##### Table of Contents



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 September 28, 2002

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: 30733

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, MN                           |  | 55343                              
|                                                               |  |                                    
|(Address of principal executive offices)                       |  | (Zip Code)                         

952-933-4666
(Registrants telephone number, including area code)

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

As of October 14, 2002, there were 32,413,814 shares of the registrants
$.01 par value Common Stock outstanding.





---

TABLE OF CONTENTS



|                              |                                                                                               |                                            |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | STATEMENTS OF OPERATIONS                  
|                              |                                                                                               | STATEMENTS OF CASH FLOWS                  
|                              |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|PART II. OTHER INFORMATION   
|                              | Item 4. Controls and Procedures                                                              
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   



---



##### Table of Contents



INDEX

|                              |                                                                                               |                                                                                                                     |    |         |       | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------- | -- | ------- | ----- | 
|                              |                                                                                               |                                                                                                                     |    | Page(s)
|                              |                                                                                               |                                                                                                                     |    |        
|Part I. FINANCIAL INFORMATION |                                                                                               |                                                                                                                     |    |        
|                              | Item 1. Financial Statements                                                                  |                                                                                                                     |    |         |      
|                              |                                                                                               | Consolidated Balance Sheets as of December 29, 2001,
and September 28, 2002 (Unaudited)                             |    |         | 3     | 
|                              |                                                                                               | Statements of Operations for the three and nine
months ended September 29, 2001, and September 28,
2002 (Unaudited) |    |         | 4     | 
|                              |                                                                                               | Statements of Cash Flows for the nine months ended
September 29, 2001, and September 28, 2002 (Unaudited)           |    |         | 5     | 
|                              |                                                                                               | Notes to Consolidated Financial Statements (Unaudited)                                                              |    |         | 6 - 7 | 
|                              | Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations |                                                                                                                     |    | 8 - 15  |      
|                              | Item 3. Quantitative and Qualitative Disclosures About Market
Risk                            |                                                                                                                     |    | 15      |      
|Part II. OTHER INFORMATION    |                                                                                               |                                                                                                                     |    |        
|                              | Item 4. Controls and Procedures                                                               |                                                                                                                     |    | 17      |      
|                              | Item 6. Exhibits and Reports on Form 8-K                                                      |                                                                                                                     |    | 17      |      
|SIGNATURES                    |                                                                                               |                                                                                                                     | 18 |        

2



---



##### Table of Contents






PART I. FINANCIAL INFORMATION




Item 1. Financial Statements




AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)

|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |         | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------- | ------------------------- | ------- | ------------ | ------ | ------------- | ------- | ----------- | ------- | 
|                                                                                                                                                                                                                                                     |                                  |                           |         | December 29, |        | September 28,
|                                                                                                                                                                                                                                                     |                                  |                           |         | 2001         |        | 2002         
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |              
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         | (unaudited)
|Assets                                                                                                                                                                                                                                               |                                  |                           |         |              |        |               |         |            
|Current assets:                                                                                                                                                                                                                                      |                                  |                           |         |              |        |               |         |            
|                                                                                                                                                                                                                                                     | Cash and cash equivalents        |                           | $       | 28,755       |        |               | $       | 71,801      |        
|                                                                                                                                                                                                                                                     | Short term investments           |                           |         | 9,013        |        |               |         |            |        
|                                                                                                                                                                                                                                                     | Accounts receivable, net         |                           |         | 25,306       |        |               |         | 25,244      |        
|                                                                                                                                                                                                                                                     | Inventories                      |                           |         | 13,991       |        |               |         | 13,533      |        
|                                                                                                                                                                                                                                                     | Deferred taxes                   |                           |         | 7,471        |        |               |         | 6,912       |        
|                                                                                                                                                                                                                                                     | Other current assets             |                           |         | 1,552        |        |               |         | 2,431       |        
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        
|                                                                                                                                                                                                                                                     |                                  | Total current assets      |         |              | 86,088 |               |         |             | 119,921 | 
|Property, plant and equipment, net                                                                                                                                                                                                                   |                                  |                           | 23,604  |              |        |               | 21,926  |            
|Goodwill, net                                                                                                                                                                                                                                        |                                  |                           | 82,365  |              |        |               | 82,365  |            
|Intangibles, net                                                                                                                                                                                                                                     |                                  |                           | 17,118  |              |        |               | 14,096  |            
|Deferred income taxes                                                                                                                                                                                                                                |                                  |                           | 3,180   |              |        |               | 2,230   |            
|Investments                                                                                                                                                                                                                                          |                                  |                           | 18,783  |              |        |               |        |            
|Investments in technology and other assets                                                                                                                                                                                                           |                                  |                           | 4,013   |              |        |               | 4,756   |            
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        
|Total assets                                                                                                                                                                                                                                         |                                  | $                         | 235,151 |              |        | $             | 245,294 |            
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |            
|Liabilities and Stockholders Equity                                                                                                                                                                                                                 |                                  |                           |         |              |        |               |         |            
|Current liabilities:                                                                                                                                                                                                                                 |                                  |                           |         |              |        |               |         |            
|                                                                                                                                                                                                                                                     | Accounts payable                 |                           | $       | 2,678        |        |               | $       | 2,298       |        
|                                                                                                                                                                                                                                                     | Accrued compensation expenses    |                           |         | 15,656       |        |               |         | 9,585       |        
|                                                                                                                                                                                                                                                     | Accrued warranty expense         |                           |         | 7,587        |        |               |         | 7,439       |        
|                                                                                                                                                                                                                                                     | Other accrued expenses           |                           |         | 4,350        |        |               |         | 4,176       |        
|                                                                                                                                                                                                                                                     | Current portion of notes payable |                           |         | 4,909        |        |               |         | 5,454       |        
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        
|                                                                                                                                                                                                                                                     |                                  | Total current liabilities |         |              | 35,180 |               |         |             | 28,952  | 
|Long-term notes payable                                                                                                                                                                                                                              |                                  |                           | 24,000  |              |        |               | 19,909  |            
|Other long-term liabilities                                                                                                                                                                                                                          |                                  |                           | 1,884   |              |        |               | 1,241   |            
|Stockholders equity:                                                                                                                                                                                                                                |                                  |                           |         |              |        |               |         |            
|Common stock, par value $.01 per share; authorized
95,000,000 shares; issued and outstanding 16,166,887 voting shares
and 11,597,941 non-voting shares for December 29, 2001;
32,060,877 voting and 341,700 non-voting shares for
September 28, 2002 |                                  |                           | 320     |              |        |               | 324     |            
|Additional paid-in capital                                                                                                                                                                                                                           |                                  |                           |         | 194,630      |        |               |         | 197,622     |        
|Deferred compensation                                                                                                                                                                                                                                |                                  |                           |         | (448         | )      |               |         | (239        | )      
|Accumulated other comprehensive loss                                                                                                                                                                                                                 |                                  |                           |         | (2,810       | )      |               |         | (1,465      | )      
|Accumulated deficit                                                                                                                                                                                                                                  |                                  |                           |         | (17,605      | )      |               |         | (1,050      | )      
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        
|Total stockholders equity                                                                                                                                                                                                                           |                                  |                           | 174,087 |              |        |               | 195,192 |            
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        
|Total liabilities and stockholders equity                                                                                                                                                                                                           |                                  | $                         | 235,151 |              |        | $             | 245,294 |            
|                                                                                                                                                                                                                                                     |                                  |                           |         |              |        |               |         |             |        

The accompanying notes are an integral part of the consolidated financial statements.

3



---



##### Table of Contents






AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |        |  
|------------------------------- | ----------------------------- | - | ------------------ | ------ | ----------------- | - | ------------- | ------ | ------------- | - | ------ | ------ | - | - | ------- | ------ | -
|                                |                               |   | Three months ended |        | Nine months ended
|                                |                               |   |                    |        |                  
|                                |                               |   | September 29,      |        | September 28,     |   | September 29, |        | September 28,
|                                |                               |   | 2001               |        | 2002              |   | 2001          |        | 2002         
|                                |                               |   |                    |        |                   |   |               |        |              
|Net sales                       |                               | $ | 28,637             |        |                   | $ | 32,771        |        |               | $ | 84,623 |        |   | $ | 103,816 |       
|Operating expenses:             |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|                                | Cost of sales                 |   |                    | 5,438  |                   |   |               | 6,233  |               |   |        | 16,622 |   |   |         | 20,485 |  
|                                | Marketing and sales           |   |                    | 10,732 |                   |   |               | 11,277 |               |   |        | 33,352 |   |   |         | 37,195 |  
|                                | General and administrative    |   |                    | 2,790  |                   |   |               | 3,178  |               |   |        | 8,432  |   |   |         | 9,816  |  
|                                | Research and development      |   |                    | 3,046  |                   |   |               | 2,696  |               |   |        | 9,127  |   |   |         | 8,727  |  
|                                | Transition and reorganization |   |                    | 1,000  |                   |   |               |       |               |   |        | 1,000  |   |   |         |       |  
|                                | Amortization of intangibles   |   |                    | 2,356  |                   |   |               | 939    |               |   |        | 6,917  |   |   |         | 2,817  |  
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|                                | Total operating expenses      |   |                    | 25,362 |                   |   |               | 24,323 |               |   |        | 75,450 |   |   |         | 79,040 |  
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Operating income                |                               |   | 3,275              |        |                   |   | 8,448         |        |               |   | 9,173  |        |   |   | 24,776  |       
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Other income (expense):         |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|                                | Royalty income                |   |                    | 749    |                   |   |               | 692    |               |   |        | 2,167  |   |   |         | 2,279  |  
|                                | Other income (expense)        |   |                    | 87     |                   |   |               | (147   | )             |   |        | 358    |   |   |         | 964    |  
|                                | Interest income               |   |                    | 448    |                   |   |               | 283    |               |   |        | 550    |   |   |         | 1,041  |  
|                                | Interest expense              |   |                    | (817   | )                 |   |               | (412   | )             |   |        | (2,962 | ) |   |         | (1,893 | )
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Income before income taxes      |                               |   | 3,742              |        |                   |   | 8,864         |        |               |   | 9,286  |        |   |   | 27,167  |       
|Income tax expense              |                               |   | 1,735              |        |                   |   | 3,456         |        |               |   | 4,341  |        |   |   | 10,612  |       
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Net income                      |                               | $ | 2,007              |        |                   | $ | 5,408         |        |               | $ | 4,945  |        |   | $ | 16,555  |       
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Earnings per share:             |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Basic                           |                               | $ | 0.06               |        |                   | $ | 0.17          |        |               | $ | 0.17   |        |   | $ | 0.51    |       
|Diluted                         |                               | $ | 0.06               |        |                   | $ | 0.16          |        |               | $ | 0.16   |        |   | $ | 0.48    |       
|                                |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Weighted average common shares: |                               |   |                    |        |                   |   |               |        |               |   |        |        |   |   |         |       
|Basic                           |                               |   | 31,491             |        |                   |   | 32,155        |        |               |   | 29,101 |        |   |   | 32,321  |       
|Diluted                         |                               |   | 34,193             |        |                   |   | 34,230        |        |               |   | 31,631 |        |   |   | 34,205  |       

The accompanying notes are an integral part of the consolidated financial statements.

4



---



##### Table of Contents






AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
STATEMENTS OF CASH FLOWS
(In thousands, except share data)
(Unaudited)

|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |        |  
|------------------------------------------------ | --------------------------------------------------------------------------------- | ------------------------------------- | ------ | ------------------------- | ------ | ------------- | ------ | ------ | ------ | -
|                                                 |                                                                                   |                                       |        | For the nine months ended
|                                                 |                                                                                   |                                       |        |                          
|                                                 |                                                                                   |                                       |        | September 29,             |        | September 28,
|                                                 |                                                                                   |                                       |        | 2001                      |        | 2002         
|                                                 |                                                                                   |                                       |        |                           |        |              
|Cash flows from operating activities:            |                                                                                   |                                       |        |                           |        |               |        |       
|                                                 | Net income                                                                        |                                       | $      | 4,945                     |        |               | $      | 16,555 |       
|                                                 | Adjustments to reconcile net income to net cash
provided by operating activities: |                                       |        |                           |        |               |        |        |       
|                                                 | Depreciation                                                                      |                                       |        | 2,755                     |        |               |        | 2,873  |       
|                                                 | Amortization of intangibles                                                       |                                       |        | 6,917                     |        |               |        | 2,817  |       
|                                                 | Deferred financing costs                                                          |                                       |        | 203                       |        |               |        | 205    |       
|                                                 | Stock-based compensation costs                                                    |                                       |        |                          |        |               |        | 9      |       
|                                                 | Noncash deferred compensation                                                     |                                       |        | 344                       |        |               |        | 136    |       
|                                                 | Noncash transition and reorganization                                             |                                       |        | 747                       |        |               |        |       |       
|                                                 | Income tax benefit related to stock option plan                                   |                                       |        | 175                       |        |               |        | 1,124  |       
|                                                 | Change in net deferred taxes                                                      |                                       |        | (882                      | )      |               |        | 1,264  |       
|                                                 | Changes in operating assets and liabilities:                                      |                                       |        |                           |        |               |        |        |       
|                                                 |                                                                                   | Accounts receivable                   |        |                           | (930   | )             |        |        | 435    |  
|                                                 |                                                                                   | Inventories                           |        |                           | (3,703 | )             |        |        | 550    |  
|                                                 |                                                                                   | Accounts payable and accrued expenses |        |                           | 3,113  |               |        |        | (6,861 | )
|                                                 |                                                                                   | Other assets                          |        |                           | (311   | )             |        |        | (1,622 | )
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|                                                 | Net cash provided by operating activities                                         |                                       |        | 13,373                    |        |               |        | 17,485 |       
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|Cash flows from investing activities:            |                                                                                   |                                       |        |                           |        |               |        |       
|                                                 | Purchase of property, plant and equipment                                         |                                       |        | (1,580                    | )      |               |        | (1,195 | )     
|                                                 | Purchase of businesses, net of cash acquired                                      |                                       |        | (13,653                   | )      |               |        |       |       
|                                                 | Purchase of investments in technology                                             |                                       |        | (4,500                    | )      |               |        |       |       
|                                                 | Purchase of marketable securities                                                 |                                       |        |                          |        |               |        | (9,446 | )     
|                                                 | Sales of marketable securities                                                    |                                       |        |                          |        |               |        | 37,242 |       
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|                                                 | Net cash (used in) provided by investing activities                               |                                       |        | (19,733                   | )      |               |        | 26,601 |       
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|Cash flows from financing activities:            |                                                                                   |                                       |        |                           |        |               |        |       
|                                                 | Issuance of common stock                                                          |                                       |        | 57,950                    |        |               |        | 1,936  |       
|                                                 | Payments on long-term debt                                                        |                                       |        | (15,583                   | )      |               |        | (3,546 | )     
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|                                                 | Net cash provided by (used in) financing activities                               |                                       |        | 42,367                    |        |               |        | (1,610 | )     
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|Effect of exchange rates                         |                                                                                   |                                       | 1,178  |                           |        |               | 570    |       
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|Net increase in cash and cash equivalents        |                                                                                   |                                       | 37,185 |                           |        |               | 43,046 |       
|Cash and cash equivalents at beginning of period |                                                                                   |                                       | 12,165 |                           |        |               | 28,755 |       
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|Cash and cash equivalents at end of period       |                                                                                   | $                                     | 49,350 |                           |        | $             | 71,801 |       
|                                                 |                                                                                   |                                       |        |                           |        |               |        |        |       
|Supplemental disclosure:                         |                                                                                   |                                       |        |                           |        |               |        |       
|                                                 | Cash paid for interest                                                            |                                       | $      | 2,744                     |        |               | $      | 852    |       
|                                                 | Cash paid for taxes                                                               |                                       | $      | 2,075                     |        |               | $      | 7,726  |       

The accompanying notes are an integral part of the consolidated financial statements.

5



---



##### Table of Contents






AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 2001.

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.

Certain 2001 amounts have been reclassified to conform to 2002 presentation.
More specifically, foreign currency exchange gains and losses have been
reclassified from General and administrative costs to Other income
(expense) below Operating income. The exchange gains and losses are the
result of the weakening and strengthening of foreign currencies, mainly the
Euro, against the US dollar and relate to translating foreign denominated
inter-company receivables to current rates. The following table presents the
quarterly exchange gains (losses) by quarter for 2001 and 2002.

|                                         |  |         |      |         |  |         |      |         |  |         |     |         |  |         |      |   |  |   |   |  |  |   |     |  |  |  |       |  
|---------------------------------------- |  | ------- | ---- | ------- |  | ------- | ---- | ------- |  | ------- | --- | ------- |  | ------- | ---- | - |  | - | - |  |  | - | --- |  |  |  | ----- | -
|                                         |  | 2001    |      | 2002   
|                                         |  |         |      |        
|                                         |  | First   |      | Second  |  | Third   |      | Fourth  |  | First   |     | Second  |  | Third  
|                                         |  | Quarter |      | Quarter |  | Quarter |      | Quarter |  | Quarter |     | Quarter |  | Quarter
|                                         |  |         |      |         |  |         |      |         |  |         |     |         |  |        
|Foreign currency exchange
gains (losses) |  |         | ($88 | )       |  |         | ($73 | )       |  | $       | 144 |         |  |         | ($91 | ) |  | $ | 5 |  |  | $ | 447 |  |  |  | ($248 | )
|                                         |  |         |      |         |  |         |      |         |  |         |     |         |  |         |      |   |  |   |   |  |  |   |     |  |  |  |       |  

2. Inventories

Inventories consist of the following (in thousands):

|                       |  |                   |        |                    |  |   |        |  
|---------------------- |  | ----------------- | ------ | ------------------ |  | - | ------ | -
|                       |  | December 29, 2001 |        | September 28, 2002
|                       |  |                   |        |                   
|Raw materials          |  | $                 | 3,366  |                    |  | $ | 3,951  |  
|Work-in-process        |  |                   | 2,210  |                    |  |   | 2,790  |  
|Finished goods         |  |                   | 11,114 |                    |  |   | 9,433  |  
|Obsolescence allowance |  |                   | (2,699 | )                  |  |   | (2,641 | )
|                       |  |                   |        |                    |  |   |        |  
|Total, net             |  | $                 | 13,991 |                    |  | $ | 13,533 |  
|                       |  |                   |        |                    |  |   |        |  

6



---



##### Table of Contents



3. Recently Issued Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations,which requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. The Company has not been involved in a business
combination since then.

In June 2001, the Financial Standards Board also issued Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets.Under SFAS
No. 142, goodwill and other intangible assets with indefinite lives are not
amortized, but tested for impairment annually, or whenever there is an
impairment indicator. In addition, upon adoption of SFAS No. 142, all goodwill
is assigned to reporting units for purposes of impairment testing and is no
longer subject to amortization. Intangible assets that are not deemed to have
an indefinite life continue to be amortized over their estimated useful lives.
The Company adopted SFAS No. 142 as of December 30, 2001, and assessed whether
goodwill had been impaired at the date of adoption, determined that it is a
single reporting unit, and, that the Companys fair value exceeded the carrying
amount of its goodwill. There was no indication that goodwill was impaired.

The following table presents a reconciliation of net income and earnings per
share adjusted for the exclusion of goodwill amortization, net of income taxes:

|                                         |  |                              |       |             |  |   |       | 
|---------------------------------------- |  | ---------------------------- | ----- | ----------- |  | - | ----- | 
|                                         |  | Total through September 2001
|                                         |  |                             
|(in thousands, except per share data)    |  | Three months                 |       | Nine months
|                                         |  |                              |       |            
|Net income, as reported                  |  | $                            | 2,007 |             |  | $ | 4,945 | 
|Add: Goodwill amortization, net of taxes |  |                              | 1,071 |             |  |   | 3,050 | 
|                                         |  |                              |       |             |  |   |       | 
|Adjusted net income                      |  | $                            | 3,078 |             |  | $ | 7,995 | 
|                                         |  |                              |       |             |  |   |       | 
|                                         |  |                              |       |             |  |   |       | 
|Reported diluted earnings per share      |  | $                            | 0.06  |             |  | $ | 0.16  | 
|Add: Goodwill amortization, net of taxes |  |                              | 0.03  |             |  |   | 0.09  | 
|                                         |  |                              |       |             |  |   |       | 
|Adjusted diluted earnings per share      |  | $                            | 0.09  |             |  | $ | 0.25  | 
|                                         |  |                              |       |             |  |   |       | 

4. Comprehensive Income

Comprehensive income for the Company is net income adjusted for changes in
value of derivative financial instruments and foreign currency translation.
Comprehensive income for the nine months through September 29, 2001, and
September 28, 2002, was:

|                                                                                                                   |  |                               |       |      |  |   |        |  
|------------------------------------------------------------------------------------------------------------------ |  | ----------------------------- | ----- | ---- |  | - | ------ | -
|                                                                                                                   |  | Nine months through September
|                                                                                                                   |  |                              
|                                                                                                                   |  | 2001                          |       | 2002
|                                                                                                                   |  |                               |       |     
|Net income                                                                                                         |  | $                             | 4,945 |      |  | $ | 16,555 |  
|Cumulative effect of change in accounting principle for
derivative and hedging activities (SFAS 133), net of
taxes |  |                               | (712  | )    |  |   |       |  
|Net loss on derivative financial instruments, net of taxes                                                         |  |                               | (995  | )    |  |   | (328   | )
|Amounts reclassified to interest expense during the
period from derivative and hedging activities, net of
taxes    |  |                               | 457   |      |  |   | 727    |  
|Foreign currency translation adjustments                                                                           |  |                               | 133   |      |  |   | 946    |  
|                                                                                                                   |  |                               |       |      |  |   |        |  
|Comprehensive income                                                                                               |  | $                             | 3,828 |      |  | $ | 17,900 |  
|                                                                                                                   |  |                               |       |      |  |   |        |  

7



---



##### Table of Contents






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 Certain Important 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

Managements discussion and analysis of financial condition and results of
operations is based upon our 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 judgements 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,
inventories, long-lived assets, warranty and sales return obligations, legal
contingencies, and income taxes. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances. The critical accounting policies that are most
important in fully understanding and evaluating our financial condition and
results of operations are discussed below.

Allowance for Doubtful Accounts and Other Accounts Receivable Related Valuation
Accounts.We maintain an allowance for doubtful accounts, returns, and
warranty claims. We rely on subjective judgments and estimates to establish
these valuation accounts. If we made different judgements, we could have
material variances in the amount and timing of our reported results for any
period. In addition, actual results could be different from our current
estimates, possibly resulting in increased future charges to earnings.

We maintain an allowance for doubtful accounts for all individual accounts
receivable that we believe are unlikely to be collected. For all other
accounts receivable, we record an allowance for doubtful accounts based on the
age of receivable balances. At September 29, 2002, our allowance for doubtful
accounts was $1.1 million compared to $.8 million at December 29, 2001. As a
percentage of total accounts receivable, the allowance was 4.2% at September
2002 compared to 3.1% at December 2001.

We maintain an allowance for returns based on historical and current trends in
product returns. At September 28, 2002, and December 29, 2001, our allowance
for sales returns was $463,000.

We maintain an allowance for estimated warranty claims. The amount of the
accrual is based on historical claims by product group and other factors.
Claims could be materially different from actual results for a variety of
reasons, including a change in our warranty policy, competition or other
external forces, manufacturing changes that could impact product quality, or as
yet unrecognized defects in products sold. At September 28, 2002, our
allowance for estimated future warranty costs was $7.4 million and $7.6 million
at December 29, 2001. If future product quality standards or policies are less
favorable than current analyses, additional warranty accruals may be required
and would reduce reported earnings in the period the revision is made.

Inventory Valuation.In general, we record our inventories at the lower of
manufacturing cost or expected market value. Each quarter, we evaluate our
inventories for obsolescence and excess quantities.

8



---



##### Table of Contents



This evaluation includes
analyses of inventory levels, historical loss trends, expected product lives,
sales levels by product and projections of future sales demand. We write off
inventories that we consider
obsolete. In addition, we maintain an allowance for inventory quantities in
excess of forecasted demand. Our inventory allowances were $2.6 million at
September 28, 2002 and $2.7 million at December 29, 2001. If future demand or
market conditions are less favorable than current estimates, additional
inventory adjustments would be required and would adversely affect income in
the period the adjustment is made. As a percentage of total inventories, the
allowance was 16.3% at September 2002 compared to 15.9% at December 2001.

Legal Liability Accrual.Each quarter, we estimate the uninsured portion of
legal representation and settlement costs of possible future product liability.
This evaluation consists of reviewing historical claims costs as well as
assessing future trends in medical device liability cases. Social and
political factors, as well as doctor and medical facility responsibility, make
litigation costs hard to predict. Accruals for future litigation costs were
$1.4 million on September 28, 2002 compared to $1.5 million at December 29,
2001. If, in the future, we determine this accrual is inadequate, the
adjustment would reduce reported income in the period the adjustment is
recorded.

Income Taxes.In the preparation of our consolidated financial statements, we
estimate income taxes in each of the jurisdictions in which we operate. This
process involves estimating actual current tax exposures and assessing
temporary differences resulting from differing treatment of items for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included in our consolidated balance sheet.

We have significant amounts of deferred tax assets that we review for
recoverability and then value accordingly. We evaluate the realizability of
our deferred tax assets on a quarterly basis and assess the need for valuation
allowances. These deferred tax assets are evaluated by considering historical
levels of income, estimates of future taxable income, and the impact of tax
planning strategies. We record a valuation allowance to reduce deferred tax
assets when we believe we will not realize all or part of our deferred tax
assets.

We maintain a valuation allowance of $682,000 to
offset tax loss carryforwards
created in a foreign jurisdiction, which, if subsequently recognized, would be
allocated to goodwill. We did not maintain any other allowances against our
net deferred tax assets at September 28, 2002. If we later determine that we
would not realize all or part of the deferred tax assets, we would adjust the
deferred tax asset valuation allowance and charge the adjustment to income in
the period we made the determination.

9



---



##### Table of Contents



Results of Operations

Three and Nine Months Through September 2001 and 2002

Net Sales.The erectile restoration product line includes four types of
inflatable and non-inflatable prostheses and smaller amounts of diagnostic
equipment. Male urinary control products include all sales of the inflatable
urinary sphincter even though a very small share of this product is used in
women. Womens health product line sales include sales of Acticon Neosphincter
to control fecal incontinence even though a small percentage of the product is
used in males. Prostate treatments include all sales of our Urolume product
even though this product is also used to treat urethral strictures.

The following table compares net sales of our product lines between the three
and nine month periods of 2001 and 2002.

|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |   |  |   |        |  |  |   |         |          |  |  |        |   |  |  |       |  
|--------------------------- |  | ---------------------------- | ------ | --------------------------- |  | ---------- | ------ | - |  | -------- | ----- | ---- |  | ---------- | ----- | - |  | - | ------ |  |  | - | ------- | -------- |  |  | ------ | - |  |  | ----- | -
|                            |  | Three months ended September |        | Nine months ended September
|                            |  |                              |        |                            
|                            |  |                              |        |                             |  |            |        |   |  | Increase |       |      |  |            |       |   |  |   |        |  |  |   |         | Increase |  |  |        |  
|                            |  | 2001                         |        | 2002                        |  | (Decrease) |        | % |  | 2001     |       | 2002 |  | (Decrease) |       | %
|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |  
|Erectile Restoration        |  | $                            | 14,970 |                             |  | $          | 16,207 |   |  | $        | 1,237 |      |  |            | 8.3   | % |  | $ | 42,566 |  |  | $ | 51,293  |          |  |  | 8,727  |   |  |  | 20.5  | %
|Male urinary control        |  |                              | 7,000  |                             |  |            | 8,295  |   |  |          | 1,295 |      |  |            | 18.5  | % |  |   | 22,022 |  |  |   | 26,439  |          |  |  | 4,417  |   |  |  | 20.1  | %
|Womens health              |  |                              | 4,885  |                             |  |            | 7,000  |   |  |          | 2,115 |      |  |            | 43.3  | % |  |   | 14,928 |  |  |   | 21,501  |          |  |  | 6,573  |   |  |  | 44.0  | %
|Prostate treatments         |  |                              | 1,782  |                             |  |            | 1,269  |   |  |          | (513  | )    |  |            | -28.8 | % |  |   | 5,107  |  |  |   | 4,583   |          |  |  | (524   | ) |  |  | -10.3 | %
|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |   |  |   |        |  |  |   |         |          |  |  |        |   |  |  |       |  
|Total                       |  | $                            | 28,637 |                             |  | $          | 32,771 |   |  | $        | 4,134 |      |  |            | 14.4  | % |  | $ | 84,623 |  |  | $ | 103,816 |          |  |  | 19,193 |   |  |  | 22.7  | %
|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |   |  |   |        |  |  |   |         |          |  |  |        |   |  |  |       |  
|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |   |  |   |        |  |  |   |         |          |  |  |        |   |  |  |       |  
|Sales within United States  |  | $                            | 24,480 |                             |  | $          | 27,376 |   |  | $        | 2,896 |      |  |            | 11.8  | % |  | $ | 70,165 |  |  | $ | 86,203  |          |  |  | 16,038 |   |  |  | 22.9  | %
|Sales outside United States |  |                              | 4,157  |                             |  |            | 5,395  |   |  |          | 1,238 |      |  |            | 29.8  | % |  |   | 14,458 |  |  |   | 17,613  |          |  |  | 3,155  |   |  |  | 21.8  | %
|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |   |  |   |        |  |  |   |         |          |  |  |        |   |  |  |       |  
|Total                       |  | $                            | 28,637 |                             |  | $          | 32,771 |   |  | $        | 4,134 |      |  |            | 14.4  | % |  | $ | 84,623 |  |  | $ | 103,816 |          |  |  | 19,193 |   |  |  | 22.7  | %
|                            |  |                              |        |                             |  |            |        |   |  |          |       |      |  |            |       |   |  |   |        |  |  |   |         |          |  |  |        |   |  |  |       |  

During the three month period through September 2002, the 8.3% increase in
erectile restoration sales was due to a shift to our new InhibiZone antibiotic
coated penile implant (released in the U.S. during the second quarter of 2001),
and increased selling prices, which more than offset a 3% decline in units.
We plan to release InhibiZone to international markets in early 2003. The 18.5%
increase in male urinary control sales was due to a combination of unit
increases, especially in the InVance male sling system, and price and unit
increases on the AMS 800 Artificial Urinary Sphincter. The 43.3% increase in
sales of womens health products was primarily due to increased sales of Sparc,
a suprapubic mid-urethral sling system which we released internationally in the
second quarter of 2001 and in the U.S. in the third quarter of 2001. The
decrease in sales of prostate products was due to lower unit sales of the
Urolume product.

During the nine month period through September 2002, the 20.5% increase in
erectile restoration sales was primarily due to a
shift to our new InhibiZone antibiotic coated penile prothesis and increased unit sales. The 20.1%
increase in male urinary control sales was due to a combination of unit
increases, especially in the InVance male sling system, and price increases on
the AMS 800 Artificial Urinary Sphincter. The 44.0% increase in womens health
sales is attributable to greater unit sales of Sparc. In the nine months
through September 2002, the decrease in sales of prostate treatment products
was due to lower unit sales of the Urolume product.

10



---



##### Table of Contents



The following table compares our dollar and percentage changes in our Statement
of Operations between the three and nine month periods through September 2001
and 2002.

|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |       |        |  
|-------------------------- | ---------------------- | ----------------------------- | ------ | ------------------------------ | ----------------------------- | ---- | ------ | ---------- | ------ | - | ----- | -------- | ------ | ---- | ----- | ---------- | ------ | - | ------ | ------ | ------ | - | ------- | ------ | ------ | -------- | ------ | ----- | ------ | - | ----- | ----- | ------ | -
|                           |                        |                               |        | Three months through September | Nine months through September
|                           |                        |                               |        |                                |                              
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       | Increase |        |      |       |            |        |   |        |        |        |   |         |        |        | Increase |        |       |        |  
|                           |                        |                               |        | 2001                           |                               | 2002 |        | (Decrease) |        | % |       | 2001     |        | 2002 |       | (Decrease) |        | %
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |  
|Net sales                  |                        | $                             | 28,637 |                                |                               | $    | 32,771 |            |        | $ | 4,134 |          |        |      | 14.4  | %          |        | $ | 84,623 |        |        | $ | 103,816 |        |        | $        | 19,193 |       |        |   | 22.7  | %    
|Operating expenses:        |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      
|                           |                        | Cost of sales                 |        |                                | 5,438                         |      |        |            | 6,233  |   |       |          | 795    |      |       |            | 14.6   | % |        |        | 16,622 |   |         |        | 20,485 |          |        |       | 3,863  |   |       |       | 23.2   | %
|                           |                        | Marketing and sales           |        |                                | 10,732                        |      |        |            | 11,277 |   |       |          | 545    |      |       |            | 5.1    | % |        |        | 33,352 |   |         |        | 37,195 |          |        |       | 3,843  |   |       |       | 11.5   | %
|                           |                        | General and administrative    |        |                                | 2,790                         |      |        |            | 3,178  |   |       |          | 388    |      |       |            | 13.9   | % |        |        | 8,432  |   |         |        | 9,816  |          |        |       | 1,384  |   |       |       | 16.4   | %
|                           |                        | Research and development      |        |                                | 3,046                         |      |        |            | 2,696  |   |       |          | (350   | )    |       |            | -11.5  | % |        |        | 9,127  |   |         |        | 8,727  |          |        |       | (400   | ) |       |       | -4.4   | %
|                           |                        | Transition and reorganization |        |                                | 1,000                         |      |        |            |       |   |       |          | (1,000 | )    |       |            | -100.0 | % |        |        | 1,000  |   |         |        |       |          |        |       | (1,000 | ) |       |       | -100.0 | %
|                           |                        | Amortization of intangibles   |        |                                | 2,356                         |      |        |            | 939    |   |       |          | (1,417 | )    |       |            | -60.1  | % |        |        | 6,917  |   |         |        | 2,817  |          |        |       | (4,100 | ) |       |       | -59.3  | %
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      
|                           |                        | Total operating expenses      |        |                                | 25,362                        |      |        |            | 24,323 |   |       |          | (1,039 | )    |       |            | -4.1   | % |        |        | 75,450 |   |         |        | 79,040 |          |        |       | 3,590  |   |       |       | 4.8    | %
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      
|Operating income           |                        |                               | 3,275  |                                |                               |      | 8,448  |            |        |   | 5,173 |          |        |      | 158.0 | %          |        |   | 9,173  |        |        |   | 24,776  |        |        |          | 15,603 |       |        |   | 170.1 | %    
|Other income (expense)     |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      
|                           | Royalty income         |                               |        | 749                            |                               |      |        | 692        |        |   |       | (57      | )      |      |       | -7.6       | %      |   |        | 2,167  |        |   |         | 2,279  |        |          |        | 112   |        |   |       | 5.2   | %     
|                           | Other income (expense) |                               |        | 87                             |                               |      |        | (147       | )      |   |       | (234     | )      |      |       | -269.0     | %      |   |        | 358    |        |   |         | 964    |        |          |        | 606   |        |   |       | 169.3 | %     
|                           | Interest income        |                               |        | 448                            |                               |      |        | 283        |        |   |       | (165     | )      |      |       | -36.8      | %      |   |        | 550    |        |   |         | 1,041  |        |          |        | 491   |        |   |       | 89.3  | %     
|                           | Interest expense       |                               |        | (817                           | )                             |      |        | (412       | )      |   |       | 405      |        |      |       | 49.6       | %      |   |        | (2,962 | )      |   |         | (1,893 | )      |          |        | 1,069 |        |   |       | 36.1  | %     
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      
|Income before income taxes |                        |                               | 3,742  |                                |                               |      | 8,864  |            |        |   | 5,122 |          |        |      | 136.9 | %          |        |   | 9,286  |        |        |   | 27,167  |        |        |          | 17,881 |       |        |   | 192.6 | %    
|Income tax expense         |                        |                               | 1,735  |                                |                               |      | 3,456  |            |        |   | 1,721 |          |        |      | 99.2  | %          |        |   | 4,341  |        |        |   | 10,612  |        |        |          | 6,271  |       |        |   | 144.5 | %    
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      
|Net income                 |                        | $                             | 2,007  |                                |                               | $    | 5,408  |            |        | $ | 3,401 |          |        |      | 169.5 | %          |        | $ | 4,945  |        |        | $ | 16,555  |        |        | $        | 11,610 |       |        |   | 234.8 | %    
|                           |                        |                               |        |                                |                               |      |        |            |        |   |       |          |        |      |       |            |        |   |        |        |        |   |         |        |        |          |        |       |        |   |       |      

The following table shows our Statement of Operations as a percentage of net
sales for the three and nine month periods through September 2001 and 2002.

|                           |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |      |  
|-------------------------- | ----------------------------- |  | -------------------- | ---- | ------------------- |  | ----- | ---- | ---- |  | ----- | ---- | - |  | ----- | ---- | -
|                           |                               |  | Three months through |      | Nine months through
|                           |                               |  | September            |      | September          
|                           |                               |  |                      |      |                    
|                           |                               |  | 2001                 |      | 2002                |  | 2001  |      | 2002
|                           |                               |  |                      |      |                     |  |       |      |     
|Net sales                  |                               |  | 100.0                | %    |                     |  | 100.0 | %    |      |  | 100.0 | %    |   |  | 100.0 | %   
|Operating expenses:        |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |     
|                           | Cost of sales                 |  |                      | 19.0 | %                   |  |       | 19.0 | %    |  |       | 19.6 | % |  |       | 19.7 | %
|                           | Marketing and sales           |  |                      | 37.5 | %                   |  |       | 34.4 | %    |  |       | 39.4 | % |  |       | 35.8 | %
|                           | General and administrative    |  |                      | 9.7  | %                   |  |       | 9.7  | %    |  |       | 10.0 | % |  |       | 9.5  | %
|                           | Research and development      |  |                      | 10.6 | %                   |  |       | 8.2  | %    |  |       | 10.8 | % |  |       | 8.4  | %
|                           | Transition and reorganization |  |                      | 3.5  | %                   |  |       | 0.0  | %    |  |       | 1.2  | % |  |       | 0.0  | %
|                           | Amortization of intangibles   |  |                      | 8.2  | %                   |  |       | 2.9  | %    |  |       | 8.2  | % |  |       | 2.7  | %
|                           |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |     
|                           | Total operating expenses      |  |                      | 88.6 | %                   |  |       | 74.2 | %    |  |       | 89.2 | % |  |       | 76.1 | %
|Operating income           |                               |  | 11.4                 | %    |                     |  | 25.8  | %    |      |  | 10.8  | %    |   |  | 23.9  | %   
|Other income and expense:  |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |     
|                           | Royalty income                |  |                      | 2.6  | %                   |  |       | 2.1  | %    |  |       | 2.6  | % |  |       | 2.2  | %
|                           | Other income and expense      |  |                      | 0.3  | %                   |  |       | -0.4 | %    |  |       | 0.4  | % |  |       | 0.9  | %
|                           | Interest income               |  |                      | 1.6  | %                   |  |       | 0.9  | %    |  |       | 0.6  | % |  |       | 1.0  | %
|                           | Interest expense              |  |                      | -2.9 | %                   |  |       | -1.3 | %    |  |       | -3.5 | % |  |       | -1.8 | %
|                           |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |     
|Income before income taxes |                               |  | 13.1                 | %    |                     |  | 27.0  | %    |      |  | 11.0  | %    |   |  | 26.2  | %   
|Income tax expense         |                               |  | 6.1                  | %    |                     |  | 10.5  | %    |      |  | 5.1   | %    |   |  | 10.2  | %   
|                           |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |     
|Net income                 |                               |  | 7.0                  | %    |                     |  | 16.5  | %    |      |  | 5.9   | %    |   |  | 16.0  | %   
|                           |                               |  |                      |      |                     |  |       |      |      |  |       |      |   |  |       |     

Cost of Goods Sold.Recent quality improvements as well as changes made to our
procedures for granting warranty credit are leading to longer-term reductions
in our warranty expenses and exposure. Future costs of goods sold will depend
on production levels, product mix, and sales volumes.

11



---



##### Table of Contents



Marketing and selling.Although decreasing as a percentage of sales, cost
increases for the three and nine month periods through September 2002 resulted
from higher employee and commission expenses to support higher sales, with a
small offset of new product rollouts costs, in 2002 than in 2001. In the
future, we expect marketing and selling costs to increase as sales increase,
but decrease as a percentage of sales. In addition, costs will vary quarter to
quarter as certain costs, such as sales meetings and product rollout costs, are
incurred independent of that quarters sales.

General and administrative.Although remaining relatively constant as a
percentage of sales, cost increases for the three and nine month periods
through September 2002 were primarily due to professional fees and services,
recruiting and relocation costs, corporate insurance, and bad debt charges,
partially offset by the closing of our Israeli manufacturing facility during
2001. We expect quarterly spending in general and administrative for the
remainder of 2002 to be consistent with the just completed quarter.

Research and development.Research and development includes costs to develop
and improve current and possible future products and the costs for regulatory
and clinical activities for our products. During 2001, we closed our Israeli
R&D facility and transferred the development activity to our U.S. facility.
This closing reduced costs by approximately $200,000 and $500,000 in the three
and nine month periods through September 2002, compared to the same periods in
2001. We expect total spending in research and development to increase in the
fourth quarter of 2002 from recent quarters and, longer term, to be in the
range of 8 to 10 percent of net sales. In addition, our costs in this area
could vary as a result of spending on purchased technologies as we discover new
opportunities.

Transition and reorganization.During the third quarter of 2001, an assessment
was completed of management personnel needs and transition and reorganization
costs of $1.0 million were recorded for employee termination costs.

Amortization of intangibles.Cost decreases are attributable to the Companys
adoption on December 30, 2001, of SFAS No. 142, Goodwill and Other Intangible
Assets.Under the provisions of SFAS No. 142, goodwill and other intangible
assets with indefinite lives are no longer amortized. For a fuller description
of this change and its impact on our financial results, see Notes to
Consolidated Financial Statements.

Royalty and other income.All of our royalty income is from the license of
certain stent-delivery technology to Boston Scientific Corporation for use
outside urology.

Other income (expense).Other income in 2001 includes a non-recurring payment
of $375,000 representing reimbursement to resolve a quality issue with a
supplier. On January 1, 2002, we terminated the AMS Retirement Annuity Plan.
In conjunction with this termination, we made an approximate $5.8 million
settlement contribution to the pension trust and recorded a gain on pension
termination of $716,000 as other income in the first quarter of 2002. The
remainder of other income and expense relates to exchange gains and losses
resulting from the weakening and strengthening of foreign currencies, mainly
the Euro, against the U.S. dollar and relate to the translating foreign
denominated inter-company receivables to current rates. See Notes to
Consolidated Financial Statements.

Interest income and interest expense.Interest income was lower in third
quarter of 2002 than in 2001 because of lower interest rates. Interest income
was higher in the nine months of 2002 because of the investment of the proceeds
from the July 2001 stock offering during the first six months of 2002.
Interest expense decreased in the three and nine month periods through
September 2002, because average borrowings under notes payable were
approximately $9.8 million and $9.6 million lower in 2002 than in 2001.

12



---



##### Table of Contents



Income tax expense.Following is a reconciliation of our statutory tax rates to
our effective tax rates for the nine month period through September 2002.

|                        |  |        |        |      |  |  |      |  
|----------------------- |  | ------ | ------ | ---- |  |  | ---- | -
|                        |  | Amount |        | Rate
|                        |  |        |        |     
|Statutory rate          |  | $      | 9,508  |      |  |  | 35.0 | %
|Meals and entertainment |  |        | 108    |      |  |  | 0.4  | %
|Deferred Compensation   |  |        | 48     |      |  |  | 0.2  | %
|State taxes             |  |        | 830    |      |  |  | 3.1  | %
|Other                   |  |        | 118    |      |  |  | 0.4  | %
|                        |  |        |        |      |  |  |      |  
|Total                   |  | $      | 10,612 |      |  |  | 39.1 | %
|                        |  |        |        |      |  |  |      |  

As part of our adoption of SFAS 142, we no longer record goodwill amortization
that previously had been a permanent non-deductible tax expense. In the first
nine months of 2001, the total was approximately $1.5 million. If these new
rules had been place in, our effective tax rate would have been approximately
41% in 2001.

Net income.The increase in net income resulted from the increase in revenues
while maintaining control over our operating costs and the change in accounting
for amortization of goodwill, all of which are described above.

Liquidity and Capital Resources

Cash and cash equivalents plus investments in short-term and long-term
marketable securities were $71.8 million as of September 28, 2002, compared to
$56.6 million as of December 29, 2001. This increase is due to cash provided
from operations plus cash flows from investing and financing activities.

Cash flows from operating activities.Cash flow provided by operating
activities totaled $17.5 million in the first nine months of 2002. Net income
plus non-cash operating expenses totaled $22.6 million the first nine months
and was offset by the $5.8 million pension plan termination payment made in the
first quarter of 2002, other changes in operating assets and liabilities, and
the tax benefit realized from stock option plans.

Cash flows from investing activities.During 2002, we purchased equipment for
$1.2 million and had sales of marketable securities, net of purchases, totaling
$27.8 million. We expect future cash flows for purchases of equipment to be
similar to prior periods.

Cash flows from financing activities.We have a senior credit facility
consisting of term debt and a $15 million revolving line of credit. Our senior
credit facility expires in March 2006. This facility is secured by
substantially all of our assets; contains restrictions concerning the payment
of dividends, incurrence of additional debt, and capital expenditures; and
contains certain financial covenants including ratios related to fixed charges
coverage and leverage. As of September 28, 2002, the outstanding principal
balance under our senior credit facility was $25.4 million, and we had no
borrowings under our revolving line of credit. On December 31, 2001, March 29,
2002, and June 28, 2002, we made quarterly principal payments totaling $3.5
million on our senior credit facility. Future payment commitments on the
senior credit facility are $5.5 million due in less than one year and $19.9
million due in more than one year but less than three years.

In the nine months through September 2002, we received $1.9 million from
issuing common stock related to our Employee Stock Purchase Plan and exercise
of options under our Equity Incentive Plan.

13



---



##### Table of Contents



Cash Commitments

Our acquisition of the distribution rights to DermMatrix, a porcine dermis
graft material used in sling and pelvic prolapse procedures, allows us to make
an additional $1.0 million payment in December 2002 to extend the supply
agreement through December 2008.

We believe that funds generated from operations, together with our balances in
cash and cash equivalents and funds available under our senior credit facility,
will be sufficient to finance our current operations and planned capital
expenditure requirements for at least the next 12 months.

Certain Important Factors

There are several important factors that could cause our business to suffer.
These factors, and their impact on the success of our business and our ability
to achieve our goals, include the following:

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 timely introduce these new products and
product improvements, or they are not well-accepted by the market, our future
growth will suffer.

Continued Use of Non-Invasive Treatment Alternatives.We sell medical devices
for invasive or minimally invasive surgical procedures. If physicians and
patients do not accept our products, our sales will decline. Physician and
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 from
the procedures using our products, and other adverse side effects from the
procedures using our products. Patients are more likely first to consider
non-invasive alternatives to treat their urological disorders. The
introduction of new oral medications or other less-invasive therapies may cause
our sales to decline 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 have 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.

Increased Supply of Sling Material.In the past we have provided human
cadaveric dermis as a service in conjunction with the sale of some of our sling
procedure kits for urinary incontinence. Currently, the available supply of
human tissue is not sufficient to meet our customers demand. In December
2001, our sole supplier of human cadaveric dermis declared bankruptcy and is no
longer supplying us. We are actively working with two other suppliers of this
material, but the available supply is still inadequate to meet our customers
needs. We continue to have a source of porcine dermis that can be used with
our sling procedure kits, but we cannot assure you that such supply will be
sufficient to meet demands. If our sources of sling materials cannot fill our
needs, sales of our sling procedure kits could decline.

Actions Related to Reimbursement for our Products.We may be unable to sell
our products on a profitable basis (in the United States and Internationally)
if third-party payors deny coverage or reduce their current levels of
reimbursement. Our revenues depend largely on government health care programs
and private health insurers reimbursing patients medical expenses.
Physicians, hospitals, and other health care providers may not purchase our
products if they do not receive satisfactory reimbursement from these
third-party payors.

14



---



##### Table of Contents



In August of this year, the Centers for Medicare and Medicaid Services, CMS,
published for comment its Proposed Rule of Changes to the Medicare Outpatient
Prospective Payment System (OPPS) and payment rates for calendar year 2003.
This proposed rule, if adopted, would result in deep cuts in hospital payment
rates for many outpatient procedures, including payments for our products for
erectile restoration, male urinary control, and benign prostatic hyperplasia.

We believe the analyses CMS used to determine the proposed payment rates are
flawed, and we have documented those flaws in a detailed comment filed with
CMS. Because of its flaws, we do not believe the proposed rule will be adopted
with the deep cuts, and we cannot predict what effect, if any, the final
rule will have on hospital payment rates, number of procedures performed in
2003, or our sales of products for the procedures.

Potential Product Recalls.If any of our products were found to be defective,
we would recall such defective product. Such a recall could result in
significant costs to us and in significant negative publicity which could harm
our ability to market our products in the future.

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




Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Hedging.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 expires June 30,

15



---



##### Table of Contents



2003. We expect that pre-tax
costs totaling approximately $1.2 million, which are recorded in other
comprehensive income (loss) at September 28, 2002, and represent the difference
between the fixed rate of the swap agreement and variable interest of the term
note, will be recognized within the next twelve months as part of interest
expense. At September 28, 2002, the fair value of the interest rate swap,
based upon quoted market prices for contracts with similar maturities, was
approximately $1.2 million.

Currency Fluctuation.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 quarter-end
exchange rates. Translation adjustments arising from the use of differing
exchange rates are
included in accumulated other comprehensive income in stockholders equity.
Realized and unrealized gains and losses on foreign currency transactions are
included in other income and expense below operating income. Pretax gains of
approximately $204,000 were recognized in the first nine months of 2002
compared to pretax losses of approximately $17,000 in 2001.

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.

16



---



##### Table of Contents






PART II. OTHER INFORMATION




Item 4. Controls and Procedures



|a) |  | Evaluation of disclosure controls and procedures.Our chief executive
officer and chief financial officer, after evaluating the effectiveness of
the Companys disclosure controls and procedures (as defined in the
Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a
date (the Evaluation Date) within 90 days before the filing date of this
quarterly report on Form 10-Q, have concluded that, as of the Evaluation
Date, our disclosure controls and procedures were adequate and designed to
ensure that material information relating to us and our consolidated
subsidiaries would be made known to them by others within those entities.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|b) |  | Changes in internal controls.There were no significant changes in our
internal controls or, to our knowledge, in other factors that could
significantly affect our disclosure controls and procedures subsequent to
the Evaluation Date.                                                                                                                                                                                                                                                                                                                                                                                                                                   




Item 6. Exhibits and Reports on Form 8-K



| | (a) |  | There are no exhibits to this Quarterly Report on Form 10-Q.                               
| | --- |  | -------------------------------------------------------------------------------------------
|
| | (b) |  | Reports on Form 8-K                                                                        
|
| |     |  | No report on Form 8-K was filed by the Company during the quarter
ended September 28, 2002.

17



---



##### Table of Contents






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, INC.          
|                 |  |    |                          |                                             
|October 28, 2002 |  | By |                          | /s/ Douglas W. Kohrs                        
|                 |  |    |                         
|Date             |  |    |                          | Douglas W. Kohrs                            
|                 |  |    |                          | Chief Executive Officer                     
|                 |  |    |                          |                                             
|October 28, 2002 |  | By |                          | /s/ M. James Call                           
|                 |  |    |                         
|Date             |  |    |                          | M. James Call                               
|                 |  |    |                          | Executive Vice President and Chief Financial
|                 |  |    |                          | Officer and Principal Accounting Officer    

18



---



##### Table of Contents



CERTIFICATIONS

Certification by Chief Executive Officer

I, Douglas W. Kohrs, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of American Medical
Systems Holdings, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a) |  | designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (Evaluation Date); and                                                                                                      
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                 |  |    |  |                                      
|---------------- |  | -- |  | -------------------------------------
|October 28, 2002 |  | By |  | /s/ Douglas W. Kohrs                 
|                 |  |    |  |                                      
|Date             |  |    |  | Douglas W. Kohrs                     
|                 |  |    |  | President and Chief Executive Officer





---



##### Table of Contents



Certification by Chief Financial Officer

I, M. James Call, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of American Medical
Systems Holdings, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a) |  | designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (Evaluation Date); and                                                                                                      
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                 |  |    |  |                                          
|---------------- |  | -- |  | -----------------------------------------
|October 28, 2002 |  | By |  | /s/ M. James Call                        
|                 |  |    |  |                                          
|Date             |  |    |  | M. James Call                            
|                 |  |    |  | Executive Vice President, Chief Financial
|                 |  |    |  | Officer and Secretary                    

The written statements of our Chief Executive Officer and Chief Financial
Officer required pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, accompanied the filing of this
report by correspondence to the Securities and Exchange Commission.