##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended
December 31, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File No. 001-31744
 MENTOR CORPORATION
  Minnesota
(State or other jurisdiction of 
incorporation or organization)
    
    41-0950791
(IRS Employer Identification No.)
 201 Mentor Drive, Santa Barbara, California 93111
 (805) 879-6000
 þ o
 þ o o
 o þ




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##### 



MENTOR CORPORATION
 INDEX
 Part I. Financial InformationItem 1.
    
    Financial Statements:Consolidated Balance Sheets (unaudited)  December 31, 2006 and March 31, 2006Consolidated Statements of Income (unaudited)  Three Months Ended December 31, 2006 and 2005Consolidated Statements of Income (unaudited)  Nine Months Ended December 31, 2006 and 2005Consolidated Statements of Cash Flows (unaudited)  Nine Months Ended December 31, 2006 and 2005Notes to Consolidated Financial Statements  December 31, 2006Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
    
    Quantitative and Qualitative Disclosures About Market RiskItem 4.
    
    Controls and ProceduresPart II. Other InformationItem 1.
    
    Legal ProceedingsItem 1A.
    
    Risk FactorsItem 2.
    
    Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity SecuritiesItem 3.
    
    Defaults upon Senior SecuritiesItem 4.
    
    Submission of Matters to a Vote of Security HoldersItem 5.
    
    Other InformationItem 6.
    
    ExhibitsExhibit 10.2Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
   2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Consolidated Financial Statements
 
 
 December 31,
    
    
    March 31,(in thousands)
    
    2006
    
    
    2006AssetsCurrent assets:Cash and cash equivalents
    
    $
    404,407
    
    
    $
    98,713Marketable securities
    
    
    114,160
    
    
    
    102,241Accounts receivable, net
    
    
    60,705
    
    
    
    58,199Inventories, net
    
    
    36,319
    
    
    
    35,139Deferred income taxes
    
    
    24,429
    
    
    
    21,764Prepaid expenses and other
    
    
    5,507
    
    
    
    5,721Current assets of discontinued operations
    
    
    
    
    
    
    96,070Total current assets
    
    
    645,527
    
    
    
    417,847Property and equipment, net
    
    
    36,048
    
    
    
    36,448Intangible assets, net
    
    
    17,584
    
    
    
    15,745Goodwill, net
    
    
    9,690
    
    
    
    9,243Other assets
    
    
    8,031
    
    
    
    8,310Non-current assets of discontinued operations
    
    
    
    
    
    
    60,264Total assets
    
    $
    716,880
    
    
    $
    547,857
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December 31,
    
    
    March 31,(in thousands)
    
    2006
    
    
    2006Liabilities and shareholders equityCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    29,120
    
    
    $
    27,685Accrued compensation
    
    
    14,922
    
    
    
    17,335Sales returns
    
    
    16,680
    
    
    
    15,544Deferred revenue
    
    
    11,831
    
    
    
    10,495Dividends payable
    
    
    7,635
    
    
    
    7,772Product liability reserves
    
    
    6,898
    
    
    
    6,701Short-term bank borrowings
    
    
    
    
    
    
    14,000Warranty reserves
    
    
    2,760
    
    
    
    3,659Interest payable
    
    
    2,063
    
    
    
    1,031Income taxes payable
    
    
    
    
    
    
    1,837Accrued royalties
    
    
    263
    
    
    
    274Other
    
    
    13,782
    
    
    
    13,819Current liabilities of discontinued operations
    
    
    35,014
    
    
    
    29,971Total current liabilities
    
    
    140,968
    
    
    
    150,123Long-term accrued liabilities
    
    
    12,634
    
    
    
    10,590Convertible subordinated notes
    
    
    150,000
    
    
    
    150,000Non-current liabilities of discontinued operations
    
    
    
    
    
    
    10,555Commitments and contingencies
Shareholders equity:Common stock, $.10 par value:Authorized  150,000,000 shares; issued and outstanding
42,419,180 shares at December 31, 2006;
43,176,495 shares at March 31, 2006;
    
    
    4,242
    
    
    
    4,318Capital in excess of par value
    
    
    28,520
    
    
    
    36,726Accumulated other comprehensive income
    
    
    10,477
    
    
    
    16,498Retained earnings
    
    
    370,039
    
    
    
    169,047Total shareholders equity
    
    
    413,278
    
    
    
    226,589Total liabilities and shareholders equity
    
    $
    716,880
    
    
    $
    547,857
   4




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##### Table of Contents



(in thousands, except per share data)
    
    2006
    
    
    2005Net sales
    
    $
    75,309
    
    
    $
    63,072Cost of sales
    
    
    18,925
    
    
    
    16,176Gross profit
    
    
    56,384
    
    
    
    46,896Selling, general, and administrative
    
    
    32,356
    
    
    
    25,694Research and development
    
    
    7,780
    
    
    
    7,78140,136
    
    
    
    33,475Operating income from continuing operations
    
    
    16,248
    
    
    
    13,421Interest expense
    
    
    (1,426
    )
    
    
    (1,397
    )Interest income
    
    
    6,346
    
    
    
    919Other income (expense), net
    
    
    (281
    )
    
    
    103Income from continuing operations before income taxes
    
    
    20,887
    
    
    
    13,046Income taxes
    
    
    6,137
    
    
    
    3,800Income from continuing operations
    
    
    14,750
    
    
    
    9,246Income (loss) from discontinued operations, net of tax
(benefit) expense of ($596) and $2,587
    
    
    (1,102
    )
    
    
    3,498Loss on sale of discontinued operations, net of taxes of ($13)
    
    
    (20
    )
    
    
    Net income
    
    $
    13,628
    
    
    $
    12,744Basic earnings (loss) per shareContinuing operations
    
    $
    0.35
    
    
    $
    0.21Discontinued operations
    
    
    (0.03
    )
    
    
    0.08Basic earnings per share
    
    
    0.33
    
    
    
    0.29Diluted earnings (loss) per shareContinuing operations
    
    $
    0.32
    
    
    $
    0.19Discontinued operations
    
    
    (0.03
    )
    
    
    0.07Diluted earnings per share
    
    
    0.29
    
    
    
    0.26Dividends per share
    
    $
    0.18
    
    
    $
    0.18Weighted average shares outstandingBasic
    
    
    41,916
    
    
    
    43,535Diluted
    
    
    49,144
    
    
    
    51,834
   5




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##### Table of Contents



(in thousands, except per share data)
    
    2006
    
    
    2005Net sales
    
    $
    221,654
    
    
    $
    195,870Cost of sales
    
    
    59,491
    
    
    
    49,245Gross profit
    
    
    162,163
    
    
    
    146,625Selling, general, and administrative
    
    
    90,792
    
    
    
    74,966Research and development
    
    
    24,654
    
    
    
    21,614115,446
    
    
    
    96,580Operating income from continuing operations
    
    
    46,717
    
    
    
    50,045Interest expense
    
    
    (4,707
    )
    
    
    (4,144
    )Interest income
    
    
    16,233
    
    
    
    2,501Other income
    
    
    494
    
    
    
    276Income from continuing operations before income taxes
    
    
    58,737
    
    
    
    48,678Income taxes
    
    
    17,490
    
    
    
    14,175Income from continuing operations
    
    
    41,247
    
    
    
    34,503Income from discontinued operations, net of taxes of $2,760 and $9,492
    
    
    1,342
    
    
    
    12,834Gain on sale of discontinued operations, net of taxes of $138,341
    
    
    222,162
    
    
    
    Net income
    
    $
    264,751
    
    
    $
    47,337Basic earnings per shareContinuing operations
    
    $
    0.98
    
    
    $
    0.80Discontinued operations
    
    
    5.33
    
    
    
    0.30Basic earnings per share
    
    
    6.32
    
    
    
    1.10Diluted earnings per shareContinuing operations
    
    $
    0.89
    
    
    $
    0.72Discontinued operations
    
    
    4.57
    
    
    
    0.25Diluted earnings per share
    
    
    5.46
    
    
    
    0.98Dividends per share
    
    $
    0.54
    
    
    $
    0.53Weighted average shares outstandingBasic
    
    
    41,898
    
    
    
    43,016Diluted
    
    
    48,948
    
    
    
    50,962
   6




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(in thousands)
    
    2006
    
    
    2005Operating Activities:Income from continuing operations
    
    $
    41,247
    
    
    $
    34,503Adjustments to derive cash flows from continuing operating activities:Depreciation
    
    
    5,640
    
    
    
    5,823Amortization
    
    
    1,889
    
    
    
    1,689Deferred income taxes
    
    
    3,477
    
    
    
    (299
    )Non-cash compensation
    
    
    8,203
    
    
    
    762Tax benefit from exercise of stock options
    
    
    8,465
    
    
    
    24,245Loss on sale of assets
    
    
    162
    
    
    
    244Loss (gain) on long-term marketable securities and investment write-downs, net
    
    
    132
    
    
    
    (139
    )Cash provided by (used in) changes in operating assets and liabilities:Accounts receivable
    
    
    (2,351
    )
    
    
    5,415Inventories
    
    
    (725
    )
    
    
    (5,503
    )Other current assets
    
    
    285
    
    
    
    (6,981
    )Accounts payable and accrued liabilities
    
    
    3,933
    
    
    
    8,312Income taxes payable
    
    
    (5,137
    )
    
    
    64Net cash provided by continuing operating activities
    
    
    65,220
    
    
    
    68,135Net cash (used) provided by discontinued operating activities net of pretax
gain of $376,620 and $0
    
    
    (95,111
    )
    
    
    15,426Net cash (used) provided by operating activities
    
    
    (29,891
    )
    
    
    83,561Investing Activities:Purchases of property and equipment
    
    
    (4,435
    )
    
    
    (4,495
    )Purchases of intangibles
    
    
    (3,505
    )
    
    
    (1,663
    )Purchases of marketable securities
    
    
    (65,609
    )
    
    
    (238,897
    )Sales of marketable securities
    
    
    53,666
    
    
    
    168,205Proceeds from the sale of the urology business
     
    
    458,066
    
    
    
    Other, net
    
    
    5
    
    
    
    48Net cash provided by (used for) continuing investing activities
    
    
    438,188
    
    
    
    (76,802
    )Net cash used for discontinued investing activities
    
    
    (50
    )
    
    
    (4,358
    )Net cash provided by (used for) investing activities
    
    
    438,138
    
    
    
    (81,160
    )Financing Activities:Repurchase of common stock
    
    
    (88,198
    )
    
    
    Proceeds from exercise of stock options and ESPP
    
    
    22,194
    
    
    
    39,723Dividends paid
    
    
    (22,842
    )
    
    
    (24,059
    )Repayments under line of credit agreements
    
    
    (14,000
    )
    
    
    (971
    )Net cash (used for) provided by continuing financing activities
    
    
    (102,846
    )
    
    
    14,693Net cash (used for) discontinued financing activities
    
    
    
    
    
    
    (2,211
    )Net cash (used for) provided by financing activities
    
    
    (102,846
    )
    
    
    12,482Effect of currency exchange rates of continuing operations
    
    
    413
    
    
    
    (1,484
    )Effect of currency exchange rates of discontinued operations
    
    
    (120
    )
    
    
    (540
    )Increase in cash and cash equivalents
    
    
    305,694
    
    
    
    12,859Cash and cash equivalents at beginning of year
    
    
    98,713
    
    
    
    76,666Cash and cash equivalents at end of period
    
    $
    404,407
    
    
    $
    89,525
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MENTOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
 Note A  Business Activity
  Note B  Summary of Significant Accounting Policies
  Basis of Presentation
  Use of Estimates
   8




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Revenue Recognition
   Warranty Reserves
  Product Liability Reserves
   9




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Employee Stock-Based Payments
    Effects of Recent Accounting Pronouncements
     10




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Note C  Interim Reporting
 st
 Fiscal 2007
    
    
    Fiscal 2006First Quarter
    
    June 30, 2006
    
    July 1, 2005Second Quarter
    
    September 29, 2006
    
    September 30, 2005Third Quarter
    
    December 29, 2006
    
    December 30, 2005
   11




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##### Table of Contents



Note D  Cash Equivalents, Marketable Securities, and Long-Term Marketable Securities and
Investments
    Gross
    
    
    Gross
    
    
    EstimatedAdjusted
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair(in thousands)
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueCash balances
    
    $
    389,872
    
    
    $
    
    
    
    $
    
    
    
    $
    389,872Money market funds
    
    
    14,535
    
    
    
    
    
    
    
    
    
    
    
    14,535State and Municipal agency obligations
    
    
    91,211
    
    
    
    
    
    
    
    
    
    
    
    91,211Mortgage-backed securities
    
    
    22,611
    
    
    
    48
    
    
    
    
    
    
    
    22,659Corporate debt securities
    
    
    290
    
    
    
    
    
    
    
    
    
    
    
    290Total available-for-sale investments
    
    $
    518,519
    
    
    $
    48
    
    
    $
    
    
    
    $
    518,567Included in cash and cash equivalents
    
    $
    404,407
    
    
    $
    
    
    
    $
    
    
    
    $
    404,407Included in current marketable securities
    
    
    114,112
    
    
    
    48
    
    
    
    
    
    
    
    114,160Total available-for-sale investments
    
    $
    518,519
    
    
    $
    48
    
    
    $
    
    
    
    $
    518,567
  12




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Gross
    
    
    Gross
    
    
    EstimatedAdjusted
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair(in thousands)
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueCash balances
    
    $
    95,054
    
    
    $
    
    
    
    $
    
    
    
    $
    95,054Money market funds
    
    
    3,659
    
    
    
    
    
    
    
    
    
    
    
    3,659State and Municipal agency obligations
    
    
    71,374
    
    
    
    
    
    
    
    
    
    
    
    71,374Mortgage-backed securities
    
    
    30,667
    
    
    
    
    
    
    
    (85
    )
    
    
    30,582Corporate debt securities
    
    
    286
    
    
    
    
    
    
    
    (1
    )
    
    
    285Total available-for-sale investments
    
    $
    201,040
    
    
    $
    
    
    
    $
    (86
    )
    
    $
    200,954Included in cash and cash equivalents
    
    $
    98,713
    
    
    $
    
    
    
    $
    
    
    
    $
    98,713Included in current marketable securities
    
    
    102,327
    
    
    
    
    
    
    
    (86
    )
    
    
    102,241Total available-for-sale investments
    
    $
    201,040
    
    
    $
    
    
    
    $
    (86
    )
    
    $
    200,954
 Note E  Inventories
   (in thousands)
    
    December 31
    
    
    March 31Raw materials
    
    $
    6,317
    
    
    $
    3,994Work in process
    
    
    5,591
    
    
    
    5,382Finished goods on consignment
    
    
    12,913
    
    
    
    11,052Finished goods
    
    
    11,498
    
    
    
    14,711$
    36,319
    
    
    $
    35,139
 Note F  Property and Equipment
   (in thousands)
    
    December 31
    
    
    March 31Land
    
    $
    55
    
    
    $
    55Buildings
    
    
    10,718
    
    
    
    10,053Leasehold improvements
    
    
    22,897
    
    
    
    21,952Furniture, fixtures and equipment
    
    
    58,744
    
    
    
    60,004Construction in progress
    
    
    3,832
    
    
    
    3,48196,246
    
    
    
    95,545Less accumulated depreciation
    
    
    (60,198
    )
    
    
    (59,097
    )$
    36,048
    
    
    $
    36,448
  13




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Note G  Product Warranties
   Nine Months EndedDecember 31,(in thousands)
    
    2006
    
    
    2005Beginning warranty reserves
    
    $
    13,603
    
    
    $
    12,025Costs of warranty claims
    
    
    (2,579
    )
    
    
    (2,165
    )Accruals for product warranties
    
    
    3,605
    
    
    
    3,128Adjustments made to accruals related to pre-existing warranties
    
    
    
    
    
    
    Ending warranty reserves
    
    $
    14,629
    
    
    $
    12,988
  Note H  Comprehensive Income
   Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net income
    
    $
    13,628
    
    
    $
    12,744
    
    
    $
    264,751
    
    
    $
    47,337Foreign currency translation adjustment
    
    
    2,036
    
    
    
    (2,338
    )
    
    
    (6,110
    )
    
    
    (11,094
    )Unrealized (gains) losses on marketable
securities and investment activities, net
    
    
    (11
    )
    
    
    97
    
    
    
    89
    
    
    
    100Comprehensive income
    
    $
    15,653
    
    
    $
    10,503
    
    
    $
    258,730
    
    
    $
    36,343
 Note I  Income Taxes
   14




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Note J  Earnings per Share
  Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,(in thousands, except per share data)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net income from continuing operations: as reported
    
    $
    14,750
    
    
    $
    9,246
    
    
    $
    41,247
    
    
    $
    34,503Add back after tax interest expense on convertible note
    
    
    802
    
    
    
    802
    
    
    
    2,406
    
    
    
    2,406Net income from continuing operations for numerator of
diluted earnings per share
    
    $
    15,552
    
    
    $
    10,048
    
    
    $
    43,653
    
    
    $
    36,909
 Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,(in thousands, except per share data)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Weighted average outstanding shares: basic
    
    
    41,916
    
    
    
    43,535
    
    
    
    41,898
    
    
    
    43,016Shares issuable through stock based compensation
arrangements
    
    
    1,054
    
    
    
    2,107
    
    
    
    1,177
    
    
    
    2,103Shares issuable through convertible notes
    
    
    5,153
    
    
    
    5,139
    
    
    
    5,150
    
    
    
    5,136Shares issuable through warrants
    
    
    1,021
    
    
    
    1,053
    
    
    
    723
    
    
    
    707Weighted average outstanding shares: diluted
    
    
    49,144
    
    
    
    51,834
    
    
    
    48,948
    
    
    
    50,962Basic earnings per share  continuing operations
    
    $
    0.35
    
    
    $
    0.21
    
    
    $
    0.98
    
    
    $
    0.80Diluted earnings per share  continuing operations
    
    $
    0.32
    
    
    $
    0.19
    
    
    $
    0.89
    
    
    $
    0.72
 Employee equity-based compensation
   15




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Convertible subordinated notes and warrants
    Note K  Stock Options, Restricted Stock and Employee Stock Purchase Plan
 Long-Term Incentive Plans
   16




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Employee Stock Purchase Plan
    Employee Stock-Based Payments
   17




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Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Stock options
    
    $
    1,297
    
    
    $
    
    
    
    $
    4,068
    
    
    $
    Restricted stock
    
    
    1,069
    
    
    
    725
    
    
    
    2,787
    
    
    
    725Performance units
    
    
    655
    
    
    
    
    
    
    
    1,348
    
    
    
    Total stock-based compensation expense, pre-tax
    
    
    3,021
    
    
    
    725
    
    
    
    8,203
    
    
    
    725Tax benefit from stock-based compensation expense
    
    
    900
    
    
    
    268
    
    
    
    2,289
    
    
    
    268Total stock-based compensation expense, net of tax
    
    $
    2,121
    
    
    $
    457
    
    
    $
    5,914
    
    
    $
    457
   18




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Pro Forma Analysis under FAS 123
 Three Months
    
    
    Nine MonthsEnded
    
    
    Ended(in thousands, except per share information)
    
    December 31, 2005Net income from continuing operations
    
    $
    9,246
    
    
    $
    34,503Deduct: compensation expense fair value method
    
    
    (1,233
    )
    
    
    (3,901
    )Net income: pro forma
    
    $
    8,013
    
    
    $
    30,602Earnings per share from continuing operations:Basic: as reported
    
    $
    0.21
    
    
    $
    0.80Impact of stock option expense
    
    
    (0.03
    )
    
    
    (0.09
    )Basic: pro forma
    
    $
    0.18
    
    
    $
    0.71Net income: as reported
    
    $
    9,246
    
    
    $
    34,503Add back after-tax interest expense on
convertible notes
    
    
    802
    
    
    
    2,406Net income: diluted earnings per share
    
    
    10,048
    
    
    
    36,909Deduct: compensation expense fair value method
    
    
    (1,233
    )
    
    
    (3,901
    )Net income: diluted earnings per share pro forma
    
    $
    8,815
    
    
    $
    33,008Earnings per share from continuing operations:Diluted: as reported
    
    $
    0.19
    
    
    $
    0.72Impact of stock option expense
    
    
    (0.02
    )
    
    
    (0.08
    )Diluted: pro forma
    
    $
    0.17
    
    
    $
    0.64
   Employee Stock Options, Restricted Stock Grants and Performance Units
   19




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##### Table of Contents



2006
    
    
    2005Weighted average fair value of common stock
    
    $
    41.49
    
    
    $
    38.63Weighted average fair value of stock options granted
    
    $
    12.64
    
    
    $
    10.00Risk-free interest rate
    
    
    4.6
    %
    
    
    4.6
    %Expected life (in years)
    
    
    5.1
    
    
    
    4.5Expected volatility
    
    
    30.0
    %
    
    
    32.0
    %Expected dividend yield
    
    
    1.4
    %
    
    
    1.8
    %
  Weighted-Weighted-
    
    
    averageaverage
    
    
    remaining
    
    
    Aggregateexercise
    
    
    contractual
    
    
    intrinsic(in thousands, except per share amounts)
    
    Options
    
    
    price
    
    
    life (Yrs)
    
    
    valueBalance unexercised at March 31, 2006
    
    
    3,682
    
    
    $
    24.10
    
    
    
    
    
    
    $
    91,222Granted
    
    
    155
    
    
    
    41.32
    
    
    
    
    
    
    
    1,170Exercised
    
    
    (1,172
    )
    
    
    18.88
    
    
    
    
    
    
    
    33,507Forfeited/expired
    
    
    (286
    )
    
    
    32.03
    
    
    
    
    
    
    
    4,820Balance unexercised at December 31, 2006
    
    
    2,379
    
    
    $
    26.83
    
    
    
    6.65
    
    
    $
    52,431Vested at December 31, 2006
    
    
    1,262
    
    
    $
    19.84
    
    
    
    5.41
    
    
    $
    36,629Exercisable at December 31, 2006
    
    
    1,262
    
    
    $
    19.84
    
    
    
    5.41
    
    
    $
    36,629
   20




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##### Table of Contents



Weighted-averagegrant dateNonvested shares (in thousands, except per share amounts)
    
    Shares
    
    
    fair valueNonvested at March 31, 2006
    
    
    279
    
    
    $
    52.71Granted
    
    
    162
    
    
    
    42.50Lapsed
    
    
    (53
    )
    
    
    52.63Forfeited
    
    
    (16
    )
    
    
    51.88Nonvested at December 31, 2006
    
    
    372
    
    
    $
    48.31
  Performance Award Program
     Fair marketvalue at dateNonvested performance stock units (in thousands)
    
    Shares
    
    
    of grantNonvested at March 31, 2006
    
    
    
    
    
    $
    Granted (maximum award)
    
    
    357
    
    
    
    7,580Vested
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Nonvested at December 31, 2006
    
    
    357
    
    
    $
    7,580
  21




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Note L  Share Repurchase Program
      Note M  Goodwill and Intangible Assets
    22




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##### Table of Contents



Note N  Long-Term Debt
 3 4
  
    
    during any fiscal quarter prior to January 1, 2019, if the closing price of the
Companys common stock for at least 20 trading days in the 30 consecutive trading day
period ending on the first trading day of such fiscal quarter is more than 120% of the
conversion price per share of the Companys common stock on such trading day;
    
    any business day on or after January 1, 2019, if the closing price of the Companys
common stock on the immediately preceding trading day is more than 120% of the conversion
price per share of the Companys common stock on such trading day;
    
    during the five business day period after any five consecutive trading day period if the
average of the trading prices of the notes for such five consecutive trading day period is
less than 98% of the average of the conversion values of the notes during such period,
subject to certain limitations;
    
    if the Company has called the notes for redemption; or
    
    if the Company makes certain significant distributions to holders of its common stock or
the Company enters into specified corporate transactions.
       23




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Note O  Short Term Bank Borrowings
 Credit Agreement
      24




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Loan and Overdraft Facility
      
    
  Note P  Related Party Transactions
   25




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##### Table of Contents



Note Q  Discontinued Operations
    (in thousands)
    
    June 2, 2006
    
    
    March 31, 2006Assets held for sale:Accounts Receivable, net
    
    $
    48,294
    
    
    $
    50,698Inventories
    
    
    38,827
    
    
    
    38,016Deferred income taxes
    
    
    539
    
    
    
    4,305Prepaid expenses and other current assets
    
    
    54,459
    
    
    
    3,051Total current assets held for sale
    
    
    142,119
    
    
    
    96,070Property, plant and equipment, net
    
    
    30,879
    
    
    
    29,497Intangible assets, net
    
    
    14,275
    
    
    
    14,063Goodwill, net
    
    
    17,009
    
    
    
    16,380Other assets
    
    
    813
    
    
    
    324Total assets held for sale
    
    $
    205,095
    
    
    $
    156,334Liabilities associated with assets held for sale:Accounts payable and accrued liabilities
    
    $
    31,904
    
    
    $
    27,220Income taxes payable
    
    
    23,440
    
    
    
    1,751Current portion of purchase price related to acquired technologies
and acquisitions
    
    
    1,000
    
    
    
    1,000Total current liabilities associated with assets held for sale
    
    
    56,344
    
    
    
    29,971Other long-term liabilities
    
    
    9,165
    
    
    
    10,555Total liabilities associated with assets held for sale
    
    $
    65,509
    
    
    $
    40,526
  26




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Note R  Postretirement Benefit Plan
  Note S  Contingencies
    27




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Item 2.  Managements Discussion and Analysis of Financial Condition and Results of Operations
 Cautionary Statement:
 The following discussion and analysis should be read in conjunction with our Unaudited Consolidated
Financial Statements and related Notes thereto contained elsewhere in this Report. The information
contained in this Quarterly Report on Form 10-Q is not a complete description of our business or
the risks associated with an investment in our securities. We urge you to carefully review and
consider the various disclosures made by us in this Report and in our other reports filed with the
Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K for the year
ended March 31, 2006, Quarterly Report on Form 10-Q for the period ended September 30, 2006, and
subsequent reports on Form 8-K , which discuss our business in greater detail.
 The section entitled Risk Factors set forth in Item 1A under Part II  Other Information, and
similar discussions in our other SEC filings, discuss some of the important risk factors that may
affect our business, results of operations and financial condition. These risks, in addition to
the other information in this Report and in our other filings with the SEC, should be carefully
considered before deciding to purchase, hold or sell our securities.
 Various statements in this Report, in future filings by us with the SEC, in our press releases and
in our oral statements made by or with the approval of authorized personnel, constitute
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements are based on current expectations and are indicated by words or
phrases such as anticipate, estimate, expect, intend, project, plan, believe, will,
seek, and similar words or phrases and involve known and unknown risks, uncertainties and other
factors which may cause actual results, performance or achievements to be materially different from
any future results, performance or achievements expressed or implied by such forward-looking
statements. Some of the factors that could affect our financial performance or cause actual
results to differ from our estimates in, or underlying, such forward-looking statements are set
forth under Item 1A -Risk Factors or elsewhere in this Report. Forward-looking statements
include statements regarding, among other things:
 
    
    Our anticipated growth strategies;
    
    Our intention to introduce or seek approval for new products;
    
    Our ability to continue to meet United States Food and Drug Administration (FDA) and
other regulatory requirements;
    
    Our anticipated outcomes of litigation and regulatory reviews;
    
    Our ability to replace sources of supply without disruption and regulatory delay; and
    
    Our expectation that selling, general and administrative expenses will increase as a
result of the adoption of SFAS 123(R)  Share-Based Payment which requires all
share-based payments be recognized in the financial statements.
  28




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These forward-looking statements are based largely on our expectations and are subject to a number
of risks and uncertainties, many of which are beyond our control. Actual results could differ
materially from these forward-looking statements as a result of the facts described in Item 1A -
Risk Factors or elsewhere including, among others, problems with suppliers, changes in the
competitive marketplace, significant product liability or other claims, product recalls,
difficulties with new product development, the introduction of new products by our competitors,
changes in the economy, FDA or other regulatory delay in approval or rejection of new or existing
products, changes in Medicare, Medicaid or third-party reimbursement policies, changes in
government regulations, use of hazardous or environmentally sensitive materials, inability to
implement new information technology systems, inability to integrate new acquisitions, and other
events. We undertake no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. In light of these risks and
uncertainties, we cannot assure you that the forward-looking information contained in this Form
10-Q will, in fact, transpire.
 Company Overview
    29




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30




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Recent Events
 Ô
 APPLICATION OF CRITICAL ACCOUNTING POLICIES
   Revenue Recognition
     31




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Accounts Receivable
  Inventories
  Warranty Reserves
  Product Liability Reserves
   32




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Goodwill and Intangible Asset Impairment
  Stock-Based Compensation Expense for Fiscal 2007 and Thereafter
    33




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##### Table of Contents



RESULTS OF OPERATIONS
  Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    25.1
    
    
    
    25.6
    
    
    
    26.8
    
    
    
    25.1Gross profit
    
    
    74.9
    
    
    
    74.4
    
    
    
    73.2
    
    
    
    74.9Selling, general and administrative expense
    
    
    43.0
    
    
    
    40.7
    
    
    
    41.0
    
    
    
    38.3Research and development expense
    
    
    10.3
    
    
    
    12.3
    
    
    
    11.1
    
    
    
    11.0Operating income
    
    
    21.6
    
    
    
    21.4
    
    
    
    21.1
    
    
    
    25.6Interest expense
    
    
    (1.9
    )
    
    
    (2.2
    )
    
    
    (2.1
    )
    
    
    (2.1
    )Interest income
    
    
    8.4
    
    
    
    1.4
    
    
    
    7.3
    
    
    
    1.3Other income (expense), net
    
    
    (0.3
    )
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.1Income before income taxes
    
    
    27.8
    
    
    
    20.7
    
    
    
    26.5
    
    
    
    24.9Income taxes
    
    
    8.2
    
    
    
    6.0
    
    
    
    7.9
    
    
    
    7.3Net income from continuing operations
    
    
    19.6
    
    
    
    14.7
    
    
    
    18.6
    
    
    
    17.6Net income (loss) from discontinued operations
    
    
    (1.5
    )
    
    
    5.5
    
    
    
    0.6
    
    
    
    6.6Gain (loss) on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    100.2
    
    
    
    Net income
    
    
    18.1
    %
    
    
    20.2
    %
    
    
    119.4
    %
    
    
    24.2
    %
 For the three-month period ended December 31, 2006 compared to the three-month period ended
December 31, 2005
 Net Sales
 Ô
 Cost of Sales and Gross Profit
  Selling, General and Administrative
   34




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Research and Development
   Interest and Other Income and Expense
 3 4
   Income Taxes
  Income from Discontinued Operations, Net of Income Taxes
   35




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##### Table of Contents



For the nine-month period ended December 31, 2006 compared to the nine-month period ended December
31, 2005
 Net Sales
  Cost of Sales and Gross Profit
  Selling, General and Administrative
   36




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##### Table of Contents



Research and Development
   Interest and Other Income and Expense
 3 4
   Income Taxes
  Net Income from Continuing Operations and Earnings Per Share
  Income from Discontinued Operations, Net of Income Taxes
   37




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Gain on Sale of Discontinued Operations, Net of Income Taxes
  FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
    December 31,
    
    
    March 31,(in thousands)
    
    2006
    
    
    2006Cash and cash equivalents
    
    $
    404,407
    
    
    $
    98,713Marketable debt securities
    
    
    114,160
    
    
    
    102,241Total cash, cash equivalents and marketable debt securities
    
    $
    518,567
    
    
    $
    200,954Percentage of total assets
    
    
    72
    %
    
    
    37
    %
  38




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##### Table of Contents



Cash Flow Changes
  Nine Months EndedDecember 31,(in thousands)
    
    2006
    
    
    2005Net cash provided by continuing operating activities
    
    $
    65,220
    
    
    $
    68,135Net cash provided by (used for) continuing investing activities
    
    
    438,188
    
    
    
    (76,802
    )Net cash (used for) provided by continuing financing activities
    
    
    (102,846
    )
    
    
    14,693Net cash (used) provided by discontinued operations
    
    
    (95,281
    )
    
    
    8,317Effect of currency exchange rates on cash and cash equivalents
    
    
    413
    
    
    
    (1,484
    )Increase  in cash and cash equivalents
    
    $
    305,694
    
    
    $
    12,859
 Cash Provided by Operating Activities of Continuing Operations
  Cash Provided by (Used for) Investing Activities of Continuing Operations
  Cash (Used) Provided by Discontinued Operations
  Cash (Used for) Provided by Financing Activities of Continuing Operations
    39




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Financing Arrangements
 Senior Credit Facility
    40




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Other Financing
      
     41




---



##### Table of Contents




   Convertible Subordinated Notes
 3 4
    
 Item 3.  Quantitative and Qualitative Disclosures about Market Risk
   42




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##### Table of Contents



Item 4.  Controls and Procedures
    
 PART II  OTHER INFORMATION
 
 Item 1.  Legal Proceedings
   
 Item 1A.  Risk Factors
   43




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The FDA approval of our MemoryGelÔbreast implants in the U.S. is conditioned on our compliance with several significant post-approval conditions, including conducting a large scale, 10-year study of patients who receive the implants.
These conditions may adversely affect the market acceptance and usage rates of our MemoryGelÔimplants, and may cause us to incur significant unanticipated expenses. Our failure to comply
with these conditions in a timely manner may result in our inability to continue to sell our MemoryGelÔimplants in the U.S.
 Ô
 Ô
  Significant product liability claims or product recalls may force us to pay substantial damage
awards and other expenses that could exceed our accruals and insurance coverages.
     44




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We are subject to substantial government regulation, which could have a material adverse affect on
our business.
  
     45




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##### Table of Contents



If we are unable to continue to develop and commercialize new technologies and products, we may
experience a decrease in demand for our products or our products could become obsolete.
    
 If we are unable to compete effectively with existing or new competitors, we could experience price
reductions, reduced demand for our products, reduced margins and loss of market share, and our
business, results of operations and financial condition would be adversely affected.
   
    
    developing and bringing new products to market before others or to provide
benefits superior to those of existing products;
    
    developing new technologies to improve existing products;
    
    developing new products at a lower cost to provide the same benefits as
existing products at the same or lower price;
    
    creating or entering new markets with existing products;
    
    increasing or improving service-related programs; and
    
    advertising in a manner that creates additional awareness and demand.
    46




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##### Table of Contents



If we suffer negative publicity concerning the safety of our products, our sales may be harmed and
we may be forced to withdraw products.
  If we are unable to implement new information technology systems or upgrade existing systems, our
ability to manufacture and sell products, maintain regulatory compliance and manage and report our
business activities may be impaired, delayed or diminished, which would cause substantial business
interruption and loss of sales, customers and profits.
  If we are unable to acquire companies, businesses or technologies as part of our growth strategy or
to successfully integrate past acquisitions, our growth, sales and profitability could suffer.
   47




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##### Table of Contents



We may not realize some of the benefits of the Coloplast transaction.
  We may not be successful in transitioning our business to focus solely on the aesthetics market,
which may harm our prospects and operating results.
  We depend upon our key personnel and our ability to attract, train, and retain employees.
  State legislatures and taxing authorities may create new laws or change their interpretation of
existing state and local tax laws that may affect future product demand or create unforeseen tax
liabilities.
  We depend on the continued use of our manufacturing plants and on single and sole source suppliers
for certain raw materials and licensed or manufactured products and
the loss of, or disruption to, any plant or
supplier could adversely affect our ability to manufacture or sell many of our products.
   48




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If our use of hazardous materials result in contamination or injury, we could suffer significant
financial loss.
  Clostridium botulinum
 Litigation may harm our business or otherwise distract our management.
  
 Item 2.  Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities
   49




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ISSUER PURCHASES OF EQUITY SECURITIESTotal Number
    
    
    Maximum Numberof Shares
    
    
    of Shares that MayTotal Number
    
    
    
    
    
    
    Purchased as
    
    
    Yet Be Purchased(in thousands
    
    of Shares
    
    
    Average Price
    
    
    Part of Publicly
    
    
    Under the Plansexcept per share amounts)
    
    Purchased
    
    
    Paid per Share
    
    
    Announced Plans
    
    
    or ProgramsOctober 1  October 31, 2006
    
    
    87
    (1)
    
    $
    48.23
    
    
    
    87
    
    
    
    4,913November 1  November 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,913December 1  December 31, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,913Total
    
    
    87
    
    
    $
    48.23
    
    
    
    87
 (1)
    
    During the period 71,600 shares were
purchased under the 10b5-1 Plan and
15,465 shares were acquired for payment
of withholding taxes upon the lapsing of
the restrictions on certain outstanding
restricted stock grants.
 
 Item 3.  Defaults Upon Senior Securities
  
 Item 4.  Submission of Matters to a Vote of Security Holders
  
 Item 5.  Other Information
     50




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51




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
    
    With respect to the provisions related to termination without cause, resignation for
Good Reason (as described below), or non-renewal of the agreement by us, the
employment agreement provides for:
 
    
    payment of full COBRA premiums for 24 months following a termination;
    
    severance compensation to be calculated as a flat 24 months severance,
determined at the executive officers then current rate of base pay; and
    
    a pro-rated amount, based on timing of the executive officers
termination or resignation relative to the end of the then current fiscal year, of
the target bonus percentage applicable to the executive officer.
 
    
    With respect to the provisions related to termination due to change of control, the
employment agreement provides for:
 
    
    payment of full COBRA premiums for 24 months following a termination;
    
    severance compensation to be calculated as a flat 24 months severance,
determined at the executive officers then current rate of base pay; and
    
    100% of the target bonus percentage applicable to the executive
officer.
        52




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##### Table of Contents



Item 6. Exhibits
 2.1
    
    Revised Binding Offer Letter from Coloplast A/S regarding purchase of Mentor Urology Business dated
May 5, 2006 Including Appendix A  Incorporated by reference to Exhibit 2.2 of the Registrants
Annual Report on Form 10-K for the year ended March 31, 2006.2.2
    
    Purchase Agreement between Coloplast A/S and Mentor Corporation dated May 17, 2006  Incorporated by
reference to Exhibit 2.3 of the Registrants Annual Report on Form 10-K for the year ended March 31,
2006.2.3
    
    Listing Schedules for Purchase Agreement between Coloplast A/S and Mentor Corporation dated May 17,
2006  Incorporated by reference to Exhibit 2.4 of the Registrants Annual Report on Form 10-K for
the year ended March 31, 2006.2.4
    
    Side Letter Agreement Between Coloplast A/S and Mentor Corporation dated June 2, 2006  Incorporated
by reference to Exhibit 2.5 of the Registrants Annual Report on Form 10-K for the year ended March
31, 2006.3.1
    
    Composite Restated Articles of Incorporation of the Company dated December 12, 2002  Incorporated by
reference to Exhibit 3.1 of the Registrants Annual Report on Form 10-K for the year ended March 31,
2003.3.2
    
    Amended and Restated Bylaws of Mentor Corporation dated September 14, 2005  Incorporated by
reference to Exhibit 3.2 of the Registrants Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005.4.1
    
    Indenture 2 3/4 % Convertible Subordinated Notes Due 2024, dated December 22, 2003  Incorporated by
reference to Exhibit 4.1 of the Registrants Quarterly Report on Form 10-Q for the quarter ended
December 31, 2003.10.1*
    
    Form of Indemnity Agreement  Incorporated by reference to Exhibit 10.1 of the Registrants Current
Report on Form 8-K filed on November 29, 2006.10.2*
    
    Employment Agreement between Mentor Corporation and Edward S. Northup dated February 5, 2007.31.1
    
    Certification of Principal Executive Officer Pursuant To Section 302 of The Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer Pursuant To Section 302 of The Sarbanes-Oxley Act of 2002.32.1
    
    CEO Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The
Sarbanes-Oxley Act of 2002.32.2
    
    CFO Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The
Sarbanes-Oxley Act of 2002.
   53




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SIGNATURES
  MENTOR CORPORATION
  MENTOR CORPORATIONDATE: February 7, 2007
    /s/JOSHUA H. LEVINEJoshua H. LevinePresident and Chief Executive OfficerDATE: February 7, 2007
    /s/LOREN L. MCFARLANDLoren L. McFarlandVice President, Chief Financial Officer and Treasurer  54




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##### Table of Contents



EXHIBIT INDEX
 ExhibitNo.
    
    Description2.1
    
    Revised Binding Offer Letter from Coloplast A/S regarding purchase of Mentor Urology Business dated
May 5, 2006 Including Appendix A  Incorporated by reference to Exhibit 2.2 of the Registrants
Annual Report on Form 10-K for the year ended March 31, 2006.2.2
    
    Purchase Agreement between Coloplast A/S and Mentor Corporation dated May 17, 2006  Incorporated by
reference to Exhibit 2.3 of the Registrants Annual Report on Form 10-K for the year ended March 31,
2006.2.3
    
    Listing Schedules for Purchase Agreement between Coloplast A/S and Mentor Corporation dated May 17,
2006  Incorporated by reference to Exhibit 2.4 of the Registrants Annual Report on Form 10-K for
the year ended March 31, 2006.2.4
    
    Side Letter Agreement Between Coloplast A/S and Mentor Corporation dated June 2, 2006  Incorporated
by reference to Exhibit 2.5 of the Registrants Annual Report on Form 10-K for the year ended March
31, 2006.3.1
    
    Composite Restated Articles of Incorporation of the Company dated December 12, 2002  Incorporated by
reference to Exhibit 3.1 of the Registrants Annual Report on Form 10-K for the year ended March 31,
2003.3.2
    
    Amended and Restated Bylaws of Mentor Corporation dated September 14, 2005  Incorporated by
reference to Exhibit 3.2 of the Registrants Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005.4.1
    
    Indenture 2 3/4 % Convertible Subordinated Notes Due 2024, dated December 22, 2003  Incorporated by
reference to Exhibit 4.1 of the Registrants Quarterly Report on Form 10-Q for the quarter ended
December 31, 2003.10.1*
    
    Form of Indemnity Agreement  Incorporated by reference to Exhibit 10.1 of the Registrants Current
Report on Form 8-K filed on November 29, 2006.10.2*
    
    Employment Agreement between Mentor Corporation and Edward S. Northup dated February 5, 2007.31.1
    
    Certification of Principal Executive Officer Pursuant To Section 302 of The Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer Pursuant To Section 302 of The Sarbanes-Oxley Act of 2002.32.1
    
    CEO Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The
Sarbanes-Oxley Act of 2002.32.2
    
    CFO Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The
Sarbanes-Oxley Act of 2002.
   55