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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended April 2, 2005
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.
| 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
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.
þ Yes o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
þ Yes o No
As of May 6, 2005, there were 69,063,974 shares of the registrant’s $.01 par value Common Stock outstanding.
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INDEX
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| Certification of CEO Pursuant to Section 302 | ||||||||
| Certification of CFO Pursuant to Section 302 | ||||||||
| Certification Pursuant to 18 U.S.C. Section 1350 | ||||||||
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
American Medical Systems Holdings, Inc.
| April 2, 2005 | January 1, 2005 | |||||||
| (Unaudited) | ||||||||
Assets | ||||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | 58,133 | $ | 35,689 | ||||
| Short term investments | 12,351 | 15,479 | ||||||
| Accounts receivable, net | 46,566 | 46,984 | ||||||
| Inventories, net | 21,088 | 21,719 | ||||||
| Deferred income taxes | 5,092 | 4,855 | ||||||
| Other current assets | 2,840 | 3,101 | ||||||
| Total current assets | 146,070 | 127,827 | ||||||
| Property, plant and equipment, net | 21,921 | 22,065 | ||||||
| Goodwill, net | 103,183 | 102,365 | ||||||
| Intangibles, net | 43,752 | 44,792 | ||||||
| Deferred income taxes | 1,774 | 2,911 | ||||||
| Investment in technology and other assets | 770 | 590 | ||||||
| Total assets | $ | 317,470 | $ | 300,550 | ||||
Liabilities and Stockholders’ Equity | ||||||||
| Current liabilities | ||||||||
| Accounts payable | $ | 5,236 | $ | 4,237 | ||||
| Accrued compensation expenses | 10,818 | 10,783 | ||||||
| Accrued warranty expense | 1,467 | 1,451 | ||||||
| Income taxes payable | 3,175 | 2,982 | ||||||
| Other accrued expenses | 27,992 | 8,835 | ||||||
| Contingent liability on acquisition | — | 19,964 | ||||||
| Total current liabilities | 48,688 | 48,252 | ||||||
| Accumulated post retirement benefit obligation | 3,126 | 3,126 | ||||||
| Total liabilities | 51,814 | 51,378 | ||||||
| Stockholders’ equity | ||||||||
| Common stock, par value $.01 per share; authorized 220,000,000 shares; issued and outstanding: | ||||||||
| 68,552,226 shares at April 2, 2005 and 67,478,544 shares at January 1, 2005 | 686 | 675 | ||||||
| Additional paid-in capital | 216,338 | 210,163 | ||||||
| Accumulated other comprehensive income | 4,177 | 5,123 | ||||||
| Retained earnings | 44,455 | 33,211 | ||||||
| Total stockholders’ equity | 265,656 | 249,172 | ||||||
| Total liabilities and stockholders’ equity | $ | 317,470 | $ | 300,550 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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American Medical Systems Holdings, Inc.
(Unaudited)
| Three Months Ended | ||||||||
| April 2, 2005 | April 3, 2004 | |||||||
Net sales | $ | 62,145 | $ | 47,313 | ||||
Cost of sales | 11,020 | 8,930 | ||||||
Gross profit | 51,125 | 38,383 | ||||||
Operating expenses | ||||||||
| Marketing and selling | 21,656 | 16,493 | ||||||
| Research and development | 4,638 | 3,584 | ||||||
| General and administrative | 5,789 | 4,876 | ||||||
| Amortization of intangibles | 1,790 | 1,061 | ||||||
| Total operating expenses | 33,873 | 26,014 | ||||||
Operating income | 17,252 | 12,369 | ||||||
Other income (expense) | ||||||||
| Royalty income | 478 | 491 | ||||||
| Interest income | 274 | 138 | ||||||
| Interest expense | (55 | ) | (201 | ) | ||||
| Other expense | (463 | ) | (156 | ) | ||||
| Total other income | 234 | 272 | ||||||
Income before income taxes | 17,486 | 12,641 | ||||||
Provision for income taxes | 6,243 | 4,614 | ||||||
Net income | $ | 11,243 | $ | 8,027 | ||||
Net income per share | ||||||||
| Basic | $ | 0.17 | $ | 0.12 | ||||
| Diluted | $ | 0.16 | $ | 0.12 | ||||
Weighted average common shares used in calculation | ||||||||
| Basic | 67,898 | 66,484 | ||||||
| Diluted | 71,250 | 69,998 | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
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American Medical Systems Holdings, Inc.
(Unaudited)
| Three Months Ended | ||||||||
| April 2, 2005 | April 3, 2004 | |||||||
Cash flows from operating activities | ||||||||
| Net income | $ | 11,243 | $ | 8,027 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
| Depreciation | 1,515 | 1,678 | ||||||
| Loss on asset disposals | 25 | 10 | ||||||
| Amortization of intangibles, including deferred financing costs | 1,790 | 1,105 | ||||||
| Non-cash deferred compensation | 9 | 8 | ||||||
| Income tax benefit related to stock options | 2,355 | 763 | ||||||
| Change in net deferred taxes | 1,089 | (290 | ) | |||||
| Changes in operating assets and liabilities | ||||||||
| Accounts receivable | (805 | ) | (1,812 | ) | ||||
| Inventories | 510 | 540 | ||||||
| Accounts payable and accrued expenses | 1,373 | 3,361 | ||||||
| Other assets | (547 | ) | 172 | |||||
| Net cash provided by operating activities | 18,557 | 13,562 | ||||||
Cash flows from investing activities | ||||||||
| Purchase of property, plant and equipment | (1,421 | ) | (165 | ) | ||||
| Purchase of business | (1,450 | ) | — | |||||
| Purchase of license agreement | (750 | ) | — | |||||
| Purchase of short term investments | (2,600 | ) | — | |||||
| Sale of short term investments | 5,728 | — | ||||||
| Net cash used in investing activities | (493 | ) | (165 | ) | ||||
Cash flows from financing activities | ||||||||
| Issuance of common stock | 3,822 | 1,674 | ||||||
| Payments on long-term debt | — | (1,637 | ) | |||||
| Net cash provided by financing activities | 3,822 | 37 | ||||||
Effect of currency exchange rates on cash | 558 | (17 | ) | |||||
Net increase in cash and cash equivalents | 22,444 | 13,417 | ||||||
Cash and cash equivalents at beginning of period | 35,689 | 58,953 | ||||||
Cash and cash equivalents at end of period | $ | 58,133 | $ | 72,370 | ||||
Supplemental disclosure | ||||||||
| Cash paid for interest | $ | 0 | $ | 132 | ||||
| Cash paid for taxes | $ | 2,415 | $ | 116 | ||||
The accompanying notes are an integral part of the consolidated financial statements. | ||||||||
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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
NOTE 1. Basis of Presentation
The consolidated financial statements included in this Form 10-Q have been prepared by American Medical Systems Holdings, Inc., without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). 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 2004. 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.
American Medical Systems has a 52 or 53 week fiscal year ending on the Saturday nearest December 31. Accordingly, the first fiscal quarters of 2005 and 2004 are represented by the three month periods ended on April 2, 2005 and April 3, 2004, respectively.
On January 10, 2005, we announced a two-for-one stock split in the form of a 100 percent stock dividend. On March 4, 2005, our stockholders approved an increase in the number of authorized shares of voting common stock from 75 million to 200 million (in addition to 20 million previously authorized shares of non-voting common stock), which was necessary to complete the stock split. The stock dividend was distributed on March 21, 2005 to stockholders of record on March 14, 2005. Our financial statements, related notes, and other financial data contained in this report have been adjusted to give retroactive effect to the stock split for all periods presented.
NOTE 2. Stock-Based Compensation
American Medical Systems has one stock-based employee compensation plan. We account for this plan under the recognition and measurement principles of APB Opinion 25,Accounting for Stock Issued to Employees, and related interpretations. The exercise price of our employee stock options 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.
The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS 123,Accounting for Stock-Based Compensation, to stock-based employee compensation.
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| Three Months Ended | ||||||||
| (in thousands, except per share data) | April 2, 2005 | April 3, 2004 | ||||||
| Net income, as reported | $ | 11,243 | $ | 8,027 | ||||
| Stock-based employee compensation expense included in reported income, net of tax | — | 15 | ||||||
| Total stock-based employee compensation expense determined under fair-value based method for all awards, net of tax | (1,479 | ) | (816 | ) | ||||
| Pro forma net income | $ | 9,764 | $ | 7,226 | ||||
| Net income per share | ||||||||
| As reported | ||||||||
| Basic | $ | 0.17 | $ | 0.12 | ||||
| Diluted | $ | 0.16 | $ | 0.12 | ||||
| Pro forma | ||||||||
| Basic | $ | 0.14 | $ | 0.11 | ||||
| Diluted | $ | 0.14 | $ | 0.10 | ||||
During the first fiscal quarter of 2005, stock options were exercised to acquire 1,052,306 shares and 21,376 shares were purchased under the employee stock purchase plan.
NOTE 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 first fiscal quarters of 2005 and 2004.
| Three Months Ended | ||||||||
| (in thousands, except per share data) | April 2, 2005 | April 3, 2004 | ||||||
| Net income | $ | 11,243 | $ | 8,027 | ||||
| Weighted-average shares outstanding for basic net income per share | 67,898 | 66,484 | ||||||
| Dilutive effect of stock options | 3,352 | 3,514 | ||||||
| Adjusted weighted-average shares outstanding and assumed conversions for diluted net income per share | 71,250 | 69,998 | ||||||
| Net income per share | ||||||||
| Basic | $ | 0.17 | $ | 0.12 | ||||
| Diluted | $ | 0.16 | $ | 0.12 | ||||
During the first fiscal quarter of 2005 and 2004, there were 506,316 and 1,150,000, respectively, of outstanding stock options excluded from the diluted earnings per share computation because the impact would have been anti-dilutive.
NOTE 4. Inventories
Inventories consist of the following:
| (in thousands) | April 2, 2005 | January 1, 2005 | ||||||
| Raw materials | $ | 5,255 | $ | 5,191 | ||||
| Work in process | 3,218 | 2,405 | ||||||
| Finished goods | 14,359 | 15,866 | ||||||
| Obsolescence | (1,744 | ) | (1,743 | ) | ||||
| Net inventories | $ | 21,088 | $ | 21,719 | ||||
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NOTE 5. Warranties
Many of our products are sold with warranty coverage for periods ranging from one year up to the patient’s lifetime. The warranty allowance is our estimate of the expected future cost of honoring current warranty obligations. Factors influencing this estimate include historical claim rates, surgical infection rates, changes in product performance, the frequency of use by the patient, the patient’s performance expectations, and changes in the terms of our policies. Changes in the warranty balance during the first fiscal quarters of 2005 and 2004 are listed below:
| Three Months Ended | ||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | ||||||
| Balance, beginning of period | $ | 1,451 | $ | 1,338 | ||||
| Provisions for warranty | 77 | 83 | ||||||
| Claims processed | (61 | ) | (83 | ) | ||||
| Balance, end of period | $ | 1,467 | $ | 1,338 | ||||
NOTE 6. Acquisition
On July 15, 2004, we acquired TherMatrx, Inc. and the shareholders of TherMatrx were paid cash consideration of $40.0 million. We also paid $1.4 million of acquisition related costs through April 2, 2005.
In addition to the initial closing payment, we will make contingent payments based on the net product revenues attributable to sales of the TherMatrx Dose Optimized Thermotherapy (DOT) product. These contingent payments will equal four times the aggregate sales of DOT products over a period of six consecutive fiscal quarters (which began on July 5, 2004 and will end on December 31, 2005) minus $40.0 million. The contractual range of contingent payments is from zero to $210.0 million which would result in a total purchase price of $40.0 million up to a maximum of $250.0 million (including the initial payment). These contingent payments will be accounted for as goodwill.
Since the time of acquisition, earnout payments of $22.9 million have been accrued, of which $1.5 million was paid during the three month period ended April 2, 2005.
The primary purpose of the TherMatrx acquisition was to gain access to their product for the treatment of benign prostatic hyperplasia (BPH). 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 purchase price, including earnout payments accrued, is currently allocated 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 | 5,536 | |||
| Deferred tax liability on assets acquired | (8,677 | ) | ||
| Goodwill | 1,485 | |||
| Purchase price, including earned contingent payments | $ | 64,344 | ||
The determination of the portion of the purchase price allocated to developed technology, customer relationships and other intangible assets and in-process research and development was based on an independent valuation study to determine the respective fair values. The developed technology, customer relationships and other intangible assets are being amortized over their estimated useful lives of 10 years, with this expense reflected as part of the amortization of intangibles line on the Consolidated Statement of Operations. In accordance with purchase accounting rules, the acquired in-process research and development of $35.0 million was expensed in our third fiscal quarter of 2004 with no related income tax benefit. Tangible assets acquired, net of liabilities assumed, were stated at fair value at the date of acquisition based on management’s assessment. We recorded a contingent liability at the time of acquisition because the net assets acquired were in excess of the initial purchase price.
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The contingent liability on acquisition was reduced from $20.9 million at initial acquisition to zero at April 2, 2005, to reflect the contingent payments to be made based on the net product revenues attributable to sales of DOT product during the period July 5, 2004 through April 2, 2005. The first contingent payment of $1.5 million was made in February 2005. The second contingent payment of approximately $21.4 million is to be made in May 2005 and is included in other accrued expenses at April 2, 2005.
Our consolidated financial statements for the three months ended April 2, 2005 include the financial results of TherMatrx. The following table contains pro forma results for the quarter ended April 3, 2004, as if the acquisition had occurred at the beginning of 2004:
| Three Months Ended | ||||
| (in thousands, except per share data) | April 3, 2004 | |||
| Revenue | $ | 52,231 | ||
| Net income | $ | 8,495 | ||
| Earnings per share | ||||
| Basic | $ | 0.13 | ||
| Diluted | $ | 0.12 | ||
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.
NOTE 7.Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151,Inventory Costs, an amendment of Accounting Research Bulletin No. 43,Inventory Pricing.SFAS No. 151 requires all companies to recognize a current-period charge for abnormal amounts of idle facility expense, freight, handling costs and wasted materials. The statement also requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. This new standard is effective for fiscal years beginning after June 15, 2005 with early adoption permitted. We adopted SFAS 151 in the first quarter of 2005 and it did not have a material impact on our consolidated financial statements.
In December 2004, the FASB issued SFAS 123 (revised 2004),Share-based Payment. SFAS 123(R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments (e.g. stock options and restricted stock) granted to employees. This applies to all transactions involving the issuance of our own equity in exchange for goods or services, including employee services. Upon adoption of SFAS 123(R), all stock option awards to employees will be recognized as expense in the income statement, typically over any related vesting period. SFAS123(R) carried forward the guidance from SFAS 123 for payment transactions with non-employees. The Securities and Exchange Commission amended the compliance date on April 14, 2005, to require public companies to adopt the standard as of the beginning of the first annual period that begins after June 15, 2005. We will, therefore, be required to adopt SFAS 123(R) in the first quarter of 2006. We believe the impact of adopting SFAS 123(R) will be similar to the pro forma disclosure impact presented previously in this footnote. SeeNotes to Consolidated Financial Statements – No 2.
SFAS 123(R) permits public companies to adopt its requirements using one of two methods:
| 1. | Modified Prospective Method under which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. | |||
| 2. | Modified Retrospective Method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. | |||
At this time, we have not determined which method of adoption we will use.
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NOTE 8. Comprehensive Income
Comprehensive income is net income adjusted for changes in the value of derivative financial instruments, unrealized gains and losses on marketable securities, and foreign currency translation.
Comprehensive income for the first fiscal quarters of 2005 and 2004 was:
| Three Months Ended | ||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | ||||||
| Net income | $ | 11,243 | $ | 8,027 | ||||
| Foreign currency translation (loss), net of taxes | (946 | ) | (421 | ) | ||||
| �� | ||||||||
| Comprehensive income | $ | 10,297 | $ | 7,606 | ||||
NOTE 9. Industry Segment Information and Foreign Operations
Since its inception, we have operated in the single industry segment of developing, manufacturing, and marketing medical devices.
We distribute products through our direct sales force and independent sales representatives in the United States, Canada, Australia, Brazil and Western Europe. Additionally, we distribute products through foreign independent distributors, primarily in Europe, Asia and South America, who then sell the products to medical institutions. No customer or distributor accounted for five percent or more of net sales during the first fiscal quarters of 2005 or 2004. Foreign subsidiary sales are predominantly to customers in Western Europe, Australia, Canada and Brazil. Substantially all of our foreign subsidiary assets are located in Western Europe, Canada, Australia and Brazil.
The following table presents net sales and long-lived assets (excluding deferred taxes) by geographical territory. No individual foreign country’s net sales or long-lived assets are material.
| Three Months Ended and Period Ending | ||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | ||||||
| United States | ||||||||
| Net sales | $ | 48,333 | $ | 36,598 | ||||
| Long-lived assets | $ | 154,187 | $ | 132,034 | ||||
| Outside United States | ||||||||
| Net sales | $ | 13,812 | $ | 10,715 | ||||
| Long-lived assets | $ | 15,439 | $ | 12,247 | ||||
NOTE 10. Goodwill and Intangible Assets
The changes in the carrying amount of goodwill for the first fiscal quarter are as follows:
| Three Months Ended | ||||
| April 2, 2005 | ||||
| Goodwill, beginning of the year, net | $ | 102,365 | ||
| Additions | 1,485 | |||
| Effect of currency translation | (667 | ) | ||
| Goodwill, end of first quarter, net | $ | 103,183 | ||
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The following table provides additional information concerning intangible assets:
| April 2, 2005 | January 1 ,2005 | |||||||||||||||||||||||
| Gross carrying | Accumulated | Net book | Gross carrying | Accumulated | Net book | |||||||||||||||||||
| (in thousands) | amount | amortization | value | amount | amortization | value | ||||||||||||||||||
| Amortized | ||||||||||||||||||||||||
| Patents | $ | 10,127 | ($ | 6,862 | ) | $ | 3,265 | $ | 10,127 | ($ | 6,581 | ) | $ | 3,546 | ||||||||||
| Licenses | 6,041 | (1,959 | ) | 4,082 | 5,291 | (1,529 | ) | 3,762 | ||||||||||||||||
| Deferred financing | 1,611 | (1,611 | ) | — | 1,611 | (1,611 | ) | — | ||||||||||||||||
| Developed technology | 48,853 | (14,219 | ) | 34,634 | 48,853 | (13,140 | ) | 35,713 | ||||||||||||||||
| Non-compete agreements | 1,111 | (1,111 | ) | — | 1,111 | (1,111 | ) | — | ||||||||||||||||
| Total amortized intangible assets | 67,743 | (25,762 | ) | 41,981 | 66,993 | (23,972 | ) | 43,021 | ||||||||||||||||
| Unamortized | ||||||||||||||||||||||||
| Trademarks | 2,233 | (462 | ) | 1,771 | 2,233 | (462 | ) | 1,771 | ||||||||||||||||
| Total intangible assets | $ | 69,976 | ($ | 26,224 | ) | $ | 43,752 | $ | 69,226 | ($ | 24,434 | ) | $ | 44,792 | ||||||||||
| Three Months Ended | ||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | ||||||
| Amortization expense | $ | 1,790 | $ | 1,061 | ||||
The estimated amortization expense for currently-owned intangibles for the years 2005 through 2009 is $7.4 million, $5.9 million, $4.7 million, $4.7 million and $4.6 million, respectively.
NOTE 11. Credit Agreement
On January 20, 2005, we entered into a credit agreement. The credit agreement provides for a $150.0 million senior unsecured five year revolving credit facility, with a $20.0 million sub-limit for the issuance of standby and commercial letters of credit, and a $10.0 million sub-limit for swing line loans. At our option, any loan under the credit agreement (other than swing line loans) bears interest at a variable rate based on LIBOR or an alternative variable rate based on either prime rate or the federal funds effective rate, in each case plus a basis point spread determined by reference to our leverage ratio. The credit agreement also contains a commitment fee which bears a rate determined by reference to our leverage ratio. At our election, the aggregate maximum principal amount available under the credit agreement may be increased by an amount up to $60.0 million. Funds are available for working capital and other lawful purposes, including permitted acquisitions.
The credit agreement contains standard affirmative and negative covenants, including two financial covenants that require we maintain a leverage ratio of not greater than 2.75 to 1.00 and an interest coverage ratio of not less than 3.00 to 1.00. The covenants also restrict: (a) the making of investments, the payment of dividends and other payments with respect to capital, the disposition of material assets other than in the ordinary course of business and mergers and acquisitions if such actions would cause our leverage ratio to be greater than 2.50 to 1.00, (b) transactions with affiliates unless such transactions are completed in the ordinary course of business and upon fair and reasonable terms, (c) the incurrence of liens and (d) substantial changes in the nature of our business. The credit agreement also contains customary events of default, including payment defaults, material inaccuracy of representations and warranties, covenant defaults, bankruptcy and involuntary proceedings, monetary judgment defaults in excess of specified amounts, cross-defaults to certain other agreements, change of control, and ERISA defaults.
As of April 2, 2005, there were no outstanding loans under this facility and we were in compliance with our loan covenants. Our current ratios in relation to the covenants are listed below:
| Credit facility | ||||||||
| Covenant | requirements | Actual | ||||||
| Leverage ratio | < 2.75 to 1.00 | 0.27 to 1.00 | ||||||
| Interest coverage ratio | > 3.00 to 1.00 | 97.20 to 1.00 | ||||||
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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. Any statements not of historical fact may be considered forward-looking statements. Written words such as “may,” “expect,” “believe,” “anticipate,” or “estimate,” or other variations of these or similar words, identify such forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially from those expressed in such forward-looking statements. Important factors known to us that could cause such material differences are identified in “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 and delivers innovative medical solutions to our target patients and physicians. Since becoming an independent company in 1998, we have worked to build a business that delivers consistent revenue and earnings growth, fueled by a robust pipeline of innovative products for significant, under-penetrated markets of patients and their physicians. We have greatly broadened our product line, building on our traditional base of products for erectile restoration and products for men’s incontinence, to include products and therapies targeted at urethral stricture and benign prostatic hyperplasia in men as well as incontinence, pelvic organ prolapse and menorrhagia in women. Our primary physician customers include urologists, gynecologists, and urogynecologists.
On January 10, 2005, we announced a two-for-one stock split in the form of a 100 percent stock dividend. On March 4, 2005, our stockholders approved an increase in the number of authorized shares of voting common stock from 75 million to 200 million (in addition to 20 million previously authorized shares of non-voting common stock), which was necessary to complete the stock split. The stock dividend was distributed on March 21, 2005 to stockholders of record on March 14, 2005. Our financial statements, related notes, and other financial data contained in this report have been adjusted to give retroactive effect to the stock split for all periods presented.
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Results of Operations
Sales Trends
Our worldwide sales were $62.1 million for the first fiscal quarter of 2005, a 31.3 percent increase over sales of $47.3 million in the comparable quarter of 2004. Of this total growth, 1.5 percentage points were the result of currency exchange rate changes and 12.1 percentage points were due to the TherMatrx product line acquired in the third quarter of 2004.
The following table compares net sales by product line and geography for the first fiscal quarters of 2005 and 2004:
| Three Months Ended | ||||||||||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | $ Increase | % Increase | ||||||||||||
Sales | ||||||||||||||||
| Product Line | ||||||||||||||||
| Men’s pelvic health | ||||||||||||||||
| Erectile restoration | $ | 20,694 | $ | 17,465 | $ | 3,229 | 18.5 | % | ||||||||
| Continence | 13,248 | 12,166 | 1,082 | 8.9 | % | |||||||||||
| Prostate treatment | 6,647 | 1,166 | 5,481 | 470.1 | % | |||||||||||
| Total men’s pelvic health | 40,589 | 30,797 | 9,792 | 31.8 | % | |||||||||||
| Women’s pelvic health | 21,556 | 16,516 | 5,040 | 30.5 | % | |||||||||||
| Total | $ | 62,145 | $ | 47,313 | $ | 14,832 | 31.3 | % | ||||||||
| Geography | ||||||||||||||||
| United States | $ | 48,333 | $ | 36,598 | $ | 11,735 | 32.1 | % | ||||||||
| Outside United States | 13,812 | 10,715 | 3,097 | 28.9 | % | |||||||||||
| Total | $ | 62,145 | $ | 47,313 | $ | 14,832 | 31.3 | % | ||||||||
| Three Months Ended | ||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | ||||||
Percent of total sales | ||||||||
| Product Line | ||||||||
| Men’s pelvic health | ||||||||
| Erectile restoration | 33 | % | 37 | % | ||||
| Continence | 21 | % | 26 | % | ||||
| Prostate treatment | 11 | % | 2 | % | ||||
| Total men’s pelvic health | 65 | % | 65 | % | ||||
| Women’s pelvic health | 35 | % | 35 | % | ||||
| Total | 100 | % | 100 | % | ||||
| Geography | ||||||||
| United States | 78 | % | 77 | % | ||||
| Outside United States | 22 | % | 23 | % | ||||
| Total | 100 | % | 100 | % | ||||
Net Sales
Men’s pelvic health products.Revenue from men’s health products grew 31.8 percent in the first fiscal quarter of 2005 over the comparable period of 2004. This was driven primarily by two events from the third quarter of 2004, namely (a) the introduction of theTactile Pumpwithin theAMS 700 series of penile prostheses and (b) the acquisition of TherMatrx, Inc.
Erectile restoration revenue increased 18.5 percent in the quarter with a 7.4 percent increase in units sold across our portfolio of offerings. The average selling price of the overall erectile restoration portfolio increased significantly due to a continued conversion to the higher pricedTactile Pumpproduct with its enhanced patient interface andInhibiZoneantibiotic treatment. Due to market dynamics and strong revenue performance in the last two quarters of fiscal 2004, we expect erectile restoration growth to slow during the year to less than 10 percent.
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Male continence sales increased 8.9 percent in the quarter with less than 1 percent growth in units sold. Unit sales increases outside the U.S. offset decreases within the U.S. in both theAMS 800 Artificial Urinary Sphincterand theInVancemale sling system product lines. Price increases made to theAMS 800line in the second quarter of 2004 and continued implant configuration changes are the primary drivers of the global sales increases in this business. With continued focus on improving market awareness and physician training on our male continence products, we anticipate sales growth of approximately 12 percent for 2005.
Prostate treatment sales increased $5.5 million from the prior year’s quarter due primarily to the acquisition of the TherMatrx product for BPH. Excluding TherMatrx sales, our prostate product sales declined slightly from the prior year’s quarter as ourUroLumeproduct is targeted toward the focused market of urethral stricture. We believe the in-office treatment of BPH market is growing at approximately 20 percent and that our prostrate business is growing in line with that market.
Women’s pelvic health products.Revenue from women’s pelvic health products grew 30.5 percent in the first fiscal quarter of 2005 over the comparable period of 2004. Our business continues to reflect the market’s shift toward the less-invasive, self-fixating slings with decreases in conventional bone anchoring devices (i.e. ourInFastproduct). Within our offering of sling products, theMonarcandBioArcexperienced both unit increases and mix benefit as their respective features of transobturator implant technique and biologic graft combined with self-fixating synthetic mesh continue to draw market share. While the supra-pubic implantation technique of theSPARCis losing portfolio share, that product remains significant within our women’s pelvic health portfolio. Our prolapse repair products approved by the FDA in mid-2004, namely theApogeeandPerigee, contributed to the women’s health growth and were not available in the first quarter of 2004.Her Optionsales remain relatively flat in recent sequential quarters as the establishment of a reimbursement level for the Current Procedural Terminology (CPT) code was not effective until January 2005. As of April 2005, we have confirmed the use of the new code and reimbursement level with a growing percentage of payers, so we expect to see growth from this product offering later in 2005. With the impact of both new product technologies and continued deployment of physician training on those new technologies, we expect our women’s pelvic health portfolio to continue to grow at rates above the market growth rate for 2005.
International sales and foreign exchange effects.Our total revenues grew $14.8 million, or 31.3 percent in the first fiscal quarter of 2005 over the comparable period of 2004. Of this growth, $0.7 million, or 1.5 percent, was due to favorable currency exchange rates, mainly the euro. Because a large share of our expenses associated with European sales are euro-denominated costs, changes in these currency rates do not affect net income and cash flows from operations by the same dollar amount as they affect sales revenues.
The following table compares revenue, expense, and other income accounts for the first fiscal quarters of 2005 and 2004:
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| Three Months Ended | $ Increase | % Increase | ||||||||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | (Decrease) | (Decrease) | ||||||||||||
| Net sales | $ | 62,145 | $ | 47,313 | $ | 14,832 | 31.3 | % | ||||||||
| Cost of sales | 11,020 | 8,930 | 2,090 | 23.4 | % | |||||||||||
| Gross profit | 51,125 | 38,383 | 12,742 | 33.2 | % | |||||||||||
| Operating expenses | ||||||||||||||||
| Marketing and selling | 21,656 | 16,493 | 5,163 | 31.3 | % | |||||||||||
| Research and development | 4,638 | 3,584 | 1,054 | 29.4 | % | |||||||||||
| General and administrative | 5,789 | 4,876 | 913 | 18.7 | % | |||||||||||
| Amortization of intangibles | 1,790 | 1,061 | 729 | 68.7 | % | |||||||||||
| Total operating expenses | 33,873 | 26,014 | 7,859 | 30.2 | % | |||||||||||
| Operating income | 17,252 | 12,369 | 4,883 | 39.5 | % | |||||||||||
| Royalty income | 478 | 491 | (13 | ) | -2.6 | % | ||||||||||
| Interest income | 274 | 138 | 136 | 98.6 | % | |||||||||||
| Interest expense | (55 | ) | (201 | ) | 146 | 72.6 | % | |||||||||
| Other income (expense) | (463 | ) | (156 | ) | (307 | ) | 196.8 | % | ||||||||
| Income before income taxes | 17,486 | 12,641 | 4,845 | 38.3 | % | |||||||||||
| Provision for income taxes | 6,243 | 4,614 | 1,629 | 35.3 | % | |||||||||||
| Net income | $ | 11,243 | $ | 8,027 | $ | 3,216 | 40.1 | % | ||||||||
| Percent of Sales | ||||||||
| For the Three Months Ended | ||||||||
| (in thousands) | April 2, 2005 | April 3, 2004 | ||||||
| Net sales | 100.0 | % | 100.0 | % | ||||
| Cost of sales | 17.7 | % | 18.9 | % | ||||
| Gross profit | 82.3 | % | 81.1 | % | ||||
| Operating expenses | ||||||||
| Marketing and selling | 34.8 | % | 34.9 | % | ||||
| Research and development | 7.5 | % | 7.6 | % | ||||
| General and administrative | 9.3 | % | 10.3 | % | ||||
| Amortization of intangibles | 2.9 | % | 2.2 | % | ||||
| Total operating expenses | 54.5 | % | 55.0 | % | ||||
| Operating income | 27.8 | % | 26.1 | % | ||||
| Royalty income | 0.8 | % | 1.0 | % | ||||
| Interest income | 0.4 | % | 0.3 | % | ||||
| Interest expense | -0.1 | % | -0.4 | % | ||||
| Other income (expense) | -0.7 | % | -0.3 | % | ||||
| Income before income taxes | 28.1 | % | 26.7 | % | ||||
| Provision for income taxes | 10.0 | % | 9.8 | % | ||||
| Net income | 18.1 | % | 17.0 | % | ||||
Cost of sales. Cost of sales as a percentage of sales decreased 1.2 percentage points from 18.9 percent in the first quarter of 2004 to 17.7 percent for the first quarter in 2005. The majority of the decrease in the rate of cost is attributed to the higher effective prices achieved across our erectile restoration, male continence and women’s health portfolios. Future costs of goods sold will continue to depend on product introductions, production levels and mix of product sold.
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Marketing and selling.Marketing and selling expenses increased by 31.3 percent in the first quarter of 2005 but remained essentially constant as a percentage of total revenue. The increase in spending was primarily due to costs associated with our TherMatrx product which we did not own in the 2004 quarter. We also continued investment in training and our sales management structure in the first quarter of 2005. We expect to continue expanding our sales and marketing investment, but our objective remains to leverage sales and marketing expense in 2005 and beyond as a percentage of sales.
Research and development.Research and development expense for the first quarter of 2005 held relatively constant as a percentage of sales for the first fiscal quarters of 2005 and 2004. Research and development spending includes investments in product development, intellectual property support, clinical studies and regulatory filings. We continue to expect total spending in research and development, over the longer term, to be in the range of 8 to 10 percent of sales.
General and administrative.General and administrative expenses as a percentage of sales for the first quarter of 2005 decreased by 1.0 percentage point from the comparable period in 2004, 9.3 percent and 10.3 percent, respectively. We expect to continue the leveraging of our current general and administrative infrastructure as we support our growing revenue base. While general and administrative expenses decreased as a percentage of sales, the dollars spent in the first quarter of 2005 increased over the first quarter of 2004.
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 2005 reflects increased amortization expense over first quarter of 2004 due mainly to the amortization of developed technology, customer relationships and other intangibles obtained with our acquisition of TherMatrx in the third 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 perpetual exclusive worldwide license was entered into during 1998 and is expected to continue to 2009. We receive a royalty equal to 2.625 percent of net sales of licensed products on a quarterly basis. We do not directly influence sales of the products on which this royalty is based and cannot give any assurance as to future income levels. To a much 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 to $0.3 million from $0.1 million during the first fiscal quarters of 2005 and 2004, respectively, due to higher levels of cash and short term investments.
Interest expense.Interest expense decreased in the first fiscal quarter of 2005 from the same period 2004 due to the repayment of the entire outstanding balance on our senior credit facility in the third quarter of 2004. We entered into a new credit agreement on January 20, 2005. As of April 2, 2005, there were no borrowings under the credit agreement.
Other income (expense).Other income (expense) primarily represents gains and losses as a result of remeasuring foreign denominated (mainly euro-based) short-term intercompany receivables to current rates. The first fiscal quarter of 2005 reflects losses due to the weakening of the euro by 5.0 percent to the U.S. dollar from the beginning of the period.
Income taxes.Our effective income tax rate for the first fiscal quarters of 2005 and 2004 were 35.7 percent and 36.5 percent, respectively. We expect our effective tax rate for 2005 to approximate the first quarter 2005 effective rate.
Liquidity and Capital Resources
Cash, cash equivalents and short term investments were $70.5 million as of April 2, 2005, compared to $51.2 million as of January 1, 2005. This increase is due primarily to cash flow generated from operating activities.
Cash flows from operating activities.Net cash from operations was $18.6 million for the first quarter of fiscal 2005, driven by a net income of $11.2 million, and depreciation and amortization of $3.3 million. Net cash from operations was $13.6 million for the three month period of fiscal 2004, resulting from net income of $8.0 million, depreciation and amortization of $2.8 million, offset by other changes in assets and liabilities.
Cash flows from investing activities.Cash used in investing activities was ($0.5) million and ($0.2) million for the three month periods of fiscal 2005 and 2004, respectively. During the three month periods of fiscal 2005 and 2004, we purchased equipment totaling $1.4 million and $0.2 million, respectively. Cash of $1.5 million was paid during the three month period of 2005 as part of the contingent payments to the TherMatrx shareholders.
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Cash flows from financing activities.Cash used in financing activities was $3.8 million during the three month period of fiscal 2005 and net to zero in the same period of 2004. Cash received from issuance of common stock was $3.8 million and $1.7 million during the three month periods of fiscal 2005 and 2004, respectively. During the first quarter of 2004, we repaid $1.6 million of debt under our previous senior credit facility.
Cash Commitments.Pursuant to our acquisition of CryoGen, Inc., 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 contractual maximum amount of the earnout payment is $110.0 million. This transaction is more fully described in our Form 8-K filed with the SEC on January 6, 2003. We do not currently anticipate an earnout payment to the former CryoGen shareholders.
On July 15, 2004, we acquired TherMatrx, Inc. and the shareholders of TherMatrx were paid cash consideration of $40.0 million. We also paid $1.4 million of acquisition related costs through April 2, 2005. In addition to the initial closing payment, we will make contingent payments based on the net product revenues attributable to sales of the TherMatrx Dose Optimized Thermotherapy (DOT) product. These contingent payments will equal four times the aggregate sales of DOT products over a period of six consecutive fiscal quarters (which began on July 5, 2004 and will end on December 31, 2005) minus $40.0 million. The contractual range of contingent payments is from zero to $210.0 million which would result in a total purchase price of $40.0 million up to a maximum of $250.0 million (including the initial payment). These contingent payments will be accounted for as goodwill. Since the time of acquisition, earnout payments of $22.9 million have been accrued, of which $1.5 million was paid during the three month period ended April 2, 2005.
On July 8, 2004, we repaid the remaining balance of 12.9 million under our prior senior credit facility and terminated the facility. This facility, which was set to expire in September 2005, was replaced with a new facility on January 20, 2005. The new agreement provides for a $150.0 million senior unsecured five-year revolving facility (U.S. dollars only), with a $20.0 million sub-limit for the issuance of standby and commercial letters of credit, and a $10.0 million sub-limit for swing line loans. At our option, any loan under the credit agreement (other than swing line loans) bears interest at a variable rate based on LIBOR or an alternative variable rate based on either prime rate or the federal funds effective rate, in each case plus a basis point spread determined by reference to our leverage ration. We have the option of increasing the aggregate maximum principal amount under the facility by $60.0 million. Funds are available under the credit facility for working capital and other lawful purposes, including permitted acquisitions. There are currently no borrowings under the facility.
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We believe that funds generated from operations, together with our balances in cash and cash equivalents, as well as short term investments and our credit facility will be sufficient to finance current operations, planned capital expenditures, and our commitment to former 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 theInhibiZoneantibiotic technology is procured from a single source. We mitigate these risks through appropriate inventory levels, defining alternative sources and comprehensive supplier management. The loss of any of these suppliers could have a materially adverse effect on our financial results in the near term, as we would be required to qualify alternate designs or sources.
Potential Product Recalls
In the event that any of our products were defective, we could voluntarily recall, or the U.S. Food and Drug Administration (the FDA) or an international regulatory body could require us to redesign or recall, any defective product. There is a possibility that we may recall products in the future and that future recalls could result in significant costs to us and in significant negative publicity which could harm our ability to market our products in the future.
Continued Physician Use and Endorsement of our Products
For us to sell our products, physicians must recommend and endorse them. We may not obtain the necessary recommendations or endorsements from physicians. Many of the products we acquired or are developing are based on new treatment methods. Acceptance of our products is dependent on educating the medical community as to the distinctive characteristics, perceived benefits, clinical efficacy, and cost-effectiveness of our products compared to competitive products, and on training physicians in the proper application of our products. We believe our products address major market opportunities, but if we are unsuccessful in marketing them, our sales and earnings could be below expectations.
Successful Introduction of New Products and Product Improvements
As part of our growth strategy, we intend to introduce a number of new products and product improvements. If we do not introduce these new products and product improvements on schedule, or if they are not well accepted by the market, our growth may be reduced.
Continued Use of Non-Invasive Treatment Alternatives
We predominantly sell devices and kits for invasive or minimally invasive surgical procedures. If patients do not accept our products and therapies, our sales may decline. Patient acceptance of our products and therapies 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
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January 1, 2004, the Centers for Medicare and Medicaid Services (CMS) increased reimbursement for certain procedures utilizing inflatable penile prostheses and urinary sphincter devices. This increase partially reversed reductions in such reimbursement rates in 2001 and 2002. Our sales history in the U.S. of these devices does not evidence an obvious correlation with changes in CMS reimbursement rates.
In the first quarter of 2004, the American Medical Association approved a CPT code for ourHer Optioncryoablation system to treat excessive uterine bleeding in the physician’s office, which was the first step toward the availability of standard reimbursement forHer Option. In January 2005, CMS published the relative value units to be applied to this therapy, resulting in a national average CMS allowable payment of $2,602 effective as of January 1, 2005. We do not expect a noticeable effect on sales ofHer Optionuntil this data has been incorporated into the reimbursement systems of the individual commercial payers across the country. We can offer no assurances as to the timing or effectiveness the new code and reimbursement level forHer Option procedures will have on the acceptance and practice of this in-office therapy.
Regulatory Approvals and Clinical Results
Regulatory authorities around the world dictate different levels of manufacturing and design information and/or clinical data for various products in order to ensure their safety and efficacy. In the event the data submitted is deemed inadequate or the clinical study results do not support approval, a product may either not be fit for commercialization or may require a redesign.
Intellectual Property Lawsuits
The medical device industry is litigious with respect to patents and other intellectual property rights. Companies in the medical device industry have used intellectual property litigation to gain a competitive advantage. In the future, we may become a party to lawsuits involving patents or other intellectual property. A legal proceeding, regardless of the outcome, would draw upon our financial resources and divert the time and efforts of our management. If we lose one of these proceedings, a court, or a similar foreign governing body, could require us to pay significant damages to third parties, require us to seek licenses from third parties and pay ongoing royalties, require us to redesign our products, or prevent us from manufacturing, using or selling our products. In addition to being costly, protracted litigation to defend or prosecute our intellectual property rights could result in our customers or potential customers deferring or limiting their purchase or use of the affected products until resolution of the litigation.
Product Liability Lawsuits
The manufacture and sale of medical devices exposes us to significant risk of product liability claims. In the past, we have had a number of product liability claims relating to our products. In the future, we may be subject to additional product liability claims, some of which may have a negative impact on our business. If a product liability claim or series of claims is brought against us for uninsured liabilities or for amounts in excess of our insurance coverage, our business could suffer. We are not currently involved in any material product liability litigation.
Costs of Physician Malpractice Insurance
Most of our products are used by physicians who are required to maintain certain levels of medical malpractice insurance to maintain their hospital privileges. As the cost of this insurance increases, certain physicians who have used our products to treat their patients may stop performing surgeries. Unless these patients who would have been treated by these physicians are referred to other physicians, sales of our products will decline.
Acquisition Integration
We have acquired businesses in the past and we may acquire other businesses in the future. Failure to successfully retain critical employees of an acquired company, failure to gain FDA approval for the products of an acquired company, or the inability to establish and maintain appropriate communications, performance expectations, regulatory compliance procedures, accounting controls, and reporting procedures could have a materially adverse affect on our business. We have integrated TherMatrx into our Minnetonka, Minnesota operations and have obtained FDA approval to transfer the manufacture of certain TherMatrx components to our Minnetonka location.
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International Sales
During the first fiscal quarter of 2005, approximately 22 percent of our sales were to customers outside the United States. Some of these sales were to governmental entities and other organizations with extended payment terms. A number of factors, including political or economic instability in the countries where we do business, could affect payment terms and our ability to collect foreign receivables. We have little influence over these factors and changes could have a materially adverse impact on our business. In addition, foreign sales are influenced by fluctuations in currency exchange rates, mainly in the euro. In recent periods, our sales have been positively impacted by increases in the value of the euro relative to the U.S. dollar. Decreases in the value of the euro relative to the U.S. dollar would negatively impact our sales.
Manufacturing Facility
We are currently operating with one manufacturing shift and have adequate physical capacity to serve our business operations for the foreseeable future. We do not have a back up facility, and the loss of our Minnetonka facility would have a materially adverse effect on our sales, earnings, and financial condition.
Ongoing Compliance with Section 404 of the Sarbanes-Oxley Act of 2002
During fiscal 2004, we expended significant resources to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Our management concluded the internal controls over financial reporting in 2004 were adequate and contain no material weaknesses. Furthermore, our 2004 year-end audit resulted in our external auditors’ ability to attest to our satisfactory assessment of our internal controls over financial reporting with no material weaknesses to report. We realize the requirements of this Act must now be maintained quarterly and are likely to evolve as the result of a reassessment of the Act’s initial implementation. Failure to respond to changes in the requirements of the Act or our inability to comply regularly with the Act’s requirements could have a materially adverse affect on our business as represented by investor confidence and possible fluctuation in our stock price.
Expensing of Stock Options as Required by SFAS 123(R)
In December 2004, the Financial Accounting Standard board issued SFAS No. 123(R),Share-Based Payment, pursuant to which all stock-based compensation awards must be measured and expensed in consolidated financial statements beginning for us with our first fiscal quarter of 2006. Though we have been including footnote disclosure of the impact of the expense that would be recorded under SFAS No. 123 to our earnings and earnings per share in our regularly published SEC filings, the impact of this change to our stock price, and to those throughout the market, is uncertain at this time.
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
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written request for any such filing. All requests for our SEC filings should be sent to the attention of Investor Relations at American Medical Systems, Inc., 10700 Bren Road West, Minnetonka, Minnesota 55343.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rates
We do not believe that the interest rate risk on earnings is material given our level of investments and their short-term nature. Also, we do not believe that the interest rate risk on expenses is material given the forecast level and timing of borrowings required in 2005.
Currency
Our operations outside of the United States are maintained in their local currency. All assets and liabilities of our international subsidiaries are translated to U.S. dollars at period-end exchange rates. Translation adjustments arising from the use of differing exchange rates are included in accumulated other comprehensive income in stockholders’ equity. Gains and losses on foreign currency transactions and short-term inter-company receivables from foreign subsidiaries are included in other income (expense).
During the first fiscal quarter of 2005 and 2004, revenues from sales to customers outside the United States were 22.2 percent and 22.6 percent of total consolidated revenues, respectively. International accounts receivable, inventory, cash, and accounts payable were 31.5 percent, 6.1 percent, 13.9 percent, and 24.5 percent of total consolidated accounts for each of these items as of April 2, 2005. The reported results of our foreign operations will be influenced by their translation into U.S. dollars by currency movements against the U.S. dollar. The result of a uniform 10 percent strengthening in the value of the U.S. dollar in the first quarter of 2005 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 $1.1 million during the quarter.
At April 2, 2005, our net investment in foreign subsidiaries translated into dollars using the period end exchange rate was $20.1 million and the potential loss in fair value resulting from a hypothetical 10 percent strengthening in the value of the U.S. dollar currency exchange rate amounts to $2.0 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
Evaluation of Disclosure Controls and Procedures
Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries, which we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934, was made known to them by others within those entities and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation of such internal control over financial reporting that occurred during our last fiscal quarter which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
Option Grants
On May 6, 2005, the Compensation Committee of the Board of Directors of American Medical Systems Holdings, Inc. approved grants to AMS executive officers of incentive stock options to purchase that specified number of shares of AMS common stock as is indicated in the table below. The options were granted under the American Medical Systems Holdings, Inc. 2005 Stock Incentive Plan and pursuant to the terms of stock option agreements between AMS and each of the below-named executive officers. The options have an exercise price of $19.69 per share, which represents the closing sale price of a share of AMS common stock as of the end of the regular trading session, as reported by the NASDAQ National Market on the date of the grant. Each of the options has a seven-year term and is exercisable on a cumulative basis, with respect to 25% of the shares covered by such option on December 31, 2005, and with respect to 6.25% of the shares covered by such option on the last day of each calendar quarter thereafter, for so long as the recipient remains continuously employed by AMS.
| Name | Title | Number of Shares | ||||||||
| Martin J. Emerson | President and Chief Executive Officer | 200,000 | ||||||||
| Carmen L. Diersen | Executive Vice President and Chief Financial Officer | 100,000 | ||||||||
| Ross A. Longhini | Executive Vice President and Chief Technology Officer | 80,000 | ||||||||
| Lawrence W. Getlin | Senior Vice President, Regulatory, Medical Affairs and Quality Systems | 50,000 | ||||||||
| Janet L. Dick | Senior Vice President, Human Resources | 50,000 | ||||||||
| John Nealon | Senior Vice President, Business Development | 40,000 | ||||||||
Base Salary Increase
On May 6, 2005, the Compensation Committee of the Board of Directors of American Medical Systems Holdings, Inc. approved a base salary increase for John Nealon to $207,500 per year in connection with his promotion to the position of Senior Vice President, Business Development, such increase to be effective as of May 2, 2005.
2005 Executive Variable Incentive Plan; Target Bonus Increases
On May 6, 2005, the Compensation Committee of the Board of Directors of American Medical Systems Holdings, Inc. approved an increase to the target bonuses of three executive officers under the 2005 Executive Variable Incentive Plan. Each of the approved increases will take effect beginning with the bonus payment for the second quarter of 2005 and the formula for calculating each target bonus will be adjusted to account for the approved increases. The new target bonus for 2005 for these three executive officers is set forth in the table below:
| Name | Title | Target Bonus | ||||||||
| Lawrence W. Getlin | Senior Vice President, Regulatory, Medical Affairs and Quality Systems | $ | 73,213 | |||||||
| Janet L. Dick | Senior Vice President, Human Resources | $ | 64,125 | |||||||
| John Nealon | Senior Vice President, Business Development | $ | 69,469 | |||||||
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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. |
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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 | ||||
| May 12, 2005 | By | /s/ Martin J. Emerson | ||
| Date | Martin J. Emerson | |||
| President and Chief Executive Officer | ||||
| May 12, 2005 | By | /s/ Carmen L. Diersen | ||
| Date | Carmen L. Diersen | |||
| Executive Vice President, Chief Financial Officer | ||||
| and Corporate Secretary (Principal Financial and Accounting Officer) |
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AMERICAN MEDICAL SYSTEMS HOLDINGS, INC.
| Item No. | Item | Filing Method | ||
| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Filed with this Report on Form 10-Q. | ||
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Filed with this Report on Form 10-Q. | ||
| 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 on Form 10-Q. |
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