##### 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                    October 2, 2004 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. x     Yes     oNo Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). x     Yes     oNo As of November 5, 2004, there were 33,713,047 shares of the registrants
$.01 par value Common Stock outstanding.    1




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INDEX Page(s)Part I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited)Consolidated Balance Sheets as of     October 2, 2004 and January 3, 2004
    
    
    3Consolidated Statements of Operations for the three and nine month     periods ended October 2, 2004 and September 27, 2003
    
    
    4Consolidated Statements of Cash Flows for the nine month     periods ended October 2, 2004 and September 27, 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6-10Item 2.
    
    Management's Discussion and Analysis ofFinancial Condition and Results of Operations
    
    
    11-20Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21Part II.
    
    OTHER INFORMATION
    
    
    22Item 5.
    
    Other Information
    
    
    22Item 6.
    
    Exhibits
    
    
    22SIGNATURES
    
    
    23EXHIBIT INDEX
    
    
    24Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification Pursuant to Section 906Unaudited Pro Forma Financial Information
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS (Unaudited) 
 American Medical Systems Holdings, Inc.
Consolidated Balance Sheets
(In thousands, except share and per share data) October 2, 2004
    
    January 3, 2004AssetsCurrent assetsCash and cash equivalents
    
    $
    23,771
    
    
    $
    58,953Short term investments
    
    
    12,634
    
    
    
    Accounts receivable, net
    
    
    40,340
    
    
    
    33,507Inventories, net
    
    
    21,113
    
    
    
    18,402Deferred income taxes
    
    
    5,815
    
    
    
    5,637Other current assets
    
    
    4,988
    
    
    
    2,896Total current assets
    
    
    108,661
    
    
    
    119,395Property, plant and equipment, net
    
    
    22,124
    
    
    
    25,489Goodwill, net
    
    
    98,931
    
    
    
    98,989Intangibles, net
    
    
    46,653
    
    
    
    17,466Deferred income taxes
    
    
    3,294
    
    
    
    12,991Investment in technology and other assets
    
    
    5,085
    
    
    
    4,997Total assets
    
    $
    284,748
    
    
    $
    279,327Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    4,264
    
    
    $
    4,621Accrued compensation expenses
    
    
    13,460
    
    
    
    9,886Accrued warranty expense
    
    
    1,429
    
    
    
    1,338Income taxes payable
    
    
    
    
    
    
    1,667Other accrued expenses
    
    
    7,427
    
    
    
    5,105Contingent liability on acquisition
    
    
    21,421
    
    
    
    Current portion of notes payable
    
    
    
    
    
    
    7,159Total current liabilities
    
    
    48,001
    
    
    
    29,776Long-term notes payable
    
    
    
    
    
    
    9,205Stockholders equityCommon stock, par value $.01 per share; authorized
95,000,000 shares; issued and outstanding:33,694,967 shares at October 2, 2004
and 33,135,354 shares at January 3, 2004
    
    
    337
    
    
    
    331Additional paid-in capital
    
    
    209,168
    
    
    
    202,341Deferred compensation
    
    
    
    
    
    
    (24
    )Accumulated other comprehensive income
    
    
    756
    
    
    
    1,367Retained earnings
    
    
    26,486
    
    
    
    36,331Total stockholders equity
    
    
    236,747
    
    
    
    240,346Total liabilities and stockholders equity
    
    $
    284,748
    
    
    $
    279,327
 The accompanying notes are an integral part of the consolidated financial statements. 3




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##### Table of Contents



American Medical Systems Holdings, Inc.
Consolidated Statements of Operations
(In thousands, except per share data) Three Months Ended
    
    Nine Months EndedOctober 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Net sales
    
    $
    52,326
    
    
    $
    39,559
    
    
    $
    148,732
    
    
    $
    121,130Cost of sales
    
    
    9,508
    
    
    
    7,110
    
    
    
    27,485
    
    
    
    21,434Gross profit
    
    
    42,818
    
    
    
    32,449
    
    
    
    121,247
    
    
    
    99,696Operating expensesMarketing and selling
    
    
    18,349
    
    
    
    15,245
    
    
    
    52,092
    
    
    
    47,026Research and development
    
    
    4,305
    
    
    
    3,739
    
    
    
    11,466
    
    
    
    11,013In-process research and development
    
    
    35,000
    
    
    
    
    
    
    
    35,000
    
    
    
    General and administrative
    
    
    5,120
    
    
    
    4,110
    
    
    
    15,206
    
    
    
    12,025Amortization of intangibles
    
    
    1,850
    
    
    
    1,150
    
    
    
    3,969
    
    
    
    3,254Total operating expenses
    
    
    64,624
    
    
    
    24,244
    
    
    
    117,733
    
    
    
    73,318Operating (loss) income
    
    
    (21,806
    )
    
    
    8,205
    
    
    
    3,514
    
    
    
    26,378Other income (expense)Royalty income
    
    
    627
    
    
    
    711
    
    
    
    1,548
    
    
    
    2,175Interest income
    
    
    231
    
    
    
    107
    
    
    
    541
    
    
    
    349Interest expense
    
    
    (357
    )
    
    
    (235
    )
    
    
    (806
    )
    
    
    (1,659
    )Other income (expense)
    
    
    3
    
    
    
    113
    
    
    
    (184
    )
    
    
    434Total other income (expense)
    
    
    504
    
    
    
    696
    
    
    
    1,099
    
    
    
    1,299(Loss) income before income taxes
    
    
    (21,302
    )
    
    
    8,901
    
    
    
    4,613
    
    
    
    27,677Provision for income taxes
    
    
    5,000
    
    
    
    1,961
    
    
    
    14,459
    
    
    
    8,946Net (loss) income
    
    $
    (26,302
    )
    
    $
    6,940
    
    
    $
    (9,846
    )
    
    $
    18,731Net (loss) income per shareBasic
    
    $
    (0.78
    )
    
    $
    0.21
    
    
    $
    (0.29
    )
    
    $
    0.57Diluted
    
    $
    (0.78
    )
    
    $
    0.20
    
    
    $
    (0.29
    )
    
    $
    0.55Weighted average common shares used in calculationBasic
    
    
    33,669
    
    
    
    32,974
    
    
    
    33,429
    
    
    
    32,773Diluted
    
    
    33,669
    
    
    
    34,455
    
    
    
    33,429
    
    
    
    34,193
 The accompanying notes are an intergral part of the consolidated financal statements. 4




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##### Table of Contents



American Medical Systems Holdings, Inc.
Consolidated Statements of Cash Flow
(In thousands) Nine Months EndedOctober 2, 2004
    
    September 27, 2003Cash flows from operating activitiesNet (loss) income
    
    
    ($9,846
    )
    
    $
    18,731Adjustments to reconcile net income to
net cash provided by operating activitiesDepreciation
    
    
    5,338
    
    
    
    4,447Loss on asset disposals
    
    
    16
    
    
    
    Amortization of intangibles
    
    
    3,969
    
    
    
    3,254Amortization of deferred financing costs
    
    
    450
    
    
    
    203Non-cash in-process research and development charge
    
    
    35,000
    
    
    
    Non-cash deferred compensation
    
    
    53
    
    
    
    129Income tax benefit related to stock option plans
    
    
    1,477
    
    
    
    1,227Change in net deferred taxes
    
    
    2,496
    
    
    
    822Changes in operating assets and liabilitiesAccounts receivable
    
    
    (1,076
    )
    
    
    (1,234
    )Inventories
    
    
    (50
    )
    
    
    (3,701
    )Accounts payable and accrued expenses
    
    
    (4,172
    )
    
    
    (423
    )Other assets
    
    
    (257
    )
    
    
    (1,065
    )Net cash provided by operating activities
    
    
    33,398
    
    
    
    22,390Cash flows from investing activitiesPurchase of property, plant and equipment
    
    
    (1,804
    )
    
    
    (3,202
    )Purchase of investments
    
    
    (12,634
    )
    
    
    Purchase of license agreement
    
    
    (2,500
    )
    
    
    Purchase of business, net of cash acquired
    
    
    (40,075
    )
    
    
    (43,152
    )Net cash used in investing activities
    
    
    (57,013
    )
    
    
    (46,354
    )Cash flows from financing activitiesIssuance of common stock
    
    
    5,326
    
    
    
    2,064Payments on long-term debt
    
    
    (16,364
    )
    
    
    (4,956
    )Net cash used in financing activities
    
    
    (11,038
    )
    
    
    (2,892
    )Effect of exchange rates on cash
    
    
    (529
    )
    
    
    1,376Net decrease in cash and cash equivalents
    
    
    (35,182
    )
    
    
    (25,480
    )Cash and cash equivalents at beginning of period
    
    
    58,953
    
    
    
    79,429Cash and cash equivalents at end of period
    
    $
    23,771
    
    
    $
    53,949Supplemental disclosureCash paid for interest
    
    $
    314
    
    
    $
    1,474Cash paid for taxes
    
    $
    13,111
    
    
    $
    6,955
 The accompanying notes are an integral part of the consolidated financial statements. 5




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 fiscal 2003. 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. The Company has a 52 or 53 week fiscal year ended on the Saturday nearest
December 31. Accordingly, the third fiscal quarters of 2004 and 2003 ended on
October 2, 2004 and September 27, 2003, respectively. The third fiscal quarter
and the first three quarters of the fiscal year are identified respectively
herein as our three and nine month periods of fiscal 2004 and 2003. 2. Stock-Based Compensation The Company has one stock-based employee compensation plan. The Company
accounts for this plan under the recognition and measurement principles of APB
Opinion 25, Accounting for Stock Issued to Employees, and related
interpretations. The exercise price of the Companys employee stock options
generally equals the market price of the underlying stock on the date of grant
for all options granted, and thus, under APB 25, no compensation expense is
recognized. However, during 2000, the Company recognized deferred compensation
of $1.4 million, reflecting the excess of the fair value of the underlying
stock on the date of grant over the exercise price. The deferred compensation
was being amortized over vesting periods of two to four years, and was fully
amortized as of the end of the first fiscal quarter of 2004. The following table illustrates the effect on net income (loss) and earnings
(loss) per share if the Company had applied the fair value recognition
provisions of SFAS 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation. Three Months Ended
    
    Nine Months Ended(in thousands, except per share data)
    
    October 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Net income (loss), as reported
    
    
    ($26,302
    )
    
    $
    6,940
    
    
    
    ($9,846
    )
    
    $
    18,731Stock-based employee compensation expense
included in reported income, net of tax
    
    
    
    
    
    
    (4
    )
    
    
    15
    
    
    
    68Total stock-based employee compensation
expense determined under fair-value based
method for all awards, net of tax
    
    
    (1,338
    )
    
    
    (1,279
    )
    
    
    (3,513
    )
    
    
    (3,359
    )Pro forma net income (loss)
    
    
    ($27,640
    )
    
    $
    5,657
    
    
    
    ($13,344
    )
    
    $
    15,440Net income (loss) per shareAs reportedBasic
    
    
    ($0.78
    )
    
    $
    0.21
    
    
    
    ($0.29
    )
    
    $
    0.57Diluted
    
    
    ($0.78
    )
    
    $
    0.20
    
    
    
    ($0.29
    )
    
    $
    0.55Pro formaBasic
    
    
    ($0.82
    )
    
    $
    0.17
    
    
    
    ($0.40
    )
    
    $
    0.47Diluted
    
    
    ($0.82
    )
    
    $
    0.16
    
    
    
    ($0.40
    )
    
    $
    0.45
 6




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During the third fiscal quarter of 2004, stock options were exercised to
acquire 47,207 shares and 10,155 shares were purchased under the employee stock
purchase plan. During the first nine months of fiscal 2004, stock options were
exercised to acquire 526,098 shares and 33,515 shares were purchased under the
employee stock purchase plan. 3. Earnings per Share The following table presents information necessary to calculate basic and
diluted net income per common share and common share equivalents for the three
and nine month periods of fiscal 2004 and 2003. Three Months Ended
    
    Nine Months Ended(in thousands, except per share data)
    
    October 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Net income (loss)
    
    
    ($26,302
    )
    
    $
    6,940
    
    
    
    ($9,846
    )
    
    $
    18,731Weighted-average shares
outstanding for basic net income per share
    
    
    33,669
    
    
    
    32,974
    
    
    
    33,429
    
    
    
    32,773Dilutive effect of stock options
    
    
    
    
    
    
    1,481
    
    
    
    
    
    
    
    1,420Adjusted weighted-average
shares outstanding and assumed
conversions for diluted net income per share
    
    
    33,669
    
    
    
    34,455
    
    
    
    33,429
    
    
    
    34,193Net income (loss) per shareBasic
    
    
    ($0.78
    )
    
    $
    0.21
    
    
    
    ($0.29
    )
    
    $
    0.57Diluted
    
    
    ($0.78
    )
    
    $
    0.20
    
    
    
    ($0.29
    )
    
    $
    0.55
 During the third quarter and for the nine months ended October 2, 2004, there
were 1,615,907 and 1,659,608 shares respectively of outstanding stock options
excluded from the diluted earnings per share computation because the impact
would have been anti-dilutive. 4. Inventories Inventories consist of the following: (in thousands)
    
    October 2, 2004
    
    January 3, 2004Raw materials
    
    $
    4,760
    
    
    $
    5,001Work in process
    
    
    2,917
    
    
    
    2,817Finished goods
    
    
    13,436
    
    
    
    10,584Net inventories
    
    $
    21,113
    
    
    $
    18,402
 5. Warranties Many of the Companys products are sold with warranty coverage for periods
ranging from one year up to the patients lifetime. The warranty accrual is
the Companys estimate of the expected future cost of honoring warranty
obligations. Factors influencing this estimate include historical claim rates,
surgical infection rates, changes in product design or performance, the
frequency of product use by the patients, the patients performance
expectations, and changes in the terms of our policies. Changes in the
warranty accrual during the nine month periods of fiscal 2004 and 2003 were as
follows: Nine months ended(in thousands)
    
    October 2, 2004
    
    September 27, 2003Balance, beginning of period
    
    $
    1,338
    
    
    $
    4,639Provisions for warranty
    
    
    322
    
    
    
    157Claims paid
    
    
    (231
    )
    
    
    (228
    )Balance, end of period
    
    $
    1,429
    
    
    $
    4,568
 6. Acquisition On July 15, 2004, the Company completed the acquisition of TherMatrx, Inc. As
a result of the merger, the shareholders of TherMatrx were initially paid cash
consideration of $40.5 million. The Company deposited $4.0 million of this
initial consideration in escrow to be held for six months after closing of the
merger to cover certain contingencies, and the balance was distributed to holders of
TherMatrx stock. The Company used cash on hand to make the initial payment of
$40.5 million. 7




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In addition to the initial closing payment, the Company will make contingent
payments based on the net product revenues attributable to sales of the
TherMatrx Dose Optimized Thermotherapy (DOT) product. These contingent
payments will equal four times the aggregate sales of DOT products over a
period of six consecutive Company fiscal quarters (which began on July 5, 2004
and will end on December 31, 2005) minus $40.0 million. The contractual range
of contingent payments is from zero to $209.5 million which would result in a
total purchase price of $40.5 million up to a maximum of $250.0 million
(including the initial payment). These contingent payments will be accounted
for as goodwill. The primary purpose of the TherMatrx acquisition was to gain access to their
product for the treatment of benign prostatic hyperplasia (BPH). The Company
believes that its current relationship with urologists will allow it to extend
the benefits of the TherMatrx product and technology to men suffering from BPH
more efficiently and effectively than TherMatrx could alone. The Company also
believes that by broadening its prostate treatment product line, it could offer
more value to its physician-customers. 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 Company has allocated the initial purchase price 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
    
    
    4,834Deferred tax liability on assets acquired
    
    
    (7,242
    )Contingent liability on acquisition
    
    
    (21,421
    )Initial purchase price
    
    $
    42,171Cash consideration to TherMatrx shareholders
    
    $
    40,501Acquisition costs
    
    
    1,670Initial purchase price
    
    $
    42,171Less cash acquired
    
    
    (2,096
    )Purchase of business, net of cash acquired
    
    $
    40,075
 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 the current period with no
related income tax benefit and is included separately in the Consolidated
Statement of Operations. Tangible assets acquired, net of liabilities assumed,
were stated at fair value at the date of acquisition based on managements
assessment. The contingent liability on acquisition is the measurement of net
assets acquired in excess of the initial purchase price and represents
contingent purchase price consideration. This purchase price allocation is
subject to final adjustments relating to certain valuation matters. The consolidated financial statements of the Company for the three and nine
months ended October 2, 2004 include the financial results of TherMatrx
beginning July 15, 2004. The following table contains pro forma results
assuming the acquisition was made at the beginning of 2003: 8




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Three Months Ended
    
    Nine Months Ended(in thousands)
    
    October 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Revenue
    
    $
    52,864
    
    
    $
    42,663
    
    
    $
    158,976
    
    
    $
    130,878Net income (loss)
    
    $
    (34,956
    )
    
    $
    7,447
    
    
    $
    (16,971
    )
    
    $
    18,300Earnings (loss) per shareBasic
    
    $
    (1.04
    )
    
    $
    0.23
    
    
    $
    (0.51
    )
    
    $
    0.56Diluted
    
    $
    (1.04
    )
    
    $
    0.22
    
    
    $
    (0.51
    )
    
    $
    0.54
 In addition to the one-time charge for in-process research and development of
$35.0 million which impacted the three and nine month periods ended October 2,
2004, the above pro forma results for the nine month period reflect $8.8
million in other acquisition related expenses recorded by TherMatrx, Inc. prior
to the effective date of the transaction. 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. 7. Patent Cross-License Agreement On September 13, 2004, the Company entered into a settlement agreement with
Mentor Corporation under which both parties agreed to dismiss the intellectual
property lawsuits involving the two companies. The Company also signed a
non-exclusive cross-license agreement covering patents related to the field of
female pelvic health. Under the cross-license agreement, the Company made a
one-time payment in the third quarter of 2004 to Mentor in the amount of $2.5
million for access to U.S. Patent No. 6,638,211 (a method patent owned by
Mentor covering the transobturator surgical approach) and derivatives thereof.
The Company will amortize this payment over the relevant sales and does not
expect this payment to materially impact its future financial results. 8. Comprehensive Income Comprehensive income for the Company is net income adjusted for changes in the
value of derivative financial instruments designated as hedges, unrealized
gains and losses on available-for-sale securities, and foreign currency
translation. Comprehensive income for the three and nine month periods in fiscal 2004 and
2003 was: Three Months Ended
    
    Nine Months Ended(in thousands)
    
    October 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Net income (loss)
    
    $
    (26,302
    )
    
    $
    6,940
    
    
    $
    (9,846
    )
    
    $
    18,731Net loss on hedges, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Amounts reclassified to interest
expense during the period from derivative
and hedging activities, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    464Translation gain (loss), net of taxes
    
    
    172
    
    
    
    689
    
    
    
    (611
    )
    
    
    1,761Comprehensive income
    
    $
    (26,130
    )
    
    $
    7,629
    
    
    $
    (10,457
    )
    
    $
    20,951
 9. Industry Segment Information and Foreign Operations Since its inception, the Company has operated in the single industry segment of
developing, manufacturing, and marketing medical devices. The Company distributes its products through its direct sales force and
independent sales representatives in the United States, Canada, Australia, and
most of Western Europe. Additionally, the Company distributes its products
through foreign independent distributors, primarily in Europe (excluding
Western Europe), Asia, and South America, who then sell the products to medical
institutions. No customer or distributor accounted for five percent or more of
the Companys net sales during 2004 or 2003. Foreign subsidiary sales are predominantly to customers in Western Europe, Australia, and Canada.
Substantially all of the Companys foreign subsidiary assets are located in
Western Europe, Australia, and Canada. 9




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##### Table of Contents



The following table presents net sales and long-lived assets by geographical
territory. No individual foreign countrys net sales or long-lived assets are
material. Three Months Ended
    
    Nine Months Ended(in thousands)
    
    October 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003United StatesNet sales
    
    $
    43,271
    
    
    $
    33,023
    
    
    $
    117,512
    
    
    $
    99,289Long-lived assets
    
    $
    160,390
    
    
    $
    140,860
    
    
    $
    160,390
    
    
    $
    140,860Outside United StatesNet sales
    
    $
    9,055
    
    
    $
    6,536
    
    
    $
    31,220
    
    
    $
    21,841Long-lived assets
    
    $
    12,403
    
    
    $
    12,078
    
    
    $
    12,403
    
    
    $
    12,078
 10. Goodwill and Intangible Assets The changes in the carrying amount of goodwill for the nine month period ended
October 2, 2004 are as follows: Goodwill balance at January 3, 2004
    
    $
    98,989Adjustment for CryoGen severance
    
    
    (58
    )Balance at October 2, 2004
    
    $
    98,931
 It is the Companys practice to assess goodwill impairment under the annual
requirement of SFAS 142 or when impairment indicators arise. The following table presents the Companys intangible assets and accumulated
amortization as of October 2, 2004 and January 3, 2004: October 2, 2004
    
    January 3, 2004Gross carrying
    
    Accumulated
    
    Net book
    
    Gross carrying
    
    Accumulated
    
    Net book(in thousands)
    
    amount
    
    amortization
    
    value
    
    amount
    
    amortization
    
    valueAmortizedPatents
    
    $
    10,141
    
    
    $
    (6,309
    )
    
    $
    3,832
    
    
    $
    10,144
    
    
    $
    (5,459
    )
    
    $
    4,685Licenses
    
    
    5,291
    
    
    
    (1,345
    )
    
    
    3,946
    
    
    
    2,790
    
    
    
    (1,048
    )
    
    
    1,742Deferred financing
    
    
    1,611
    
    
    
    (1,611
    )
    
    
    
    
    
    
    1,611
    
    
    
    (1,161
    )
    
    
    450Developed technology
    
    
    48,853
    
    
    
    (11,749
    )
    
    
    37,104
    
    
    
    17,853
    
    
    
    (9,035
    )
    
    
    8,818Non-compete agreements
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    
    
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    Total amortized intangible assets
    
    
    67,007
    
    
    
    (22,125
    )
    
    
    44,882
    
    
    
    33,509
    
    
    
    (17,814
    )
    
    
    15,695UnamortizedTrademarks
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771
    
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771Total intangible assets
    
    $
    69,240
    
    
    $
    (22,587
    )
    
    $
    46,653
    
    
    $
    35,742
    
    
    $
    (18,276
    )
    
    $
    17,466
 Three months ended
    
    Nine months ended(in thousands)
    
    October 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Amortization expense
    
    $
    1,850
    
    
    $
    1,150
    
    
    $
    3,969
    
    
    $
    3,254
 Estimated amortization expense for existing intangibles for the years 2004
through 2008 is $5.8 million, $6.1 million, $5.8 million, $4.9 million and $5.0
million, respectively. 11. Long Term Debt On July 8, 2004, the Company repaid the entire outstanding balance of $12.9
million under its senior credit facility and terminated the credit facility.
The original maturity of the term notes required quarterly principal
payments through September 2005. The Company plans to begin negotiations to
establish a credit facility during the fourth quarter of 2004. 10




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##### 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 Risk Factors. We undertake no
obligation to correct or update any forward-looking statements, whether as a
result of new information, future events, or otherwise. You are advised,
however, to consult any future disclosures we make on related subjects in
future filings with the SEC. Critical Accounting Policies and Estimates We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. Managements
discussion and analysis of financial condition and results of operations are
based upon the consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect (1) the reported amounts of assets, liabilities,
revenues, and expenses; and (2) the related disclosure of contingent assets and
liabilities. At each balance sheet date, we evaluate our estimates, including
but not limited to, those related to accounts receivable and sales return
obligations, inventories, long-lived assets, warranty, legal contingencies, and
income taxes. The critical accounting policies that are most important in fully
understanding and evaluating the financial condition and results of operations
are discussed in our Form 10-K on file with the SEC. Overview American Medical Systems develops, manufactures, and markets medical devices
for physician customers, primarily urologists, gynecologists and
urogynecologists. Our products are utilized by physicians to treat male
disorders such as erectile dysfunction, incontinence, and prostate disease; and
also female disorders such as incontinence, excessive uterine bleeding, and
pelvic organ prolapse. Our strategy has been to develop innovative products
that provide our customers with therapy options to better, and/or less
invasively, manage under-treated urological and gynecological conditions. Our product offering includes a full line of erectile restoration products
including both inflatable and non-inflatable prostheses to replace
non-functioning penile erectile tissue. For male urinary control we sell our
AMS 800 Artificial Urinary Sphincterand the InVancesling system. For
urethral stricture and benign prostatic hyperplasia (BPH) symptoms we sell
urethral stents and surgical resection loops. The ProstaJect® chemical
prostate ablation system is currently available outside of the U.S. and is
expected to be in a Phase III clinical trial in the U.S. in the near future.
Our womens health products include several products for stress urinary
incontinence (InFast, SPARC, Monarcand BioArcSP and BioArcTO). Through
the acquisition of CryoGen, Inc. in January 2003, we added the Her Option®
therapy to our womens health portfolio for excessive menstrual bleeding. On July 15, 2004, we acquired TherMatrx, Inc., a privately held company focused
on providing physicians an in-office alternative for BPH. Each year in the
United States, over three million men seek treatment for the non-cancerous
enlargement of the prostate gland known as BPH. Current invasive therapies
offered for BPH include surgically removing the entire prostate, resecting a
portion of the prostate, or performing a transurethral incision of the
prostatic tissue. Other less invasive procedures performed in the hospital
include prostatic stenting, laser-based resection, radio-frequency energy
ablation, and the delivery of microwave energy. While some of these therapies
may be performed under certain circumstances in a physicians office, they are
neither as comfortable for the patient nor as appropriate for the office
setting as the TherMatrx microwave therapy for BPH symptoms. In the three month period of 2004, we recorded a non-recurring charge of $35.0
million for in-process research and development expenses with no associated
income tax benefit, related to the acquisition of TherMatrx, Inc. in accordance with the rules of purchase accounting. In our October 28,
2004 press release 11




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##### Table of Contents



announcing our financial results for the three and nine
month periods of 2004, we incorrectly reported an income tax benefit in our
statement of operations of $12.8 million related to the reversal of a deferred
tax liability that was established in purchase accounting for the bookto-tax
basis difference on the $35.0 million charge. We have since confirmed that no
deferred income tax liabilities are to be provided on differences in initial
bases for income tax and financial reporting purposes, related to in-process
research and development acquired and subsequently written off in a purchase
business combination. Accordingly, our statement of operations in this Form
10-Q appropriately excludes any income tax benefit related to this in-process
research and development charge. This $12.8 million increase in income tax expense had the effect of changing
net income <loss> for the three and nine month periods of 2004 from
<$13.5 million> (or <$.040 per share>) and $2.9 million (or $0.09
per share) respectively as reported in the October 28, 2004 press release, to a
net <loss> of <$26.3 million> (or <$0.78 per share>) and
<$9.8 million> (or <$0.29 per share>) respectively in this Form
10-Q. This correction also reduced retained earnings by $12.8 million,
increased the contingent liability on acquisition by $13.3 million, and
increased deferred tax assets by $0.5 million in this Form 10-Q compared to the
amounts previously reported in the press release. During the third quarter of 2003 we recognized a non-recurring tax benefit of
$1.1 million resulting from the implementation of research and development tax
credits and extraterritorial income exclusions. Results of Operations The following table compares net sales by product line and geography for the
three and nine month periods of fiscal 2004 and 2003: Three Months Ended
    
    $ Increase
    
    % Increase
    
    Nine Months Ended
    
    $ Increase
    
    % Increase(in thousands)
    
    October 2, 2004
    
    September 27, 2003
    
    (Decrease)
    
    (Decrease)
    
    October 2, 2004
    
    September 27, 2003
    
    (Decrease)
    
    (Decrease)SalesProduct LineMens healthErectile restoration
    
    $
    18,620
    
    
    $
    17,058
    
    
    $
    1,562
    
    
    
    9.2
    %
    
    $
    54,004
    
    
    $
    52,876
    
    
    $
    1,128
    
    
    
    2.1
    %Continence
    
    
    11,143
    
    
    
    8,561
    
    
    
    2,582
    
    
    
    30.2
    %
    
    
    35,575
    
    
    
    29,064
    
    
    
    6,511
    
    
    
    22.4
    %Prostate treatment
    
    
    5,514
    
    
    
    1,188
    
    
    
    4,326
    
    
    
    364.1
    %
    
    
    7,769
    
    
    
    3,699
    
    
    
    4,070
    
    
    
    110.0
    %Total mens health
    
    
    35,277
    
    
    
    26,807
    
    
    
    8,470
    
    
    
    31.6
    %
    
    
    97,348
    
    
    
    85,639
    
    
    
    11,709
    
    
    
    13.7
    %Womens health
    
    
    17,049
    
    
    
    12,752
    
    
    
    4,297
    
    
    
    33.7
    %
    
    
    51,384
    
    
    
    35,491
    
    
    
    15,893
    
    
    
    44.8
    %Total
    
    $
    52,326
    
    
    $
    39,559
    
    
    $
    12,767
    
    
    
    32.3
    %
    
    $
    148,732
    
    
    $
    121,130
    
    
    $
    27,602
    
    
    
    22.8
    %GeographyUnited States
    
    $
    43,271
    
    
    $
    33,023
    
    
    $
    10,248
    
    
    
    31.0
    %
    
    $
    117,512
    
    
    $
    99,289
    
    
    $
    18,223
    
    
    
    18.4
    %Outside United States
    
    
    9,055
    
    
    
    6,536
    
    
    
    2,519
    
    
    
    38.5
    %
    
    
    31,220
    
    
    
    21,841
    
    
    
    9,379
    
    
    
    42.9
    %Total
    
    $
    52,326
    
    
    $
    39,559
    
    
    $
    12,767
    
    
    
    32.3
    %
    
    $
    148,732
    
    
    $
    121,130
    
    
    $
    27,602
    
    
    
    22.8
    %Percent of total salesProduct LineMens healthErectile restoration
    
    
    36
    %
    
    
    43
    %
    
    
    
    
    
    
    
    
    
    
    36
    %
    
    
    44
    %Continence
    
    
    21
    %
    
    
    22
    %
    
    
    
    
    
    
    
    
    
    
    24
    %
    
    
    24
    %Prostate treatment
    
    
    11
    %
    
    
    3
    %
    
    
    
    
    
    
    
    
    
    
    5
    %
    
    
    3
    %Total mens health
    
    
    67
    %
    
    
    68
    %
    
    
    
    
    
    
    
    
    
    
    65
    %
    
    
    71
    %Womens health
    
    
    33
    %
    
    
    32
    %
    
    
    
    
    
    
    
    
    
    
    35
    %
    
    
    29
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    
    
    
    
    
    
    
    
    100
    %
    
    
    100
    %GeographyUnited States
    
    
    83
    %
    
    
    83
    %
    
    
    
    
    
    
    
    
    
    
    79
    %
    
    
    82
    %Outside United States
    
    
    17
    %
    
    
    17
    %
    
    
    
    
    
    
    
    
    
    
    21
    %
    
    
    18
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    
    
    
    
    
    
    
    
    100
    %
    
    
    100
    %
 Net Sales.Sales in the three month period of 2004 grew broadly worldwide,
contributing to our total net sales of $52.3 million. Net sales increased by
32.3 percent in the three month period of 2004 as compared to the same period
in 2003. Net sales for the nine month period of 2004 grew 22.8 percent as
compared to the same period of 2003. Sales growth in the three and nine month
periods of fiscal 2004 were driven primarily by unit volume growth of new
products and, to a lesser degree, by pricing increases and the positive impact
of foreign currency exchange rates (1 percentage point and 2 percentage points
for the three and nine month periods respectively). Sales for the three and
nine month periods of 2004 included $4.6 million of our TherMatrx BPH product
which we acquired on July 15, 2004. 12




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##### Table of Contents



International sales, which this quarter represented 17.0 percent of our net
sales in the three month period of 2004, grew 38.5 percent over the same period
in 2003 (including 8.1 percent growth due to favorable currency effects). U.S.
sales grew 31.0 percent from the year ago period. Growth in the U.S.,
excluding erectile restoration sales, was 48.8 percent. Worldwide erectile restoration revenues resumed growth in the three month
period of 2004, increasing 9.2 percent over the same period last year. This
growth rate was in the single digits both domestically and internationally.
The U.S. growth was primarily driven by the increased volume and price on the
strength of the new AMS 700 Tactile Pumpproduct. We received clearance for
this product from the Food and Drug Administration in our second fiscal quarter
of 2004, and began selling this product in the U.S. on a limited basis during
our third fiscal quarter. Erectile restoration revenues increased 2.1 percent
during the nine month period of fiscal 2004 over the comparable period last
year. Sales of our male urinary continence products increased 30.2 percent and 22.4
percent in the three and nine month periods of fiscal 2004 over the year ago
periods, primarily due to unit sales growth in both the AMS 800 Artificial
Urinary Sphincterand the InVancesling. Prostate treatment product sales increased $4.3 million and $4.1 million in the
three and nine month periods of fiscal 2004, respectively, driven by sales of
our TherMatrx product, acquired in July 2004. Sales of our other prostate
products declined 22.7 percent and 14.2 percent in the three and nine month
periods of fiscal 2004 as we continue to reposition the UroLume®product toward
obstructive urethral conditions such as urethral stricture. Sales of womens health products increased 33.7 percent and 44.8 percent in the
three and nine month periods of fiscal 2004, respectively. The market for
female incontinence products continues to expand rapidly driven by the
acceptance of minimally invasive therapies. Monarcis now our number one
selling product for the treatment of female incontinence. Sales of this
product grew significantly in our third fiscal quarter of 2004, its seventh
quarter of availability in Europe and fifth full quarter of use in the U.S. We
are continuing Monarctraining and proctoring for gynecologists and urologists
worldwide. Our BioArcsling system continued to grow sequentially during the
third fiscal quarter of 2004. BioArcis the only product available which
offers physicians the choice of a biologic graft material attached to the
self-fixating sling. In the third fiscal quarter of 2004, we further expanded
the BioArcseries from the BioArcSP (suprapubic surgical approach) to include
the BioArcTO (transobturator surgical approach). We expanded our female pelvic prolapse product portfolio during the second
fiscal quarter of 2004 with the FDAs clearance of the Apogeeand Perigee.
Although we have received regulatory clearance for these products, our
physician training began in June 2004 and continued into the third quarter of
2004. We will continue to train physicians in the fourth quarter of 2004 for
purposes of conducting post-market studies which we believe will support wider
product availability in 2005. Sales of our Her Option®product remain at a modest level as reimbursement
rates for that products use in the physicians office remains pending. We do
anticipate having a reimbursement level established for this product beginning
in January 2005. 13




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##### Table of Contents



The following table compares revenue, expense, and other income accounts for
the three and nine month periods of fiscal 2004 and 2003: Three Months Ended
    
    $ Increase
    
    % Increase
    
    Nine Months Ended
    
    $ Increase
    
    % Increase(in thousands)
    
    October 2, 2004
    
    September 27, 2003
    
    (Decrease)
    
    (Decrease)
    
    October 2, 2004
    
    September 27, 2003
    
    (Decrease)
    
    (Decrease)Net sales
    
    $
    52,326
    
    
    $
    39,559
    
    
    $
    12,767
    
    
    
    32.3
    %
    
    $
    148,732
    
    
    $
    121,130
    
    
    $
    27,602
    
    
    
    22.8
    %Cost of sales
    
    
    9,508
    
    
    
    7,110
    
    
    
    2,398
    
    
    
    33.7
    %
    
    
    27,485
    
    
    
    21,434
    
    
    
    6,051
    
    
    
    28.2
    %Gross profit
    
    
    42,818
    
    
    
    32,449
    
    
    
    10,369
    
    
    
    32.0
    %
    
    
    121,247
    
    
    
    99,696
    
    
    
    21,551
    
    
    
    21.6
    %Operating expenses
Marketing and selling
    
    
    18,349
    
    
    
    15,245
    
    
    
    3,104
    
    
    
    20.4
    %
    
    
    52,092
    
    
    
    47,026
    
    
    
    5,066
    
    
    
    10.8
    %Research and development
    
    
    4,305
    
    
    
    3,739
    
    
    
    566
    
    
    
    15.1
    %
    
    
    11,466
    
    
    
    11,013
    
    
    
    453
    
    
    
    4.1
    %In-process research & development
    
    
    35,000
    
    
    
    
    
    
    
    35,000
    
    
    
    
    
    
    
    35,000
    
    
    
    
    
    
    
    35,000General and administrative
    
    
    5,120
    
    
    
    4,110
    
    
    
    1,010
    
    
    
    24.6
    %
    
    
    15,206
    
    
    
    12,025
    
    
    
    3,181
    
    
    
    26.5
    %Amortization of intangibles
    
    
    1,850
    
    
    
    1,150
    
    
    
    700
    
    
    
    60.9
    %
    
    
    3,969
    
    
    
    3,254
    
    
    
    715
    
    
    
    22.0
    %Total operating expenses
    
    
    64,624
    
    
    
    24,244
    
    
    
    40,380
    
    
    
    166.6
    %
    
    
    117,733
    
    
    
    73,318
    
    
    
    44,415
    
    
    
    60.6
    %Operating income
    
    
    (21,806
    )
    
    
    8,205
    
    
    
    (30,011
    )
    
    
    -365.8
    %
    
    
    3,514
    
    
    
    26,378
    
    
    
    (22,864
    )
    
    
    -86.7
    %Royalty income
    
    
    627
    
    
    
    711
    
    
    
    (84
    )
    
    
    -11.8
    %
    
    
    1,548
    
    
    
    2,175
    
    
    
    (627
    )
    
    
    -28.8
    %Interest income
    
    
    231
    
    
    
    107
    
    
    
    124
    
    
    
    115.9
    %
    
    
    541
    
    
    
    349
    
    
    
    192
    
    
    
    55.0
    %Interest expense
    
    
    (357
    )
    
    
    (235
    )
    
    
    (122
    )
    
    
    -51.9
    %
    
    
    (806
    )
    
    
    (1,659
    )
    
    
    853
    
    
    
    51.4
    %Other income (expense)
    
    
    3
    
    
    
    113
    
    
    
    (110
    )
    
    
    -97.3
    %
    
    
    (184
    )
    
    
    434
    
    
    
    (618
    )
    
    
    -142.4
    %Income before income taxes
    
    
    (21,302
    )
    
    
    8,901
    
    
    
    (30,203
    )
    
    
    -339.3
    %
    
    
    4,613
    
    
    
    27,677
    
    
    
    (23,064
    )
    
    
    -83.3
    %Provision for income taxes
    
    
    5,000
    
    
    
    1,961
    
    
    
    3,039
    
    
    
    155.0
    %
    
    
    14,459
    
    
    
    8,946
    
    
    
    5,513
    
    
    
    61.6
    %Net income
    
    $
    (26,302
    )
    
    $
    6,940
    
    
    $
    (33,242
    )
    
    
    -479.0
    %
    
    $
    (9,846
    )
    
    $
    18,731
    
    
    $
    (28,577
    )
    
    
    -152.6
    %
 Percent of Sales
    
    Percent of Sales(in thousands)
    
    For the Three Months Ended
    
    For the Nine Months EndedOctober 2, 2004
    
    September 27, 2003
    
    October 2, 2004
    
    September 27, 2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    18.2
    %
    
    
    18.0
    %
    
    
    18.5
    %
    
    
    17.7
    %Gross profit
    
    
    81.8
    %
    
    
    82.0
    %
    
    
    81.5
    %
    
    
    82.3
    %Operating expensesMarketing and selling
    
    
    35.1
    %
    
    
    38.5
    %
    
    
    35.0
    %
    
    
    38.8
    %Research and development
    
    
    8.2
    %
    
    
    9.5
    %
    
    
    7.7
    %
    
    
    9.1
    %In-process research & development
    
    
    66.9
    %
    
    
    0.0
    %
    
    
    23.5
    %
    
    
    0.0
    %General and administrative
    
    
    9.8
    %
    
    
    10.4
    %
    
    
    10.2
    %
    
    
    9.9
    %Amortization of intangibles
    
    
    3.5
    %
    
    
    2.9
    %
    
    
    2.7
    %
    
    
    2.7
    %Total operating expenses
    
    
    123.5
    %
    
    
    61.3
    %
    
    
    79.2
    %
    
    
    60.5
    %Operating income
    
    
    -41.7
    %
    
    
    20.7
    %
    
    
    2.4
    %
    
    
    21.8
    %Royalty income
    
    
    1.2
    %
    
    
    1.8
    %
    
    
    1.0
    %
    
    
    1.8
    %Interest income
    
    
    0.4
    %
    
    
    0.3
    %
    
    
    0.4
    %
    
    
    0.3
    %Interest expense
    
    
    -0.7
    %
    
    
    -0.6
    %
    
    
    -0.5
    %
    
    
    -1.4
    %Other income (expense)
    
    
    0.0
    %
    
    
    0.3
    %
    
    
    -0.1
    %
    
    
    0.4
    %Income before income taxes
    
    
    -40.7
    %
    
    
    22.5
    %
    
    
    3.1
    %
    
    
    22.8
    %Provision for income taxes
    
    
    9.6
    %
    
    
    5.0
    %
    
    
    9.7
    %
    
    
    7.4
    %Net income
    
    
    -50.3
    %
    
    
    17.5
    %
    
    
    -6.6
    %
    
    
    15.5
    %American Medical Systems Holdings, Inc.
 Cost of sales.Cost of sales as a percentage of sales increased .2 percentage
points and .8 percentage points during the three and nine month periods of
fiscal 2004, respectively. Over half of the increase in nine month period of
2004 was due to a greater portion of our revenues coming from womens health
products and sales in international markets, both of which carry a lower margin
than our consolidated average. Inventory reserves for lesser-used product
sizes have also increased slightly over the nine month period of 2004 as we
prepare to phase out older products in favor of new product releases. These
unfavorable increases were partially offset by the favorable foreign exchange
impact on our gross profit. Future cost of goods sold will continue to depend
on product phase-ins, production levels and product mix. Marketing and selling.Marketing and selling expense increased in the three
and nine month periods of fiscal 2004, but declined by 3.4 and 3.8 percentage
points relative to sales, respectively. The dollar increase reflects higher
sales volume, as well as additional personnel and marketing expenditures
associated with our acquisition of TherMatrx in July 2004. The decline as a
percent of sales resulted from our ability to continue to leverage the
investments made as we broaden the line of products sold through our sales
channel. Accordingly, our objective remains to increase sales and marketing
expenses in absolute dollars, but to decrease as a percentage of sales. 14




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Research and development.Research and development expense was 8.2 percent and
7.7 percent of sales during the three and nine month periods of fiscal 2004,
respectively. Over half of the three and nine month dollar increase relates to
additional personnel and expenditures associated with our acquisition of
TherMatrx. We expect total spending in research and development, over the
longer term, to be in the range of 8 to 10 percent of sales. In-process research and development.The in-process research and development
expense in the three and nine month periods of 2004 relates to the acquisition
of TherMatrx in July 2004. In accordance with the rules of purchase accounting,
in the three month period of 2004, we recognized a charge related to value
assigned to in-process research and development of TherMatrx at the time of
acquisition. An independent valuation of assets acquired was performed. General and administrative.General and administrative expenses during the
three and nine month periods of fiscal 2004 increased 24.6 percent and 26.5
percent, respectively, over the year ago periods. Over half of the increase in
the three and nine month periods of fiscal 2004 was attributable to external
Sarbanes-Oxley Act related spending, combined with legal costs related to
intellectual property matters and bad debt expense. In addition, general and
administrative expenses increased approximately $0.4 million in the three and
nine month periods of 2004 due to expenditures associated with our acquisition
of Thermatrx. Amortization of intangibles.Amortization of intangibles includes amortization
expense on our definite-lived intangible assets, consisting of patents,
licenses and developed technology. The 2004 three and nine month increases
reflect amortization of developed technology, customer relationships and other
intangibles obtained with our acquisition of TherMatrx. We expect amortization
of intangibles to be approximately $1.8 million in the fourth 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 exclusive
worldwide license was entered into during 1998, with expiration immediately
following the term of the various licensed patents. We receive a royalty equal
to 2.625 percent of net sales of licensed products on a quarterly basis. We do
not directly influence sales of the products on which this royalty is based and
cannot give any assurance as to future income levels. To a 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 during the three and nine month
periods of fiscal 2004 due to higher levels of investments resulting from
greater cash generated from operations in fiscal 2004 than in fiscal 2003. Interest expense.Interest expense increased during the third fiscal quarter
of 2004 due to the repayment of the entire outstanding balance on our senior
credit facility. As a result of this early repayment, the remaining balance of
$0.3 million in loan origination fees that was being amortized over the life of
the loan was charged to interest expense. Interest expense declined during the
nine month period of fiscal 2004, primarily due to the expiration of our
interest rate swap agreement as well as a decline in our long term debt
balance. We hedged a portion of our original $65.0 million variable rate term
note, as was required by our senior credit facility, by entering into an
interest rate swap agreement in which we agreed to exchange, at specified
intervals, the calculated difference between the fixed interest rate of the
swap and the variable interest rate on a portion of our debt. This interest
rate swap agreement expired June 30, 2003. Future interest expense will depend
on the level of borrowing required to make contingent payments to the former
TherMatrx shareholders. We do not expect any interest expense in the fourth
fiscal quarter of 2004. Other income.Other income and expense primarily represents gains and losses
as a result of remeasuring foreign denominated (mainly euro-based) short-term
inter-company receivables to current rates. The nine month period of fiscal
2004 reflects losses due to the weakening of the euro by 0.9 percent to the
U.S. dollar from the beginning of the period, while the three and nine month
periods of fiscal 2003 reflect gains due to the strengthening of the euro by
0.6 percent and 10.8 percent, respectively, to the U.S. dollar from the
beginning of the period. Income taxes.Our effective income tax rate for the three and nine month
periods of fiscal 2004 differed from statutory income tax rates primarily
because no tax benefit was recorded on the $35.0 million in-process research
and development charge incurred in connection with the TherMatrx acquisition
and in accordance with purchase accounting rules provided by EITF 96-7. The
effective tax rates for the three and nine month periods of fiscal 2003 were 22.0 percent and 32.3 percent respectively. During
the third quarter of fiscal 15




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2003, we applied for and began to recognize the tax benefits related to research and development tax credits and extraterritorial
income exclusions. We recognized a non-recurring tax benefit of $1.1 million
during the third fiscal quarter of 2003 resulting from these tax planning
strategies. Liquidity and Capital Resources Cash and cash equivalents were $23.8 million as of October 2, 2004, compared to
$59.0 million as of January 3, 2004. This decrease is due primarily to our
acquisition of TherMatrx in July 2004, our repayment of our outstanding credit
facility and investments in certain tax-advantaged municipal debt that is
classified as available-for-sale securities. As of October 2, 2004, the value
of these investments was $12.6 million. Cost approximates market value for the
investments, which mature between January 2005 and June 2005. These uses of
cash were partially offset by our continued strong growth in revenue and net
income. Cash flows from operating activities.Net cash from operations was $33.4
million for the nine month period of fiscal 2004, driven by a net loss of $9.8
million, increased for certain non-cash expenses including in-process research
and development of $35.0 million and depreciation and amortization of $9.7
million. Working capital effects included an increase in accounts receivable
of $1.1 million resulting primarily from higher revenues in our foreign
subsidiaries, and a decrease of $4.2 million in accounts payable and accrued
expenses. Net cash from operations was $22.4 million for the nine month period
of fiscal 2003, resulting from net income of $18.7 million, depreciation and
amortization of $7.9 million, offset by other changes in assets and
liabilities. Cash flows from investing activities.Cash used in investing activities was
$57.0 million and $46.4 million for the nine month periods of fiscal 2004 and
2003, respectively. During the nine month periods of fiscal 2004 and 2003, we
purchased equipment totaling $1.8 million and $3.2 million, respectively.
During the nine month period of fiscal 2004, we purchased investments of $12.6
million. During the third fiscal quarter of 2004 we had a cash outlay of $40.1
million related to the acquisition of TherMatrx, and a $2.5 million cash outlay
for a cross-licensing agreement covering patents related to the field of female
pelvic health. During the first fiscal quarter of 2003, we had a cash outlay
of $43.2 million related to the acquisition of CryoGen Inc and the purchase of
the Dura IIline of erectile restoration products from Endocare, Inc. Cash flows from financing activities.Cash used in financing activities was
$11.0 million and $2.9 million during the nine month periods of fiscal 2004 and
2003, respectively. Cash received under our stock option and employee stock
purchase plans was $5.3 million and $2.1 million during the nine month periods
of fiscal 2004 and 2003, respectively. Payments made under our senior credit
facility were $16.4 million and $5.0 million during the nine month periods of
fiscal 2004 and 2003, respectively. On July 8, 2004, we repaid the entire outstanding balance of $12.9 million
under our senior credit facility and terminated the credit facility. The
original maturity of the term notes required quarterly principal payments
through September 2005. We were in compliance with all required financial
covenants during both of the nine month periods covered. Cash Commitments.Pursuant to our acquisition of CryoGen, Inc. on January 2,
2003, we have agreed to pay CryoGens former shareholders an earnout payment
contingent upon sales of CryoGen products. The earnout payment will be equal
to three times our net sales of CryoGen products during four consecutive
quarters, less our $40.0 million initial acquisition payment. The earnout
period expires December 31, 2005. If our net CryoGen product sales do not
exceed $13.3 million during any consecutive four-quarter period prior to
December 31, 2005, no earnout payment will be required. The maximum amount of
the earnout payment is $110.0 million. This transaction is more fully
described in our Form 8-K filed with the SEC on January 6, 2003. We do not
currently anticipate an earnout payment to the former CryoGen shareholders. On July 15, 2004, the Company completed the acquisition of TherMatrx, Inc. As
a result of the merger, the shareholders of TherMatrx were initially paid cash
consideration of $40.5 million. The Company deposited $4.0 million of this
initial consideration in escrow to be held for six months after closing of the
merger to cover certain contingencies, and the balance was distributed to
holders of TherMatrx stock. The Company used cash on hand to make the initial
payment of $40.5 million. 16




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##### Table of Contents



In addition to the initial closing payment, the Company will make contingent
payments based on the net product revenues attributable to sales of the
TherMatrx Dose Optimized Thermotherapy (DOT) product. These contingent
payments will equal four times the aggregate sales of DOT products over a
period of six consecutive Company fiscal quarters (which began on July 5, 2004
and will end on December 31, 2005) minus $40.0 million. The contractual range
of contingent payments is from zero to $209.5 million which would result in a
total purchase price of $40.5 million up to a maximum of $250.0 million
(including the initial payment). These payments will be accounted for as
goodwill. Sales of the TherMatrx product were $5.1 million during the entire three month
period ending October 2, 2004. We owned TherMatrx for 11 of the 13 weeks of
this period, during which time TherMatrx revenues totaled $4.6 million and
which are reflected in our results of operations. Accordingly, if product
sales remained flat during the contingent payment period, the total amount of
the contingent payments would be $82.4 million. We believe that funds generated from operations, together with our balances in
cash and cash equivalents, as well as short term investments and our plans to
add a new credit facility will be sufficient to finance current operations,
planned capital expenditures, and our commitment to TherMatrx shareholders. 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 InhibiZone antibiotic technology is procured from a sole 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 they are not well-accepted by the market,
our growth may be reduced. 17




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##### Table of Contents



Continued Use of Non-Invasive Treatment Alternatives We predominantly sell devices and kits for invasive or minimally invasive
surgical procedures. If patients do not accept our products, our sales may
decline. Patient acceptance of our products depends on a number of factors,
including the failure of non-invasive therapies, the degree of invasiveness
involved in the procedures using our products, the rate and severity of
complications, and other adverse side effects from the procedures using our
products. Patients are more likely to first consider non-invasive alternatives
to treat their urological disorders. The introduction of new oral medications
or other less-invasive therapies 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 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 of
these devices does not evidence an obvious correlation with changes in CMS
reimbursement rates. In March of 2004 we were informed by the American Medical Association that the
organizations Current Procedural Terminology (CPT) Editorial Panel had
approved a CPT code for our Her Optioncryoablation system to treat excessive
uterine bleeding. The receipt of this CPT code is the first step toward the
availability of standard reimbursement for Her Option.A noticeable effect on
sales of Her Optionis not expected until such reimbursement is established
(currently anticipated to be January 2005). We can offer no assurances that a
new code for Her Optionprocedures will be in place by January 2005 or that the
reimbursement will adequately cover the costs of performing the procedure. Regulatory Approvals and Clinical Results Regulatory authorities around the world dictate different levels of data and/or
clinical study 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
commercializable 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. 18




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##### Table of Contents



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 establish and maintain appropriate communications, performance
expectations, regulatory compliance procedures, accounting controls, and
reporting procedures could have a material adverse affect on our business. We
are currently integrating TherMatrx into our Minnetonka operations and recently
obtained FDA approval to manufacture the TherMatrx product at our Minnetonka
location. International Sales During the three and nine month periods of fiscal 2004, approximately 17.0
percent and 21.0 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. 19




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##### Table of Contents



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. 20




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rates We do not believe that our interest rate risk is material given the low
volatility of interest rates in recent years and the low level and relatively
short-term nature of our short term investments. On July 8, 2004, we repaid
the entire outstanding balance of $12.9 million under our senior credit
facility and terminated the credit facility. Currency Our operations outside of the United States are maintained in their local
currency. All assets and liabilities of our international subsidiaries are
translated to U.S. dollars at period-end exchange rates. Translation
adjustments arising from the use of differing exchange rates are included in
accumulated other comprehensive income in stockholders equity. Gains and
losses on foreign currency transactions and short-term inter-company
receivables from foreign subsidiaries are included in other income (expense). During the three and nine month periods of fiscal 2004, revenues from sales to
customers outside the United States were 17.0 percent and 21.0 percent of total
consolidated revenues, respectively, and international accounts receivable,
inventory, cash, and accounts payable were 36.6 percent, 4.9 percent, 21.0
percent, and 19.3 percent of total consolidated accounts for each of these
items as of October 2, 2004. 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 fiscal 2004 levels relative to each of the
currencies in which our revenues and expenses are denominated would have
resulted in a decrease in net income of approximately $0.6 million and $1.6
million during the three and nine month periods of fiscal 2004, respectively. At October 2, 2004, our net investment in foreign subsidiaries translated into
dollars using the period end exchange rate was $18.9 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 $0.7 million.
Actual amounts may differ. Inflation We do not believe that inflation has had a material effect on our results of
operations in recent years and periods. There can be no assurance, however,
that our business will not be adversely affected by inflation in the future. 
 ITEM 4. CONTROLS AND PROCEDURES Our chief executive officer and chief financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in the
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
by this Quarterly Report on Form 10-Q, have concluded that, based on such
evaluation, our disclosure controls and procedures were adequate and designed
to ensure that material information relating to us and our consolidated
subsidiaries, which we are required to disclose in the reports we file or
submit under the Securities Exchange Act of 1934, was made known to them by
others within those entities and reported within the time periods specified in
the Securities and Exchange Commissions rules and forms. There were no changes in our internal control over financial reporting
identified in connection with the evaluation of such internal control over
financial reporting that occurred during our last fiscal quarter which have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. In accordance with the Sarbanes-Oxley Act of 2002, we are performing an
evaluation of our internal controls in order to attest to compliance with
Section 404 of the Act by fiscal year end. 21




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##### Table of Contents



PART II. OTHER INFORMATION 
 ITEM 5. OTHER INFORMATION We are filing as Exhibit 99.1 to this Form 10-Q revised pro forma financial
information for TherMatrx, Inc. which we previously filed as Exhibit 99.3 to
the Form 8-K/A filed on October 8, 2004 solely to amend the Current Report on
Form 8-K dated July 15, 2004, that was initially filed with the Securities and
Exchange Commission (the SEC) on July 29, 2004, and was amended by a Current
Report on Form 8-K/A that was filed with the SEC on September 28, 2004. The
pro forma adjustment to retained earnings (accumulated deficit) in the pro
forma balance sheet and note number 1 to the pro forma financial statements
included as part of Exhibit 99.1 to this Form 10-Q have been corrected to
reflect that the non-recurring charge of $35.0 million for in-process research
and development expenses related to the acquisition of TherMatrx, Inc. has no
related income tax benefit in accordance with the rules of purchase accounting.
The revised pro forma financial information filed as Exhibit 99.1 to this
Form 10-Q does not contain any other changes or reflect any events occurring
after the filing date of the original Form 8-K nor otherwise modify or update
any of the information contained therein or the Forms 8-K/A filed on September
28, 2004 or October 8, 2004. We have concurrently filed the revised pro forma
financial information on a Current Report on Form 8-K/A, as Exhibit 99.1
thereto. 
 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.99.1
    
    Unaudited pro forma financial
information of TherMatrx, Inc.
    
    Filed with this Report.
 22




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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, INCNovember 12, 2004
    
    By     /s/  Douglas W. KohrsDate
    
    Douglas W. KohrsChairman and Chief Executive OfficerNovember 12, 2004
    
    By      /s/  Carmen L. DiersenDate
    
    Carmen L. DiersenExecutive Vice President and Chief Financial
Officer (Principal Financial and Accounting
Officer) 23




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
EXHIBIT INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED OCTOBER 2, 2004 Item No.
    
    Item
    
    Method of Filing31.1
    
    Certification of Chief Executive
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.31.2
    
    Certification of Chief Financial
Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
    
    Filed with this Report.32.1
    
    Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
    
    Filed with this Report.99.1
    
    Unaudited pro forma financial
information of TherMatrx, Inc.
    
    Filed with this Report.
 24