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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 3, 2004
    
    000 - 30733
   AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.  Delaware
(State of Incorporation)
    
    41-1978822
(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 x 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. x Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes x No o As of June 27, 2003,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 $370,589,582. As of March 10, 2004, 33,244,419 shares of Common Stock 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 2004 Annual Meeting of
Stockholders to be held May 6, 2004 (the 2004 Proxy Statement).




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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC. FORM 10-K For the Fiscal Year Ended January 3, 2004 TABLE OF CONTENTS Description
    
    PagePART IItem 1. Business.
    
    1Item 1a. Risk Factors.
    
    8Item 2. Properties.
    
    10Item 3. Legal Proceedings.
    
    10Item 4. Submission of Matters to a Vote of Security Holders.
    
    10Item 4a. Executive Officers of The Registrant.
    
    11PART IIItem 5. Market For Registrants Common Equity and Related Stockholder Matters.
    
    12Item 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.
    
    23Item 8. Financial Statements.
    
    23Item 9. Changes In and Disagreements With
Accountants on Accounting and Financial Disclosure.
    
    24Item 9a. Controls and Procedures.
    
    24PART IIIItem 10. Directors and Executive Officers of the Registrant.
    
    24Item 11. Executive Compensation.
    
    25Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters.
    
    25Item 13. Certain Relationships and Related Transactions.
    
    25Item 14. Principal Accountant Fees and Services
    
    25PART IVItem 15. Exhibits, Financial Statement Schedules, and Reports On Form 8-K.
    
    26EXHIBIT INDEX
    
    E-1Bylaws, as Amended, of the CompanyEmployment Agreement - Carmen Diersen2003 Management Incentive PlanFourth Amendment to Credit AgreementFifth Amendment to Credit AgreementConsent of Ernst & Young LLPCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification Pursuant to Section 906
 i




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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 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 for erectile restoration; other mens health needs,
including products for incontinence, stricture, and prostate disease; and
womens health needs, including products for incontinence, menorrhagia,
prolapse, and other pelvic floor disorders. We estimate these diseases affect
approximately 242 million people in the United States and Europe, profoundly
diminishing their quality of life and significantly impacting their
relationships. Our product development and acquisition strategy has focused on
expanding our product offering and on adding less-invasive medical devices for
surgeons and their patients. We believe that nearly 70 million men and women
are potential candidates for treatment with our products, although only a few
of these ever seek treatment. 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 erectile
dysfunction, incontinence, prostate disease, menorrhagia, prolapse, or other
pelvic disorders has grown with the publicity for new treatments, especially
new drug therapies, but the portion seeking treatment remains relatively small.
When patients do seek treatment, they generally begin with medical treatment
rather than surgical treatment, regardless of the severity of the disease.
Only if medical therapy is unsuccessful and the patient persists with seeking a
cure 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 non-aging quality of life, the expanding availability of safe and
effective treatments, and increasing patient and physician awareness of these
treatments. The diseases we treat are seldom life threatening but can profoundly affect the
quality of ones life. The burden of these diseases increases with age. The
incidence of erectile dysfunction and incontinence in men increases with age
and with the incidence of prostate surgery, which also grows with age. Female
incontinence is linked to pregnancy and childbirth among younger women, but
occurs independently as women age. As a result, we believe that as the baby
boomer generation moves into their mid- to late-50s, which is happening during
this decade, the growth in the 1




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need for our products will accelerate. We also believe that this group and
those that follow will be less willing to accept the natural deterioration of
body functions, and their desire to maintain a non-aging quality of life will
amplify their increased demand for procedures using our products. Providing an expanding portfolio of
treatment options is an important business
driver for us. In the last several years we have successfully introduced a
series of new products to meet our target physician and patient needs. In
2003, products introduced in the last three years accounted for 47 percent of
our consolidated revenue. Our product development and acquisition strategy has
focused on expanding our product offering with products and procedures which
improve outcomes, reduce operating time and operating trauma, 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 Pfizers extensive advertising campaign for
Viagra. We anticipate the combined advertising expenditures for currently
available erectile dysfunction drugs will exceed $200 million in 2004.
Advertising for incontinence management may reach $100 million in 2004, with
campaigns selling absorbent pads and drugs. 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 by sponsoring meetings where
their 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-consumer 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 June 2003, we began extensive training and proctoring
for gynecologists and urologists in the United States for our Monarcproduct 
an innovative treatment for women with stress incontinence. From June through
December 2003, we trained more than 1,000 U.S. surgeons on the Monarcsystem.
In 2003, physicians successfully performed over 12,000 Monarcprocedures around
the world, with more than half of those occurring in the fourth quarter, and we
expect that this new product will be a growing revenue contributor in 2004.
With thirty years experience, we believe we have a very strong franchise with
urologists; we are working to build a similarly strong franchise with
gynecologists. This gynecologist franchise is critical to our growth because
most women who suffer from incontinence and the other diseases our products can
treat are more likely to first seek help from a gynecologist or other primary
care physician than from a urologist. The expansion of our product offering, combined with increasing physician and
patient awareness, has greatly increased our business opportunities. For
example, where only 2 percent of men have symptoms of urinary incontinence by
age 45, and 6 percent by age 65, nearly 30 percent of women report some degree
of incontinence by age 45 and nearly 50 percent by age 65. This means that
while there may be four million men with some degree of incontinence in areas
where we have a direct sales force, there are approximately 53 million women
with some degree of incontinence. Seventy percent of procedures utilizing our
products in 2003 were for womens health, compared to less than three percent
in 1999. Erectile Restoration Net sales of these products were $59.2 million, $69.6 million, and $72.4
million in 2001, 2002, and 2003, and were 50.2 percent, 49.1 percent, and 43.0
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 Viagra or a similar-acting drug. 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 2001, we began offering
two 2




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significant improvements to our AMS 700inflatable prostheses: (1) a parylene
coating on certain internal surfaces of the prosthesis, to reduce friction and
increase durability, and (2) our InhibiZoneantibiotic surface treatment to
help reduce the risk of surgical infections. Physician preference for this new
product, which carries a higher price than any of our untreated products, was a
major contributor to the growth in erectile restoration sales in 2002 and 2003.
In April 2003, we expanded our range of erectile restoration products by
purchasing the Dura IIline of prostheses from Endocare. Mens Bladder Control Net sales of these products were $30.5 million, $35.3 million, and $39.8
million in 2001, 2002, and 2003, and were 25.9 percent, 24.9 percent, and 23.6
percent of sales in those years. Approximately four million 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
during prostate 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 and 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, which is a less invasive procedure for men with mild to
moderate incontinence. This system uses technology which came with our 1999
acquisition of Influence Inc. to support the bulbous urethra and improve
urinary control. Prostate Treatments Net sales of these products were $7.1 million, $6.1 million, and $4.9 million
in 2001, 2002, and 2003, and were 6.0 percent, 4.3 percent and 2.9 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 these restrictions include increased urination frequency, sudden
urges to urinate, and weak urine flow. Nearly 70 percent of men over age 65
have some indications of BPH, and approximately 31 million of them have
symptoms that require treatment. For those who find existing drug treatments
unacceptable, the conventional treatment is a transurethral resection of the
prostate (TURP). We offer the UroLumeendoprosthesis stent as a less invasive
procedure for men who may not be good surgical candidates. Newer,
less-invasive tissue ablation techniques such as lasers, RF energy needles, and
microwave therapy are becoming increasingly available as alternatives to
procedures using our products. As a result, we do not expect to reverse the
declining revenue trend of recent years unless we acquire a new technology. In
1999, we acquired exclusive worldwide distribution rights for the ProstaJect
system to inject ethanol or other medicaments to treat prostate disease. This
therapy is currently in U.S. clinical trials and is approved for sale in
Europe. Womens Health Net sales of these products were $21.1 million, $30.7 million, and $51.2
million in 2001, 2002, and 2003, and were 17.9 percent, 21.7 percent, and 30.4
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 mixed. Pads and diapers are often used to contain and absorb leaks,
and may be acceptable for controlling mild incontinence; new drugs may be shown
to be effective, especially for urge incontinence. Our products treat stress
incontinence, which generally results from a weakening of the tissue
surrounding the bladder, urethra, and bladder neck from childbirth and aging.
Pregnancy and childbirth trauma may also cause fecal incontinence, pelvic organ
prolapse, and other pelvic floor disorders. Incontinence may be relieved
through exercise to strengthen pelvic floor muscles, or the injection of
collagen or some other bulking agent into the wall of the urethra, bladder
neck, or sphincter to narrow the passage. Surgical solutions are generally
recommended only if these therapies are not effective. Prolapse and other
pelvic floor defects may be repaired with a variety of open, laparoscopic, and
transvaginal surgeries. We offer a broad range of systems to restore continence including the
Artificial Urinary Sphincter (outside the U.S.), and the In-Fast, SPARC,
Monarc,and BioArc SPsling systems. This broad range allows the surgeon to
select the procedure most appropriate to the patients symptoms and anatomy.
With an In-Fastprocedure, which we have 3




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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 allow better placement of the bone anchors which hold 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 SPARC II, with several
improvements in form and function. Since its introduction, SPARChas been the
major sales driver in our products for womens health. The Monarcprocedure
was introduced at the end of 2002, and uses unique helical needles to place a
self-fixating, sub-fascial hammock through the transobturator foramina. This
procedure may be done without disrupting the endopelvic fascia and is
especially valuable for women who have scarring from previous abdominal surgery
and are not good candidates for a SPARCprocedure. 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 a biological graft material attached to a
self-fixating synthetic sling. The new BioArc SPsystem employs the same
suprapubic approach of the SPARCsystem, which has been used in more than
70,000 procedures since we introduced it in 2001, and we expect it will fill a
niche for physicians who would prefer not to use traditional sling material
around the urethra. The Acticonneosphincter, an extension of our urinary control technology, is
used to cure severe fecal incontinence. We also offer InteGraftpelvic
reconstructive materials and a growing number of surgical tools to repair
bladder and other pelvic organ prolapse. Approximately 28 million women in the United States and Europe suffer from
excessive uterine bleeding, or menorrhagia. Menorrhagia is socially
debilitating and causes anemia. Drug therapies are effective for some women,
but many end up with a hysterectomy. We estimate that as many as 150,000 (25
percent of all hysterectomies) in the United States each year are the result of
menorrhagia. Other procedures which have some efficacy include dilation and
curettage to remove the endometrial tissue from the uterus, and several new
techniques to destroy the endometrium with heat or cold. On December 30, 2002,
two days after the close of our 2002 fiscal year, 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 can be performed in the gynecologists office, allowing the patient
to keep her uterus and normal hormonal levels, and avoids the hospital stay and
recovery time associated with a hysterectomy. We believe that Her Option
offers significant advantages over other therapies to the patient, her
physician, and the healthcare system. These other therapies are, however,
supported by more marketing resources and have a greater installed base of
experienced users than CryoGen has. Further, this is our most significant
venture into products used primarily by gynecologists rather than urologists.
Our success with this product will depend on, among other things, our ability
to quickly understand the needs of gynecologists and build a marketing and
sales organization to address those needs, and our ability to obtain adequate
reimbursement for physicians performing this procedure in their office. On
March 2, 2004, the American Medical Association notified us that it had
approved a Category I Current Procedure Terminology code for an endometrial
cryoablation procedure using Her Option. This code is used by physicians and
payers to describe medical procedures, without which reimbursement decisions
are difficult, if not impossible. We expect the code to be published in the
fall of 2004 and be effective in January 2005. According to the letter from
the AMA, the code will apply to Her Optionprocedures done in a hospital,
ambulatory surgical center, or physicians office. Selling and Marketing We sell our products in the United States, Canada, Australia, and most European
countries through direct field representatives. We have 114 employees in our
U.S. sales force and 54 employees in our international sales force. We have 46
independent distributors who represent our products in other countries and
account for less than five percent of our world-wide 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. Our marketing people are 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 U.S. hospitals 4




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at prices ranging from $6,100 for an inflatable system which, when implanted,
is practically indistinguishable from the dysfunctional tissue it replaces, to
$2,700 for a much simpler prosthesis which creates a somewhat less natural
rigidity. Products for womens bladder control are similar to each other in
cost and value, and range from $800 to $1,000, plus, in many instances, the
cost of the sling material. Systems for mens bladder control are much more
complicated and costly than those for women, and sell for prices ranging from
$2,000 to $6,300. Manufacturing and Supply We use approximately 80,000 square feet of our facility in Minnetonka 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, some materials are only supplied by a limited number of
vendors. 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 facility, although we work with
physicians, research hospitals, and universities around the world. None of
this work is funded by customers or other outside institutions. 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 2003, we increased our spending on new product development activities,
including clinical and regulatory work, by 26 percent, from $11.9 million in
2002 (8.4 percent of sales) to $14.9 million in 2003 (8.9 percent of sales). We
spent $11.9 million on research and development activities in 2001. Within
this area, we increased our investment in research and product design work by
51 percent. For 2004, we are planning on further increases, spending between 8
and 10 percent of sales on new product development. We plan to introduce several new products during 2004, none of which will
require the investment of a material amount of our assets. These new products
are all expansions of our existing product and physician franchise, including
delivery-system improvements to our InVancemale sling product; the BioArc TO,
an extension of the BioArc SPwe launched for female incontinence in 2003 using
the transobturator approach to place a sub-fascial hammock rather than the
supra-pubic approach to place a sling; and a more easily activated pump for our
inflatable prostheses, and new products for prolapse repair. 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, 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 male bladder
control systems. Principal competitors for our prostate products include drug 5




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manufacturers and other minimally-invasive treatment suppliers such as Johnson
& Johnson, Laserscope, Medtronic, Thermatrx, and Urologix. Our principal
competitors for womens health products include, for treating menorrhagia,
Boston Scientific, Johnson & Johnson, and Novacept; and, for other products,
Boston Scientific, C.R. Bard, Johnson & Johnson, and Mentor. 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 113 issued U.S. patents, nearly 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 advantages
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. We are currently involved in an intellectual property
lawsuit with Mentor Corporation which is described under Item 3 Legal
Proceedings. 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
for marketing. 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. Some of our products may require
approval of a New Drug Application, or NDA. The PMA and NDA processes 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. The same caveat applies to
investigational new drug (IND) studies that support an NDA. 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 incontinence 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 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. 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 6




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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. The FDA has proposed a more comprehensive regulatory framework that builds upon
and supersedes the existing regulations for human tissue-based products.
Implementation of this proposed regulatory approach may lead to medical device
submissions for some of the tissue products we provide with our sling kits. 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 reimbursing at rates which do not cover the full cost
of procedures. These activities may be particularly detrimental to AMS because
our products treat quality-of-life conditions rather than life-threatening
conditions, and 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 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. For example, from 2001 to 2002 Medicare
reimbursement for hospital-based outpatient surgical procedures using our
inflatable penile prostheses for erectile restoration, including the
pass-through payment for our device, decreased approximately 32 percent, and
U.S. sales of products used in these surgeries increased 18 percent. From 2002
to 2003, reimbursement declined another 9 percent, and our sales increased less
than 1 percent. For 2004, reimbursement for these procedures, including the
payment for our device, will increase 27 percent over 2003. Ultimately, we
cannot predict the frequency or severity of future reimbursement reductions,
and such future reductions, if they occur, could have a material, adverse
effect on our revenue growth rates and profitability. Employees We employ 587 people in the following areas: 156 in manufacturing, 254 in sales
and marketing, 81 in administration, 49 in regulatory, clinical and quality
assurance, and 47 in research and development. We do not have any active
organized labor unions. We believe we have an excellent relationship with our
employees. Financial Information about Geographic Areas Approximately
18.7 percent of our 2003 consolidated revenues are from sales to
customers outside of the United States. 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 are dependent on raw materials from one or two suppliers
who may not be able to meet our demands or who may decide to stop supplying us
because of their concerns about product liability claims or other reasons.
Losing any of these raw material suppliers could have a material adverse effect
on our sales and income. As a result of recent supplier consolidations, we now
rely on only one source for the silicone elastomer used in some of our
implantable products; the loss of this supplier would have a material adverse
effect on our cost of goods sold and income, as we would be required to qualify
an additional supplier. We procure human cadaveric dermis through two
processors, and we have one supplier of porcine dermis. Potential Product Recalls In the event that any of our products were defective, we could voluntarily
recall, or the FDA 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.
For example, during 2003 we have committed significant marketing and selling
resources to making the Monarcsub-fascial hammock for urinary incontinence and
the Her Optiontherapy for excessive uterine bleeding available to physicians
and their patients. We believe both of these products address major market
opportunities, but if we are unsuccessful in marketing either of them, our
sales and earnings might be below expectations. Successful Introduction of New Products and Product Improvements As part of our growth strategy, we intend to introduce a number of new products
and product improvements. If we do not introduce these new products and
product improvements on schedule, or they are not well-accepted by the market,
our growth will suffer. Continued Use of Non-Invasive Treatment Alternatives We predominantly sell devices and kits for invasive or minimally invasive
surgical procedures. If patients do not accept our products, our sales may
decline. Patient acceptance of our products depends on a number of factors,
including the failure of non-invasive therapies, the degree of invasiveness
involved in the procedures using our products, the rate and severity of
complications, and other adverse side effects from the procedures using our
products. Patients are more likely to first consider non-invasive alternatives
to treat their urological disorders. The introduction of new oral medications
or other less-invasive therapies might cause our sales to decline. Actions Related to Reimbursement for Procedures Using our Products Some portions of our revenues depend on U.S. and non-U.S. government health
care programs and private health insurers reimbursing patients medical
expenses. Physicians, hospitals, and other health care providers might not
purchase our products if they do not receive satisfactory reimbursement from
these third-party payers for the cost of procedures using our products. For
example, effective January 1, 2003, the Centers for Medicare and
Medicaid Ser- 8




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##### Table of Contents



vices (CMS) again reduced the hospital payment rates for certain procedures in
which our products are used. We do not believe these reductions had a
material, adverse effect on our sales or earnings in 2003, but we do not know
if hospitals that treat Medicare and Medicaid patients have prohibited
physicians from performing procedures using our products. While CMS has
increased some of these procedure reimbursement rates effective January 1,
2004, we do not know whether these increases will be sufficient incentive for
hospitals to allow or encourage physicians to provide services using our
products. Further, in the United States there have been, and we expect that
there will continue to be, a number of federal and state proposals to control
health care costs. Government and private insurers, both inside and outside of
the United States, may lower their reimbursement rates in the future, which
could adversely affect future hospital and physician support for our products. As previously noted, the American Medical Association has announced it will be
issuing a Category I CPT code for cryoablation using Her Option. This decision
starts a process of updating the AMAs Resource-Based Relative Value Scale
(RBRVS), which will be referenced by health care payers in determining payments
for the procedure. We expect the RBRVS update will be published in late 2004
and become effective in January 2005. We can offer no assurances that a new
code for Her Optionprocedures will be in place by January 2005 or that the
reimbursement will adequately cover the costs of performing the procedure. If
reimbursement for the Her Optionprocedure were not adequate to cover the full
cost of performing the procedure, our sales and earnings would be below
expectations. Intellectual Property Lawsuits The medical device industry is litigious with respect to patents and other
intellectual property rights. Companies in the medical device industry have
used intellectual property litigation to gain a competitive advantage. We are
currently involved in an intellectual property lawsuit with Mentor Corporation
relating to our Monarcsub-fascial hammock for the treatment of female
incontinence. See Item 3 Legal Proceedings for more specific information
regarding this lawsuit. If Mentor were to succeed in this lawsuit, the court
could require us to pay significant damages to Mentor, prevent us from selling
our Monarcsub-fascial hammock for the treatment of female incontinence, or
both. The occurrence of any of these would have a negative impact on our
business. In the future, we may become a party to other lawsuits involving patents or
other intellectual property. A legal proceeding, regardless of the outcome,
could drain our financial resources and divert the time and efforts of our
management. If we lose one of these proceedings, a court, or a similar foreign
governing body, could require us to pay significant damages to third parties,
require us to seek licenses from third parties and pay ongoing royalties,
require us to redesign our products, or prevent us from manufacturing, using or
selling our products. In addition to being costly, protracted litigation to
defend or prosecute our intellectual property rights could result in our
customers or potential customers deferring or limiting their purchase or use of
the affected products until resolution of the litigation. Product Liability Lawsuits The manufacture and sale of medical devices exposes us to significant risk of
product liability claims. In the past, we have had a number of product
liability claims relating to our products. In the future, we may be subject to
additional product liability claims, some of which may have a negative impact
on our business. If a product liability claim or series of claims is brought
against us for uninsured liabilities or for amounts in excess of our insurance
coverage, our business could suffer. We are not currently involved in any
material product liability litigation. Costs of Physician Malpractice Insurance Most of our products are used by physicians who are required to maintain
certain levels of medical malpractice insurance to maintain their hospital
privileges. As the cost of this insurance increases, certain physicians who
have used our products to treat their patients may stop performing surgeries.
Unless these patients who would have been treated by these physicians are
referred to other physicians, sales of our products will decline. Acquisition Integration On December 30, 2002, we acquired CryoGen, Inc. which we initially maintained
as a San Diego-based subsidiary. In August 2003, we announced our decision to
combine our San Diego operations into our Minnetonka facility, 9




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##### Table of Contents



where we expect to obtain FDA approval for manufacturing and product service.
Failure to obtain this approval in a timely manner could have a material
adverse impact on our business. International Sales In 2003, approximately 19 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 material adverse
impact on our business. 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 material adverse effect on our sales, earnings, and financial
condition. 
 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, Canada,
France, Germany, the Netherlands, Spain and the United Kingdom. 
 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. In October 2003, we filed a suit against Mentor Corporation seeking a
declaratory judgment that we do not infringe any valid claim of U.S. Patent No.
6,638,211, which is owned by Mentor, that the claims of the 211 patent are
invalid and unenforceable against us, and enjoining Mentor from making charges
that we infringe the 211 patent. In February 2004, Mentor filed suit in U.S.
District Court for the District of Minnesota against us, alleging that we were
inducing infringement and contributing to the infringement of the 211 patent
by selling our Monarcsub-fascial hammock in the United States. Mentor is
seeking a declaratory judgment that we have infringed the 211 patent and
enjoining us from infringing the 211 patent, and damages to compensate Mentor
for our alleged infringement, as well as trebling of damages by reason of
willful infringement. We believe that Mentors complaint is without merit and
intend to vigorously prosecute our complaint and defend against Mentors
complaint. We do not expect this lawsuit to have a material affect on our
sales, earnings, or cash flows. 
 Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth
quarter of 2003. 10




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Item 4A. Executive Officers of the Registrant Our executive officers, with their ages and biographical information are as
follows: Name
    
    Age
    
    TitleDouglas W. Kohrs
    
    
    46
    
    
    Chief Executive Officer and Chairman of the BoardM. James Call
    
    
    58
    
    
    Executive Vice President, Strategic Planning and DevelopmentJanet L. Dick
    
    
    47
    
    
    Vice President, Human ResourcesCarmen L. Diersen
    
    
    43
    
    
    Executive Vice President, Chief Financial OfficerMartin J. Emerson
    
    
    40
    
    
    President, Chief Operating OfficerRichard J. Faleschini
    
    
    57
    
    
    Vice President and General Manager, AMS GynecologyLawrence W. Getlin
    
    
    58
    
    
    Vice President, Regulatory, Medical Affairs and Quality SystemsRoss A. Longhini
    
    
    42
    
    
    Executive Vice President, Chief Technology Officer
 Douglas W. Kohrshas served as our Chief Executive Officer and one of our
directors since 1999. From 1999 to 2004, he was also our President. In March
2004, he became Chairman of our Board of Directors. Mr. Kohrs has 21 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., SpineCore 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. M. James Callhas served as our Executive Vice President, Strategic Planning
and Development since March 2004. Since July 2001 he has also served as our
Chief Financial Officer and Secretary, and he will continue to serve as our
Chief Financial Officer until March 22, 2004. From 1995 through 2001, Mr. Call
was Chief Financial Officer of Interventional Technologies Inc., a private
company acquired by Boston Scientific Corporation in 2001. Janet L. Dickhas served as our Vice President, Human Resources since 1996.
Overall, Ms. Dick has spent almost 19 years in positions of increasing
responsibility within our human resources department and Schneider (USA)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. Carmen L. Diersenjoined us as an Executive Vice President in March 2004. She
will assume the office of Chief Financial Officer on March 22, 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 positions of increasing responsibility at Honeywell Inc. Martin J. Emersonhas served as our President since March 2004. 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 18 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. 11




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##### Table of Contents



Richard J. Faleschinihas served as our Vice President and General Manager,
since January 2003. From November 1999 through December 2002, he served as our
Vice President, Sales and Marketing. Mr. Faleschini has over 24 years
experience in medical device sales, marketing and general management. From
July 1995 to August 1999, he served in various executive positions at
Medtronic, Inc. with responsibilities for several sectors of its cardiovascular
businesses, including coronary stents, most recently as Vice President, U.S.
Cardiovascular Health Care Systems Marketing. Lawrence W. Getlin, J.D.,has served as our Vice President, Regulatory, Medical
Affairs, and Quality Systems and Compliance since 1990. 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. Mr. Getlin currently serves
as AMS representative on the board of directors of InjecTx Inc., a privately
held company that supplies us with our ProstaJectethanol injection systems. Ross A. Longhinihas served as our Executive Vice President and Chief
Technology Officer since January 2003. Mr. Longhini has 21 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. 
 PART II 
 Item 5. Market for Registrants Common Equity and Related Stockholder Matters Market Information 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. 2002
    
    2003High
    
    Low
    
    High
    
    LowFirst quarter
    
    $
    24.54
    
    
    $
    18.20
    
    
    $
    17.78
    
    
    $
    13.68Second quarter
    
    $
    24.56
    
    
    $
    20.06
    
    
    $
    17.60
    
    
    $
    14.13Third quarter
    
    $
    22.91
    
    
    $
    15.62
    
    
    $
    23.24
    
    
    $
    16.85Fourth quarter
    
    $
    21.01
    
    
    $
    13.08
    
    
    $
    23.39
    
    
    $
    20.06
 Holders On March 1, 2004, there were approximately 123 shareholders of record and 2,400
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 prohibits us from
paying any cash dividends without our lenders consent. 12




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##### Table of Contents



Securities Authorized for Issuance Under Equity Compensation Plans The information in the Compensation and Other BenefitsSecurities Authorized
for Issuance Under Equity Compensation Plans section of our 2004 Proxy
Statement is incorporated in this Annual Report on Form 10-K by reference. 13




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##### Table of Contents



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
    
    1999
    
    2000
    
    2001
    
    2002
    
    2003Net sales
    
    $
    81,353
    
    
    $
    100,317
    
    
    $
    117,938
    
    
    $
    141,648
    
    
    $
    168,283Operating expenses:Cost of goods sold (1)
    
    
    31,419
    
    
    
    21,891
    
    
    
    23,140
    
    
    
    24,605
    
    
    
    27,353Marketing and sales
    
    
    30,400
    
    
    
    39,277
    
    
    
    44,931
    
    
    
    50,152
    
    
    
    63,324General and administrative
    
    
    7,889
    
    
    
    12,128
    
    
    
    12,047
    
    
    
    13,186
    
    
    
    16,882Research and development
    
    
    9,552
    
    
    
    12,225
    
    
    
    11,899
    
    
    
    11,858
    
    
    
    14,924Amortization of intangibles
    
    
    4,260
    
    
    
    8,360
    
    
    
    9,374
    
    
    
    3,775
    
    
    
    4,160Transition and reorganization
    
    
    3,000
    
    
    
    1,000
    
    
    
    1,000
    
    
    
    
    
    
    
    In-process research
and development
    
    
    7,354
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    93,874
    
    
    
    94,881
    
    
    
    102,391
    
    
    
    103,576
    
    
    
    126,643Operating income (loss)
    
    
    (12,521
    )
    
    
    5,436
    
    
    
    15,547
    
    
    
    38,072
    
    
    
    41,640Other income (expense)Royalty and other
    
    
    4,205
    
    
    
    2,928
    
    
    
    (213
    )
    
    
    4,172
    
    
    
    3,801Interest
    
    
    (6,873
    )
    
    
    (6,943
    )
    
    
    (2,932
    )
    
    
    (1,628
    )
    
    
    (1,352
    )Income (loss) before income taxes
    
    
    (15,189
    )
    
    
    1,421
    
    
    
    12,402
    
    
    
    40,616
    
    
    
    44,089Income tax expense (2)
    
    
    (5,340
    )
    
    
    1,369
    
    
    
    5,872
    
    
    
    15,730
    
    
    
    15,039Net income (loss)
    
    
    ($9,849
    )
    
    $
    52
    
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    29,050Net income per share (3)Basic
    
    
    
    
    
    $
    0.00
    
    
    $
    0.22
    
    
    $
    0.77
    
    
    $
    0.88Diluted
    
    
    
    
    
    $
    0.00
    
    
    $
    0.20
    
    
    $
    0.73
    
    
    $
    0.85
  (1)
    
    In connection with the Companys acquisition from Pfizer, Inc., inventories were recorded at fair market value on the
date of acquisition. This accounting treatment required a $21.8 million write-up of inventories above costs. We charged this
write-up to cost of goods sold over the following six months as the acquired inventory was sold. We charged cost of goods
sold $10.2 million in the period from September 11 to December 31, 1998, and $11.6 million in the first quarter of 1999
related to this fair market value cost adjustment. In the fourth quarters of 2002 and 2003, we reduced our warranty allowance
by $2.9 million and $3.1 million and reduced our cost of goods sold and increased our operating income by the same amounts.  (2)
    
    During the third quarter of 2003, the Company 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.  (3)
    
    No net income per share is presented during fiscal year 1999 because no shares of common stock were outstanding. 14




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Balance Sheet Data
    
    1999
    
    2000
    
    2001
    
    2002
    
    2003Cash and cash equivalents
    
    $
    6,940
    
    
    $
    12,165
    
    
    $
    28,755
    
    
    $
    79,429
    
    
    $
    58,953Working capital
    
    
    5,844
    
    
    
    22,068
    
    
    
    50,908
    
    
    
    97,286
    
    
    
    89,619Total assets
    
    
    179,008
    
    
    
    181,262
    
    
    
    235,151
    
    
    
    251,645
    
    
    
    279,327Long-term liabilities
    
    
    95,821
    
    
    
    38,980
    
    
    
    25,884
    
    
    
    18,860
    
    
    
    9,205Redeemable preferred stock
    
    
    67,465
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity (deficit)
    
    
    (21,836
    )
    
    
    109,523
    
    
    
    174,087
    
    
    
    204,262
    
    
    
    240,346
 
 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,
stricture, and prostate disease which are used by urologists, to products for
womens incontinence used by urologists and gynecologists, and, in 2003,
products for menorrhagia and other pelvic disorders used by gynecologists. Results of Operations Sales trends The following table compares net sales (in thousands) of our product lines
between 2001 and 2002, and between 2002 and 2003. Increase
    
    
    
    
    
    
    
    
    
    IncreaseProduct Line
    
    2001
    
    2002
    
    Dollars
    
    Percent
    
    2002
    
    2003
    
    Dollars
    
    PercentMens healthErectile
restoration
    
    $
    59,230
    
    
    $
    69,554
    
    
    $
    10,324
    
    
    
    17.4
    %
    
    $
    69,554
    
    
    $
    72,385
    
    
    $
    2,831
    
    
    
    4.1
    %Bladder control
    
    
    30,543
    
    
    
    35,316
    
    
    
    4,773
    
    
    
    15.6
    %
    
    
    35,316
    
    
    
    39,758
    
    
    
    4,442
    
    
    
    12.6
    %Prostate treatment
    
    
    7,100
    
    
    
    6,063
    
    
    
    (1,037
    )
    
    
    -14.6
    %
    
    
    6,063
    
    
    
    4,923
    
    
    
    (1,140
    )
    
    
    -18.8
    %Total
    
    
    96,873
    
    
    
    110,933
    
    
    
    14,060
    
    
    
    14.5
    %
    
    
    110,933
    
    
    
    117,066
    
    
    
    6,133
    
    
    
    5.5
    %Womens health
    
    
    21,065
    
    
    
    30,715
    
    
    
    9,650
    
    
    
    45.8
    %
    
    
    30,715
    
    
    
    51,217
    
    
    
    20,502
    
    
    
    66.7
    %Total
    
    $
    117,938
    
    
    $
    141,648
    
    
    $
    23,710
    
    
    
    20.1
    %
    
    $
    141,648
    
    
    $
    168,283
    
    
    
    26,635
    
    
    
    18.8
    %
 Mens health products. During 2002, revenue from erectile restoration products
increased due to a continued shift to the InhibiZoneantibiotic coated penile
implant introduced in 2001, which carries a higher selling price than the
non-coated AMS 700product to recover the cost of its drug-eluting benefit.
Erectile restoration unit volume declined by 2.5 percent during 2002. The 2003
increase in erectile restoration sales reflects a continued shift to our
InhibiZoneimplants, which represent 55 percent of our total erectile
restoration volume, up from 43 percent in 2002. The increase also reflects
higher sales of our non-inflatable implants, including the recently acquired
Dura IIproduct line. These increases were partially offset by lower unit
volume on our Ambicorand non-coated AMS 700products resulting from our
customers preference for the InhibiZoneproduct. Overall unit volume
increased approximately 1 percent from 2002 to 2003. The 2002 increase in male bladder control sales was due to a combination of
unit and price increases. Approximately one half of the 2003 increase in male
bladder control revenues was due to price increases on both the AMS 15




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800 Artificial Urinary Sphincterand the InVancemale sling system, with the
remaining increase from higher volumes on both products. Price and volume
increases in both products resulted from product and procedure improvement. Prostate treatment sales continue to decline with unit volume of our UroLume
product, particularly in the U.S., as customers continue to prefer newer BPH
treatments. Womens health products.Revenue growth from womens health products was 45.8
percent in 2002 and 66.7 percent in 2003 with the market introduction and
physician acceptance of our SPARCand Monarcsling systems for female stress
urinary incontinence, partially offset by a decrease in InFastunit sales as
customers shifted over to our SPARCproduct. We believe that the less invasive
nature of our sling procedures and the unprecedented number of surgical options
we now have available for treating incontinence are encouraging more and more
physicians to recommend our treatments. International sales and foreign exchange effects. During 2003, revenues
increased $3.9 million as a result of favorable currency exchange rates, mainly
the Euro. If currency exchange rates in 2003 were the same as in 2002, total
2003 sales would have been $164.4 million, an increase of $22.7 million, or
16.0 percent. Because a large share of our expenses associated with European
sales are Euro-denominated costs, changes in these currency rates do not affect
net income and cash flows from operations by the same dollar amount as they
affect sales revenues. The following table shows sales by customer location
(in thousands). Increase
    
    
    
    
    
    
    
    
    
    IncreaseCustomer location
    
    2001
    
    2002
    
    Dollars
    
    Percent
    
    2002
    
    2003
    
    Dollars
    
    PercentWithin U.S.
    
    $
    97,069
    
    
    $
    116,523
    
    
    $
    19,454
    
    
    
    20.0
    %
    
    $
    116,523
    
    
    $
    136,765
    
    
    $
    20,242
    
    
    
    17.4
    %Outside U.S.Before FX impact
    
    
    20,869
    
    
    
    24,412
    
    
    
    3,543
    
    
    
    16.9
    %
    
    
    25,125
    
    
    
    27,593
    
    
    
    2,468
    
    
    
    9.8
    %Currency impact
    
    
    
    
    
    
    713
    
    
    
    713
    
    
    
    
    
    
    
    
    
    
    
    3,925
    
    
    
    3,925
    
    
    
    Total
    
    
    20,869
    
    
    
    25,125
    
    
    
    4,256
    
    
    
    20.4
    %
    
    
    25,125
    
    
    
    31,518
    
    
    
    6,393
    
    
    
    25.4
    %Total
    
    $
    117,938
    
    
    $
    141,648
    
    
    $
    23,710
    
    
    
    20.1
    %
    
    $
    141,648
    
    
    $
    168,283
    
    
    $
    26,635
    
    
    
    18.8
    %
 Operating Expenses The following table compares the dollar (in thousands) and percentage change in
the Statement of Operations between 2001 and 2002 and between 2002 and 2003. Increase
    
    
    
    
    
    
    
    
    
    Increase2001
    
    2002
    
    Dollars
    
    Percent
    
    2002
    
    2003
    
    Dollars
    
    PercentNet sales
    
    $
    117,938
    
    
    $
    141,648
    
    
    $
    23,710
    
    
    
    20.1
    %
    
    $
    141,648
    
    
    $
    168,283
    
    
    $
    26,635
    
    
    
    18.8
    %Operating expensesCost of goods sold
    
    
    23,140
    
    
    
    24,605
    
    
    
    1,465
    
    
    
    6.3
    %
    
    
    24,605
    
    
    
    27,353
    
    
    
    2,748
    
    
    
    11.2
    %Marketing and selling
    
    
    44,931
    
    
    
    50,152
    
    
    
    5,221
    
    
    
    11.6
    %
    
    
    50,152
    
    
    
    63,324
    
    
    
    13,172
    
    
    
    26.3
    %R&D
    
    
    11,899
    
    
    
    11,858
    
    
    
    (41
    )
    
    
    -0.3
    %
    
    
    11,858
    
    
    
    14,924
    
    
    
    3,066
    
    
    
    25.9
    %G&A
    
    
    12,047
    
    
    
    13,186
    
    
    
    1,139
    
    
    
    9.5
    %
    
    
    13,186
    
    
    
    16,882
    
    
    
    3,696
    
    
    
    28.0
    %Transition and reorg.
    
    
    1,000
    
    
    
    
    
    
    
    (1,000
    )
    
    
    -100.0
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Intangible amortization
    
    
    9,374
    
    
    
    3,775
    
    
    
    (5,599
    )
    
    
    -59.7
    %
    
    
    3,775
    
    
    
    4,160
    
    
    
    385
    
    
    
    10.2
    %Total
    
    
    102,391
    
    
    
    103,576
    
    
    
    1,185
    
    
    
    1.2
    %
    
    
    103,576
    
    
    
    126,643
    
    
    
    23,067
    
    
    
    22.3
    %Operating income
    
    $
    15,547
    
    
    $
    38,072
    
    
    $
    22,525
    
    
    
    144.9
    %
    
    $
    38,072
    
    
    $
    41,640
    
    
    $
    3,568
    
    
    
    9.4
    %Other income (expense)Interest income
    
    
    881
    
    
    
    1,130
    
    
    
    249
    
    
    
    28.3
    %
    
    
    1,130
    
    
    
    476
    
    
    
    (654
    )
    
    
    -57.9
    %Interest expense
    
    
    (3,813
    )
    
    
    (2,758
    )
    
    
    (1,055
    )
    
    
    -27.7
    %
    
    
    (2,758
    )
    
    
    (1,828
    )
    
    
    (930
    )
    
    
    -33.7
    %Royalty income
    
    
    2,926
    
    
    
    3,032
    
    
    
    106
    
    
    
    3.6
    %
    
    
    3,032
    
    
    
    2,797
    
    
    
    (235
    )
    
    
    -7.8
    %Other
    
    
    (3,139
    )
    
    
    1,140
    
    
    
    4,279
    
    
    
    136.3
    %
    
    
    1,140
    
    
    
    1,004
    
    
    
    (136
    )
    
    
    -11.9
    %Total
    
    
    (3,145
    )
    
    
    2,544
    
    
    
    5,689
    
    
    
    180.9
    %
    
    
    2,544
    
    
    
    2,449
    
    
    
    (95
    )
    
    
    -3.7
    %Income before taxes
    
    
    12,402
    
    
    
    40,616
    
    
    
    28,214
    
    
    
    227.5
    %
    
    
    40,616
    
    
    
    44,089
    
    
    
    3,473
    
    
    
    8.6
    %Income tax expense
    
    
    5,872
    
    
    
    15,730
    
    
    
    9,858
    
    
    
    167.9
    %
    
    
    15,730
    
    
    
    15,039
    
    
    
    (691
    )
    
    
    -4.4
    %Net income
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    18,356
    
    
    
    281.1
    %
    
    $
    24,886
    
    
    $
    29,050
    
    
    $
    4,164
    
    
    
    16.7
    %
 16




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##### Table of Contents



The following table shows the Statement of Operations as a percentage of
net sales for 2001, 2002, and 2003. 2001
    
    2002
    
    2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Operating expensesCost of goods sold
    
    
    19.6
    %
    
    
    17.4
    %
    
    
    16.3
    %Marketing and selling
    
    
    38.1
    %
    
    
    35.4
    %
    
    
    37.6
    %R&D
    
    
    10.1
    %
    
    
    8.4
    %
    
    
    8.9
    %G&A
    
    
    10.2
    %
    
    
    9.3
    %
    
    
    10.0
    %Transition and reorg.
    
    
    0.8
    %
    
    
    0.0
    %
    
    
    0.0
    %Intangible amortization
    
    
    7.9
    %
    
    
    2.7
    %
    
    
    2.5
    %Total
    
    
    86.8
    %
    
    
    73.1
    %
    
    
    75.3
    %Operating income
    
    
    13.2
    %
    
    
    26.9
    %
    
    
    24.7
    %Other income (expense)Interest income
    
    
    0.7
    %
    
    
    0.8
    %
    
    
    0.3
    %Interest expense
    
    
    -3.2
    %
    
    
    -1.9
    %
    
    
    -1.1
    %Royalty income
    
    
    2.5
    %
    
    
    2.1
    %
    
    
    1.7
    %Other
    
    
    -2.7
    %
    
    
    0.8
    %
    
    
    0.6
    %Total
    
    
    -2.7
    %
    
    
    1.8
    %
    
    
    1.5
    %Income before taxes
    
    
    10.5
    %
    
    
    28.7
    %
    
    
    26.2
    %Income tax expense
    
    
    5.0
    %
    
    
    11.1
    %
    
    
    8.9
    %Net income
    
    
    5.5
    %
    
    
    17.6
    %
    
    
    17.3
    %
 Cost of goods sold.During 2002, and continuing into 2003, we experienced a
significant decrease in warranty claims. With further investigation, we
concluded that these decreases were primarily the result of recent improvements
in the quality and durability of our products and our claims processing
procedures. As a result, cost of goods sold in 2002 and 2003 reflect favorable
reductions in our warranty allowance of $2.9 million and $3.1 million,
respectively. Without these favorable adjustments, cost of goods sold during
2002 would have been $27.5 million, or 19.4 percent of sales, and $30.5
million, or 18.1 percent of sales for 2003. See Critical Accounting Policies
and Estimatesfor further details on the warranty reversal. Excluding the effect of favorable currency exchange rates on revenue of $3.9
million and the warranty reversal, 2003 cost of goods sold would have been 18.6
percent of sales, a 0.8 percentage point reduction from 2002. This decrease is
due mainly to higher production volumes and product mix changes. 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. This benefit has been
partially offset by a higher portion of our revenues coming from womens health
products, which generally carry a slightly lower gross margin. Future cost of
goods sold will continue to depend on production levels and product mix. Marketing and selling. Cost increases in 2002 resulted from higher employee and
commission expenses to support higher sales and new product rollout costs. A
significant portion of this 2002 increase was to strengthen our international
infrastructure, leading to increased international sales in 2002 and 2003.
Marketing and selling expenses increased further in 2003 as we expanded our
work with (1) gynecologists for Her Optionby establishing a separate direct
gynecology sales force; (2) other womens health products; and (3) erectile
dysfunction patients. Increased spending for womens health products totaled
$10.4 million in 2003. We expect to continue these higher activity and
spending levels going forward, although we expect them to decline as a share of
sales as our sales increase. 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 believe this new shared service center will allow us
to grow our European business faster, more efficiently and with greater
control. We expect marketing and selling expense to be between 30 and 35
percent of sales going forward. 17




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##### Table of Contents



General and administrative. Cost increases in 2002 compared to 2001 were
primarily due to professional fees and services, recruiting and relocation
costs, and corporate insurance, partially offset by $0.6 million in savings due
to the closing of our Influence facility in Israel during 2001. 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. We
will incur additional expenses in 2004 to extend the capabilities of these
systems to our other international offices. The Sarbanes-Oxley Act passed in July 2002 has increased the focus on our
financial reporting, public disclosure, and compliance practices, and 2003
expenses have increased for additional personnel and resources to comply with
this act and related regulations. We expect costs to continue to increase in
future periods in order to comply with the legal and financial requirements of
the Sarbanes-Oxley Act and related regulations. 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. Cost increases during 2002 in
clinical studies and product development were more than offset by savings of
$0.7 million from the closing of our Israeli research and development facility
during 2001. Cost increases during 2003 were primarily to support Her Option
and other womens health products. We expect total spending in research and
development to increase further in 2004, and in the longer term to continue to
be in the range of 8 to 10 percent of net sales. In addition, costs in this
area could vary as a result of spending on purchased technologies. Amortization of intangibles. The decreases in amortization in 2002 compared to
2001 are attributable to the Companys adoption of SFAS No. 142, Goodwill and
Other Intangible Assets, on December 30, 2001. Under the provisions of SFAS
No. 142, goodwill and other intangible assets with indefinite lives are no
longer amortized. 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 Statement  No.
5. 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 at least 2009. We receive a royalty equal to 2.625 percent of net
sales of licensed products on a quarterly basis, which accounted for $2.9
million, $3.0 million, and $2.8 million in other income in 2001, 2002, and
2003. Interest income. The 2002 increase in interest income was due to the full year
investment of proceeds from our July 2001 secondary public offering, while 2001
reflects only one-half year of interest income on these proceeds. Interest
income was lower in 2003 than in 2002 due to (1) lower cash balances as a
result of the CryoGen and Dura IIacquisitions in 2003, and (2) lower interest
rates. Interest expense. Interest expense decreased in 2002 as average borrowings
declined by approximately $5.0 million. 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 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 do not expect any swap-related
expenses going forward. Other. 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.
We made this contribution to the pension plan to fully fund under-funded
pension plan liabilities that had accrued due to declining investment balances
in the plan and low interest rates, and to fund early retirement benefits. Other expense for 2001 includes the write-off of our $3.0 million investment in
Collagenesis Corporation (see Notes to Consolidated Financial Statements). The remainder of other income and expense includes exchange gains and losses
resulting from the fluctuations in foreign currencies, mainly the Euro, against
the U.S. dollar and relate to translating foreign denominated inter-company
receivables to current rates. 18




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##### Table of Contents



Income tax expense As part of our adoption of Statements of Financial Accounting Standards No.
142, Goodwill and Other Intangible Assets, we no longer record goodwill
amortization that had been a permanent non-deductible expense. In 2001, the
total of this non-deductible amortization was approximately $1.9 million. If
the rules that we adopted in 2002 were in place in 2001, the effective tax rate
in 2001 would have been approximately 41 percent. Our 2003 effective tax rate
was approximately 34.0 percent after taking into account the $1.1 million we
recognized with our application for certain U.S. tax benefits related to
Research and Development Tax Credits and Extraterritorial Income Exclusion for
the years 1999 through 2002. Without the recognition of these credits, our tax
rate would have been 36.6 percent, down from 38.7 percent in 2002, reflecting
our use of current-period federal and state tax credits. We expect our
effective tax rate in 2004 to be in the range of 36 percent to 37 percent. Liquidity and Capital Resources Cash and cash equivalents were $59.0 million as of January 3, 2004, compared to
$79.4 million as of December 28, 2002. This $20.5 million decrease is
primarily caused by debt repayments and the acquisition of CryoGen and Dura II.
These decreases were partially offset by cash provided from operations
totaling $34.1 million. Cash flows from operating activities Operating activities generated $25.3 million, $28.8 million, and $34.1 million
of positive cash flow in 2001, 2002, and 2003. During 2003, net income
adjusted for the non-cash expenses of depreciation and amortization resulted in
a $7.1 million current year increase and totaled $39.7 million compared to
$32.6 million in 2002 and $19.8 million in 2001. During 2003, accounts payable
and accrued expenses decreased $3.5 million, primarily as a result of an
additional $3.1 million reduction in the allowance for warranty claims (see
Critical Accounting Policies and Estimates). This compares to the $7.9 million
decrease in 2002 related to a $5.8 million pension plan termination payment in
addition to a $2.9 million reduction in the allowance for warranty claims, and
a $3.9 million increase in 2001 resulting from a non-cash expense of $0.7
million due to the acceleration of stock option vesting for a former employee
and a non-cash expense of $3.4 million related to the write-off of an
investment in Collagenesis. In addition, during 2003 the Company increased
inventories and accounts receivable by $3.1 million and $3.9 million to support
business expansion, primarily in womens health. Deferred income tax assets
increased by $3.1 million in 2003, mainly due to an assessment and resulting
increase in the Section 382 Net Operating Loss limitation. Cash flows for investing activities During 2001, we invested $1.5 million in InjecTx (reported as a technology
investment) and spent $1.5 million to acquire worldwide distribution rights for
DermMatrix, a porcine dermis graft material used in sling and pelvic prolapse
procedures (reported as a purchase of intangibles). We made additional $1.0
million investments for each of these ventures during 2002. In addition,
during 2001 we made milestone and contingent purchase price payments relating
to the Influence acquisition totaling $11.5 million and a $3.0 million
investment in Collagenesis Corporation. Fixed asset additions during 2001 and
2002 were $2.7 million and $1.7 million, respectively. During 2003, we used
$44.1 million to acquire CryoGen and Dura II, and $6.5 million for capital
expenditures. Cash flows from financing activities We have a senior credit facility consisting of term debt and a $15.0 million
revolving line of credit, which incurs a commitment fee of .25 percent for
unused portions. The senior credit facility expires in September 2005. This
facility is secured by substantially all of our assets, and contains certain
restrictions requiring prior bank group approval. The restrictions prohibit
the payment of dividends and the incurrence of additional debt, limit capital
expenditures to $10.0 million for any fiscal year (plus the unused portion of
this $10.0 million capital expenditure limit for the preceding fiscal year),
limit acquisitions to an aggregate of $25.0 million in any fiscal year,
prohibit sale and leaseback agreements, and limit operating leases (except for
vehicles for sales personnel) to $1.0 million in any fiscal year. In addition, we are subject to, and in full compliance with, four financial
covenants: a leverage ratio, an interest coverage ratio, a fixed charge
coverage ratio, and a required minimum level of consolidated EBITDA. The
following table sets forth these covenants and our compliance as of January 3,
2004: 19




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##### Table of Contents



Credit facilityCovenant
    
    requirements
    
    Company actualLeverage ratio
    
    
    <2.50
    
    
    
    0.29Interest coverage ratio
    
    
    >3.00
    
    
    
    30.93Fixed charge coverage ratio
    
    
    >1.25
    
    
    
    4.06Minimum consolidated EBITDA
    
    >$
    35.0
    million
    
    $
    56.5
    million
 As of January 3, 2004, the outstanding principal balance under the term debt
portion of the senior credit facility was $16.4 million. We did not have an
outstanding balance under the revolving line of credit, so we have $15.0
million of availability under that portion of the senior credit facility. Contractual Obligations The following table sets forth the past payments and future commitments (in
thousands) under the senior credit facility and operating leases. Less than
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    1 year
    
    13 years
    
    35 years
    
    5 yearsCredit facility
    
    $
    17,527
    
    
    $
    7,907
    
    
    $
    9,620
    
    
    
    
    
    
    
    Automobile leases
    
    
    2,636
    
    
    
    926
    
    
    
    1,033
    
    
    
    677
    
    
    
    Office and facility
rent
    
    
    1,979
    
    
    
    615
    
    
    
    845
    
    
    
    519
    
    
    
    Total
    
    $
    22,142
    
    
    $
    9,448
    
    
    $
    11,498
    
    
    $
    1,196
    
    
    
    
 Our credit facility consists of term debt and a revolving line of credit that
expire in September 2005. Payments shown include interest at the indexed rate
at January 3, 2004. 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 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. 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. The
representative of the former CryoGen shareholders has made a claim for a
purchase price adjustment based on CryoGens net equity at the time of closing
of the transaction. We do not believe the former CryoGen shareholders are
entitled to a purchase price adjustment, and we do not believe that the
resolution will be material to us. This transaction is more fully described in
our Form 8-K filed with SEC on January 6, 2003. We believe that funds generated from operations, together with our balances in
cash and cash equivalents and funds available under our senior credit facility,
will be sufficient to finance current operations, planned capital expenditures,
and commitments to CryoGen shareholders for at least the next twelve months. 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 20




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##### Table of Contents



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 The Company recognizes revenue when legal title to the goods passes to its
customers. Approximately half of the
Companys revenue is generated from inventory loaned to customers or from
consigned inventory maintained at hospitals or with field representatives. In
these situations, revenue is recognized at the time the product has been
implanted or used. The Company reports sales net of estimated returns,
rebates, and other trade discounts. We have no post-shipment obligations associated with our sales. The shipment
of product to distributors, which is less than five percent of our revenues,
affects the timing of revenue recognition because the distributors take title
FOB our dock. 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. Allowance for Doubtful Accounts and Other Accounts Receivable Related Valuation
Accounts We maintain an allowance for doubtful accounts and sales returns that are
calculated using subjective judgments and estimates to establish these
valuation accounts. Different judgments 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. An allowance for doubtful accounts is maintained for all individual accounts
receivable that we believe are unlikely to be collected. For all other
accounts receivable, an allowance for doubtful accounts based on the age of
receivable balances is recorded. At December 28, 2002 and January 3, 2004, the
allowance for doubtful accounts was $1.0 million. The allowance was 3.4
percent and 3.2 percent of gross accounts receivable at the end of 2002 and
2003, respectively. We maintain an allowance for returns based on historical and current trends in
product returns. At December 28, 2002 this allowance was $0.4 million, and
increased to $1.8 million at January 3, 2004, in connection with our product
return policies for Her Optionsales to gynecologists offices. Inventory Valuation Inventories are recorded at the lower of manufacturing cost or net realizable
value. Each quarter, we evaluate our inventories for obsolescence and excess
quantities. This evaluation includes analyses of inventory levels, historical
loss trends, expected product lives, sales levels by product, and projections
of future sales demand. We write off inventories we consider obsolete. In
addition, we record an allowance for inventory quantities in excess of
forecasted demand. Inventory allowances were $2.7 million and $1.9 million at
the end of 2002 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, 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, 21




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##### Table of Contents



the 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 3, 2004, our accrued warranty allowance was $1.3
million compared to $4.5 million at December 28, 2002. If we experience
further changes in any of the factors that influence this estimate, we will
make additional adjustments to this accrued warranty allowance. Legal Liability Accrual Each quarter, we estimate the uninsured portion of legal representation and
settlement costs of possible future product liability. This evaluation
consists of reviewing historical claims costs as well as assessing future
trends in medical device liability cases. Social and political factors, as
well as surgeon and medical facility responsibility, make litigation costs hard
to predict. Accruals for future litigation costs were $1.1 million at December
28, 2002, and increased to $1.3 million on January 3, 2004. If, in the future,
we determine that this accrual is inadequate, the adjustment would reduce
reported income in the period we recorded the adjustment. 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 an
assessment for 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. A valuation allowance of $0.7 million is maintained to offset tax loss carry
forwards created in a foreign jurisdiction, which, if subsequently recognized,
would be allocated to goodwill. No other allowances against net deferred tax
assets are maintained at January 3, 2004. 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. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation 46, Consolidation of Variable Interest Entities, an
interpretation of ARB 51 (FIN 46). FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The Company is required to apply FIN 46 to all new variable
interest entities created or acquired after January 31, 2003. For variable
interest entities created or acquired prior to February 1, 2003, management is
required to apply FIN 46, as amended, for periods ending after December 15, 2003.
The Company has determined that FIN 46 has no impact upon adoption. In May 2003, FASB issued SFAS 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity.SFAS 150 establishes
standards for issuer classification and measurement of certain financial
instruments with characteristics of both liabilities and equity, and
is effective for financial instruments entered into or modified after May 31,
2003. Instruments
that fall within the scope of SFAS 150 must be classified as a
liability. For financial instruments issued prior to June 1, 2003, SFAS 150 is
effective for the Company in the second 22




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##### Table of Contents



quarter of fiscal year 2004. Adoption
is not expected to have an impact on the Companys consolidated financial
statements. In January 2004, the FASB issued FASB Staff Position (FSP) FAS 106-1,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003, which permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of this Act.
Regardless of whether a sponsor elects that deferral, FSP FAS 106-1 requires
certain disclosures pending further consideration of the underlying accounting
issues. The guidance in FSP FAS 106-1 is effective for interim or annual
financial statements of fiscal years ending after December 7, 2003. The
Company has elected to defer accounting for these effects, if any, until
authoritative guidance on the accounting is
issued or until there is a significant event that ordinarily would call for
re-measurement of the plans assets and obligations. In December 2003, the FASB issued FAS 132 (Revised) (FAS 132-R), Employers
Disclosure about Pensions and Other Postretirement Benefits. FAS 132-R retains
disclosure requirements of the original FAS 132 and requires additional
disclosures relating to assets, obligations, cash flows, and net periodic
benefits cost. FAS 132-R is effective for fiscal years ending after December
15, 2003. Interim period disclosures are effective for interim periods
beginning after December 15, 2003. The adoption of the disclosure provisions
of FAS 132-R did not have a material effect on the Companys Consolidated
Financial Statements. 
 Item 7a. Quantitative and Qualitative Disclosures about Market Risk Interest Rates We hedged a portion of our original $65.0 million variable rate term note, as
required by our senior credit facility, by entering into an interest rate swap
agreement in which we agree to exchange, at specified intervals, the calculated
difference between the fixed interest rate of the swap and the variable
interest rate on a portion of our debt. This interest rate swap agreement
expired June 30, 2003. We do not believe that our interest rate risk is
material. 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 quarter-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 are included in other income (expense).
For 2003, revenues from sales to customers outside the United States were 18.7
percent of total consolidated revenues; and, at year-end, international
accounts receivable, inventory, cash, and accounts payable were 33 percent, 9
percent, 14 percent, and 28 percent of total consolidated accounts for each of
these items. Changes in the relative value of the U.S. dollar and the Euro
would affect our sales, Euro-denominated expenses, and the U.S. dollars value
of European assets and liabilities. If these changes were large and rapid,
they could have a material effect on our results of operations. 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 Our Consolidated Financial Statements and the report of our independent
certified public accountants 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. 23




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##### Table of Contents



Item 9.
    Changes In and Disagreements With Accountants
On Accounting and Financial Disclosure None 
 Item 9A. 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 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. 
 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 and Election of Directors  Other Information about Nominees
and Other Directors sections of our 2004 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 Section 16(a) Beneficial Ownership Reporting
Compliance section of our 2004 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 2004 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 2004 Proxy Statement is incorporated in this Annual Report on
Form 10-K by reference. 24




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##### Table of Contents



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, Election
of DirectorsCompensation Committee Interlocks and Insider Participation,
Compensation Committee Report on Executive Compensation, and Compensation
and Other Benefits sections of our 2004 Proxy Statement is incorporated in
this Annual Report on Form 10-K by reference. 
  Item 12.
    Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters The information in the Compensation and Other BenefitsSecurities Authorized
for Issuance Under Equity Compensation Plans and Principal Stockholders and
Beneficial Ownership of Management sections of our 2004 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 2004 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 Principal Accountant Fees and Services section of our
2004 Proxy Statement is incorporated in this Annual Report on Form 10-K by
reference. 25




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##### Table of Contents



PART IV 
 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Financial Statements Our following Consolidated Financial Statements and the Independent Auditors
Report thereon are included herein (page numbers refer to pages in this Annual
Report on Form 10-K) Report of Independent Auditors
    
    
    F-1Consolidated Balance Sheets as of December 28, 2002 and January 3, 2004
    
    
    F-2Consolidated Statements of Operations for the years ended December 29, 2001, December 28, 2002, and January 3, 2004
    
    
    F-3Consolidated Statements of Changes in Stockholders Equity for the years ended December 29, 2001, December 28, 2002, and January 3, 2004
    
    
    F-4Consolidated Statements of Cash Flows for the years ended December 29, 2001, December 28, 2002, and January 3, 2004
    
    
    F-7Notes to Consolidated Financial Statements for the years ended December 29, 2001, December 28, 2002, and January 3, 2004
    
    
    F-8
 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. No other
supplemental schedules are required. Additions charged toBalance at
    
    
    
    
    
    
    
    Balancebeginning
    
    Costs and
    
    Other
    
    
    
    
    
    at endof period
    
    expenses
    
    accounts
    
    Deductions
    
    of periodValuation Accounts:Year ended December 29, 2001Deducted from asset accountsAllowance for doubtful accounts
    
    $
    696
    
    
    $
    580
    
    
    
    
    
    
    $
    474
    (1)
    
    $
    802Allowance for obsolete
inventories
    
    $
    3,140
    
    
    $
    310
    
    
    
    
    
    
    $
    751
    (2)
    
    $
    2,699Allowance for sales returns
    
    $
    138
    
    
    $
    4,044
    
    
    
    
    
    
    $
    3,719
    
    
    $
    463Year 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
    
    
    $
    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)
    
    $
    1,779Qualifying Accounts:Year ended December 29, 2001Product liability allowance
    
    $
    1,211
    
    
    $
    300
    
    
    
    
    
    
    $
    13
    (4)
    
    $
    1,498Product warranty allowance
    
    $
    7,548
    
    
    $
    516
    
    
    
    
    
    
    $
    477
    (5)
    
    $
    7,587Year 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)
    
    $
    1,338
 Notes:  (1)
    
    Uncollectible accounts written off, net of recoveries(2)
    
    Obsolete 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 27




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##### Table of Contents



Exhibits The exhibits to this Annual Report on Form 10-K are listed in the Exhibit Index
attached hereto. 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 1, 2004, 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, 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 to this Annual Report on Form
10-K under Item 14(c):  1.
    
    Employment Agreement, dated April 23, 1999, between
Douglas Kohrs and American Medical Systems, Inc.2.
    
    Amendment to the Employment Agreement, dated April 17,
2000, between Douglas Kohrs and American Medical Systems, Inc.3.
    
    Second Amendment to Employment Agreement, dated January 1,
2002, between Douglas Kohrs and American Medical Systems, Inc.4.
    
    Stock Option Agreement, dated April 23, 1999, between
Douglas Kohrs and American Medical Systems, Inc.5.
    
    Employment Agreement, dated July 30, 2001, between M.
James Call and American Medical Systems, Inc.6.
    
    Consulting Agreement, dated September 1, 1999, between
Medical Genesis and American Medical Systems, Inc.7.
    
    Employment Agreement, dated January 1, 2003, between Ross
Longhini and American Medical Systems, Inc.8.
    
    Employment Agreement, dated March 1, 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.
    
    2003 Management Incentive Plan. Reports on Form 8-K: On October 22, 2003, we filed a Current Report on Form 8-K relating to the
announcement of our results of operation for the third quarter of fiscal year
2003. 28




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##### Table of Contents



FINANCIAL STATEMENTS AND NOTES THERETO REPORT OF INDEPENDENT AUDITORS To the Shareholders and Board of Directors
of American Medical Systems Holdings, Inc. We have audited the accompanying consolidated balance sheets of American
Medical Systems Holdings, Inc. as of December 28, 2002, 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
3, 2004. Our audits also included the financial statement schedule
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 audits. We conducted our audits in accordance with auditing standards generally
accepted in the 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. as of December 28, 2002, and January 3, 2004, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended January 3, 2004, in conformity with accounting
principles generally accepted in the United States. 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. As discussed in Note 5 to the consolidated financial statements, the Company
changed its method of accounting for goodwill to conform to Statement of
Financial Accounting Standards 142 effective December 30, 2001. Ernst & Young LLPMinneapolis, Minnesota
January 30, 2004
 F-1




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##### Table of Contents



American Medical Systems Holdings Inc.
Consolidated Balance Sheets
(In thousands except share and per share data) December 28, 2002
    
    January 3, 2004AssetsCurrent assetsCash and cash equivalents
    
    $
    79,429
    
    
    $
    58,953Accounts receivable, net
    
    
    27,208
    
    
    
    33,507Inventories, net
    
    
    13,475
    
    
    
    18,402Deferred income taxes
    
    
    3,542
    
    
    
    5,637Other current assets
    
    
    2,155
    
    
    
    2,896Total current assets
    
    
    125,809
    
    
    
    119,395Property, plant and equipment, net
    
    
    21,328
    
    
    
    25,489Goodwill, net
    
    
    80,607
    
    
    
    98,989Intangibles, net
    
    
    15,691
    
    
    
    17,466Deferred income taxes
    
    
    3,068
    
    
    
    12,991Investment in technology and other assets
    
    
    5,142
    
    
    
    4,997Total assets
    
    $
    251,645
    
    
    $
    279,327Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    3,000
    
    
    $
    4,621Accrued compensation expenses
    
    
    10,246
    
    
    
    9,886Accrued warranty expense
    
    
    4,526
    
    
    
    1,338Income taxes payable
    
    
    569
    
    
    
    1,667Other accrued expenses
    
    
    4,182
    
    
    
    5,105Current portion of notes payable
    
    
    6,000
    
    
    
    7,159Total current liabilities
    
    
    28,523
    
    
    
    29,776Long-term notes payable
    
    
    18,000
    
    
    
    9,205Other long-term liabilities
    
    
    860
    
    
    
    Stockholders equityCommon stock, par value $.01 per share;
authorized 95,000,000 shares; issued

and outstanding: 32,156,873 voting and
341,700 non-voting shares at December 28,
2002; and 33,135,354 voting shares at January 3, 2004
    
    
    325
    
    
    
    331Additional paid-in capital
    
    
    197,991
    
    
    
    202,341Deferred compensation
    
    
    (198
    )
    
    
    (24
    )Accumulated other comprehensive income (loss)Cumulative translation adjustment
    
    
    (678
    )
    
    
    1,367Derivative financial instruments
    
    
    (459
    )
    
    

    Retained earnings
    
    
    7,281
    
    
    
    36,331Total stockholders equity
    
    
    204,262
    
    
    
    240,346Total liabilities and stockholders equity
    
    $
    251,645
    
    
    $
    279,327
 The accompanying notes are an integral part of the consolidated financial statements. F-2




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##### Table of Contents



American Medical Systems Holdings Inc.
Consolidated Statements of Operations
(In thousands, except share and per share data) 2001
    
    2002
    
    2003Sales
    
    $
    117,938
    
    
    $
    141,648
    
    
    $
    168,283Operating expensesCost of goods sold
    
    
    23,140
    
    
    
    24,605
    
    
    
    27,353Marketing and selling
    
    
    44,931
    
    
    
    50,152
    
    
    
    63,324General and administrative
    
    
    12,047
    
    
    
    13,186
    
    
    
    16,882Research and development
    
    
    11,899
    
    
    
    11,858
    
    
    
    14,924Transition and
reorganization
    
    
    1,000
    
    
    
    
    
    
    
    Amortization of intangibles
    
    
    9,374
    
    
    
    3,775
    
    
    
    4,160Total operating expenses
    
    
    102,391
    
    
    
    103,576
    
    
    
    126,643Operating income
    
    
    15,547
    
    
    
    38,072
    
    
    
    41,640Other income (expense)Royalty income
    
    
    2,926
    
    
    
    3,032
    
    
    
    2,797Other income (expense)
    
    
    (3,139
    )
    
    
    1,140
    
    
    
    1,004Interest income
    
    
    881
    
    
    
    1,130
    
    
    
    476Interest expense
    
    
    (3,813
    )
    
    
    (2,758
    )
    
    
    (1,828
    )Total other income (expense)
    
    
    (3,145
    )
    
    
    2,544
    
    
    
    2,449Income before income taxes
    
    
    12,402
    
    
    
    40,616
    
    
    
    44,089Income tax expense
    
    
    5,872
    
    
    
    15,730
    
    
    
    15,039Net income
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    29,050Net income per shareBasic
    
    $
    0.22
    
    
    $
    0.77
    
    
    $
    0.88Diluted
    
    $
    0.20
    
    
    $
    0.73
    
    
    $
    0.85Weighted average common shares used in calculationBasic
    
    
    29,792
    
    
    
    32,232
    
    
    
    32,854Diluted
    
    
    32,068
    
    
    
    34,176
    
    
    
    34,313
 The accompanying notes are an integral part of the consolidated financial statements. F-3




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American Medical Systems Holdings Inc.
Consolidated Statements of Changes in Stockholders Equity
(Page 1 of 3, in thousands) Common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    AccumulatedAdditional
    
    Accumulated
    
    
    
    
    
    otherPar
    
    paid in
    
    earnings
    
    Deferred
    
    comprehensiveShares
    
    value
    
    capital
    
    (deficit)
    
    compensation
    
    income
    
    TotalBalances at December 31, 2000
    
    
    27,765
    
    
    $
    278
    
    
    $
    135,449
    
    
    ($
    24,135
    )
    
    ($
    996
    )
    
    ($
    1,073
    )
    
    $
    109,523Comprehensive IncomeNet Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,530
    
    
    
    
    
    
    
    
    
    
    
    6,530Cumulative effect of change
in accounting
principal for derivative
and hedging activities
SFAS 133, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (712
    )
    
    
    (712
    )Net loss on derivative
financial instruments, net
of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (928
    )
    
    
    (928
    )Amounts reclassified to
interest expense from
derivative and hedging
activities, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    476
    
    
    
    476Cumulative translation
Adjustment, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (573
    )
    
    
    (573
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,793Issuance of common stockStock options exercised
    
    
    425
    
    
    
    4
    
    
    
    735
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    739ESPP
    
    
    55
    
    
    
    1
    
    
    
    498
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    499Public offering
    
    
    3,500
    
    
    
    35
    
    
    
    53,786
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53,821Direct grants
    
    
    1
    
    
    
    
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Purchase of minority interest
in consolidated subsidiary
    
    
    214
    
    
    
    2
    
    
    
    3,231
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,233Accelerated stock
option vesting recorded
as compensation expense
    
    
    
    
    
    
    
    
    
    
    747
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    747Compensation cost of stock
options issued to
non-employees
    
    
    
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19Income tax benefit
from stock option plans
    
    
    
    
    
    
    
    
    
    
    240
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    240Amortization of
deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    446
    
    
    
    
    
    
    
    446Deferred compensation
forfeitures
    
    
    
    
    
    
    
    
    
    
    (102
    )
    
    
    
    
    
    
    102
    
    
    
    
    
    
    
    Balances at December 29, 2001
    
    
    31,960
    
    
    $
    320
    
    
    $
    194,630
    
    
    ($
    17,605
    )
    
    ($
    448
    )
    
    ($
    2,810
    )
    
    $
    174,087
 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
(Page 2 of 3, in thousands) Common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    AccumulatedAdditional
    
    Accumulated
    
    
    
    
    
    otherPar
    
    paid in
    
    earnings
    
    Deferred
    
    comprehensiveShares
    
    value
    
    capital
    
    (deficit)
    
    compensation
    
    income
    
    TotalBalances at December 29, 2001
    
    
    31,960
    
    
    $
    320
    
    
    $
    194,630

    
    
    ($
    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
    
    
    
    973Cumulative translation
adjustment, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    971
    
    
    
    971Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,559Issuance of common stockStock options exercised
    
    
    495
    
    
    
    5
    
    
    
    1,653
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,658Employee stock purchase plan
    
    
    42
    
    
    
    
    
    
    
    693
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    693Direct grants
    
    
    2
    
    
    
    
    
    
    
    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
    
    
    32,499
    
    
    $
    325
    
    
    $
    197,991
    
    
    $
    7,281
    
    
    ($
    198
    )
    
    ($
    1,137
    )
    
    $
    204,262
 The accompanying notes are an integral part of the consolidated financial statements. F-5




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##### Table of Contents



American Medical Systems Holdings Inc.Consolidated Statements of Changes in Stockholders Equity
(Page 3 of 3, in thousands) Common stock
    
    Additional
    
    Accumulated
    
    
    
    
    
    AccumulatedotherPar
    
    paid in
    
    earnings
    
    Deferred
    
    comprehensiveShares
    
    value
    
    capital
    
    (deficit)
    
    compensation
    
    income
    
    TotalBalances at December 28, 2002
    
    
    32,499
    
    
    $
    325
    
    
    $
    197,991
    
    
    $
    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
    
    
    
    460Cumulative translation
adjustment, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,049
    
    
    
    2,049Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,554Issuance of common stockStock options exercised
    
    
    577
    
    
    
    6
    
    
    
    1,907
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,913Employee stock purchase plan
    
    
    58
    
    
    
    
    
    
    
    776
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    776Direct grants
    
    
    1
    
    
    
    
    
    
    
    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
    
    
    
    
    
    
    
    Balance at January 3, 2004
    
    
    33,135
    
    
    $
    331
    
    
    $
    202,341
    
    
    $
    36,331
    
    
    ($
    24
    )
    
    $
    1,367
    
    
    $
    240,346
 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
(In thousands) 2001
    
    2002
    
    2003Cash flows from operating activitiesNet income
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    29,050Adjustments to reconcile net income to
net cash provided by operating activitiesDepreciation
    
    
    3,852
    
    
    
    3,935
    
    
    
    6,487Loss on asset disposals
    
    
    15
    
    
    
    36
    
    
    
    224Amortization of intangibles
    
    
    9,374
    
    
    
    3,775
    
    
    
    4,160Deferred financing costs
    
    
    270
    
    
    
    420
    
    
    
    270Non-cash deferred compensation
    
    
    446
    
    
    
    176
    
    
    
    136Non-cash transition and reorganization
    
    
    747
    
    
    
    
    
    
    
    Non-cash impairment of investment in technology
    
    
    3,000
    
    
    
    
    
    
    
    Non-cash stock-based compensation
    
    
    45
    
    
    
    46
    
    
    
    35Income tax benefit related to stock option plan
    
    
    240
    
    
    
    1,043
    
    
    
    1,670Change in net deferred taxes
    
    
    3,876
    
    
    
    3,652
    
    
    
    3,117Changes in operating assets and liabilitiesAccounts receivable
    
    
    (2,418
    )
    
    
    (1,215
    )
    
    
    (3,906
    )Inventories
    
    
    (4,360
    )
    
    
    673
    
    
    
    (3,108
    )Accounts payable and accrued expenses
    
    
    3,898
    
    
    
    (7,857
    )
    
    
    (3,526
    )Other assets
    
    
    (257
    )
    
    
    (732
    )
    
    
    (473
    )Net cash provided by operating activities
    
    
    25,258
    
    
    
    28,838
    
    
    
    34,136Cash flows from investing activitiesPurchase of property, plant, and equipment
    
    
    (2,698
    )
    
    
    (1,695
    )
    
    
    (6,450
    )Purchases of businesses
    
    
    (11,499
    )
    
    
    
    
    
    
    (44,135
    )Purchase of investments in technology
    
    
    (4,500
    )
    
    
    (1,000
    )
    
    
    Purchase of short and long-term investments
    
    
    (27,796
    )
    
    
    (9,446
    )
    
    
    Sale of short and long-term investments
    
    
    
    
    
    
    37,242
    
    
    
    Purchase of other intangibles
    
    
    (1,500
    )
    
    
    (1,010
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    (47,993
    )
    
    
    24,091
    
    
    
    (50,585
    )Cash flows from financing activitiesIssuance of common stock
    
    
    55,059
    
    
    
    2,351
    
    
    
    2,689Payments on long-term debt
    
    
    (15,583
    )
    
    
    (4,909
    )
    
    
    (7,636
    )Net cash provided by (used in) financing activities
    
    
    39,476
    
    
    
    (2,558
    )
    
    
    (4,947
    )Effect of exchange rates on cash
    
    
    (151
    )
    
    
    303
    
    
    
    920Net increase (decrease) in cash and cash equivalents
    
    
    16,590
    
    
    
    50,674
    
    
    
    (20,476
    )Cash and cash equivalents at beginning of period
    
    
    12,165
    
    
    
    28,755
    
    
    
    79,429Cash and cash equivalents at end of period
    
    $
    28,755
    
    
    $
    79,429
    
    
    $
    58,953Supplemental disclosureCash paid for interest
    
    $
    3,403
    
    
    $
    2,447
    
    
    $
    1,643Cash paid for taxes
    
    $
    2,084
    
    
    $
    10,308
    
    
    $
    9,255
 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; other mens health, including products for incontinence,
stricture, and prostate disease; and womens health needs, including products
for incontinence, menorrhagia, and other pelvic floor disorders. 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 Effective January 1, 2001, the Company changed its fiscal year to a 52-or
53-week fiscal year ending on the Saturday nearest December 31. Accordingly,
fiscal years 2001, 2002, and 2003 ended on December 29, December 28, and
January 3, and are identified herein as 2001, 2002, and 2003. Fiscal years
2001 and 2002 consisted of 52 weeks, and 2003 consisted of 53 weeks. Cash and Cash Equivalents For financial reporting purposes, the Company considers all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents. The Companys cash and cash equivalent balances are
primarily with two investment managers, and the majority is invested in
high-grade commercial paper, tax-advantaged municipal debt, government
securities, and daily money market funds, and are carried at cost which
approximates market. Concentration of Risks The Companys accounts receivable are primarily due from hospitals located
mainly in the United States and Western Europe. Although the Company does not
require collateral from its customers, concentrations of credit risk in the
United States are mitigated by a large number of geographically dispersed
customers. The Company does not presently anticipate losses in excess of
allowances provided associated with trade receivables, although collection
could be impacted by the underlying economies of the other countries. Allowance for Doubtful Accounts The Company estimates the allowance for doubtful accounts by analyzing those
accounts receivable that have reached their due date and by applying rates
based upon historical trends. 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. The allowance for doubtful
accounts was $1.0 million at December 28, 2002, and January 3, 2004. Inventories Inventories are stated at the lower of cost or market, determined on the
first-in-first-out method. 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: F-8




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##### Table of Contents



Asset class
    
    Useful livesBuilding
    
    20 yearsMachinery and equipment
    
    8-12 yearsFurniture, fixtures, and other
    
    3-12 yearsSoftware
    
    3-5 yearsHer Optionequipment
    
    3 years
 Maintenance, repairs, and minor improvements are charged to expense as
incurred. Significant improvements are capitalized. Her Optionequipment consists of cryosurgical compressor systems which are used
with disposable control units in each procedure. The estimated useful lives of
this equipment are based upon managements estimates of its usage by
physicians, factoring in new technology and rollouts by the Company. To the
extent that the Company experiences changes in the usage of this equipment or
introductions of new technologies to the market, the estimated useful lives of
this equipment may change in a future period. Her Optionequipment had a net
carrying value of $4.5 million at January 3, 2004. Goodwill and Other Intangible Assets Goodwill is the excess of the purchase price over the fair value of the other
net assets of acquired businesses. In 2001, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards 142, Goodwill and
Other Intangible Assets.Under SFAS 142, 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. Intangible assets that are not
deemed to have an indefinite life will continue to be amortized over their
estimated useful lives. The Company adopted SFAS 142 on the first day of
fiscal 2002. See Note 5 for the pro forma effects of adopting this standard. 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. Following the definition of SFAS 142, we operate as one reporting unit engaged
in developing, manufacturing, and marketing medical devices. The Company
assesses goodwill impairment annually, or more frequently, if a change in
circumstances or the occurrence of events suggest the remaining value may not
be recoverable. Other intangible assets include patents, non-compete agreements, trade names,
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 impairment in
accordance with SFAS 144, Accounting for the Impairment and Disposal of
Long-Lived Assets. Long-Lived Assets The Company follows 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.
If an indicator of impairment exists, the Company measures the impairment
utilizing discounted cash flows as an estimate of fair value. Revenue Recognition The Company recognizes revenue when legal title to the goods passes to its
customers. Approximately half of the Companys revenue is generated from
inventory loaned to customers or from consigned inventory maintained at
hospitals or with field representatives. In these situations, revenue is
recognized at the time the product has been implanted or used. The Company
reports sales net of estimated returns, rebates, and other trade discounts. F-9




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##### Table of Contents



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 promotional costs charged to operations during 2001,
2002, and 2003 were $2.1 million, $2.5 million, and $4.8 million. Product Warranty Costs The Company adopted Financial Accounting Standards Board Interpretation No. 45,
Guarantors accounting and disclosure requirements for guarantees, including
indirect indebtedness to others(FIN 45), during the first quarter of 2003.
FIN 45 requires disclosures concerning the Companys obligations under certain
guarantees (see Note 6). The Company provides a warranty on its products and accrues estimated future
warranty costs based on its history of actual warranty costs incurred.
Warranty costs are included as part of cost of goods sold. Software Development Costs The Company capitalizes 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. Income Taxes The Company accounts 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. Foreign Currency Translation The financial statements for operations outside the United States are
maintained in their local currency. All assets and liabilities of the
Companys 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. 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, obsolete
inventories, product warranty, product liability claims, and income taxes. The
Company is 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. F-10




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##### Table of Contents



Stock Based Compensation At January 3, 2004, the Company has one stock-based employee compensation plan,
which is described more fully in Note 8. The Company accounts for this plan
under the recognition and measurement principles of APB Opinion 25, Accounting
for Stock Issued to Employees,and related interpretations. The exercise price
of the Companys employee stock options generally equals the market price of
the underlying stock on the date the option is granted, and thus, under APB 25,
no compensation expense is recognized. During 2000, the Company recognized
deferred compensation of $1.4 million for options granted prior to its 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 is being amortized over the option vesting periods of two to four years. 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 the Companys 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. Management believes, however, that
the assumptions used in the following presentation are appropriate within the
limits of the model, and does not believe that reasonable changes in these
assumptions would have a material impact on the Companys 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. The following table illustrates
the effect on net income and net income per share
if the Company had applied the fair value recognition provisions of SFAS 123,
Accounting for Stock-Based Compensation,to stock-based employee compensation
(in thousands, except per share data): 2001
    
    2002
    
    2003Net income, as reported
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    29,050Stock-based employee
compensation expense included
in reported income, net of tax
    
    
    277
    
    
    
    109
    
    
    
    84Total stock-based
employee compensation expense
determined under fair-value based
method for all awards, net of tax
    
    
    (1,860
    )
    
    
    (3,389
    )
    
    
    (3,093
    )Pro forma net income
    
    $
    4,947
    
    
    $
    21,606
    
    
    $
    26,041Net income per shareAs reportedBasic
    
    $
    0.22
    
    
    $
    0.77
    
    
    $
    0.88Diluted
    
    $
    0.20
    
    
    $
    0.73
    
    
    $
    0.85Pro formaBasic
    
    $
    0.17
    
    
    $
    0.67
    
    
    $
    0.79Diluted
    
    $
    0.15
    
    
    $
    0.63
    
    
    $
    0.76
 Net Income per Share The following table presents information necessary to calculate basic and
diluted net income per common share and common share equivalents for the years
ended 2001, 2002, and 2003 (in thousands, except per share data): 2001
    
    2002
    
    2003Net income
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    29,050Weighted-average shares outstanding
for basic net income per share
    
    
    29,792
    
    
    
    32,232
    
    
    
    32,854Dilutive effect of stock options
    
    
    2,276
    
    
    
    1,944
    
    
    
    1,459Adjusted weighted-average shares
outstanding and assumed conversions for diluted net income per share
    
    
    32,068
    
    
    
    34,176
    
    
    
    34,313Net income per shareBasic
    
    $
    0.22
    
    
    $
    0.77
    
    
    $
    0.88Diluted
    
    $
    0.20
    
    
    $
    0.73
    
    
    $
    0.85
 F-11




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Employee stock options of 501,700, 519,450, and 557,402 for fiscal 2001, 2002,
and 2003 respectively, were excluded from the diluted net income per share
calculation because their effect would be antidilutive. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation 46, Consolidation of Variable Interest Entities, an
interpretation of ARB 51 (FIN 46). FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The Company is required to apply FIN 46 to all new variable
interest entities created or acquired after January 31, 2003. For variable
interest entities created or acquired prior to February 1, 2003, management is
required to apply FIN 46, as amended, for periods ending after December 15,
2003. The Company has determined that FIN 46 has no impact upon adoption. In May 2003, FASB issued SFAS 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity.SFAS 150 establishes
standards for issuer classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. Instruments
that fall within the scope of SFAS 150 must be classified as a liability, and
is effective for financial instruments entered into or modified after May 31,
2003. For financial instruments issued prior to June 1, 2003, SFAS 150 is
effective for the Company in the second quarter of fiscal year 2004. Adoption
is not expected to have an impact on the Companys consolidated financial
statements. In January 2004, the FASB issued FASB Staff Position (FSP) FAS 106-1,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003, which permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of this Act.
Regardless of whether a sponsor elects that deferral, FSP FAS 106-1 requires
certain disclosures pending further consideration of the underlying accounting
issues. The guidance in FSP FAS 106-1 is effective for interim or annual
financial statements of fiscal years ending after December 7, 2003. The
Company has elected to defer accounting for these effects, if any, until
authoritative guidance on the accounting is issued or until there is a
significant event that ordinarily would call for re-measurement of the plans
assets and obligations. In December 2003, the FASB issued FAS 132 (Revised) (FAS 132-R), Employers
Disclosure about Pensions and Other Postretirement Benefits.FAS 132-R retains
disclosure requirements of the original FAS 132 and requires additional
disclosures relating to assets, obligations, cash flows, and net periodic
benefits cost. FAS 132-R is effective for fiscal years ending after December
15, 2003. Interim period disclosures are effective for interim periods
beginning after December 15, 2003. The adoption of the disclosure provisions
of FAS 132-R did not have a material effect on the Companys consolidated
financial statements. Reclassification Certain 2001 and 2002 amounts have been reclassified to conform to the 2003
presentation. 2. Acquisitions CryoGen On December 30, 2002, the Company completed a merger with CryoGen Inc. under
which CryoGen became a wholly-owned subsidiary of the Company. In conjunction
with the merger, the Company paid the former share- F-12




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##### Table of Contents



holders of CryoGen $36.2 million, and paid $4.1 million of acquisition related
liabilities. The Company has 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
receive an earnout payment (a) equal to three times the net revenue from sales
of CryoGens products during any four consecutive quarters ending three years
after closing, less (b) $40.0 million. If net revenues from 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 payment, if any, will be accounted for as goodwill. The
primary purpose of the CryoGen acquisition was to gain access to CryoGens
products and technology and further the Companys strategy of developing more
and better treatments to improve womens health. The Company believes that
many women with incontinence and other pelvic disorders it treats (through
urologists and gynecologists) also suffer from menorrhagia and uterine
fibroids, and the Companys investments in these markets would allow it to
extend the highly-effective benefits of the CryoGen products and technology to
these women more efficiently and effectively than CryoGen could. The Company
also believes that by broadening its offerings beyond incontinence treatments,
it could offer more value to its physician-customers. The Company believes 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.
The Company believes a gynecologist could use the Her Optionto cure
menorrhagia in the office without monitored anesthesia with significant savings
to the healthcare system. The consolidated financial statements of the Company
for 2003 include the financial results of CryoGen from December 30, 2002, the
date of the purchase. Following are as-reported results for the Company and pro forma results of the
combined companies for 2001 and 2002 as if the acquisition had occurred at the
beginning of the year (in thousands, except per share data): 2001
    
    2002
    
    2003Reported
    
    Pro forma
    
    Reported
    
    Pro forma
    
    ReportedRevenue
    
    $
    117,938
    
    
    $
    119,888
    
    
    $
    141,648
    
    
    $
    144,310
    
    
    $
    168,283Net income (loss)
    
    $
    6,530
    
    
    ($
    3,431
    )
    
    $
    24,886
    
    
    $
    16,866
    
    
    $
    29,050Net income (loss) per share:Basic
    
    $
    0.22
    
    
    ($
    0.12
    )
    
    $
    0.77
    
    
    $
    0.52
    
    
    $
    0.88Diluted
    
    $
    0.20
    
    
    ($
    0.12
    )
    
    $
    0.73
    
    
    $
    0.49
    
    
    $
    0.85
 The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed as a result of this acquisition (in thousands): AssetsCurrent assets
    
    $
    1,707Goodwill
    
    
    17,820Intangible assets
    
    
    5,009Deferred tax asset
    
    
    16,206Other long-term assets
    
    
    4,420Total assets acquired
    
    $
    45,162LiabilitiesCurrent liabilities
    
    
    3,205Net assets acquired
    
    $
    41,957
 Goodwill of $17.8 million recorded in the transaction will not be amortized and
will not be tax deductible for the Company. The intangible assets are composed of $4.6 million in developed technology and
$0.4 million in patents. An independent consultant determined the value of the
developed technology using a discounted cash flow method over the estimated
economic life of the technology. The developed technology will be amortized
over the remaining life of 10 years, with a full years amortization of $0.5
million included in 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. F-13




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##### Table of Contents



Deferred tax assets consist of $17.6 million in Federal income tax net
operating loss carryforward 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. The Company used $1.6 million of this
net operating loss in 2003 and expects 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. The NOLs begin expiring in 2012;
the Company does not expect to lose utilization through expiration. Other long-term assets 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, the Company acquired the Dura IIline of erectile restoration
products from Endocare, Inc. The Company 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 the Companys
product line between its inflatable prostheses and its non-inflatable
prostheses with an adjustable, non-inflatable product. There are no contingent
payments related to this acquisition. The consolidated financial statements of
the Company for 2003 include the financial results of this business from the
date of the purchase. The allocation of the purchase price for the acquisition, based on the
Companys internal valuation study, is as follows (in thousands): AssetsInventory
    
    $
    408Goodwill
    
    
    562Intangible assets
    
    
    1,180Other long-term assets
    
    
    28Total assets acquired
    
    $
    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 will be amortized over the remaining life of seven and
one-half years. Goodwill of $0.6 million recorded in the transaction will not be amortized and
will not be tax deductible for the Company. Influence In 1999, the Company acquired Influence Inc., a supplier of bone anchors and
sling products used primarily for treating female incontinence. During 2001,
the Company made contingent purchase price and milestone payments totaling
$11.5 million that have been recorded as goodwill. In September 2001, the
Company acquired the minority interest relating to the original acquisition of
Influence, and in December 2001 made the final milestone payment relating to
this minority interest by issuing 214,436 shares of common stock with a market
value of $3.2 million, which was recorded as goodwill. The Company has made
all contingent purchase price and milestone payments required under the
acquisition agreement. As of January 3, 2004, the Companys balance sheet includes the following
related to goodwill and intangible assets resulting from this acquisition (in
thousands): AccumulatedAsset balance
    
    amortization
    
    Net balanceTrademarks & tradenames
    
    $
    2,208
    
    
    $
    450
    
    
    $
    1,758R&D technology
    
    
    9,892
    
    
    
    7,104
    
    
    
    2,788Other intangibles
    
    
    3,088
    
    
    
    1,491
    
    
    
    1,597Goodwill
    
    
    24,686
    
    
    
    3,613
    
    
    
    21,073Total
    
    $
    39,874
    
    
    $
    12,658
    
    
    $
    27,216
 F-14




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##### Table of Contents



The primary purpose of the Influence acquisition was to enter the womens
bladder control business and set a foundation for participating in the broader
womens health marketplace. Investments in Technology In 1999, the Company signed an exclusive, long-term agreement with InjecTx Inc.
to distribute its prostate injection system worldwide. The Company made an
initial $2.0 million equity investment in October 1999 and additional equity
investments of $1.5 million in March 2001 and $1.0 million in May 2002. The
Company currently owns 19 percent of the capital stock of InjecTx. While an
officer of the Company is on InjecTx board of directors, the Company has no
control or influence on the strategy or operations of InjecTx and acts solely
as a distributor of some of the products InjecTx develops and manufactures.
The Company has performed an assessment under FIN 46 to determine if this
entity is a Variable Interest Entity. InjecTx does not meet the conditions of
FIN 46 and can continue to be accounted for on a cost basis. The Company will
continue to evaluate this assessment. In 2001, the Company made a $3.0 million equity investment in Collagenesis
Corporation. Pursuant to the terms of the agreement with Collagenesis, the
Company converted its equity position into a $3.0 million 10 percent Senior
Subordinated Convertible Voting Promissory Note in April 2001. In December
2001, Collagenesis declared bankruptcy, with the Company receiving no proceeds
from the liquidation of the Collagenesis assets. In December 2001, the
Companys investment in Collagenesis was written off and charged to other
expense. 3. Transition and Reorganization Expense During the third quarter of 2001, the Company completed an assessment of senior
management personnel needs and, as a result of this review, recorded $1.0
million of transition and reorganization expenses for 2001. All benefits under
Company transition and reorganization plans were paid as of December 28, 2002.
Below is a summary of transition and reorganization expenditures (in
thousands): Acceleratedoption stockSeverance
    
    vesting
    
    Other
    
    TotalBalance at December 31, 2000
    
    $
    665
    
    
    $
    
    
    
    $
    
    
    
    $
    665Accrued
    
    
    222
    
    
    
    747
    
    
    
    31
    
    
    
    1,000Paid
    
    
    (695
    )
    
    
    (747
    )
    
    
    (31
    )
    
    
    (1,473
    )Balance at December 29, 2001
    
    
    192
    
    
    
    
    
    
    
    
    
    
    
    192Accrued
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Paid
    
    
    (192
    )
    
    
    
    
    
    
    
    
    
    
    (192
    )Balance at December 28, 2002
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
 F-15




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##### Table of Contents



4. Balance Sheet Information The following provides additional information (in thousands) concerning
selected balance sheet accounts: 2002
    
    2003Accounts receivableTrade accounts receivable
    
    $
    25,973
    
    
    $
    32,324Other receivables
    
    
    2,191
    
    
    
    2,216Allowance for doubtful accounts
    
    
    (956
    )
    
    
    (1,033
    )Net accounts receivable
    
    $
    27,208
    
    
    $
    33,507InventoriesWork-in-progress
    
    $
    4,147
    
    
    $
    5,260Raw materials
    
    
    1,938
    
    
    
    2,823Finished goods
    
    
    10,138
    
    
    
    12,267Obsolescence allowance
    
    
    (2,748
    )
    
    
    (1,948
    )Net inventories
    
    $
    13,475
    
    
    $
    18,402Property, plant, and equipmentLand and building
    
    $
    13,915
    
    
    $
    14,408Machinery and equipment
    
    
    13,071
    
    
    
    22,384Software
    
    
    5,987
    
    
    
    6,747Furniture, fixtures, and other
    
    
    2,812
    
    
    
    3,043Accumulated depreciation
    
    
    (14,457
    )
    
    
    (21,093
    )Net property, plant, equipment
    
    $
    21,328
    
    
    $
    25,489
 5. Goodwill and Intangible Assets We assess goodwill impairment under the annual requirement of SFAS 142
annually, or when impairment indicators arise. The following table presents a reconciliation of net income and net income per
share adjusted for the exclusion of goodwill amortization, net of income taxes
(in thousands, except per share data): 2001
    
    2002
    
    2003Net income
    
    $
    6,530
    
    
    $
    24,886
    
    
    $
    29,050Goodwill amortization, net of taxes
    
    
    4,218
    
    
    
    
    
    
    
    Adjusted net income
    
    $
    10,748
    
    
    $
    24,886
    
    
    $
    29,050Adjusted net income per shareBasic
    
    $
    0.36
    
    
    $
    0.77
    
    
    $
    0.88Diluted
    
    $
    0.34
    
    
    $
    0.73
    
    
    $
    0.85
 F-16




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The changes in carrying amount of goodwill for 2002 and 2003 (in thousands) are
as follows: 2002
    
    2003Goodwill, beginning of year
    
    $
    94,553
    
    
    $
    94,553Additions
    
    
    
    
    
    
    18,382Goodwill, end of year
    
    $
    94,553
    
    
    $
    112,935Accumulated amortization
    
    
    (13,946
    )
    
    
    (13,946
    )Net goodwill
    
    $
    80,607
    
    
    $
    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. The following table provides additional information concerning intangible
assets (in thousands): Weighted
    
    December 28, 2002
    
    January 3, 2004average
    
    Gross
    
    
    
    
    
    
    
    
    
    Grossremaining
    
    carrying
    
    Accumulated
    
    Net book
    
    carrying
    
    Accumulated
    
    Net booklife (years)
    
    amount
    
    amortization
    
    value
    
    amount
    
    amortization
    
    valueIntangible AssetsAmortizedPatents
    
    
    6.0
    
    
    $
    9,693
    
    
    ($
    4,246
    )
    
    $
    5,447
    
    
    $
    10,144
    
    
    ($
    5,459
    )
    
    $
    4,685Licenses
    
    
    4.9
    
    
    
    2,762
    
    
    
    (671
    )
    
    
    2,091
    
    
    
    2,790
    
    
    
    (1,048
    )
    
    
    1,742Deferred financing
    
    
    1.7
    
    
    
    1,611
    
    
    
    (891
    )
    
    
    720
    
    
    
    1,611
    
    
    
    (1,161
    )
    
    
    450Developed technology
    
    
    6.4
    
    
    
    12,073
    
    
    
    (6,411
    )
    
    
    5,662
    
    
    
    17,853
    
    
    
    (9,035
    )
    
    
    8,818Non-compete agreements
    
    
    
    
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    
    
    
    
    1,111
    
    
    
    (1,111
    )
    
    
    Total
    
    
    6.0
    
    
    
    27,250
    
    
    
    (13,330
    )
    
    
    13,920
    
    
    
    33,509
    
    
    
    (17,814
    )
    
    
    15,695UnamortizedTrademarks
    
    
    N/A
    
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771
    
    
    
    2,233
    
    
    
    (462
    )
    
    
    1,771Total intangible assets
    
    
    
    
    
    $
    29,483
    
    
    ($
    13,792
    )
    
    $
    15,691
    
    
    $
    35,742
    
    
    ($
    18,276
    )
    
    $
    17,466
 F-17




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The following discloses actual and expected aggregate amortization expense (in
thousands) for 2001 through 2008: Year
    
    Actual
    
    Expected2001
    
    $
    9,374
    
    
    
    2002
    
    
    3,775
    
    
    
    2003
    
    
    4,160
    
    
    
    2004
    
    
    
    
    
    $
    4,1602005
    
    
    
    
    
    
    2,7002006
    
    
    
    
    
    
    2,2002007
    
    
    
    
    
    
    1,3002008
    
    
    
    
    
    
    1,300
 6. Warranties Many of the Companys products are sold with warranty coverage for periods
ranging from one year up to the patients lifetime. The accrued warranty
allowance is the Companys estimate of the expected future cost of honoring
current warranty obligations. Factors influencing this estimate include
historical claim rates, surgical infection rates, and 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 2001 through 2003 (in thousands) are listed below. The
adjustment represents a reduction in managements estimate of the future cost
of honoring the Companys warranty obligations, resulting from recent
improvements in the quality and durability of its products and
changes in its
claims processing. 2001
    
    2002
    
    2003Balance at beginning of period
    
    $
    7,548
    
    
    $
    7,587
    
    
    $
    4,526Adjustment to allowance
    
    
    
    
    
    
    (2,913
    )
    
    
    (3,069
    )Provisions for warranty
    
    
    516
    
    
    
    
    
    
    
    150Claims processed
    
    
    (477
    )
    
    
    (148
    )
    
    
    (269
    )Balance at end of period
    
    $
    7,587
    
    
    $
    4,526
    
    
    $
    1,338
 7. Long-Term Debt and Senior Credit Facility In April 2000, the Company established a credit facility consisting of term
notes totaling $100.0 million and a $15.0 million revolving line of credit
which incurs a commitment fee of .25 percent for unused portions. During 2001,
the Company repaid $15.6 million of the term note. During 2002 and 2003, the
Company made total quarterly principal payments of $4.9 million and $7.6
million respectively. The term note now requires quarterly principal payments
of $1.6 million through March 2004, and $1.8 million from June 2004 through
March 2005, and a final payment of $5.5 million in September 2005. The Company had an interest swap agreement covering the term note, establishing
a fixed rate of 10.065 percent on this portion of the debt. The swap agreement
expired in June 2003, and through amendment to the Credit Agreement, the
requirement for such a swap agreement was removed. The term note bears
interest, payable quarterly, at the Base Rate (the higher of the Federal Funds
rate plus 0.5 percent, or the Prime Rate) plus 1 percent for Base Rate loans,
or LIBOR plus two percentage points for Eurodollar loans. During 2003, the
Company did not request any loans. The interest rate at January 3, 2004, based
on LIBOR plus two percentage points was 3.15 percent. F-18




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##### Table of Contents



The debt carrying value of the $16.4 million outstanding at January 3, 2004,
approximates fair value estimated using the Companys incremental borrowing
rate for similar liabilities. The senior credit facility is secured by
substantially all of the Companys assets and contains certain restrictions
requiring prior bank group approval. The restrictions prohibit the payment of
dividends and the incurrence of additional debt, limit capital expenditures to
$10.0 million for any fiscal year (plus the unused portion of this $10.0
million capital expenditure limit for the preceding fiscal year), limit
acquisitions not to exceed an aggregate of $25.0 million in any fiscal year,
prohibit the entering into sale and leaseback agreements, and limit operating
leases (except for vehicles for sales personnel) to $1.0 million in any fiscal
year. The Company is subject to, and is in full compliance with, four financial
covenants including a leverage ratio, an interest coverage ratio, a fixed
charge coverage ratio, and a required minimum level of consolidated EBITDA.
The following table sets forth these covenants and our compliance as of January
3, 2004. Credit facilityrequirements
    
    ActualLeverage ratio
    
    
    <2.50
    
    
    
    0.29Interest coverage ratio
    
    
    >3.00
    
    
    
    30.93Fixed charge coverage ratio
    
    
    >1.25
    
    
    
    4.06Minimum consolidated EBITDA
    
    >$35.0 million
    
    $56.5 million
 Derivatives and Hedging The Company adopted SFAS 133, as amended by SFAS 138, Accounting for Derivative
Instruments and Hedging Activities, on January 1, 2001. SFAS 133 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. In accordance with
the transition provisions of SFAS 133, the Company recorded a cumulative loss
adjustment to OCI, in 2001, of $0.7 million, after taxes, to recognize the fair
value of its derivatives as of the date of adoption. All of the derivatives used by the Company were designated as cash flow hedges
at the time of adoption of SFAS 133. 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, if any, was reported as part of other expense and
was immaterial in 2001, 2002 and 2003. All derivatives are adjusted to their
fair market values at the end of each quarter. Unrealized net gains and losses
for cash flow hedges, net of any amounts reported as part of interest expense,
were recorded in OCI. The Companys credit risk related to derivatives is
considered low because they are entered into with only strong creditworthy
counterparties. The Companys interest rate swap agreement expired June 30, 2003, and the
senior credit facility was amended to eliminate the need to renew it. Pre-tax
losses totaling approximately $0.9 million were recognized during 2003 in
interest expense. 8. Stockholders Equity Public Offerings and Common Stock In July 2001, the Company completed a follow-on public offering of 3,500,000
shares of common stock at an offering price of $16.40 per share. The Company
received proceeds of $53.8 million after deducting $3.7 million for
underwriting and issuance costs. Net proceeds were used for the retirement of
debt, working capital, and other general corporate purposes. F-19




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##### Table of Contents



During 2002 and 2003, Warburg Pincus Equity Partners converted all of the
outstanding shares of non-voting stock that it owned into an equal number of
shares of voting common stock in connection with WPEPs distribution of the
Companys common stock to its limited partners. Stock Incentive Plan The Companys 2000 Equity Incentive Plan, as amended, provides for granting to
eligible employees and certain other individuals nonqualified and incentive
stock options. The Company has reserved 7,355,000 shares of common stock for
issuance under the Plan; it has granted options to purchase an aggregate of
5,520,381 shares (net of cancellations), and 1,834,619 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: Options
    
    Weighted averageoutstanding
    
    exercise price per shareBalance at December 31, 2000
    
    
    3,146,070
    
    
    $
    3.35Granted
    
    
    899,875
    
    
    
    13.23Exercised
    
    
    (424,938
    )
    
    
    1.74Cancelled or expired
    
    
    (123,327
    )
    
    
    4.78Balance at December 29, 2001
    
    
    3,497,680
    
    
    
    6.03Granted
    
    
    680,555
    
    
    
    20.45Exercised
    
    
    (495,126
    )
    
    
    3.35Cancelled or expired
    
    
    (267,989
    )
    
    
    10.63Balance at December 28, 2002
    
    
    3,415,120
    
    
    
    8.93Granted
    
    
    1,084,552
    
    
    
    16.66Exercised
    
    
    (576,874
    )
    
    
    3.32Cancelled or expired
    
    
    (148,309
    )
    
    
    16.20Balance at January 3, 2004
    
    
    3,774,489
    
    
    $
    11.72
 F-20




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##### Table of Contents



An aggregate of 1,376,780, 1,831,121, and 2,261,348 shares were exercisable at
the end of 2001, 2002, and 2003. Exercise prices and weighted-average
remaining contractual life for options outstanding at the end of 2003 are
summarized as follows: Total
    
    ExercisableWeighted aver-
    
    Weighted
    
    
    
    
    
    WeightedNumber
    
    age remaining
    
    average
    
    Number
    
    averageRange of exercise prices
    
    of shares
    
    contractual life
    
    exercise price
    
    of shares
    
    exercise price$1.67
    
    
    1,091,351
    
    
    5.3 years
    
    $
    1.67
    
    
    
    1,091,351
    
    
    $
    1.67$6.67 - $11.49
    
    
    432,714
    
    
    6.9 years
    
    
    8.98
    
    
    
    337,748
    
    
    
    8.94$12.56 - $17.00
    
    
    1,516,554
    
    
    8.3 years
    
    
    15.47
    
    
    
    610,302
    
    
    
    15.22$17.35 - $22.75
    
    
    733,870
    
    
    8.6 years
    
    
    20.53
    
    
    
    221,947
    
    
    
    21.31Total
    
    
    3,774,489
    
    
    7.3 years
    
    $
    11.72
    
    
    
    2,261,348
    
    
    $
    8.34
 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 the Company had
accounted for its 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: 2001
    
    2002
    
    2003Risk free interest rate
    
    
    4.25
    %
    
    
    3.00
    %
    
    
    3.81
    %Expected dividend rate
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Stock price volatility
    
    
    .4582
    
    
    
    .6175
    
    
    
    .4320Expected life of option
    
    5 years
    
    
    5 years
    
    
    7 years
 The weighted average fair value of options granted during 2001, 2002, and 2003
was $6.03, $9.66, and $8.42. Employee Stock Purchase Plan The Company has 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 300,000 common shares were reserved for
issuance under the ESPP, and 155,977 shares have been issued. 9. Commitments and Contingent Liabilities Product Liability The Company is self-insured for product liability claims below $1 million for
each occurrence and $3 million in the aggregate, and maintains product
liability insurance above these limitations. The Company is involved in a number of claims and lawsuits considered normal in
its business, including product liability matters. While it is not possible to
predict the outcome of legal actions brought against the Company, the Company
believes that the liability resulting from the pending claims and suits would
not have a material, adverse effect on its financial position at January 3,
2004, or on the results of its operations and cash flows for the year then
ended. Operating Leases The Company has future minimum lease payment obligations for automobiles,
office space, and other facilities of: $1.5 million for 2004, $1.1 million for
2005, $0.7 million for 2006, $0.6 million for 2007, and $0.6 million for 2008.
Lease payments were $1.6 million, $1.3 million, and $1.7 million in 2001, 2002,
and 2003, 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 and sales office outside the U.S. The
primary lease for the CryoGen facility expires on August 31, 2005. The Company
has sublet the premises for the remaining lease term. F-21




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##### Table of Contents



10. Industry Segment Information and Foreign Operations Since its inception, the Company has operated in the single industry segment
developing, manufacturing, and marketing medical devices. The Company distributes its products through its direct sales force and
independent sales representatives in the United States, Canada, Australia, and
most of Europe. Additionally, the Company distributes its products through
foreign independent distributors, primarily in Europe, Asia, and South America,
who then sell the products to medical institutions. No customer or distributor
accounted for five percent or more of the Companys net sales during 2001,
2002, or 2003. Foreign subsidiary sales are predominantly to customers in
Western Europe, Australia, and Canada. Substantially all of the Companys
foreign subsidiary assets are located in Western Europe, Australia, and Canada.
At the end of 2002 and 2003, consolidated accounts receivable included $9.5
million and $12.5 million due from customers located outside of the United
States. The following table presents net sales and long-lived assets by geographical
territory (in thousands). No individual foreign countrys net sales or
long-lived assets are material. 2001
    
    2002
    
    2003United StatesNet sales
    
    $
    97,069
    
    
    $
    116,523
    
    
    $
    136,765Long-lived assets
    
    $
    113,481
    
    
    $
    110,121
    
    
    $
    134,682Outside United StatesNet sales
    
    $
    20,869
    
    
    $
    25,125
    
    
    $
    31,518Long-lived assets
    
    $
    13,619
    
    
    $
    12,647
    
    
    $
    12,260
 11.
Pension and Other Post-Retirement Benefits Prior to 2002, the Company had pension plans covering most employees worldwide.
For U.S. employees, the Company sponsored the AMS Retirement Annuity Plan
which covered substantially all U.S. employees hired before January 1, 2000.
Plan benefits depended on years of service and employee final average earnings.
Participants vested in their benefits after as few as five years of service. On January 1, 2002, the Company terminated its AMS Retirement Annuity Plan.
Effective December 31, 2001, all benefits ceased accruing with respect to
service and salary. Therefore, benefits were frozen as of that date. In
conjunction with the termination, the Company contributed $5.8 million to the
Plan and recorded a $0.7 million gain on pension plan termination as other
income. Plan assets were distributed to participants during fiscal 2002. The Company still sponsors a post-retirement plan in the United States, which
provides medical, dental, and life insurance benefits to certain retirees and
their eligible dependents at reduced rates. Employees hired before 2000 are
eligible if they meet age and service requirements and qualify for retirement
benefits. The Company does not fund other post-retirement benefit plans, but
contributes to the plans as benefits are paid. The plan was measured as of
January 3, 2004. The cost of the post-retirement benefit plan (in thousands)
was as follows: 2002
    
    2003Service cost
    
    $
    100
    
    
    $
    118Interest cost
    
    
    125
    
    
    
    132Amortization of net actuarial losses
    
    
    (159
    )
    
    
    (143
    )Expected return on plan assets
    
    
    
    
    
    
    Net benefits costs
    
    $
    66
    
    
    $
    107
 F-22




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##### Table of Contents



The following tables present reconciliations of the benefit obligation of the
plans, the plan assets of the pension plan and the funded status of the plans
(in thousands). Pension
    
    Other Benefits2002
    
    2003
    
    2002
    
    2003Change in benefit obligationBenefit obligation at beginning
of year
    
    $
    19,367
    
    
    $
    0
    
    
    $
    1,726
    
    
    $
    2,021Service cost
    
    
    
    
    
    
    
    
    
    
    100
    
    
    
    118Interest cost
    
    
    
    
    
    
    

    
    
    
    125
    
    
    
    132Actuarial (gains) or losses
    
    
    6,882
    
    
    
    
    
    
    
    149
    
    
    
    186Benefit payments
    
    
    
    
    
    
    
    
    
    
    (80
    )
    
    
    (100
    )Curtailments
    
    
    (6,206
    )
    
    
    
    
    
    
    
    
    
    
    Settlements
    
    
    (20,043
    )
    
    
    
    
    
    
    
    
    
    
    (69
    )Benefit obligation at end of year
    
    $
    0
    
    
    $
    0
    
    
    $
    2,021
    
    
    $
    2,288Change in plan assetsFair value of assets at beginning
of year
    
    $
    14,221
    
    
    
    
    
    
    
    
    
    
    
    Actual return on plan assets
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    Employer contributions
    
    
    5,811
    
    
    
    
    
    
    
    
    
    
    
    Benefit payments
    
    
    (20,043
    )
    
    
    
    
    
    
    
    
    
    
    Fair value of plan assets at end
of year
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0Funded statusFunded status
    
    
    
    
    
    
    
    
    
    ($
    2,021
    )
    
    ($
    2,288
    )Prior service cost
    
    
    
    
    
    
    
    
    
    
    (838
    )
    
    
    (704
    )Unrecognized net actuarial gain
    
    
    
    
    
    
    
    
    
    
    (394
    )
    
    
    (190
    )Net amount of accrued benefit cost
    
    $
    0
    
    
    $
    0
    
    
    ($
    3,253
    )
    
    ($
    3,182
    )
 The assumptions used in estimating the annual cost related to these plans
include: 2002
    
    2003Discount rate
    
    
    6.8
    %
    
    
    6.3
    %Rate of future compensation increase
    
    
    4.5
    %
    
    
    4.0
    %
 An average increase of 10.0 percent in the cost of covered health care benefits
was assumed for 2004 and is projected to gradually decrease to 5.0 percent by
2013 and remain at that level thereafter. Since the employee subsidy cap is
close to being 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. Measurements of the accumulated postretirement
benefit obligation and net periodic post-retirement benefit cost in the
accompanying financial statements and notes do not reflect the effects of the
Act on the Companys plan. Specific authoritative guidance on the accounting
for the federal subsidy is pending, and that guidance, when issued, could
require the Company (as plan sponsor) to change previously reported
information. The Company has not yet identified the actions it might take in
response to the Act. 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. The Company matches a
portion of these contributions and makes additional contributions to the Plan
based upon operating profit. The Plan is intended to satisfy the requirements
of Section 401(a)(27) of the Internal Revenue Code. Generally, all employees
of the Company are eligible to participate in the Plan. The Company made
matching contributions of $1.1 million in 2001 and 2002, and $1.2 million in
2003. There were no profit sharing contributions in 2001. Profit sharing
contributions were $1.1 million in 2002 and $0.9 million in 2003. F-23




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##### Table of Contents



13. Income Taxes Components of the Companys income before income taxes are as follows (in
thousands): Taxable income
    
    2002
    
    2002
    
    2003U.S.
    
    $
    11,915
    
    
    $
    40,716
    
    
    $
    44,229Outside U.S.
    
    
    487
    
    
    
    (100
    )
    
    
    (140
    )Total
    
    $
    12,402
    
    
    $
    40,616
    
    
    $
    44,089
 Components of the Companys income tax expense are as follows (in thousands): Income tax expense
    
    2001
    
    2002
    
    2003CurrentU.S.Federal
    
    $
    4,431
    
    
    $
    11,125
    
    
    $
    10,338State
    
    
    684
    
    
    
    953
    
    
    
    1,384Outside U.S.
    
    
    185
    
    
    
    
    
    
    
    200DeferredU.S.Federal
    
    
    526
    
    
    
    3,373
    
    
    
    2,995State
    
    
    46
    
    
    
    279
    
    
    
    122Outside U.S.
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    5,872
    
    
    $
    15,730
    
    
    $
    15,039
 F-24




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##### Table of Contents



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
    
    2001
    
    2002
    
    2003Statutory rate
    
    $
    4,217
    
    
    $
    14,216
    
    
    $
    15,430Meals & entertainment
    
    
    142
    
    
    
    162
    
    
    
    255Goodwill
    
    
    639
    
    
    
    
    
    
    
    Prior year tax credits
    
    
    
    
    
    
    
    
    
    
    (1,100
    )Current year tax credits
    
    
    
    
    
    
    
    
    
    
    (780
    )Foreign
    
    
    20
    
    
    
    3
    
    
    
    121Other
    
    
    262
    
    
    
    106
    
    
    
    103State taxes
    
    
    592
    
    
    
    1,243
    
    
    
    1,010Total
    
    $
    5,872
    
    
    $
    15,730
    
    
    $
    15,039
 F-25




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##### Table of Contents



During the third quarter of 2003, the Company 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 of $0.8 million
were reflected in income tax expense for fiscal year 2003. 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 the Companys deferred income tax assets and liabilities at the end of 2002
and 2003 are as follows (in thousands): 2002
    
    2003Deferred tax assetsFederal NOL
    
    $
    
    
    
    $
    16,054Intellectual property
    
    
    7,665
    
    
    
    7,070Foreign NOL
    
    
    684
    
    
    
    722Post retirement benefit
liability
    
    
    1,392
    
    
    
    1,351Accrued warranty expenses
    
    
    1,720
    
    
    
    550Interest rate swap
    
    
    327
    
    
    
    Acquisition assets
    
    
    728
    
    
    
    1,191Compensation accruals
    
    
    866
    
    
    
    1,818Start up costs
    
    
    50
    
    
    
    Workforce and patents
    
    
    721
    
    
    
    835Other, primarily allowances
    
    
    397
    
    
    
    1,496Valuation allowance
    
    
    (684
    )
    
    
    (684
    )Total deferred tax assets
    
    
    13,866
    
    
    
    30,403Deferred tax liabilities:Acquired technology
    
    
    2,554
    
    
    
    1,889Goodwill
    
    
    2,002
    
    
    
    5,343Currency translation
adjustment
    
    
    
    
    
    
    745Acquisition step-up
    
    
    
    
    
    
    2,073Tax over book amortization
    
    
    2,308
    
    
    
    498Other
    
    
    392
    
    
    
    1,227Total deferred tax liabilities
    
    
    7,256
    
    
    
    11,775Net deferred tax asset
    
    $
    6,610
    
    
    $
    18,628
 On January 3, 2004, the Company had foreign tax loss carryforwards of
approximately $1.8 million with no expiration. Realization of the future tax
benefits related to the net deferred tax assets is dependent on many factors,
including the Companys ability to generate taxable income within the net
operating loss carryforward period. To the extent the net operating losses
were created in a foreign jurisdiction, the Company has included a valuation
allowance of $0.7 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. The Company believes that future taxable income will be
sufficient to realize the remaining recorded asset. The Company has a U.S. Federal tax loss carryforward of approximately $45.0
million with the initial amount of $3.7 million expiring in 2012 and the total
amount expiring by the end of 2022. Management believes that future taxable
income will be sufficient to realize these tax loss carryforwards and has
established a deferred tax asset of $16.1 million. F-26




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##### Table of Contents



14.
Quarterly Financial Data (unaudited; in thousands, except per share
data) 2002
    
    2003First
    
    Second
    
    Third
    
    Fourth
    
    First
    
    Second
    
    Third
    
    FourthNet sales
    
    $
    34,715
    
    
    $
    36,330
    
    
    $
    32,771
    
    
    $
    37,832
    
    
    $
    39,347
    
    
    $
    42,224
    
    
    $
    39,559
    
    
    $
    47,153Gross profit
    
    
    27,583
    
    
    
    29,210
    
    
    
    26,538
    
    
    
    33,712
    
    
    
    32,404
    
    
    
    34,843
    
    
    
    32,449
    
    
    
    41,234Operating income
    
    
    7,721
    
    
    
    8,609
    
    
    
    8,448
    
    
    
    13,294
    
    
    
    8,681
    
    
    
    9,492
    
    
    
    8,205
    
    
    
    15,262Net income
    
    
    5,417
    
    
    
    5,730
    
    
    
    5,408
    
    
    
    8,331
    
    
    
    5,454
    
    
    
    6,337
    
    
    
    6,940
    
    
    
    10,319Net income per shareBasic
    
    $
    0.17
    
    
    $
    0.18
    
    
    $
    0.17
    
    
    $
    0.25
    
    
    $
    0.17
    
    
    $
    0.19
    
    
    $
    0.21
    
    
    $
    0.31Diluted
    
    $
    0.16
    
    
    $
    0.17
    
    
    $
    0.16
    
    
    $
    0.24
    
    
    $
    0.16
    
    
    $
    0.19
    
    
    $
    0.20
    
    
    $
    0.30
 During the fourth quarters of 2002 and 2003, the Company reduced the allowance
for estimated warranty claims by $2.9 million and $3.1 million; these
adjustments were 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, the Company 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. The Companys 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 third quarter of each year typically having the lowest sales
and the fourth quarter of each typically having the highest sales. 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, 2004
    
    AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.By:   /s/ Douglas W. KohrsDouglas W. KohrsChairman of the Board and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 17, 2004 by the following persons on
behalf of the registrant and in the capacities indicated. Signature
    
    Title/s/ Douglas W. Kohrs
Douglas W. Kohrs
    
    Chairman of the Board and Chief Executive Officer
(Principal Executive Officer) and Director/s/ M. James Call
M. James Call
    
    Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)/s/ Richard B. Emmitt
Richard B. Emmitt
    
    Director/s/ Albert Jay Graf
Albert Jay Graf
    
    Director/s/ Christopher H. Porter
Christopher H. Porter, Ph.D.
    
    Director/s/ David W. Stassen
David W. Stassen
    
    Director/s/ Thomas E. Timbie
Thomas E. Timbie
    
    Director/s/ Elizabeth H. Weatherman
Elizabeth H. Weatherman
    
    Director
 F-28




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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 3, 2004
 Item No.
    
    Item
    
    Filing Method3.1
    
    Amended and Restated Certificate of
Incorporation of the Company.
    
    Incorporated by reference to Exhibit 3.1
of the Companys Form 10-Q for the Quarter
Ended September 30, 2000 (File No. 30733).3.2
    
    Bylaws, as amended, of the Company.
    
    Filed with this Annual Report on Form 10-K.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
    
    Employment Agreement, dated April 23, 1999,
between Douglas Kohrs and American Medical
Systems, Inc.
    
    Incorporated by reference to Exhibit 10.2
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.3
    
    Amendment to the Employment Agreement, dated
April 17, 2000, between Douglas Kohrs and
American Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.3
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.4
    
    Second Amendment to Employment Agreement,
dated January 23, 2002, between Douglas
Kohrs and American Medical Systems, Inc.
    
    Incorporated by reference to Exhibit 10.4
of the Companys Form 10-K for the Fiscal
Year Ended December 29, 2001 (File No.
000-30733).10.5
    
    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).10.6
    
    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).
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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.
    
    Filed with this Annual Report on Form 10-K.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
    
    2003 Management Incentive Plan.
    
    Filed with this Annual Report on Form 10-K.10.15
    
    Lease, dated July 22, 2002, between
Manufacturers Life Insurance Company
(U.S.A.) and Cryogen, Inc.
    
    Incorporated by reference to Exhibit 10.15
of the Companys Form 10-K for the Fiscal
Year Ended December 28, 2002 (File No.
000-30733).10.16
    
    Credit Agreement, dated March 24, 2000,
among American Medical Systems, Inc.,
American Medical Systems Holdings, Inc.,
Bank of America, N.A., as agent for the four
lenders, and Banc of America Securities LLC,
as sole lead arranger and sole book manager.
    
    Incorporated by reference to Exhibit 10.22
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.17
    
    Security Agreement, dated March 24, 2000,
among American Medical Systems Holdings,
Inc., American Medical Systems, Inc.,
Influence, Inc. and Banc of America, N.A.
    
    Incorporated by reference to Exhibit 10.23
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.18
    
    Form of Revolving Note issued under Credit
Agreement.
    
    Incorporated by reference to Exhibit 10.24
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.19
    
    Form of Tranche A Term Note issued under
Credit Agreement.
    
    Incorporated by reference to Exhibit 10.25
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).
 E-2




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##### Table of Contents



Item No.
    
    Item
    
    Filing Method10.20
    
    Form of Tranche B Term Note issued under
Credit Agreement.
    
    Incorporated by reference to Exhibit 10.26
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.21
    
    Parent Joinder Agreement, dated March 24,
2000, between American Medical Systems
Holdings, Inc. and Bank of America, N.A.
    
    Incorporated by reference to Exhibit 10.27
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.22
    
    Pledge Agreement, dated March 24, 2000,
among American Medical Systems Holdings,
Inc., American Medical Systems, Inc.,
Influence, Inc. and Banc of America, N.A.
    
    Incorporated by reference to Exhibit 10.28
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.23
    
    Guaranty and Investment Agreement, dated
March 24, 2000, among Warburg, Pincus Equity
Partners, L.P., other affiliates of Warburg
Pincus and Bank of America, N.A.
    
    Incorporated by reference to Exhibit 10.29
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.24
    
    Letter Agreement, dated March 24, 2000,
among Warburg, Pincus Equity Partners, L.P.,
other affiliates of Warburg Pincus and Bank
of America, N.A.
    
    Incorporated by reference to Exhibit 10.30
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.25
    
    Mortgage and Security Agreement and Fixture
Financing Statement with Assignment of
Leases and Rents, dated April 17, 2000,
between American Medical Systems, Inc. and
Bank of America, N.A.
    
    Incorporated by reference to Exhibit 10.39
of the Companys Registration Statement on
Form S-1 (File No. 333-37488).10.26
    
    First Amendment to Credit Agreement, dated
January 3, 2001, among American Medical
Systems, Inc., American Medical Systems
Holdings, Inc., Bank of America, N.A., as
agent for the four lenders, and Banc of
America Securities LLC, as sole lead
arranger and sole book manager.
    
    Incorporated by reference to Exhibit 10.36
of the Companys Annual Report on Form
10-K for the year ended December 31, 2000
(File No. 000-30733).10.27
    
    Second Amendment and Release Agreement,
dated February 20, 2001, among American
Medical Systems, Inc., American Medical
Systems Holdings, Inc., Bank of America,
N.A., as agent for the four lenders, and
Banc of America Securities LLC, as sole lead
arranger and sole book manager.
    
    Incorporated by reference to Exhibit 10.37
of the Companys Annual Report on Form
10-K for the year ended December 31, 2000
(File No. 000-30733).10.28
    
    Third Amendment to Credit Agreement, dated
December 27, 2002, among American Medical
Systems, Inc., American Medical Systems
Holdings, Inc., Bank of America, N.A., as
agent for the four lenders, and Banc of
America Securities LLC, as sole lead
arranger and sole book manager.
    
    Incorporated by reference to Exhibit 10.28
of the Companys Annual Report on Form
10-K for the year ended December 28, 2002
(File No. 000-30733).
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##### Table of Contents



Item No.
    
    Item
    
    Filing Method10.29
    
    Fourth Amendment to Credit Agreement, dated
October 31, 2003, among American Medical
Systems, Inc., American Medical Systems
Holdings, Inc., Bank of America, N.A., as
agent for the four lenders, and Banc of
America Securities LLC, as sole lead
arranger and sole book manager.
    
    Filed with this Annual Report on Form 10-K.10.30
    
    Fifth Amendment to Credit Agreement, dated
December 31, 2003, among American Medical
Systems, Inc., American Medical Systems
Holdings, Inc., Bank of America, N.A., as
agent for the four lenders, and Banc of
America Securities LLC, as sole lead
arranger and sole book manager.
    
    Filed with this Annual Report on Form 10-K.10.31
    
    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).10.32
    
    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).10.33
    
    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).21.1
    
    Subsidiaries of American Medical Systems
Holdings, Inc.
    
    Incorporated by reference to Exhibit 21.1
of the Companys Form 10-K for the Fiscal
Year Ended December 28, 2002 (File No.
000-30733).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-4