Edgar Filing: AMERICAN MEDICAL SYSTEMS HOLDINGS INC

e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
		EXCHANGE ACT OF 1934


For the quarterly period ended June 28, 2003


[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
		EXCHANGE ACT OF 1934

For the transition period from ______ to ______


Commission File Number: 00030733

AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.

(Exact name of registrant as specified in its charter)


Delaware		41-1978822

(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)


10700 Bren Road West, Minnetonka, Minnesota		55343

(Address of principal executive offices)		(Zip Code)

952-930-6000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] Yes [ ] No

As of August 1, 2003, there were 32,940,739 shares of the registrant’s $.01 par value Common Stock outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM. 1. FINANCIAL STATEMENTS
		Consolidated Balance Sheets
		Statements of Operations
		Consolidated Statements of Cash Flow
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
EXHIBIT INDEX
EX-10.1 2000 Equity Incentive Plan, as amended
EX-10.2 Agreement of Purchase and Sale
EX-31.1 Certification of CEO Pursuant to Rule 302
EX-31.2 Certification of CFO Pursuant to Rule 302
EX-32.1 Certification Pursuant to 18 USC Sec. 906

INDEX


		Page(s)

Part I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets as of December 28, 2002, and June 28, 2003		3
	Statements of Operations for the three and six months ended June 29, 2002, and June 28, 2003		4
	Statements of Cash Flows for the six months ended June 29, 2002, and June 28, 2003		5
	Notes to Consolidated Financial Statements		6 - 9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10 - 16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		17
Item 4.	Controls and Procedures		17
Part II.	OTHER INFORMATION
Item 4.	Shareholder Votes		18
Item 6.	Exhibits and Reports on Form 8-K		19
SIGNATURES			20

PART I. FINANCIAL INFORMATION

ITEM. 1. FINANCIAL STATEMENTS

American Medical Systems Holdings Inc.
Consolidated Balance Sheets
(In thousands)


					December 28, 2002			June 28, 2003

Assets
	Current assets
		Cash and equivalents			$	79,429		$	44,399
		Accounts receivable, net				27,208			29,938
		Inventories				13,475			17,160
		Deferred taxes				3,542			4,607
		Other current taxes				2,155			1,037

		Total current assets				125,809			97,141
	Property, plant and equipment, net					21,328			24,484
	Goodwill, net					80,607			115,139
	Intangibles, net					15,691			23,292
	Deferred income taxes					3,068			—
	Investment in technology and other assets					5,142			5,064

	Total assets				$	251,645		$	265,120

Liabilities and Stockholders’ Equity
	Current liabilities
		Accounts payable			$	3,000		$	3,123
		Accrued compensation expenses				10,246			10,373
		Accrued warranty expense				4,526			4,591
		Other accrued expenses				4,751			4,356
		Current portion of notes payable				6,000			6,546

	Total current liabilities					28,523			28,989
	Long-term notes payable					18,000			14,727
	Deferred income taxes					—			1,571
	Other long-term liabilities					860			—
	Stockholders’ equity
			Common stock, par value $0.1 per share; authorized 95,000,000 shares; issued and outstanding 32,156,873 voting and 341,700 non-voting shares for December 28, 2002; and 32,554,151 voting and 341,700 non-voting shares for June 28, 2003			325			329
			Additional paid-in capital			197,991			200,142
			Deferred compensation			(198	)		(104	)
			Accumulated other comprehensive income (loss):
				Cumulative translation adjustment		(678	)		394
				Derivative financial instruments		(459	)		—
			Retained earnings			7,281			19,072

	Total stockholders’ equity					204,262			219,833

	Total liabilities and stockholders’ equity				$	251,645		$	265,120

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

American Medical Systems Holdings Inc.
Statements of Operations
(In thousands, except per share data)


		Three months through June						Six months through June

		2002			2003			2002			2003

Sales		$	36,330		$	42,224		$	71,045		$	81,571
Operating expenses
	Cost of goods sold		7,120			7,381			14,252			14,324
	Marketing and selling		13,108			16,984			25,918			31,781
	Research and development		3,197			3,483			6,031			7,274
	General and administrative		3,357			3,845			6,636			7,915
	Amortization of intangibles		939			1,039			1,878			2,104

	Total operating expenses		27,721			32,732			54,715			63,398
Operating income			8,609			9,492			16,330			18,173
Other income (expense)
	Royalty income		747			687			1,530			1,464
	Other income		445			286			1,166			321
	Interest income		325			112			758			242
	Interest expense		(718	)		(698	)		(1,481	)		(1,424	)

Income before income taxes			9,408			9,879			18,303			18,776
Income tax expense			3,678			3,542			7,156			6,985

Net income		$	5,730		$	6,337		$	11,147		$	11,791

Net income per share
	Basic	$	0.18		$	0.19		$	0.35		$	0.36
	Diluted	$	0.17		$	0.19		$	0.33		$	0.35
Weighted average common shares used in calculation
	Basic		32,171			32,800			32,072			32,673
	Diluted		34,245			34,077			34,244			34,057

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

American Medical Systems Holdings Inc.
Consolidated Statements of Cash Flow
(In thousands)


				Six months through June

				2002			2003

Cash flows from operating activities
	Net income			$	11,147		$	11,791
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation			2,028			2,865
		Amortization of intangibles			1,874			2,104
		Deferred financing costs			135			135
		Non-cash deferred compensation			6			16
		Non-cash stock-based compensation			96			72
		Income tax benefit related to stock option plan			542			892
		Change in net deferred taxes			2,231			(992	)
	Changes in operating assets and liabilities:
			Accounts receivable		(723	)		(1,270	)
			Inventories		938			(2,166	)
			Accounts payable and accrued expenses		(9,490	)		(3,039	)
			Other assets		78			1,320

	Net cash provided by operating activities				8,862			11,728

Cash flows from investing activities
			Purchase of property, plant and equipment		($920	)		($1,599	)
			Purchases of businesses		—			(43,069	)
			Purchase of short and long-term investments		(9,446	)		—
			Sale of short and long-term investments		6,375			—

	Net cash used in investing activates				(3,991	)		(44,668	)

Cash flows from financing activities:
			Issuance of common stock	$	991		$	1,269
			Payments on long-term debt		(3,546	)		(3,319	)

	Net cash used in financing activities				(2,555	)		(2,050	)

Effect of exchange rates					411			(40	)

Net increase (decrease) in cash and cash equivalents				$	2,727			($35,030	)
Cash and cash equivalents at beginning of period					28,755			79,429

Cash and cash equivalents at end of period				$	31,482		$	44,399

Supplemental disclosure
			Cash paid for interest	$	1,136		$	1,301
			Cash paid for taxes	$	6,688		$	6,641

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

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

1. Basis of Presentation

The consolidated financial statements included in this Form 10-Q have been prepared by American Medical Systems Holdings Inc., without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The consolidated financial statements include the accounts of the company and its subsidiaries, and all significant inter-company accounts and transactions are eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to these rules and regulations. The year-end balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. These unaudited consolidated interim financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes included in its Annual Report on Form 10-K for 2002. All amounts are in thousands, except per share data.

These statements reflect, in management’s opinion, all adjustments (which include only normal, recurring adjustments) necessary for a fair presentation of the financial position and the results of operations and cash flows for the periods presented. The results of operations for any interim period may not be indicative of results for the full year.

2. Stock-Based Compensation

The Company has one stock-based employee compensation plan. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The exercise price of the Company’s employee stock options generally equals the market price of the underlying stock on the date of grant for all options granted, and thus, under APB 25, no compensation expense is recognized. However, during 2000, the Company recognized deferred compensation of $1.4 million, reflecting the excess of the fair value of the underlying stock on the date of grant over the exercise price. The deferred compensation is being amortized over vesting periods of two to four years.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.


			Six months through June

			2002			2003

Net income, as reported			$	11,147		$	11,791
Add: Stock-based employee compensation expense included in reported income, net of tax effects				88			72
Subtract: Total stock-based employee compensation expense determined under fair value based method for all awards net of related tax effects				(1,694	)		(2,080	)

Pro forma net income			$	9,541		$	9,783

Earnings per share:
	As reported
		Basic	$	0.35		$	0.36
		Diluted	$	0.33		$	0.35
	Pro forma
		Basic	$	0.30		$	0.29
		Diluted	$	0.28		$	0.29

3. Earnings per Share

The following table presents information necessary to calculate basic and diluted earnings per common share and common share equivalents for the three and six months through June, 2002 and 2003.


	Three months through June				Six months through June

	2002		2003		2002		2003

Earnings	$	5,730	$	6,337	$	11,147	$	11,791
Weighted-average shares outstanding for basic earnings per share		32,171		32,800		32,072		32,673
Dilutive effect of stock options		2,074		1,277		2,172		1,384

Adjusted weighted-average shares outstanding and assumed conversion for diluted earnings per share		34,245		34,077		34,244		34,057

Basic earnings per share	$	0.18	$	0.19	$	0.35	$	0.36
Diluted earnings per share	$	0.17	$	0.19	$	0.33	$	0.35

4. Inventories

Inventories consist of the following:


	December 28, 2002			June 28, 2003

Raw materials	$	4,147		$	4,863
Work-in process		1,938			3,184
Finished goods		10,138			11,580
Obsolescence allowance		(2,748	)		(2,467	)

Total, net	$	13,475		$	17,160

5. Warranties

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.

Many of the Company’s products are sold with warranty coverage for periods ranging from one year up to the patient’s lifetime. Replacement product is covered under the terms of the warranty agreement. The amount of the accrued warranty allowance is the estimate of the expected future cost of honoring warranty obligations. Factors influencing this estimate include historical claim rates, changes in product performance, the frequency of use by the patient, and the patient’s performance expectations, surgical infection rates and product reliability are functions of raw material properties, manufacturing processes, and surgical technique. Beginning and ending balances, and other changes in warranty allowances during the six months through June 2003 were as follows:




Balance at beginning of period	$	4,526
Balance assumed from CryoGen acquisition		65
Provisions for warranty		150
Claims processed		(150	)

Balance at end of period	$	4,591

6. Acquisitions

CryoGen

On December 30, 2003, 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 shareholders of CryoGen $36.2 million and paid $3.8 million in acquisition-related costs of the sellers. In addition to the initial consideration for the CryoGen acquisition, CryoGen’s former shareholders may receive an earnout payment equal to three times sales of CryoGen’s products during any four consecutive company fiscal quarters ending three years after closing, less $40 million. If 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 million. The primary purpose of the merger was to gain access to CryoGen’s products and technology. The consolidated financial statements of the Company for the three and six-month periods ended June 28, 2003, include the financial results of CryoGen from December 30, 2002, the date the purchase transaction was effective, and which represents the date when the Company effectively took control of CryoGen.

The Company has received a preliminary formal valuation study of this acquisition. Based on this preliminary study, the Company has recorded goodwill of approximately $28.5 million, including approximately $0.9 million in acquisition costs consisting of legal, accounting, and other expenses. The allocation of the purchase price for the acquisition and other purchase accounting adjustments is as follows:


Total acquisition cost

Purchase price		$	36,242
Company acquisition costs			896
Deficit of liabilities in excess of assets acquired			2,536

Total			39,674
Less amounts allocated to:
	Developed technology		(9,400	)
	Fixed assets		(1,752	)
	Inventory		(14	)

Goodwill		$	28,508

Dura II

On April 7, 2003, the Company acquired the Dura II line of erectile restoration products from Endocare, Inc. The Company paid Endocare $2.2 million for all intellectual property, production equipment, and current Dura II inventory.

The Company intends to do an internal valuation study of this product acquisition. The Company has recorded goodwill of approximately $1.8 million, including acquisition costs consisting of legal services. The allocation of the purchase price for the acquisition is as follows:



Acquisition cost

Purchase price		$	2,150
Company acquisition costs			26

Total			2,176
Less amounts allocated to:
	Fixed assets		(28	)
	Inventory		(351	)

Goodwill		$	1,797

7. Comprehensive Income

Comprehensive income for the Company is net income adjusted for changes in value of derivative financial instruments, unrealized gains and losses on marketable securities, and foreign currency translation. Comprehensive income for the six months through June, 2002 and 2003, were:


		Six months through June

(in thousands)		2002			2003

Net income		$	11,147		$	11,791
Net loss on derivative financial
	instruments, net of taxes		(42	)		(5	)
Amounts reclassified to interest expense during the period from derivative and hedging activities, net of taxes			481			464
Unrealized losses on marketable securities, net of taxes			(69	)		—
Cumulative translation adjustment			780			1,072

Comprehensive income		$	12,297		$	13,322

8. Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 requires companies that control another entity through interests other than voting interests to consolidate the controlled entity. FIN 46 was effective immediately for variable interest entities created, or in which the company obtains an interest, after January 31, 2003. For all variable interest entities created on or before January 31, 2003, the provisions are effective July 31, 2003. The Company is evaluating the impact of this interpretation.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “may,” “expect,” “believe,” “anticipate,” or “estimate,” identify such forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially from those expressed in such forward-looking statements. Some of the factors that could cause such material differences are identified in “Certain Important Factors”. We undertake no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise. You are advised, however, to consult any future disclosures we make on related subjects in future filings with the SEC.

Critical Accounting Policies and Estimates

We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Management’s discussion and analysis of financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect (1) the reported amounts of assets, liabilities, revenues, and expenses; and (2) the related disclosure of contingent assets and liabilities. At each balance sheet date, we evaluate our estimates, including but not limited to, those related to accounts receivable and sales return obligations, inventories, long-lived assets, warranty, legal contingencies, and income taxes. The critical accounting policies that are most important in fully understanding and evaluating the financial condition and results of operations are discussed in our most recent Annual Report on Form 10-K on file with the SEC.

RESULTS OF OPERATIONS

Overview

We manufacture and market a broad range of proprietary products for erectile restoration; other men’s health, including products for incontinence, stricture, and prostate disease; and women’s health, including products for incontinence, menorrhagia, and other pelvic floor disorders. 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 estimate that nearly 18 million men and women are potential candidates for treatment with our products, although only a very small share of them ever seek treatment.

Results of Operations

The following is a discussion of the results of our operations and financial condition for the second fiscal quarter and first six months of 2003 compared to the second fiscal quarter and first six months of 2002. On August 11, we announced our decision to move the work currently done at our San Diego facility to our Minnetonka facility. Continued growth of this business will depend on our ability to retain key employees, move manufacturing, product development and service, and other critical functions, and our ability to obtain appropriate FDA and other regulatory approvals to carry on manufacturing and related activities in Minnetonka. We expect this move will increase our operating costs during the transition period, and will reduce operating costs thereafter.

Net Sales. Our erectile restoration products include several types of inflatable and non-inflatable prostheses to replace non-functioning penile erectile tissue. In April 2003, we expanded our range of erectile restoration products by purchasing the Dura II line of prostheses from Endocare. For male urinary control we sell our Artificial Urinary Sphincter and the InVance sling system. For urethral stricture and BPH symptoms we sell urethral stents, surgical resection loops, and a chemical ablation system (in clinical trials in the U.S.). Our women’s health products include several products for urinary control (Urinary Sphincter, InFast, Sparc, and Monarc), the Her Option products recently added with the CryoGen acquisition, and a variety of other products for pelvic vault repairs.

The following table compares net sales of our product lines between 2002 and 2003.


		Three months through June												Six months through June
								Increase												Increase
		2002			2003			(Decrease)			%			2002			2003			(Decrease)			%

Erectile restoration		$	17,793		$	17,964		$	171			1.0	%	$	35,089		$	35,818		$	729			2.1	%
Men’s health
	Male urinary control		9,117			10,727			1,610			17.7	%		18,134			21,010			2,876			15.9	%
	Other		1,670			1,309			(361	)		-21.6	%		3,313			2,508			(805	)		-24.3	%
Women’s health			7,750			12,224			4,474			57.7	%		14,509			22,235			7,726			53.2	%

	Total	$	36,330		$	42,224		$	5,894			16.2	%	$	71,045		$	81,571		$	10,526			14.8	%

Sales within the United States		$	29,668		$	33,919		$	4,251			14.3	%	$	58,827		$	66,266		$	7,439			12.6	%
Sales outside the United States			6,662			8,305			1,643			24.7	%		12,218			15,305			3,087			25.3	%

	Total	$	36,330		$	42,224		$	5,894			16.2	%	$	71,045		$	81,571		$	10,526			14.8	%

Share of total sales:
Erectile restoration			49	%		43	%								49	%		44	%
Men’s health
	Male urinary control		25	%		25	%								26	%		26	%
	Other		5	%		3	%								5	%		3	%
Women’s health			21	%		29	%								20	%		27	%

	Total		100	%		100	%								100	%		100	%
Sales within the United States			82	%		80	%								83	%		81	%
Sales outside the United States			18	%		20	%								17	%		19	%

	Total		100	%		100	%								100	%		100	%

Approximately $1.1 million of the increase during the three months ended June 2003 and $2.0 million of the increase in the six months ended June 2003 was due to changes in currency exchange rates, mainly the Euro. If these currency exchange rates in 2003 were the same as in 2002, and we had not otherwise raised prices, total sales in the second quarter of 2003 would have been $41.1 million, an increase of $4.8 million, or 13.2 percent, and total sales for the six months through June 2003 would have been $79.6 million, an increase of $8.5 million, or 12.0 percent.

Erectile restoration sales in the three and six-month periods ended June 2003 were up slightly due to price and mix changes. The increases in sales of male urinary control products were due to a combination of unit increases, especially in the InVance sling system, and favorable currency exchange rates on sales of products in Europe. The decline in sales of other men’s health products were due to lower demand for our urethral stents for BPH. The increases in sales of women’s health products were primarily due to greater unit sales, primarily SPARC and Monarc, and to a lesser extent, sales of Her Option products. Sales of Her Option products (used to cure excessive uterine bleeding) were approximately $1.0 million and $1.8 million, net of allowance for returns, in the three and six-month periods ended June 2003.

The following table compares the dollar and percentage change in the Statement of Operations between 2002 and 2003.


		Three months through June												Six months through June
								Increase												Increase
		2002			2003			(Decrease)			%			2002			2003			(Decrease)			%

Net sales		$	36,330		$	42,224		$	5,894			16.2	%	$	71,045		$	81,571		$	10,526			14.8	%
Operating expenses:
	Cost of sales		7,120			7,381			261			3.7	%		14,252			14,324			72			0.5	%
	Marketing and sales		13,108			16,984			3,876			29.6	%		25,918			31,781			5,863			22.6	%
	Research and development		3,197			3,483			286			8.9	%		6,031			7,274			1,243			20.6	%
	General and administrative		3,357			3,845			488			14.5	%		6,636			7,915			1,279			19.3	%
	Amortization of intangibles		939			1,039			100			10.6	%		1,878			2,104			226			12.0	%

Total operating expenses			27,721			32,732			5,011			18.1	%		54,715			63,398			8,683			15.9	%

Operating income			8,609			9,492			883			10.3	%		16,330			18,173			1,843			11.3	%
Royalty income			747			687			(60	)		-8.0	%		1,530			1,464			(66	)		-4.3	%
Other income			445			286			(159	)		-35.7	%		1,166			321			(845	)		-72.5	%
Interest income			325			112			(213	)		-65.5	%		758			242			(516	)		-68.1	%
Interest expense			(718	)		(698	)		20			2.8	%		(1,481	)		(1,424	)		57			3.8	%

Income before income taxes			9,408			9,879			471			5.0	%		18,303			18,776			473			2.6	%
Income tax expense			3,678			3,542			136			3.7	%		7,156			6,985			171			2.4	%

Net income		$	5,730		$	6,337		$	607			10.6	%	$	11,147		$	11,791		$	644			5.8	%

Cost of goods sold. Cost of goods sold declined as a percentage of sales as a result of volume, mix changes, and favorable foreign currency exchange rates. Cost of goods sold as a share of sales has benefited from relatively fixed overhead costs being spread over higher manufacturing volumes. Future cost of goods sold will depend on production levels and product mix.

Marketing and selling. Approximately half of the cost increase during the three and six months ended June 2003 compared to the same periods in 2002 were due to our support of Her Option products. In addition, during the second quarter of 2003, we incurred approximately $0.7 million of costs to consolidate much of our European operations into a new shared service center in Amsterdam. We expect selling and marketing expense to continue to increase at about 20 percent of the sales increase going forward. In addition, we expect to incur approximately $0.3 million of additional costs related to the European headquarters move which should be completed by September 2003.

Research and development. Research and development expense 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 the three months through June 2003 compared to the same period in 2002 were to support Her Option products. Increased spending for the six-month period was for Her Option and other products. We expect total spending in research and development to increase in 2003 compared to 2002, and longer term, 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 as new opportunities are discovered.

General and administrative. Cost increases during the three and six-month periods ended June 2003 compared to the same periods in 2002 were due to approximately $0.3 million and $0.8 million of additional costs related to the CryoGen acquisition and $0.2 million and $0.5 million to support the extension of systems to our European offices. These cost increases were partially offset by approximately $0.3 million and $0.5 million lower spending on outside professional services. We expect spending in general and administrative to continue higher in 2003 compared to 2002 due but to generally decline as a share of sales.

Amortization of intangibles. During the second quarter of 2003, we started amortizing the definite-lived intangible assets from the CryoGen acquisition. This additional amortization was partially offset by a change in estimate of useful life for the worldwide distribution rights to DermMatrix, a porcine graft material used in sling and pelvic prolapse procedures. We expect amortization of intangibles to be approximately $1.2 million in future quarters.

Royalty income. Most of our royalty income is from the license of our stent-delivery technology for medical use outside urology.

Other income. On January 1, 2002, we terminated the AMS Retirement Annuity Plan. In conjunction with this termination, we contributed approximately $5.8 million to the pension trust and recorded a gain on pension plan termination of $0.7 million. Substantially all of the remainder of other income and expense relates to exchange gains and losses resulting from the weakening and strengthening of foreign currencies, mainly the Euro, against the U.S. dollar and relate to translating foreign denominated inter-company receivables to current rates.

Interest income. Interest income was lower in 2003 than in 2002 due to lower levels of investments and returns. Investment levels were reduced by approximately $40.0 million used for the CyroGen acquisition.

Interest expense. We hedged a portion of our original $65.0 million variable rate term note, as required by our senior credit facility, by entering into an interest rate swap agreement in which we agreed to exchange, at specified intervals, the calculated difference between the fixed interest rate of the swap and the variable interest rate on a portion of our debt. This interest rate swap agreement expired June 30, 2003. Pre-tax losses totaling $0.4 million and $0.8 million in the three and six-month periods ended June 2003 were recorded as interest expense. We did not renew the swap agreement and do not expect those swap-related expenses going forward.

Income taxes. We believe our use of certain federal tax credits will result in a lower effective tax rate for 2003 then in 2002. During the second quarter of 2003 we adjusted our provision for income taxes to reflect our current estimate of our tax liability.

Net income. Increases in net income in 2003 resulted from the increase in sales while maintaining control over operating costs, all of which are described above.

Liquidity and Capital Resources

Cash and cash equivalents were $44.4 million as of June 28, 2003, compared to $79.4 million as of December 28, 2002. This decrease is due primarily to the cash paid for the CryoGen acquisition, offset somewhat by cash from operations. Each of these is described below.

Cash flows from operating activities. Cash flow provided by operating activities totaled $11.7 million in the first six months of fiscal 2003. Net income plus the non-cash expenses of depreciation and amortization totaled $16.8 million. Changes in operating assets and liabilities were a use of cash totaling approximately $5.2 million.

Cash flows from investing activities. On December 30, 2002, we acquired CryoGen, Inc. for cash payments totaling approximately $36.2 million paid to CryoGen shareholders and $3.8 million paid to CryoGen creditors. In addition, we incurred approximately $0.9 million of capitalized acquisition expenses. On April 7, 2003, we acquired the Dura II erectile restoration product line from Endocare, Inc. for $2.2 million. During the first six months of 2003, we purchased equipment for $1.6 million. We expect capital expenditures to continue in the range of $2.0 to $3.0 million annually.

Cash flows from financing activities. We have a senior credit facility, which consists of term debt and a $15 million revolving line of credit. The senior credit facility expires in March 2006. This facility is secured by substantially all of our assets, and contains restrictions concerning the payment of dividends, incurrence of additional debt, and capital expenditures. In addition, we are subject to, and in compliance with, certain financial covenants including ratios related to fixed charges coverage and leverage. During the first six months of 2003, we made regular principal payments of $2.7 million bringing the quarter-end balance to $21.3 million. In addition to the above senior credit facility payments made during 2003, we paid $0.6 million of debt acquired as part CryoGen on December 30, 2002.

The following table sets forth the future payment obligations under our senior credit facility:


	Payments due by period

			Less than		One to		Four to
	Total		one year		three years		five years

Future payment obligation	$	21,273	$	6,546	$	14,727		—

During the first six months of 2003, we received $1.3 million from issuing common stock under our Employee Stock Purchase Plan and exercises of options under our Equity Incentive Plan.

Cash Commitments

In addition to the initial consideration for the CryoGen acquisition, CryoGen’s former shareholders may receive an earn-out payment equal to three times our sales of CryoGen’s products during any four consecutive quarters ending three years after closing, less $40 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 earn-out payment will be made. The maximum amount of the earn-out payment is $110 million. This transaction is more fully described in our form 8-K filed with the 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 and planned capital expenditure requirements for at least the next twelve months.

Certain Important Factors

There are several important factors that could cause our actual results to differ materially from our anticipated results. These factors, and their impact on the success of our operations and our ability to achieve our goals, include the following:

Continued Physician Use and Endorsement of our Products

In order 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 Monarc sub-fascial hammock for urinary incontinence, and Her Option therapy 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 may 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 timely introduce these new products and product improvements, 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 first to consider non-invasive alternatives to treat their urological disorders. The introduction of new oral medications or other less-invasive therapies may cause our sales to decline.

Actions Related to Reimbursement for our Products

Our revenues depend largely on U.S. and O.U.S. government health care programs and private health insurers reimbursing patients’ medical expenses. Physicians, hospitals, and other health care providers may not purchase our products if they do not receive satisfactory reimbursement from these third-party payors for the cost of procedures using our products. Effective January 1, 2003, the Centers for Medicare and Medicaid Services again reduced the hospital payment rates for certain procedures in which our products are used. We do not believe these reductions will have a material adverse effect on our sales or earnings in 2003, but we cannot assure you that hospitals which treat Medicare and Medicaid patients will not prohibit physicians from performing procedures which use our products. If any hospital were to prohibit these procedures, sales of our products would decline unless physicians who had been performing these procedures in that hospital were able to obtain surgical privileges in other hospitals which did allow these procedures. Further, changes in the relative reimbursement rates for different products may cause hospitals to encourage physicians to use lower cost products from our product lines, thereby having a material adverse effect on our sales and earnings.

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.

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.

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 implement a recall of, 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.

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. Additionally, we could experience a material design or manufacturing failure in our products, a quality system failure, other safety issues, or heightened regulatory scrutiny that would warrant a recall of some of our products. Our existing product liability insurance coverage may be inadequate to protect us from any liabilities we might incur. If a product liability claim or series of claims is brought against us for uninsured liabilities or in excess of our insurance

coverage, our business could suffer. In addition, a recall of some of our products, whether or not the result of a product liability claim, could result in significant costs to us.

Acquisition Integration

On December 30, 2002, we acquired CryoGen Inc., which we have maintained as a San Diego-based subsidiary. On August 11 we announced our decision to move the work to our Minnetonka facility. Continued growth of this business will depend on our ability to retain key employees, move manufacturing, product development and service, and other critical functions, and our ability to obtain appropriate FDA and other regulatory approvals to carry on manufacturing and related activities in Minnetonka.

Seasonality

Our business is seasonal, with the third quarter of each year typically having the lowest sales and earnings, and fourth quarter of each year typically having the highest sales and earnings. There can be no assurance that future seasonal fluctuations will not vary from this pattern or that these or other variations will not adversely affect our business and results of operations.

ADDITIONAL INFORMATION ON AMS

We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended. As a result, we are required to file periodic reports and other information with the SEC, such as annual, quarterly, and current reports, and proxy and information statements. You are advised to read this report in conjunction with the other reports, proxy statements, and other documents we file from time to time with the SEC. If you would like more information regarding AMS, you may read and copy the reports, proxy and information statements and other documents we file with the SEC, at prescribed rates, at the SEC’s public reference room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information regarding the operation of the SEC’s public reference rooms by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available to the public free of charge at the SEC’s website. The address of this website is http://www.sec.gov.

We also make all of our SEC filings, such as our annual, quarterly and current reports and proxy statements, available to the public free from charge on our website www.AmericanMedicalSystems.com. Our website is not intended to be, and is not, a part of this Quarterly Report on Form 10-Q. We place our SEC filings on our website on the same day as we file such material with the SEC. In addition, we will provide electronic or paper copies of our SEC filings (excluding exhibits) to any AMS stockholder free of charge upon receipt of a written request for any such filing. All requests for our SEC filings should be sent to the attention of Investor Relations at American Medical Systems, Inc., 10700 Bren Road West, Minnetonka, Minnesota 55343.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Hedging. We hedged a portion of our original $65.0 million variable rate term note, as required by our senior credit facility, by entering into an interest rate swap agreement in which we agreed to exchange, at specified intervals, the calculated difference between the fixed interest rate of the swap and the variable interest rate on a portion of our debt. This interest rate swap agreement expired June 30, 2003.

Currency fluctuations. 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.

Inflation. We do not believe that inflation has had a material effect on our results of operations in recent years and periods. There can be no assurance, however, that our business will not be adversely affected by inflation in the future.

ITEM 4. CONTROLS AND PROCEDURES

a)		*Evaluation of disclosure controls and procedures.* Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries, which we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934, was made known to them by others within those entities and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

b)		*Changes in internal controls over financial reporting.* There were no changes in our internal control over financial reporting identified in connection with the evaluation of such internal control over financial reporting that occurred during our last fiscal quarter which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

(a)		Our annual meeting of stockholders was held on May 7, 2003.

(b)		Douglas W. Kohrs, Thomas E. Timbie, and Elizabeth H. Weatherman were re-elected as directors of the company. Albert Jay Graf, David W. Stassen, and Christopher H. Porter continued their terms as directors after the meeting.

(c)		At the annual meeting, our stockholders were presented with and asked to vote upon two proposals: (1) to elect three directors, all incumbent directors, to serve for three-year terms, or until their successors are elected and duly qualified; (2) to amend our 2000 Equity Incentive Plan to increase the number of shares reserved for issuance under this plan from 5,355,000 to 7,355,000 shares.

The names of these nominees for director and voting results are:


	Votes		Votes		Votes		Broker
Name	For		Against		Withheld		Non-Votes

Douglas W. Kohrs		24,410,444		0		6,005,647		0

Thomas E. Timbie		28,313,032		0		2,103,059		0

Elizabeth H. Weatherman		28,969,984		0		1,446,107		0

24,680,805 shares were voted for the proposal to increase the shares reserved for issuance under the 2000 Equity Incentive Plan; 3,180,775 shares were voted against the proposal; 4,675 shares abstained from voting on the proposal; and 2,549,835 shares were represented by broker non-votes.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

Exhibits


Item No.	Item	Method of Filing

10.1	2000 Equity Incentive Plan, as amended	Filed with this Report.

10.2	Agreement of Purchase and Sale, dated April 17, 2003, among American Medical Systems, Inc., Endocare, Inc. and Timm Medical Technologies, Inc.	Filed with this Report.

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed with this Report.

31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed with this Report.

32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed with this Report.

Reports on Form 8-K

The Company filed a currant report of Form-8 on August 5, 2003 furnishing a press release reporting its financial results for the quarter ended June 28, 2003.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		AMERICAN MEDICAL SYSTEMS HOLDINGS, INC

August 11, 2003	By	\s\ Douglas W. Kohrs

Date		Douglas W. Kohrs Chief Executive Officer

August 11, 2003	By	\s\ M. James Call

Date		M. James Call Executive Vice President and Chief Financial Officer and Principal Accounting Officer

EXHIBIT INDEX


Exhibit No.	Description	Method of Filing

10.1	2000 Equity Incentive Plan, as amended	Filed with this Report.

10.2	Agreement of Purchase and Sale, dated April 17, 2003, among American Medical Systems, Inc., Endocare, Inc. and Timm Medical Technologies, Inc.	Filed with this Report.

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed with this Report.

31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed with this Report.

32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed with this Report.

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