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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period
ended  April 2, 2005 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to Commission File Number:
00030733 AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
  Delaware
    
    41-1978822(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 10700 Bren Road West, Minnetonka, Minnesota
    
    
    55343(Address of principal executive offices)
    
    (Zip Code)
 952-930-6000 
  Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes           o No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). þ Yes           o No As of May 6, 2005, there were 69,063,974 shares of the registrants $.01 par value Common
Stock outstanding.   1




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INDEX PagePART I FINANCIAL INFORMATIONITEM 1 FINANCIAL STATEMENTS (UNAUDITED)Consolidated Balance Sheets as of
April 2, 2005 and January 1, 2005
    
    
    3Consolidated Statements of Operations for
the three month periods ended April 2,
2005 and April 3, 2004
    
    
    4Consolidated Statements of Cash Flow for
the three month periods ended April 2,
2005 and April 3, 2004
    
    
    5Notes to Consolidated Financial Statements
    
    
    6ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
    
    
    12ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    21ITEM 4 CONTROLS AND PROCEDURES
    
    
    21PART II OTHER INFORMATIONITEM 5 OTHER INFORMATION
    
    
    22ITEM 6 EXHIBITS
    
    
    23SIGNATURES
    
    
    24EXHIBIT INDEX
    
    
    25Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification Pursuant to 18 U.S.C. Section 1350
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) American Medical Systems Holdings, Inc. 
 Consolidated Balance Sheets
  April 2, 2005
    
    
    January 1, 2005(Unaudited)AssetsCurrent assetsCash and cash equivalents
    
    $
    58,133
    
    
    $
    35,689Short term investments
    
    
    12,351
    
    
    
    15,479Accounts receivable, net
    
    
    46,566
    
    
    
    46,984Inventories, net
    
    
    21,088
    
    
    
    21,719Deferred income taxes
    
    
    5,092
    
    
    
    4,855Other current assets
    
    
    2,840
    
    
    
    3,101Total current assets
    
    
    146,070
    
    
    
    127,827Property, plant and equipment, net
    
    
    21,921
    
    
    
    22,065Goodwill, net
    
    
    103,183
    
    
    
    102,365Intangibles, net
    
    
    43,752
    
    
    
    44,792Deferred income taxes
    
    
    1,774
    
    
    
    2,911Investment in technology and other assets
    
    
    770
    
    
    
    590Total assets
    
    $
    317,470
    
    
    $
    300,550Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    5,236
    
    
    $
    4,237Accrued compensation expenses
    
    
    10,818
    
    
    
    10,783Accrued warranty expense
    
    
    1,467
    
    
    
    1,451Income taxes payable
    
    
    3,175
    
    
    
    2,982Other accrued expenses
    
    
    27,992
    
    
    
    8,835Contingent liability on acquisition
    
    
    
    
    
    
    19,964Total current liabilities
    
    
    48,688
    
    
    
    48,252Accumulated post retirement benefit obligation
    
    
    3,126
    
    
    
    3,126Total liabilities
    
    
    51,814
    
    
    
    51,378Stockholders equityCommon stock, par value $.01 per share; authorized
220,000,000 shares; issued and outstanding:68,552,226 shares at April 2, 2005
and 67,478,544 shares at January 1, 2005
    
    
    686
    
    
    
    675Additional paid-in capital
    
    
    216,338
    
    
    
    210,163Accumulated other comprehensive income
    
    
    4,177
    
    
    
    5,123Retained earnings
    
    
    44,455
    
    
    
    33,211Total stockholders equity
    
    
    265,656
    
    
    
    249,172Total liabilities and stockholders equity
    
    $
    317,470
    
    
    $
    300,550
 The accompanying notes are an integral part of the consolidated financial statements. 3




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American Medical Systems Holdings, Inc. 
 Consolidated Statements of Operations
 
 Three Months EndedApril 2, 2005
    
    
    April 3, 2004Net sales
    
    $
    62,145
    
    
    $
    47,313Cost of sales
    
    
    11,020
    
    
    
    8,930Gross profit
    
    
    51,125
    
    
    
    38,383Operating expensesMarketing and selling
    
    
    21,656
    
    
    
    16,493Research and development
    
    
    4,638
    
    
    
    3,584General and administrative
    
    
    5,789
    
    
    
    4,876Amortization of intangibles
    
    
    1,790
    
    
    
    1,061Total operating expenses
    
    
    33,873
    
    
    
    26,014Operating income
    
    
    17,252
    
    
    
    12,369Other income (expense)Royalty income
    
    
    478
    
    
    
    491Interest income
    
    
    274
    
    
    
    138Interest expense
    
    
    (55
    )
    
    
    (201
    )Other expense
    
    
    (463
    )
    
    
    (156
    )Total other income
    
    
    234
    
    
    
    272Income before income taxes
    
    
    17,486
    
    
    
    12,641Provision for income taxes
    
    
    6,243
    
    
    
    4,614Net income
    
    $
    11,243
    
    
    $
    8,027Net income per shareBasic
    
    $
    0.17
    
    
    $
    0.12Diluted
    
    $
    0.16
    
    
    $
    0.12Weighted average common shares used in calculationBasic
    
    
    67,898
    
    
    
    66,484Diluted
    
    
    71,250
    
    
    
    69,998
 The accompanying notes are an integral part of the consolidated financial statements. 4




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American Medical Systems Holdings, Inc. 
 Condensed Statements of Cash Flow
 
 Three Months EndedApril 2, 2005
    
    
    April 3, 2004Cash flows from operating activitiesNet income
    
    $
    11,243
    
    
    $
    8,027Adjustments to reconcile net income to
net cash provided by operating activitiesDepreciation
    
    
    1,515
    
    
    
    1,678Loss on asset disposals
    
    
    25
    
    
    
    10Amortization of intangibles, including deferred financing costs
    
    
    1,790
    
    
    
    1,105Non-cash deferred compensation
    
    
    9
    
    
    
    8Income tax benefit related to stock options
    
    
    2,355
    
    
    
    763Change in net deferred taxes
    
    
    1,089
    
    
    
    (290
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    (805
    )
    
    
    (1,812
    )Inventories
    
    
    510
    
    
    
    540Accounts payable and accrued expenses
    
    
    1,373
    
    
    
    3,361Other assets
    
    
    (547
    )
    
    
    172Net cash provided by operating activities
    
    
    18,557
    
    
    
    13,562Cash flows from investing activitiesPurchase of property, plant and equipment
    
    
    (1,421
    )
    
    
    (165
    )Purchase of business
    
    
    (1,450
    )
    
    
    Purchase of license agreement
    
    
    (750
    )
    
    
    Purchase of short term investments
    
    
    (2,600
    )
    
    
    Sale of short term investments
    
    
    5,728
    
    
    
    Net cash used in investing activities
    
    
    (493
    )
    
    
    (165
    )Cash flows from financing activitiesIssuance of common stock
    
    
    3,822
    
    
    
    1,674Payments on long-term debt
    
    
    
    
    
    
    (1,637
    )Net cash provided by financing activities
    
    
    3,822
    
    
    
    37Effect of currency exchange rates on cash
    
    
    558
    
    
    
    (17
    )Net increase in cash and cash equivalents
    
    
    22,444
    
    
    
    13,417Cash and cash equivalents at beginning of period
    
    
    35,689
    
    
    
    58,953Cash and cash equivalents at end of period
    
    $
    58,133
    
    
    $
    72,370Supplemental disclosureCash paid for interest
    
    $
    0
    
    
    $
    132Cash paid for taxes
    
    $
    2,415
    
    
    $
    116The accompanying notes are an integral part of the consolidated financial statements.
 5




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 1. Basis of Presentation The consolidated financial statements included in this Form 10-Q have been prepared by American
Medical Systems Holdings, Inc., without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to these rules and regulations. The year-end
balance sheet was derived from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles. These unaudited consolidated interim
financial statements should be read in conjunction with the Companys consolidated financial
statements and related notes included in its Annual Report on Form 10-K for fiscal 2004. All
amounts presented in tables are in thousands, except per share data. These statements reflect, in managements opinion, all adjustments (which include only normal,
recurring adjustments) necessary for a fair presentation of the financial position and the results
of operations and cash flows for the periods presented. The results of operations for any interim
period may not be indicative of results for the full year. American Medical Systems has a 52 or 53 week fiscal year ending on the Saturday nearest December
31. Accordingly, the first fiscal quarters of 2005 and 2004 are represented by the three month
periods ended on April 2, 2005 and April 3, 2004, respectively. On January 10, 2005, we announced a two-for-one stock split in the form of a 100 percent stock
dividend. On March 4, 2005, our stockholders approved an increase in the number of authorized
shares of voting common stock from 75 million to 200 million (in addition to 20 million previously
authorized shares of non-voting common stock), which was necessary to complete the stock split. The
stock dividend was distributed on March 21, 2005 to stockholders of record on March 14, 2005. Our
financial statements, related notes, and other financial data contained in this report have been
adjusted to give retroactive effect to the stock split for all periods presented. NOTE 2. Stock-Based Compensation American Medical Systems has one stock-based employee compensation plan. We account for this plan
under the recognition and measurement principles of APB Opinion 25, Accounting for Stock Issued to
Employees, and related interpretations. The exercise price of our employee stock options equals the
market price of the underlying stock on the date of grant for all options granted, and thus, under
APB 25, no compensation expense is recognized. The following table illustrates the effect on net income and earnings per share if we had applied
the fair value recognition provisions of SFAS 123, Accounting for Stock-Based Compensation, to
stock-based employee compensation. 6




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Three Months Ended(in thousands, except per share data)
    
    April 2, 2005
    
    
    April 3, 2004Net income, as reported
    
    $
    11,243
    
    
    $
    8,027Stock-based employee compensation expense
included in reported income, net of tax
    
    
    
    
    
    
    15Total stock-based employee compensation
expense determined under fair-value based
method for all awards, net of tax
    
    
    (1,479
    )
    
    
    (816
    )Pro forma net income
    
    $
    9,764
    
    
    $
    7,226Net income per shareAs reportedBasic
    
    $
    0.17
    
    
    $
    0.12Diluted
    
    $
    0.16
    
    
    $
    0.12Pro formaBasic
    
    $
    0.14
    
    
    $
    0.11Diluted
    
    $
    0.14
    
    
    $
    0.10
 During the first fiscal quarter of 2005, stock options were exercised to acquire 1,052,306
shares and 21,376 shares were purchased under the employee stock purchase plan. NOTE 3. Earnings per Share The following table presents information necessary to calculate basic and diluted net income per
common share and common share equivalents for the first fiscal quarters of 2005 and 2004. Three Months Ended(in thousands, except per share data)
    
    April 2, 2005
    
    
    April 3, 2004Net income
    
    $
    11,243
    
    
    $
    8,027Weighted-average shares
outstanding for basic net income per share
    
    
    67,898
    
    
    
    66,484Dilutive effect of stock options
    
    
    3,352
    
    
    
    3,514Adjusted weighted-average
shares outstanding and assumed
conversions for diluted net income per share
    
    
    71,250
    
    
    
    69,998Net income per shareBasic
    
    $
    0.17
    
    
    $
    0.12Diluted
    
    $
    0.16
    
    
    $
    0.12
 During the first fiscal
quarter of 2005 and 2004, there were 506,316 and 1,150,000,
respectively, of outstanding stock options excluded from the diluted earnings per share computation
because the impact would have been anti-dilutive. NOTE 4. Inventories Inventories consist of the following: (in thousands)
    
    April 2, 2005
    
    
    January 1, 2005Raw materials
    
    $
    5,255
    
    
    $
    5,191Work in process
    
    
    3,218
    
    
    
    2,405Finished goods
    
    
    14,359
    
    
    
    15,866Obsolescence
    
    
    (1,744
    )
    
    
    (1,743
    )Net inventories
    
    $
    21,088
    
    
    $
    21,719
 7




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NOTE 5. Warranties Many of our products are sold with warranty coverage for periods ranging from one year up to the
patients lifetime. The warranty allowance is our estimate of the expected future cost of honoring
current warranty obligations. Factors influencing this estimate include historical claim rates,
surgical infection rates, changes in product performance, the frequency of use by the patient, the
patients performance expectations, and changes in the terms of our policies. Changes in the
warranty balance during the first fiscal quarters of 2005 and 2004 are listed below: Three Months Ended(in thousands)
    
    April 2, 2005
    
    
    April 3, 2004Balance, beginning of period
    
    $
    1,451
    
    
    $
    1,338Provisions for warranty
    
    
    77
    
    
    
    83Claims processed
    
    
    (61
    )
    
    
    (83
    )Balance, end of period
    
    $
    1,467
    
    
    $
    1,338
 NOTE 6. Acquisition On July 15, 2004, we acquired TherMatrx, Inc. and the shareholders of TherMatrx were paid cash
consideration of $40.0 million. We also paid $1.4 million of acquisition related costs through
April 2, 2005. In addition to the initial closing payment, we will make contingent payments based on the net
product revenues attributable to sales of the TherMatrx Dose Optimized Thermotherapy (DOT) product.
These contingent payments will equal four times the aggregate sales of DOT products over a period
of six consecutive fiscal quarters (which began on July 5, 2004 and will end on December 31, 2005)
minus $40.0 million. The contractual range of contingent payments is from zero to $210.0 million
which would result in a total purchase price of $40.0 million up to a maximum of $250.0 million
(including the initial payment). These contingent payments will be accounted for as goodwill. Since the time of acquisition, earnout payments of $22.9 million have been accrued, of which $1.5
million was paid during the three month period ended April 2, 2005. The primary purpose of the TherMatrx acquisition was to gain access to their product for the
treatment of benign prostatic hyperplasia (BPH). The primary advantage of the TherMatrx treatment
over other BPH treatments is the comfort level for the patient and its appropriateness for the
office setting. The purchase price, including earnout payments accrued, is currently allocated as follows: (in thousands)
    
    AmountDeveloped technology, customer relationships and other intangible assets
    
    $
    31,000In-process research and development
    
    
    35,000Tangible assets acquired, net of liabilities assumed
    
    
    5,536Deferred tax liability on assets acquired
    
    
    (8,677
    )Goodwill
    
    
    1,485Purchase price, including earned contingent payments
    
    $
    64,344
 The determination of the portion of the purchase price allocated to developed technology,
customer relationships and other intangible assets and in-process research and development was
based on an independent valuation study to determine the respective fair values. The developed
technology, customer relationships and other intangible assets are being amortized over their
estimated useful lives of 10 years, with this expense reflected as part of the amortization of
intangibles line on the Consolidated Statement of Operations. In accordance with purchase
accounting rules, the acquired in-process research and development of $35.0 million was expensed in
our third fiscal quarter of 2004 with no related income tax benefit. Tangible assets acquired, net
of liabilities assumed, were stated at fair value at the date of acquisition based on managements
assessment. We recorded a contingent liability at the time of acquisition because the net assets
acquired were in excess of the initial purchase price. 8




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The contingent liability on acquisition
was reduced from $20.9 million at initial
acquisition to zero at April 2, 2005, to reflect the contingent payments
to be made based on the net product
revenues attributable to sales of DOT product during the period July 5, 2004 through April 2, 2005.
The first contingent payment of $1.5 million was made in February 2005. The second contingent
payment of approximately $21.4 million is to be made in May 2005 and is included in other accrued
expenses at April 2, 2005. Our consolidated financial statements for the three months ended April 2, 2005 include the
financial results of TherMatrx. The following table contains pro forma results for the quarter
ended April 3, 2004, as if the acquisition had occurred at the beginning of 2004: Three Months Ended(in thousands, except per share data)
    
    April 3, 2004Revenue
    
    $
    52,231Net income
    
    $
    8,495Earnings per shareBasic
    
    $
    0.13Diluted
    
    $
    0.12
 The pro forma consolidated results do not purport to be indicative of results that would have
occurred had the acquisition been in effect for the periods presented, nor do they purport to be
indicative of the results that will be obtained in the future. NOTE 7. Recent Accounting Pronouncements In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of Accounting
Research Bulletin No. 43, Inventory Pricing.SFAS No. 151 requires all companies to recognize a
current-period charge for abnormal amounts of idle facility expense, freight, handling costs and
wasted materials. The statement also requires that the allocation of fixed production overhead to
the costs of conversion be based on the normal capacity of the production facilities. This new
standard is effective for fiscal years beginning after June 15, 2005 with early adoption permitted.
We adopted SFAS 151 in the first quarter of 2005 and it did not have a material impact on our
consolidated financial statements. In December 2004, the FASB issued SFAS 123 (revised 2004), Share-based Payment. SFAS 123(R)
requires all entities to recognize compensation expense in an amount equal to the fair value of
share-based payments (e.g. stock options and restricted stock) granted to employees. This applies
to all transactions involving the issuance of our own equity in exchange for goods or services,
including employee services. Upon adoption of SFAS 123(R), all stock option awards to employees
will be recognized as expense in the income statement, typically over any related vesting period.
SFAS123(R) carried forward the guidance from SFAS 123 for payment transactions with non-employees.
The Securities and Exchange Commission amended the compliance date on April 14, 2005, to require
public companies to adopt the standard as of the beginning of the first annual period that begins
after June 15, 2005. We will, therefore, be required to adopt SFAS 123(R) in the first quarter of
2006. We believe the impact of adopting SFAS 123(R) will be similar to the pro forma disclosure
impact presented previously in this footnote. See Notes to Consolidated Financial Statements  No
2. SFAS 123(R) permits public companies to adopt its requirements using one of two methods:  1.
    Modified Prospective Method under which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS 123(R) for all share-based
payments granted after the effective date and (b) based on the requirements of SFAS 123
for all awards granted to employees prior to the effective date of SFAS 123(R) that remain
unvested on the effective date.2.
    Modified Retrospective Method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based on the
amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either
(a) all prior periods presented or (b) prior interim periods of the year of adoption. At this time, we have not determined which method of adoption we will use. 9




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NOTE 8. Comprehensive Income Comprehensive income is net income adjusted for changes in the value of derivative financial
instruments, unrealized gains and losses on marketable securities, and foreign currency
translation. Comprehensive income for the first fiscal quarters of 2005 and 2004 was: Three Months Ended(in thousands)
    
    April 2, 2005
    
    
    April 3, 2004Net income
    
    $
    11,243
    
    
    $
    8,027Foreign currency translation (loss), net of taxes
    
    
    (946
    )
    
    
    (421
    )Comprehensive income
    
    $
    10,297
    
    
    $
    7,606
 NOTE 9. Industry Segment Information and Foreign Operations Since its inception, we have operated in the single industry segment of developing, manufacturing,
and marketing medical devices. We distribute products through our direct sales force and independent sales representatives in the
United States, Canada, Australia, Brazil and Western Europe. Additionally, we distribute products
through foreign independent distributors, primarily in Europe, Asia and South America, who then
sell the products to medical institutions. No customer or distributor accounted for five percent
or more of net sales during the first fiscal quarters of 2005 or 2004. Foreign subsidiary sales
are predominantly to customers in Western Europe, Australia, Canada and Brazil. Substantially all
of our foreign subsidiary assets are located in Western Europe, Canada, Australia and Brazil. The following table presents
net sales and long-lived assets (excluding deferred taxes) by geographical territory. No individual foreign countrys net sales or long-lived assets are
material. Three Months Ended and Period Ending(in thousands)
    
    April 2, 2005

    
    April 3, 2004United StatesNet sales
    
    $
    48,333
    
    
    $
    36,598Long-lived assets
    
    $
    154,187
    
    
    $
    132,034Outside United StatesNet sales
    
    $
    13,812
    
    
    $
    10,715Long-lived assets
    
    $
    15,439
    
    
    $
    12,247
 NOTE 10. Goodwill and Intangible Assets The changes in the carrying amount
of goodwill for the first fiscal quarter are as follows: Three Months EndedApril 2, 2005Goodwill, beginning of the year, net
    
    $
    102,365Additions
    
    
    1,485Effect of currency translation
    
    
    (667
    )Goodwill, end of first quarter, net
    
    $
    103,183
 10




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The following table provides additional information concerning intangible assets: April 2, 2005
    
    
    January 1 ,2005Gross carrying
    
    
    Accumulated
    
    
    Net book
    
    
    Gross carrying
    
    
    Accumulated
    
    
    Net book(in thousands)
    
    amount
    
    
    amortization
    
    
    value
    
    
    amount
    
    
    amortization
    
    
    valueAmortizedPatents
    
    $
    10,127
    
    
    ($
    6,862
    )
    
    $
    3,265
    
    
    $
    10,127
    
    
    ($
    6,581
    )
    
    $
    3,546Licenses
    
    
    6,041
    
    
    
    (1,959
    )
    
    
    4,082
    
    
    
    5,291
    
    
    
    (1,529
    )
    
    
    3,762Deferred financing
    
    
    1,611
    
    
    
    (1,611
    )
    
    
    
    
    
    
    1,611
    
    
    
    (1,611
    )
    
    
    Developed technology
    
    
    48,853
    
    
    
    (14,219
    )
    
    
    34,634
    
    
    
    48,853
    
    
    
    (13,140
    )
    
    
    35,713Non-compete agreements
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    
    
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    Total
amortized intangible assets
    
    
    67,743
    
    
    
    (25,762
    )
    
    
    41,981
    
    
    
    66,993
    
    
    
    (23,972
    )
    
    
    43,021UnamortizedTrademarks
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771
    
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771Total intangible assets
    
    $
    69,976
    
    
    ($
    26,224
    )
    
    $
    43,752
    
    
    $
    69,226
    
    
    ($
    24,434
    )
    
    $
    44,792
 Three Months Ended(in thousands)
    
    April 2, 2005
    
    
    April 3, 2004Amortization expense
    
    $
    1,790
    
    
    $
    1,061
 The estimated amortization expense for currently-owned intangibles for the years 2005 through
2009 is $7.4 million, $5.9 million, $4.7 million, $4.7 million and $4.6 million, respectively. NOTE 11. Credit Agreement On January 20, 2005, we entered into a credit agreement. The credit agreement provides for a $150.0
million senior unsecured five year revolving credit facility, with a $20.0 million sub-limit for
the issuance of standby and commercial letters of credit, and a $10.0 million sub-limit for swing
line loans. At our option, any loan under the credit agreement (other than swing line loans) bears
interest at a variable rate based on LIBOR or an alternative variable rate based on either prime
rate or the federal funds effective rate, in each case plus a basis point spread determined by
reference to our leverage ratio. The credit agreement also contains a commitment fee which bears a
rate determined by reference to our leverage ratio. At our election, the aggregate maximum
principal amount available under the credit agreement may be increased by an amount up to $60.0
million. Funds are available for working capital and other lawful purposes, including permitted
acquisitions. The credit agreement contains standard affirmative and negative covenants, including two financial
covenants that require we maintain a leverage ratio of not greater than 2.75 to 1.00 and an
interest coverage ratio of not less than 3.00 to 1.00. The covenants also restrict: (a) the making
of investments, the payment of dividends and other payments with respect to capital, the
disposition of material assets other than in the ordinary course of business and mergers and
acquisitions if such actions would cause our leverage ratio to be greater than 2.50 to 1.00, (b)
transactions with affiliates unless such transactions are completed in the ordinary course of
business and upon fair and reasonable terms, (c) the incurrence of liens and (d) substantial
changes in the nature of our business. The credit agreement also contains customary events of
default, including payment defaults, material inaccuracy of representations and warranties,
covenant defaults, bankruptcy and involuntary proceedings, monetary judgment defaults in excess of
specified amounts, cross-defaults to certain other agreements, change of control, and ERISA
defaults. As of April 2, 2005, there were no outstanding loans under this facility and we were in compliance
with our loan covenants. Our current ratios in relation to the covenants are listed below: Credit facilityCovenant
    
    requirements
    
    
    ActualLeverage ratio
    
    < 2.75 to 1.00
    
    
    0.27 to 1.00Interest coverage ratio
    
    > 3.00 to 1.00
    
    
    97.20 to 1.00
 11




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements within the meaning of the Private Securities Litigation Reform
Act of 1995. Any statements not of historical fact may be considered forward-looking statements.
Written words such as may, expect, believe, anticipate, or estimate, or other variations
of these or similar words, 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. Important factors known to us that could cause
such material differences are identified in Risk Factors. We undertake no obligation to correct
or update any forward-looking statements, whether as a result of new information, future events, or
otherwise. You are advised, however, to consult any future disclosures we make on related subjects
in future filings with the SEC. Critical Accounting Policies and Estimates We base our estimates on historical experience and on various other assumptions that we believe to
be reasonable under the circumstances. Managements discussion and analysis of financial condition
and results of operations are based upon the consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and judgments that affect
(1) the reported amounts of assets, liabilities, revenues, and expenses and (2) the related
disclosure of contingent assets and liabilities. At each balance sheet date, we evaluate our
estimates, including but not limited to, those related to accounts receivable and sales return
obligations, inventories, long-lived assets, warranty, legal contingencies, and income taxes. The
critical accounting policies that are most important in fully understanding and evaluating the
financial condition and results of operations are discussed in our Form 10-K on file with the SEC. Overview American Medical Systems develops and delivers innovative medical solutions to our target patients
and physicians. Since becoming an independent company in 1998, we have worked to build a business
that delivers consistent revenue and earnings growth, fueled by a robust pipeline of innovative
products for significant, under-penetrated markets of patients and their physicians. We have
greatly broadened our product line, building on our traditional base of products for erectile
restoration and products for mens incontinence, to include products and therapies targeted at
urethral stricture and benign prostatic hyperplasia in men as well as incontinence, pelvic organ
prolapse and menorrhagia in women. Our primary physician customers include urologists,
gynecologists, and urogynecologists. On January 10, 2005, we announced a two-for-one stock split in the form of a 100 percent stock
dividend. On March 4, 2005, our stockholders approved an increase in the number of authorized
shares of voting common stock from 75 million to 200 million (in addition to 20 million previously
authorized shares of non-voting common stock), which was necessary to complete the stock split. The
stock dividend was distributed on March 21, 2005 to stockholders of record on March 14, 2005. Our
financial statements, related notes, and other financial data contained in this report have been
adjusted to give retroactive effect to the stock split for all periods presented. 12




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##### Table of Contents



Results of Operations Sales Trends Our worldwide sales were $62.1 million for the first fiscal quarter of 2005, a 31.3 percent
increase over sales of $47.3 million in the comparable quarter of 2004. Of this total growth, 1.5
percentage points were the result of currency exchange rate changes and 12.1 percentage points were
due to the TherMatrx product line acquired in the third quarter of 2004. The following table compares net sales by product line and geography for the first fiscal quarters
of 2005 and 2004: Three Months Ended(in thousands)
    
    April 2, 2005
    
    
    April 3, 2004
    
    
    $ Increase
    
    
    % IncreaseSalesProduct LineMens pelvic healthErectile restoration
    
    $
    20,694
    
    
    $
    17,465
    
    
    $
    3,229
    
    
    
    18.5
    %Continence
    
    
    13,248
    
    
    
    12,166
    
    
    
    1,082
    
    
    
    8.9
    %Prostate treatment
    
    
    6,647
    
    
    
    1,166
    
    
    
    5,481
    
    
    
    470.1
    %Total mens pelvic health
    
    
    40,589
    
    
    
    30,797
    
    
    
    9,792
    
    
    
    31.8
    %Womens pelvic health
    
    
    21,556
    
    
    
    16,516
    
    
    
    5,040
    
    
    
    30.5
    %Total
    
    $
    62,145
    
    
    $
    47,313
    
    
    $
    14,832
    
    
    
    31.3
    %GeographyUnited States
    
    $
    48,333
    
    
    $
    36,598
    
    
    $
    11,735
    
    
    
    32.1
    %Outside United States
    
    
    13,812
    
    
    
    10,715
    
    
    
    3,097
    
    
    
    28.9
    %Total
    
    $
    62,145
    
    
    $
    47,313
    
    
    $
    14,832
    
    
    
    31.3
    %
  Three Months Ended(in thousands)
    
    April 2, 2005

    
    April 3, 2004Percent of total salesProduct LineMens pelvic healthErectile restoration
    
    
    33
    %
    
    
    37
    %Continence
    
    
    21
    %
    
    
    26
    %Prostate treatment
    
    
    11
    %
    
    
    2
    %Total mens pelvic health
    
    
    65
    %
    
    
    65
    %Womens pelvic health
    
    
    35
    %
    
    
    35
    %Total
    
    
    100
    %
    
    
    100
    %GeographyUnited States
    
    
    78
    %
    
    
    77
    %Outside United States
    
    
    22
    %
    
    
    23
    %Total
    
    
    100
    %
    
    
    100
    %
 Net Sales Mens pelvic health products.Revenue from mens health products grew 31.8 percent in the first
fiscal quarter of 2005 over the comparable period of 2004. This was driven primarily by two events
from the third quarter of 2004, namely (a) the introduction of the Tactile Pumpwithin the AMS 700
series of penile prostheses and (b) the acquisition of TherMatrx, Inc. Erectile restoration revenue increased 18.5 percent in the quarter with a 7.4 percent increase in
units sold across our portfolio of offerings. The average selling price of the overall erectile
restoration portfolio increased significantly due to a continued conversion to the higher priced
Tactile Pumpproduct with its enhanced patient interface and InhibiZoneantibiotic treatment. Due
to market dynamics and strong revenue performance in the last two quarters of fiscal 2004, we
expect erectile restoration growth to slow during the year to less than 10 percent. 13




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##### Table of Contents



Male continence sales increased 8.9 percent in the quarter with less than 1 percent growth in units
sold. Unit sales increases outside the U.S. offset decreases within the U.S. in both the AMS 800
Artificial Urinary Sphincterand the InVancemale sling system product lines. Price increases made
to the AMS 800line in the second quarter of 2004 and continued implant configuration changes are
the primary drivers of the global sales increases in this business. With continued focus on
improving market awareness and physician training on our male continence products, we anticipate
sales growth of approximately 12 percent for 2005. Prostate treatment sales increased $5.5 million from the prior years quarter due primarily to the
acquisition of the TherMatrx product for BPH. Excluding TherMatrx sales, our prostate product
sales declined slightly from the prior years quarter as our UroLumeproduct is targeted toward the
focused market of urethral stricture. We believe the in-office treatment of BPH market is growing
at approximately 20 percent and that our prostrate business is growing in line with that market. Womens pelvic health products.Revenue from womens pelvic health products grew 30.5 percent in
the first fiscal quarter of 2005 over the comparable period of 2004. Our business continues to
reflect the markets shift toward the less-invasive, self-fixating slings with decreases in
conventional bone anchoring devices (i.e. our InFastproduct). Within our offering of sling
products, the Monarcand BioArcexperienced both unit increases and mix benefit as their respective
features of transobturator implant technique and biologic graft combined with self-fixating
synthetic mesh continue to draw market share. While the supra-pubic implantation technique of the
SPARCis losing portfolio share, that product remains significant within our womens pelvic health
portfolio. Our prolapse repair products approved by the FDA in mid-2004, namely the Apogeeand
Perigee, contributed to the womens health growth and were not available in the first quarter of
2004. Her Optionsales remain relatively flat in recent sequential quarters as the establishment
of a reimbursement level for the Current Procedural Terminology (CPT) code was not effective until
January 2005. As of April 2005, we have confirmed the use of the new code and reimbursement level
with a growing percentage of payers, so we expect to see growth from this product offering later in
2005. With the impact of both new product technologies and continued deployment of physician
training on those new technologies, we expect our womens pelvic health portfolio to continue to
grow at rates above the market growth rate for 2005. International sales and foreign exchange effects.Our total revenues grew $14.8 million, or 31.3
percent in the first fiscal quarter of 2005 over the comparable period of 2004. Of this growth,
$0.7 million, or 1.5 percent, was due to favorable currency exchange rates, mainly the euro.
Because a large share of our expenses associated with European sales are euro-denominated costs,
changes in these currency rates do not affect net income and cash flows from operations by the same
dollar amount as they affect sales revenues. The following table compares revenue, expense, and other income accounts for the first fiscal
quarters of 2005 and 2004: 14




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##### Table of Contents



Three Months Ended
    
    
    $ Increase

    
    % Increase(in thousands)
    
    April 2, 2005
    
    
    April 3, 2004
    
    
    (Decrease)

    
    (Decrease)Net sales
    
    $
    62,145
    
    
    $
    47,313
    
    
    $
    14,832
    
    
    
    31.3
    %Cost of sales
    
    
    11,020
    
    
    
    8,930
    
    
    
    2,090
    
    
    
    23.4
    %Gross profit
    
    
    51,125
    
    
    
    38,383
    
    
    
    12,742
    
    
    
    33.2
    %Operating expensesMarketing and selling
    
    
    21,656
    
    
    
    16,493
    
    
    
    5,163
    
    
    
    31.3
    %Research and development
    
    
    4,638
    
    
    
    3,584
    
    
    
    1,054
    
    
    
    29.4
    %General and administrative
    
    
    5,789
    
    
    
    4,876
    
    
    
    913
    
    
    
    18.7
    %Amortization of intangibles
    
    
    1,790
    
    
    
    1,061
    
    
    
    729
    
    
    
    68.7
    %Total operating expenses
    
    
    33,873
    
    
    
    26,014
    
    
    
    7,859
    
    
    
    30.2
    %Operating income
    
    
    17,252
    
    
    
    12,369
    
    
    
    4,883
    
    
    
    39.5
    %Royalty income
    
    
    478
    
    
    
    491
    
    
    
    (13
    )
    
    
    -2.6
    %Interest income
    
    
    274
    
    
    
    138
    
    
    
    136
    
    
    
    98.6
    %Interest expense
    
    
    (55
    )
    
    
    (201
    )
    
    
    146
    
    
    
    72.6
    %Other income (expense)
    
    
    (463
    )
    
    
    (156
    )
    
    
    (307
    )
    
    
    196.8
    %Income before income taxes
    
    
    17,486
    
    
    
    12,641
    
    
    
    4,845
    
    
    
    38.3
    %Provision for income taxes
    
    
    6,243
    
    
    
    4,614
    
    
    
    1,629
    
    
    
    35.3
    %Net income
    
    $
    11,243
    
    
    $
    8,027
    
    
    $
    3,216
    
    
    
    40.1
    %
 Percent of SalesFor the Three Months Ended(in thousands)
    
    April 2, 2005
    
    April 3, 2004Net sales
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    17.7
    %
    
    
    18.9
    %Gross profit
    
    
    82.3
    %
    
    
    81.1
    %Operating expensesMarketing and selling
    
    
    34.8
    %
    
    
    34.9
    %Research and development
    
    
    7.5
    %
    
    
    7.6
    %General and administrative
    
    
    9.3
    %
    
    
    10.3
    %Amortization of intangibles
    
    
    2.9
    %
    
    
    2.2
    %Total operating expenses
    
    
    54.5
    %
    
    
    55.0
    %Operating income
    
    
    27.8
    %
    
    
    26.1
    %Royalty income
    
    
    0.8
    %
    
    
    1.0
    %Interest income
    
    
    0.4
    %
    
    
    0.3
    %Interest expense
    
    
    -0.1
    %
    
    
    -0.4
    %Other income (expense)
    
    
    -0.7
    %
    
    
    -0.3
    %Income before income taxes
    
    
    28.1
    %
    
    
    26.7
    %Provision for income taxes
    
    
    10.0
    %
    
    
    9.8
    %Net income
    
    
    18.1
    %
    
    
    17.0
    %
 Cost of sales. Cost of sales as a percentage of sales decreased 1.2 percentage points from
18.9 percent in the first quarter of 2004 to 17.7 percent for the first quarter in 2005. The
majority of the decrease in the rate of cost is attributed to the higher effective prices achieved
across our erectile restoration, male continence and womens health portfolios. Future costs of
goods sold will continue to depend on product introductions, production levels and mix of product
sold. 15




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##### Table of Contents



Marketing and selling.Marketing and selling expenses increased by 31.3 percent in the first
quarter of 2005 but remained essentially constant as a percentage of total revenue. The increase
in spending was primarily due to costs associated with our TherMatrx product which we did not own
in the 2004 quarter. We also continued investment in training and our sales management structure
in the first quarter of 2005. We expect to continue expanding our sales and marketing investment,
but our objective remains to leverage sales and marketing expense in 2005 and beyond as a
percentage of sales. Research and development.Research and development expense for the first quarter of 2005 held
relatively constant as a percentage of sales for the first fiscal quarters of 2005 and 2004.
Research and development spending includes investments in product development, intellectual
property support, clinical studies and regulatory filings. We continue to expect total spending in
research and development, over the longer term, to be in the range of 8 to 10 percent of sales. General and administrative.General and administrative expenses as a percentage of sales for the
first quarter of 2005 decreased by 1.0 percentage point from the comparable period in 2004, 9.3
percent and 10.3 percent, respectively. We expect to continue the leveraging of our current
general and administrative infrastructure as we support our growing revenue base. While general
and administrative expenses decreased as a percentage of sales, the dollars spent in the first
quarter of 2005 increased over the first quarter of 2004. Amortization of intangibles.Amortization of intangibles includes amortization expense on our
definite-lived intangible assets, consisting of patents, licenses and developed technology. The
first quarter of 2005 reflects increased amortization expense over first quarter of 2004 due mainly
to the amortization of developed technology, customer relationships and other intangibles obtained
with our acquisition of TherMatrx in the third quarter of 2004. Royalty income.Our royalty income is primarily from the license of our stent-delivery technology
for medical use outside of urology. This perpetual exclusive worldwide license was entered into
during 1998 and is expected to continue to 2009. We receive a royalty equal to 2.625 percent of
net sales of licensed products on a quarterly basis. We do not directly influence sales of the
products on which this royalty is based and cannot give any assurance as to future income levels.
To a much lesser extent, royalty income includes fees from the sale of rights to a magnetic
intraurethral valve pump device for the management of female incontinence. Interest income.Interest income increased to $0.3 million from $0.1 million during the first
fiscal quarters of 2005 and 2004, respectively, due to higher levels of cash and short term
investments. Interest expense.Interest expense decreased in the first fiscal quarter of 2005 from the same
period 2004 due to the repayment of the entire outstanding balance on our senior credit facility in
the third quarter of 2004. We entered into a new credit agreement on January 20, 2005. As of
April 2, 2005, there were no borrowings under the credit agreement. Other income (expense).Other income (expense) primarily represents gains and losses as a result
of remeasuring foreign denominated (mainly euro-based) short-term intercompany receivables to
current rates. The first fiscal quarter of 2005 reflects losses due to the weakening of the euro
by 5.0 percent to the U.S. dollar from the beginning of the period. Income taxes.Our effective income tax rate for the first fiscal quarters of 2005 and 2004 were
35.7 percent and 36.5 percent, respectively. We expect our effective tax rate for 2005 to
approximate the first quarter 2005 effective rate. Liquidity and Capital Resources Cash, cash equivalents and short term investments were $70.5 million as of April 2, 2005, compared
to $51.2 million as of January 1, 2005. This increase is due primarily to cash flow generated from
operating activities. Cash flows from operating activities.Net cash from operations was $18.6 million for the first
quarter of fiscal 2005, driven by a net income of $11.2 million, and depreciation and amortization
of $3.3 million. Net cash from operations was $13.6 million for the three month period of fiscal
2004, resulting from net income of $8.0 million, depreciation and amortization of $2.8 million,
offset by other changes in assets and liabilities. Cash flows from investing activities.Cash used in investing activities was ($0.5) million and
($0.2) million for the three month periods of fiscal 2005 and 2004, respectively. During the three
month periods of fiscal 2005 and 2004, we purchased equipment totaling
$1.4 million and $0.2
million, respectively. Cash of $1.5 million was paid during the three
month period of 2005 as part
of the contingent payments to the TherMatrx shareholders. 16




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##### Table of Contents



Cash flows from financing activities.Cash used in financing activities was $3.8 million during
the three month period of fiscal 2005 and net to zero in the same period of 2004. Cash received
from issuance of common stock was $3.8 million and $1.7 million during the three month periods of
fiscal 2005 and 2004,
respectively. During the first quarter of 2004, we repaid $1.6 million of debt under our previous
senior credit facility. Cash Commitments.Pursuant to our acquisition of CryoGen, Inc., we have agreed to pay
CryoGens former shareholders an earnout payment contingent upon sales of CryoGen products. The
earnout payment will be equal to three times our net sales of CryoGen products during four
consecutive quarters, less our $40.0 million initial acquisition payment. The earnout period
expires December 31, 2005. If our net CryoGen product sales do not exceed $13.3 million during any
consecutive four-quarter period prior to December 31, 2005, no earnout payment will be required.
The contractual maximum amount of the earnout payment is $110.0 million. This transaction is more
fully described in our Form 8-K filed with the SEC on January 6, 2003. We do not currently
anticipate an earnout payment to the former CryoGen shareholders. On July 15, 2004, we acquired TherMatrx, Inc. and the shareholders of TherMatrx were paid cash
consideration of $40.0 million. We also paid $1.4 million of acquisition related costs through
April 2, 2005. In addition to the initial closing payment, we will make contingent payments based
on the net product revenues attributable to sales of the TherMatrx Dose Optimized Thermotherapy
(DOT) product. These contingent payments will equal four times the aggregate sales of DOT products
over a period of six consecutive fiscal quarters (which began on July 5, 2004 and will end on
December 31, 2005) minus $40.0 million. The contractual range of contingent payments is from zero
to $210.0 million which would result in a total purchase price of $40.0 million up to a maximum of
$250.0 million (including the initial payment). These contingent payments will be accounted for as
goodwill. Since the time of acquisition, earnout payments of $22.9 million have been accrued, of
which $1.5 million was paid during the three month period ended April 2, 2005. On July 8, 2004, we repaid the remaining balance of 12.9 million under our prior senior credit
facility and terminated the facility. This facility, which was set to expire in September 2005, was
replaced with a new facility on January 20, 2005. The new agreement provides for a $150.0 million
senior unsecured five-year revolving facility (U.S. dollars only), with a $20.0 million sub-limit
for the issuance of standby and commercial letters of credit, and a $10.0 million sub-limit for
swing line loans. At our option, any loan under the credit agreement (other than swing line
loans) bears interest at a variable rate based on LIBOR or an alternative variable rate based on
either prime rate or the federal funds effective rate, in each case plus a basis point spread
determined by reference to our leverage ration. We have the option of increasing the aggregate
maximum principal amount under the facility by $60.0 million. Funds are available under the credit
facility for working capital and other lawful purposes, including permitted acquisitions. There
are currently no borrowings under the facility. 17




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##### Table of Contents



We believe that funds generated from operations, together with our balances in cash and cash
equivalents, as well as short term investments and our credit facility will be sufficient to
finance current operations, planned capital expenditures, and our commitment to former TherMatrx
shareholders. Risk Factors There are several factors that could cause our actual results to differ materially from our
anticipated results. Some of these factors, and their impact on the success of our operations and
our ability to achieve our goals, are discussed below. Supplier Risks Many of our products utilize raw materials or components that are either single or sole sourced.
These sources of supply could encounter manufacturing difficulties or may unilaterally decide to
stop supplying us because of product liability concerns or other factors. We currently rely on
single source suppliers for the silicone and fabric used in our male prostheses and for the porcine
dermis and mesh used in many of our female products. Furthermore, we use single sources for the
TherMatrx consoles and disposables. A key component of the InhibiZoneantibiotic technology is
procured from a single source. We mitigate these risks through appropriate inventory levels,
defining alternative sources and comprehensive supplier management. The loss of any of these
suppliers could have a materially adverse effect on our financial results in the near term, as we
would be required to qualify alternate designs or sources. Potential Product Recalls In the event that any of our products were defective, we could voluntarily recall, or the U.S. Food
and Drug Administration (the FDA) or an international regulatory body could require us to redesign
or recall, any defective product. There is a possibility that we may recall products in the future
and that future recalls could result in significant costs to us and in significant negative
publicity which could harm our ability to market our products in the future. Continued Physician Use and Endorsement of our Products For us to sell our products, physicians must recommend and endorse them. We may not obtain the
necessary recommendations or endorsements from physicians. Many of the products we acquired or are
developing are based on new treatment methods. Acceptance of our products is dependent on educating
the medical community as to the distinctive characteristics, perceived benefits, clinical efficacy,
and cost-effectiveness of our products compared to competitive products, and on training physicians
in the proper application of our products. We believe our products address major market
opportunities, but if we are unsuccessful in marketing them, our sales and earnings could be below
expectations. Successful Introduction of New Products and Product Improvements As part of our growth strategy, we intend to introduce a number of new products and product
improvements. If we do not introduce these new products and product improvements on schedule, or if
they are not well accepted by the market, our growth may be reduced. Continued Use of Non-Invasive Treatment Alternatives We predominantly sell devices and kits for invasive or minimally invasive surgical procedures. If
patients do not accept our products and therapies, our sales may decline. Patient acceptance of our
products and therapies depends on a number of factors, including the failure of non-invasive
therapies, the degree of invasiveness involved in the procedures using our products, the rate and
severity of complications, and other adverse side effects from the procedures using our products.
Patients are more likely to first consider non-invasive alternatives to treat their urological
disorders. The introduction of new oral medications or other less-invasive therapies could cause
our sales to decline. Actions Related to Reimbursement for Procedures Using our Products Our physician and hospital customers depend on third party government and non-government entities
for reimbursement for services provided to patients. The level of such third party reimbursement
may influence whether or not customers purchase our products. Effective 18




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##### Table of Contents



January 1, 2004, the
Centers for Medicare and Medicaid Services (CMS) increased reimbursement for certain procedures
utilizing inflatable penile prostheses and urinary sphincter devices. This increase partially
reversed reductions in such reimbursement rates in 2001 and 2002. Our sales history in the U.S. of
these devices does not evidence an obvious correlation with changes in CMS reimbursement rates. In the first quarter of 2004, the American Medical Association approved a CPT code for our Her
Optioncryoablation system to treat excessive uterine bleeding in the physicians office, which was
the first step toward the availability of standard reimbursement for Her Option. In January 2005,
CMS published the relative value units to be applied to this therapy, resulting in a national
average CMS allowable payment of $2,602 effective as of January 1, 2005. We do not expect a
noticeable effect on sales of Her Optionuntil this data has been incorporated into the
reimbursement systems of the individual commercial payers across the country. We can offer no
assurances as to the timing or effectiveness the new code and reimbursement level for Her Option
procedures will have on the acceptance and practice of this in-office therapy. Regulatory Approvals and Clinical Results Regulatory authorities around the world dictate different levels of manufacturing and design
information and/or clinical data for various products in order to ensure their safety and efficacy.
In the event the data submitted is deemed inadequate or the clinical study results do not support
approval, a product may either not be fit for commercialization or may require a redesign. Intellectual Property Lawsuits The medical device industry is litigious with respect to patents and other intellectual property
rights. Companies in the medical device industry have used intellectual property litigation to gain
a competitive advantage. In the future, we may become a party to lawsuits involving patents or
other intellectual property. A legal proceeding, regardless of the outcome, would draw upon our
financial resources and divert the time and efforts of our management. If we lose one of these
proceedings, a court, or a similar foreign governing body, could require us to pay significant
damages to third parties, require us to seek licenses from third parties and pay ongoing royalties,
require us to redesign our products, or prevent us from manufacturing, using or selling our
products. In addition to being costly, protracted litigation to defend or prosecute our
intellectual property rights could result in our customers or potential customers deferring or
limiting their purchase or use of the affected products until resolution of the litigation. Product Liability Lawsuits The manufacture and sale of medical devices exposes us to significant risk of product liability
claims. In the past, we have had a number of product liability claims relating to our products. In
the future, we may be subject to additional product liability claims, some of which may have a
negative impact on our business. If a product liability claim or series of claims is brought
against us for uninsured liabilities or for amounts in excess of our insurance coverage, our
business could suffer. We are not currently involved in any material product liability litigation. Costs of Physician Malpractice Insurance Most of our products are used by physicians who are required to maintain certain levels of medical
malpractice insurance to maintain their hospital privileges. As the cost of this insurance
increases, certain physicians who have used our products to treat their patients may stop
performing surgeries. Unless these patients who would have been treated by these physicians are
referred to other physicians, sales of our products will decline. Acquisition Integration We have acquired businesses in the past and we may acquire other businesses in the future. Failure
to successfully retain critical employees of an acquired company, failure to gain FDA approval for
the products of an acquired company, or the inability to establish and maintain appropriate
communications, performance expectations, regulatory compliance procedures, accounting controls,
and reporting procedures could have a materially adverse affect on our business. We have integrated
TherMatrx into our Minnetonka, Minnesota operations and have obtained FDA
approval to transfer the
manufacture of certain TherMatrx components to our Minnetonka location. 19




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International Sales During the first fiscal quarter of 2005, approximately 22 percent of our sales were to customers
outside the United States. Some of these sales were to governmental entities and other
organizations with extended
payment terms. A number of factors, including political or economic instability in the countries
where we do business, could affect payment terms and our ability to collect foreign receivables. We
have little influence over these factors and changes could have a materially adverse impact on our
business. In addition, foreign sales are influenced by fluctuations in currency exchange rates,
mainly in the euro. In recent periods, our sales have been positively impacted by increases in the
value of the euro relative to the U.S. dollar. Decreases in the value of the euro relative to the
U.S. dollar would negatively impact our sales. Manufacturing Facility We are currently operating with one manufacturing shift and have adequate physical capacity to
serve our business operations for the foreseeable future. We do not have a back up facility, and
the loss of our Minnetonka facility would have a materially adverse effect on our sales, earnings,
and financial condition. Ongoing Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 During fiscal 2004, we expended significant resources to comply with the requirements of Section
404 of the Sarbanes-Oxley Act of 2002. Our management concluded the internal controls over
financial reporting in 2004 were adequate and contain no material weaknesses. Furthermore, our 2004
year-end audit resulted in our external auditors ability to attest to our satisfactory assessment
of our internal controls over financial reporting with no material weaknesses to report. We realize
the requirements of this Act must now be maintained quarterly and are likely to evolve as the
result of a reassessment of the Acts initial implementation. Failure to respond to changes in the
requirements of the Act or our inability to comply regularly with the Acts requirements could have
a materially adverse affect on our business as represented by investor confidence and possible
fluctuation in our stock price. Expensing of Stock Options as Required by SFAS 123(R) In December 2004, the Financial Accounting Standard board issued SFAS No. 123(R), Share-Based
Payment, pursuant to which all stock-based compensation awards must be measured and expensed in
consolidated financial statements beginning for us with our first fiscal quarter of 2006. Though
we have been including footnote disclosure of the impact of the expense that would be recorded
under SFAS No. 123 to our earnings and earnings per share in our regularly published SEC filings,
the impact of this change to our stock price, and to those throughout the market, is uncertain at
this time. 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 20




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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 Rates We do not believe that the interest rate risk on earnings is material given our level of
investments and their short-term nature. Also, we do not believe that the interest rate risk on
expenses is material given the forecast level and timing of borrowings required in 2005. Currency Our operations outside of the United States are maintained in their local currency. All assets and
liabilities of our international subsidiaries are translated to U.S. dollars at period-end exchange
rates. Translation adjustments arising from the use of differing exchange rates are included in
accumulated other comprehensive income in stockholders equity. Gains and losses on foreign
currency transactions and short-term inter-company receivables from foreign subsidiaries are
included in other income (expense). During the first fiscal quarter of 2005 and 2004, revenues from sales to customers outside the
United States were 22.2 percent and 22.6 percent of total consolidated revenues, respectively.
International accounts receivable, inventory, cash, and accounts payable were 31.5 percent, 6.1
percent, 13.9 percent, and 24.5 percent of total consolidated accounts for each of these items as
of April 2, 2005. The reported results of our foreign operations will be influenced by their
translation into U.S. dollars by currency movements against the U.S. dollar. The result of a
uniform 10 percent strengthening in the value of the U.S. dollar in the first quarter of 2005
relative to each of the currencies in which our revenues and expenses are denominated would have
resulted in a decrease in net income of approximately $1.1 million during the quarter. At April 2, 2005, our net investment in foreign subsidiaries translated into dollars using the
period end exchange rate was $20.1 million and the potential loss in fair value resulting from a
hypothetical 10 percent strengthening in the value of the U.S. dollar currency exchange rate
amounts to $2.0 million. Actual amounts may differ. Inflation We do not believe that inflation has had a material effect on our results of operations in recent
years and periods. There can be no assurance, however, that our business will not be adversely
affected by inflation in the future. 
 ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our chief executive officer and chief financial officer, after evaluating the effectiveness of our
disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e))
as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that,
based on such evaluation, our disclosure controls and procedures were adequate and designed to
ensure that material information relating to us and our consolidated subsidiaries, which we are
required to disclose in the reports we file or submit under the Securities Exchange Act of 1934,
was made known to them by others within those entities and reported within the time periods
specified in the Securities and Exchange Commissions rules and forms. Changes in Internal Control Over Financial Reporting There were no changes in our internal control over financial reporting identified in connection
with the evaluation of such internal control over financial reporting that occurred during our last
fiscal quarter which have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. 21




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PART II. OTHER INFORMATION 
 ITEM 5. OTHER INFORMATION Option Grants On May 6, 2005, the Compensation Committee of the Board of Directors of American Medical Systems
Holdings, Inc. approved grants to AMS executive officers of incentive stock options to purchase
that specified number of shares of AMS common stock as is indicated in the table below. The
options were granted under the American Medical Systems Holdings, Inc. 2005 Stock Incentive Plan
and pursuant to the terms of stock option agreements between AMS and each of the below-named
executive officers. The options have an exercise price of $19.69 per share, which represents the
closing sale price of a share of AMS common stock as of the end of the regular trading session, as
reported by the NASDAQ National Market on the date of the grant. Each of the options has a
seven-year term and is exercisable on a cumulative basis, with respect to 25% of the shares covered
by such option on December 31, 2005, and with respect to 6.25% of the shares covered by such option
on the last day of each calendar quarter thereafter, for so long as the recipient remains
continuously employed by AMS. Name
    
    
    Title
    
    
    Number of SharesMartin J. Emerson
    
    
    President and Chief Executive Officer
    
    
    

200,000Carmen L. Diersen
    
    
    Executive Vice President and Chief Financial Officer
    
    
    

100,000Ross A. Longhini
    
    
    Executive Vice President and Chief Technology Officer
    
    
    
    80,000Lawrence W. Getlin
    
    
    Senior Vice President, Regulatory, Medical Affairs and Quality Systems
    
    
    
    50,000Janet L. Dick
    
    
    Senior Vice President, Human Resources
    
    
    
    50,000John Nealon
    
    
    Senior Vice President, Business Development
    
    
    
    40,000
 Base Salary Increase On May 6, 2005, the Compensation Committee of the Board of Directors of American Medical Systems
Holdings, Inc. approved a base salary increase for John Nealon to $207,500 per year in connection
with his promotion to the position of Senior Vice President, Business Development, such increase to
be effective as of May 2, 2005. 2005 Executive Variable Incentive Plan; Target Bonus Increases On May 6, 2005, the Compensation Committee of the Board of Directors of American Medical Systems
Holdings, Inc. approved an increase to the target bonuses of three executive officers under the
2005 Executive Variable Incentive Plan. Each of the approved increases will take effect beginning
with the bonus payment for the second quarter of 2005 and the formula for calculating each target
bonus will be adjusted to account for the approved increases. The new target bonus for 2005 for
these three executive officers is set forth in the table below: Name
    
    
    Title
    
    
    Target BonusLawrence W. Getlin
    
    
    Senior Vice President, Regulatory, Medical Affairs and Quality Systems
    
    
    $
    73,213Janet L. Dick
    
    
    Senior Vice President, Human Resources
    
    
    $
    64,125John Nealon
    
    
    Senior Vice President, Business Development
    
    
    $
    69,469
 22




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ITEM 6. EXHIBITS Item No.
    
    Item
    
    Method of Filing31.1
    
    Certification of Chief Executive
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.31.2
    
    Certification of Chief Financial
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.32.1
    
    Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
    
    Filed with this Report.
 23




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN MEDICAL SYSTEMS
HOLDINGS, INCMay 12, 2005
    
    By
    
    /s/ Martin J. EmersonDate
    
    
    
    Martin J. EmersonPresident and Chief Executive OfficerMay 12, 2005
    
    By
    
    /s/ Carmen L. DiersenDate
    
    
    
    Carmen L. DiersenExecutive Vice President, Chief Financial Officerand Corporate Secretary (Principal Financial and Accounting Officer)
 24




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
 EXHIBIT INDEX TO QUARTERLY REPORT ON FORM 10-Q
 For the Fiscal Quarter Ended April 2, 2005
 Item No.
    
    Item
    
    Filing Method31.1
    
    Certification of Chief
Executive Officer pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
    
    Filed with this Report on
Form 10-Q.31.2
    
    Certification of Chief
Financial Officer pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
    
    Filed with this Report on
Form 10-Q.32.1
    
    Certification pursuant to 18
U.S.C. Section 1350, as
adopted pursuant to Section
906 of the Sarbanes-Oxley Act
of 2002
    
    Filed with this Report on
Form 10-Q.
 25