American Medical Systems Holdings, Inc., Q4 2008 (Qtr End 01/03/09) Earnings Conference Call

American Medical Systems Holdings, Inc., (AMMD)

Q4 2008 Earnings Call

February 17, 2009 5:00 pm ET

Executives

Anthony Bihl - Chief Executive Office

Ross A. Longhini - Chief Operating Officer

Mark A. Heggestad - Chief Financial Officer

Analysts

David Lewis – Morgan Stanley

Tycho Peterson - J.P. Morgan

Brooks West – Craig Hallum

Jonathan Block – SunTrust Robinson Humphrey

Jayson Bedford – Raymond James

Amy – Piper Jaffray

Unidentified Analyst

Presentation

Operator

Good afternoon. I would like to welcome everyone to the AMS Q4 2008 earnings conference call. (Operator Instructions). Mr. Bihl, you may begin your conference.

Anthony Bihl

Thank you for joining us today to discuss American Medical Systems’ fourth quarter results. With me this afternoon are Ross Longhini, Chief Operating Officer, and Mark Heggestad, Chief Financial Officer.

Before continuing, I must preface all comments with the Safe Harbor statement. Some of the statements made today will be forward-looking and are made under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Any such statements are subject to risk and uncertainties that could cause actual results to differ materially from those anticipated. Those risks and uncertainties are referenced in today’s press release and are described in our most recent Form 10-K and other recent filings we have made with the Securities and Exchange Commission.

During this call we will be discussing certain financial measures which differ from the comparable measures prepared in accordance with Generally Accepted Accounting Principles or GAAP. A reconciliation of these non-GAAP financial measures to the related GAAP financial measures can be found in the American Medical System’s fourth quarter 2008 earnings release including in the financial tables which are part of the release. With these statements we can move forward reviewing the AMS business as covered in our press release issued earlier today.

American Medical Systems posted a solid fourth quarter with revenue and non-GAAP earnings surpassing our guidance. Total fourth quarter revenues were $134 million, an increase of 3% over the comparable period of 2007 and above our guidance of between $126 million and $132 million in sales. On a constant currency basis, revenues grew 5.9%. We will be discussing our revenues on the basis of how we’re now organized and view our products internally. That is, Men’s Health, which includes the male continence and erectile restoration product lines, then Women’s Health, which includes female continence, prolapse product lines, and Her Option urine health product, and BPH therapy which include the GreenLight Laser Therapy and TherMatrx product lines.

Fourth quarter Men’s Health revenue was $58.7 million, an increase of 7.3% over the comparable period last year. On a constant currency basis, Men’s Health actually grew 10.5%. Women’s Health reported fourth quarter revenue of $45.2 million, an increase of 7.8% on a reported basis and actually a gain of 10.3% on a constant currency basis over the comparable period last year. BPH therapy revenues of $30.2 million declined 9.9% on a reported basis and actually 6.9% on a constant currency basis in the fourth quarter compared to the same period last year.

Non-GAAP earnings per share were $0.26 for the fourth quarter or an increase of 44% over the fourth quarter of 2007 non-GAAP EPS of $0.18 and up ahead of our guidance of between $0.21 and $0.25.

For the full year revenues of $501.6 million increased 8.1% from $463.9 million reported the prior year and rose 7.1% on a constant currency basis. Fiscal 2008 non-GAAP earnings per share of $0.70 grew 63% over non-GAAP earnings per share of $0.43 in 2007.

Again, this quarter, our strong focus on expense and working capital management resulted in an improved operating leverage and favorable cash flows. Both inventory turns and DSOs improved again this quarter. This enabled us to generate $37.1 million in cash from operations and reduced our debt by $40.7 million in the quarter and $119.7 million in the year, both above our expectations.

In particular as Mark will discuss, these strong cash flows enable us to retire some of our convertible debt at a considerable discount in the fourth quarter.

Before turning the call over to Mark to review the financial results and discuss our guidance, I’d first like to provide color on the results in each of our product lines. Next, I’ll provide an update on the status of our major initiatives to improve the laser therapy business, and finally, I will highlight a few changes to our organizational structure.

As we have discussed before, AMS is a company with a portfolio of several high performing product lines which hold leading positions in attractive markets all focused on pelvic health. In fact, four of our product lines ended the year with annual sales around $100 million each and a fifth crossed the $15 million mark. Specifically in 2008, Men’s continence and erectile restoration exceeded the $100 million mark in sales while Women’s continence was right on the cost; laser therapy, despite its challenges, finished the year in excess of $100 million, and prolapse topped $50 million in sales for the year.

Within our portfolio we operate two unique business models; one, an implantable medical devices business comprised of our continence, erectile restoration and prolapse repair product lines; and two, a capital equipment with trailing disposables business including Laser Therapy, Her Option, and TherMatrx product lines.

Our implantable product lines continue to generate steady topline growth while our capital equipment and trailing disposable businesses are not yet reliably growing to our expectations. This portfolio approach provides stability as the performance of difference businesses can vary during their lifecycles for a variety of reasons. This is evidenced by a very robust mid-teens gain in our implantables business product lines offset by declines in our capital product lines. Without question, our objective remains to ensure that each of our product lines is contributing to the profitable growth of AMS over time, and we’re focused on the required changes in our capital equipment product lines to achieve this objective.

Turning now to our product lines, our fourth quarter revenue was highlighted by solid performance in both male and female continence as well as very strong growth in prolapse. However, this was offset by declines in our capital related prouct lines, laser therapy, TherMatrix and her option. The male continence product lines posted mid-teens growth largely due to continued adoption of the AdVance Sling System. Our erectile restoration business growth rate continued the slowing trend of the last several quarters and in the most recent quarter grew in the low single digits. We recently began the launch of a new malleable penile prosthesis, Spectra, for which we received FDA marketing clearance in the fall.

The female continence product lines demonstrated mid teens growth led by our MiniArc Sling System and prolapse repair accelerated to double-digit growth due primarily to the fourth quarter launch of Elevate Posterior system used to treat posterior vaginal prolapse.

Also notable in the fourth quarter, there appeared to be no measurable revenue impact from the FDP Public Health Notice issues in October 2008 regarding mesh materials used to treat incontinence and prolapse. We are very pleased with our Elevate Anterior product used to treat anterior vaginal prolapse, achieved FDA clearance at the end of December.

We will begin a phased roll out in the first half of the year as we continue to collect clinical data and will formally launch the anterior solution in the second half of the year. With initial feedback very positive on Elevate Anterior, it’s expected to further contribute to growth in this business.

Her Option was down double-digits in the fourth quarter. Our focus for Her Option is to drive the profit contribution of this business by emphasizing probe sales over consult sales.

Let me switch gears a bit to discuss our Ovion women's permanent contraception product. As you may recall, we had been working on a design improvement with the technology following initial clinical trials. Now, after balancing the cost and benefits of bringing this technology to market coupled with the established competition and our desire to develop a truly differentiated product, we’ve decided to suspend development efforts on Ovion while we evaluate various alternatives to maximize the value of this asset.

Within the BPH therapy business, the laser therapy product line declined to 9.4% compared to last year’s quarter on a reported basis, down 6% on a constant currency basis. We do continue to see some stabilization in the US market where we achieved small positive growth over the same quarter 2007; however, our international sales continued to decline.

Our TherMatrx business declined again this quarter as expected as the overall market for microwave BPH therapies continues to decline. To put TherMatrx in perspective, this product line now accounts for less than 3% of our total revenues.

Let me now delve a little more deeply into the laser therapy product line and update you on our four main initiatives to improve performance in this segment. The four main initiatives are, number one, manage the BPH therapy as its own business unit; number two, realign our US laser sales team separating capital sales from fiber sales to more effectively support the clinical outcomes and procedure growth and therefore fiber use; number three, to implement the concept of one AMS to leverage the value of the excellent longstanding relationship that our men’s and women’s health reps have in the urologist’s office; and four, to drive a 10 percentage point increase in gross margins by 1020.

So how are we doing? Well, we have identified a candidate for the role of BPGM to run the BPH therapy business which includes GreenLight and TherMatrx. This individual will be a seasoned veteran from the capital disposable medical systems selling model. We expect to have the new leader on board within the 60 to 90 days. Functionally, we have separated out the resources devoted to BPH therapy business, so that we can move forward on this plan and measure our progress effectively.

Our global sales meeting in early January marked progress on our plan to separate our US laser sales force into two groups, and they engage all of salespeople in promoting GreenLight laser therapy through the one AMS team. We now drive the US laser console sales through a small group of territory managers skilled in selling capital equipment with its longer, more complex selling cycle. At the same time, we established a larger group of dedicated laser therapy territory managers whose sole focus is on supporting fiber sales through more frequent contact and clinical support with physicians.

Regarding one AMS, we’ve begun cross training our men’s health and full line reps on GreenLight laser therapy so that when they enter the urologist’s office, they’re not just thinking about continence or erectile restoration, but rather the entire solution for the urologist. While all of our US reps are incentiviced to promote GreenLight, selected men’s and full line sales reps will have GreenLight sales as part of their annual quota. This team of one AMS emphasizes the importance of leveraging the AMS brand and the many deep relationships that our implantable sales forces have forged with urologists over the years.

Finally, we have a concrete plan in place to enable us to achieve our gross margin goal of 10 percentage point increase from 2008 gross margin of 49.9%. This means we expect to exceed a 60% gross margin in the year 2010. The improvement will result from a combination of reducing manufacturing costs on fibers and consoles, a mix shift towards fibers, reduced service costs resulting from improved system reliability and efficient deployment of service personnel. We’ve already made considerable progress on extending console and fiber reliability and reducing manufacturing costs.

So we remain committed to the success of GreenLight therapy as it offers an excellent solution for physicians treating their patients with BPH. This is reinforced by market research that unequivocally confirms that GreenLight is regarded highly amongst physicians who treat BPH because it provides the ideal combination of effectiveness, minimal side effects, patient satisfaction, and physician productivity. The research has also verified that physicians continue to transition away from the more invasive TURP procedure to less invasive therapies like GreenLight.

Finally, market data and demographics continue to indicate a growing number of men seeking treatment for BPH. While drug therapies have captured much of the growth in patients seeking treatment, we believe a number of these patients will ultimately require or desire surgical solutions, and we remain convinced about our ability to gain share of these surgical procedures.

Turning now to one of our other leading companywide initiatives, that’s the more aggressive expansion into international markets, let me update you on our progress here as well. As you may recall, we’ve talked about better capitalizing on the market opportunities for our products in Europe, Asia, and Latin America markets. To that end, we’ve announced changes to our worldwide sales and marketing structure including a key management hire.

Specifically, we’ve created a 3-region structure for organizing sales, marketing, and supporting business functions. The three regions are Europe, Middle East, and Africa; Asia Pacific and Latin America; and North America. These regions are being managed by regional general managers. Francois Georgelin was named Vice President and General Manager for Europe, Middle East, and Africa, and Mike Ryan was named Vice President and General Manager for Asia Pacific and Latin America Region.

Francois comes to AMS with extensive experience in emerging and European markets gained at companies such Gambro, Medtronic, and Johnson & Johnson. Mike Ryan is a 22-year AMS veteran. He is a strong and experienced international sales leader who will now focus his efforts on some of the fastest-growing health care markets in the world. Regarding the North America role, we have solid leadership in place today to effectively drive our growth in these markets. We expect that in the future we’ll fill the North America role at a later time.

Before I turn the call over to Mark, let me make a comment on the current environment. Though it’s difficult to know with precision, we do expect the global recession to continue through this year, and we have incorporated many important macro factors into our outlook. Mark will provide our detailed guidance shortly, but suffice it to say that we’re watching the economy carefully and taking a cautious stance to fiscal 2009. We’ll continue to drive operational and working capital efficiencies throughout this period.

At this time, I’d like to turn the call over to Mark Heggestad.

Mark Heggestad

Tony has addressed our revenue performance for each of our major product lines, so I’ll limit my comments on revenue to summarizing revenue by geography before turning to the rest of the P&L.

Fourth quarter US revenue at 72% of sales grew 6.3% over the prior year to $97 million, international revenue, at 28% of sales, declined 4.7% to $37 million. The unprecedented strengthening of the US dollar in the fourth quarter negatively impacted the comparison between years by $3.8 million. Excluding this currency impact, international sales rose 5% in the fourth quarter versus the prior year.

Consistent with the first three quarters of 2008, we continued to drive increased efficiencies and leverage throughout our business, thus ensuring the strength of our bottomline performance and cash generation. This is evidenced in our strong P&L performance where the 2008 gross margin percentage was a healthy 79.1% versus a gross margin percentage of 78.7% reported in the comparable period of 2007. Consistent with prior quarters, the 2008 fourth quarter gross margins in driven by our historically high margins in the base business of 85.7%, partially offset by the comparatively lower laser therapy gross margin which improved to 53.1% in the fourth quarter. As Tony mentioned, one of our key initiatives in laser therapy is to drive a 10% point improvement in gross margin by 2010 from our 2008 baseline of 49.9%.

This quarter’s results reflect some early benefits of that hard work, and we expect continued improvement as we go through 2009. One of the most prevailing trends in our business this year has been our ability to leverage our operating expenses. This was again strongly evident in the fourth quarter where our adjusted operating income margin excluding the accelerated amortization charge, which I will discuss in a moment, came in at 28.6%, up 6 percentage points versus a comparable margin a year ago of 22.6%. Marketing, selling and G&A spending in the fourth quarter were down $6.6 million, or 11.4% versus the prior year. R&D spending of $12.3 million increased 9.4% over the prior year, and at 9.2% of sales tracked closely to our targeted R&D spend of approximately 10% of revenue.

The $21.5 million amortization of intangibles line item is made up of $4.4 million in normal ongoing amortization expense, plus a $17.1 million one-time adjustment for accelerated amortization related to the TherMatrx product line and GreenLight PV technology. The GreenLight PV is a predecessor to the current GreenLight HPS technology. This charge was driven by declining revenues in the TherMatrx product line as fewer microwave BPH procedures are being performed in office as well as declining revenues from the GreenLight PV laser technology which has been obsoleted by the GreenLight HPS technology at a much faster rate than originally anticipated. This non-cash one-time charge will reduce future amortization charges. I will provide more detail on the impact of future periods in the guidance section.

Royalty income in the fourth quarter of 2008 of $898,000 is at our current run rate. As a result of our aggressive debt pay down and proactive management of our borrowing costs, 2008 fourth quarter interest expense of $6.4 million declined significantly from the $9.1 million incurred in the fourth quarter of 2007. I will provide more light on our cash management and pay down of our debt later. The other income expense line of $3.2 million in expense was driven by the unprecedented strengthening of the US dollar in Q4. Each quarter, we are required to mark to market our inter-company receivable from foreign affiliates. This mark to market cost us $3 million in Q4. The impact related to his activity in future quarters will be minimized as we have now hedged the majority of our inter-company mark to market exposure; however, with that said, we have also partially hedged our 2009 exposure, so there may be some volatility in this line item as we go through 2009 related to the gains and/or losses we will likely realize on our P&L hedging contract.

On a very positive note, we also recorded a $10.1 million gain on extinguishment of debt in the fourth quarter. In December, we used $23.4 million of incremental cash generated during the quarter to retire $34.5 million of our convertible notes which were trading at less than 70% of par at that time. I’ll provide more details on the mechanics of this transaction in a moment.

The Q4 and full year 2008 tax rate came in lower than originally anticipated due to a favorable resolution on audits of our 2004 and 2005 federal tax returns. Our fourth quarter tax rate was further reduced by the retroactive reinstatement of the 2008 R&D tax credit. As a result of these factors, our reported fourth quarter tax rate was 34.4% and the full year tax rate was 38.3%.

Excluding the negative impact of the accelerated amortization charge and also excluding the positive impact of the gain on extinguishment of debt, non-GAAP adjusted net income was $19.1 million and EPS of $0.26. This represents a 46% and 44% increase respectively over similarly adjusted net income and EPS of a year ago. I would now like to turn your attention to our balance sheet and 2008 cash management where we capped a very successful year with an extremely productive fourth quarter. We ended the fourth quarter with a cash and short-term investment balance of $43 million. Sash generated from operating activities in the fourth quarter of 2008 was $37.1 million, compared to $19.9 million in the same period last year. Continuing the strong gains we saw in the first three quarters of 2008, we reduced our accounts receivable by $13.4 million, compared to the same time last year and have decreased DSOs by 12 days or 16%.

This achievement exceeds our goal of decreasing worldwide DSOs by 9% by the end of 2008. Also contributing to this increase in cash provided by operations is the continued reduction in inventory levels throughout 2008. As we reduced inventory levels by 37% from the prior year, the company has put in place several initiatives to optimize our inventory levels and we continue to experience real improvements in all manufacturing locations.

As a result of the success we have leveraging our operations and managing our working capital, we were able to significantly our recent guidance for total 2008 debt reduction of $85 million by paying down $120 million in 2008. $40.7 million of the debt pay down occurred in the fourth quarter and consisted of two components. First of all, we paid $6.2 million on our senior secured credit facility in Q4 bringing the balance of that debt down to $228.8 million at year end. In addition, we took advantage of the recent discount on our convertible bonds and applied $23.4 million of cash to retire $34.5 million face value of our convertible bonds in Q4 bringing the year end balance on our convertible bonds down to $339.3 million.

The mechanics of this buyback particularly in light of the debt covenants imposed by our senior secured debt are worth noting as it speaks to the tremendous value of our cash flows. As a reminder, we were bound by our covenants to use 75% of our excess cash flow to retire our senior secured debt as long as our leverage ratio exceeded 4 times. Our 2008 total leverage ratio fell below 4 which lessened the restriction on our use of cash. Specifically, we are now required to apply 50% of our excess cash flow to retire the senior secured debt.

After meeting this requirement, we were further restricted by the same covenants to apply no more than $15 million per year of cash to reduce convertible debt. The $15 million limitation has a one year carryover and we have $30 million available in 2008 to retire the convertible debt. We used $23.4 million of the $30 million available recognizing that the current prices on our convert were compelling. We will have another $22 million available to us in 2009—the $7 million we did not use in the repurchase plus an additional $15 million attributable to 2009. Further activity in this area will be impacted by a number of variables including the current discount rate and other potential operating uses of our cash.

The added significance of these transactions is the extra breathing room we have achieved in our debt covenants. We are now at a total leverage to EBITDA ratio of 3.7 times, nicely below our goal of under 4 by the end of the fourth quarter and down significantly from 6.3 at the time of the Laser Scope acquisition, a significant milestone as we endeavor to gain financial flexibility in our capital structure.

To reemphasize the point I started this discussion with, we were able to increase our cash and short term investments balance on hand by $7.2 million during the quarter to $43 million even with the substantial debt reduction.

I would now like to turn our attention to our first quarter and fiscal 2009 outlook. While we remain mindful of the economy, we’re confident in forecasting continued strength in our implantable product line, mainly men’s and women’s continence and prolapse repair, and we maintain our expectations for slower growth on erectile restoration and moderating declines in the capital equipment product line. We are also negatively impacted by the current foreign currency environment in terms of comparing 2009 performance against the prior year. Based on these factors, we are guiding our full year 2009 revenue at $495 to $515 million. Keeping in mind the seasonality of our business by quarter, we are guiding first quarter revenue in the range of $117 to $124 million. This guidance assumes the foreign currencies we may be impacted by do not fluctuate significantly from current rates.

Before providing guidance on EPS, I need to remind you of a new required change in accounting that will impact our 2009 GAAP net income and EPS as well as prior years’ earnings. As you know, in May 2008, the Financial Accounting Standard Board finalized new rules on accounting for certain convertible notes. This will impact how we account for our now $340 million convertible note. This new accounting becomes effective in 2009 and requires retroactive restatement of our financial statements beginning with the year we obtained the notes which was mid 2006. The restated EPS for years 2008, 2007, and 2006 are included in a table we filed today in the form 8-K with our press release. As a result of this new accounting for convertible notes, restated GAAP EPS will reduce for each of years 2008 and 2007 by $0.16. Further these new requirements will reduce our 2009 reported GAAP EPS by approximately $0.12. It is important to note that this accounting change has absolutely no impact on our cash flow.

Given the significant impact of the amortization of financing costs resulting from this new accounting for convertible notes combined with the amortization of intangibles, the company now has two significant charges in GAAP earnings that inhibit consistent comparisons to many other companies. Accordingly, we will guide to non-GAAP adjusted earnings per share which we define as GAAP EPS excluding the impact of amortization of intangibles and also excluding the impact of amortization of financing costs. Given this definition, we are guiding 2009 non-GAAP adjusted EPS in the range of $0.86 to $0.99. This guidance excludes the impact of intangible amortization expense which in 2009 is approximately $13.5 million, or $0.11 per share, and also excludes the impact of amortization of financing cost which in 2009 is approximately $18.5 million, or $0.15.

It is important to note that the $0.15 per share related to the amortization of financing costs is made up of two components. One component is the $0.12 per share I previously referred to which pertains to the new accounting for convertible notes. The second component which is approximately $0.03 per share relates to the amortization of financing costs we were previously recognizing under prior accounting.

Concerning the first quarter of 2009, we expect non-GAAP adjusted EPS in the range of $0.15 to $0.19. Again, this guidance excludes the impact of amortization of intangibles which is approximately $0.025 and amortization of financing costs which is slightly less than $0.04. All guidance also excludes the impact of any unusual nonrecurring type charges such as IPRD.

Some of the key assumptions that go into this guidance include continuing gross margin improvement. We anticipate we will improve the gross margin percentage by 1 to 2 percentage points in 2009 versus 2008 primarily driven by margin improvements in the capital product line. Our guidance also assumes continuing operating margin improvements through a combination of gross margin improvement, a modest leveraging in our SG&A, and maintaining R&D spending at approximately 10% of sales.

Given the ongoing paydown of our debt, we expect interest expense will decrease from $27.4 million recorded in 2008 to approximately $22 million in 2009. We are assuming a tax rate of approximately 39% in 2009. We look forward to another year of strong cash flow and anticipate we will pay down approximately $85 million of our debt in 2009. We made huge leaps forward in the leveraging of our P&L and working capital management in 2008, and although we will continue to do so in 2009, it will likely not be at the fast-paced level we did in 2008. We picked off a lot of low-hanging fruit in 2008 and improvements going forward will be steady and consistent. With that said, I’m excited about where we have positioned ourselves as we wrap up 2008 and look forward to a very productive 2009.

I will now the turn the call back to Tony.

Tony Bihl

In summary, we’re pleased with the fourth quarter results. We’ve done a very good job of managing our P&L. We’ve exceeded our top and bottomline guidance range, and we continue to demonstrate strong execution on expense management and considerable cash flow generation throughout our organization.

Let me pause just for a moment. Along with our release of financial results for the quarter and the year, we also announced today that Ross Longhini, our Chief Operating Office, has elected to leave AMS in April this year. It’s certainly with regret that we communicate this as Ross has been such a positive and influential force in AMS throughout his 6-year career here. He’s been a great leader and a champion of driving our technology through new products. For me personally, it’s been my absolute pleasure to work alongside Ross and Mark in leading AMS. He’s helped me and supported me through my transition in these past 9 months, and for that, I truly admire and appreciate Ross. He’s a talented executive, and I’m certain that he’ll soon be running a company for himself.

I do want to confirm that going forward the role of chief operating officer will not be filled. The general managers of the company’s three businesses, men’s health, women’s health, and BPH therapy, will now report directly to me, and in addition, we will take some steps to add a top technology leader to our executive team to reinforce our ongoing commitment to being the technology leader in the pelvic health markets we serve.

So let me stop now and turn the call over to Ross for some comments.

Ross Longhini

As many of you know, I’ve been at AMS just over 6 years now and contributing to its growth from about $150 million company to a $500 million company. AMS has entered into BPH and prolapse markets during this time, and we’ve truly solidified our position as a world leader in restoring continence in patients globally. Personally, AMS has given me the opportunities to grow as well. I’ve been able to learn and contribute first as a CTO, then as a COO, and briefly as CEO. Through these experiences, I’ve come to the decision that I would like to lead a company and will be leaving in April as Tony indicated.

AMS has been, is, and will be a company whose mission and values are aligned with what I believe in. It’s a company that truly believes in making a difference in people’s lives, including patients, physicians, and employees. The solutions it provides profoundly change the quality of life for patients, but very importantly the dignity of those patients as well. These are foundational to the company, and they have made my time here worthwhile at a level that goes way beyond a professional career.

I humbly served the company for these past six years and will continue to believe in what AMS does no matter where my life turns. I owe a debt of gratitude of which I will never be able to repay to AMS for what is has provided me. The education alone has been priceless. However, the most valuable aspect of my time at AMS would be the relationships I have forged both inside and outside the company. The organization is strong. We have solid leadership in place, and during the past nine months, I’ve developed a sincere and open relationship with Tony and know that he’s a very capable leader who will guide AMS to its next phase of growth. I have high confidence that the values underpinning the company and the incredible talent comprising the company will result in restoring the dignity and quality of life for many more patients around the world.

Thank you, and now I’ll turn it back to Tony.

Tony Bihl

Before opening the call to the Q&A session, in order to allow as many analysts to ask questions as possible, please observe our request that you ask no more than two questions—one leading question and one followup, and then return to the queue. Thanks very much for your consideration in advance for that. Operator, would you please provide instructions for questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tom Gunderson – Piper Jaffray.

Amy – Piper Jaffray

This is Amy in for Tom. Tony, you touched briefly on the economy, and how that can weigh heavily on elective procedures, but I was wondering if you can give us a little more color as to how incontinence procedures may be more resilient than say impotence or BPH procedures.

Tony Bihl

I think we’ve expressed that in the past and our view is probably the same today, and that is incontinence does seem to be a procedure that hasn’t been affected by economy so much. It’s not a procedure that’s viewed as an elective procedure by the patients themselves. Once the decision is made to address the problem, patients seem to go forward with the procedure. We don’t view very many of our procedures as really elective. Sometimes, we think of them are deferrable perhaps. Even our erectile restoration businesses, as Mark pointed out, we’ve seen declining growth rates, but we do continue to see growth in those businesses, and we remain cautiously positive that those things will operate and continue to go through a soft economy. BPH, I think what we’ve talked about in the past is that we had some concerns that the purchase of capital equipment at a time when money could be tight for hospitals might be difficult. Again, we’ve addressed that by providing alternatives such as leasing programs or fiber usage programs, and so while our sales may be deferred over time, we believe that our focus there is going to continue to drive procedure growth. So overall we’re cautious about what could develop with the economy. There are still some unknowns about what will happen as the improvement programs are rolled out through the government, but I think we won’t see any new turns in this like we’ve seen in the past.

Amy – Piper Jaffray

With the new three geographic region structure, just curious how we should think about these different regions in terms of contribution to topline growth in 2009 and beyond.

Tony Bihl

We look at the growth rates in these markets. Again, if you look at where our business is today, roughly 70% US market and 30% outside the US. We believe the healthcare market is probably significantly greater outside the US as an under-penetrated market for us, and so we’re looking for more in the areas of double digit growth outside the US, with moderate single digit growth in the US, and again, the economies outside the US are struggling as well, so we’re cautious about that, but we believe that by putting solid infrastructure in place and by moving into new markets with existing products, we give ourselves a good opportunity for growth there, so I would say, generally speaking, you should be thinking double-digit growth outside the US.

Operator

Your next question comes from the line of (Garret Hope).

Unidentified Analyst

I know you’ve kind of restructured the way you report, but when you give the margin detail on the two separate businesses within men’s health, can you break out whether you’re including for matrix in BPH in the other line that’s going to be expending on the gross margin line?

Mark A. Heggestad

When we’ve been reporting the laser BPH margin, it’s always been the laser therapy margin historically. Quite honestly, the margins aren’t that different between the TherMatrx and the laser therapy margins, and again, you’ve got to remember in terms of order of magnitude, the TherMatrx is significantly smaller business, so it really doesn’t have that much impact on the margin, but with that all said, it’s the laser therapy margins that we’ve been reporting.

Unidentified Analyst

I’m assuming there that the rest of the business includes biocontrol continuum and the other revenue that the BPH treatment only includes those two lines. Is that correct?

Mark A. Heggestad

That is correct.

Unidentified Analyst

Turning to the P&L, SG&A, you said there was going to be some sort of leverage, and then R&D at about 10%. R&D has been running about 9% over the past couple of years, so can you explain the step up there, if that’s something to be concerned about, if there’s anything incremental there, and then in the SG&A, how much approximately we could see improved without giving guidance?

Mark A. Heggestad

On the R&D side, we’ve kept the stated goal of around 10%. If you look at historically, we’ve almost always been slightly under that. This is a place where we can give a lot of credit to Ross’s leadership over the years. The R&D is sometimes a place where it’s easy to cut back because you can get short term gains but then sacrifice the long term. We always keep a stated goal in mind of close to 10%, and I think with that goal we find that we usually run it somewhere between 9% and 10%, and again as we look forward to 2009, right now our intention is to get very close to 10%, and if we go looking for savings, that’s one of the places we’ll sometimes go, but as of right now, that’s the way we’re looking at it. On the SG&A, again we saw a significant leveraging of SG&A in 2008. We will have some leveraging of SG&A in 2009, but I think again it would be shortsighted of us to not make some investments in those areas as we look forward. If you take a look at our absolute dollars, we actually declined in SG&A spending from 2007 to 2008, and we have small incremental increase going forward in 2009, so our operating margins on those lines will increase, but at a significantly lower rate of increase than you saw in 2008.

Operator

Your next question comes from the line of David Lewis with Morgan Stanley.

David Lewis – Morgan Stanley

In terms of the currency impact you’re forecasting in your guidance for 2009, could you quantify that impact, Mark?

Mark A. Heggestad

Yes. If you take a look at 2009, again, the best information you have is the rate you have available today, so you take a look at our 2009 guidance which is in the area of $495 to $515 million, remember that about 30% of our revenue comes from international locations. If you just use the euro as a proxy, and sometimes that can be dangerous but for now if you just use the euro as a proxy, the 2008 average rate on the euro was about 1.47, and for the last several weeks it’s been fluctuating in the 1.25 to 1.30 range, so that’s about an 11 to 14 percent impact on about 30% of our revenue, so if you take a mid point on all that, you’re talking about a $20 million impact on our total revenue of $495 to $515. So if you take that into account, we’re talking about growth rate on a constant currency basis is in the 2.5% to 7% range.

David Lewis – Morgan Stanley

Tony, looking at American Med the last 8 years versus the last 8 to 12 months, what is the new growth rate as you think about the next 24 months? This was an 18 to 22 percent grower five years ago or four years ago. It’s become sort of a 10 to 12 percent grower now constant currency, albeit in a difficult year, anywhere from 2 to 7 percent; let’s call it 5%. As you look out the next three years, is that number three, is it five, is it ten?

Tony Bihl

As we’ve talked about it, if you look at the implantable business, we reported today that even for 2008, the implantable businesses saw mid teens growth. That’s probably in the neighborhood of 14 to 16% range that you were talking about in the past for the company, and as we’ve talked in the past, our capital businesses are those that have been consistently declining, and so our objective is to get those capital businesses turned and becoming profitable growth contributors for the company. We’ve talked about the laser therapy as the one that we’re putting a tremendous amount of focus on and that we’re careful in how we predict that because we know that we have a lot to learn there and we have to get some turnaround done, but we see that being in the high single digits and maybe double digits range if we can get our arms around that and get it turned in the right direction, so you combine the numbers together from that current portfolio, and that gets you in the ballpark. I think you’ve got to keep in mind, this implantables business, the continence business, erectile restoration, prolapse business, are still seeing very strong growth, and perhaps even growth rates similar to what you remember in the past.

David Lewis – Morgan Stanley

The word product innovation has come up several times in this conference call. I know it’s been the hallmark of American Medical. Tony, given that this new technology individual is a critical function you want to bring internally, do you think American Med is in the midst of a product cycle void, or do you think the product cycle was as robust as it has been historically, but the company has just been hit by a series of external or exogenous factors?

Tony Bihl

As you know in the year 2008, we brought a very strong new product to marketplace in the prolapse business in Elevate, and we have high hopes for Elevate Anterior as we go forward in2009. We’re working diligently on our laser technologies, and we’ll do some interesting things in that marketplace, so I don’t have great worries about where we are from a technology perspective. I think it might appear to be a little bit of a void in some areas, but we’ve got new things in the pipeline. We’ve got good product line extensions, and we still have some very exciting things in terms of what we’re doing in neuromuscular stimulation with our products, in terms of Continuum, in terms of Topaz, so I think there’s a lot of exciting stuff out ahead of us here. There was a comment about the money we’re spending in R&D, and clearly the recognition of 10% partially is because of the increasing demand on clinical data that we’ve got to be prepared for with the kind of products that are coming out in the market in the future. I have good high hopes and positive prospects for what’s coming next. I think the message that I clearly want to send with this idea of bringing a senior technical leader is that we want to keep ourselves in that forefront. During Ross’s tenure, we’ve built very strong R&D leadership in each of our business units, and I think that’s a strength for us. We’re increased the talent in those teams, and they’re coming up the curve very quickly. So again, I’m positive about what I see for our future there.

David Lewis – Morgan Stanley

This may frankly, Tony, just be semantics, but for the last ten years that we’ve watched American Med, there has always been this COO function. Maybe just talk in more specifics about how comfortable you are that the GM structure gives you the same type of operating visibility and control as a COO structure.

Tony Bihl

Let’s separate out personalities and people from it because obviously Ross is a huge asset to the company in many more ways beyond what we call that role, but my experiences have been to have general managers reporting directly to me in previous companies. It gives you a very close firsthand understanding of what’s happening in the business, and it’s a very workable plan when you find the right talent. AMS has the right talent in those roles, and so I think we’ll do a very effective job in managing as we go forward there, so I think some of the history with AMS, probably a chief technology officer migrated to chief operating officer, and again a lot of that is the talent that we have and the additional roles they can take on, but I’m very comfortable with the structure we’re talking about in the future. We’ll flatten the organization a bit, and what happens with times like that is new talent gets to step up and fill the void, and I think that’s a great opportunity for the leadership in the company. Again, very comfortable with the structure. Sorry, not to have Ross as part of the leadership team, but great companies are built with more depth, and I think AMS has that depth, and we’ll be okay.

Operator

Your next question comes from the line of Tycho Peterson.

Tycho Peterson - J.P. Morgan

Question on Ovion, for starters, I assume that wasn’t significant in terms of R&D spend, but if you could help us think about that with regard to your comments before about going to 10% on R&D, and then also what your best guess as to what happens? Is that a sale of the product, or you just pull the plug and let it die out? How do we think about that?

Tony Bihl

First of all, over the last year of 2008, it hasn’t been a huge absorber of R&D expenses. As you know, after the clinical studies that we did, we put a focused team together to look at could we come up with a real game change here in terms of technologies, and I’ll say very positively that we’ve continued to add to the intellectual property portfolio on Ovion. I think as we said in the dialogue here earlier as we look at the time horizon before a product comes to market as we look at the competitive landscape out there and as we look at the cost and risk of bringing a product to market, we just back up and ask ourselves is there a better way or is there a better answer for AMS, and so I want to reinforce that we don’t preclude that one of the options is to go forward with developing a product and bringing it to market, but I think like any good business we stop and ask ourselves a question is this portfolio more valuable monetized in some other way, and so I think that sort of speaks for itself. We’ll see whether the technology might be more valuable to someone in the near term, and based on what we find out there in the marketplace, we’ll make a decision about how to go forward, but we’ve stopped the development work now. We will focus the small amount of research money we were focusing in this area on other projects, and we are all about focus on some key aspects of new product technology, and we’ve talked a lot about those, and so I think this will allow us to be focused.

Tycho Peterson - J.P. Morgan

Maybe one for Ross on MiniArc. I know you’ve been a big supporter of the product. How do we think about where we are in the adoption cycle and the growth going forward?

Ross Longhini

MiniArc has still done very well for us, but it still represents, I think, maybe a quarter or third at the most of our total sling business, so it’s got a long ways to go. However, having looked through a product development cycle that was a little too slow on the sling business between Monarch and MiniArc, we realized that keeping that line fresh and exciting is important to us going forward, and so what you will see is a more for rapid cadence of new products in competitive marketplaces like incontinence and prolapse in order to keep the growth rates high, so long ways to go yet, but it is between a quarter and a third of our market by the way, just verified that. It’s got a long ways to go yet, and we have a lot of new exciting technologies that are built off that platform to make that procedure even less invasive over time and to continue to hasten the recuperation period with which people can get back to normal activities.

Tycho Peterson - J.P. Morgan

Just one on the international markets. Tony can you remind us, with Japan you’ve got the three products—AUS, Monarch, and HPS, can you remind us how we should be thinking about timelines and your progress there?

Tony Bihl

We’re still moving ahead on our product registration activities. As you know, the time horizon in Japan is often in excess of a year after you submit all the data that’s required for the registration applications, and so our thought process is during the year 2010, we’ll begin to see the revenues in Japan. That’s how we are doing our planning.

Operator

(Operator Instructions). Your next question comes from the line of Brooks West with Craig Hallum.

Brooks West – Craig Hallum

Mark, as you look at the balance sheet, and I don’t have your debt schedule in front of me, but given where you are in the leverage ratios, can you remind me when is your next ratio step-down? Then as you look at the $85 million in pay down scheduled for next year? Does that skew to the convertible opportunity or how are you approaching that?

Mark Heggestad

Our covenant actually have a gradual step down usually by quarter, so for instance as we look out over the coming year, it ranges anywhere from 4-1/2 here to day to 3-1/2 by the end of 2009, so we are doing very good in terms of putting cushion between that required covenant, and that’s our total leverage ratio. There is a number of covenants, but that’s the one that’s usually been the closest in the past and continues to be the closest, and again we’re putting quite a bit of cushion on that. In terms of taking advantage of the convert, we’re going to continue to look at those opportunities. Our number one goal is to just reduce debt as quickly as we can. A person can ask why didn’t we do even more. We did have little bit more available to us in 2008 as we were winding up the year. There were two reasons. One is that we did want to maintain a pretty high level of cash, and we weren’t certain how much cash we’d pull in as we got closer to the end of the quarter, but secondly, once we got into the market and started buying, we did see that discount rate start to evaporate a little bit on us, and then as we’ve gone forward here in January and early February, the discount rate is evaporating even more, so we are going to be very opportunistic as we go forward, but each time we have cash available to us, we’ll look at whether it makes sense to retire some of the converts on the open market or just go ahead and continue to apply it towards our senior security debt.

Brooks West – Craig Hallum

Tony, as you look at the Laserscope business which is still falling off or maybe is decelerating, are you looking at that trend continuing into 2009, and when do you think in a long-term view that business might kind of start to turn around?

Tony Bihl

We look at 2009 as sort of the turnaround year, and many of the changes that we’ve made, particularly I described the changes to the US sales force, and if we look at the sale force outside the US, we’ve agreed to put a significant number of new sales reps in the field particularly in this surgical procedure area for procedure utilization and fiber sales, and we began the year with openings in that area, and we are working diligently to get those filled, so I suspect that the first half of the year we will continue to see the trends we have been seeing, and as we continue to move through the second half of the year, we expect to see or hope to see some positive trends in that area, so I think we’ve tempered our expectations there. That said, from our sales meeting, it was exciting to see that our men’s health, women’s health, and full line reps very actively and very positively took on the laser business. I think they see it as a very positive therapy to bring to the physicians they know. It’s a no-brainer from their perspective to get somebody, to get a physician started up to consider GreenLight. Every US sales rep at AMS now has the opportunity to earn a little extra money by promoting GreenLight, and more than 40 of our men’s and full line sales reps now have GreenLight as part of their quota in addition to the laser therapy reps themselves, so we’re putting an awful lot of support behind this and watching it very carefully so it doesn’t impact any other parts of our business, but I’ll tell you the positives. Our people say we’re going to give this a really good shot and we’re going to really bring GreenLight technology to the marketplace full way leveraging the AMS brand, and so I really have high expectations that in 2009, we’re going to get a very clear, much clearer picture about where this is going to go, and I remain optimistic about it.

Brooks West – Craig Hallum

Tony, do you see a bigger opportunity in the US versus OUS or how do you see those markets playing out for Laserscope?

Tony Bihl

OUS as a percentage versus other AMS products, OUS and laser is something like 40% of the business, but I think there are some new markets that are opening themselves to us. We’ve gotten some recent approvals and some new geographies for the GreenLight including Brazil latter part of last year and now China just recently this year where the GreenLight has now been approved for distribution in those markets as well, so I think there’s some upside potential that’s going to come from those, but I suspect that again all the world economies are under some strain, so we’re kind of looking at it from a whole balanced approach, sort of a combination of US and international and not relying on either one or the other to be the driver of growth, different slightly than other parts of our business.

Operator

Your next question comes from the line of Jonathan Block with SunTrust Robinson Humphrey.

Jonathan Block – SunTrust Robinson Humphrey

First question just has to deal with the specifics behind the increase in the Laserscope gross margin. In other words, what do you think we can get on the fiber, what do you think we can get on the console, and how do we view that, do we view the increase as linear throughout 2009?

Mark Heggestad

I’ll answer the latter part of your question first. It won’t necessarily be linear. We’ll probably see some of these improvements somewhat linear throughout ’09, but as we’ve seen in this business, there’s a lot of seasonality in this business. It is similar to other businesses but even more it’s usually a somewhat soft Q1, stronger on Q2, a very soft Q3, and then a very strong Q4, and so with that you have volumes that go through the factory at different points in time and that certainly has an impact on your margin, so you won’t actually see linearity in the margin as the year progresses. In terms of where that margin will come from, probably as opposed to talking about it on fiber versus console because actually mix is one of them so it actually gets hard to talk about it that way, there are there main drivers that’ll drive that margin improvement. One is just reduction in cost, and the factory out in San Jose and factory in Phoenix have a number of initiatives in place to drive cost out of the product. Second is reliability. Again, there’s been significant improvement in reliability over the course of 2008. I think we’re going to really start to see reaping and rewards from that as we flow through 2009 in terms of warranty cost, service cost, those types of things, and then as I mentioned at the beginning, the third part of that increase in margin is just from a utilization standpoint. There is significant focus on driving utilization of this fiber, and with that we expect there will be some increase in mix of fibers versus consoles, and that’ll have a natural impact on the gross margin improvement as well.

Jonathan Block – SunTrust Robinson Humphrey

The second question really has to do more with sentiment. If you go back to last quarter, you were looking at an economy that was arguably falling apart, maybe that hasn’t changed, but that while that swings, you had the letter on the meshes, and in light of that you post a solid quarter, you’re able to re-exhale, prolapse at double digit. At some point throughout the quarter, you get the approval on the prolapse for the product, so last quarter you guys sounded very conservative. You sound a bit more upbeat. Do you feel better standing here today that you got the product portfolio to fight through this? You have the ability to leverage the P&L and delever the balance sheet to deliver the double digit plus on the bottom line?

Tony Bihl

I think the uncertainty in the marketplace has not been reduced at all. One could argue it’s becoming more difficult, and as we see the European economies going through the struggle that it’s going through as well. I guess I would say though that we’re smarter every day about how to manage in times like this, and so I feel confident in our ability to adapt and adjust as we need to. As you said in the fourth quarter, the public health notice didn’t have the impact. It was not clear to us what might happen there. We were positive about our position, but we were pleasantly responded to in terms of how physicians looked at the notice, and they responded as we hoped they would. They were careful and thoughtful about how they used the meshes as they always had been, and so we didn’t see a big change in our business, but I think anybody who tells you that the economy is clearer to them now is optimistic at best, so I think that’s still out there. I just say I think we’re smarter every day about how to manage our way through it, so I think our guidance reflects how we really feel and that is that we’ll continue to plough through with growth. we will continue to drive markets. We’re not going to let ourselves get so conservative that we miss opportunity, and I think that’s important at times like this. We’ll be bullish where we see opportunities, and we’ll go after them strongly, but we are going to be careful how we do it overall.

Mark Heggestad

Jonathan maybe I’ll just add to that. You asked about what that means on the bottom line as well in terms of growth rate, and again I think you take into account what Tony was talking about on the top line, certainly can put some pressure on the bottom line. I think we put some very good leverage in place, and we’ll watch this very carefully, and I think there’s quite a bit of confidence around us that we certainly should be able to drive double digit growth on the bottom line as we go through this economy.

Jonathan Block – SunTrust Robinson Humphrey

Specific to the FDA letter on the meshes, do you think four months is ample time to say you believe it’s behind you?

Tony Bihl

We would like to think that, but I think what we have said is we don’t see any impact on revenue growth. The dialogue out in the marketplace continues, and we all know that there are some cases where there are attorneys who would like to get class action kind of things going and so we’ll just remain in our current position, that is we’ll continue to educate the marketplace as best we can, work with the physicians that we work with and keep doing our business, but I think to say that everything is behind now might be little bit premature.

Operator

Your next question comes from the line of Jayson Bedford with Raymond James.

Jayson Bedford – Raymond James

Just in terms of the Her Option business, I guess what have you done or what can you do to improve the profitability?

Tony Bihl

Our primary focus is as we’ve described and that is we focus less on console sales and more on continuing to promote the usage of the probe and the procedure, and if you think about it in the razor-razor blade model, there’s a lot less margin associated with selling the equipment itself and more profitability in selling the probe, and so we’ve focused on that area. We spread the sales load around a little bit differently than we had in the past and so there are more people in our US sales force carrying the probe, but there are less people purely focused on that role, and that’s reduced some of our selling expenses in that area, and so we think we can continue to drive profitability in that way.

Jayson Bedford – Raymond James

Secondly, reimbursement has been favorable for most of your portfolio. Any thought of taking price in 2009 in any of the key products?

Tony Bihl

Built into our financials are some price increases for 2009, and I think we’ve done a fairly good job in the past of driving that. It’s a value proposition that seems to hold up fairly strongly, so we have some assumptions on price increases built into our 2009 planning.

Jayson Bedford – Raymond James

I don’t mean to pin you down, but are we talking to 1 to 2% across the board?

Tony Bihl

In those ranges.

Operator

There are no further questions at this time. Do you have any closing remarks?

Tony Bihl

Again for everyone, thanks for joining us on the call today and for your continued interest in American Medical Systems. Fortunately even in this tenuous economy our diverse portfolio of products maintains a strong leadership position. We’ll continue to take the actions necessary to maintain the leadership including our ongoing focus on leveraging our cost structure and generating cash flow and paying down our debt, so thanks again, and we’ll look forward to talking to you all at the end of next quarter.

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