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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
    Form 10-K Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
 For the fiscal year ended:
    
    Commission file number:January 1, 2005
    
    000  30733
    AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.  Delaware
    
    41-1978822(State of Incorporation)
    
    (IRS Employer Identification No.)
 10700 Bren Road West
Minnetonka, Minnesota 55343
(Address of Principal Executive Offices, Including Zip Code) Registrants Telephone Number, Including Area Code:952-930-6000    Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share    Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12b-2) Yes þ No o As of July 2, 2004,the last business day of the registrants most recently completed second fiscal
quarter, the aggregate market value of the voting and non-voting common stock of the registrant
(based upon the closing price of the voting Common Stock as of that date as reported by The NASDAQ
Stock Market and excluding shares beneficially owned by directors, executive officers, and
affiliates of AMS) was approximately $1,108,769,720. As of March 14, 2005, 68,496,870 shares of Common Stock (calculated after giving
effect for a two-for-one stock split to be distributed on March 21, 2005 to stockholders of record
on March 14, 2005) of the registrant were outstanding. Part III of this Annual Report on Form 10-K incorporates by reference information (to the extent
specific sections are referred to in this Annual Report) from the registrants Proxy Statement for
its 2005 Annual Meeting of Stockholders to be held May 5, 2005 (the 2005 Proxy Statement).




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. FORM 10-K For the Fiscal Year Ended January 1, 2005 TABLE OF CONTENTS Description
    
    PagePART IItem 1. Business
    
    
    1Item 1A. Risk Factors
    
    
    8Item 2. Properties
    
    
    10Item 3. Legal Proceedings
    
    
    11Item 4. Submission of Matters to a Vote of Security Holders
    
    
    11Item 4A. Executive Officers of the Registrant
    
    
    11PART IIItem 5. Market For Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    13Item 6. Selected Financial Data
    
    
    14Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 7A. Quantitative and Qualitative Disclosures about Market Risk
    
    
    24Item 8. Financial Statements and Supplementary Data
    
    
    24Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    24Item 9A. Controls and Procedures
    
    
    24Item 9B. Other Information
    
    
    25PART IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    26Item 11. Executive Compensation
    
    
    26Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matter
    
    
    27Item 13. Certain Relationships and Related Transactions
   
    
    27Item 14. Principal Accountant Fees and Services
    
    
    27PART IVItem 15.
Exhibits and Financial Statement Schedules
    
    
    28FINANCIAL STATEMENTS AND NOTES THERETO
    
    
    F-1EXHIBIT INDEX
    
    
    E- 1Amended and Restated Certificate of Incorporation2005 Executive Variable Incentive PlanSummary of Director CompensationSubsidiariesConsent of Ernst & Young LLPCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification Pursuant to 18 U.S.C. Section 1350




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FORWARD-LOOKING INFORMATION This Annual Report on Form 10-K contains certain 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 this Annual Report on Form 10-K beginning on page 8 and in the
Management Discussion and Analysis of Financial Condition and Results of Operations beginning on
page 15 of this Annual Report on Form 10-K. 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. 
 PART I 
 Item 1. Business Overview Since its inception in 1972, American Medical Systems Holdings, Inc. has operated as a single
business developing, manufacturing, and marketing medical devices to physicians. We manufacture
and market a broad and well-established line of proprietary products targeted at the pelvic health
disease states of erectile dysfunction, male urinary incontinence, benign prostatic hyperplasia
(BPH), male urethral stricture, fecal incontinence, female urinary incontinence, pelvic organ
prolapse and menorrhagia. We estimate these diseases affect approximately 242 million people in
the United States and Europe. Nearly 70 million of these men and women have conditions
sufficiently severe so as to profoundly diminish their quality of life and significantly impact
their relationships. Our product development and acquisition strategies have focused on expanding
our product offering and on adding less-invasive solutions for surgeons and their patients. We maintain a website at www.AmericanMedicalSystems.com.We are not including the information
contained on our website as a part of, nor incorporating it by reference into, this Annual Report
on Form 10-K. We make available free of charge on our website our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports, as
soon as reasonably practicable after we electronically file such material with, or furnish such
material to, the Securities and Exchange Commission. Markets and Products In recent years, the number of people seeking treatment for the various pelvic health disorders has
grown with the publicity for new treatments and drug therapies, but the portion of afflicted
patients seeking treatment remains relatively small. When patients do seek treatment, they
generally begin with medical options rather than surgical treatment, regardless of the severity of
the disease. Also, when patients initially seek treatment, their first physician contact is
usually with a general practitioner or gynecologist and not with a surgical specialist. Only once
medical therapy has proven unsuccessful is surgery considered. Sales of our products benefit from some of the same factors which drive sales in many other medical
device companies: an aging population with a desire to maintain a high quality of life, the
expanding availability of safe and effective treatments, the minimally invasiveness of these
therapies, and increasing patient and physician awareness of these treatments. The diseases we treat can profoundly affect the quality of ones life and the burden of these
diseases increases with age. The incidence of erectile dysfunction, benign prostatic hyperplasia
and incontinence in men increases with age and with the incidence of prostate cancer surgery, which
also grows with age. Female incontinence and pelvic organ prolapse are linked to pregnancy and
childbirth among younger women, but also occur independently as women age. As a result, we believe
that as the middle of the baby boomer generation moves into their mid- to late-50s during this
decade, the growth in the prospective patient pool for our products will accelerate. We also
believe that this 1




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demographic group and those that follow will be less willing to accept the natural deterioration of
body functions. Their desire to maintain a consistent quality of life will amplify their increased
demand for our products and therapies. As a result, our strategy of providing an expanding
portfolio of treatment options is an important business driver. In the last several years we have
successfully introduced new products and therapies to meet our target physician and patient needs.
Our product development and acquisition strategies have focused on expanding our product offering
with products and procedures which improve outcomes, reduce operating time and trauma, economically
benefit the overall health care system, and thereby increase the value of our products to
physicians, patients, and payers. Increasing patient awareness of these new treatments is critical to our continued success. We
believe that advertising by pharmaceutical companies and increased private internet access to
healthcare information has greatly increased patients awareness of treatment options for their
medical conditions. For example, erectile dysfunction has become a more widely recognized disease
largely due to the pharmaceutical industrys extensive advertising campaign for Viagra®, Levitra®
and Cialis®. Going forward, we expect significant advertising investments for the use of
continence drugs in female patients suffering from stress urinary incontinence in addition to the
significant awareness already developed for adult incontinence pads. As these patients seek
treatment, we expect many of them will learn about and choose a treatment using one of our
products. We facilitate that decision by working closely with physicians who are skilled in
procedures using our products and therapies, and by sponsoring meetings where patients can learn
more about the benefits of these procedures. While the principal focus of our marketing efforts
continues to be with physicians, we have increased our direct-to-patient programs, primarily
through physician practices, and may increase them more in the future. Building physician awareness continues to be an important element of our marketing strategy. In
2003, we began extensive training and proctoring for gynecologists and urologists in the United
States for our Monarcproduct. In 2004, after FDA clearance of the Apogeeand Perigeeproducts, we
furthered our commitment to physician training as we introduced surgical systems to the field of
pelvic organ prolapse. Through the end of 2004, nearly 5,000 physicians were trained on Monarcand
approximately 300 had been trained on our prolapse repair systems. With over thirty years of
experience, we believe we have a very strong franchise with urologists and we are working to build
a similarly strong franchise with gynecologists. This gynecology franchise is critical to our
growth because most women who suffer from incontinence and other pelvic disorders are more likely
to first seek help from a gynecologist. The expansion of our product offering, combined with increasing physician and patient awareness,
has greatly increased our business opportunities. With the acquisition of TherMatrx in 2004, we
expanded into a marketplace which currently treats approximately 240,000 men annually for benign
prostatic hyperplasia. By extending our focus in 1999 beyond our founders targeted male market to
include women, we moved into the field of female pelvic health, a business representing 73 percent
of procedures utilizing our products in 2004. Erectile Restoration Net sales of erectile restoration products were $74.1 million, $72.4 million, and $69.6 million in
2004, 2003, and 2002, and were 35.5 percent, 43.0 percent, and 49.1 percent of sales in those
years. Erectile dysfunction is the inability to achieve or maintain an erection sufficient for
sexual intercourse. It is most often caused by vascular disease, complications from diabetes, or
prostate surgery which can damage both nerves and arteries necessary for erectile function. This
disease can also be caused by spinal cord injury, and may have a psychogenic component. Erectile
dysfunction may affect 94 million men and their partners around the world. The primary treatment
for erectile dysfunction is the class of drugs referred to as PDE-5 inhibitors. If these drugs do
not work, the patient may try a vacuum device or a topical or injected drug before considering a
penile implant such as those we offer. If the patient elects to have implant surgery, the surgeon
replaces the erectile tissues of the penis with a prosthesis which provides sufficient rigidity for
sexual intercourse. We lead the penile implant market with a series of semi-rigid malleable prostheses and a complete
range of more naturally functioning inflatable prostheses, including the AMS 700 CXand Ultrex. In
recent years, we have introduced significant improvements to our AMS 700inflatable prostheses
including a Parylenecoating on certain internal surfaces of the prosthesis to increase durability,
the InhibiZoneantibiotic surface treatment to address the risk of surgical infections and, in
2004, the Tactile Pumpto improve ease of use for patients. Physician preference for these new
products, which carried higher prices than predecessor products, contributed to the growth in
erectile restoration sales in 2004 and 2003. 2




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Male Continence Net sales of these products were $48.2 million, $39.8 million, and $35.3 million in 2004, 2003, and
2002, and were 23.1 percent, 23.6 percent, and 24.9 percent of sales in those years. Approximately
760,000 men in the U.S. and Europe suffer from urinary incontinence, the uncontrolled release of
urine from the body. In men, this most often results from nerve and sphincter damage caused during
prostate cancer surgery. Male incontinence may be managed with a catheter and leg-bag to collect
the urine, or with pads and diapers to absorb the leaks. These measures are not ideal, as they
come with recurring replacement product costs, the potential for infection, and embarrassing leaks
and odor. Since 1972, when we introduced the Artificial Urinary Sphincter, we have been the world leader with
surgical solutions for male incontinence. This fully implanted system includes an inflatable
urethral cuff to restrict flow through the urethra, and a control pump which allows the patient to
discretely open the cuff when he wishes to urinate. Since 2000, we have also been selling the
InVancesling system, a less-invasive procedure for men with mild to moderate incontinence. Prostate Treatments Net sales of these products were $14.7 million, $4.9 million, and $6.1 million in 2004, 2003, and
2002, and were 7.0 percent, 2.9 percent, and 4.3 percent of sales in those years. Our products can
be used to relieve restrictions on the normal flow of urine from the bladder caused by an enlarged
prostate, generally the result of benign prostatic hyperplasia (BPH) or urethral strictures.
Symptoms of BPH include increased urination frequency, sudden urges to urinate, and weak urine
flow. Nearly 70 percent of men over age 65 have some symptoms of BPH, and approximately 31 million
of them have symptoms requiring treatment. For those experiencing a physical obstruction of the
prostatic urethra, the conventional treatment is removal of the prostatic tissue performed in the
operating room as either a transurethral resection of the prostate (TURP) or photovaporization of
the prostate (PVP). While the former of these is a surgical technique, the latter is a technology
offered by Laserscope, a company providing laser technology to various healthcare fields. We
offer the UroLumeendoprosthesis stent as a less invasive procedure for men within this group who
may not be good surgical candidates. For those men not yet to the point of urethral obstruction, but for whom symptomatic relief is
desired, pharmaceuticals or less-invasive tissue ablation techniques including microwave therapy or
radiofrequency energy delivered to the prostate and performed in a physicians office are available
as therapeutic options. Over 2 million men in the U.S. are on drug or hormone therapy for BPH. We
estimate that approximately 70,000 men received office-based therapy for BPH during 2004, though
this number is growing at approximately 35% per year. It is within this market segment that our
2004 acquisition of TherMatrx is positioned. The growth in our revenue in the prostate treatments
market was driven exclusively by our entry to the in-office BPH market with the TherMatrx Dose
Optimized Therapy (DOT) offering. We acquired TherMatrx early in the third quarter of 2004 and
fully integrated it into our operations by early November 2004. Womens Health Net sales of these products were $71.8 million, $51.2 million, and $30.7 million in 2004, 2003, and
2002, and were 34.4 percent, 30.4 percent and 21.7 percent of sales in those years. Approximately
53 million women in the United States and Europe suffer from urinary or fecal incontinence. These
diseases can lead to debilitating medical and social problems, from embarrassment to anxiety and
depression. There are three types of urinary incontinence: stress, urge, and the combination of
the two (mixed). Pads and diapers are often used to contain and absorb leaks, and may be
acceptable for controlling mild incontinence. Pelvic floor exercises, drug therapy and electrical
nerve stimulation are currently used to treat urge incontinence. Our products treat stress
incontinence, which generally results from a weakening of the tissue surrounding the bladder and
urethra which can be a result of childbirth and aging. Pregnancy, labor, and childbirth may also
cause fecal incontinence, pelvic organ prolapse, and other pelvic floor disorders. Incontinence
may be treated through exercises to strengthen pelvic floor muscles, or through the injection of
collagen or some other bulking agent into the wall of the urethra or bladder neck to narrow the
passage. Surgical solutions are generally recommended only if these other therapies are not
effective. Prolapse and other pelvic floor defects may be treated with a variety of open,
laparoscopic, and transvaginal surgeries. We offer a broad range of systems to restore female continence including the Artificial Urinary
Sphincter(approved for use outside the U.S.), and the In-Fast, SPARC, Monarc,and BioArcsling
systems. This broad range allows the surgeon to select the procedure most appropriate to 3




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the
patients symptoms and anatomy. With an In-Fastprocedure, which we have been selling since acquiring Influence in 1999, the surgeon uses a transvaginal
approach to support the urethra and bladder neck with a sling attached to the back of the pubis.
During 2002, we introduced the In-Fast Ultra, with a new profile designed to minimize periurethral
dissection and increased ease of bone screw placement which holds the support material in place.
We introduced the SPARCprocedure in 2001 as the first complete system to place a self-fixating,
mid-urethral sling with a suprapubic approach. During 2002, we launched several improvements to
SPARC. Since its introduction, SPARChas been the major sales driver in our products for womens
health. At the end of 2002, we introduced the Monarc, a product incorporating unique helical
needles to place a self-fixating, sub-fascial hammock through the obturator foramina. This
procedure may be done without disrupting the endopelvic fascia and is especially valuable for women
who have scarring from previous abdominal surgery. In the fourth quarter of 2003, we launched our
fourth female incontinence offering, the BioArc SPsling system, in the United States. The BioArc
SPsling is the only system available that offers physicians the choice of incorporating a biologic
graft with a self-fixating synthetic. The new BioArc SPsystem employs the same suprapubic
approach of the SPARCsystem, which has been used in more than 100,000 procedures since we
introduced it in 2001, and we expect it will fill a niche for physicians who would prefer not to
use a synthetic material to support the urethra. In 2004, we further expanded upon the philosophy
of graft material choice through the introduction of BioArc TO, a combination of the Monarcs
transobturator surgical technique with the BioArcscharacteristic choice of biologic material. The Acticonneosphincter, an extension of our urinary control technology, is used to treat severe
fecal incontinence. Over 230,000 procedures are performed annually in the United States to repair some form of pelvic
organ prolapse in women. These procedures have historically been performed through the use of
suture and graft materials designed for other surgical applications. In the first half of 2004, we
announced FDA clearance of the Apogeeand Perigeesystems. The Apogeesystem is designed to repair
vaginal vault prolapse, a condition often resulting from the removal of the supporting mechanisms
for the apex of the vagina as the result of hysterectomy. The Perigeesystem targets repair of
cystocele, or the herniation of the bladder through the anterior wall of the vagina. We also offer
InteGraftpelvic reconstructive materials for use in traditional pelvic organ prolapse procedures. Approximately 28 million women in the United States and Europe suffer from excessive uterine
bleeding, or menorrhagia. Menorrhagia may cause anemia and can be socially debilitating. Drug
therapies are effective for some women, but many end up undergoing a hysterectomy. We estimate
that as many as 200,000 hysterectomies performed in the United States each year are the result of
menorrhagia. Other menorrhagia procedures which have some efficacy include dilation and curettage
to remove the endometrial tissue from the uterus, uterine artery embolization, and several
therapies to destroy the endometrium with heat. On December 30, 2002, we acquired CryoGen, Inc.
and its Her Optioncryoablation therapy. This system uses a microprocessor-controlled probe to
eliminate excessive menstrual bleeding by freezing the lining of the uterus and reducing its
ability to regenerate. The procedure, unlike other heat-based therapies, was designed to be
administered in the gynecologists office. The patient can keep her uterus and maintain normal
hormonal levels, avoiding a hospital stay and the recovery time associated with a hysterectomy. We
believe that Her Optionoffers significant advantages over other therapies to the patient, her
physician, and the healthcare system. These other therapies have, however, been available and
reimbursed for a longer period of time, and, as a result, currently have a larger installed base of
experienced users. 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 Medicare 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 payors across the country. Selling and Marketing We sell our products in the United States, Canada, Australia, Brazil, and most European countries
through direct field representatives. At the end of 2004, we had 192 employees in our U.S. sales
and marketing force and 68 employees in international sales and marketing. We also had 48
independent distributors who represented our products in other countries and accounted for
approximately three percent of our worldwide sales. No single customer or group of customers
accounts for more than five percent of our total sales. Local market conditions, including the
regulatory and competitive situation, determine the type of products we sell in each market. 4




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Our marketing organization is responsible for understanding patient and physician needs, guiding
new product development, and increasing the awareness, understanding, and preference for our
products among physicians and patients. In pricing our products we consider our costs of developing, manufacturing, and distributing the
productsincluding the cost of regulatory compliance and physician trainingand the value they
bring to the patient and the health care system. For erectile restoration, as an example, we offer
a range of products which sell to hospitals at prices ranging from $6,300 for an inflatable
system which, when implanted, is practically indistinguishable
from the dysfunctional tissue it replaces, to $2,000 for a much simpler prosthesis which creates
less natural rigidity. Products for womens urinary incontinence are distinguished primarily by
surgical implantation technique and range from $800 to $1,000. Systems for mens urinary
incontinence are more surgically and technologically demanding than those for women, and sell for
prices ranging from $2,600 to $6,600. Manufacturing and Supply We use approximately 80,000 square feet of our facility in Minnetonka, Minnesota for manufacturing,
warehousing, and distribution of our products. We maintain warehouses to support local
distribution in countries outside the U.S. where we have direct sales representation. Although many of the materials we purchase for our products are available from multiple sources,
many of our products utilize raw materials or components that are either single or sole sourced.
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. We maintain a comprehensive quality assurance and quality control program, which includes
documentation of all material specifications, operating procedures, equipment maintenance, and
quality control test methods. Our documentation systems comply with appropriate FDA and ISO
requirements. Research and Development We are committed to developing new products and improving our current products to provide
physicians with better clinical outcomes through less invasive and more efficient products and
procedures. Most of our research and development activities are carried out in our Minnetonka,
Minnesota facility, although we work with physicians, research hospitals, and universities around
the world. Many of the ideas for new and improved products come from a global network of leading
physicians, who also work with us in evaluating new concepts and in conducting clinical trials to
gain regulatory approvals. The development process for any new product can range from several
months to several years, primarily depending on the regulatory pathway required for approval. In
2005, we anticipate the release of eight new products including the AMS 700 with Tactile Pumpfor
international markets in the treatment of erectile restoration; the InVance Male Sling with
InhibiZonefor male urinary incontinence; the Apogee and Perigee products for
pelvic organ prolapse with pre-attached biologic graft material; a
next generation vaginal vault prolapse product;

the BioArc SP and the
BioArc TO products for female urinary incontinence with pre-attached biologic graft
material; and an upgrade to our Her Optioncryoablation probe for menorrhagia. Our spending on research and development activities, including clinical and regulatory work totaled
$15.8 million, $14.9 million and $11.9 million in 2004, 2003, and 2002. These research and
development dollars represented 7.6 percent, 8.9 percent, and 8.4 percent of sales for each year
respectively. We will continue to target R&D spending at between 8 and 10 percent of sales for the
foreseeable future. Competition Competition in the medical device industry is intense and characterized by extensive research
efforts and rapid technological progress. The primary competitive factors include clinical
outcomes, distribution capabilities, and price relative to (1) competitive technologies and (2)
reimbursements to physicians and hospitals for their services. Many of our competitors have
greater resources to develop and market products, broader distribution resources, and potentially
higher economies of scale than we do. Our competitive capability depends on our ability to develop
new products and innovative procedures, obtain regulatory clearance and ensure regulatory
compliance for our products, 5




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assist our customers in obtaining reimbursement, protect the proprietary technology of our products
and manufacturing process, and maintain and develop preference for our products among physicians
and patients. All of these abilities require recruiting, retaining, and developing skilled and
dedicated employees, and maintaining and developing excellent relationships with physicians and
suppliers. Our principal competitor in the erectile restoration market is Mentor Corporation. We have no
significant competitor in the market for surgical treatment of male continence. Principal
competitors for our prostate therapy include drug manufacturers and other minimally-invasive
treatment suppliers including Urologix, Medtronic, Johnson & Johnson and Boston Scientific
Corporation. Our principal competitors for womens continence products include Johnson & Johnson,
Boston Scientific, C.R. Bard and Mentor Corporation. In the field of menorrhagia treatments, our
competitors include Cytyc, Boston Scientific, and Johnson & Johnson. Intellectual Property We rely on intellectual property including patents, trade secrets, technical innovations, and
various licensing agreements to protect and build our competitive position. We have 146 issued
U.S. patents, half of them issued in the last four years, and numerous international patents
covering various aspects of our technology. We also have U.S. and international patent
applications pending. We review third party products and patents to protect our rights and to
avoid infringing the legitimate rights of others. We file patent applications to protect technology, inventions, and improvements that we consider
important, but we cannot be sure our applications will be granted, or that, if granted, the patents
will provide competitive protection for our products, or that our competitors will not challenge
or circumvent these patent rights. Costs to defend our patents or to protect our activities from
the patent claims of others could be substantial, even if we were ultimately successful in
defending the claim. We do not believe that any of our products infringe any valid claims of
patents or other proprietary rights held by third parties. Government Regulation Numerous governmental authorities, principally the FDA and comparable foreign regulatory agencies,
regulate the development, testing, manufacturing, labeling, marketing, and distribution of our
products. In Europe and certain other countries, we comply with the European Union Directives for
Medical Devices and certify our compliance with the CE Mark. In other countries outside the United
States, we ensure appropriate registration and authorization. In the U.S., our products fall into
FDA Classes I, II, and III depending on the indications for use and the risk they pose to the
patient. Class I includes devices with the lowest risk and Class III includes those with the
greatest risk. The class to which our products are assigned determines the type of pre-marketing application
required for FDA clearance. If the product is classified as Class I or II, and if it is not
exempt, a 510(k) will be required to obtain marketing clearance. It generally takes several months
from the date of most 510(k) submissions to obtain clearance, and it may take longer, particularly
if a clinical trial is required. For Class III devices, a pre-market approval application (PMA) is
generally required. The PMA process can be expensive, uncertain, require detailed and
comprehensive data, and generally take significantly longer than the 510(k) process. If human clinical trials of a device are required, either for a 510(k) submission or a PMA, the
sponsor of the trial, usually the manufacturer or the distributor of the device must file an
investigational device exemption (IDE) application prior to commencing human clinical trials. The
FDA may not approve the IDE and, even if it is approved, the FDA may not accept that the data
derived from the studies supports the safety and efficacy of the device or warrants the
continuation of clinical trials. Our core implantable products have been approved through the PMA or Product Development Protocol
(PDP) application process. Most of our other products, including our new products for womens
pelvic organ prolapse were approved through the 510(k) pre-market notification process. We have
conducted clinical trials to support our PMA or PDP regulatory approvals. The FDA and international regulatory authorities also periodically inspect our operations to assure
themselves of our compliance with applicable quality system regulations. We must comply with a
host of regulatory requirements that apply to medical devices, drug device combination products and
human tissue products marketed in the United States and internationally. If we fail to comply with these regulatory requirements, which are
subject to change, our business, financial condition, and results of operations could be
significantly harmed. 6




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We are also subject to the National Organ Transplant Act, or NOTA, because we provide human tissue
in connection with our sling systems for urinary incontinence and female pelvic support. NOTA
prohibits the purchase and sale of human organs, including related tissue, for valuable
consideration, but it does not prohibit the payment of reasonable expenses associated with the
removal, transportation, processing, preservation, quality control, implantation and storage of
human tissue. NOTA enables the federal government to impose civil and criminal penalties on those
found to have violated this federal statute. With improvements in other biologic solutions, human
allograft tissue has become an increasingly smaller portion of our business and is expected to be
eliminated from our product offering during 2005. Third-Party Reimbursement Most of our products are purchased by hospitals which are reimbursed for their services by
third-party payers including Medicare, Medicaid, comparable foreign agencies, private health care
insurance, and managed care plans. The reimbursement environment facing our customers varies
widely, as do our customers systems for dealing with such variation. We support the efforts of
our customers to obtain appropriate reimbursement by providing them with the information necessary
to align the utilization of our products with procedures for which reimbursement is established and
through ongoing efforts to aid payers in informal decision making. We believe our support of
customer reimbursement efforts is critical to the ongoing acceptance and success of our products. Many third-party payers (including Medicare, Medicaid, and other large, influential payers) are
seeking to reduce their costs by denying coverage for certain procedures, including new procedures
for which efficacy has not yet been well established, or are reimbursing at rates which do not cover
the full cost of procedures. These activities may be particularly detrimental to AMS because we
are developing new products for new procedures. These new products and procedures may not find
market acceptance because of delays in third-party payer acceptance of the medical value of the new
procedures. The reimbursement rates for several procedures that use our products have fluctuated
over the last few years, and it is likely that these fluctuations will continue. We are not able to determine what effect, if any, Medicare reimbursement changes have on our U.S.
revenues. We believe the average age of patients receiving our products is less than 60 years old
and, therefore, a significant portion of our revenues are not directly affected by Medicare
reimbursement trends. Further, the amount that hospitals pay medical device suppliers is not
always tied directly to Medicare reimbursement rates. Hospitals may consider the total volume
generated by a particular surgical specialty or practice and compensate suppliers at rates higher
than Medicare reimbursement rates for particular procedures to maintain volumes on other procedures
performed by that specialty. Finally, Medicare reimbursement rates are affected by regional
variations and, for inpatient procedures, by disease severity factors, making the correlation
between national reimbursement rate adjustments and our sales and pricing less than clear.
Ultimately, we cannot predict the frequency or severity of future reimbursement reductions, and
such future reductions, if they occur, could have a materially adverse effect on our revenue growth
rates and profitability. Employees As of January 1, 2005, we employed 627 people in the following areas: 152 in manufacturing; 219 in
U.S. sales, marketing and distribution; 68 in administration; 45 in regulatory, clinical and
quality assurance; 49 in research and development; and 94 internationally. We do not have any
organized labor unions. We believe we have an excellent relationship with our employees. Financial Information about Geographic Areas Approximately 20.9 percent, 18.7 percent, and 17.7 percent of our consolidated revenues in 2004,
2003 and 2002 were from sales to customers outside of the United States. See Notes to Consolidated
Financial Statements  No. 10for more information. 7




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##### Table of Contents



Item 1A. 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
they are not well accepted by the market, our growth may be reduced. Continued Use of Non-Invasive Treatment Alternatives We predominantly sell devices and kits for invasive or minimally invasive surgical procedures. If
patients do not accept our products, our sales may decline. Patient acceptance of our products
depends on a number of factors, including the failure of non-invasive therapies, the degree of
invasiveness involved in the procedures using our products, the rate and severity of complications,
and other adverse side effects from the procedures using our products. Patients are more likely to
first consider non-invasive alternatives to treat their urological disorders. The introduction of
new oral medications or other less-invasive therapies could cause our sales to decline. 8




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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 in the U.S. of
these devices does not evidence an obvious correlation with changes in CMS reimbursement rates. The first quarter of 2004, the American Medical Association approved a CPT code for our Her Option
cryoablation 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
Medicare 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. 9




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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. International Sales During the fiscal 2004, approximately 20.9 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 has concluded the internal controls over
financial reporting are 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 third fiscal quarter of 2005. 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. 
 Item 2. Properties Our corporate headquarters, main warehouse, and manufacturing operations are located in a
180,000 square foot building we own in Minnetonka, Minnesota. We believe we have sufficient
capacity to meet production requirements for our products for the foreseeable future. We lease office space for our international operations in Australia, Brazil, Canada, France,
Germany, the Netherlands, Spain and the United Kingdom. 10




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Item 3. Legal Proceedings We have been and are also currently subject to various legal proceedings and other matters
which arise in the ordinary course of business, including product liability claims. 
 Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth fiscal quarter of 2004. 
 Item 4A. Executive Officers of the Registrant Our executive officers, with their ages and biographical information are as follows: Name
    
    Age
    
    TitleDouglas W. Kohrs
    
    47
    
    Chairman of the Board; DirectorMartin J. Emerson
    
    41
    
    President and Chief Executive Officer; DirectorCarmen L. Diersen
    
    44
    
    Executive Vice President and Chief Financial Officer; Corporate SecretaryRoss A. Longhini
    
    43
    
    Executive Vice President and Chief Technology OfficerLawrence W. Getlin
    
    59
    
    Vice President, Regulatory, Medical Affairs and Quality Systems;Corporate Compliance OfficerJanet L. Dick
    
    48
    
    Vice President of Human Resources
 Douglas W. Kohrshas served as one of our directors since 1999 and he became Chairman of the Board
in March 2004. From 1999 to March 2004, he was our President and from 1999 until January 4, 2005
he also served as our Chief Executive Officer. Mr. Kohrs has 22 years of experience in the medical
device industry. He was part of the founding team at Spine-Tech when it was formed in 1991 to
develop and commercialize the BAK spinal fusion cage, a novel implantable device to improve the
surgical treatment of degenerative disc disease, and was Vice President of Research and Development
and Vice President of Marketing. He was General Manager of Sulzer Spine-Tech Inc. from 1998 to
1999. Mr. Kohrs currently serves as a director of Disc Dynamics, Inc., ev3, Inc., and Pioneer
Surgical Technologies, all of which are privately-held companies, and Kyphon, Inc., which is a
publicly-held company engaged in orthopedic medical devices. Martin J. Emersonhas served as our President and Chief Executive Officer and as a director since
January 4, 2005. Mr. Emerson also served as our President and Chief Operating Officer from March
2004 until January 4, 2005. From January 2003 to March 2004, he served as our Executive Vice
President, Global Sales and Marketing, and Chief Operating Officer. From 2000 through 2002, he
served as Vice President and General Manager of International. Mr. Emerson has over 19 years
experience in the medical device field in finance and general management capacities. From 1998 to
2000, he served as General Manager and Finance Director for Boston Scientific Corporation in
Singapore. Also in Singapore, he was Vice President and Regional Financial Officer with MasterCard
International from 1997 to 1998. Mr. Emersons earlier experience was with Baxter International
from 1985 to 1997, most recently as Vice President Finance, Hospital Business, Brussels, from 1995
to 1997. Carmen L. Diersenhas served as our Executive Vice President, Chief Financial Officer, and
Corporate Secretary since March 2004. From 1992 to 2004, she held positions of increasing domestic
and international responsibility in finance, business development, and general management at
Medtronic, Inc. Most recently, Ms. Diersen was Vice President, Business Development. From March
2002 through 2003, she was Vice President, General Manager, Musculoskeletal Tissue Services; and
from February 1999 through March 2002, she was Vice President of Finance and Administration and
Vice President of Business Development, Americas and Asia Pacific. From 1982 to 1992, she held
various positions at Honeywell, Inc. Ms. Diersen currently serves as a director of Memry
Corporation, a publicly-held company that provides design, engineering, development and
manufacturing services to the medical device industry and other industries. 11




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Ross A. Longhinihas served as our Executive Vice President and Chief Technology Officer since
January 2003. Mr. Longhini has 22 years of experience in the field of medical device product
development. From 1998 to 2002, he served in various management positions in Sulzer Spine-Tech of
Minnesota including Vice President, Research and Development, Clinical & Regulatory. From 1991 to
1998, he worked at I.V. Infusion Therapy of 3M which was sold to Gaseby in 1996 then purchased by
Smiths Medical Systems in 1997. From 1983 to 1991, he worked at 3M Dental Products. Lawrence W. Getlin, J.D.has served as our Vice President, Regulatory, Medical Affairs, and Quality
Systems since 1990 and Corporate Compliance Officer since 2003. He is a member of the American Bar
Association and the California State Bar, as well as the U.S. Court of Appeals 9th District, and
District Court, Central District of California, and is Regulatory Affairs Certified. Janet L. Dickhas served as our Vice President of Human Resources since 1996. Overall, Ms. Dick
has spent 20 years in positions of increasing responsibility within our human resources department
and Schneiders human resources department, both of which were divisions of Pfizer at the time. Her
prior human resources career was in banking, commercial construction, and mortgage banking. 12




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PART II 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities Market Information Our common stock is currently traded on the NASDAQ National Market under the symbol AMMD. The
following table sets forth, for the periods indicated, the high and low closing sales prices per
share of our common stock as reported on the NASDAQ National Market. These prices do not include
adjustments for retail mark-ups, mark-downs, or commissions. On January 10, 2005, we announced a
two-for-one stock split in the form of a 100% 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 will be distributed on March
21, 2005 to stockholders of record on March 14, 2005. The following stock prices have been
adjusted to give retroactive effect to the stock split for all periods presented. 2004
    
    
    2003High
    
    
    Low
    
    
    High
    
    
    LowFirst quarter
    
    $
    15.29
    
    
    $
    10.60
    
    
    $
    8.89
    
    
    $
    6.84Second quarter
    
    $
    17.02
    
    
    $
    12.27
    
    
    $
    8.80
    
    
    $
    7.07Third quarter
    
    $
    18.70
    
    
    $
    14.25
    
    
    $
    11.62
    
    
    $
    8.43Fourth quarter
    
    $
    21.84
    
    
    $
    16.31
    
    
    $
    11.70
    
    
    $
    10.03
 Holders On March 10, 2005, there were approximately 125 shareholders of record and
17,733 beneficial stockholders. Dividends We have never declared or paid cash dividends. We intend to retain all future earnings for the
operation and expansion of our business. We do not anticipate declaring or paying cash dividends
on our common stock in the foreseeable future. In addition, our current senior credit facility
places certain restrictions on paying cash dividends. Securities Authorized for Issuance under Equity Compensation Plans The information in the Executive Compensation and Other
Benefits  Securities Authorized for Issuance Under Equity
Compensation Plans section of our 2005
Proxy Statement is incorporated in this Annual Report on Form 10-K by reference. 13




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Item 6. Selected Financial Data The following tables present five years of data (in thousands) from our statement of
operations and balance sheet. Statement of Operations Data
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Net
sales
    
    $
    208,772
    
    
    $
    168,283
    
    
    $
    141,648
    
    
    $
    117,938
    
    
    $
    100,317Cost of
sales (1)
    
    
    38,331
    
    
    
    27,353
    
    
    
    24,605
    
    
    
    23,140
    
    
    
    21,891Gross
profit
    
    
    170,441
    
    
    
    140,930
    
    
    
    117,043
    
    
    
    94,798
    
    
    
    78,426Operating
expensesMarketing and selling
    
    
    72,910
    
    
    
    63,107
    
    
    
    50,152
    
    
    
    44,931
    
    
    
    39,277Research and development
    
    
    15,786
    
    
    
    14,924
    
    
    
    11,858
    
    
    
    11,899
    
    
    
    12,225In-process research and development (2)
    
    
    35,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    General and administrative
    
    
    21,617
    
    
    
    17,099
    
    
    
    13,186
    
    
    
    12,047
    
    
    
    12,128Amortization of intangibles
    
    
    5,708
    
    
    
    4,160
    
    
    
    3,775
    
    
    
    9,374
    
    
    
    8,360Transition and reorganization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,000
    
    
    
    1,000Total operating expenses
    
    
    151,021
    
    
    
    99,290
    
    
    
    78,971
    
    
    
    79,251
    
    
    
    72,990Operating
income
    
    
    19,420
    
    
    
    41,640
    
    
    
    38,072
    
    
    
    15,547
    
    
    
    5,436Other
(expense) incomeRoyalty and other
    
    
    2,249
    
    
    
    3,801
    
    
    
    4,172
    
    
    
    3,187
    
    
    
    2,928Interest, net
    
    
    (266
    )
    
    
    (1,352
    )
    
    
    (1,628
    )
    
    
    (2,932
    )
    
    
    (6,943
    )Investment impairment (3)
    
    
    (4,500
    )
    
    
    
    
    
    
    
    
    
    
    (3,400
    )
    
    
    Total other (expense) income
    
    
    (2,517
    )
    
    
    2,449
    
    
    
    2,544
    
    
    
    (3,145
    )
    
    
    (4,015
    )Income
before income taxes
    
    
    16,903
    
    
    
    44,089
    
    
    
    40,616
    
    
    
    12,402
    
    
    
    1,421Provision
for income taxes (4)
    
    
    20,023
    
    
    
    15,039
    
    
    
    15,730
    
    
    
    5,872
    
    
    
    1,369Net
(loss) income
    
    
    ($3,120
    )
    
    $
    29,050
    
    
    $
    24,886
    
    
    $
    6,530
    
    
    $
    52Net
(loss) income per share (5)Basic
    
    
    ($0.05
    )
    
    $
    0.44
    
    
    $
    0.39
    
    
    $
    0.11
    
    
    $
    0.00Diluted
    
    
    ($0.05
    )
    
    $
    0.42
    
    
    $
    0.36
    
    
    $
    0.10
    
    
    $
    0.00
   (1)
    
    During the fourth quarters of 2003 and 2002, we reduced warranty allowance by $3.1 million and $2.9
million, and reduced cost of sales and increased operating income by the same amounts.(2)
    
    In the third quarter of 2004, we
recognized a $35.0 million in-process research and development
charge related to the acquisition of TherMatrx. For a more complete description of this item and its impact on
financial results see Notes to Consolidated Financial Statements
 No. 2.(3)
    
    During the fourth quarter of 2004, we recognized an investment impairment loss of $4.5 million
related to our investment in InjecTx. For a more complete description of this item and its impact on financial
results see Notes to Consolidated Financial Statements 
No. 5. During 2001, we recognized a $3.4
million investment impairment loss related to our investment in Collagenesis Corporation.(4)
    
    During the third quarter of 2003, we applied for and recognized U.S. tax benefits related to research and
development and extraterritorial income exclusion tax credits for the years 1999 through 2002, resulting in a
$1.1 million reduction in 2003 tax expense.(5)
    
    Amounts per share have been adjusted to give retroactive effect to the March 21, 2005 stock split for all periods presented. Balance Sheet Data
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Cash, cash equivalents, and
short-term investments
    
    $
    51,168
    
    
    $
    58,953
    
    
    $
    79,429
    
    
    $
    28,755
    
    
    $
    12,165Working capital
    
    
    79,575
    
    
    
    92,729
    
    
    
    100,371
    
    
    
    54,030
    
    
    
    25,175Total assets
    
    
    300,550
    
    
    
    279,327
    
    
    
    251,645
    
    
    
    235,151
    
    
    
    181,262Long-term liabilities
    
    
    3,126
    
    
    
    12,315
    
    
    
    21,945
    
    
    
    29,006
    
    
    
    42,087Stockholders equity
    
    
    249,172
    
    
    
    240,346
    
    
    
    204,262
    
    
    
    174,087
    
    
    
    109,523
 14




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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Introductory 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 will be 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. Results of Operations Sales trends The following table compares net sales of our product lines and geographies between 2004 and 2003,
and between 2003 and 2002. $ Increase
    
    
    % Increase
    
    
    
    
    
    
    
    
    
    
    $ Increase
    
    
    % Increase(in thousands)
    
    2004
    
    
    2003
    
    
    (Decrease)
    
    
    (Decrease)
    
    
    2003
    
    
    2002
    
    
    (Decrease)
    
    
    (Decrease)SalesProduct LineMens healthErectile restoration
    
    $
    74,070
    
    
    $
    72,385
    
    
    $
    1,685
    
    
    
    2.3
    %
    
    $
    72,385
    
    
    $
    69,554
    
    
    $
    2,831
    
    
    
    4.1
    %Male continence
    
    
    48,242
    
    
    
    39,758
    
    
    
    8,484
    
    
    
    21.3
    %
    
    
    39,758
    
    
    
    35,316
    
    
    
    4,442
    
    
    
    12.6
    %Prostate treatments
    
    
    14,697
    
    
    
    4,923
    
    
    
    9,774
    
    
    
    198.5
    %
    
    
    4,923
    
    
    
    6,063
    
    
    
    (1,140
    )
    
    
    -18.8
    %Total mens health
    
    
    137,009
    
    
    
    117,066
    
    
    
    19,943
    
    
    
    17.0
    %
    
    
    117,066
    
    
    
    110,933
    
    
    
    6,133
    
    
    
    5.5
    %Womens health
    
    
    71,763
    
    
    
    51,217
    
    
    
    20,546
    
    
    
    40.1
    %
    
    
    51,217
    
    
    
    30,715
    
    
    
    20,502
    
    
    
    66.7
    %Total
    
    $
    208,772
    
    
    $
    168,283
    
    
    $
    40,489
    
    
    
    24.1
    %
    
    $
    168,283
    
    
    $
    141,648
    
    
    $
    26,635
    
    
    
    18.8
    %GeographyUnited States
    
    $
    165,140
    
    
    $
    136,765
    
    
    $
    28,375
    
    
    
    20.7
    %
    
    $
    136,765
    
    
    $
    116,523
    
    
    $
    20,242
    
    
    
    17.4
    %Outside United States
    
    
    43,632
    
    
    
    31,518
    
    
    
    12,114
    
    
    
    38.4
    %
    
    
    31,518
    
    
    
    25,125
    
    
    
    6,393
    
    
    
    25.4
    %Total
    
    $
    208,772
    
    
    $
    168,283
    
    
    $
    40,489
    
    
    
    24.1
    %
    
    $
    168,283
    
    
    $
    141,648
    
    
    $
    26,635
    
    
    
    18.8
    %Percent of total salesProduct LineMens healthErectile restoration
    
    
    35.5
    %
    
    
    43.0
    %
    
    
    
    
    
    
    
    
    
    
    43.0
    %
    
    
    49.1
    %Male continence
    
    
    23.1
    %
    
    
    23.6
    %
    
    
    
    
    
    
    
    
    
    
    23.6
    %
    
    
    24.9
    %Prostate treatments
    
    
    7.0
    %
    
    
    2.9
    %
    
    
    
    
    
    
    
    
    
    
    2.9
    %
    
    
    4.3
    %Total mens health
    
    
    65.6
    %
    
    
    69.6
    %
    
    
    
    
    
    
    
    
    
    
    69.6
    %
    
    
    78.3
    %Womens health
    
    
    34.4
    %
    
    
    30.4
    %
    
    
    
    
    
    
    
    
    
    
    30.4
    %
    
    
    21.7
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    
    
    
    
    
    
    
    
    100.0
    %
    
    
    100.0
    %GeographyUnited States
    
    
    79.1
    %
    
    
    81.3
    %
    
    
    
    
    
    
    
    
    
    
    81.3
    %
    
    
    82.3
    %Outside United States
    
    
    20.9
    %
    
    
    18.7
    %
    
    
    
    
    
    
    
    
    
    
    18.7
    %
    
    
    17.7
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    
    
    
    
    
    
    
    
    100.0
    %
    
    
    100.0
    %
 15




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##### Table of Contents



Mens health products. Revenue from mens health products grew 17 percent in 2004, following an
increase of 5.5 percent in 2003, primarily driven by the acquisition of TherMatrx, Inc. in the
third quarter of 2004 and strength in our male continence products. Erectile restoration products
increased 2.3 percent in 2004, and 4.1 percent in 2003. In 2004, a 6.3 percent increase in the
average selling price for these products was partially offset by a 3.7 percent reduction in units
sold, in part due to 2004 including 52 weeks versus 2003s 53-week fiscal year. This performance
as measured in units sold is reflective of an overall market for erectile restoration implant units
in 2004 which was essentially flat. The increase in average selling price was due to InhibiZone
antibiotic treated penile implants and the introduction of the Tactile Pumpproduct, which was
approved for use by the FDA in July 2004. The 2003 increase in erectile restoration sales was also
due to the higher selling price of InhibiZoneproducts. The increase in erectile restoration sales
in 2004 and 2003 also reflects higher sales of our non-inflatable implants, including the Dura II
product line, which was acquired in 2003. Increases in unit volume and prices boosted sales of male continence products in 2004 and 2003.
Unit sales of the AMS 800 Artificial Urinary Sphincterand the InVancemale sling system climbed 12
percent and 38 percent, respectively in 2004, more than doubling the increase registered in 2003.
Price and volume increases in both products during 2004 and 2003 resulted from product and
procedure improvement. Prostate treatment sales in 2004 increased $9.8 million over 2003, with the July 2004 acquisition
of TherMatrx contributing $10.5 million to 2004 prostate treatment sales. Excluding TherMatrx
sales, our prostate product sales declined $0.7 million and $1.1 million during 2004 and 2003,
respectively, as we continued to reposition the UroLumeproduct toward obstructive urethral
conditions such as urethral stricture. Womens health products.Revenue from womens health products grew 40 percent in 2004, following
an increase of 67 percent in 2003, reflecting a continuing shift to the less-invasive self-fixating
slings (SPARC, Monarc, and BioArc), partially offset by declining sales of InFast, the conventional
bone anchoring device for treating incontinence. Sales of prolapse repair products continued to
grow in 2004 on the strength of higher unit volume reflecting new product introductions (Apogee and
Perigee) in an expanding market. Uterine health treatments, established in 2003 with the
acquisition of Cryogen, contributed less to overall sales in 2004, as the approval of a Current
Procedural Terminology (CPT) code in 2004 was not followed by the establishment of a reimbursement
level effective until January 2005. International sales and foreign exchange effects. Our total revenues grew $40.5 million, or 24.1
percent in 2004 from 2003. Of this growth, $3.5 million, or 2.1 percent, was due to favorable
currency exchange rates, mainly the euro. In 2003, $3.9 million, or 2.8 percent, of the revenue
increase from 2002 was due to favorable currency exchange rates. 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. Customer location
    
    2004
    
    
    2003
    
    
    $ Increase
    
    
    % Increase
    
    
    2003
    
    
    2002
    
    
    $ Increase
    
    
    % IncreaseWithin U.S.
    
    $
    165,140
    
    
    $
    136,765
    
    
    $
    28,375
    
    
    
    20.7
    %
    
    $
    136,765
    
    
    $
    116,523
    
    
    $
    20,242
    
    
    
    17.4
    %Outside United StatesBefore FX Impact
    
    
    40,098
    
    
    
    31,518
    
    
    
    8,580
    
    
    
    27.2
    %
    
    
    27,593
    
    
    
    25,125
    
    
    
    2,468
    
    
    
    9.8
    %Subtotal
    
    
    205,238
    
    
    
    168,283
    
    
    
    36,955
    
    
    
    22.0
    %
    
    
    164,358
    
    
    
    141,648
    
    
    
    22,710
    
    
    
    16.0
    %Currency Impact
    
    
    3,534
    
    
    
    
    
    
    
    3,534
    
    
    
    
    
    
    
    3,925
    
    
    
    
    
    
    
    3,925
    
    
    
    Total
    
    $
    208,772
    
    
    $
    168,283
    
    
    $
    40,489
    
    
    
    24.1
    %
    
    $
    168,283
    
    
    $
    141,648
    
    
    $
    26,635
    
    
    
    18.8
    %
 16




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##### Table of Contents



Operating Expenses The following table compares the dollar and percentage change in the Statement of Operations
between 2004 and 2003, and between 2003 and 2002. $ Increase
    
    
    % Increase
    
    
    
    
    
    
    
    
    
    
    $ Increase
    
    
    % Increase(in thousands)
    
    2004
    
    
    2003
    
    
    (Decrease)
    
    
    (Decrease)
    
    
    2003
    
    
    2002
    
    
    (Decrease)
    
    
    (Decrease)Net sales
    
    $
    208,772
    
    
    $
    168,283
    
    
    $
    40,489
    
    
    
    24.1
    %
    
    $
    168,283
    
    
    $
    141,648
    
    
    $
    26,635
    
    
    
    18.8
    %Cost of sales
    
    
    38,331
    
    
    
    27,353
    
    
    
    10,978
    
    
    
    40.1
    %
    
    
    27,353
    
    
    
    24,605
    
    
    
    2,748
    
    
    
    11.2
    %Gross profit
    
    
    170,441
    
    
    
    140,930
    
    
    
    29,511
    
    
    
    20.9
    %
    
    
    140,930
    
    
    
    117,043
    
    
    
    23,887
    
    
    
    20.4
    %Operating expensesMarketing and selling
    
    
    72,910
    
    
    
    63,107
    
    
    
    9,803
    
    
    
    15.5
    %
    
    
    63,107
    
    
    
    50,152
    
    
    
    12,955
    
    
    
    25.8
    %Research and development
    
    
    15,786
    
    
    
    14,924
    
    
    
    862
    
    
    
    5.8
    %
    
    
    14,924
    
    
    
    11,858
    
    
    
    3,066
    
    
    
    25.9
    %In-process research & development
    
    
    35,000
    
    
    
    
    
    
    
    35,000
    
    
    
    n/a
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    General and administrative
    
    
    21,617
    
    
    
    17,099
    
    
    
    4,518
    
    
    
    26.4
    %
    
    
    17,099
    
    
    
    13,186
    
    
    
    3,913
    
    
    
    29.7
    %Amortization of intangibles
    
    
    5,708
    
    
    
    4,160
    
    
    
    1,548
    
    
    
    37.2
    %
    
    
    4,160
    
    
    
    3,775
    
    
    
    385
    
    
    
    10.2
    %Total operating expenses
    
    
    151,021
    
    
    
    99,290
    
    
    
    51,731
    
    
    
    52.1
    %
    
    
    99,290
    
    
    
    78,971
    
    
    
    20,319
    
    
    
    25.7
    %Operating income
    
    
    19,420
    
    
    
    41,640
    
    
    
    (22,220
    )
    
    
    -53.4
    %
    
    
    41,640
    
    
    
    38,072
    
    
    
    3,568
    
    
    
    9.4
    %Royalty income
    
    
    2,079
    
    
    
    2,797
    
    
    
    (718
    )
    
    
    -25.7
    %
    
    
    2,797
    
    
    
    3,032
    
    
    
    (235
    )
    
    
    -7.8
    %Interest income
    
    
    517
    
    
    
    476
    
    
    
    41
    
    
    
    8.6
    %
    
    
    476
    
    
    
    1,130
    
    
    
    (654
    )
    
    
    -57.9
    %Interest expense
    
    
    (783
    )
    
    
    (1,828
    )
    
    
    1,045
    
    
    
    57.2
    %
    
    
    (1,828
    )
    
    
    (2,758
    )
    
    
    930
    
    
    
    33.7
    %Investment impairment
    
    
    (4,500
    )
    
    
    
    
    
    
    (4,500
    )
    
    
    n/a
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income
    
    
    170
    
    
    
    1,004
    
    
    
    (834
    )
    
    
    -83.1
    %
    
    
    1,004
    
    
    
    1,140
    
    
    
    (136
    )
    
    
    -11.9
    %Income before income taxes
    
    
    16,903
    
    
    
    44,089
    
    
    
    (27,186
    )
    
    
    -61.7
    %
    
    
    44,089
    
    
    
    40,616
    
    
    
    3,473
    
    
    
    8.6
    %Provision for income taxes
    
    
    20,023
    
    
    
    15,039
    
    
    
    4,984
    
    
    
    33.1
    %
    
    
    15,039
    
    
    
    15,730
    
    
    
    (691
    )
    
    
    -4.4
    %Net (loss) income
    
    
    ($3,120
    )
    
    $
    29,050
    
    
    
    ($32,170
    )
    
    
    -110.7
    %
    
    $
    29,050
    
    
    $
    24,886
    
    
    $
    4,164
    
    
    
    16.7
    %
 The following table shows the Statement of Operations as a percentage of net sales for 2004, 2003,
and 2002. 2004
    
    
    2003
    
    
    2002Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    18.4
    %
    
    
    16.3
    %
    
    
    17.4
    %Gross profit
    
    
    81.6
    %
    
    
    83.7
    %
    
    
    82.6
    %Operating expensesMarketing and selling
    
    
    34.9
    %
    
    
    37.5
    %
    
    
    35.4
    %Research and development
    
    
    7.6
    %
    
    
    8.9
    %
    
    
    8.4
    %In-process research & development
    
    
    16.8
    %
    
    
    0.0
    %
    
    
    0.0
    %General and administrative
    
    
    10.4
    %
    
    
    10.2
    %
    
    
    9.3
    %Amortization of intangibles
    
    
    2.7
    %
    
    
    2.5
    %
    
    
    2.7
    %Total operating expenses
    
    
    72.3
    %
    
    
    59.0
    %
    
    
    55.8
    %Operating income
    
    
    9.3
    %
    
    
    24.7
    %
    
    
    26.9
    %Royalty income
    
    
    1.0
    %
    
    
    1.7
    %
    
    
    2.1
    %Interest income
    
    
    0.2
    %
    
    
    0.3
    %
    
    
    0.8
    %Interest expense
    
    
    -0.4
    %
    
    
    -1.1
    %
    
    
    -1.9
    %Investment impairment
    
    
    -2.2
    %
    
    
    0.0
    %
    
    
    0.0
    %Other income
    
    
    0.1
    %
    
    
    0.6
    %
    
    
    0.8
    %Income before income taxes
    
    
    8.1
    %
    
    
    26.2
    %
    
    
    28.7
    %Provision for income taxes
    
    
    9.6
    %
    
    
    8.9
    %
    
    
    11.1
    %Net (loss) income
    
    
    -1.5
    %
    
    
    17.3
    %
    
    
    17.6
    %
 Cost of goods sold.During 2002, and continuing into 2003, we experienced a significant decrease
in warranty claims. These decreases were primarily due to improvements in the quality and
durability of our products and our claims processing procedures. As a result, cost of goods sold
in 2003 and 2002 reflect favorable reductions in warranty allowance of $3.1 million and $2.9
million, respectively. 17




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##### Table of Contents



Cost of goods sold as a percentage of sales increased 2.1 percentage points from 2003 to 2004. Of
this increase, 1.9 percentage points, or $3.1 million, is due to the 2003 reduction in our warranty
allowance. Partially offsetting the 2003 warranty allowance impact is the 0.3 percentage point
favorable impact of foreign currency. The remaining .5 percentage points increase in 2004 cost of good sold as a percentage of sales is due mainly to the
costs of integrating TherMatrx and product mix changes, partially offset by higher production
volumes. Cost of goods sold as a percent of sales has generally benefited from relatively fixed
overhead costs, which account for more than a quarter of our
cost of goods sold being spread over
higher manufacturing volumes. In 2003, cost of goods sold
as a percentage of sales decreased 1.1 percentage points from
2002. Of
this decrease 0.3 percentage points, or $3.9 million, was due to favorable currency impact on
revenue in 2003. The remaining .8 percentage point decrease in 2003 was due to higher production
volumes and product mix changes. Future cost of goods sold will continue to depend on production
levels, labor costs, raw material costs and product mix. Marketing and selling. Marketing and selling expenses increased in 2004 due to additional U.S.
sales personnel and the addition of the TherMatrx sales organization. Both of these additions
were in support of the $40.5 million increase in 2004 net sales from 2003. However, marketing and
selling expenses as a percentage of net sales decreased 2.6 percent from 2003 as we leveraged prior
investments in this area. The increase in 2003 from 2002 reflects the expansion of our work with
(1) gynecologists for Her Optionby establishing a separate direct gynecology sales force; (2)
other womens health products; and (3) erectile restoration patients. In addition, we spent
approximately $1.2 million during 2003 to consolidate much of our European marketing and selling
operations into a new shared service center in Amsterdam. We expect to continue investing in
marketing and selling in support of increasing sales levels, but expect marketing and selling
expenses will decrease as a percentage of sales. Research and development. Research and development includes costs to develop and improve current
and possible future products plus the costs for regulatory and clinical activities for these
products. Over 40 percent of the 2004 research and development increase relates to additional
personnel and research and development expenditures associated with our acquisition of TherMatrx.
Cost increases during 2003 were primarily to support Her Optionand other womens health products.
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 2004 in-process research and development (IPR&D) expense
relates to our acquisition of TherMatrx in July 2004. In accordance with the rules of purchase
accounting, we recognized a one-time charge of $35.0 million related to value assigned to IPR&D for
a transurethral microwave therapy device that had not yet reached technological feasibility and had
no future alternative use. This device will provide a therapeutic dose of microwave energy to the
patients prostate to treat benign prostate hyperplasia. This device includes updated components,
new software, and a significantly updated user interface. In fiscal 2004, we incurred $0.4 million
in costs, and expect to incur $0.8 million in fiscal 2005. This device will be subject to approval by the FDA. With an anticipated launch in 2006, this
capital device will replace the current capital equipment component of the TherMatrxsystem. We used the excess earnings method to estimate the fair value of the IPR&D, using projections for
incremental sales and expenses associated with the new device for the years 2006 through 2014. No
incremental sales and expenses for the device are expected after 2014, as yet-to-be defined
products are expected to replace this device by that time. General and administrative. General and administrative cost increases in 2004 compared to 2003
were mainly due to $1.7 million of professional fees and services associated with Sarbanes-Oxley
compliance, $0.8 million of international bad debt expense, $0.7 million of legal costs related to
intellectual property matters and $0.6 million due to the acquisition of TherMatrx. Major cost
increases during 2003 were due to $2.0 million of additional costs related to the CryoGen
operation, including the relocation of the San Diego operation to Minnesota in the fourth quarter
of 2003, $0.6 million of additional product liability insurance expenses, and $0.2 million of costs
to support the extension of communication and information systems to our European offices. Amortization of intangibles. The increase in intangible amortization in 2004 compared to 2003 is
primarily due to the amortization of definite-lived assets from the TherMatrx acquisition. The
increase in amortization expense in 2003 compared to 2002 reflects the amortization of
definite-lived assets from the CryoGen and Dura IIacquisitions. For a more complete description
of this change and its impact on financial results see Notes to Consolidated Financial Statements 
No. 2. 18




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##### Table of Contents



Other income (expense) Royalty income.Most of our royalty income is 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. Interest income. The increase in 2004 reflects an increase in rates partially offset by lower cash
balances in the interest bearing accounts. Cash balances declined due to prepayment of the credit
facility in July 2004 (see Notes to Consolidated Financial Statements  No. 7) and the
consideration paid for TherMatrx in July 2004 (see Notes to Consolidated Financial Statements  No.
2). Interest income was lower in 2003 than in 2002 due to lower cash balances as a result of the
CryoGen and Dura IIacquisitions in 2003, and lower interest rates. Interest expense. Interest expense decreased in 2004 as a result of the termination of our prior
credit facility in July 2004. The decline during 2003 reflects a $7.6 million decline in notes
payable, as well as the expiration of our interest rate swap agreement on June 30, 2003. We had
hedged a portion of our original $65.0 million variable rate term loan, as required by our prior
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. Pre-tax expense from this agreement
was $0.9 million during 2003. We did not renew the swap agreement and have no requirement for such
an agreement under our new credit facility. Investment impairment.We recognized a $4.5 million loss associated with the write-off of our
common and preferred stock investment in InjecTx, a company focused on the development of ethanol
ablation systems for prostate treatments. We own 19% of the stock of InjecTx and signed an
exclusive, long-term agreement with InjecTx to distribute its injection system worldwide. For a
more complete description of this change, see Notes to Consolidated Financial Statements  No. 5. Other. Other income in 2004 and 2003 is due mainly to gains resulting from the fluctuations in
foreign currencies, mainly the euro, against the U.S. dollar and relate primarily to translating
foreign denominated inter-company receivables to current rates. Other income in 2002 reflects a
gain on pension plan termination. On January 1, 2002, we terminated the AMS Retirement Annuity
Plan. At the time of this termination, we contributed approximately $5.8 million to the pension
plan and recorded a gain on pension plan termination of $0.7 million. This contribution to the
pension plan fully funded under-funded pension plan liabilities that had accrued due to declining
investment balances in the plan and low interest rates, and funded early retirement benefits. Income tax
expense
In 2004, the reported tax rate of 118.5 percent was higher than the effective tax rate applied to
taxable income due to the $35.0 million in-process research and development charge and the $4.5
million investment impairment charge, both of which are not currently deductible for tax purposes.
We expect our effective tax rate for 2005 to be approximately 35.5 percent. The 2003 reported tax rate was 34.1 percent including the $1.1 million tax benefit recognized with
the application for certain U.S. tax benefits related to research and development tax credits and
extraterritorial income exclusion for the years 1999 through 2002. Liquidity and Capital Resources Cash, cash equivalents, and short-term investments were $51.2 million as of January 1, 2005,
compared to $59.0 million as of January 3, 2004. The decrease is primarily due to the acquisition
of TherMatrx in July 2004, and the early repayment of amounts owed under the credit facility, which
was terminated in July 2004. These decreases were partially offset by cash flow from operations. Cash flows from operating activities Cash provided from operations in 2004 totaling $49.0 million represents an increase of $14.9
million over 2003, primarily reflecting the increase in overall gross profit and a reduction in
working capital requirements, partially offset by investments in marketing and selling, and general
and administrative expenses. 19




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##### Table of Contents



Cash provided from operations in 2003 was $34.1 million, an increase of $5.3 million over 2002.
This was due to an increase in net income, adjusted for non-cash expenses of depreciation and
amortization and partially offset by increases in working capital. Cash flows from investing activities Cash used in investing activities was $61.1 million and $50.6 million in 2004 and 2003, and cash
provided by investing activities was $24.1 million in 2002. During 2004, 2003 and 2002, we
purchased property, plant and equipment totaling $3.7 million, $6.5 million and $1.7 million,
respectively. During 2004, we had net purchases of investments totaling $15.5 million, and in 2002
we had net sales of investments totaling $27.8 million. During 2004, we had a net cash outlay of
$39.4 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
2003, we had a net cash outlay of $44.1 million related to the acquisition of CryoGen, Inc. and the
purchase of the Dura IIline of erectile restoration products from Endocare, Inc. During 2002, we
made an additional $1.0 million investment in InjecTx relating to one of our prostate treatment
products (reported as a technology investment) and made an additional $1.0 million investment to
acquire worldwide distribution rights to a porcine dermis graft material used in sling and pelvic
prolapse procedures (reported as a purchase of intangibles). Cash flows from financing activities Cash used in financing activities was $10.3 million, $4.9 million and $2.6 million during 2004,
2003 and 2002, respectively. Cash received under our stock option and employee stock purchase
plans was $6.1 million, $2.7 million and $2.4 million during 2004, 2003 and 2002, respectively.
Payments made under our senior credit facility were $16.4 million, $7.6 million and $4.9 million
during 2004, 2003 and 2002, respectively. 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 ratio. 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. The new credit agreement contains standard affirmative and negative covenants, including the two
financial covenants set forth below: Credit facilityCovenant
    
    requirementsLeverage ratio
    
    
    < 2.75Interest coverage ratio
    
    
    > 3.00
 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 acquisition 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. Contractual Obligations The following table sets forth the future commitments (in thousands) under the senior credit
facility (see Notes to Consolidated Financial Statements  No. 7)and operating leases. 20




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Less than
    
    
    
    
    
    
    
    
    
    
    More than(in thousands)
    
    Total
    
    
    1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsCredit facility (commitment fees)
    
    $
    825
    
    
    $
    165
    
    
    $
    330
    
    
    $
    330
    
    
    
    Automobile leases
    
    
    2,094
    
    
    
    823
    
    
    
    854
    
    
    
    417
    
    
    
    Office and facility rent
    
    
    1,065
    
    
    
    457
    
    
    
    361
    
    
    
    247
    
    
    
    Total
    
    $
    3,984
    
    
    $
    1,445
    
    
    $
    1,545
    
    
    $
    994
    
    
    
    
 The automobiles are used by sales personnel. The lease terms for automobiles are typically three
years. The office and facility rent includes the CryoGen manufacturing facility in San Diego, the
TherMatrx facility in Northbrook, Illinois, and sales offices outside the U.S. The lease for the
CryoGen facility expires on August 31, 2005. We have sublet the premises for the remaining lease
term. The lease for the TherMatrx facility expires January 31, 2006. In 2003, we acquired CryoGen, Inc. Pursuant to the acquisition agreement, we will pay CryoGens
former shareholders an earnout payment equal to three times our net revenues from sales of
CryoGens products over a period of four consecutive quarters ending three years after closing,
less $40.0 million. If our net product revenues attributable to sales of CryoGens products during
any such four-quarter period do not exceed $13.3 million, no earnout payment will be made. The
maximum amount of the earnout payment is $110.0 million. This transaction is more fully described
in our Form 8-K filed with the SEC on January 6, 2003. We do not currently anticipate an earnout
payment to the former CryoGen shareholders. On July 15, 2004, we acquired TherMatrx, Inc. At closing, the shareholders of TherMatrx were
initially paid cash consideration of $40.5 million. We 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 former TherMatrx shareholders. We used cash on
hand to make the initial payment of $40.5 million. Included in the $40.5 million initial payment
was $0.5 million for an estimated increase in net asset value. There was no increase in net asset
value, and we were repaid the $0.5 million in February 2005 when the amount in escrow was
distributed to former TherMatrx shareholders. 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. At the end of the fourth quarter of 2004, we incurred
our first contingent payment to former TherMatrx shareholders in the amount of $0.9 million,
payable in the first quarter of 2005. We believe that funds generated from operations, together with our balances in cash and cash
equivalents along with funds available under our senior credit facility, will be sufficient to
finance current operations, planned capital expenditures, and commitments to former TherMatrx and
CryoGen shareholders through the terms of these agreements. 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 is 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 below. Revenue Recognition Policy We sell our products primarily through a direct sales force. Approximately 44 percent of our
revenue is generated from consigned inventory or from inventory with field
representatives. For these products, revenue is recognized at the time the product has been used
or implanted. For 21




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all other
transactions, we recognize revenue when title to the goods and risk of loss transfer to customers, providing there are no remaining
performance obligations required from us or any matters requiring customer acceptance. In cases
where we utilize distributors or ship product directly to the end user, we recognize revenue upon
shipment provided all revenue recognition criteria have been met. We record estimated sales
returns, discounts and rebates as a reduction of net sales in the sale period revenue is
recognized. All of our customers have rights of return for the occasional ordering or shipping error. We
maintain an allowance for these returns and reduce reported revenue for expected returns from
shipments during each reporting period. This allowance is based on historical and current trends
in product returns. At January 1, 2005, this allowance was $2.3 million, an increase of $0.6
million from January 3, 2004. Allowance for Doubtful Accounts We estimate the allowance for doubtful accounts by analyzing those accounts receivable that have
reached their due date and by applying rates based upon historical write-off trends and specific
account reserves. Accounts are written off sooner in the event of bankruptcy or other
circumstances that make further collection unlikely. When it is deemed probable that a customer
account is uncollectible, that balance is written off against the existing allowance. Different
estimates could have material variances in the amount and timing of our reported results for any
period. In addition, actual results could be different from current estimates, possibly resulting
in increased future charges to earnings. At January 1, 2005, the allowance for doubtful accounts was $2.0 million, compared to $1.0 million
on January 3, 2004. This increase relates to sales growth and an increased provision on
international receivables. The allowance was 4.1 percent and 3.0 percent of gross accounts
receivable at the end of 2004 and 2003, respectively. Inventory Valuation Inventories are stated at the lower of cost or market determined on the first-in-first-out method.
Each quarter, we evaluate our inventories for obsolescence and excess quantities. This evaluation
includes analyses of inventory levels, historical loss trends, expected product lives, product at
risk of expiration, sales levels by product, and projections of future sales demand. We reserve
inventories we consider obsolete. In addition, we record an allowance for inventory quantities in
excess of forecasted demand. Inventory allowances were $1.7 million and $1.9 million at the end of
2004 and 2003. The reduction reflects enhanced inventory management practices. If future demand
or market conditions are less favorable than current estimates, additional inventory adjustments
would be required and would adversely affect income in the period the adjustment is made. Warranty Accrual / Allowance We warrant all of our products to be free from manufacturing defects. In addition, if a product
fails, we may provide replacements at no cost or a substantial discount from list price. We
maintain a warranty allowance to cover the cost of replacements for our erectile restoration,
incontinence, BPH, and menorrhagia products. When we sell products, we record an expense for the
expected costs of future warranty-related claims, and increase the warranty allowance by an
equivalent amount. We reduce the warranty allowance by the cost of the replacement device when an
actual claim is awarded. Thus, the balance of the warranty allowance is an estimate of the future
cost of honoring our warranty obligation. Factors influencing this estimate include historical
claim rates, changes in product performance, frequency of use by the patient, the patients
performance expectations, and changes in the terms of our product replacement policy. Product
reliability is a function of raw material properties, manufacturing processes, and surgical
technique. During 2002, we noted a significant decrease in warranty claims. With further investigation, we
concluded that this decrease was the result of recent improvements in the quality and durability of
our products and changes in our claims processing. Because we expected these trends to affect
warranty claims for the foreseeable future, we determined that the warranty allowance should be
reduced by approximately $2.9 million. In 2003, the trend of lower claims experience continued, and
further analysis indicated another adjustment of $3.1 million to the accrued warranty allowance was
appropriate. These adjustments have been recorded as reductions to cost of goods sold and as
increases in reported operating income and net income. At January 1, 2005, our accrued warranty
allowance was $1.5 million compared to $1.3 million at January 3, 2004. Of the $0.2 million
increase reported in warranty allowances, most was due to the acquisition of TherMatrx. If we
experience further changes in any of the factors that influence this estimate, we will make
additional adjustments to this accrued warranty allowance. 22




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Product Liability Accrual Each quarter, we estimate the uninsured portion of legal representation and settlement costs of
product liability claims and lawsuits. This evaluation consists of reviewing historical claims
costs as well as assessing future trends in medical device liability cases. Social and political
factors, as well as surgeon and medical facility responsibility, make litigation costs hard to
predict. Accruals for future litigation costs were $0.7 million at January 1, 2005, versus $1.3
million at January 3, 2004. During 2004, we reduced our accrual by $0.6 million to reflect a
change in estimate related to identified claims and lawsuits in our 2004 year end accrual balance.
If, in the future, we determine that this accrual is inadequate, the adjustment would reduce
reported income in the period we recorded the adjustment. Valuation of IPR&D, Goodwill and Other Intangible Assets When we acquire another company, the purchase price is allocated, as applicable, between in-process
research and development (IPR&D), other identifiable intangible assets, tangible assets, and
goodwill as required by U.S. GAAP. IPR&D is defined as the value assigned to those projects for
which the related products have not received regulatory approval and have no alternative future
use. Determining the portion of the purchase price allocated to IPR&D and other intangible assets
requires significant estimates. The amount of the purchase price allocated to IPR&D and other
intangible assets is determined by estimating the future cash flows of each project or technology
and discounting the net cash flows back to their present values. The discount rate used is
determined at the time of acquisition in accordance with accepted valuation methods. For IPR&D,
these methodologies include consideration of the risk of the project not achieving commercial
feasibility. Goodwill is the excess of the purchase price over the fair value of net assets, including IPR&D, of
acquired businesses. We assess goodwill impairment indicators quarterly, or more frequently, if a
change in circumstances or the occurrence of events suggest the remaining value may not be
recoverable. The test for impairment requires us to make several estimates about fair value, most
of which are based on projected future cash flows. Our estimates associated with the goodwill
impairment tests are considered critical due to the amount of goodwill recorded on our consolidated
balance sheets and the judgment required in determining fair value amounts, including projected
future cash flows. Goodwill was $102.4 million as of January 1, 2005 and $99.0 million as of
January 3, 2004. Other intangible assets consist primarily of purchased technology, patents, and trademarks and are
amortized using the straight-line method over their estimated useful lives. We review these
intangible assets for impairment annually or as changes in circumstance or the occurrence of events
suggest the remaining value may not be recoverable. Other intangible assets, net of accumulated
amortization, were $44.8 million as of January 1, 2005 and $17.5 million as of January 3, 2004. Income Taxes In the preparation of the consolidated financial statements, income taxes in each of the
jurisdictions in which we operate are estimated. This process involves estimating actual current
tax exposures and assessing temporary differences resulting from differing treatment of items for
tax and accounting purposes. These differences result in deferred tax assets and liabilities,
which are included in our consolidated balance sheet. We have significant amounts of deferred tax assets that are reviewed for recoverability and then
valued accordingly. We evaluate the realizable value of the deferred tax assets on a quarterly and
yearly basis, as well as assess the need for valuation allowances by considering historical levels
of income, estimates of future taxable income, and the impact of tax planning strategies. We
record a valuation allowance to reduce deferred tax assets when we believe all or part of our
deferred tax assets will not be realized. Valuation allowances for 2004 and 2003 of $0.9 million and $0.7 million, respectively, are
maintained to offset tax loss carry forwards created in a foreign jurisdiction, which, if
subsequently recognized, would be allocated to goodwill. In addition, in 2004 a $1.7 million
valuation allowance was established for the capital loss carry forward related to the investment
impairment (see Notes to Consolidated Financial Statements  No. 13).No other allowances against
net deferred tax assets are maintained at January 1, 2005. If a determination is made that we
would not realize all or part of the deferred tax assets, an adjustment to the deferred tax asset
valuation allowance and a charge to income in the period of the determination would be made. 23




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Recent Accounting Pronouncements See Notes to Consolidated Financial Statements  No.1, Recent Accounting Pronouncements. 
 Item 7A. 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 fiscal 2004 and 2003, revenues from sales to customers outside the United States were 20.9
percent and 18.7 percent of total consolidated revenues, respectively, and international accounts
receivable, inventory, cash, and accounts payable were 36.2 percent, 5.4 percent, 23.6 percent, and
15.2 percent of total consolidated accounts for each of these items as of January 1, 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 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 $2.0 million during 2004. At January 1, 2005, our net investment in foreign subsidiaries translated into dollars using the
period end exchange rate was $21.6 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 $2.2 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 8. Financial Statements and Supplementary Data Our Consolidated Financial Statements and the reports of our independent registered public
accounting firm are included in this Annual Report on Form 10-K beginning on page F-1. The index
to this report and the financial statements is included in Item 15. 
 Item 9. Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure None 
 Item 9A. Controls and Procedures 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 Annual Report on Form 10-K, have concluded that, based
on such evaluation, our disclosure controls and procedures were adequate and designed to ensure
that material information relating 24




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##### Table of Contents



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 year which have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining effective internal control over
financial reporting. Our internal control over financial reporting is designed to provide
reasonable assurance to our management and our Board of Directors regarding the preparation and
fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation. Management assessed the effectiveness of our internal control over financial reporting as of
January 1, 2005. In making this assessment, we used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control  Integrated
Framework. Based on our assessment, we believe that, as of January 1, 2005, our internal control
over financial reporting is effective based on those criteria. Our assessment of the effectiveness of internal control over financial reporting as of January 1,
2005, has been audited by Ernst & Young, LLP, the independent registered public accounting firm who
also audited our consolidated financial statements. Ernst & Youngs attestation report on AMS
managements assessment of internal control over financial reporting appears on page F-1 of this
Form 10-K. 
 Item 9B. Other Information None 25




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PART III 
 Item 10. Directors and Executive Officers of the Registrant Directors of the Registrant The information in the Election of Directors-Information About Nominees and other Directors
section of our 2005 Proxy Statement is incorporated in this Annual Report on Form 10-K by
reference. Executive Officers of the Registrant Information about our executive officers is included in this Annual Report on Form 10-K under Item
4A, Executive Officers of the Registrant. Compliance with Section 16(a) of the Exchange Act The information in the Principal Shareholders and Management Beneficial Ownership section of our
2005 Proxy Statement is incorporated in this Annual Report on Form 10-K by reference. Audit Committee Financial Expert The information in the Election of Directors  Board and Board Committees section of our 2005
Proxy Statement is incorporated in this Annual Report on Form 10-K by reference. Identification of the Audit Committee The information in the Election of Directors  Board and Board Committees section of our 2005
Proxy Statement is incorporated in this Annual Report on Form 10-K by reference. Code of Ethics Our Code of Ethics for Senior Financial Management applies to our chief executive officer, chief
financial officer, controller, and other employees performing similar functions who have been
identified by the chief executive officer, and meets the requirements of the Securities and
Exchange Commission. We have posted our Code of Ethics for Senior Financial Management on our
website, at www.AmericanMedicalSystems.com. We intend to disclose any amendments to and any
waivers from a provision of our Code of Ethics for Senior Financial Management on our website
within five business days following such amendment or waiver. The information contained or
connected to our website is not incorporated by reference into this Form 10-K and should not be
considered part of this or any report that we file with or furnish to the Securities and Exchange
Commission. 
 Item 11. Executive Compensation The information in the Election of DirectorsDirector Compensation, Executive Compensation
and Other Benefits  Compensation Committee Interlocks and Insider
Participation, and Executive Compensation and Other Benefits
 Compensation
Committee Report on Executive Compensation, sections of our
2005 Proxy Statement is incorporated in this Annual Report on Form 10-K by reference. 26




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##### Table of Contents



Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information in the Executive Compensation and Other BenefitsSecurities Authorized for Issuance
Under Equity Compensation Plans and Principal Stockholders and Management Beneficial Ownership
sections of our 2005 Proxy Statement is incorporated in this Annual Report on Form 10-K by
reference. 
 Item 13. Certain Relationships and Related Transactions The information in the Certain Transactions section of our 2005 Proxy Statement is
incorporated in this Annual Report on Form 10-K by reference. 
 Item 14. Principal Accountant Fees and Services The information in the
Audit Committee ReportAudit and Non-Audit Fees section of our 2005 Proxy Statement is
incorporated in this Annual Report on Form 10-K by reference. 27




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##### Table of Contents



PART IV 
 Item 15. Exhibits and Financial Statement Schedule (a) Financial Statements Our following Consolidated Financial Statements and Reports of Independent Registered Public
Accounting Firm thereon are included herein (page numbers refer to pages in this Annual Report on
Form 10-K). Reports of Independent Registered Public Accounting Firm
    
    
    F-1Consolidated Balance Sheets as of
January 1, 2005, and January 3, 2004
    
    
    F-3Consolidated Statements of Operations for the years ended
January 1, 2005, January 3, 2004, and December 28, 2002
    
    
    F-4Consolidated Statements of Changes in Stockholders Equity for the
years ended January 1, 2005, January 3, 2004, and December 28, 2002
    
    
    F-5Consolidated Statements of Cash Flows for the years ended
January 1, 2005, January 3, 2004, and December 28, 2002
    
    
    F-7Notes to Consolidated Financial Statements for the years ended
January 1, 2005, January 3, 2004, and December 28, 2002.
    
    
    F-8
 (b) Financial Statement Our schedule of valuation and qualifying accounts (in thousands) should be read in conjunction with
the consolidated financial statements (page numbers refer to pages in this Annual Report on Form
10-K). All other schedules are omitted because they are not applicable or the required information
is shown in the financial statements or notes thereto. Schedule II 
Valuation and Qualifying Accounts.
    
    
    F-27
 (c) Exhibits The exhibits to this Annual Report on Form 10-K are listed in the Exhibit Index
on pages E-1 to E-3
to this Report. A copy of any of the exhibits listed in the Exhibit Index will be sent at a
reasonable cost to any stockholder as of March 18, 2005, upon receipt from any such person of a
written request for any such exhibit. Requests should be sent to the attention of Corporate
Secretary, American Medical Systems, Inc., 10700 Bren Road West, Minnetonka, Minnesota 55343. The following is a list of each management
contract or compensatory plan or arrangement required to
be filed as an exhibit (or incorporated by reference) to this Annual Report on Form 10-K:  1.
    Amended and Restated Employment Agreement, dated January 5, 2005, between
Douglas W. Kohrs and American Medical Systems, Inc.2.
    Employment Agreement, dated April 26, 2004, between Martin J. Emerson and
American Medical Systems, Inc.3.
    First Amendment to Employment Agreement, dated January 5, 2005, between
Martin J. Emerson and American Medical Systems, Inc.4.
    Stock Option Agreement, dated April 23, 1999, between Douglas Kohrs and
American Medical Systems, Inc.6.
    Consulting Agreement, dated September 1, 1999, between Medical Genesis and American
Medical Systems, Inc. 28




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##### Table of Contents



7.
    Employment Agreement, dated January 1, 2003, between Ross Longhini and
American Medical Systems, Inc.8.
    Employment Agreement, dated March 9, 2004, between Carmen L. Diersen and
American Medical Systems, Inc.9.
    2000 Equity Incentive Plan, as amended.10.
    Form of Incentive Stock Option Agreement.11.
    Form of Non-Qualified Stock Option Agreement.12.
    Employee Stock Purchase Plan.13.
    2005 Executive Variable Incentive Plan. 29




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FINANCIAL STATEMENTS AND NOTES THERETO 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders
American Medical Systems Holdings, Inc. We have audited managements
assessment, included in Managements Report on
Internal Control over Financial Reporting included in Item 9A, that American Medical Systems
Holdings, Inc. maintained effective internal control over financial reporting as of January 1, 2005,
based on criteria established in Internal Control  Integrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission (the COSO criteria). American Medical Systems
Holdings, Inc.s management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on managements assessment and an opinion
on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that American Medical Systems Holdings, Inc. maintained
effective internal control over financial reporting as of January 1, 2005, is fairly stated, in all
material respects, based on the COSO criteria. Also, in our opinion, American Medical Systems
Holdings, Inc. maintained, in all material respects, effective internal control over financial
reporting as of January 1, 2005, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of American Medical Systems Holdings, Inc.
as of January 1, 2005 and January 3, 2004, and the related consolidated statements of operations,
changes in stockholders equity, and cash flows for each of the
three years in the period ended
January 1, 2005 of American Medical Systems Holdings, Inc. and our report dated March 8, 2005,
expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Minneapolis, Minnesota
March 8, 2005 F-1




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders
American Medical Systems Holdings, Inc. We have audited the accompanying consolidated balance sheets of American Medical Systems Holdings,
Inc. and subsidiaries as of January 1, 2005 and January 3, 2004, and the related consolidated
statements of operations, changes in stockholders equity, and cash flows for each of the three
years in the period ended January 1, 2005. Our audits also included the financial statement
schedules listed in Item 15. These financial statements and schedule are the responsibility of
the Companys management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of American Medical Systems Holdings, Inc. and
subsidiaries at January 1, 2005 and January 3, 2004, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended January 1, 2005, in
conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as
a whole presents fairly, in all material respects, the information set forth herein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of American Medical Systems Holdings, Inc.s internal
control over financial reporting as of January 1, 2005, based on criteria established in Internal
Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 8, 2005 expressed in an unqualified opinion thereon. /s/ Ernst & Young LLP Minneapolis, Minnesota
March 8, 2005 F-2




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American Medical Systems Holdings, Inc. 
 Consolidated Balance Sheets
  January 1, 2005
    
    
    January 3, 2004AssetsCurrent assetsCash and cash equivalents
    
    $
    35,689
    
    
    $
    58,953Short term investments
    
    
    15,479
    
    
    
    Accounts receivable, net
    
    
    46,984
    
    
    
    33,507Inventories, net
    
    
    21,719
    
    
    
    18,402Deferred income taxes
    
    
    4,855
    
    
    
    5,637Other current assets
    
    
    3,101
    
    
    
    2,896Total current assets
    
    
    127,827
    
    
    
    119,395Property, plant and equipment, net
    
    
    22,065
    
    
    
    25,489Goodwill
    
    
    102,365
    
    
    
    98,989Intangibles, net
    
    
    44,792
    
    
    
    17,466Deferred income taxes
    
    
    2,911
    
    
    
    12,991Investment in technology and other assets
    
    
    590
    
    
    
    4,997Total assets
    
    $
    300,550
    
    
    $
    279,327Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    4,237
    
    
    $
    4,621Accrued compensation expenses
    
    
    10,783
    
    
    
    6,776Accrued warranty expense
    
    
    1,451
    
    
    
    1,338Income taxes payable
    
    
    2,982
    
    
    
    1,667Other accrued expenses
    
    
    8,835
    
    
    
    5,105Contingent liability on acquisition
    
    
    19,964
    
    
    
    Current portion of notes payable
    
    
    
    
    
    
    7,159Total current liabilities
    
    
    48,252
    
    
    
    26,666Accumulated post retirement benefit obligation
    
    
    3,126
    
    
    
    3,110Long-term notes payable
    
    
    
    
    
    
    9,205Stockholders equityCommon stock, par value $.01 per share; authorized
220,000,000 shares; issued and outstanding:67,478,544 shares at January 1, 2005
and 66,270,708 shares at January 3, 2004
    
    
    675
    
    
    
    663Additional paid-in capital
    
    
    210,163
    
    
    
    202,009Deferred compensation
    
    
    
    
    
    
    (24
    )Accumulated other comprehensive income
    
    
    5,123
    
    
    
    1,367Retained earnings
    
    
    33,211
    
    
    
    36,331Total stockholders equity
    
    
    249,172
    
    
    
    240,346Total liabilities and stockholders equity
    
    $
    300,550
    
    
    $
    279,327
 The accompanying notes are an integral part of the consolidated financial
statements. F-3




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##### Table of Contents



American Medical Systems Holdings, Inc. 
 Consolidated Statements of Operations
  2004
    
    
    2003
    
    
    2002Net sales
    
    $
    208,772
    
    
    $
    168,283
    
    
    $
    141,648Cost of sales
    
    
    38,331
    
    
    
    27,353
    
    
    
    24,605Gross profit
    
    
    170,441
    
    
    
    140,930
    
    
    
    117,043Operating expensesMarketing and selling
    
    
    72,910
    
    
    
    63,107
    
    
    
    50,152Research and development
    
    
    15,786
    
    
    
    14,924
    
    
    
    11,858In-process research and development
    
    
    35,000
    
    
    
    
    
    
    
    General and administrative
    
    
    21,617
    
    
    
    17,099
    
    
    
    13,186Amortization of intangibles
    
    
    5,708
    
    
    
    4,160
    
    
    
    3,775Total operating expenses
    
    
    151,021
    
    
    
    99,290
    
    
    
    78,971Operating income
    
    
    19,420
    
    
    
    41,640
    
    
    
    38,072Other income (expense)Royalty income
    
    
    2,079
    
    
    
    2,797
    
    
    
    3,032Interest income
    
    
    517
    
    
    
    476
    
    
    
    1,130Interest expense
    
    
    (783
    )
    
    
    (1,828
    )
    
    
    (2,758
    )Investment impairment
    
    
    (4,500
    )
    
    
    
    
    
    
    Other income
    
    
    170
    
    
    
    1,004
    
    
    
    1,140Total other (expense) income
    
    
    (2,517
    )
    
    
    2,449
    
    
    
    2,544Income before income taxes
    
    
    16,903
    
    
    
    44,089
    
    
    
    40,616Provision for income taxes
    
    
    20,023
    
    
    
    15,039
    
    
    
    15,730Net (loss) income
    
    
    ($3,120
    )
    
    $
    29,050
    
    
    $
    24,886Net (loss) income per shareBasic
    
    
    ($0.05
    )
    
    $
    0.44
    
    
    $
    0.39Diluted
    
    
    ($0.05
    )
    
    $
    0.42
    
    
    $
    0.36Weighted average common
shares used in calculationBasic
    
    
    67,006
    
    
    
    65,708
    
    
    
    64,464Diluted
    
    
    67,006
    
    
    
    68,626
    
    
    
    68,352
 The accompanying notes are
an integral part of the consolidated financial statements. F-4




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##### Table of Contents



American Medical Systems Holdings, Inc. 
 Consolidated Statements of Changes in Stockholders Equity
  AccumulatedAdditional
    
    
    Retained
    
    
    
    
    
    
    OtherCommon Stock
    
    
    Paid-In
    
    
    Earnings
    
    
    Deferred
    
    
    ComprehensiveShares
    
    
    Par Value
    
    
    Capital
    
    
    (Deficit)
    
    
    Compensation
    
    
    (Loss) Income
    
    
    TotalBalances at December 29, 2001
    
    
    63,921
    
    
    $
    639
    
    
    $
    194,311
    
    
    
    ($17,605
    )
    
    
    ($448
    )
    
    
    ($2,810
    )
    
    $
    174,087Comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,886
    
    
    
    
    
    
    
    
    
    
    
    24,886Net loss on derivative financial
instruments, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (271
    )
    
    
    (271
    )Amounts reclassified to interest
expense during the period from
derivative and hedging activities,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    973
    
    
    
    973Foreign currency translation adjustment,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    971
    
    
    
    971Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,559Issuance of common stockStock options exercised
    
    
    990
    
    
    
    10
    
    
    
    1,648
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,658Employee stock purchase plan
    
    
    84
    
    
    
    1
    
    
    
    692
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    693Direct grants
    
    
    4
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20Compensation cost of stock
options issued to non-employees
    
    
    
    
    
    
    
    
    
    
    26
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26Income tax benefit
from stock option plans
    
    
    
    
    
    
    
    
    
    
    1,043
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,043Amortization of
deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    176
    
    
    
    
    
    
    
    176Deferred compensation
forfeitures
    
    
    
    
    
    
    
    
    
    
    (74
    )
    
    
    
    
    
    
    74
    
    
    
    
    
    
    
    Balances at December 28, 2002
    
    
    64,999
    
    
    $
    650
    
    
    $
    197,666
    
    
    $
    7,281
    
    
    
    ($198
    )
    
    
    ($1,137
    )
    
    $
    204,262Comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,050
    
    
    
    
    
    
    
    
    
    
    
    29,050Net loss on derivative financial
instruments, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    (5
    )Amounts reclassified to interest
expense during the period from
derivative and hedging activities,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    460
    
    
    
    460Foreign currency translation adjustment,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,049
    
    
    
    2,049Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,554Issuance of common stockStock options exercised
    
    
    1,154
    
    
    
    12
    
    
    
    1,901
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,913Employee stock purchase plan
    
    
    116
    
    
    
    1
    
    
    
    775
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    776Direct grants
    
    
    2
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11Compensation cost of stock
options issued to non-employees
    
    
    
    
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24Income tax benefit
from stock option plans
    
    
    
    
    
    
    
    
    
    
    1,670
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,670Amortization of
deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    
    
    
    
    136Deferred compensation
forfeitures
    
    
    
    
    
    
    
    
    
    
    (38
    )
    
    
    
    
    
    
    38
    
    
    
    
    
    
    
    Balances at January 3, 2004
    
    
    66,271
    
    
    $
    663
    
    
    $
    202,009
    
    
    $
    36,331
    
    
    
    ($24
    )
    
    $
    1,367
    
    
    $
    240,346
 F-5




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##### Table of Contents



American Medical Systems Holdings, Inc.
Consolidated Statements of Changes in Stockholders Equity (continued)
(In thousands) AccumulatedAdditional
    
    
    Retained
    
    
    
    
    
    
    OtherCommon Stock
    
    
    Paid-In
    
    
    Earnings
    
    
    Deferred
    
    
    ComprehensiveShares
    
    
    Par Value
    
    
    Capital
    
    
    (Deficit)
    
    
    Compensation
    
    
    (Loss) Income
    
    
    TotalBalances at January 3, 2004
    
    
    66,271
    
    
    $
    663
    
    
    $
    202,009
    
    
    $
    36,331
    
    
    
    ($24
    )
    
    $
    1,367
    
    
    $
    240,346Comprehensive incomeNet loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,120
    )
    
    
    
    
    
    
    
    
    
    
    (3,120
    )Foreign currency translation adjustment,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,772
    
    
    
    3,772Unrealized (loss) on available-for-sale
securities, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16
    )
    
    
    (16
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    636Issuance of common stock:Stock options exercised
    
    
    1,124
    
    
    
    11
    
    
    
    5,095
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,106Employee stock purchase plan
    
    
    84
    
    
    
    1
    
    
    
    959
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    960Compensation cost of stock
options issued to
non-employees
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54Income tax benefit
from stock option plans
    
    
    
    
    
    
    
    
    
    
    2,047
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,047Amortization of
deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23
    
    
    
    
    
    
    
    23Deferred compensation
forfeitures
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    Balances at January 1, 2005
    
    
    67,479
    
    
    $
    675
    
    
    $
    210,163
    
    
    $
    33,211
    
    
    $
    
    
    
    $
    5,123
    
    
    $
    249,172
 The accompanying notes are
an integral part of the consolidated financial statements. F-6




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##### Table of Contents



American Medical Systems Holdings, Inc. 
 Consolidated Statements of Cash Flow
  2004
    
    
    2003
    
    
    2002Cash flows from operating activitiesNet (loss) income
    
    
    ($3,120
    )
    
    $
    29,050
    
    
    $
    24,886Adjustments to reconcile net (loss) income to
net cash provided by operating activities:Depreciation
    
    
    7,052
    
    
    
    6,487
    
    
    
    3,935Loss on asset disposals
    
    
    243
    
    
    
    224
    
    
    
    36Amortization of intangibles
    
    
    5,708
    
    
    
    4,160
    
    
    
    3,775Amortization of deferred financing costs
    
    
    450
    
    
    
    270
    
    
    
    420Non-cash in-process research and development charge
    
    
    35,000
    
    
    
    
    
    
    
    Non-cash investment impairment
    
    
    4,500
    
    
    
    
    
    
    
    Non-cash deferred compensation
    
    
    77
    
    
    
    171
    
    
    
    222Income tax benefit related to stock option plans
    
    
    2,047
    
    
    
    1,670
    
    
    
    1,043Change in net deferred taxes
    
    
    2,529
    
    
    
    3,117
    
    
    
    3,652Changes in operating assets and liabilities, net of acquisitions:Accounts receivable
    
    
    (7,009
    )
    
    
    (3,906
    )
    
    
    (1,215
    )Inventories
    
    
    (369
    )
    
    
    (3,108
    )
    
    
    673Accounts payable and accrued expenses
    
    
    1,835
    
    
    
    (3,526
    )
    
    
    (7,857
    )Other assets
    
    
    250
    
    
    
    (473
    )
    
    
    (732
    )Net cash provided by operating activities
    
    
    49,193
    
    
    
    34,136
    
    
    
    28,838Cash flows from investing activitiesPurchase of property, plant and equipment
    
    
    (3,686
    )
    
    
    (6,450
    )
    
    
    (1,695
    )Purchase of business, net of cash acquired
    
    
    (39,418
    )
    
    
    (44,135
    )
    
    
    Purchase of investments in technology
    
    
    (2,500
    )
    
    
    
    
    
    
    (1,000
    )Purchase of short-term investments
    
    
    (19,633
    )
    
    
    
    
    
    
    (9,446
    )Sale of short-term investments
    
    
    4,154
    
    
    
    
    
    
    
    37,242Purchase of other intangibles
    
    
    
    
    
    
    
    
    
    
    (1,010
    )Net cash (used in) provided by investing activities
    
    
    (61,083
    )
    
    
    (50,585
    )
    
    
    24,091Cash flows from financing activitiesIssuance of common stock
    
    
    6,066
    
    
    
    2,689
    
    
    
    2,351Payments on long-term debt
    
    
    (16,364
    )
    
    
    (7,636
    )
    
    
    (4,909
    )Net cash used in financing activities
    
    
    (10,298
    )
    
    
    (4,947
    )
    
    
    (2,558
    )Effect of exchange rates on cash
    
    
    (1,076
    )
    
    
    920
    
    
    
    303Net (decrease) increase in cash and cash equivalents
    
    
    (23,264
    )
    
    
    (20,476
    )
    
    
    50,674Cash and cash equivalents at beginning of period
    
    $
    58,953
    
    
    $
    79,429
    
    
    
    28,755Cash and cash equivalents at end of period
    
    $
    35,689
    
    
    $
    58,953
    
    
    $
    79,429Supplemental disclosureCash paid for interest
    
    $
    358
    
    
    $
    1,643
    
    
    $
    2,447Cash paid for taxes
    
    $
    14,807
    
    
    $
    9,255
    
    
    $
    10,308
 The accompanying notes are an integral part of the consolidated financial statements. F-7




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Business Description and Significant Accounting Policies Business Description American Medical Systems Holdings, Inc. manufactures and markets a broad line of proprietary
surgical products to urologists and gynecologists for erectile restoration, benign prostatic
hyperplasia (BPH), male urethral stricture, urinary and fecal incontinence, menorrhagia, and pelvic
organ prolapse. Principles of Consolidation The consolidated financial statements include the accounts of American Medical Systems Holdings,
Inc. and its subsidiaries after elimination of inter-company transactions and accounts. Accounting Periods We have a 52-or 53-week fiscal year ending on the Saturday nearest December 31. Accordingly,
fiscal years 2004, 2003, and 2002 ended on January 1, 2005; January 3, 2004; and December 28, 2002;
respectively, and are identified herein as 2004, 2003, 2002. Fiscal years 2002 and 2004 consisted
of 52 weeks, and 2003 consisted of 53 weeks. Stock Split On January 10, 2005, we announced a two-for-one stock split in the form of a 100% 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 will be 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. Cash and Cash Equivalents For financial reporting purposes, we consider all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Our cash and cash equivalent
balances are primarily with two investment managers, and the majority is invested in daily money
market funds, and high-grade commercial paper, and are carried at cost which approximates market. Short-Term Investments We classify investments as available-for-sale securities and record them at fair value. The following table identifies short-term investments by contractual maturity dates: (in thousands)
    
    Fair Value
    
    
    MaturityMunicipal notes and bonds
    
    $
    11,253
    
    
    Less than 1 yearCertificates of deposit
    
    
    586
    
    
    Less than 1 yearMunicipal variable rate
    
    
    3,640
    
    
    Greater than 10 yearsShort-term investments
    
    $
    15,479
 The total amount of unrealized losses for 2005 was $0.03 million and was recorded, net of tax
effect, as a separate component of accumulated other comprehensive income. Concentration of Risks Accounts receivable are primarily due from hospitals located mainly in the United States and
Western Europe. Although we do not require collateral from our customers, concentrations of credit
risk in the United States are mitigated by a large number of geographically dispersed customers.
We do not presently anticipate losses in excess of
allowances provided associated with trade
receivables, although collection could be impacted by the underlying economies of the countries. F-8




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##### Table of Contents



Allowance for Doubtful Accounts We estimate the allowance for doubtful accounts by analyzing those accounts receivable that have
reached their due date and by applying rates based upon historical write-off trends and specific
account reserves. Accounts are written off sooner in the event of bankruptcy or other
circumstances that make further collection unlikely. When it is deemed probable that a customer
account is uncollectible, that balance is written off against the existing allowance. Bad debt
expense was $1.8 million, $0.8 million and $0.6 million, in 2004, 2003 and 2002 respectively. The
allowance for doubtful accounts was $2.0 million at January 1, 2005 and $1.0 million at January 3,
2004. Inventories Inventories are stated at the lower of cost or market, determined on the first-in-first-out method.
On a quarterly basis, we evaluate inventories for obsolescence and excess quantities. The
evaluation includes analyses of inventory levels, historical loss trends, expected product lives,
product at risk of expiration, sales levels by product, and projections of future sales demand. We
reserve for inventory we consider obsolete. In addition, we record an allowance for inventory
quantities in excess of forecasted demand. Property, Plant and Equipment Property, plant and equipment, and major system software are carried at cost less accumulated
depreciation. Depreciation is recorded using the straight-line method over the following estimated
useful asset lives: Asset class
    
    Useful livesBuilding
    
    20 yearsMachinery and equipment
    
    5-12 yearsFurniture, fixtures, and other
    
    3-12 yearsSoftware
    
    3-5 yearsHer Optionconsoles
    
    3 years
 Maintenance, repairs, and minor improvements are charged to expense as incurred. Significant
improvements are capitalized. To the extent that we experience changes in the usage of equipment
or invest in enhancements to equipment, the estimated useful lives of equipment may change in a
future period. Her Optionconsoles are cryosurgical compressor systems which are used with disposable probes in
each procedure. The useful life of this capital equipment is estimated by management. Her Option
equipment had a net carrying value of $2.4 million at January 1, 2005, and $4.5 million on January
3, 2004. In-Process Research and Development, Goodwill and Other Intangible Assets When we acquire another company, the purchase price is allocated, as applicable, between in-process
research and development (IPR&D), other identifiable intangible assets, tangible assets, and
goodwill as required by U.S. GAAP. IPR&D is defined as the value assigned to those projects for
which the related products have not received regulatory approval, have no alternative future use,
and is immediately expensed. Determining the portion of the purchase price allocated to IPR&D and other intangible assets requires significant estimates. The amount of
the purchase price allocated to IPR&D and other intangible assets is determined by estimating the
future cash flows of each project or technology and discounting the net cash flows back to their
present values. The discount rate used is determined at the time of acquisition in accordance with
accepted valuation methods. For IPR&D, these methodologies include consideration of the risk of
the project not achieving commercial feasibility. Goodwill is the excess of the purchase price over the fair value of the other net assets, including
IPR&D, of acquired businesses. Under SFAS 142, Goodwill and Other Intangible Assets, goodwill and
other intangible assets with indefinite lives are not amortized, but are assigned to reporting
units and tested for impairment annually during the fourth quarter, or whenever there is an
impairment indicator. We operate as one reporting unit engaged in developing, manufacturing, and
marketing medical devices. We assess goodwill impairment indicators quarterly, or more frequently,
if a change in circumstances or the occurrence of events suggests the remaining value may not be
recoverable. Intangible assets that are not deemed to have an indefinite life are amortized over
their estimated useful lives. F-9




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The first step of the impairment test compares the fair value of a reporting unit with its carrying
amount, including goodwill and other indefinite lived intangible assets. If the fair value is less
than the carrying amount, the second step determines the amount of the impairment by comparing the
implied fair value of the goodwill with the carrying amount of that goodwill. An impairment charge
is recognized only when the calculated fair value of a reporting unit, including goodwill and
indefinite lived intangible assets, is less than its carrying amount. Other intangible assets include patents, non-compete agreements, and developed research and
development technologies. They are amortized using the straight-line method over their respective
estimated useful lives. Intangible assets with definite useful lives are reviewed for indicators
of impairment quarterly in accordance with SFAS 144, Accounting for the Impairment and Disposal of
Long-Lived Assets. Long-Lived Assets We follow SFAS 144 which requires impairment losses to be recorded on long-lived assets used in
operations when events and circumstances indicate the assets may be impaired and the undiscounted
cash flows estimated to be generated by those assets are less than the carrying amount of those
assets. Periodically, if an indicator of impairment exists, we measure any potential impairment
utilizing discounted cash flows as an estimate of fair value. Revenue Recognition We sell our products primarily through a direct sales force. Approximately 44 percent of our
revenue is generated from consigned inventory or from inventory with field
representatives. For these products, revenue is recognized at the time the product has been used
or implanted. For all other transactions, we recognize revenue when title to the goods and risk of
loss transfer to our customers providing there are no remaining performance obligations required
from us or any matters requiring customer acceptance. In cases where we utilize distributors or
ship product directly to the end user, we recognize revenue upon shipment provided all revenue
recognition criteria have been met. We record estimated sales returns, discounts and rebates as a
reduction of net sales in the sale period revenue is recognized. All of our customers have rights of return for the occasional ordering or shipping error. We
maintain an allowance for these returns and reduce reported revenue for expected returns from
shipments during each reporting period. This allowance is based on historical and current trends
in product returns. This allowance was $2.3 million and $1.7 million at January 1, 2005 and
January 3, 2004 respectively. Royalty Income Royalties from licensees are based on third-party sales of licensed products and are recorded as
other income in accordance with contract terms when third-party results are reliable, measurable,
and collectibility is reasonably assured. Royalty estimates are made in advance of amounts
collected using historical and forecasted trends. Research and Development Research and development costs are expensed as incurred. Advertising and Promotional Costs Advertising and promotional costs are charged to operations in the year incurred. Advertising and
promotion costs charged to operations during 2004, 2003, and 2002 were $2.6 million, $2.7 million
and $2.5 million, respectively. Product Warranty Costs We provide a warranty allowance to cover the cost of replacements for our erectile restoration,
BPH, incontinence, and menorrhagia products. The warranty allowance is an estimate of the future
cost of honoring our warranty obligations. Warranty costs are included as part of the cost of
goods sold. We warrant all of our products to be free from manufacturing defects. In addition, if a product
fails, we may provide replacements at no cost or a substantial discount from list price. We
maintain a warranty allowance to cover the cost of replacements for our erectile restoration,
incontinence, BPH, and menorrhagia products. When we sell products,
we record an expense for the
expected costs of future warranty-related claims, and increase the warranty allowance by an
equivalent amount. We reduce the warranty allowance by the cost of the replacement device when an
actual claim is awarded. F-10




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Product Liability We estimate the uninsured portion of legal representation and settlement costs of product liability
claims and lawsuits quarterly. This evaluation consists of reviewing historical claims costs as
well as assessing future trends in medical device liability cases. Social and political factors,
as well as surgeon and medical facility responsibility, make litigation costs hard to predict. If,
in the future, we determine that our accrual is inadequate, the adjustment would reduce reported
income in the period we recorded the adjustment. Software Development Costs We capitalize certain costs incurred in connection with developing or obtaining software for
internal use in accordance with AICPA Statement of Position 98-1, Accounting for Computer Software
Developed For or Obtained for Internal Use.The net book value of capitalized software development
costs was $0.6 million as of January 1, 2005 and $1.8 million as of January 3, 2004. Income Taxes We account for income taxes using the liability method. With this method, deferred tax assets and
liabilities are recorded based on the differences between the tax basis of assets and liabilities
and their carrying amounts for financial reporting purposes using enacted tax rates in effect in
the years in which the differences are expected to reverse. We have significant amounts of deferred tax assets that are reviewed for recoverability and then
valued accordingly. We evaluate the realizable value of the deferred tax assets on a quarterly and
yearly basis, as well as assess the need for valuation allowances by considering historical levels
of income, estimates of future taxable income, and the impact of tax planning strategies. We
record a valuation allowance to reduce deferred tax assets when we believe all or part of our
deferred tax assets will not be realized. Foreign Currency Translation The financial statements for operations outside the United States are maintained in their local
currency. All assets and liabilities of our international subsidiaries are translated to United
States dollars at year-end exchange rates, while elements of the statement of operations are
translated at average exchange rates in effect during the year. Translation adjustments arising
from the use of differing exchange rates are included in accumulated other comprehensive income
(loss) in stockholders equity with the exception of inter-company balances not considered
permanently invested. Gains and losses on foreign currency transactions are included in other
income or loss. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from these
estimates. The most significant areas which require managements estimates relate to the
allowances for doubtful accounts receivable, sales return reserve, excess and obsolete inventories,
product warranty, product liability claims, and income taxes. We are subject to risks and
uncertainties, such as changes in the health care environment, competition, and legislation that
may cause actual results to differ from estimated results. Stock Based Compensation At January 1, 2005 we have one stock-based employee compensation plan, which is described more
fully in Notes to Consolidated Financial Statements  No. 8. 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 generally equals the
market price of the underlying stock on the date the option is granted, and thus, under APB 25, no
compensation expense is recognized. During 2000, we recognized deferred compensation of $1.4
million for options granted prior to our initial public offering, as an estimate of the
excess of the fair value of the underlying stock on the date of grant over the exercise price; this
deferred compensation asset was being amortized over the option vesting periods of two to four
years, and is fully amortized as of January 1, 2005. F-11




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The Black-Scholes option valuation model was developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including the expected stock
price volatility. Because our employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input assumptions can affect
the fair value estimate, in managements opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options. We believe,
however, that the assumptions used in the following presentation are appropriate within the limits
of the model, and we do not believe that reasonable changes in these assumptions would have a
material impact on our financial condition, earnings, or cash flows. For purpose of pro forma
disclosure, the estimated fair value of the options is amortized to expense over the options
vesting period. Pro forma information regarding net income and net income per share required by SFAS 123, and as
amended by SFAS 148, has been determined as if we had accounted for our employee stock options
under the fair value method of SFAS 123. The fair value for these options was estimated at the
date of grant using the Black-Scholes option pricing model with the following weighted-average
assumptions: 2004
    
    
    2003
    
    
    2002Risk free interest rate
    
    
    3.71
    %
    
    
    3.81
    %
    
    
    3.00
    %Expected dividend rate
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Stock price volatility
    
    
    0.4145
    
    
    
    0.4320
    
    
    
    0.6175Expected life of option
    
    7 years
    
    7 years
    
    5 years
 The weighted average fair value of options granted during 2004, 2003 and 2002 was $7.29, $4.21
and $4.83 per share. The following table illustrates the effect on net income and net income per share if we had applied
the fair value recognition provisions of SFAS 123, Accounting for Stock-Based Compensation,to
stock-based employee compensation (in thousands, except per share data): (in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    2002Net (loss) income, as reported
    
    
    ($3,120
    )
    
    $
    29,050
    
    
    $
    24,886Stock-based employee compensation expense
included in reported income, net of tax
    
    
    15
    
    
    
    84
    
    
    
    109Total stock-based employee compensation
expense determined under fair-value based
method for all awards, net of tax
    
    
    (4,984
    )
    
    
    (3,093
    )
    
    
    (3,389
    )Pro forma net (loss) income
    
    
    ($8,089
    )
    
    $
    26,041
    
    
    $
    21,606Net (loss) income per shareAs reportedBasic
    
    
    ($0.05
    )
    
    $
    0.44
    
    
    $
    0.39Diluted
    
    
    ($0.05
    )
    
    $
    0.42
    
    
    $
    0.36Pro formaBasic
    
    
    ($0.12
    )
    
    $
    0.40
    
    
    $
    0.34Diluted
    
    
    ($0.12
    )
    
    $
    0.38
    
    
    $
    0.32
 Net Income per Share We present both basic and diluted net (loss) income per share amounts. Basic net (loss) income per
share is calculated by dividing net (loss) income by the weighted average number of common shares
outstanding during the year. Diluted net (loss) income per share is based upon the weighted average
number of common and common equivalent shares outstanding during the year which is calculated using
the treasury stock method for stock options. Common equivalent shares are excluded from the
computation in periods in which they have an anti-dilutive effect. Stock options for which the
exercise price exceeds the average market price over the period have an anti-dilutive effect on net
(loss) income per share and, accordingly, are excluded from the calculation. When there is a net
(loss), other potentially dilutive securities are not included in the calculation of net (loss) per
share since their inclusion would be anti-dilutive. F-12




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The following table presents information necessary to calculate basic and diluted net (loss) income
per common share and common share equivalents for the years ended 2004, 2003, and 2002: (in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    2002Net (loss) income
    
    
    ($3,120
    )
    
    $
    29,050
    
    
    $
    24,886Weighted-average shares
outstanding for basic net income per share
    
    
    67,006
    
    
    
    65,708
    
    
    
    64,464Dilutive effect of stock options
    
    
    
    
    
    
    2,918
    
    
    
    3,888Adjusted weighted-average
shares outstanding and assumed conversions
for diluted net (loss) income per share
    
    
    67,006
    
    
    
    68,626
    
    
    
    68,352Net (loss) income per shareBasic
    
    
    ($0.05
    )
    
    $
    0.44
    
    
    $
    0.39Diluted
    
    
    ($0.05
    )
    
    $
    0.42
    
    
    $
    0.36
 Employee stock options of 8,214,968; 1,114,804 and 1,038,900 for fiscal 2004, 2003 and 2002,
respectively, were excluded from the diluted net income per share calculation because their effect
would be anti-dilutive. Since 2004 is in a net (loss) position,
100 percent of outstanding
employee stock options are excluded from the diluted net (loss) per share calculation. In 2003 and 2002, only those options with an exercise price above the
market value are excluded from this calculation. 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 will be effective for fiscal years beginning after June 15, 2005. Adoption is not expected
to have a material impact on our consolidated financial statements. In December 2004, the Financial Accounting Standards Board 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 options 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. We will be required to adopt SFAS 123(R) in the third
quarter of 2005. 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 1. Currently, we use the Black-Scholes-Merton
formula to estimate the value of stock options granted
to employees. However, SFAS 123(R) also requires that the benefits of
tax deductions in excess of recognized compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods after the
effective date. While we cannot estimate what those amounts will be in the future
(because they depend on, among other things, when employees exercise stock options), the amount of
operating cash flows recognized in prior periods for such excess tax deductions were $2.0 million,
$1.7 million, and $1.0 million in 2004, 2003 and 2002, respectively. SFAS 123(R) permits public companies to adopt its requirements using one of two methods: 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. F-13




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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. Reclassification Certain 2003 and 2002 amounts have been reclassified to conform to the 2004 presentation. 2. Acquisitions TherMatrx On July 15, 2004, we acquired TherMatrx, Inc. At closing, the shareholders of TherMatrx were
initially paid cash consideration of $40.5 million. We 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. We used cash on hand
to make the initial payment of $40.5 million. Included in the $40.5 million initial payment was
$0.5 million for an estimated increase in net asset value. There was no increase in net asset
value, and we were repaid the $0.5 million in January 2005 when the amount in escrow was
distributed to TherMatrx shareholders. We also incurred $1.0 million of acquisition related costs
during 2004 which are netted against the contingent liability on acquisition. 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. The primary purpose of the TherMatrx acquisition was to gain access to their product for the
treatment of BPH. We believe that our current relationship with urologists will allow us to extend
the benefits of the TherMatrx product and technology to men suffering from BPH more efficiently and
effectively than TherMatrx could alone. We also believe that by broadening our prostate treatment
product line, we can offer more value to our 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 initial purchase price was 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
    
    
    4,455Deferred tax liability on assets acquired
    
    
    (8,578
    )Contingent liability on acquisition (including $1,014 of acquisition costs)
    
    
    (20,863
    )Initial purchase price
    
    $
    41,014
 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 F-14




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##### Table of Contents



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 contingent liability on acquisition was reduced from $20.9 million at initial acquisition to
$20.0 million at January 1, 2005, to reflect the contingent payment to be made based on the net
product revenues attributable to sales of DOT product during the period July 5, 2004 through
January 1, 2005. This contingent payment of $0.9 million was made in February 2005 and is included
in other accrued expenses at January 1, 2005. Our consolidated financial statements for the year ended January 1, 2005 include the financial
results of TherMatrx beginning July 15, 2004. Following are our as-reported results and pro forma
results of the combined companies, as if the acquisition had occurred at the beginning of 2003 (in
thousands, except per share data):


2004
    
    
    2003(in thousands, except per share data)
    
    Reported
    
    
    Pro forma
    
    
    Reported
    
    
    Pro formaRevenue
    
    $
    208,772
    
    
    $
    219,232
    
    
    $
    168,283
    
    
    $
    181,265Net (loss) income
    
    ($
    3,120
    )
    
    ($
    9,708
    )
    
    $
    29,050
    
    
    $
    28,267Net (loss) income per share:Basic
    
    ($
    0.05
    )
    
    ($
    0.14
    )
    
    $
    0.44
    
    
    $
    0.43Diluted
    
    ($
    0.05
    )
    
    ($
    0.14
    )
    
    $
    0.42
    
    
    $
    0.41


In addition to the one-time charge for in-process research and development of $35.0 million
which impacted 2004, the above pro forma results for 2004 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.

CryoGen

On December 30, 2002, we completed a merger with CryoGen, Inc. under which CryoGen became our
wholly-owned subsidiary. In conjunction with the merger, we paid the former shareholders of
CryoGen $36.2 million, and paid $4.1 million of acquisition-related liabilities. We also incurred
$1.6 million of acquisition-related legal and severance costs during 2003. In addition to the
initial consideration for the CryoGen acquisition, CryoGens former shareholders may contractually
receive an earnout payment contingent upon sales of CryoGen products. Any earnout payment is to be
equal to three times our net sales of CryoGen products during four consecutive quarters, less $40.0
million. 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. We
do not currently anticipate an earnout payment to the former CryoGen shareholders.

The primary purpose of the CryoGen acquisition was to gain access to their products and technology
and further our strategy of developing more and better treatments to improve womens health. We
believe that many women with incontinence and other pelvic disorders (treated by urologists and
gynecologists) also suffer from menorrhagia and uterine fibroids, and our investments in these
markets allow us to extend the highly-effective benefits of the CryoGen products and technology to
these women more efficiently and effectively than CryoGen could. We also believe that by
broadening our offerings beyond incontinence treatments, we can offer more value to our physician
customers. We believe as many as 150,000 American women every year suffer from hysterectomies
that might be avoided by using less invasive treatments such as Her Option. The primary advantage
of Her Optionover other less-invasive treatments is patient comfort. Gynecologists can use Her
Optionto cure menorrhagia in the office without monitored anesthesia with significant savings to
the healthcare system. Our consolidated financial statements for 2003 and 2004 include the
financial results of CryoGen from December 30, 2002, the date of the purchase.

F-15



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The initial purchase price was allocated as follows: (in thousands)
    
    AmountDeveloped technology and patents
    
    $
    5,009Tangible assets acquired, net of liabilities assumed
    
    
    2,922Deferred tax asset on assets acquired
    
    
    16,206Goodwill (including $5,757 of acquisition costs)
    
    
    17,820Initial purchase price
    
    $
    41,957
 Goodwill of $17.8 million recorded in the transaction will not be amortized and will not be tax
deductible for us. The intangible assets are composed of $4.6 million in developed technology and $0.4 million in
patents. We determined the value of the developed technology using a
discounted cash flow method over the estimated economic life of the technology. The developed
technology is amortized over the useful life of 10 years, with a full years amortization of $0.5
million included for both 2004 and 2003 results and reflected as part of the amortization of
intangibles line on the Consolidated Statement of Operations; acquired patents retained their value
as recorded on the CryoGen balance sheet on the date of acquisition, and are being amortized over
their useful lives. Deferred tax assets consist of $17.6 million related to federal income tax net operating loss
carryforwards of $50.4 million from the CryoGen pre-acquisition operations, offset by $1.4 million
in tax value of timing differences related to the assets and liabilities acquired in the
transaction. We used $4.5 million of this net operating loss in 2004 and expect to use the entire
carryforward amount subject to an annual Section 382 limitation of $4.5 million per year through
2007, and $1.8 million per year thereafter. While the NOLs begin expiring in 2012, we do not
expect to lose utilization through expiration. Tangible assets acquired consist mainly of Her Optioncompressor systems recorded at fair value,
determined by an independent consultant to be $3.8 million at the date of acquisition. Current
liabilities assumed in the transaction are composed of trade accounts payable, compensation
accruals, and other normal operating accruals. Dura II On April 7, 2003, we acquired the Dura IIline of erectile restoration products from Endocare, Inc.
We paid Endocare $2.2 million for all intellectual property, production equipment, and current
Dura IIinventory. The primary purpose of this acquisition was to fill the void in our product
line between our inflatable prostheses and our non-inflatable prostheses with an adjustable,
non-inflatable product. There are no contingent payments related to this acquisition. Our
consolidated financial statements for 2003 and 2004 include the financial results of this business
from the date of the purchase. The allocation of the initial purchase price for the acquisition, based on our internal valuation
study, is as follows (in thousands): (in thousands)
    
    AmountDeveloped technology
    
    $
    1,180Tangible assets acquired
    
    
    436Goodwill
    
    
    562Initial purchase price
    
    $
    2,178
 The developed technology asset, included in intangible assets, was valued using a discounted cash
flow method over the estimated economic life of the technology. This asset is being amortized over
its remaining life of seven and one-half years from the date of acquisition. Goodwill of $0.6 million recorded in the transaction will not be amortized and will not be tax
deductible. Pro forma results are not provided because amounts are not material. F-16




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3. Balance Sheet Information The following provides additional information (in thousands) concerning selected balance sheet
accounts: 2004
    
    
    2003Accounts ReceivableTrade accounts receivable
    
    $
    46,993
    
    
    $
    32,324Other receivables
    
    
    1,978
    
    
    
    2,216Allowance for doubtful accounts
    
    
    (1,987
    )
    
    
    (1,033
    )Net accounts receivable
    
    $
    46,984
    
    
    $
    33,507InventoriesRaw materials
    
    $
    5,191
    
    
    $
    5,260Work in process
    
    
    2,405
    
    

    
    2,823Finished goods
    
    
    15,866
    
    
    
    12,267Obsolescence allowance
    
    
    (1,743
    )
    
    
    (1,948
    )Net inventories
    
    $
    21,719
    
    
    $
    18,402Property, plant, and equipmentLand and building
    
    $
    16,434
    
    
    $
    14,408Machinery and equipment
    
    
    21,386
    
    
    
    22,384Software
    
    
    7,338
    
    
    
    6,747Furniture, fixtures, and other
    
    
    3,631
    
    
    
    3,043Accumulated depreciation
    
    
    (26,724
    )
    
    
    (21,093
    )Net property, plant, and equipment
    
    $
    22,065
    
    
    $
    25,489
 4. Goodwill and Intangible Assets The changes in carrying amount of goodwill for 2004 and 2003 (in thousands) are as follows: 2004
    
    
    2003Goodwill, beginning of year, net
    
    $
    98,989
    
    
    $
    80,607Additions
    
    
    
    
    
    
    18,382Effect of currency translation
    
    
    3,376
    
    
    
    Goodwill, end of year, net
    
    $
    102,365
    
    
    $
    98,989
 Under the provisions of SFAS 142, trademarks have been classified as an indefinite-lived asset, and
accordingly, are no longer being amortized. Definite-lived intangibles are being amortized over
periods ranging from two to ten years. F-17




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##### Table of Contents



The following table provides additional information concerning intangible assets: Weighted avg
    
    
    January 1, 2005
    
    
    January 3, 2004remaining life
    
    
    Gross carrying
    
    
    Accumulated
    
    
    Net book
    
    
    Gross carrying
    
    
    Accumulated
    
    
    Net book(in thousands)
    
    (years)
    
    
    amount
    
    
    amortization
    
    
    value
    
    
    amount
    
    
    amortization
    
    
    valueAmortizedPatents
    
    
    7.5
    
    
    $
    10,127
    
    
    ($
    6,605
    )
    
    $
    3,522
    
    
    $
    10,144
    
    
    ($
    5,459
    )
    
    $
    4,685Licenses
    
    
    4.1
    
    
    
    5,291
    
    
    
    (1,529
    )
    
    
    3,762
    
    
    
    2,790
    
    
    
    (1,048
    )
    
    
    1,742Deferred financing
    
    
    
    
    
    
    1,611
    
    
    
    (1,611
    )
    
    
    
    
    
    
    1,611
    
    
    
    (1,161
    )
    
    
    450Developed technology
    
    
    7.0
    
    
    
    48,853
    
    
    
    (13,140
    )
    
    
    35,713
    
    
    
    17,853
    
    
    
    (9,035
    )
    
    
    8,818Non-compete agreements
    
    
    
    
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    
    
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    Total amortized intangible assets
    
    
    6.6
    
    
    
    66,993
    
    
    
    (23,996
    )
    
    
    42,997
    
    
    
    33,509
    
    
    
    (17,814
    )
    
    
    15,695UnamortizedTrademarks
    
    
    n/a
    
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771
    
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771Total intangible assets
    
    
    
    
    
    $
    69,226
    
    
    ($
    24,458
    )
    
    $
    44,768
    
    
    $
    35,742
    
    
    ($
    18,276
    )
    
    $
    17,466
 The following discloses actual and expected aggregate amortization expense for currently-owned
intangible assets (in thousands) for 2002 through 2009: Year
    
    Actual
    
    
    Expected2002
    
    $
    3,775
    
    
    
    2003
    
    
    4,160
    
    
    
    2004
    
    
    5,708
    
    
    
    2005
    
    
    
    
    
    $
    6,1432006
    
    
    
    
    
    
    5,8402007
    
    
    
    
    
    
    4,9802008
    
    
    
    
    
    
    5,0592009
    
    
    
    
    
    
    4,579
 Patent Cross-License Agreement On September 13, 2004, we entered into a settlement agreement with Mentor Corporation under which
both parties agreed to dismiss the intellectual property lawsuits involving the two companies. We
also signed a non-exclusive cross-license agreement covering patents related to the field of female
pelvic health. Under the cross-license agreement, we made a one-time payment in the third quarter
of 2004 to Mentor in the amount of $2.5 million for access to a method patent owned by Mentor
covering the transobturator surgical approach and derivatives thereof. This investment has been
recorded as a license agreement in our intangible assets and is being amortized over our expected
revenue-producing life of 5 years. 5. Investment in Technology In 1999, we signed an exclusive, long-term agreement with InjecTx to distribute its urethral
injection system worldwide. We made an initial $2.0 million equity investment in October 1999, an
additional equity investments of $1.5 million in March 2001, and $1.0 million in May 2002, and have
accounted for this on a cost basis. This equates to 19 percent of common and preferred stock of
InjecTx. Since that time we have continued to develop the urethral injection system for BPH,
ProstaJect. Over the course of 2004, we worked with the FDA to clarify the requirements in the first phase of
the U.S. clinical trial of ProstaJect. The FDA established the requirement for a significant
number of patients to support NDA approval. As we have been unsuccessful in reducing these patient
numbers, we have suspended our activities toward gaining FDA approval of this product. This, in
combination with our acquisition of TherMatrx in the third quarter of 2004 and the determination of
the net present value of estimated future cash flows, has led us to conclude the likeli
hood of U.S. commercialization of ProstaJecthas diminished dramatically, thus, the value of our
equity ownership in InjecTx was impaired. F-18




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##### Table of Contents



During the fourth quarter of 2004, we recognized an investment impairment loss of $4.5 million
which is reflected as a separate component of other income and expenses on the Consolidated
Statement of Operations. For tax purposes, this capital loss can only be utilized against future
capital gains which are uncertain and therefore a complete valuation allowance has been established
related to this deferred tax asset (see Notes to Consolidated
Financial Statements  No. 13). 6. 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 for 2002 through 2004 are listed below. The adjustment shown for 2002 and 2003
represent a reduction in managements estimate of the future cost of honoring our warranty
obligations, resulting from improvements in the quality and durability of our products and changes
in our claims processing. The adjustment for 2004 represents warranty provision that was added as
part of the TherMatrx acquisition. (in thousands)
    
    2004
    
    
    2003
    
    
    2002Balance,
beginning of period
    
    $
    1,338
    
    
    $
    4,526
    
    
    $
    7,587Adjustment to allowance
    
    
    75
    
    
    
    (3,069
    )
    
    
    (2,913
    )Provisions for warranty
    
    
    334
    
    
    
    150
    
    
    
    Claims processed
    
    
    (296
    )
    
    
    (269
    )
    
    
    (148
    )Balance, end of period
    
    $
    1,451
    
    
    $
    1,338
    
    
    $
    4,526
 7. Long-Term Debt and Senior Credit Facility During 2004, we repaid the entire outstanding balance of $16.4 million and terminated the former
senior credit facility. 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. As of March 17, 2005, there were no borrowings outstanding under the credit
agreement. 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 and an interest
coverage ratio of not less than 3 to 1. 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. F-19




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##### Table of Contents



Derivatives and Hedging SFAS 133, Accounting for Derivative Instruments and Hedging Activities, requires that all
derivatives be recorded on the consolidated balance sheet at their fair value. Changes in the fair
value of derivatives are recorded each period in earnings or other comprehensive income (loss)
(OCI) depending on the type of hedging instrument and the effectiveness of those hedges. Our only derivative, an interest rate swap agreement was designated as a cash flow hedge and
expired June 30, 2003. Pre-tax losses totaling approximately $0.9 million were recognized during
2003 in interest expense. During 2003 and 2002, the effective portion of the cumulative gain or
loss on the derivative instrument was reported as a component of OCI in stockholders equity and
recognized in earnings in the same period or periods during which the hedged transaction affected
earnings. The ineffective portion of the derivative instrument, was reported as part of other
expense and was immaterial in 2003 and 2002. 8. Stockholders Equity Stock Incentive Plan The 2000 Equity Incentive Plan, as amended, provides for granting to eligible employees and certain
other individuals nonqualified and incentive stock options. We have reserved 14,710,000 shares of
common stock for issuance under the Plan. We have granted options to purchase an aggregate of
12,830,888 shares (net of cancellations), and 1,879,112 shares remain available for future option
grants. Twenty-five percent of the options granted under the Plan generally become exercisable on the first
anniversary date of the grant and 6.25 percent at the end of each quarter thereafter. Options are
granted with an exercise price equal to the fair market value of the common stock on the date of
the grant. The options typically expire, if not exercised, ten years after the date of grant. Activity in the
Plan was as follows: Weighted avgOptions
    
    
    exercise priceoutstanding
    
    
    per shareBalance at December 29, 2001
    
    
    6,995,360
    
    
    $
    3.02Granted
    
    
    1,361,110
    
    
    $
    10.23Exercised
    
    
    (990,252
    )
    
    $
    1.68Cancelled or expired
    
    
    (535,978
    )
    
    $
    5.32Balance at December 28, 2002
    
    
    6,830,240
    
    
    $
    4.47Granted
    
    
    2,169,104
    
    
    $
    8.33Exercised
    
    
    (1,153,748
    )
    
    $
    1.66Cancelled or expired
    
    
    (296,618
    )
    
    $
    8.10Balance at January 3, 2004
    
    
    7,548,978
    
    
    $
    5.86Granted
    
    
    2,258,700
    
    
    $
    15.48Exercised
    
    
    (1,124,136
    )
    
    $
    4.55Cancelled or expired
    
    
    (468,574
    )
    
    $
    8.99Balance at January 1, 2005
    
    
    8,214,968
    
    
    $
    8.51
 F-20




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##### Table of Contents



An aggregate of 4,807,282; 4,522,696 and 3,662,242 shares were exercisable at the end of 2004,
2003, and 2002. Exercise prices and weighted-average remaining contractual life for options
outstanding at the end of 2004 are summarized as follows: Options Outstanding
    
    
    Options ExercisableWeighted avg
    
    
    Weighted avg
    
    
    
    
    
    
    Weighted avgNumber
    
    
    remaining
    
    
    exercise
    
    
    Number
    
    
    exerciseRange of exercise prices
    
    of shares
    
    
    contractual life
    
    
    price
    
    
    of shares
    
    
    price$.84
    
    
    1,691,838
    
    
    4.2 years
    
    $
    0.84
    
    
    
    1,691,838
    
    
    $
    0.84$3.34 - $7.81
    
    
    1,549,722
    
    
    6.2 years
    
    $
    6.04
    
    
    
    1,399,786
    
    
    $
    5.92$8.00 - $8.68
    
    
    1,822,886
    
    
    7.9 years
    
    $
    8.12
    
    
    
    960,342
    
    
    $
    8.10$10.15 - $19.99
    
    
    3,150,522
    
    
    8.8 years
    
    $
    14.06
    
    
    
    755,316
    
    
    $
    11.73Total
    
    
    8,214,968
    
    
    7.2 years
    
    $
    8.51
    
    
    
    4,807,282
    
    
    $
    5.48
 Employee Stock Purchase Plan We have an Employee Stock Purchase Plan that allows employees to elect, in advance of each calendar
quarter, to contribute up to 10 percent of their compensation, subject to certain limitations, to
purchase shares of common stock at the lower of 85 percent of the fair market value on the first or
last day of each quarter. A total of 600,000 common shares were reserved for issuance under the
ESPP and 420,940 shares have been issued. 9. Commitments and Contingent Liabilities Product Liability We are self-insured for product liability claims below $1 million for each occurrence and $3
million in the aggregate, and maintain product liability insurance above these limitations. We are involved in a number of claims and lawsuits considered normal in our business, including
product liability matters. While it is not possible to predict the outcome of legal actions, we
believe that any liability resulting from the pending claims and suits that would potentially
exceed existing accruals would not have a material, adverse effect on our financial position or on our
results of operations or cash flows for any period. Operating Leases We have future minimum lease payment obligations for automobiles, office space, and other
facilities of $1.3 million for 2005, $0.8 million for 2006, $0.5 million for 2007, $0.3 million for
2008, and $0.3 million for 2009. Lease expense was $1.6 million, $1.7 million and $1.3 million in
2004, 2003, and 2002, respectively. The automobiles, which are typically leased for three years,
are used by sales personnel. The office obligations include the CryoGen manufacturing facility in
San Diego, the former TherMatrx facility near Chicago, and sales office outside the U.S. The
primary lease for the CryoGen facility expires on August 31, 2005. The lease for the TherMatrx
facility expires January 31, 2006. 10. Industry Segment Information and Foreign Operations Since its inception, we have operated in the single industry segment 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 2004, 2003, or 2002. Foreign subsidiary sales are predominantly to
customers in Western Europe, Canada, Australia, and Brazil. At the end of 2004 and 2003,
consolidated accounts receivable included $17.0 million and $12.5 million due from customers
located outside of the United States. F-21




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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. (in thousands)
    
    2004
    
    
    2003
    
    2002United StatesNet sales
    
    $
    165,140
    
    
    $
    136,765
    
    
    $
    116,523Long-lived assets
    
    $
    153,528
    
    
    $
    134,682
    
    
    $
    110,121Outside United StatesNet sales
    
    $
    43,632
    
    
    $
    31,518
    
    
    $
    25,125Long-lived assets
    
    $
    16,285
    
    
    $
    12,260
    
    
    $
    12,647
 11. Post-Retirement Benefits We have an unfunded post-retirement plan in the United States, which provides medical, dental, and
life insurance benefits at reduced rates to certain retirees and their eligible dependents.
Employees hired before 2000 are eligible if they meet age and service requirements and qualify for
retirement benefits. We provide funds to the plans as benefits are paid. The plan obligation was
measured as of January 1, 2005 and January 3, 2004, respectively. The cost of the post-retirement
benefit plan (in thousands) was as follows: 2004
    
    
    2003
    
    
    2002Service cost
    
    $
    112
    
    
    $
    118
    
    
    $
    100Interest cost
    
    
    132
    
    
    
    132
    
    
    
    125Amortization of net actuarial losses
    
    
    (142
    )
    
    
    (143
    )
    
    
    (159
    )Net benefit costs
    
    $
    102
    
    
    $
    107
    
    
    $
    66
 The following tables present reconciliations of the benefit obligation of the plan, the plan
assets of the pension plan and the funded status of the plan (in thousands): Other benefits2004
    
    
    2003Change in benefit obligationBenefit obligation at beginning of year
    
    $
    2,288
    
    
    $
    2,021Service cost
    
    
    112
    
    
    
    118Interest cost
    
    
    132
    
    
    
    132Actuarial (gains) or losses
    
    
    (16
    )
    
    
    186Benefit payments
    
    
    (66
    )
    
    
    (100
    )Settlements
    
    
    
    
    
    
    (69
    )Benefit obligation at end of year
    
    $
    2,450
    
    
    $
    2,288Change in plan assetsFair value of assets at beginning of year
    
    $
    
    
    
    $
    Actual return on plan assets
    
    
    
    
    
    
    Employer contributions
    
    
    
    
    
    
    Benefit payments
    
    
    
    
    
    
    Fair value of plan assets at end of year
    
    $
    
    
    
    $
    Funded statusFunded status
    
    ($
    2,450
    )
    
    ($
    2,288
    )Prior service cost
    
    
    (570
    )
    
    
    (704
    )Unrecognized net actuarial gain
    
    
    (198
    )
    
    
    (190
    )Net amount of accrued benefit cost
    
    ($
    3,218
    )
    
    ($
    3,182
    )Current
    
    $
    (92
    )
    
    $
    (72
    )Long term
    
    
    (3,126
    )
    
    
    (3,110
    )Net amount of accrued benefit cost
    
    $
    (3,218
    )
    
    $
    (3,182
    )
 F-22




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##### Table of Contents



The benefits expected to be paid in each of the next five fiscal years and the aggregate for
the five fiscal years thereafter are projected as follows (in thousands): 2005
    
    $
    92,0002006
    
    
    97,0002007
    
    
    113,0002008
    
    
    125,0002009
    
    
    130,0002010 - 2014
    
    $
    956,000
 The assumptions used in estimating the annual cost related to these plans include: 2004
    
    
    2003Discount rate
    
    
    5.8
    %
    
    
    6.3
    %Rate of future compensation increase
    
    
    4.0
    %
    
    
    4.0
    %
 An average increase of 9.0 percent in the cost of covered health care benefits was assumed for
2005 and is projected to gradually decrease to 5.0 percent by 2013 and remain at that level
thereafter. Since the employee subsidy cap has been reached, the health care cost trend rate
sensitivity analysis is no longer applicable. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 became
law. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a
federal subsidy to sponsors or retiree health care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. Our drug plan does not meet the actuarially
equivalent test because of a combination of the drug plan cost and the subsidy cap; therefore, the
plan is assumed to not qualify for the federal subsidy. In May 2004, the FASB issued FASB Staff Position (FSP) FAS 106-2, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,
which provides guidance on the accounting for the effects of the Act for employers that sponsor
postretirement health care plans that provide prescription drug benefits. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors
or retiree health care benefit plans that provide a benefit that is at least actuarially equivalent
to Medicare Part D. 12. Savings and Investment Plan The AMS Savings and Investment Plan allows employees in the United States to contribute a portion
of their salary to the Plan. We match a portion of these contributions and make additional
contributions to the Plan based upon a percent of operating profit above an established hurdle
rate. The additional percentage contribution and hurdle rate are established annually by senior
management. The Plan is intended to satisfy the requirements of Section 401(a) (27) of the
Internal Revenue Code. Generally, all of our employees are eligible to participate in the Plan.
Matching contributions of $1.4 million, $1.2 million and $1.1 million were made in 2004, 2003 and
2002, respectively. Profit sharing contributions were $1.9 million, $0.9 million and $1.1 million
in 2004, 2003 and 2002, respectively. 13. Income Taxes Components of our income before income taxes are as follows (in thousands): Pretax income
    
    2004
    
    
    2003
    
    
    2002U.S.
    
    $
    16,771
    
    
    $
    44,229
    
    
    $
    40,716Foreign
    
    
    132
    
    
    
    (140
    )
    
    
    (100
    )Total
    
    $
    16,903
    
    
    $
    44,089
    
    
    $
    40,616
 F-23




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##### Table of Contents



Components of income tax expense are as follows (in thousands): Income tax expense
    
    2004
    
    
    2003
    
    
    2002CurrentU.S.Federal
    
    $
    14,989
    
    
    $
    10,338
    
    
    $
    11,125State
    
    
    1,852
    
    
    
    1,384
    
    
    
    953Foreign
    
    
    653
    
    
    
    200
    
    
    
    DeferredU.S.Federal
    
    
    2,976
    
    
    
    2,995
    
    
    
    3,373State
    
    
    88
    
    
    
    122
    
    
    
    279Foreign
    
    
    (535
    )
    
    
    
    
    
    
    Total
    
    $
    20,023
    
    
    $
    15,039
    
    
    $
    15,730
 A reconciliation of income tax expense computed at the United States statutory rate to the
effective income tax rate is as follows (in thousands): Income tax reconciliation
    
    2004
    
    
    2003
    
    
    2002Statutory rate
    
    $
    5,916
    
    
    $
    15,430
    
    
    $
    14,216In process R&D
    
    
    12,250
    
    
    
    
    
    
    
    Investment write-off
    
    
    1,678
    
    
    
    
    
    
    
    Meals and entertainment
    
    
    245
    
    
    
    255
    
    
    
    162Prior year tax credits
    
    
    
    
    
    
    (1,100
    )
    
    
    Foreign
    
    
    79
    
    
    
    121
    
    
    
    3Current year tax credits
    
    
    (1,138
    )
    
    
    (780
    )
    
    
    Other
    
    
    (272
    )
    
    
    103
    
    
    
    106State taxes
    
    
    1,265
    
    
    
    1,010
    
    
    
    1,243Total
    
    $
    20,023
    
    
    $
    15,039
    
    
    $
    15,730
 On July 15, 2004, we completed the acquisition of TherMatrx, Inc. (see Notes to Consolidated
Financial Statements  No.2). Of the purchase price, $35.0 million was allocated to in-process
research and development and expensed. This amount will not be deductible for tax purposes, and no
deferred tax benefit is recorded or required by applicable accounting rules, resulting in the tax
related amount being reflected as a permanent difference. During the fourth quarter, we recognized a $4.5 million write-off of an equity investment in
InJectx, a 1999 investment in a company focused on the development of ethanol ablation systems for
prostate treatments. This created a capital loss carryforward which, for tax purposes, can only be
utilized to offset future capital gains. This capital loss carryforward will expire in 5 years. A
valuation allowance of $1.7 million for this capital loss carryforward has been established in the
current year as the likelihood of generating future capital gains to offset this capital loss
carryforward is not certain. During the third quarter of 2003, we applied for and recognized the U.S. tax benefits related to
research and development tax credits and extraterritorial income exclusion for the years 1999
through 2002. This resulted in a $1.1 million reduction to 2003 tax expense. Annual research and
development and extraterritorial income exclusion tax credits were reflected in income tax expense
for fiscal years 2004 and 2003 of $1.1 million and $0.8 million respectively. F-24




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##### Table of Contents



Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for income
tax purposes. Significant components of deferred income tax assets and liabilities at the end of
2004 and 2003 are as follows (in thousands): 2004
    
    
    2003Deferred tax assets:Federal NOL
    
    $
    14,873
    
    
    $
    16,054Intellectual property
    
    
    7,537
    
    
    
    7,070Other, primarily allowances
    
    
    2,424
    
    
    
    1,496Capital loss
    
    
    1,710
    
    
    
    Post retirement benefit liability
    
    
    1,449
    
    
    
    1,351Foreign NOL
    
    
    1,213
    
    
    
    722Workforce and patents
    
    
    1,003
    
    
    
    835Compensation accruals
    
    
    776
    
    
    
    1,818Accrued warranty expenses
    
    
    554
    
    
    
    550Foreign
    
    
    298
    
    
    
    Acquisition assets
    
    
    222
    
    
    
    1,191Valuation allowance
    
    
    (2,647
    )
    
    
    (684
    )Total deferred tax assets
    
    
    29,412
    
    
    
    30,403Deferred tax liabilities:Acquisition step-up
    
    
    12,406
    
    
    
    2,073Goodwill
    
    
    6,375
    
    
    
    5,343Acquired technology
    
    
    1,405
    
    
    
    1,889Currency translation adj
    
    
    789
    
    
    
    745Prepaid insurance and other
    
    
    671
    
    
    
    1,227Tax over book amortization
    
    
    
    
    
    
    498Total deferred tax liabilities
    
    
    21,646
    
    
    
    11,775Net deferred tax asset
    
    $
    7,766
    
    
    $
    18,628
 On January 1, 2005, we had foreign tax loss carryforwards of approximately $3.3 million with
no expiration. Realization of the future tax benefits related to the net deferred tax assets is
dependent on many factors, including the ability to generate taxable income in the related
jurisdiction. To the extent the net operating losses were created in a foreign jurisdiction, we
have included a valuation allowance of $0.9 million, which, if subsequently recognized, will be
allocated to goodwill. This amount represents the approximate amount by which the net operating
losses are projected to exceed future income in that foreign jurisdiction. We believe that future
taxable income will be sufficient to realize the remaining recorded asset. We have a U.S. federal tax loss carryforward of approximately $46.0 million of which $3.6 million
is limited by IRC Section 382 with the remaining NOL expiring between 2012 and 2022. 2004 income
tax expense has been reduced by $2.3 million due to the utilization of NOL. Management believes
that future taxable income will be sufficient to realize these tax loss carryforwards and has
established a deferred tax asset of $14.9 million. On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004. The Act creates
a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by
providing an 85 percent dividends received deduction for certain dividends from controlled foreign
corporations. The deduction is subject to a number of limitations and, as of today, uncertainty
remains as to how to interpret numerous provisions of the Act. As such, we will assess our
position on repatriation of foreign earnings in 2005. As of January 1, 2005, undistributed earnings of international subsidiaries of approximately $2.2
million were considered to have been reinvested indefinitely and, accordingly, we have not provided
U.S. taxes on such earnings. F-25




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##### Table of Contents



14. Quarterly Financial Data(unaudited; in thousands, except per share data) 2004
    
    
    2003First
    
    
    Second
    
    
    Third
    
    
    Fourth
    
    
    First
    
    
    Second
    
    
    Third
    
    
    Fourth13 weeks
    
    
    13 weeks
    
    
    13 weeks
    
    
    13 weeks
    
    
    13 weeks
    
    
    13 weeks
    
    
    13 weeks
    
    
    14 weeksNet sales
    
    $
    47,313
    
    
    $
    49,093
    
    
    $
    52,326
    
    
    $
    60,040
    
    
    $
    39,347
    
    
    $
    42,224
    
    
    $
    39,559
    
    
    $
    47,153Gross profit
    
    
    38,383
    
    
    
    40,046
    
    
    
    42,818
    
    
    
    49,194
    
    
    
    32,404
    
    
    
    34,843
    
    
    
    32,449
    
    
    
    41,234Operating income
    
    
    12,369
    
    
    
    12,951
    
    
    
    (21,806
    )
    
    
    15,906
    
    
    
    8,681
    
    
    
    9,492
    
    
    
    8,205
    
    
    
    15,262Net income
    
    
    8,027
    
    
    
    8,429
    
    
    
    (26,302
    )
    
    
    6,726
    
    
    
    5,454
    
    
    
    6,337
    
    
    
    6,940
    
    
    
    10,319Net income (loss) per
share:Basic
    
    $
    0.12
    
    
    $
    0.13
    
    
    ($
    0.39
    )
    
    $
    0.10
    
    
    $
    0.08
    
    
    $
    0.10
    
    
    $
    0.11
    
    
    $
    0.16Diluted
    
    $
    0.12
    
    
    $
    0.12
    
    
    ($
    0.39
    )
    
    $
    0.10
    
    
    $
    0.08
    
    
    $
    0.09
    
    
    $
    0.10
    
    
    $
    0.15
 We acquired TherMatrx during 2004 (see Notes to Consolidated Financial Statements  No.2).
This acquisition resulted in a one-time in-process research and development charge of $35.0 million
in the third quarter of 2004, resulting in a corresponding decrease to both operating income and
net income. During the fourth quarter of 2004, we recognized an investment impairment loss of $4.5
million related to its equity ownership in InjecTx (see Notes to Consolidated Financial Statements
- No. 5), resulting in a corresponding decrease to net income. During the fourth quarter of 2003,
we reduced the allowance for estimated warranty claims by $3.1 million; this adjustment was
recorded as a reduction in cost of goods sold and an increase in gross profit, operating income,
and net income. During the third quarter of 2003, we applied for and recognized the U.S. tax
benefits related to research and development tax credits and extraterritorial income exclusion for
the years 1999 through 2002; this resulted in a $1.1 million reduction in 2003 tax expense. Quarterly and annual earnings per share are calculated independently based on the weighted average
number of shares outstanding during the period. Sales and operating results have varied and are expected to continue to vary significantly from
quarter to quarter as a result of seasonal patterns, with the first and third quarters of each year
typically having lower sales and the fourth quarter of each typically having the highest sales. In
2004, the acquisition of TherMatrx in the third quarter resulted in increased sales for that
quarter, compared to prior year trends. F-26




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##### Table of Contents



Financial Statement Schedules-Schedule II  Valuation and Qualifying Accounts. This schedule of valuation and qualifying accounts (in thousands) should be read in conjunction
with the consolidated financial statements. All other schedules are omitted because they are not
applicable or the required information is shown in the financial statement or notes thereto. Balance at
    
    
    Additions charged to:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atBeginning of
    
    
    Costs and
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    End ofPeriod
    
    
    Expenses
    
    
    
    
    
    
    Accounts
    
    
    
    
    
    
    Deductions
    
    
    
    
    
    
    PeriodValuation Accounts:Year ended December 28, 2002Deducted from asset accountsAllowance for doubtful accounts
    
    $
    802
    
    
    $
    580
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    426
    
    
    
    (1
    )
    
    $
    956Allowance for obsolete inventories
    
    $
    2,699
    
    
    $
    1,659
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,610
    
    
    
    (2
    )
    
    $
    2,748Allowance for sales returns
    
    $
    463
    
    
    $
    2,225
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2,275
    
    
    
    (3
    )
    
    $
    413Year ended January 3, 2004Deducted from asset accountsAllowance for doubtful accounts
    
    $
    956
    
    
    $
    847
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    770
    
    
    
    (1
    )
    
    $
    1,033Allowance for obsolete inventories
    
    $
    2,748
    
    
    $
    1,083
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,883
    
    
    
    (2
    )
    
    $
    1,948Allowance for sales returns
    
    $
    413
    
    
    $
    3,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2,561
    
    
    
    (3
    )
    
    $
    1,779Year ended January 1, 2005Deducted from asset accountsAllowance for doubtful accounts
    
    $
    1,033
    
    
    $
    1,801
    
    
    
    
    
    
    $
    111
    
    
    
    (8
    )
    
    $
    958
    
    
    
    (1
    )
    
    $
    1,987Allowance for obsolete inventories
    
    $
    1,948
    
    
    $
    1,283
    
    
    
    
    
    
    
    25
    
    
    
    (8
    )
    
    $
    1,513
    
    
    
    (2
    )
    
    $
    1,718Allowance for sales returns
    
    $
    1,779
    
    
    $
    2,298
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,731
    
    
    
    (3
    )
    
    $
    2,346Qualifying Accounts:Year ended December 28, 2002Product liability allowance
    
    $
    1,498
    
    
    $
    360
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    720
    
    
    
    (4
    )
    
    $
    1,138Product warranty allowance
    
    $
    7,587
    
    
    
    ($2,913
    )
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    $
    148
    
    
    
    (5
    )
    
    $
    4,526Year ended January 3, 2004Product liability allowance
    
    $
    1,138
    
    
    $
    360
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    190
    
    
    
    (4
    )
    
    $
    1,308Product warranty allowance
    
    $
    4,526
    
    
    
    ($2,919
    )
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    $
    269
    
    
    
    (5
    )
    
    $
    1,338Year ended January 1, 2005Product liability allowance
    
    $
    1,308
    
    
    
    ($294
    )
    
    
    (7
    )
    
    
    
    
    
    
    
    
    
    $
    334
    
    
    
    (4
    )
    
    $
    680Product warranty allowance
    
    $
    1,338
    
    
    $
    334
    
    
    
    
    
    
    
    75
    
    
    
    (8
    )
    
    $
    296
    
    
    
    (5
    )
    
    $
    1,376
   Notes:(1)
    
    Uncollectable accounts written off, net of recoveries(2)
    
    Obsolete and excess inventory disposals(3)
    
    Returned product(4)
    
    Product liability claims(5)
    
    Product warranty claims(6)
    
    Reduction of warranty allowance (net of provision) recorded as a reduction in cost of goods sold(7)
    
    Reduction of product liability recorded to
reflect identified claims and lawsuits in ending balance of $0.6 million, net of current year provision of $0.3 million. Recorded as a reduction to general and administrative expenses.(8)
    
    Allowances and reserves on purchased balance sheet of TherMatrx, acquired in July 2004. Acticon, Apogee, AMS Ambicor, AMS 650, AMS 700, AMS 700 CX and Ultrex, AMS Artificial Urinary
Sphincter 800, BioArc, BioArc SP, BioArc TO, Dura II, Her Option, In-Fast, In-Fast Ultra,
InhibiZone, InteDerm, InteGraft, InteMesh, IntePro, InteLata, InteXçn, InVance, Monarc, Parylene,
Perigee, ProstaJect, Solutions for Life, SPARC, Straight-In, TherMatrx, and UroLume are trademarks
of AMS or its subsidiaries. F-27




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. Dated: March 17, 2005
    
    

    AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.By /s/ Martin J. EmersonMartin J. EmersonPresident and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below on March 15, 2005 by the following persons on behalf of the registrant and in the
capacities indicated. Signature
    
    Title/s/
    
    Martin J. Emerson
    
    President and Chief Executive Officer(Principal Executive Officer) and DirectorMartin J. Emerson/s/
    
    Carmen L. Diersen
    
    Executive Vice President, Chief Financial Officerand Corporate SecretaryCarmen L. Diersen
    
    (Principal Financial and Accounting Officer)/s/
    
    Douglas W. Kohrs
    
    Chairman of the Board and DirectorDouglas W. Kohrs/s/
    
    Richard B. Emmitt
    
    DirectorRichard B. Emmitt/s/
    
    Albert Jay Graf
    
    DirectorAlbert Jay Graf/s/
    
    Christopher H. Porter, Ph.D.
    
    DirectorChristopher H. Porter, Ph.D./s/
    
    Thomas E. Timbie
    
    DirectorThomas E. Timbie/s/
    
    Elizabeth H. Weatherman
    
    DirectorElizabeth H. Weatherman




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##### Table of Contents



AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. 
 EXHIBIT INDEX TO ANNUAL REPORT
 ON FORM 10-K
For the Year Ended January 1, 2005
 Item No.
    
    Item
    
    Filing Method3.1
    
    Amended and Restated Certificate of Incorporation of the Company.
    
    Filed with this Annual Report on Form 10-K.3.2
    
    Bylaws, as amended, of the Company.
    
    Incorporated by reference to Exhibit 3.2
of the Companys Form 10-K for the Year
Ended January 3, 2004 (File No.
000-30733).4.1
    
    Registration Rights Agreement, dated June
30, 2000, among the investors listed on
Schedule 1 to the Agreement and American
Medical Systems Holdings, Inc.
    
    Incorporated by reference to Exhibit 4.1
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).4.2
    
    Certificate of Incorporation of the Company.
    
    See Exhibit 3.1 above.4.3
    
    Bylaws of the Company.
    
    See Exhibit 3.2 above.10.1
    
    Stockholders Agreement, dated April 17,
2000, among Warburg, Pincus Equity Partners,
L.P., the then existing stockholders of
American Medical Systems Holdings, Inc. and
American Medical Systems Holdings, Inc.
    
    Incorporated by reference to Exhibit 10.1
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.2
    
    Amended and Restated Employment Agreement,
dated January 5, 2005, between Douglas Kohrs
and American Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.3
of the Companys Current Report on Form
8-K filed on January 5, 2005 (File No.
000-30733).10.3
    
    Stock Option Agreement, dated April 23,
1999, between Douglas Kohrs and American
Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.4
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.4
    
    Employment Agreement, dated April 26, 2004,
between Martin J. Emerson and American
Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.1
of the Companys form 10-Q for the Fiscal
Quarter Ended April 2, 2004.10.5
    
    First Amendment to Employment Agreement,
dated January 5, 2005, between Martin J.
Emerson and American Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.2
of the Companys Current Report on Form
8-K filed on January 5, 2005 (File No.
000-30733).10.6
    
    Employment Agreement, dated July 30, 2001,
between M. James Call and American Medical
Systems Inc.
    
    Incorporated by reference to Exhibit 10.8
of the Companys Form 10-K for the Fiscal
Year Ended December 29, 2001 (File No.
000-30733).10.7
    
    Employment Agreement, dated January 1, 2003,
between Ross Longhini and American Medical
Systems, Inc.
    
    Incorporated by reference to Exhibit 10.8
of the Companys Annual Report on Form
10-K for the year ended December 28, 2002
(File No. 000-30733).
 E-1




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##### Table of Contents



Item No.
    
    Item
    
    Filing Method10.8
    
    Employment Agreement, dated March 9, 2004,
between Carmen Diersen and American Medical
Systems, Inc.
    
    Incorporated by reference to Exhibit 10.8
of the Companys Annual Report on Form
10-K for the year ended January 3, 2004
(File No. 000-30733).10.9
    
    Consulting Agreement, dated September 1,
1999, between Medical Genesis and American
Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.8
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.10
    
    2000 Equity Incentive Plan, as amended.
    
    Incorporated by reference to Exhibit 10.1
of the Companys Form 10-Q for the Fiscal
Quarter Ended June 28, 2003 (File No.
000-30733).10.11
    
    Form of Incentive Stock Option Agreement.
    
    Incorporated by reference to Exhibit 10.10
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.12
    
    Form of Non-Qualified Stock Option Agreement.
    
    Incorporated by reference to Exhibit 10.11
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.13
    
    Employee Stock Purchase Plan.
    
    Incorporated by reference to Exhibit 10.12
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.14
    
    2005 Executive Variable Incentive Plan.
    
    Filed with this Annual Report on Form 10-K.10.15
    
    Summary of Director Compensation
    
    Filed with this Annual Report on Form 10-K.10.16
    
    Agreement and Plan of Merger, dated as of
December 13, 2002, by and among American
Medical Systems, Inc., Snowball Acquisition
Corp., Cryogen, Inc. and Robert Knarr.
    
    Incorporated by reference to Exhibit 2.1
of the Companys Current Report on Form
8-K filed on December 17, 2002 (File No.
000-30733).10.17
    
    First Amendment to Agreement and Plan of
Merger, dated December 18, 2002, by and
among American Medical Systems, Inc.,
Snowball Acquisition Corp., Cryogen, Inc.
and Robert Knarr.
    
    Incorporated by reference to Exhibit 2.1
of the Companys Current Report on Form
8-K filed on January 6, 2003 (File No.
000-30733).10.18
    
    Agreement of Purchase and Sale, dated April
17, 2003, among American Medical Systems,
Inc., Endocare, Inc. and Timm Medical
Technologies, Inc.
    
    Incorporated by reference to Exhibit 10.2
of the Companys Form 10-Q for the Fiscal
Quarter Ended June 28, 2003 (File No.
000-30733).
 E-2




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##### Table of Contents



Item No.
    
    Item
    
    Filing Method10.19
    
    Agreement and Plan of Merger, dated as of
June 15, 2004, by and among American Medical
Systems, Inc.; Leio Acquisition Corp.;
TherMatrx, Inc.; TherMatrx Investment
Holdings LLC and BSD Medical Corporation, as
Principal Stockholders, and TherMatrx
Investments Holdings LLC, as Stockholders
Representative.
    
    Incorporated by reference to Exhibit 2.1
of the Companys Current Report on Form
8-K filed on June 15, 2004 (File No.
000-30733).10.20
    
    Credit Agreement, dated as of January 20,
2005, among American Medical Systems
Holdings, Inc., American Medical Systems,
Inc., KeyBank National Association, as
Administrative Agent, Swing Line Lender, and
L/C Issuer, and the lenders from time to
time party thereto.
    
    Incorporated by reference to Exhibit 10.1
of the Companys Current Report on Form
8-K filed on January 20, 2005 (File No.
000-30733).21.1
    
    Subsidiaries of American Medical Systems
Holdings, Inc.
    
    Filed with this Annual Report on Form 10-K.23.1
    
    Consent of Ernst & Young LLP.
    
    Filed with this Annual Report on Form 10-K.31.1
    
    Certification of Chief Executive Officer
pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
    
    Filed with this Annual Report on
Form 10-K.31.2
    
    Certification of Chief Financial Officer
pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
    
    Filed with this Annual Report on
Form 10-K.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 Annual Report on
Form 10-K.
 E-3