American Medical Systems Holdings Inc. Q3 2008 Earnings Call Transcript

| About: American Medical (AMMD)
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American Medical Systems Holdings Inc. (NASDAQ:AMMD) Q3 2008 Earnings Call November 4, 2008 5:00 PM ET


Tony Bihl - Chief Executive Officer

Ross Longhini - Chief Operating Officer

Mark Heggestad - Chief Financial Officer


Tom Gunderson - Piper Jaffray

David Lewis - Morgan Stanley

Philip Legendy - Thomas Weisel Partners

Greg Simpson - Stifel Nicolaus

Jason Bedford - Raymond James

Jean - JP Morgan

Jonathan Block- Suntrust Robinson Humphrey

James Sidoti - Sidoti & Co.


Good afternoon. My name is Felicia and I will be your conference operator today. At this time I would like to welcome everyone to the American Medical Systems 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions). Mr. Bihl, you may begin your conference.

Tony Bihl

Well good afternoon. This is Tony Bihl, CEO of American Medical Systems. Thank you for joining us on today’s call to discuss American Medical Systems third quarter results. With me this afternoon are Ross Longhini, our Chief Operating Officer; and Mark Heggestad, our 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 that 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 American Medical Systems third quarter 2008 earnings release, including the financial tables which are part of the release. With these statements we can move forward with reviewing the AMS business as covered in the press release issued earlier today.

So American Medical Systems posted a solid third quarter with revenue and earnings achieving our guidance. Total third quarter revenues were $117.5 million, an increase of 7.7% over a comparable period of 2007 and above the mid point of our guidance of $114 million to $120 million.

Non-GAAP EPS adjusted to exclude a $7.5 million in-process R&D charge were $0.14 for the third quarter, or an increase of 56% over the third quarter of 2007 and at the high end of our guidance of $0.11 to $0.14.

Once again, our strong focus on expense management resulted in improved operating leverage and favorable cash management which enabled us to generate $32 million in cash from operations and reduce our debt by $37 million in the quarter and $79 million through the first three quarters of this year, well above the $50 million we originally guided at the beginning of 2008. Both inventory turns and DSOs improved again this quarter ahead of the initial expectations going into the quarter.

Now, we would be remiss as managers if we didn’t acknowledge that the global economic turmoil has had some dampening affect on our business. Though the impact is difficult to quantify, numerous indicators suggest increasing pressure on a few of our businesses. As a result this outlook has prompted us to reduce our 2008 revenue guidance in order to adopt a more cautious stance, particularly as it relates to foreign currency and demand for certain products, tightening spending on capital equipment and some reduction in surgical procedures.

Taken together we’re providing fourth quarter guidance as noted in our press release of revenues in the range of $126 million to $132 million and earnings per share in the range of $0.21 to $0.25. Mark will provide more details behind our guidance in a few minutes. So while the global economy is a variable that we can’t control or predict we do have a solid handle on our business fundamentals and our product portfolio, both of which are strong.

As we’ve discussed before, AMS is a portfolio company characterized by several high performing product lines, which hold leading positions in attractive markets all focused on [inaudible]. If we do operate two unique business models, one an implantable medical devises business comprised of our continence, erectile restoration and prolapse repair product lines and two, a capital and trailing disposable business including Laser Therapy, Her Option and TherMatrx.

The implantable medical devises business continues to generate strong top line growth with operating margins in the high 20% range. Three of these businesses have annual sales of around $100 million and are growing at or above expectation. Clearly, AMS has mastered the business model for implantable devises through 35 years of technology leadership, close connection with physicians and profitable growth.

The capital equipment and disposables business requires a different business model and a different go to market approach, which we continue to refine. We have not yet achieved a model which provides consistent growth and predictability in these businesses and our third quarter results show performance below our expectations in Laser Therapy and Ther Matrx and Her Option. All three declined in sales quarter-over-quarter.

We’re still learning how to master the differences required to operate these capital businesses and leverage the strength of the AMS brand with physicians. I’ll return to discuss our Laser Therapy business before going into the Q-and-A session later.

As with any portfolio, at any one time, some businesses are performing above, some at, and some below expectations. The significance of our portfolio approach is to bring stability to AMS while developing those businesses in new therapy areas for our future. This is evidenced by the third quarter’s positive results even in the face of economic challenges and lagging capital equipment businesses.

Our objectives for the remainder of today’s call include the following: First, Mark will provide some details on our key financial results for the third quarter and guidance for the fourth quarter and fiscal 2008. Then Ross will follow to provide some summary of our products. Finally I will return to discuss our Laser Therapy business in more detail and then our regular question-and-answer session will follow to allow you time for further review of our quarter.

I’ll now turn the call over to Mark Heggestad.

Mark Heggestad

Thank you, Tony. Our third quarter 2008 revenue was $117.5 million, representing a 7.7% increase over $109 million in a comparable quarter of 2007. Our third quarter revenue profile was very similar to what we’ve experienced in recent quarters. We had very solid growth in our implantable businesses led by male and female incontinence; however, the strength in our implantable businesses was once again partially offset by decline in our capital related businesses, i.e. Laser Therapy, TherMatrx, and Her Option.

While we do not believe the economy is a primary contributor to our sales performances in these businesses we do believe there’s an impact especially as it relates to more elective procedures and our capital based sales.

Third quarter Men’s Health revenue of $78.2 million grew 5.7% over the comparable period last year, excluding Laser Therapy for Men’s Health results in growth of 12.2% over the third quarter last year. This growth was driven by modest performance in the erectile restoration business and significant growth in male continence, driven equally by the Advance Sling System and Artificial Urinary Sphincter with InhibiZone.

The Laser Therapy product line declined 6.2% from the same quarter last year representing an improvement over second quarter performance but below expectation. Geographically, the Laser Therapy shortfall had a different mix in previous quarters. For the first time in several quarters we saw modest growth in the US market primarily driven by growth in the mobile provider sector; however, this was offset by increased decline in the international markets.

International Laser Therapy revenue was not down across the board, but several select markets show declines in the third quarter. In a few minutes, Tony will elaborate on the Laser Therapy business, our findings surrounding the market opportunity and initiatives we are putting in place to optimize this business.

Women’s health continued its double-digit growth with third quarter revenue of $39.3 million growing 11.9% over the comparable period last year. This growth was driven by continued momentum from MiniArc Sling System used to treat female incontinence. Prolapse repair maintained its single-digit growth in the third quarter and we look forward to the potential provided by the recent launched Elevate Posterior and the future launch of Elevate Anterior.

Her Option on the other hand continues to be a very volatile business down 16% in the third quarter versus the same period a year ago. We believe the Her Option business is hampered even more so by the current economy as is one of our more elective procedures, it has a high capital component to it and physicians based purchases appear to be more highly impacted by economic conditions than hospital-based purchases. Nevertheless, we continue to drive initiatives to stabilize this product line.

Total US third quarter revenue grew 7.0% over the prior year to $84.5 million. Total international third quarter revenue grew 9.8% to $33 million. Favorable foreign exchange rate comparisons between years added $2.1 million to the international growth.

As noted in the second quarter conference call, the company recognized in the third quarter of 2008 an IPRD charge of $7.5 million related to a milestone payment on the 2006 acquisition of Biocontrol. This payment represents continued progress in the development of our product line, which will initially address urge incontinence and interstitial cystitis. Ross will elaborate more on this exciting technology in a few minutes.

Excluding the impact of this IPRD charge the company reported third quarter net income of $10.3 million or $0.14 per share. This compares to net income from continuing operations for the same period last year of $6.9 million or $.09 per share. This represents a 49% increase in earnings growth over the prior year and on a year-to-date basis, net income of $32.5 million has increased 75% over the prior year. All dialogue in the remainder of this conference call will exclude the impact of the $7.5 million IPRD charge.

As with the first two quarters of 2008, we continue to reach significant benefits driven by our focus and execution on expense and cash management. Despite a potential softening on the top line related to current economic conditions we are confident in the ability of our management and employees to continue to drive increased efficiencies and leverage throughout our business, thus insuring the strength of our bottom line performance.

The third quarter 2008 gross margin percentage was strong 78.8% versus a gross margin percentage of 77.6% recorded in the comparable period of 2007. The 2008 third quarter gross margin represents the continued high margins we have historically experienced with the base business, 85.8% in this third quarter, combined with relatively lower Laser Therapy gross margins, which were 52.1% in this third quarter.

We have discussed in prior quarters the many initiatives we have pursued to drive the Laser Therapy gross margin. This quarter’s results reflect some of the benefits of that hard work and we look forward to continued improvement going forward.

As we have stated throughout the year, we are committed to leveraging the operating investments we made in 2007. This was evident in no quarter more so than this third quarter. 2008 third quarter operating income margins came in at 21.3% versus the comparable margin a year ago of 16.3%. Marketing, selling and G & A spending were down year-over-year. R&D spending of 11.3 million increased 13.5% over the prior year, but is very close to our targeted R&D spend of approximately 10% of revenue.

As a result of the continued pay down of our debt and proactive management of our interest rate, 2008 third quarter interest expense of $6.2 million was down significantly from the $9.5 million incurred in the third quarter of 2007. This decreased interest expense is driven by a combination of reduced debt. We paid down $79 million of our debt in the first three quarters of 2008, as well as, a reduction in the floating interest rate on our senior secured debt.

Royalty income in the third quarter 2008 of $700,000 is a normal run rate for us, but is down significantly from the $3.5 million of royalty income recognized in the third quarter of 2007. 2007 contained a one-time payment relating to licensing of our microwave therapy technology.

The 2008 year-to-date tax rate excluding the impact of the Biocontrol IPRD payment is 40%, up from the full year 2007 adjusted tax rate of 38.2%. The primary item impacting comparability between years is the loss of the federal R&D tax credit in 2008. As part of the Emergency Economic Stabilization Act passed on October 3, 2008, the R&D tax credit was retroactively reinstated for 2008. The impact of the reinstated R&D tax credit will reduce our full year tax rate by a little less than one percentage point and will be entirely recognized in the fourth quarter tax provision.

We ended the third quarter with a cash and short-term investment balance of $35.8 million; cash generated from operating activities in the third quarter of 2008 was $32.1 million, compared to $14.2 million in the same period last year. Continuing the strong gains we saw in the first half of 2008 we reduced our accounts receivable by $6.8 million, compared to the same time last year and we have improved DSOs 12 days.

This improvement is particularly significant given we have an increasing percentage of our sales coming from international locations where sales terms are longer, but we continue to offset that phenomenon with marked improvements in each of our geographies. We are confident we will achieve our DSO improvement 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 in 2008. The company has put in place several initiatives to optimize our inventory levels and we continue to experience real improvements in all manufacturing locations.

In addition to the significant progress in working capital management, also contributing to cash provided by operations was continued leveraging of the 2007 investments in the sales marketing and G&A infrastructure, as we continue to drive initiatives to optimize our investments in these areas we anticipate continued momentum in our cash generation and debt pay down.

The company paid $37.3 million on our senior secured debt in the third quarter bringing the quarter end balance to $235 million. These prepayments will provide for improvement against future financial covenants and reduced interest expense. In fact, our current projections indicate our total leverage to EBITDA ratio will be under four by the end of the fourth quarter, a significant milestone as we endeavor to gain financial flexibility in our capital structure. This will represent significant progress since the Laserscope acquisition when our total leverage ratio was 6.3 times.

In early 2008 we guided that debt total pay down in 2008 would be approximately $50 million. We increased that to $70 million in our second quarter conference call. With $79 million of debt pay down year-to-date, we will now increase the 2008 projected debt pay down to $85 million.

We historically do not generate a significant amount of cash in the fourth quarter due to the seasonal increase of inventory build, receivables and the timing of tax payments, and finally given the current economic times we believe it is prudent to increase our cash and short-term investment balance on hand at the end of the fiscal year. With that said, let me assure you our revolver commitment to remain available to the company and we are not faced with any near term debt maturities.

Capital expenditures during the first three quarters of 2008 were $4.1 million, compared to $13.9 million in the same period last year, when we were completing the expansion of our corporate headquarters and upgrading our ERP system. We expect 2008 full year capital expenditures to be well below our initial guidance of $15 million.

I would now like to discuss our fourth quarter outlook. As Tony will elaborate on in a few minutes we have significant work ahead of us before we will realize the full potential of our Laser Therapy business. Although we are confident in the continuing success of our implantable business, we are cautious in our outlook as a result of the recent declines in our capital businesses, the impact of the economy in general and the continued strengthening of the US dollar.

Based on these concerns, we are guiding our fourth quarter revenue to $126 million to $132 million and a resulting 2008 full year revenue guidance of $494 million to $500 million. Despite the caution built into the revenue guidance we are very confident in our ability to manage the bottom line, and therefore guide fourth quarter EPS to a range of $0.21 to $0.25 and resulting 2008 EPS of $0.65 to $0.69. This guidance excludes the impact of any unusual non-recurring type charges such as the IPRD charge recognized in the third quarter.

Finally, I bring your attention to required change in accounting that will impact our 2009 net income and earnings per share. As most of you know and in May of 2008 the FASB finalized new rules on accounting for certain convertible notes, this will impact how we account for our $374 million convertible note. This new accounting will become effective for us the beginning of 2009 and will require retroactive restatement of our financial statements beginning with the year we obtain the notes, which was mid 2006.

Although we have not completely analyzed the full extent of the accounting change our initial estimates indicates that these new requirements will impact our 2009 reported GAAP EPS by approximately $0.13. It is important to remember that this accounting change will have absolutely no impact on our cash flow.

I will now turn the call over to Ross.

Ross Longhini

Thanks Mark. I’d like to take a few minutes to review key operational topics related to each of our product lines. For starters, while not at the exceptional growth rates of the prior quarters, our male continence products continue to do very well with sales up 25% year-over-year. AdVance, our male sling product and artificial urinary sphinct with InhibiZone continue to pace growth in this segment even though both products anniversaried their introduction in our largest markets.

We were pleased to have eight abstracts regarding our male incontinence products presented at the recently held international continence society meeting in Cairo. Our erectile restoration product line grew at the lower end of our growth expectation, which we believe is partly attributable to the effect of slowing economy has hired on those procedures that are not considered immediately medically necessary.

We recently received FDA approval for our new malleable penile prosthesis, Spectra, and are now preparing for market release, which will occur during the first quarter of next year. This product combines the best features of our three malleable product lines and will benefit our operations team by significantly reducing the number of items we manufacture and inventory.

Later this quarter, we will launch additional surgical tools that are intended to improve ease of implantation and simplify operating room logistics for all of our penile prosthesis. Tony will be elaborating on the laser business during the call so I will limit my discussion on Laser Therapy to two operational items, namely, reliability and manufacturing cost.

The reliability of the HPS council continues to improve throughout our entire installed worldwide base. Our average time between service call is now over a year and has increased dramatically since the product was launched. Our operations teams have done an excellent job of implementing cost reduction programs for both the councils and the fibers.

We have reduced the direct expenses associated with the council by $3400 for this year and for the fibers by $19 this year. These projects along with the pending cost reduction initiatives position us well for achieving our target of increasing the gross margin of this business by 10 percentage points this year.

Turning to our development stage product continuum, which is used to reduce the time required for an anastomosis of the urethra and bladder in a radical prostatectomy procedure. We have recently reinitiated in OUS clinical study in order to gain more feedback on the recent improvements we have made to the device and procedure. We continue to monitor that data and once completed, we will decide upon our market launch plans.

In our women’s health business, our female continence product line continues to perform above expectation. While growing in excess of 20% during the quarter, we do expect this growth rate to moderate somewhat as we saturate the MiniArc early adopters and wait for longer term clinical data to become available.

Although MiniArc partially anniversaritive launch in the third quarter its momentum does still continue. MiniArc now represents over 20% of all of the female stress incontinence procedures done with our product. Our female incontinence products were well represented at the American Urogynecologic Society Meeting in September as well as international continence society meeting held last month will be at 15 abstracts presented.

The prolapse repair business grew 7% in the quarter very similar to our growth rate in the second quarter. We did begin elevate posterior position training during the quarter and have been very enthusiastic about the physicians reactions to the product. We have trained approximately 300 physicians who have done over 900 cases today.

Currently we have enrolled over 150 patients in the Elevate Posterior study including both the fully synthetic and the biologic version and early results continue to be very encouraging. We recently began our clinical study of Elevate Anterior and plan to begin a phase rollout during the first half of next year, although the timing is dependent upon gaining FDA 5 10-K approval. Our initial results have been very promising. We do expect Elevate to accelerate the growth of our prolapse repair business.

We are quite enthusiastic about reaccelerating the growth in our prolapse business with new products and new clinical data. However, this enthusiasm is somewhat dampened by the uncertainty associated with the recent FDA public health notice regarding prolapse and female stress urinary incontinence procedures which utilize mesh.

For those of you who have not read the notice, the FDA posted a notification on October 21st stating that they have received more than 1,000 reports of complications from nine manufacturers during the last three years, which regards to the use of mesh when used trans-vaginally to treat pelvic organ prolapse and stress urinary incontinence.

The notification suggests that physicians received specialized training, be vigilant in looking for complications, be watchful for surgical procedure complications, and properly inform patients regarding potential complications. The notification does not allege any product defects or malfunction.

AMS has filed approximately 50 medical device reports with the FDA during this three-year period, while our products were used to treat nearly 300 thousand patients. We believe that the clinical data for mesh augmented pelvic floor repair continued to be very compelling. Our experience with [APA G] and [PARA G] for instance have shown that prolapse recurrence rate is 5% to 10% which compares with the 30 to 50% for traditional procedures that do not use mesh.

Interestingly the complication rates are quite similar for both mesh augmented repairs and traditional repairs. For example, that this perennial rate is similar for both types of procedures. Obviously, mesh exposure is not a problem with tradition repair techniques; however, this complication is most often treated by simply applying topical estrogen cream to the exposed site.

Although it is difficult to determine the effect of this information on future growth rates, the physicians we have talked to have overwhelmingly fitted that they believe in the use of mesh augmented repairs particularly given their higher success rate and similar complication rates relative to traditional repairs and will continue to use them for treating their patients.

Moving to Her Option. We continue to work on improving our sales and marketing efficiency. We have seen that making changes to our sales structure has resulted in some significant swings in revenue performance; however we do intend to find the right balance between top line growth and profitability. We still believe that Her Option is an excellent choice for physicians and their patients; however calling on the gynecology office has not been strength for AMS.

We plan to continue to make changes to stabilize the revenue while improving the profitability of this product line. Similar to what we have learned in the laser business we must place more emphasis on procedure growth relative to council placement.

Turning to our neuromuscular stimulation technology, we expect to first launch successor for the treatment of interstitial cystitis outside the United States during the first quarter next year. The study for US regulatory approval of the female urge incontinence application of this technology is slated to begin in 2009.

As Mark mentioned we did make a $7.5 million milestone payment to Biocontrol during the quarter. This milestone payment was made based upon the substantial completion of the technology transfer. The original purchase agreement was slightly amended such that AMS agreed to pay the milestone prior to 100% completion of the milestone in exchange for reducing our reliability in the event that future disputes were to arise between Biocontrol and AMS.

Finally, our colorectal product line is comprised of Acticon or artificial bowel center and the development stage product Topaz a less invasive device intended to treat mild to moderate fecal incontinence. As I have mentioned before this technology is truly exploring new ground and is therefore subject to clinical efficacy risk. We implanted 29 patients in our initial feasibility study and only have short-term follow-up so far.

The initial results are promising; however, further follow-up is needed. We will have six-month follow-up on 20 of the patients by January. Based upon this information, we will make plans for our next step towards clinical understanding and regulatory approval.

With that summary, I will now turn the call back to Tony.

Tony Bihl

Thank you, Ross and Mark for your commentaries. Let me now turn to the Laser Therapy business. On our second quarter call we said that we would provide you with more details on this call and the subsequent fourth quarter call about our plans to turnaround the Laser Therapy business.

I want to first emphasize while improving the Laser Therapy business is a high priority we will do this in a manner, which does not compromise the investment and management effort needed to support our implantables business. We’ve made significant progress to date to improve the performance of Laser Therapy. System reliability has improved dramatically, the Go program was launched in the first quarter to increase awareness through patient and physician out reach and we’ve rebuilt the relationships with mobile providers who account for approximately 60% of our US sales.

Our market research is confirmed a number of things that we knew about the laser technology, namely that GreenLight is regarded highly among physicians who treat BPH, because it provides the ideal combination of effectiveness, minimal side effects patient satisfaction and physician productivity.

The research also verified that physicians continued to transition away from the more in base of TERP procedure, to less invasive therapies like GreenLight to go at a slower conversion rate than was expected. During the third quarter we completed more in depth analysis of the US market and our Laser Therapy business plans with the help of an outside business-consulting group.

This research concluded that there was minimal growth in BPH surgical procedures over the last two years due to increasing use of pharmaceutical therapies. However, the underlying demographic trends, the ongoing shift away from invasive TERP procedures, the increasing number of patients seeking treatment for BPH, these all suggest that the market remains attractive for us.

With that is a backdrop I’d like to discuss four initiatives that we’re pursuing in our Laser Therapy business. As mentioned earlier, AMS has mastered the medical implantables business model. However, our experience in research had convinced us that capital equipment and disposable businesses pose unique challenges and require a different business model and go to market approach to achieve similar master it.

To accomplish this, AMS will form a BPH therapy division, separating this from our current Men’s Health division and staffing this business with leadership, experience, and operating this business model. In this way we will organize a full business team devoted to improving the Laser Therapy and TherMatrx businesses. We are currently recruiting for a VP level Manager for this business and expect to have a person on Board within the next few months.

Next we’ve analyzed our sales approach for the business. To date the Laser Therapy sales organization has largely operated on the legacy structure that came with the Laserscope acquisition. As a result, the sales force is distinct, and the rest of the AMS sales force, which has been calling on urologists for 35 years in both numerous long term and productive relationships. As such, we have not fully capitalized on the benefits of those longstanding ties.

The focus of the Laser Therapy sales force has primarily been on placement of the laser console, where we’ve had some success. However, we have placed less focus on growing the utilization of the console and this limits fiber sales and ultimately impacts the volume and stability of sales overtime.

So in order to build this business, we have to be effective at both placing new laser consoles and driving fiber sales. We understand that these activities require different selling processes and different call frequency with physicians. We’re now developing specific plans which will focus more sales effort and resources on driving fiber sales through utilization of the existing install base of consoles without negatively impacting our console sales. This will ultimately be the basis for sustainable growth in this business.

At the same time, we want to strengthen the connection between the implantables and Laser Therapy sales forces, to more effectively leverage the strong physician relationships across all AMS product lines under a theme One AMS, but for competitive reasons we’re not prepared to discuss more details about this initiative today and we’ll be in a better position to discuss it on our next call.

Third, we’re driving to a 10-percentage point improvement in gross margins in our BPH business over the next 12 to 18 months. This will result from a combination of reducing manufacturing cost on both the fibers and consoles, and improving service costs through system reliability and efficient deployment of our service personnel.

As we’ve discussed on the last call and today’s call we’ve already made significant progress in trimming costs and upgrading reliability, but there’s stillroom that exists to take out more cost. A diligent focus on reducing our cost will enable us to compete more effectively and profitably in this market.

Finally, we want to capitalize on growth opportunities for Laser Therapy by more aggressively targeting sales and marketing investment in selected developed markets in Europe, Asia, as well as Canada.

So in summary we’re pleased with the third quarter results and the breadth of our financial performance across several of our portfolio businesses. We’ve done a good job of managing our P&L. We’ve achieved our top line guidance range. We’ve hit the bottom line. We continue to demonstrate strong execution on expense management and improved cash flow generation throughout our organization. It is actually this disciplined management in our cost structure in particular that gives us confidence in managing AMS even in the difficult economic environment.

While we acknowledge our capital equipment and trailing disposables business require a different strategy, the growth and stability of the rest of our product family bolsters our outlook for the balance of the year and the Laser Therapy status is under performer, as we believe temporary. We have the resources and the technology and we are building the team necessary to execute a turnaround of what we know is a compelling technology addressing a meaningful market opportunity. We’ll continue to focus on driving growth in our portfolio businesses, leveraging our cost structure, generating cash flow, and paying down debt.

So before opening up our call to the Q-and-A session, in order to allow as many analysts to ask questions as possible, please observe our request that you ask just two questions, one leading question and one follow-up and then return to the queue. Thank you for your consideration.

Felicia, if you’d open up the line and provide instructions for questions.

Question-and-Answer Session


(Operator Instructions). Your first question comes from Tom Gunderson - Piper Jaffray.

Tom Gunderson - Piper Jaffray

Question one is on the BPH laser business and the 64/ 40 split between direct or between mobile providers and direct. Can you give us a little bit more color? You mentioned a little bit, but it would seem that in these tough economic times as hospitals pull in on their spending, that having the mobile units out there would be exactly what they need if they want to increase their hospital revenues and profits without having to put out any capital expenses or some plans. (a) is that a correct assessment and; (b) is that something you’re going to try and enhance going forward until we get out of this tough economy?

Tony Bihl

Yes, Tom thanks. Clearly, as you mentioned, the mobile providers have been an important channel for us to bring Laser Therapy to the market and as you say, for physicians who provide a small number of procedures certainly it is a very efficient process and so we have been rebuilding our relationship with mobile providers and I feel very, very positive about those relationships.

As Mark indicated we did see some good indication; we haven’t claimed victory yet, but some good indication of growth again in the US in the Laser Therapy areas. So clearly, mobile providers will be a part of our growth plan here in the US. We do have a direct business and again, the focus on driving utilization through fiber sales will be the formula for ongoing success there.

Tom Gunderson - Piper Jaffray

And then the second question is you seem to have managed the tough economy and elective procedures, deferrable procedures if you will fairly well through the first nine months and yet guiding down in Q4 from previous guidance. Mark, can you put a number on what you expect the decline from FX to be in Q4?

Mark Heggestad

Yes, that’s a good question, Tom. So when we’ve put our guidance out, obviously over the last couple weeks, FX has been kind of fluctuating anywhere between, if you just use the Euro as a standard for us around anywhere from 125 to 130, and if you take a look at what the average Euro was a year ago, it was around 145, so you’re talking about a 10% to 15% impact on our international base dollar.

So, if you just look at it that way, if you just say, our total dollars, our total revenue, about 30% of it comes from an international location and when you take a look at that revenue, there’s a 10% to 15% negative impact on that revenue if the Euro stays in the 125 to 130 range.


Your next question comes from David Lewis – Morgan Stanley.

David Lewis - Morgan Stanley

Just to follow-up on Tom’s question, what I’m trying to get at here is you’re talking about economic weakness, but you’re really only lowering the fourth quarter by $9 million. It looks like at least half of that is coming from currency, so is this really about currency or is this really about your true procedural weakness?

Mark Heggestad

I’d say it’s primarily about currency. If you take a look and without getting into all of the numbers but just keep it here in place, we’ve got about a $2 million favorable impact from currency this quarter and so if you just looked at our growth rate on a constant currency base, it’s certainly down slightly from the second quarter.

When we built our guidance if you look at the top end of our guidance and if you adjust for currency so you’re looking at constant currency the way I just talked to Tom, we’re looking at a growth rate at the very top end of our guidance that’s pretty close to Q3, not quite at Q3 but pretty close to Q3, so to a certain degree right now the Q4 number on a constant currency basis at the top end is looking somewhat similar to what we saw here in Q3.

David Lewis - Morgan Stanley

Okay, so I understand that. It looks like its more currency than procedure weakness, but in terms of profitability can you kind of walk me through? I wasn’t aware you had active hedging programs, so how are you able to maintain the top end of the EPS guidance range if this currency is dropping through?

Mark Heggestad

Yes, that’s a good question and if you think about FX or foreign exchange and the way it impacts our P&L, first of all you got to remember there’s two different ways it impacts us. It impacts us operationally and we talked about how it’s impacting revenue. Some of that gets offset by the local expenses that we have, so it doesn’t drop through to the bottom line. In fact about 60% of the impact drops through to the bottom line.

When we look at our fourth quarter, that bottom line impact is around 50% hedged so we’ve locked in the rate and we know where it’s going to impact. If the dollar continues to strengthen such that it drops below 1.25, it’s going to have a further negative impact but only about half of it because we’re hedged.

The second piece you got to always remember is the way foreign exchange rates impact your inter company account and again, if the dollar strengthens that has a negative impact on us. We’ve absorbed some of that impact already here in the first half of the fourth quarter, but we’ve hedged the majority of that for the remainder of the quarter, so no matter where the dollar goes up or down, we pretty much locked in that impact on our P&L.

David Lewis - Morgan Stanley

Okay and then maybe one last question for Tony; I apologize, currency was maybe my one question, but Tony obviously with the currency and the cost cutting and the fourth quarter starting to come through the leverage and the businesses there and the debt pay down was pretty dramatic, so obviously people are still concerned about the balance sheet. What can you say about what you’ve seen in the last two quarters and what do you think about cost cutting heading into next year to give people more comfort that the balance sheet and the cash flow here is simply not a concern? Thank you.

Tony Bihl

Maybe just a comment about it; I think all of us have got as good business stewards. We have to look at the economy that’s coming ahead of us and some uncertainties that go with it and to be cautious about how we manage our expenses. So we have been very careful as we are putting together our planning going forward, to prepare ourselves for what could be softness going forward.

We want to do that in an environment that doesn’t stop us from taking advantage of growth so from a very operational perspective we’re cautious and conservative on spending growth and we’ll watch as the year develops.


Your next question comes from the line of Philip Legendy - Thomas Weisel Partners.

Philip Legendy - Thomas Weisel Partners

I wonder if you could expand a little bit on your commentary about the impact of the FDA safety warning. It’s obviously early days, but there are a few weeks under the belt now. Operating underneath that warning, I wonder if there’s any feedback from the sales force in terms of how it’s affecting the ability to convert new doctors to MESH procedures.

Ross Longhini

Sure, Philip. This is Ross. It’s been 13 days, I spent two weeks and that went out. Obviously not everybody found out about it overnight, so right now we have very little data to go on. There’s no indication of any kind of messiest area of any kind whatsoever, as I mentioned in my prepared remarks earlier, physicians continue to tell us that they intend to continue to use mesh with their patients, who have prolapse and incontinence.

The issue has been probably a little bit more focused on prolapse than incontinence. There’s a lot more incontinence procedures that have been done and frankly a lot of the complications that we see anyway is particularly the vaginal; erosion are on the prolapse side of the business, very, very few of those are on the incontinence side of the business, so the discussion is more on the prolapsed side, but even then, a lot of physicians say that I just can’t go back to the traditional repairs that have very, very high recurrence rate.

In fact, that’s why you may recall why AMS got into the treatment of prolapsed repairs. Back in 2004 was because we saw that there was a significant opportunity to improve a patient’s health through reducing the high recurrence rate that exists with a lot of the traditional prolapse procedures.

Philip Legendy - Thomas Weisel Partners

As a follow-up to that, do you have an estimate as to how penetrated mesh kit prolapse procedures are into kind of the total surgical procedure bucket?

Ross Longhini

Well, the prolapsed repairs, we think it’s in the 20% to 30% range, something like that. It’s a little bit hard to tell, because a lot of physicians use generic mesh and then simply if you will manufacture their own prolapse kit with that and so they’re just using a sheet of mesh cutting it out and then, kind of suturing it in the place, so those we don’t have a real good handle on how, many repairs are done that way, but that’s our estimate right now.

Still a lot of the lower grade prolapse procedures are simply done with vacations and for some of those lower grade procedures that might be the right way to do it given the state of the technology.

Philip Legendy - Thomas Weisel Partners

Okay and then the second question for Tony. You mentioned potential impact to elective procedures and it sounds like penile implants are one area where you’re really seeing the impact. How do you think about the rest of the business is positioned in terms of, lack of a better or the electivity food chain? I mean, are these procedures and are you seeing evidence that people would postpone these procedures because they are -- generally we’re talking about folks who failed other therapies, and so you’d think these are fairly acute cases?

Tony Bihl

Phil, we think the most elective of our procedures as you point out are the erectile restoration area, where patients could theoretically delay taking action and we have certainly, a significant number of anecdotal kind of feedbacks from some of the major implanters about what they’re seeing in their patient flow right now, so that’s certainly one of the areas.

I think another area as Mark pointed out is anywhere where there’s potentially capital investment to be made and that one we’ll watch closely. I think finally, in the Her Option area we believe that some number of the procedures for treating menorrhagia perhaps could be considered elective and there may be reducing impact of procedures in that area as well. Other than that we don’t expect that most of our other procedures are so susceptible to this kind of a decline. They aren’t so elective.


Your next question comes from Greg Simpson – Stifel Nicolaus.

Greg Simpson - Stifel Nicolaus

Just a couple of quick ones. First of all Tony, I apologize if you said this and maybe I missed it, but on the expected Laserscope gross margin improvement in 2009, is that 10 points on a full year basis or exiting the year? I mean, if we just throw it out just to be simple, that Laserscope gross margins ran around 50% in ‘08 are we talking full year 10% improvement or by year-end?

Tony Bihl

Well, what we said was a 10 percentage point improvement from where we are today over the next 12 to 18 months.

Greg Simpson - Stifel Nicolaus

Okay, good. That clears it up for me, and then in the ED business and I’m not trying to get you guys to play economist here, but could you maybe give us a little more detail, were you looking at a kind of mid single-digit growth rate in Q3 and is that probably a decent guess for kind of the sustainable growth in that business here in this economic environment?

Tony Bihl

Yes Greg, that’s a good guess, and yes, that’s probably what we’re looking at going forward.


Your next question comes from Jason Bedford – Raymond James.

Jason Bedford - Raymond James

Just a couple of quickies here; you mentioned I think Tony, building some infrastructure internationally to support I think Laserscope, and I’m just wondering, how many folks do you plan on adding and then just when we look to ‘09 do you anticipate that revenue growth will exceed OpEx growth?

Tony Bihl

Yes Jason, first of all, we talked about the focus of our selling efforts and I think the key message there was we need to have some increased touch point for physicians to grow this procedure utilization. I think that we’ve identified there are some areas outside of the US where our infrastructure perhaps is at its limits for what potential growth we could have.

Now we need to make a very careful investment there, so we’ll put together our plans for that now, but we think there are some markets where with some more robust training in place and perhaps some additional sales effort, we can maybe capture some growth and as I said Europe, some parts of Asia and certainly in Canada where we think there may be some opportunities.

The overall growth rates I don’t want to commit numbers at this moment in terms of sales, but we think we’re probably talking about some number that could be in a 10% to 20% range around the world.

Jason Bedford - Raymond James

And in terms of additional headcount or --?

Tony Bihl

Yes. Some of that will balance in other ways, but the point is we want to get that focused on this business and we want to do it in a very careful way and in the right market, so it’s something you’ll see as a sliding scale through the year.

Mark Heggestad

Maybe Jason, maybe another way to look at it is certainly between operating expenses and gross margin, we absolutely intend to continue the leverage of this business in 2009, but our operating margin will continue to improve through 2009.

Jason Bedford - Raymond James

Okay and then a quick question for Ross on the new fiber; besides the durability and gross margin benefits, are there performance benefits associated with the new fiber?

Ross Longhini

The new fiber performance is not significantly different than the older product; it’s very similar. In the laboratory it performs maybe slightly better, more importantly I think a lot of our training programs had improved the fiber performance and that’s simply making sure that the fiber stays clean. If you keep the fiber clean a lot more of the energy gets transmitted through the cap on the fiber and therefore is effective in vaporizing tissue.

Some of the work that we’re doing now in our R&D labs out in San Jose is to significantly improve a next generation fiber if you will and we believe that’s some opportunity to take the fiber performance to a whole other level.


Your next question comes from Tycho Peterson.

Jean – JP Morgan

Hi, this is from [Jean] in for Tycho today. Thanks for taking the questions. For MiniArc, you mentioned you’re starting to see saturation among kind of your early adopters. Could you give us more color on where you’re seeing most demand geographically and particularly what the outlook is for European demand?

Tony Bihl

Sure, the adoption of MiniArc has been strongest since its introduction in the US and in Europe not quite so fast. In this particular case, we don’t know exactly why adoption curves happen the way they do, but certainly in this particular case, the network of physicians we have that were very pleased with the product and adopted in their practice had got very good early results, really bolstered the adoption of that product in the US and that just didn’t happen quite as quickly outside the US.

We do expect to go over that overtime, due to the fact that the clinical results had been very encouraging in the early going that it will become more and more of the standard of care for some procedures.

Jean – JP Morgan

Okay, and my second question is on, you had previously mentioned that you were exploring some offshore manufacturing opportunities to potentially reduce labor costs and tax rate going forward and could you give us an update; you mentioned areas such as Mexico and Puerto Rico as a potential places for outsourcing?

Tony Bihl

Yes, first of all, I don’t know that we’ve done anything like that specifically and we’re not in the process of doing anything like that. The only context that we come up in is we certainly look at opportunities to bring down our tax rate and probably the best way or the most effective way to do that is indeed look at some level of offshore manufacturing, but at this stage in the game; number one, we’re just developing the strategy to do that; we’re looking at our options and our possibilities, including where that might be. So at this time there’s certainly nothing concrete to move anything offshore and or any specific locations that we would do that.


Your next question comes from Jonathan Block – Suntrust Robinson Humphrey.

Jonathan Block- Suntrust Robinson Humphrey

On the laser side Tony, I think in some of your comments for the initiatives you mentioned placing the consoles and I don’t know if I was just looking into it, but the placing instead of selling has that increased from last quarter and will that actually act as one of the initiatives going forward?

Tony Bihl

Jonathan, I think what we’ve said in the past and will continue to be our view going forward is that we have to have flexibility there to not let capital acquisition be a barrier to placing this therapy in the hands of a physician.

That said, up to now we haven’t had a tremendous demand for that and now we don’t know what’s going to happen as maybe capital tightens up etc through time, but we haven’t made any final determination that let’s go to a very high placement of consoles as a strategy or anything else.

I think our general belief and some of the work from our studies have said that we’ve actually in the US got pretty good coverage of laser consoles and the issue is we just haven’t done sufficient work to follow-up to again drive the utilization for those consoles so I think our focus is more in that area.

I think my message was in these kinds of businesses you have to be able to do both things. You have to continue to place consoles. You have to bring new technology in consoles out every four to five years to continue to provide renewal there, so you don’t want to stop doing that, but you have to have a very robust utilization program and that’s where our focus will be.

Jonathan Block- Suntrust Robinson Humphrey

Okay, and then Mark without specifically going down the guidance road for 2009, I think at your ex currency, I have year-to-date revenue growth somewhere around the mid single-digit, so maybe just more a question for clarity. When we think out to ‘09 maybe that mid single digit is sort of our base case and then we’d be going up against likely a couple hundred basis points of FX headwind?

Mark Heggestad

Yes, I mean we’re not going to get into any sort of dialogue around 2009 at this stage in the game, including how we think FX is going to play out.

Jonathan Block- Suntrust Robinson Humphrey

Okay and then a last one of I can just slip something in. Just clearly advance in MiniArc have been growth drivers both in current markets and for new markets, so are you guys hearing anything on the competitive front for either of those market opportunities?

Tony Bihl

Sure. There continue to be a few products that are introduced out there in the marketplace. Most of those products that are direct competitors with AdVance have been represented by relatively small companies and haven’t had a lot of traction. There are some bigger players coming into the market now and they don’t have a lot of time under their belt yet in order to judge how that’s going to go.

On the MiniArc side of course we were second to market in that category of products following the J&J TBT secured product. There are more products coming out; I think Boston Scientific has a product they plan to launch in fairly soon here as well or just recently have launched possibly. So, there will be more competition out there and having said that we are pretty confident that the clinical data that supports both AdVance and MiniArc is quite compelling and we believe that that data will keep us in a strong position.


Your next question comes from James Sidoti – Sidoti & Co.

James Sidoti – Sidoti & Co.

Looking at your fourth quarter guidance, you have a basically flat revenue number but EPS up because of lower cost. Is this a trend that you think you can continue? I know you don’t want to give guidance for ‘09 but could you see ‘09 EPS going up despite flat revenue, because of some of the programs you put in place to reduce costs?

Ross Longhini

Yes, and Jim again you got to remember, when you look at that flat revenue, if you remove the impact of foreign exchange rates, at the high end of that guidance you’re actually talking about a 6% to 7% growth rate and again we don’t want to get into dialogue around 2009.

Obviously, we’ve got a lot of initiatives in place here on the Laser Therapy business and we’ve got to gain a better understanding of what that means. FX rates obviously will have a significant impact and we’ll continue to watch the economy very carefully and see where that settles out on our numbers, but with that said we have been very effective here throughout 2008 in managing our expenses. Certainly, don’t believe that we’re going to continue to leverage in at the same level that we managed them in 2008, but yes, we do believe going into 2009 we have room to continue to leverage them.

James Sidoti

Okay and then can you just give us the tax rate you expect in the fourth quarter with the R & D tax credit?

Ross Longhini

Yes. We’re expecting that if you look at it from a full year standpoint, the R&D tax credit will bring our current year-to-date rate down by about a percentage point. What that means for the fourth quarter is that we’re probably somewhere around 37.5% for the fourth quarter, so it all comes through in the fourth quarter.


Your next question comes from Greg Simpson – Stifel Nicolaus.

Greg Simpson - Stifel Nicolaus

Yes thanks, one quick follow-up. Mark, a little outside the box here. It’s been a year plus since you guys implemented the new ERP system. You guys seem to have a pretty good handle on the business despite the challenges of Laserscope and some of these other issues. I’m just curious if you can give us kind of a look back and how the ERP system is operating and helping you?

Mark Heggestad

Yes, great question Greg and actually there’s two major components I believe in what you just said. Certainly the ERP is very valuable. It is an ERP system, it’s a standardized system. We have it across our entire company other than a couple of smaller locations, so it gives us the ability to see a lot of information on a daily basis.

It gives us the ability to do a lot of trending. It gives us the ability to have our functions talk to each other, cross function; it certainly helps us from an inventory-planning standpoint; its certainly helping us from globally managing our DSO. So, you name it and its being very advantageous for us.

We haven’t even begun to tap what you can do with a robust ERP system like we have in place, but I’d like to add-on to that. I think what our management team has done and what our employees have done in terms of understanding the value of taking the investments we currently have and how important it is to run this company as efficiently as possible, especially in these current economic times, you can have the greatest system in the world, but you can’t do it without the management team and the employees and they are just doing a phenomenal job of understanding that need and stepping up and doing it.


There are no further questions at this time, sir.

Tony Bihl

Well very good, Felicia, thank you. Well again let me just close by thanking you all for joining us on the call today and for your continued interest in American Medical Systems. While the effects of a faltering economy are present, our underlying business remains healthy and our outlook particularly in the longer term remains favorable. Our portfolio of products focused on pelvic health combined with technology leadership give us a very robust base on which to build over the long-term. So thank you again and we look forward to talking with you at the end of the next quarter. Bye now.


Thank you. This concludes today’s conference call. You may now disconnect.

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