in the
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
by this Quarterly Report on Form 10-Q, have concluded that, based on such
evaluation, our disclosure controls and procedures were adequate and designed
to ensure that material information relating to us and our consolidated
subsidiaries, which we are required to disclose in the reports we file or
submit under the Securities Exchange Act of 1934, was made known to them by
others within those entities and reported within the time periods specified in
the Securities and Exchange Commissions rules and forms. There were no changes in our internal control over financial reporting
identified in connection with the evaluation of such internal control over
financial reporting that occurred during our last fiscal quarter which have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. 20




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PART II. OTHER INFORMATION 
 ITEM 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS  a)
    
    Our annual meeting of stockholders was held on May 6, 2004.b)
    
    Albert Jay Graf was re-elected as director of the company. Douglas W.
Kohrs, Richard B. Emmitt, Christopher H. Porter, Thomas E. Timbie, and
Elizabeth H. Weatherman, continued their terms as directors after the
meeting. David W. Stassen resigned from the Board of Directors,
effective at the meeting, and did not stand for re-election. Accordingly,
the seat on the Board of Directors previously held by Mr. Stassen remained
vacant following the meeting.c)
    
    At the annual meeting, our stockholders were presented with and asked to
vote upon two proposals: (1) to elect one director to serve for
three-year term, or until his successor is elected and duly qualified; (2)
to transact other business if properly brought before the Annual Meeting
or any adjournment thereof. The name of the nominee for director and
voting results are: Votes
    
    
    
    
    
    BrokerName
    
    For
    
    Withheld
    
    Non-VotesAlbert Jay Graft
    
    
    28,005,859
    
    
    
    1,065,517
    
    
    
    0
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  a)
    
    Exhibits Item No.
    
    Item
    
    Method of Filing31.1
    
    Certification of Chief Executive
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.31.2
    
    Certification of Chief Financial
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.32.1
    
    Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
    
    Filed with this Report.
  b)
    
    Reports on Form 8-K On April 29, 2004, we filed a Current Report on Form 8-K
furnishing our press release dated April 29, 2004, announcing
results of operations for the quarter ended April 3, 2004. On June 16, 2004 we filed a Current Report on Form 8-K reporting
that we entered into an agreement and plan of merger to acquire
TherMatrx, Inc. 21




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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. AMERICAN MEDICAL SYSTEMS
HOLDINGS, INCAugust 12, 2004
    
    By
    
    /s/ Douglas W. KohrsDate
    
    
    
    Douglas W. KohrsChairman and Chief Executive OfficerAugust 12, 2004
    
    By
    
    /s/ Carmen L. DiersenDate
    
    
    
    Carmen L. DiersenExecutive Vice President and Chief FinancialOfficer (Principal Financial and AccountingOfficer)
 22




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
 EXHIBIT INDEX TO QUARTERLY REPORT ON FORM 10-Q
 FOR QUARTER ENDED JULY 3, 2004
 Item No.
    
    Item
    
    Method of Filing31.1
    
    Certification of Chief Executive
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.31.2
    
    Certification of Chief Financial
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.32.1
    
    Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
    
    Filed with this Report.
 23