Summary of AMERICAN MEDICAL SYSTEMS HOLDINGS INC

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. Any statements not of historical fact may be considered 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 as a result of many factors, including, but not limited to, those discussed under the heading "Forward-Looking Statements" below. Critical Accounting Policies and Estimates 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 U.S. generally accepted accounting principles. 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, valuation of share-based payments and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The critical accounting policies that are most important in fully understanding and evaluating the financial condition and results of operations are discussed in our Form 10-K for the year ended January 3, 2009.
Overview
We are the world leader in developing and delivering innovative solutions to physicians treating men's and women's pelvic health conditions, thereby recognized as the technology leader in the markets we serve. We have built a business that consistently delivers growth, fueled by a robust pipeline of innovative products for significant, under-penetrated markets. We have consistently diversified our product portfolio, building on our traditional base of products for men's incontinence and erectile restoration, to include products and therapies targeted at benign prostatic hyperplasia (BPH) in men, as well as urinary incontinence, pelvic organ prolapse and menorrhagia in women. We estimate there are as many as 1.8 billion incidences of these conditions in the global markets we serve, with many people suffering from multiple conditions. Treatment options for these conditions vary considerably depending on the severity of the condition. Approximately 450 million of these men and women have conditions sufficiently severe so as to profoundly diminish their quality of life and significantly impact their relationships. Our addressable market is contained within this group of patients. Our product development and acquisition strategies have focused on expanding our product offering for surgical solutions, including less-invasive solutions for surgeons and their patients. Our primary physician customers include urologists, gynecologists, urogynecologists and colorectal surgeons.
Our net sales grew from $120.4 million in the first quarter of 2008 to $123.6 million in the first quarter of 2009. In the first quarter of 2009, men's health contributed $59.5 million, or 48 percent of total net sales, BPH therapy contributed $25.4 million, or 21 percent of total net sales, and women's health contributed $38.7 million, or 31 percent of total net sales. We continue to see benefits from a number of company-wide initiatives we implemented in 2008 to reduce working capital, manage expenses and drive operating leverage throughout our business. As a result, we generated net income of $17.1 million in the first quarter of 2009, compared to $6.1 million in the first quarter of 2008, and cash provided by operating activities of $28.2 million in the first quarter of 2009, compared to $7.4 million in the first quarter of 2008. We also retired $35.9 million of debt in the first quarter of 2009.
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 Quarterly Report on Form 10-Q. We make available free of charge on our website our Quarterly Reports on Form 10-Q, Annual Reports on Form 10-K, 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.

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Results of Operations
The following table compares net sales by product line and geography for the
three month periods ended April 4, 2009 and March 29, 2008.

                               Three Months Ended
      (in thousands)    April 4, 2009     March 29, 2008     $ Increase        % Increase
      Net Sales
      Product Line
      Men's health      $      59,459       $     52,675       $  6,784            12.9 %
      BPH therapy              25,453             30,933         (5,480 )         -17.7 %
      Women's health           38,726             36,754          1,972             5.4 %


      Total             $     123,638       $    120,362       $  3,276             2.7 %


      Geography
      United States     $      89,670       $     84,393       $  5,277             6.3 %
      International            33,968             35,969         (2,001 )          -5.6 %


      Total             $     123,638       $    120,362       $  3,276             2.7 %




                                              Three Months Ended
               Percent of net sales     April 4, 2009     March 29, 2008

               Men's health                   48.1 %             43.8 %
               BPH therapy                    20.6 %             25.7 %
               Women's health                 31.3 %             30.5 %


               Total                         100.0 %            100.0 %


               Geography
               United States                  72.5 %             70.1 %
               International                  27.5 %             29.9 %


               Total                         100.0 %            100.0 %

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The following table compares revenue, expense, and other income (expense) for the three months ended April 4, 2009 and March 29, 2008:

                                                          Three Months Ended                   $ Increase          % Increase
(in thousands)                                   April 4, 2009         March 29, 2008          (Decrease)          (Decrease)
Net sales                                       $     123,638          $     120,362          $    3,276                 2.7 %
Cost of sales                                          23,342                 28,990              (5,648 )             -19.5 %

Gross profit                                          100,296                 91,372               8,924                 9.8 %

Operating expenses
Marketing and selling                                  43,348                 45,081              (1,733 )              -3.8 %
Research and development                               12,811                 11,300               1,511                13.4 %
General and administrative                             10,779                 10,155                 624                 6.1 %
Amortization of intangibles                             3,265                  4,347              (1,082 )             -24.9 %


Total operating expenses                               70,203                 70,883                (680 )              -1.0 %


Operating income                                       30,093                 20,489               9,604                46.9 %

Royalty income                                            933                    355                 578               162.8 %
Interest income                                           103                    195                 (92 )             -47.2 %
Interest expense                                       (5,410 )               (8,057 )            (2,647 )             -32.9 %
Amortization of financing costs                        (3,981 )               (4,120 )              (139 )              -3.4 %
Gain on extinguishment of debt                          4,562                      -              (4,562 )               n/a
Other income                                              552                  1,345                (793 )             -59.0 %


Income before taxes                                    26,852                 10,207              16,645               163.1 %

Provision for income taxes                              9,772                  4,120               5,652               137.2 %

Net income                                      $      17,080          $       6,087          $   10,993               180.6 %




                                                     Percent of Sales
                                                For the Three Months Ended
                                            April 4, 2009       March 29, 2008
        Net sales                                  100.0 %               100.0 %
        Cost of sales                               18.9 %                24.1 %

        Gross profit                                81.1 %                75.9 %

        Operating expenses
        Marketing and selling                       35.1 %                37.5 %
        Research and development                    10.4 %                 9.4 %
        General and administrative                   8.7 %                 8.4 %
        Amortization of intangibles                  2.6 %                 3.6 %


        Total operating expenses                    56.8 %                58.9 %


        Operating income                            24.3 %                17.0 %

        Royalty income                               0.8 %                 0.3 %
        Interest income                              0.1 %                 0.2 %
        Interest expense                            -4.4 %                -6.7 %
        Amortization of financing costs             -3.2 %                -3.4 %
        Gain on extinguishment of debt               3.7 %                 0.0 %
        Other income                                 0.4 %                 1.1 %

        Income before taxes                         21.7 %                 8.5 %

        Provision for income taxes                   7.9 %                 3.4 %


        Net income                                  13.8 %                 5.1 %

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Comparison of the Three Months Ended April 4, 2009 to the Three Months Ended March 29, 2008
Net sales. Net sales of $123.6 million in the first quarter of 2009 represented an increase of 2.7 percent compared to $120.4 million in the first quarter of 2008. The strengthening of the U.S. dollar in first quarter of 2009, as compared to the first quarter of 2008, reduced revenue approximately $4.5 million. Growth in our business continues to be driven by the success of innovative products, particularly the AdVance� male sling for treating mild male incontinence, the MiniArc� Single-Incision Sling for treating female incontinence, and the InhibiZone�-coated AMS 800� Artificial Urinary Sphincter. We believe the current worldwide economic crisis has resulted and may continue to result in some reductions in the procedures using our products. Although a majority of our products are subject to reimbursement from third party government and non-government entities, some procedures that use our products can be deferred by patients. In light of the current economic conditions, patients may not have employer-provided healthcare, be as willing to take time off from work or spend their money on deductibles and co-payments often required in connection with the procedures that use our products. While we believe current economic conditions may have contributed to a softening in our recent revenue growth rates, the specific impact is difficult to measure. Furthermore, we cannot predict how these economic conditions will impact our future sales.
Men's health products. Net sales of men's health products increased 12.9 percent to $59.5 million in the first quarter of 2009 compared to $52.7 million in the first quarter of 2008. This includes the negative impact of foreign currency exchange rates of approximately $2.1 million. The largest portion of this increase is in the male continence product line, driven by the continued success of the AdVance� male sling and the AMS 800� with InhibiZone�. Growth in sales of our erectile restoration products is consistent with market growth rates. BPH therapy products. Net sales from BPH therapy products declined 17.7 percent to $25.5 million in the first quarter of 2009 compared to $30.9 million in the same period in 2008, as this area of our business is more directly impacted by the recent economic pressures on hospital capital purchases. This was compounded in certain foreign distributor markets due to unfavorable foreign currency exchange rates, especially distributors that purchase from us in U.S. dollars but sell in local currencies. In addition, BPH therapy revenue was negatively impacted due to foreign currency exchange rates by approximately $1.2 million. We also experienced a decline in sales of our Thermatrx� product due to a shift away from microwave therapies for in-office procedures and lower in-office reimbursement rates for this therapy.
Women's health products. Net sales of our women's health products increased 5.4 percent to $38.7 million in the first quarter of 2009 compared to $36.8 million in the first quarter of 2008. This includes the negative impact of foreign currency exchange rates of approximately $1.2 million. The female continence product line, driven by the MiniArc� sling, contributed strong growth in dollars and units over the same period in 2008. We also experienced strong growth from the new Elevate posterior transvaginal prolapse repair system. Our Her Option� products experienced a decline in revenues and units compared to the first quarter of 2008. Revenue growth in this area has been impacted as the industry continues to experience lower than expected adoption rates for office-based procedures, coupled with our strategy of growing higher margin procedure volume versus console sales.
Net sales by geography and foreign exchange effects. Net sales in the United States increased 6.3 percent to $89.7 million in the first quarter of 2009 compared to $84.4 million in the first quarter of 2008. This growth was led by our male and female continence product lines. International net sales decreased 5.6 percent to $34.0 million in the first quarter of 2009 compared to $36.0 million in the first quarter of 2008, largely as a result of the negative impact of approximately $4.5 million in foreign currency exchange rate changes, with the strengthening of the U.S. dollar. This was offset by growth of $2.5 million, which was led by our male continence product line. International sales represented 27.5 percent and 29.9 percent of our total net sales in the first quarter of 2009 and the first quarter of 2008, respectively. Gross profit. Gross profit improved to 81.1 percent of sales in the first quarter of 2009, from 75.9 percent in the first quarter of 2008. Margins increased in the current quarter due to cost reductions achieved through operational efficiencies and improved reliability on our laser therapy products, which resulted in lower warranty and service costs. We also realized higher margins through pricing gains and changes in the mix of products sold, particularly with lower capital sales than in the same period the previous year. Future gross profit will continue to depend upon product mix, production levels, labor costs, raw material costs and our ability to manage overhead costs. Marketing and selling. Marketing and selling expenses as a percentage of revenue decreased to 35.1 percent in the first quarter of 2009 compared to 37.5 percent in the same period in the prior year. This decrease is primarily due to the timing of marketing expenses and the effects of the fluctuation in foreign currencies against the U.S. dollar.
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. Research and development expenses as a percentage of revenue increased to 10.4 percent in the first quarter of 2009 compared to 9.4 percent in the same period of 2008. These ratios are in line with our long-term goal for spending on research and development of approximately ten percent of sales.

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General and administrative. General and administrative expenses as a percentage of sales remained relatively flat in the first quarter of 2009 compared to the same period of 2008. Our objective remains to leverage general and administrative expense as a percentage of sales.
Amortization of intangibles. Amortization of intangibles includes amortization expense on our definite-lived intangible assets, consisting of patents, licenses and developed technology. The first quarter of 2009 reflects decreased amortization expense over the same period of 2008 primarily due to the $17.1 million charge recognized in the fourth quarter of 2008 for the acceleration of amortization to adjust the carrying value of certain intangible assets related to the Thermatrx and GreenLight PV technology to their fair values, which results in lower on-going amortization expense.
Royalty income. Our royalty income is from licensing our intellectual property. We do not directly influence sales of the products on which these royalties are based and cannot give any assurance as to future income levels. Royalty income in the first quarter of 2009 increased approximately $0.6 million compared to the same period last year due to increased sales related to certain of our licensed technologies.
Interest income. Interest income of $0.1 million and $0.2 million in the first quarter of 2009 and in the first quarter of 2008, respectively, was relatively consistent and insignificant, as we used the majority of our excess cash in both periods to pay down debt.
Interest expense. Interest expense decreased by $2.6 million in the first quarter of 2009 from the comparable period in 2008 due to decreases in our effective interest rate and the impact of prepayments made over the past year. Interest expense includes interest incurred on our Convertible Notes, which carry a fixed interest rate of 3.25 percent, and the interest incurred on our Credit Facility, which generally carries a floating interest rate of LIBOR plus 2.25 percent. Our weighted average interest rate on the credit facility was 4.6 percent and 4.9 percent for the three months ended April 4, 2009 and March 29, 2008, respectively. Average borrowings during the first quarter of 2009 on the Credit Facility were $228.8 million, compared to $316.1 million in the first quarter of 2008. Average borrowings on our Convertible Notes were $332.1 million and $373.8 million for the three months ended April 4, 2009 and March 29, 2008, respectively. We have entered into interest rate swaps, which were designated as cash flow hedging instruments and which have remaining terms of one to fifteen months as of April 4, 2009. The notional amount of the hedges at April 4, 2009 represents a significant portion of our floating rate debt. The notional amount of the swap contracts amortizes over their terms, and the amount of floating rate debt hedged in the future will depend on prepayments and additional contracts.
Effective beginning in the first quarter of 2009, we adopted FASB Staff Position (FSP) APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). This FSP changes the balance sheet classification of a component of our Convertible Notes between equity and debt, and results in additional non-cash economic interest cost being reflected in the statement of operations. This change in accounting has been applied to our prior period financial statements on a retrospective basis, as described in our financial statements in Note 2, Recently Issued and Adopted Accounting Pronouncements.
Amortization of financing costs. Amortization of financing costs in the first quarter of 2009 and in the first quarter of 2008 was $4.0 million and $4.1 million, respectively, and was comprised of the incremental non-cash interest cost of our Convertible Notes under FSP APB 14-1 and amortization of the costs associated with the issuance of the Credit Facility and Convertible Notes. The lower amortization in the first quarter of 2009 was due to a lower outstanding balance on both the Credit Facility and Convertible Notes, which reduces amortization of financing costs using the effective interest method. Other income. Other income decreased by $0.8 million in the first quarter of 2009 compared to the same period in 2008. The primary cause of the change in other income relates to the impact of fluctuations in foreign currencies, mainly the Euro, against the U.S. dollar on foreign denominated inter-company receivables and payables.
Provision for income taxes. Our effective income tax rate was 36.4 percent and 40.4 percent for the first quarter of 2009 and first quarter of 2008, respectively. The decrease in the current quarter effective tax rate is primarily due to the reinstatement of the federal research and development tax credit during the fourth quarter of 2008, a decrease in non-tax deductible stock compensation expense and an increase in our domestic manufacturing deduction. Liquidity and Capital Resources
Cash and cash equivalents were $14.5 million as of April 4, 2009, compared to $11.6 million as of January 3, 2009. In addition, short-term investments were $27.9 million as of April 4, 2009, compared to $31.3 million as of January 3, 2009. Short-term investments consist mostly of highly liquid money market funds that have not experienced any negative impact on liquidity or a decline in principal value. Overall, cash, cash equivalents and short-term investments remained relatively consistent, decreasing only $0.5 million in the first quarter of 2009.

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Cash flows from operating activities. Net cash provided by operating activities was $28.2 million in the first quarter of 2009, versus $7.4 million provided during the comparable period of 2008, which is an increase of $20.8 million. This increase is partially driven by an increase in net income, adjusted for reclassifications and non-cash items, of $3.5 million, in the first quarter of 2009, compared to the same period last year. In addition, cash used for accounts payable and accrued expenses was $20.8 million lower this period versus the same period last year, the most significant change being the cash payment of $15.0 million in the three month period ended March 29, 2008, for settlement of litigation of the CryoGen arbitration award (see financial statements, Note 9, Litigation Settlements).
Cash flows from investing activities. Cash provided by investing activities was $2.9 million during the first quarter of 2009, versus $0.6 million used in the comparable period of 2008. During the first quarter of 2009, we made purchases of short-term money market investments and property, plant and equipment of $18.1 million and $1.1 million, respectively. These outflows of cash were offset by our sale of short-term investments of $21.5 million and gains of $0.7 million related to the settlement of certain derivative contracts. During the first quarter of 2008, we received $1.6 million of payments related to our disposal of the Laserscope business, offset by purchases of intangibles and property, plant and equipment.
Cash flows from financing activities. Cash used for financing activities was $28.8 million during the first quarter of 2009, versus $2.5 million used in the same period of 2008. Cash used for repayment of long-term debt under our Credit Facility was $8.6 million and $5.8 million for the first quarter of 2009 and 2008, respectively. In addition, we repurchased Convertible notes with a principal amount of $27.3 million for a cash payment of $21.1 million during the first quarter of 2009. Thus, the total debt retired in the first quarter of 2009 was $35.9 million. Cash received from the issuance of common stock was $0.9 million and $2.4 million during the first quarter of 2009 and 2008, respectively, the majority of which came from our employees exercising stock options.
We issued our Convertible Notes with a stated maturity of July 1, 2036 pursuant to an Indenture dated as of June 27, 2006 as supplemented by the first supplemental indenture dated September 6, 2006 (the Indenture) between us, certain of our significant domestic subsidiaries, as guarantors of the Convertible Notes, and U.S. Bank National Association, as trustee for the benefit of the holders of the Convertible Notes, which specifies the terms of the Convertible Notes. The Convertible Notes bear interest at the rate of 3.25 percent per year, payable semiannually. The Convertible Notes are our direct, unsecured, senior subordinated obligations, rank junior to our Credit Facility and will rank junior in right of payment to all of our future senior secured debt as provided in the Indenture.
In addition to regular interest on the Convertible Notes, we will also pay contingent interest beginning July 1, 2011, if the average trading price of the Convertible Notes for the five consecutive trading days immediately before the last trading day before the relevant six-month period equals or exceeds 120 percent of the principal amount of the Convertible Notes. The Convertible Notes are convertible under certain circumstances for cash and shares of our common stock, if any, at a conversion rate of 51.5318 shares of our common stock per $1,000 principal amount of Convertible Notes (which is equal to an initial conversion price of approximately $19.406 per share), subject to adjustment. Upon conversion, we would be required to satisfy up to 100 percent of the principal amount of the Convertible Notes solely in cash, with any amounts above the principal amount to be satisfied in shares of our common stock.
The following table illustrates the number of shares issued upon full conversion of the Convertible Notes assuming various market prices for our stock:

          If the market price of our    The number of shares issued upon
              our stock is:               full conversion would be (1):
          $25.00                                   3.6 million
          $30.00                                   5.7 million
          $35.00                                   7.2 million

(1) The formula to calculate the shares issued upon full conversion of our Convertible Notes is as follows:

$312.0 million principal x Market price of stock at time of - $312.0 million = Shares issued ( $19.406 conversion price conversion principal ) upon full

Market price of stock at time of conversion conversion

If a holder elects to convert its Convertible Note in connection with a designated event that occurs prior to July 1, 2013, we will pay, to the extent described in the Indenture, a make whole premium by increasing the conversion rate applicable to such Convertible Notes. All of the above conversion rights will be subject to certain limitations imposed by our Credit Facility.

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