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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended October 2, 2004
or
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 00030733
AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 41-1978822 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
10700 Bren Road West, Minnetonka, Minnesota | 55343 | |||
| (Address of principal executive offices) | (Zip Code) | |||
952-930-6000
(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 oNo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
x Yes oNo
As of November 5, 2004, there were 33,713,047 shares of the registrant’s $.01 par value Common Stock outstanding.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
American Medical Systems Holdings, Inc.
Consolidated Balance Sheets
(In thousands, except share and per share data)
| October 2, 2004 | January 3, 2004 | |||||||
Assets | ||||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | 23,771 | $ | 58,953 | ||||
| Short term investments | 12,634 | — | ||||||
| Accounts receivable, net | 40,340 | 33,507 | ||||||
| Inventories, net | 21,113 | 18,402 | ||||||
| Deferred income taxes | 5,815 | 5,637 | ||||||
| Other current assets | 4,988 | 2,896 | ||||||
| Total current assets | 108,661 | 119,395 | ||||||
| Property, plant and equipment, net | 22,124 | 25,489 | ||||||
| Goodwill, net | 98,931 | 98,989 | ||||||
| Intangibles, net | 46,653 | 17,466 | ||||||
| Deferred income taxes | 3,294 | 12,991 | ||||||
| Investment in technology and other assets | 5,085 | 4,997 | ||||||
| Total assets | $ | 284,748 | $ | 279,327 | ||||
Liabilities and Stockholders’ Equity | ||||||||
| Current liabilities | ||||||||
| Accounts payable | $ | 4,264 | $ | 4,621 | ||||
| Accrued compensation expenses | 13,460 | 9,886 | ||||||
| Accrued warranty expense | 1,429 | 1,338 | ||||||
| Income taxes payable | — | 1,667 | ||||||
| Other accrued expenses | 7,427 | 5,105 | ||||||
| Contingent liability on acquisition | 21,421 | — | ||||||
| Current portion of notes payable | — | 7,159 | ||||||
| Total current liabilities | 48,001 | 29,776 | ||||||
| Long-term notes payable | — | 9,205 | ||||||
| Stockholders’ equity | ||||||||
| Common stock, par value $.01 per share; authorized 95,000,000 shares; issued and outstanding: | ||||||||
| 33,694,967 shares at October 2, 2004 and 33,135,354 shares at January 3, 2004 | 337 | 331 | ||||||
| Additional paid-in capital | 209,168 | 202,341 | ||||||
| Deferred compensation | — | (24 | ) | |||||
| Accumulated other comprehensive income | 756 | 1,367 | ||||||
| Retained earnings | 26,486 | 36,331 | ||||||
| Total stockholders’ equity | 236,747 | 240,346 | ||||||
| Total liabilities and stockholders’ equity | $ | 284,748 | $ | 279,327 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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American Medical Systems Holdings, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | |||||||||||||
Net sales | $ | 52,326 | $ | 39,559 | $ | 148,732 | $ | 121,130 | ||||||||
Cost of sales | 9,508 | 7,110 | 27,485 | 21,434 | ||||||||||||
Gross profit | 42,818 | 32,449 | 121,247 | 99,696 | ||||||||||||
Operating expenses | ||||||||||||||||
| Marketing and selling | 18,349 | 15,245 | 52,092 | 47,026 | ||||||||||||
| Research and development | 4,305 | 3,739 | 11,466 | 11,013 | ||||||||||||
| In-process research and development | 35,000 | — | 35,000 | — | ||||||||||||
| General and administrative | 5,120 | 4,110 | 15,206 | 12,025 | ||||||||||||
| Amortization of intangibles | 1,850 | 1,150 | 3,969 | 3,254 | ||||||||||||
| Total operating expenses | 64,624 | 24,244 | 117,733 | 73,318 | ||||||||||||
Operating (loss) income | (21,806 | ) | 8,205 | 3,514 | 26,378 | |||||||||||
Other income (expense) | ||||||||||||||||
| Royalty income | 627 | 711 | 1,548 | 2,175 | ||||||||||||
| Interest income | 231 | 107 | 541 | 349 | ||||||||||||
| Interest expense | (357 | ) | (235 | ) | (806 | ) | (1,659 | ) | ||||||||
| Other income (expense) | 3 | 113 | (184 | ) | 434 | |||||||||||
| Total other income (expense) | 504 | 696 | 1,099 | 1,299 | ||||||||||||
(Loss) income before income taxes | (21,302 | ) | 8,901 | 4,613 | 27,677 | |||||||||||
Provision for income taxes | 5,000 | 1,961 | 14,459 | 8,946 | ||||||||||||
Net (loss) income | $ | (26,302 | ) | $ | 6,940 | $ | (9,846 | ) | $ | 18,731 | ||||||
Net (loss) income per share | ||||||||||||||||
| Basic | $ | (0.78 | ) | $ | 0.21 | $ | (0.29 | ) | $ | 0.57 | ||||||
| Diluted | $ | (0.78 | ) | $ | 0.20 | $ | (0.29 | ) | $ | 0.55 | ||||||
Weighted average common shares used in calculation | ||||||||||||||||
| Basic | 33,669 | 32,974 | 33,429 | 32,773 | ||||||||||||
| Diluted | 33,669 | 34,455 | 33,429 | 34,193 | ||||||||||||
The accompanying notes are an intergral part of the consolidated financal statements.
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American Medical Systems Holdings, Inc.
Consolidated Statements of Cash Flow
(In thousands)
| Nine Months Ended | ||||||||
| October 2, 2004 | September 27, 2003 | |||||||
Cash flows from operating activities | ||||||||
| Net (loss) income | ($9,846 | ) | $ | 18,731 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
| Depreciation | 5,338 | 4,447 | ||||||
| Loss on asset disposals | 16 | — | ||||||
| Amortization of intangibles | 3,969 | 3,254 | ||||||
| Amortization of deferred financing costs | 450 | 203 | ||||||
| Non-cash in-process research and development charge | 35,000 | — | ||||||
| Non-cash deferred compensation | 53 | 129 | ||||||
| Income tax benefit related to stock option plans | 1,477 | 1,227 | ||||||
| Change in net deferred taxes | 2,496 | 822 | ||||||
| Changes in operating assets and liabilities | ||||||||
| Accounts receivable | (1,076 | ) | (1,234 | ) | ||||
| Inventories | (50 | ) | (3,701 | ) | ||||
| Accounts payable and accrued expenses | (4,172 | ) | (423 | ) | ||||
| Other assets | (257 | ) | (1,065 | ) | ||||
| Net cash provided by operating activities | 33,398 | 22,390 | ||||||
Cash flows from investing activities | ||||||||
| Purchase of property, plant and equipment | (1,804 | ) | (3,202 | ) | ||||
| Purchase of investments | (12,634 | ) | — | |||||
| Purchase of license agreement | (2,500 | ) | — | |||||
| Purchase of business, net of cash acquired | (40,075 | ) | (43,152 | ) | ||||
| Net cash used in investing activities | (57,013 | ) | (46,354 | ) | ||||
Cash flows from financing activities | ||||||||
| Issuance of common stock | 5,326 | 2,064 | ||||||
| Payments on long-term debt | (16,364 | ) | (4,956 | ) | ||||
| Net cash used in financing activities | (11,038 | ) | (2,892 | ) | ||||
Effect of exchange rates on cash | (529 | ) | 1,376 | |||||
Net decrease in cash and cash equivalents | (35,182 | ) | (25,480 | ) | ||||
Cash and cash equivalents at beginning of period | 58,953 | 79,429 | ||||||
Cash and cash equivalents at end of period | $ | 23,771 | $ | 53,949 | ||||
Supplemental disclosure | ||||||||
| Cash paid for interest | $ | 314 | $ | 1,474 | ||||
| Cash paid for taxes | $ | 13,111 | $ | 6,955 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The consolidated financial statements included in this Form 10-Q have been prepared by American Medical Systems Holdings, Inc. (the Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to these rules and regulations. The year-end balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. These unaudited consolidated interim financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes included in its Annual Report on Form 10-K for fiscal 2003. All amounts presented in tables are in thousands, except per share data.
These statements reflect, in management’s opinion, all adjustments (which include only normal, recurring adjustments) necessary for a fair presentation of the financial position and the results of operations and cash flows for the periods presented. The results of operations for any interim period may not be indicative of results for the full year.
The Company has a 52 or 53 week fiscal year ended on the Saturday nearest December 31. Accordingly, the third fiscal quarters of 2004 and 2003 ended on October 2, 2004 and September 27, 2003, respectively. The third fiscal quarter and the first three quarters of the fiscal year are identified respectively herein as our three and nine month periods of fiscal 2004 and 2003.
2. Stock-Based Compensation
The Company has one stock-based employee compensation plan. The Company accounts for this plan under the recognition and measurement principles of APB Opinion 25,Accounting for Stock Issued to Employees, and related interpretations. The exercise price of the Company’s employee stock options generally equals the market price of the underlying stock on the date of grant for all options granted, and thus, under APB 25, no compensation expense is recognized. However, during 2000, the Company recognized deferred compensation of $1.4 million, reflecting the excess of the fair value of the underlying stock on the date of grant over the exercise price. The deferred compensation was being amortized over vesting periods of two to four years, and was fully amortized as of the end of the first fiscal quarter of 2004.
The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
| Three Months Ended | Nine Months Ended | |||||||||||||||
| (in thousands, except per share data) | October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | ||||||||||||
| Net income (loss), as reported | ($26,302 | ) | $ | 6,940 | ($9,846 | ) | $ | 18,731 | ||||||||
| Stock-based employee compensation expense included in reported income, net of tax | — | (4 | ) | 15 | 68 | |||||||||||
| Total stock-based employee compensation expense determined under fair-value based method for all awards, net of tax | (1,338 | ) | (1,279 | ) | (3,513 | ) | (3,359 | ) | ||||||||
| Pro forma net income (loss) | ($27,640 | ) | $ | 5,657 | ($13,344 | ) | $ | 15,440 | ||||||||
| Net income (loss) per share | ||||||||||||||||
| As reported | ||||||||||||||||
| Basic | ($0.78 | ) | $ | 0.21 | ($0.29 | ) | $ | 0.57 | ||||||||
| Diluted | ($0.78 | ) | $ | 0.20 | ($0.29 | ) | $ | 0.55 | ||||||||
| Pro forma | ||||||||||||||||
| Basic | ($0.82 | ) | $ | 0.17 | ($0.40 | ) | $ | 0.47 | ||||||||
| Diluted | ($0.82 | ) | $ | 0.16 | ($0.40 | ) | $ | 0.45 | ||||||||
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During the third fiscal quarter of 2004, stock options were exercised to acquire 47,207 shares and 10,155 shares were purchased under the employee stock purchase plan. During the first nine months of fiscal 2004, stock options were exercised to acquire 526,098 shares and 33,515 shares were purchased under the employee stock purchase plan.
3. Earnings per Share
The following table presents information necessary to calculate basic and diluted net income per common share and common share equivalents for the three and nine month periods of fiscal 2004 and 2003.
| Three Months Ended | Nine Months Ended | |||||||||||||||
| (in thousands, except per share data) | October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | ||||||||||||
| Net income (loss) | ($26,302 | ) | $ | 6,940 | ($9,846 | ) | $ | 18,731 | ||||||||
| Weighted-average shares outstanding for basic net income per share | 33,669 | 32,974 | 33,429 | 32,773 | ||||||||||||
| Dilutive effect of stock options | — | 1,481 | — | 1,420 | ||||||||||||
| Adjusted weighted-average shares outstanding and assumed conversions for diluted net income per share | 33,669 | 34,455 | 33,429 | 34,193 | ||||||||||||
| Net income (loss) per share | ||||||||||||||||
| Basic | ($0.78 | ) | $ | 0.21 | ($0.29 | ) | $ | 0.57 | ||||||||
| Diluted | ($0.78 | ) | $ | 0.20 | ($0.29 | ) | $ | 0.55 | ||||||||
During the third quarter and for the nine months ended October 2, 2004, there were 1,615,907 and 1,659,608 shares respectively of outstanding stock options excluded from the diluted earnings per share computation because the impact would have been anti-dilutive.
4. Inventories
Inventories consist of the following:
| (in thousands) | October 2, 2004 | January 3, 2004 | ||||||
| Raw materials | $ | 4,760 | $ | 5,001 | ||||
| Work in process | 2,917 | 2,817 | ||||||
| Finished goods | 13,436 | 10,584 | ||||||
| Net inventories | $ | 21,113 | $ | 18,402 | ||||
5. Warranties
Many of the Company’s products are sold with warranty coverage for periods ranging from one year up to the patient’s lifetime. The warranty accrual is the Company’s estimate of the expected future cost of honoring warranty obligations. Factors influencing this estimate include historical claim rates, surgical infection rates, changes in product design or performance, the frequency of product use by the patients, the patients’ performance expectations, and changes in the terms of our policies. Changes in the warranty accrual during the nine month periods of fiscal 2004 and 2003 were as follows:
| Nine months ended | ||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | ||||||
| Balance, beginning of period | $ | 1,338 | $ | 4,639 | ||||
| Provisions for warranty | 322 | 157 | ||||||
| Claims paid | (231 | ) | (228 | ) | ||||
| Balance, end of period | $ | 1,429 | $ | 4,568 | ||||
6. Acquisition
On July 15, 2004, the Company completed the acquisition of TherMatrx, Inc. As a result of the merger, the shareholders of TherMatrx were initially paid cash consideration of $40.5 million. The Company deposited $4.0 million of this initial consideration in escrow to be held for six months after closing of the merger to cover certain contingencies, and the balance was distributed to holders of TherMatrx stock. The Company used cash on hand to make the initial payment of $40.5 million.
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In addition to the initial closing payment, the Company will make contingent payments based on the net product revenues attributable to sales of the TherMatrx Dose Optimized Thermotherapy (DOT) product. These contingent payments will equal four times the aggregate sales of DOT products over a period of six consecutive Company fiscal quarters (which began on July 5, 2004 and will end on December 31, 2005) minus $40.0 million. The contractual range of contingent payments is from zero to $209.5 million which would result in a total purchase price of $40.5 million up to a maximum of $250.0 million (including the initial payment). These contingent payments will be accounted for as goodwill.
The primary purpose of the TherMatrx acquisition was to gain access to their product for the treatment of benign prostatic hyperplasia (BPH). The Company believes that its current relationship with urologists will allow it to extend the benefits of the TherMatrx product and technology to men suffering from BPH more efficiently and effectively than TherMatrx could alone. The Company also believes that by broadening its prostate treatment product line, it could offer more value to its physician-customers. The primary advantage of the TherMatrx treatment over other BPH treatments is the comfort level for the patient and its appropriateness for the office setting.
The Company has allocated the initial purchase price as follows:
| (in thousands) | Amount | |||
| Developed technology, customer relationships and other intangible assets | $ | 31,000 | ||
| In-process research and development | 35,000 | |||
| Tangible assets acquired, net of liabilities assumed | 4,834 | |||
| Deferred tax liability on assets acquired | (7,242 | ) | ||
| Contingent liability on acquisition | (21,421 | ) | ||
| Initial purchase price | $ | 42,171 | ||
| Cash consideration to TherMatrx shareholders | $ | 40,501 | ||
| Acquisition costs | 1,670 | |||
| Initial purchase price | $ | 42,171 | ||
| Less cash acquired | (2,096 | ) | ||
| Purchase of business, net of cash acquired | $ | 40,075 | ||
The determination of the portion of the purchase price allocated to developed technology, customer relationships and other intangible assets and in-process research and development was based on an independent valuation study to determine the respective fair values. The developed technology, customer relationships and other intangible assets are being amortized over their estimated useful lives of 10 years, with this expense reflected as part of the amortization of intangibles line on the Consolidated Statement of Operations. In accordance with purchase accounting rules, the acquired in-process research and development of $35.0 million was expensed in the current period with no related income tax benefit and is included separately in the Consolidated Statement of Operations. Tangible assets acquired, net of liabilities assumed, were stated at fair value at the date of acquisition based on management’s assessment. The contingent liability on acquisition is the measurement of net assets acquired in excess of the initial purchase price and represents contingent purchase price consideration. This purchase price allocation is subject to final adjustments relating to certain valuation matters.
The consolidated financial statements of the Company for the three and nine months ended October 2, 2004 include the financial results of TherMatrx beginning July 15, 2004. The following table contains pro forma results assuming the acquisition was made at the beginning of 2003:
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| Three Months Ended | Nine Months Ended | |||||||||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | ||||||||||||
| Revenue | $ | 52,864 | $ | 42,663 | $ | 158,976 | $ | 130,878 | ||||||||
| Net income (loss) | $ | (34,956 | ) | $ | 7,447 | $ | (16,971 | ) | $ | 18,300 | ||||||
| Earnings (loss) per share | ||||||||||||||||
| Basic | $ | (1.04 | ) | $ | 0.23 | $ | (0.51 | ) | $ | 0.56 | ||||||
| Diluted | $ | (1.04 | ) | $ | 0.22 | $ | (0.51 | ) | $ | 0.54 | ||||||
In addition to the one-time charge for in-process research and development of $35.0 million which impacted the three and nine month periods ended October 2, 2004, the above pro forma results for the nine month period reflect $8.8 million in other acquisition related expenses recorded by TherMatrx, Inc. prior to the effective date of the transaction.
The pro forma consolidated results do not purport to be indicative of results that would have occurred had the acquisition been in effect for the periods presented, nor do they purport to be indicative of the results that will be obtained in the future.
7. Patent Cross-License Agreement
On September 13, 2004, the Company entered into a settlement agreement with Mentor Corporation under which both parties agreed to dismiss the intellectual property lawsuits involving the two companies. The Company also signed a non-exclusive cross-license agreement covering patents related to the field of female pelvic health. Under the cross-license agreement, the Company made a one-time payment in the third quarter of 2004 to Mentor in the amount of $2.5 million for access to U.S. Patent No. 6,638,211 (a method patent owned by Mentor covering the transobturator surgical approach) and derivatives thereof. The Company will amortize this payment over the relevant sales and does not expect this payment to materially impact its future financial results.
8. Comprehensive Income
Comprehensive income for the Company is net income adjusted for changes in the value of derivative financial instruments designated as hedges, unrealized gains and losses on available-for-sale securities, and foreign currency translation.
Comprehensive income for the three and nine month periods in fiscal 2004 and 2003 was:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | ||||||||||||
| Net income (loss) | $ | (26,302 | ) | $ | 6,940 | $ | (9,846 | ) | $ | 18,731 | ||||||
| Net loss on hedges, net of taxes | — | — | — | (5 | ) | |||||||||||
| Amounts reclassified to interest expense during the period from derivative and hedging activities, net of taxes | — | — | — | 464 | ||||||||||||
| Translation gain (loss), net of taxes | 172 | 689 | (611 | ) | 1,761 | |||||||||||
| Comprehensive income | $ | (26,130 | ) | $ | 7,629 | $ | (10,457 | ) | $ | 20,951 | ||||||
9. Industry Segment Information and Foreign Operations
Since its inception, the Company has operated in the single industry segment of developing, manufacturing, and marketing medical devices.
The Company distributes its products through its direct sales force and independent sales representatives in the United States, Canada, Australia, and most of Western Europe. Additionally, the Company distributes its products through foreign independent distributors, primarily in Europe (excluding Western Europe), Asia, and South America, who then sell the products to medical institutions. No customer or distributor accounted for five percent or more of the Company’s net sales during 2004 or 2003. Foreign subsidiary sales are predominantly to customers in Western Europe, Australia, and Canada. Substantially all of the Company’s foreign subsidiary assets are located in Western Europe, Australia, and Canada.
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The following table presents net sales and long-lived assets by geographical territory. No individual foreign country’s net sales or long-lived assets are material.
| Three Months Ended | Nine Months Ended | |||||||||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | ||||||||||||
| United States | ||||||||||||||||
| Net sales | $ | 43,271 | $ | 33,023 | $ | 117,512 | $ | 99,289 | ||||||||
| Long-lived assets | $ | 160,390 | $ | 140,860 | $ | 160,390 | $ | 140,860 | ||||||||
| Outside United States | ||||||||||||||||
| Net sales | $ | 9,055 | $ | 6,536 | $ | 31,220 | $ | 21,841 | ||||||||
| Long-lived assets | $ | 12,403 | $ | 12,078 | $ | 12,403 | $ | 12,078 | ||||||||
10. Goodwill and Intangible Assets
The changes in the carrying amount of goodwill for the nine month period ended October 2, 2004 are as follows:
| Goodwill balance at January 3, 2004 | $ | 98,989 | ||
| Adjustment for CryoGen severance | (58 | ) | ||
| Balance at October 2, 2004 | $ | 98,931 | ||
It is the Company’s practice to assess goodwill impairment under the annual requirement of SFAS 142 or when impairment indicators arise.
The following table presents the Company’s intangible assets and accumulated amortization as of October 2, 2004 and January 3, 2004:
| October 2, 2004 | January 3, 2004 | |||||||||||||||||||||||
| Gross carrying | Accumulated | Net book | Gross carrying | Accumulated | Net book | |||||||||||||||||||
| (in thousands) | amount | amortization | value | amount | amortization | value | ||||||||||||||||||
| Amortized | ||||||||||||||||||||||||
| Patents | $ | 10,141 | $ | (6,309 | ) | $ | 3,832 | $ | 10,144 | $ | (5,459 | ) | $ | 4,685 | ||||||||||
| Licenses | 5,291 | (1,345 | ) | 3,946 | 2,790 | (1,048 | ) | 1,742 | ||||||||||||||||
| Deferred financing | 1,611 | (1,611 | ) | — | 1,611 | (1,161 | ) | 450 | ||||||||||||||||
| Developed technology | 48,853 | (11,749 | ) | 37,104 | 17,853 | (9,035 | ) | 8,818 | ||||||||||||||||
| Non-compete agreements | 1,111 | (1,111 | ) | — | 1,111 | (1,111 | ) | — | ||||||||||||||||
| Total amortized intangible assets | 67,007 | (22,125 | ) | 44,882 | 33,509 | (17,814 | ) | 15,695 | ||||||||||||||||
| Unamortized | ||||||||||||||||||||||||
| Trademarks | 2,233 | (462 | ) | 1,771 | 2,233 | (462 | ) | 1,771 | ||||||||||||||||
| Total intangible assets | $ | 69,240 | $ | (22,587 | ) | $ | 46,653 | $ | 35,742 | $ | (18,276 | ) | $ | 17,466 | ||||||||||
| Three months ended | Nine months ended | |||||||||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | ||||||||||||
| Amortization expense | $ | 1,850 | $ | 1,150 | $ | 3,969 | $ | 3,254 | ||||||||
Estimated amortization expense for existing intangibles for the years 2004 through 2008 is $5.8 million, $6.1 million, $5.8 million, $4.9 million and $5.0 million, respectively.
11. Long Term Debt
On July 8, 2004, the Company repaid the entire outstanding balance of $12.9 million under its senior credit facility and terminated the credit facility. The original maturity of the term notes required quarterly principal payments through September 2005. The Company plans to begin negotiations to establish a credit facility during the fourth quarter of 2004.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “may,” “expect,” “believe,” “anticipate,” or “estimate,” identify such forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially from those expressed in such forward-looking statements. Some of the factors that could cause such material differences are identified in “Risk Factors”. We undertake no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise. You are advised, however, to consult any future disclosures we make on related subjects in future filings with the SEC.
Critical Accounting Policies and Estimates
We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Management’s discussion and analysis of financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect (1) the reported amounts of assets, liabilities, revenues, and expenses; and (2) the related disclosure of contingent assets and liabilities. At each balance sheet date, we evaluate our estimates, including but not limited to, those related to accounts receivable and sales return obligations, inventories, long-lived assets, warranty, legal contingencies, and income taxes. The critical accounting policies that are most important in fully understanding and evaluating the financial condition and results of operations are discussed in our Form 10-K on file with the SEC.
Overview
American Medical Systems develops, manufactures, and markets medical devices for physician customers, primarily urologists, gynecologists and urogynecologists. Our products are utilized by physicians to treat male disorders such as erectile dysfunction, incontinence, and prostate disease; and also female disorders such as incontinence, excessive uterine bleeding, and pelvic organ prolapse. Our strategy has been to develop innovative products that provide our customers with therapy options to better, and/or less invasively, manage under-treated urological and gynecological conditions.
Our product offering includes a full line of erectile restoration products including both inflatable and non-inflatable prostheses to replace non-functioning penile erectile tissue. For male urinary control we sell ourAMS 800 Artificial Urinary Sphincter™and theInVance™sling system. For urethral stricture and benign prostatic hyperplasia (BPH) symptoms we sell urethral stents and surgical resection loops. TheProstaJect® chemical prostate ablation system is currently available outside of the U.S. and is expected to be in a Phase III clinical trial in the U.S. in the near future. Our women’s health products include several products for stress urinary incontinence (InFast™,SPARC™,Monarc™andBioArc™SP andBioArc™TO). Through the acquisition of CryoGen, Inc. in January 2003, we added theHer Option® therapy to our women’s health portfolio for excessive menstrual bleeding.
On July 15, 2004, we acquired TherMatrx, Inc., a privately held company focused on providing physicians an in-office alternative for BPH. Each year in the United States, over three million men seek treatment for the non-cancerous enlargement of the prostate gland known as BPH. Current invasive therapies offered for BPH include surgically removing the entire prostate, resecting a portion of the prostate, or performing a transurethral incision of the prostatic tissue. Other less invasive procedures performed in the hospital include prostatic stenting, laser-based resection, radio-frequency energy ablation, and the delivery of microwave energy. While some of these therapies may be performed under certain circumstances in a physician’s office, they are neither as comfortable for the patient nor as appropriate for the office setting as the TherMatrx microwave therapy for BPH symptoms.
In the three month period of 2004, we recorded a non-recurring charge of $35.0 million for in-process research and development expenses with no associated income tax benefit, related to the acquisition of TherMatrx, Inc. in accordance with the rules of purchase accounting. In our October 28, 2004 press release
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announcing our financial results for the three and nine month periods of 2004, we incorrectly reported an income tax benefit in our statement of operations of $12.8 million related to the reversal of a deferred tax liability that was established in purchase accounting for the book—to-tax basis difference on the $35.0 million charge. We have since confirmed that no deferred income tax liabilities are to be provided on differences in initial bases for income tax and financial reporting purposes, related to in-process research and development acquired and subsequently written off in a purchase business combination. Accordingly, our statement of operations in this Form 10-Q appropriately excludes any income tax benefit related to this in-process research and development charge.
This $12.8 million increase in income tax expense had the effect of changing net income <loss> for the three and nine month periods of 2004 from <$13.5 million> (or <$.040 per share>) and $2.9 million (or $0.09 per share) respectively as reported in the October 28, 2004 press release, to a net <loss> of <$26.3 million> (or <$0.78 per share>) and <$9.8 million> (or <$0.29 per share>) respectively in this Form 10-Q. This correction also reduced retained earnings by $12.8 million, increased the contingent liability on acquisition by $13.3 million, and increased deferred tax assets by $0.5 million in this Form 10-Q compared to the amounts previously reported in the press release.
During the third quarter of 2003 we recognized a non-recurring tax benefit of $1.1 million resulting from the implementation of research and development tax credits and extraterritorial income exclusions.
Results of Operations
The following table compares net sales by product line and geography for the three and nine month periods of fiscal 2004 and 2003:
| Three Months Ended | $ Increase | % Increase | Nine Months Ended | $ Increase | % Increase | |||||||||||||||||||||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | (Decrease) | (Decrease) | October 2, 2004 | September 27, 2003 | (Decrease) | (Decrease) | ||||||||||||||||||||||||
Sales | ||||||||||||||||||||||||||||||||
| Product Line | ||||||||||||||||||||||||||||||||
| Men’s health | ||||||||||||||||||||||||||||||||
| Erectile restoration | $ | 18,620 | $ | 17,058 | $ | 1,562 | 9.2 | % | $ | 54,004 | $ | 52,876 | $ | 1,128 | 2.1 | % | ||||||||||||||||
| Continence | 11,143 | 8,561 | 2,582 | 30.2 | % | 35,575 | 29,064 | 6,511 | 22.4 | % | ||||||||||||||||||||||
| Prostate treatment | 5,514 | 1,188 | 4,326 | 364.1 | % | 7,769 | 3,699 | 4,070 | 110.0 | % | ||||||||||||||||||||||
| Total men’s health | 35,277 | 26,807 | 8,470 | 31.6 | % | 97,348 | 85,639 | 11,709 | 13.7 | % | ||||||||||||||||||||||
| Women’s health | 17,049 | 12,752 | 4,297 | 33.7 | % | 51,384 | 35,491 | 15,893 | 44.8 | % | ||||||||||||||||||||||
| Total | $ | 52,326 | $ | 39,559 | $ | 12,767 | 32.3 | % | $ | 148,732 | $ | 121,130 | $ | 27,602 | 22.8 | % | ||||||||||||||||
| Geography | ||||||||||||||||||||||||||||||||
| United States | $ | 43,271 | $ | 33,023 | $ | 10,248 | 31.0 | % | $ | 117,512 | $ | 99,289 | $ | 18,223 | 18.4 | % | ||||||||||||||||
| Outside United States | 9,055 | 6,536 | 2,519 | 38.5 | % | 31,220 | 21,841 | 9,379 | 42.9 | % | ||||||||||||||||||||||
| Total | $ | 52,326 | $ | 39,559 | $ | 12,767 | 32.3 | % | $ | 148,732 | $ | 121,130 | $ | 27,602 | 22.8 | % | ||||||||||||||||
Percent of total sales | ||||||||||||||||||||||||||||||||
| Product Line | ||||||||||||||||||||||||||||||||
| Men’s health | ||||||||||||||||||||||||||||||||
| Erectile restoration | 36 | % | 43 | % | 36 | % | 44 | % | ||||||||||||||||||||||||
| Continence | 21 | % | 22 | % | 24 | % | 24 | % | ||||||||||||||||||||||||
| Prostate treatment | 11 | % | 3 | % | 5 | % | 3 | % | ||||||||||||||||||||||||
| Total men’s health | 67 | % | 68 | % | 65 | % | 71 | % | ||||||||||||||||||||||||
| Women’s health | 33 | % | 32 | % | 35 | % | 29 | % | ||||||||||||||||||||||||
| Total | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||||||||||||||||||
| Geography | ||||||||||||||||||||||||||||||||
| United States | 83 | % | 83 | % | 79 | % | 82 | % | ||||||||||||||||||||||||
| Outside United States | 17 | % | 17 | % | 21 | % | 18 | % | ||||||||||||||||||||||||
| Total | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||||||||||||||||||
Net Sales.Sales in the three month period of 2004 grew broadly worldwide, contributing to our total net sales of $52.3 million. Net sales increased by 32.3 percent in the three month period of 2004 as compared to the same period in 2003. Net sales for the nine month period of 2004 grew 22.8 percent as compared to the same period of 2003. Sales growth in the three and nine month periods of fiscal 2004 were driven primarily by unit volume growth of new products and, to a lesser degree, by pricing increases and the positive impact of foreign currency exchange rates (1 percentage point and 2 percentage points for the three and nine month periods respectively). Sales for the three and nine month periods of 2004 included $4.6 million of our TherMatrx BPH product which we acquired on July 15, 2004.
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International sales, which this quarter represented 17.0 percent of our net sales in the three month period of 2004, grew 38.5 percent over the same period in 2003 (including 8.1 percent growth due to favorable currency effects). U.S. sales grew 31.0 percent from the year ago period. Growth in the U.S., excluding erectile restoration sales, was 48.8 percent.
Worldwide erectile restoration revenues resumed growth in the three month period of 2004, increasing 9.2 percent over the same period last year. This growth rate was in the single digits both domestically and internationally. The U.S. growth was primarily driven by the increased volume and price on the strength of the newAMS 700 Tactile Pump™product. We received clearance for this product from the Food and Drug Administration in our second fiscal quarter of 2004, and began selling this product in the U.S. on a limited basis during our third fiscal quarter. Erectile restoration revenues increased 2.1 percent during the nine month period of fiscal 2004 over the comparable period last year.
Sales of our male urinary continence products increased 30.2 percent and 22.4 percent in the three and nine month periods of fiscal 2004 over the year ago periods, primarily due to unit sales growth in both theAMS 800 Artificial Urinary Sphincterand theInVancesling.
Prostate treatment product sales increased $4.3 million and $4.1 million in the three and nine month periods of fiscal 2004, respectively, driven by sales of our TherMatrx product, acquired in July 2004. Sales of our other prostate products declined 22.7 percent and 14.2 percent in the three and nine month periods of fiscal 2004 as we continue to reposition theUroLume®product toward obstructive urethral conditions such as urethral stricture.
Sales of women’s health products increased 33.7 percent and 44.8 percent in the three and nine month periods of fiscal 2004, respectively. The market for female incontinence products continues to expand rapidly driven by the acceptance of minimally invasive therapies.Monarcis now our number one selling product for the treatment of female incontinence. Sales of this product grew significantly in our third fiscal quarter of 2004, its seventh quarter of availability in Europe and fifth full quarter of use in the U.S. We are continuingMonarctraining and proctoring for gynecologists and urologists worldwide. OurBioArcsling system continued to grow sequentially during the third fiscal quarter of 2004.BioArcis the only product available which offers physicians the choice of a biologic graft material attached to the self-fixating sling. In the third fiscal quarter of 2004, we further expanded theBioArcseries from theBioArcSP (suprapubic surgical approach) to include theBioArcTO (transobturator surgical approach).
We expanded our female pelvic prolapse product portfolio during the second fiscal quarter of 2004 with the FDA’s clearance of theApogee™andPerigee™. Although we have received regulatory clearance for these products, our physician training began in June 2004 and continued into the third quarter of 2004. We will continue to train physicians in the fourth quarter of 2004 for purposes of conducting post-market studies which we believe will support wider product availability in 2005.
Sales of ourHer Option®product remain at a modest level as reimbursement rates for that product’s use in the physician’s office remains pending. We do anticipate having a reimbursement level established for this product beginning in January 2005.
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The following table compares revenue, expense, and other income accounts for the three and nine month periods of fiscal 2004 and 2003:
| Three Months Ended | $ Increase | % Increase | Nine Months Ended | $ Increase | % Increase | |||||||||||||||||||||||||||
| (in thousands) | October 2, 2004 | September 27, 2003 | (Decrease) | (Decrease) | October 2, 2004 | September 27, 2003 | (Decrease) | (Decrease) | ||||||||||||||||||||||||
| Net sales | $ | 52,326 | $ | 39,559 | $ | 12,767 | 32.3 | % | $ | 148,732 | $ | 121,130 | $ | 27,602 | 22.8 | % | ||||||||||||||||
| Cost of sales | 9,508 | 7,110 | 2,398 | 33.7 | % | 27,485 | 21,434 | 6,051 | 28.2 | % | ||||||||||||||||||||||
| Gross profit | 42,818 | 32,449 | 10,369 | 32.0 | % | 121,247 | 99,696 | 21,551 | 21.6 | % | ||||||||||||||||||||||
| Operating expenses Marketing and selling | 18,349 | 15,245 | 3,104 | 20.4 | % | 52,092 | 47,026 | 5,066 | 10.8 | % | ||||||||||||||||||||||
| Research and development | 4,305 | 3,739 | 566 | 15.1 | % | 11,466 | 11,013 | 453 | 4.1 | % | ||||||||||||||||||||||
| In-process research & development | 35,000 | — | 35,000 | 35,000 | — | 35,000 | ||||||||||||||||||||||||||
| General and administrative | 5,120 | 4,110 | 1,010 | 24.6 | % | 15,206 | 12,025 | 3,181 | 26.5 | % | ||||||||||||||||||||||
| Amortization of intangibles | 1,850 | 1,150 | 700 | 60.9 | % | 3,969 | 3,254 | 715 | 22.0 | % | ||||||||||||||||||||||
| Total operating expenses | 64,624 | 24,244 | 40,380 | 166.6 | % | 117,733 | 73,318 | 44,415 | 60.6 | % | ||||||||||||||||||||||
| Operating income | (21,806 | ) | 8,205 | (30,011 | ) | -365.8 | % | 3,514 | 26,378 | (22,864 | ) | -86.7 | % | |||||||||||||||||||
| Royalty income | 627 | 711 | (84 | ) | -11.8 | % | 1,548 | 2,175 | (627 | ) | -28.8 | % | ||||||||||||||||||||
| Interest income | 231 | 107 | 124 | 115.9 | % | 541 | 349 | 192 | 55.0 | % | ||||||||||||||||||||||
| Interest expense | (357 | ) | (235 | ) | (122 | ) | -51.9 | % | (806 | ) | (1,659 | ) | 853 | 51.4 | % | |||||||||||||||||
| Other income (expense) | 3 | 113 | (110 | ) | -97.3 | % | (184 | ) | 434 | (618 | ) | -142.4 | % | |||||||||||||||||||
| Income before income taxes | (21,302 | ) | 8,901 | (30,203 | ) | -339.3 | % | 4,613 | 27,677 | (23,064 | ) | -83.3 | % | |||||||||||||||||||
| Provision for income taxes | 5,000 | 1,961 | 3,039 | 155.0 | % | 14,459 | 8,946 | 5,513 | 61.6 | % | ||||||||||||||||||||||
| Net income | $ | (26,302 | ) | $ | 6,940 | $ | (33,242 | ) | -479.0 | % | $ | (9,846 | ) | $ | 18,731 | $ | (28,577 | ) | -152.6 | % | ||||||||||||
| Percent of Sales | Percent of Sales | |||||||||||||||
| (in thousands) | For the Three Months Ended | For the Nine Months Ended | ||||||||||||||
| October 2, 2004 | September 27, 2003 | October 2, 2004 | September 27, 2003 | |||||||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
| Cost of sales | 18.2 | % | 18.0 | % | 18.5 | % | 17.7 | % | ||||||||
| Gross profit | 81.8 | % | 82.0 | % | 81.5 | % | 82.3 | % | ||||||||
| Operating expenses | ||||||||||||||||
| Marketing and selling | 35.1 | % | 38.5 | % | 35.0 | % | 38.8 | % | ||||||||
| Research and development | 8.2 | % | 9.5 | % | 7.7 | % | 9.1 | % | ||||||||
| In-process research & development | 66.9 | % | 0.0 | % | 23.5 | % | 0.0 | % | ||||||||
| General and administrative | 9.8 | % | 10.4 | % | 10.2 | % | 9.9 | % | ||||||||
| Amortization of intangibles | 3.5 | % | 2.9 | % | 2.7 | % | 2.7 | % | ||||||||
| Total operating expenses | 123.5 | % | 61.3 | % | 79.2 | % | 60.5 | % | ||||||||
| Operating income | -41.7 | % | 20.7 | % | 2.4 | % | 21.8 | % | ||||||||
| Royalty income | 1.2 | % | 1.8 | % | 1.0 | % | 1.8 | % | ||||||||
| Interest income | 0.4 | % | 0.3 | % | 0.4 | % | 0.3 | % | ||||||||
| Interest expense | -0.7 | % | -0.6 | % | -0.5 | % | -1.4 | % | ||||||||
| Other income (expense) | 0.0 | % | 0.3 | % | -0.1 | % | 0.4 | % | ||||||||
| Income before income taxes | -40.7 | % | 22.5 | % | 3.1 | % | 22.8 | % | ||||||||
| Provision for income taxes | 9.6 | % | 5.0 | % | 9.7 | % | 7.4 | % | ||||||||
| Net income | -50.3 | % | 17.5 | % | -6.6 | % | 15.5 | % | ||||||||
American Medical Systems Holdings, Inc. | ||||||||||||||||
Cost of sales.Cost of sales as a percentage of sales increased .2 percentage points and .8 percentage points during the three and nine month periods of fiscal 2004, respectively. Over half of the increase in nine month period of 2004 was due to a greater portion of our revenues coming from women’s health products and sales in international markets, both of which carry a lower margin than our consolidated average. Inventory reserves for lesser-used product sizes have also increased slightly over the nine month period of 2004 as we prepare to phase out older products in favor of new product releases. These unfavorable increases were partially offset by the favorable foreign exchange impact on our gross profit. Future cost of goods sold will continue to depend on product phase-ins, production levels and product mix.
Marketing and selling.Marketing and selling expense increased in the three and nine month periods of fiscal 2004, but declined by 3.4 and 3.8 percentage points relative to sales, respectively. The dollar increase reflects higher sales volume, as well as additional personnel and marketing expenditures associated with our acquisition of TherMatrx in July 2004. The decline as a percent of sales resulted from our ability to continue to leverage the investments made as we broaden the line of products sold through our sales channel. Accordingly, our objective remains to increase sales and marketing expenses in absolute dollars, but to decrease as a percentage of sales.
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Research and development.Research and development expense was 8.2 percent and 7.7 percent of sales during the three and nine month periods of fiscal 2004, respectively. Over half of the three and nine month dollar increase relates to additional personnel and expenditures associated with our acquisition of TherMatrx. We expect total spending in research and development, over the longer term, to be in the range of 8 to 10 percent of sales.
In-process research and development.The in-process research and development expense in the three and nine month periods of 2004 relates to the acquisition of TherMatrx in July 2004. In accordance with the rules of purchase accounting, in the three month period of 2004, we recognized a charge related to value assigned to in-process research and development of TherMatrx at the time of acquisition. An independent valuation of assets acquired was performed.
General and administrative.General and administrative expenses during the three and nine month periods of fiscal 2004 increased 24.6 percent and 26.5 percent, respectively, over the year ago periods. Over half of the increase in the three and nine month periods of fiscal 2004 was attributable to external Sarbanes-Oxley Act related spending, combined with legal costs related to intellectual property matters and bad debt expense. In addition, general and administrative expenses increased approximately $0.4 million in the three and nine month periods of 2004 due to expenditures associated with our acquisition of Thermatrx.
Amortization of intangibles.Amortization of intangibles includes amortization expense on our definite-lived intangible assets, consisting of patents, licenses and developed technology. The 2004 three and nine month increases reflect amortization of developed technology, customer relationships and other intangibles obtained with our acquisition of TherMatrx. We expect amortization of intangibles to be approximately $1.8 million in the fourth quarter of 2004.
Royalty income.Our royalty income is primarily from the license of our stent-delivery technology for medical use outside of urology. This exclusive worldwide license was entered into during 1998, with expiration immediately following the term of the various licensed patents. We receive a royalty equal to 2.625 percent of net sales of licensed products on a quarterly basis. We do not directly influence sales of the products on which this royalty is based and cannot give any assurance as to future income levels. To a lesser extent, royalty income includes fees from the sale of rights to a magnetic intraurethral valve pump device for the management of female incontinence.
Interest income.Interest income increased during the three and nine month periods of fiscal 2004 due to higher levels of investments resulting from greater cash generated from operations in fiscal 2004 than in fiscal 2003.
Interest expense.Interest expense increased during the third fiscal quarter of 2004 due to the repayment of the entire outstanding balance on our senior credit facility. As a result of this early repayment, the remaining balance of $0.3 million in loan origination fees that was being amortized over the life of the loan was charged to interest expense. Interest expense declined during the nine month period of fiscal 2004, primarily due to the expiration of our interest rate swap agreement as well as a decline in our long term debt balance. We hedged a portion of our original $65.0 million variable rate term note, as was required by our senior credit facility, by entering into an interest rate swap agreement in which we agreed to exchange, at specified intervals, the calculated difference between the fixed interest rate of the swap and the variable interest rate on a portion of our debt. This interest rate swap agreement expired June 30, 2003. Future interest expense will depend on the level of borrowing required to make contingent payments to the former TherMatrx shareholders. We do not expect any interest expense in the fourth fiscal quarter of 2004.
Other income.Other income and expense primarily represents gains and losses as a result of remeasuring foreign denominated (mainly euro-based) short-term inter-company receivables to current rates. The nine month period of fiscal 2004 reflects losses due to the weakening of the euro by 0.9 percent to the U.S. dollar from the beginning of the period, while the three and nine month periods of fiscal 2003 reflect gains due to the strengthening of the euro by 0.6 percent and 10.8 percent, respectively, to the U.S. dollar from the beginning of the period.
Income taxes.Our effective income tax rate for the three and nine month periods of fiscal 2004 differed from statutory income tax rates primarily because no tax benefit was recorded on the $35.0 million in-process research and development charge incurred in connection with the TherMatrx acquisition and in accordance with purchase accounting rules provided by EITF 96-7. The effective tax rates for the three and nine month periods of fiscal 2003 were 22.0 percent and 32.3 percent respectively. During the third quarter of fiscal
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2003, we applied for and began to recognize the tax benefits related to research and development tax credits and extraterritorial income exclusions. We recognized a non-recurring tax benefit of $1.1 million during the third fiscal quarter of 2003 resulting from these tax planning strategies.
Liquidity and Capital Resources
Cash and cash equivalents were $23.8 million as of October 2, 2004, compared to $59.0 million as of January 3, 2004. This decrease is due primarily to our acquisition of TherMatrx in July 2004, our repayment of our outstanding credit facility and investments in certain tax-advantaged municipal debt that is classified as available-for-sale securities. As of October 2, 2004, the value of these investments was $12.6 million. Cost approximates market value for the investments, which mature between January 2005 and June 2005. These uses of cash were partially offset by our continued strong growth in revenue and net income.
Cash flows from operating activities.Net cash from operations was $33.4 million for the nine month period of fiscal 2004, driven by a net loss of $9.8 million, increased for certain non-cash expenses including in-process research and development of $35.0 million and depreciation and amortization of $9.7 million. Working capital effects included an increase in accounts receivable of $1.1 million resulting primarily from higher revenues in our foreign subsidiaries, and a decrease of $4.2 million in accounts payable and accrued expenses. Net cash from operations was $22.4 million for the nine month period of fiscal 2003, resulting from net income of $18.7 million, depreciation and amortization of $7.9 million, offset by other changes in assets and liabilities.
Cash flows from investing activities.Cash used in investing activities was $57.0 million and $46.4 million for the nine month periods of fiscal 2004 and 2003, respectively. During the nine month periods of fiscal 2004 and 2003, we purchased equipment totaling $1.8 million and $3.2 million, respectively. During the nine month period of fiscal 2004, we purchased investments of $12.6 million. During the third fiscal quarter of 2004 we had a cash outlay of $40.1 million related to the acquisition of TherMatrx, and a $2.5 million cash outlay for a cross-licensing agreement covering patents related to the field of female pelvic health. During the first fiscal quarter of 2003, we had a cash outlay of $43.2 million related to the acquisition of CryoGen Inc and the purchase of theDura IIline of erectile restoration products from Endocare, Inc.
Cash flows from financing activities.Cash used in financing activities was $11.0 million and $2.9 million during the nine month periods of fiscal 2004 and 2003, respectively. Cash received under our stock option and employee stock purchase plans was $5.3 million and $2.1 million during the nine month periods of fiscal 2004 and 2003, respectively. Payments made under our senior credit facility were $16.4 million and $5.0 million during the nine month periods of fiscal 2004 and 2003, respectively.
On July 8, 2004, we repaid the entire outstanding balance of $12.9 million under our senior credit facility and terminated the credit facility. The original maturity of the term notes required quarterly principal payments through September 2005. We were in compliance with all required financial covenants during both of the nine month periods covered.
Cash Commitments.Pursuant to our acquisition of CryoGen, Inc. on January 2, 2003, we have agreed to pay CryoGen’s former shareholders an earnout payment contingent upon sales of CryoGen products. The earnout payment will be equal to three times our net sales of CryoGen products during four consecutive quarters, less our $40.0 million initial acquisition payment. The earnout period expires December 31, 2005. If our net CryoGen product sales do not exceed $13.3 million during any consecutive four-quarter period prior to December 31, 2005, no earnout payment will be required. The maximum amount of the earnout payment is $110.0 million. This transaction is more fully described in our Form 8-K filed with the SEC on January 6, 2003. We do not currently anticipate an earnout payment to the former CryoGen shareholders.
On July 15, 2004, the Company completed the acquisition of TherMatrx, Inc. As a result of the merger, the shareholders of TherMatrx were initially paid cash consideration of $40.5 million. The Company deposited $4.0 million of this initial consideration in escrow to be held for six months after closing of the merger to cover certain contingencies, and the balance was distributed to holders of TherMatrx stock. The Company used cash on hand to make the initial payment of $40.5 million.
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In addition to the initial closing payment, the Company will make contingent payments based on the net product revenues attributable to sales of the TherMatrx Dose Optimized Thermotherapy (DOT) product. These contingent payments will equal four times the aggregate sales of DOT products over a period of six consecutive Company fiscal quarters (which began on July 5, 2004 and will end on December 31, 2005) minus $40.0 million. The contractual range of contingent payments is from zero to $209.5 million which would result in a total purchase price of $40.5 million up to a maximum of $250.0 million (including the initial payment). These payments will be accounted for as goodwill.
Sales of the TherMatrx product were $5.1 million during the entire three month period ending October 2, 2004. We owned TherMatrx for 11 of the 13 weeks of this period, during which time TherMatrx revenues totaled $4.6 million and which are reflected in our results of operations. Accordingly, if product sales remained flat during the contingent payment period, the total amount of the contingent payments would be $82.4 million.
We believe that funds generated from operations, together with our balances in cash and cash equivalents, as well as short term investments and our plans to add a new credit facility will be sufficient to finance current operations, planned capital expenditures, and our commitment to TherMatrx shareholders.
Risk Factors
There are several factors that could cause our actual results to differ materially from our anticipated results. Some of these factors, and their impact on the success of our operations and our ability to achieve our goals, are discussed below.
Supplier Risks
Many of our products utilize raw materials or components that are either single or sole sourced. These sources of supply could encounter manufacturing difficulties or may unilaterally decide to stop supplying us because of product liability concerns or other factors. We currently rely on single source suppliers for the silicone and fabric used in our male prostheses and for the porcine dermis and mesh used in many of our female products. Furthermore, we use single sources for the TherMatrx consoles and disposables. A key component of theInhibiZone™ antibiotic technology is procured from a sole source. We mitigate these risks through appropriate inventory levels, defining alternative sources and comprehensive supplier management. The loss of any of these suppliers could have a materially adverse effect on our financial results in the near term, as we would be required to qualify alternate designs or sources.
Potential Product Recalls
In the event that any of our products were defective, we could voluntarily recall, or the U.S. Food and Drug Administration (the FDA) or an international regulatory body could require us to redesign or recall, any defective product. There is a possibility that we may recall products in the future and that future recalls could result in significant costs to us and in significant negative publicity which could harm our ability to market our products in the future.
Continued Physician Use and Endorsement of our Products
For us to sell our products, physicians must recommend and endorse them. We may not obtain the necessary recommendations or endorsements from physicians. Many of the products we acquired or are developing are based on new treatment methods. Acceptance of our products is dependent on educating the medical community as to the distinctive characteristics, perceived benefits, clinical efficacy, and cost-effectiveness of our products compared to competitive products, and on training physicians in the proper application of our products. We believe our products address major market opportunities, but if we are unsuccessful in marketing them, our sales and earnings could be below expectations.
Successful Introduction of New Products and Product Improvements
As part of our growth strategy, we intend to introduce a number of new products and product improvements. If we do not introduce these new products and product improvements on schedule, or they are not well-accepted by the market, our growth may be reduced.
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Continued Use of Non-Invasive Treatment Alternatives
We predominantly sell devices and kits for invasive or minimally invasive surgical procedures. If patients do not accept our products, our sales may decline. Patient acceptance of our products depends on a number of factors, including the failure of non-invasive therapies, the degree of invasiveness involved in the procedures using our products, the rate and severity of complications, and other adverse side effects from the procedures using our products. Patients are more likely to first consider non-invasive alternatives to treat their urological disorders. The introduction of new oral medications or other less-invasive therapies could cause our sales to decline.
Actions Related to Reimbursement for Procedures Using our Products
Our physician and hospital customers depend on third party government and non-government entities for reimbursement for services provided to patients. The level of such third party reimbursement may influence whether or not customers purchase our products.
Effective January 1, 2004, the Centers for Medicare and Medicaid Services (CMS) increased reimbursement for certain procedures utilizing inflatable penile prostheses and urinary sphincter devices. This increase partially reversed reductions in such reimbursement rates in 2001 and 2002. Our sales history of these devices does not evidence an obvious correlation with changes in CMS reimbursement rates.
In March of 2004 we were informed by the American Medical Association that the organization’s Current Procedural Terminology (CPT) Editorial Panel had approved a CPT code for ourHer Optioncryoablation system to treat excessive uterine bleeding. The receipt of this CPT code is the first step toward the availability of standard reimbursement forHer Option.A noticeable effect on sales ofHer Optionis not expected until such reimbursement is established (currently anticipated to be January 2005). We can offer no assurances that a new code forHer Optionprocedures will be in place by January 2005 or that the reimbursement will adequately cover the costs of performing the procedure.
Regulatory Approvals and Clinical Results
Regulatory authorities around the world dictate different levels of data and/or clinical study for various products in order to ensure their safety and efficacy. In the event the data submitted is deemed inadequate or the clinical study results do not support approval, a product may either not be commercializable or may require a redesign.
Intellectual Property Lawsuits
The medical device industry is litigious with respect to patents and other intellectual property rights. Companies in the medical device industry have used intellectual property litigation to gain a competitive advantage. In the future, we may become a party to lawsuits involving patents or other intellectual property. A legal proceeding, regardless of the outcome, would draw upon our financial resources and divert the time and efforts of our management. If we lose one of these proceedings, a court, or a similar foreign governing body, could require us to pay significant damages to third parties, require us to seek licenses from third parties and pay ongoing royalties, require us to redesign our products, or prevent us from manufacturing, using or selling our products. In addition to being costly, protracted litigation to defend or prosecute our intellectual property rights could result in our customers or potential customers deferring or limiting their purchase or use of the affected products until resolution of the litigation.
Product Liability Lawsuits
The manufacture and sale of medical devices exposes us to significant risk of product liability claims. In the past, we have had a number of product liability claims relating to our products. In the future, we may be subject to additional product liability claims, some of which may have a negative impact on our business. If a product liability claim or series of claims is brought against us for uninsured liabilities or for amounts in excess of our insurance coverage, our business could suffer. We are not currently involved in any material product liability litigation.
Costs of Physician Malpractice Insurance
Most of our products are used by physicians who are required to maintain certain levels of medical malpractice insurance to maintain their hospital privileges. As the cost of this insurance increases, certain physicians who have used our products to treat their patients may stop performing surgeries. Unless these patients who would have been treated by these physicians are referred to other physicians, sales of our products will decline.
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Acquisition Integration
We have acquired businesses in the past, and we may acquire other businesses in the future. Failure to successfully retain critical employees of an acquired company, failure to gain FDA approval for the products of an acquired company, or the inability establish and maintain appropriate communications, performance expectations, regulatory compliance procedures, accounting controls, and reporting procedures could have a material adverse affect on our business. We are currently integrating TherMatrx into our Minnetonka operations and recently obtained FDA approval to manufacture the TherMatrx product at our Minnetonka location.
International Sales
During the three and nine month periods of fiscal 2004, approximately 17.0 percent and 21.0 percent of our sales were to customers outside the United States. Some of these sales were to governmental entities and other organizations with extended payment terms. A number of factors, including political or economic instability in the countries where we do business, could affect payment terms and our ability to collect foreign receivables. We have little influence over these factors and changes could have a materially adverse impact on our business. In addition, foreign sales are influenced by fluctuations in currency exchange rates, mainly in the Euro. In recent periods, our sales have been positively impacted by increases in the value of the Euro relative to the U.S. Dollar. Decreases in the value of the Euro relative to the U.S. dollar would negatively impact our sales.
Manufacturing Facility
We are currently operating with one manufacturing shift and have adequate physical capacity to serve our business operations for the foreseeable future. We do not have a back up facility, and the loss of our Minnetonka facility would have a materially adverse effect on our sales, earnings, and financial condition.
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ADDITIONAL INFORMATION ON AMS
We are currently subject to the informational requirements of the Securities Exchange Act of 1934, as amended. As a result, we are required to file periodic reports and other information with the SEC, such as annual, quarterly, and current reports, and proxy and information statements. You are advised to read this Form 10-Q in conjunction with the other reports, proxy statements, and other documents we file from time to time with the SEC. If you would like more information regarding AMS, you may read and copy the reports, proxy and information statements and other documents we file with the SEC, at prescribed rates, at the SEC’s public reference room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information regarding the operation of the SEC’s public reference rooms by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available to the public free of charge at the SEC’s website. The address of this website ishttp://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 websitewww.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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rates
We do not believe that our interest rate risk is material given the low volatility of interest rates in recent years and the low level and relatively short-term nature of our short term investments. On July 8, 2004, we repaid the entire outstanding balance of $12.9 million under our senior credit facility and terminated the credit facility.
Currency
Our operations outside of the United States are maintained in their local currency. All assets and liabilities of our international subsidiaries are translated to U.S. dollars at period-end exchange rates. Translation adjustments arising from the use of differing exchange rates are included in accumulated other comprehensive income in stockholders’ equity. Gains and losses on foreign currency transactions and short-term inter-company receivables from foreign subsidiaries are included in other income (expense).
During the three and nine month periods of fiscal 2004, revenues from sales to customers outside the United States were 17.0 percent and 21.0 percent of total consolidated revenues, respectively, and international accounts receivable, inventory, cash, and accounts payable were 36.6 percent, 4.9 percent, 21.0 percent, and 19.3 percent of total consolidated accounts for each of these items as of October 2, 2004. The reported results of our foreign operations will be influenced by their translation into U.S. dollars by currency movements against the U.S. dollar. The result of a uniform 10 percent strengthening in the value of the U.S. dollar in fiscal 2004 levels relative to each of the currencies in which our revenues and expenses are denominated would have resulted in a decrease in net income of approximately $0.6 million and $1.6 million during the three and nine month periods of fiscal 2004, respectively.
At October 2, 2004, our net investment in foreign subsidiaries translated into dollars using the period end exchange rate was $18.9 million and the potential loss in fair value resulting from a hypothetical 10 percent strengthening in the value of the U.S. dollar currency exchange rate amounts to $0.7 million. Actual amounts may differ.
Inflation
We do not believe that inflation has had a material effect on our results of operations in recent years and periods. There can be no assurance, however, that our business will not be adversely affected by inflation in the future.
ITEM 4. CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries, which we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934, was made known to them by others within those entities and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There were no changes in our internal control over financial reporting identified in connection with the evaluation of such internal control over financial reporting that occurred during our last fiscal quarter which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
In accordance with the Sarbanes-Oxley Act of 2002, we are performing an evaluation of our internal controls in order to attest to compliance with Section 404 of the Act by fiscal year end.
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PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
We are filing as Exhibit 99.1 to this Form 10-Q revised pro forma financial information for TherMatrx, Inc. which we previously filed as Exhibit 99.3 to the Form 8-K/A filed on October 8, 2004 solely to amend the Current Report on Form 8-K dated July 15, 2004, that was initially filed with the Securities and Exchange Commission (the “SEC”) on July 29, 2004, and was amended by a Current Report on Form 8-K/A that was filed with the SEC on September 28, 2004. The pro forma adjustment to retained earnings (accumulated deficit) in the pro forma balance sheet and note number 1 to the pro forma financial statements included as part of Exhibit 99.1 to this Form 10-Q have been corrected to reflect that the non-recurring charge of $35.0 million for in-process research and development expenses related to the acquisition of TherMatrx, Inc. has no related income tax benefit in accordance with the rules of purchase accounting. The revised pro forma financial information filed as Exhibit 99.1 to this Form 10-Q does not contain any other changes or reflect any events occurring after the filing date of the original Form 8-K nor otherwise modify or update any of the information contained therein or the Forms 8-K/A filed on September 28, 2004 or October 8, 2004. We have concurrently filed the revised pro forma financial information on a Current Report on Form 8-K/A, as Exhibit 99.1 thereto.
ITEM 6. EXHIBITS
| Item No. | Item | Method of Filing | ||
| 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. | ||
| 99.1 | Unaudited pro forma financial information of TherMatrx, Inc. | Filed with this Report. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| AMERICAN MEDICAL SYSTEMS HOLDINGS, INC | ||||
| November 12, 2004 | By /s/ Douglas W. Kohrs | |||
| Date | Douglas W. Kohrs | |||
| Chairman and Chief Executive Officer | ||||
| November 12, 2004 | By /s/ Carmen L. Diersen | |||
| Date | Carmen L. Diersen | |||
| Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) | ||||
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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
EXHIBIT INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED OCTOBER 2, 2004
| Item No. | Item | Method of Filing | ||
| 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. | ||
| 99.1 | Unaudited pro forma financial information of TherMatrx, Inc. | Filed with this Report. |
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