**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**Washington, D.C. 20549

**FORM 10-Q**

| (MarkOne) |                                                                                                                                                                  |
|-----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| x         |               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934 |

For the quarterly period ended**December 31, 2005**

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                   

Commission File No. 0-7955

**MENTOR CORPORATION**(Exact Name of Registrant asSpecified in its Charter)

| Minnesota                                                       |  | 41-0950791                        |
|-----------------------------------------------------------------|--|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |  | (IRS Employer Identification No.) |

**201 Mentor Drive, Santa Barbara, California 93111**(Address of Principal Executive Offices) (Zip Code)

**(805) 879-6000**(Registrant's telephone number including area code)

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or such shorter period that the Registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.  Yes x    No  o

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of "accelerated filer and largeaccelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):  Largeaccelerated filer x    Accelerated filero     Non-accelerated filer o

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o    No x

As of February 3, 2006 there were approximately 43,965,911 Common Shares, $.10 par value per share,outstanding. 

 

 

 

----

**MENTOR CORPORATION**

**INDEX**

| Part I.  Financial Information |
|--------------------------------|
| Item 1.                        | Financial Statements: |
|                                | Consolidated Balance Sheets  (unaudited) - December 31, 2005 and March 31, 2005 |
|                                | Consolidated Statements of  Income (unaudited) - Three Months Ended December 31, 2005 and 2004 |
|                                | Consolidated Statements of  Income (unaudited) - Nine Months Ended December 31, 2005 and 2004 |
|                                | Consolidated Statements of  Cash Flows (unaudited) - Nine Months Ended December 31, 2005 and 2004 |
|                                | Notes to Consolidated  Financial Statements - December 31, 2005 |
| Item 2.                        | Management's Discussion and  Analysis of Financial Condition and Results of Operations |
| Item 3.                        | Quantitative and  Qualitative Disclosures About Market Risk |
| Item 4.                        | Controls and Procedures |
| Part II. Other  Information    |
| Item 1.                        | Legal Proceedings |
| Item 1A.                       | Risk Factors |
| Item 2.                        | Unregistered Sales of  Equity Securities and Use of Proceeds |
| Item 3.                        | Defaults upon Senior  Securities |
| Item 4.                        | Submission of Matters to a  Vote of Security Holders |
| Item 5.                        | Other Information |
| Item 6.                        | Exhibits |

| 2 |
|---|

----

**PART I - FINANCIAL INFORMATION**

**Item 1.  ConsolidatedFinancial Statements**

| Mentor Corporation                               |
|--------------------------------------------------|
| Consolidated Balance Sheets                      |
| (Unaudited)                                      |
|                                                  |  |
|                                                  | **December 31,** | March 31, |
| (in thousands)                                   | **2005** | 2005 |
| **Assets**                                       | ** ** |  |
| Current assets:                                  | ** ** |  |
|  Cash and cash equivalents                  | ** $** | **89,525 ** |  $ | 76,666  |
|  Marketable securities                      | **107,452 ** | 36,228  |
|  Accounts receivable, net                   | **100,799 ** | 110,749  |
|  Inventories                                | **76,087 ** | 74,679  |
|  Deferred income taxes                      | **24,430 ** | 23,976  |
|  Prepaid income taxes                       | **5,139 ** | 1,500  |
|  Prepaid expenses and  other                | **16,618 ** | 15,074  |
| Total current assets                             | **420,050 ** | 338,872  |
|                                             | ** ** |  |
| Property and equipment, net                      | **66,627 ** | 72,287  |
| Intangible assets, net                           | **30,053 ** | 32,155  |
| Goodwill, net                                    | **23,040 ** | 24,080  |
| Other assets                                     | **10,508 ** | 10,207  |
|                                             | ** $** | **550,278 ** |  $ | 477,601  |
| See notes to consolidated  financial statements. | ** ** |  |

|  

 

 

 

3 |
|-----------------------------------|

----

| Mentor Corporation                                                               |
|----------------------------------------------------------------------------------|
| Consolidated Balance Sheets                                                      |
| (Unaudited)                                                                      |
|                                                                                  |  |
|                                                                                  | **December 31,** | March 31, |
| (in thousands)                                                                   | **2005** | 2005 |
| **Liabilities and  shareholders' equity**                                        | ** ** |  |
| Current liabilities:                                                             | ** ** |  |
|  Accounts payable                                                           | ** $** | **35,369 ** |  $ | 31,290  |
|   Accrued  compensation                                                | **19,377 ** | 28,680  |
|   Warranty  reserves                                                   | **21,107 ** | 19,245  |
|   Short-term bank  borrowings                                          | **- ** | 3,182  |
|   Sales returns                                                        | **13,895 ** | 13,612  |
|  Deferred revenue                                                           | **10,779 ** | 10,111  |
|  Product liability  reserves                                                | ** 6,685 ** | 6,483  |
|   Income taxes  payable                                                | **2,080 ** | 2,917  |
|  Accrued royalties                                                          | **900 ** | 785  |
|   Current portion  of purchase price related to acquired               | **1,100 ** | 1,812  |
|       technologies  and acquisitions               |
|   Interest  payable                                                    | **- ** | 1,083  |
|   Dividends  payable                                                   | **7,905 ** | 6,927  |
|   Other                                                                | **18,612 ** | 15,732  |
| Total current liabilities                                                        | **137,809 ** | 141,859  |
|                                                                                  | ** ** |  |
| Long-term accrued  liabilities                                                   | **9,278 ** | 10,587  |
| Convertible subordinated  notes                                                  | **150,000 ** | 150,000  |
|                                                                                  | ** ** |  |
| Shareholders' equity:                                                            | ** ** |  |
|   Common Stock,  $.10 par value:                                       | ** ** |  |
|     Authorized  - 150,000,000 shares; issued and outstanding | ** ** |  |
|     43,915,248  shares at December 31, 2005;                      | ** ** |  |
|     40,745,626  shares at March 31, 2005;                    | **4,392 ** | 4,075  |
|  Capital in  excess of par value                                            | **87,297 ** | 8,419  |
|  Deferred compensation                                                      | **(14,464)** | -  |
|  Accumulated other  comprehensive income                                    | **14,167 ** | 25,162  |
|  Retained  earnings                                                         | **161,799 ** | 137,499  |
|                                                                                  | **253,191 ** | 175,155  |
|                                                                                  | ** $** | **550,278 ** |  $ | 477,601  |
| See notes to consolidated  financial statements.                                 | ** ** |  |

|  

 

4 |
|-------------------|

----

| Mentor Corporation                               |
|--------------------------------------------------|
| Consolidated Statements of Income                |
| Three Months Ended December 31, 2005 and 2004    |
| (Unaudited)                                      |
|                                                  |  |
| (in thousands, except per  share data)           | **2005    ** | 2004     |
|                                             | ** ** |  |
| Net sales                                        | ** $** | **120,516 ** |  $ | 120,601  |
| Cost of sales                                    | **41,007 ** | 42,856  |
| Gross profit                                     | **79,509 ** | 77,745  |
|                                                  | ** ** |  |
| Selling, general and  administrative expense     | **50,384 ** | 45,353  |
| Research and development  expense                | **9,460 ** | 8,053  |
|                                                  | **59,844 ** | 53,406  |
|                                                  | ** ** |  |
| Operating income                                 | **19,665 ** | 24,339  |
|  Interest expense                           | **(1,408)** | (1,346) |
|  Interest income                            | **952 ** | 683  |
|  Other income  (expense), net               | **(78)** | 432  |
| Income before income taxes                       | **19,131 ** | 24,108  |
| Income taxes                                     | **6,387 ** | 7,779  |
| Net income                                       | ** $** | **12,744 ** |  $ | 16,329  |
|                                                  | ** ** |  |
| Basic earnings per share                         | ** $** | **0.29 ** |  $ | 0.39  |
| Diluted earnings per share                       | ** $** | **0.26 ** |  $ | 0.34  |
| Dividends per share                              | ** $** | **0.18 ** |  $ | 0.17  |
|                                                  | ** ** |  |
| Weighted average shares  outstanding             | ** ** |  |
| Basic                                            | **43,535 ** | 42,367  |
| Diluted                                          | **51,834 ** | 49,987  |
|                                                  | ** ** |  |
| See notes to consolidated  financial statements. | ** ** |  |
|                                                  | ** ** |  |

|  

 

5 |
|-------------------|

----

| Mentor Corporation                               |
|--------------------------------------------------|
| Consolidated Statements of Income                |
| Nine Months Ended December 31, 2005 and 2004     |
| (Unaudited)                                      |
|                                                  |  |
| (in thousands, except per  share data)           | **2005    ** | 2004     |
|                                             | ** ** |  |
| Net sales                                        | ** $** | **370,114 ** |  $ | 351,812  |
| Cost of sales                                    | **127,354 ** | 127,469  |
| Gross profit                                     | **242,760 ** | 224,343  |
|                                                  | ** ** |  |
| Selling, general and  administrative expense     | **143,361 ** | 129,173  |
| Research and development  expense                | **26,643 ** | 24,636  |
|                                                  | **170,004 ** | 153,809  |
|                                                  | ** ** |  |
| Operating income                                 | **72,756 ** | 70,534  |
|  Interest expense                           | **(4,294)** | (3,982) |
|  Interest income                            | **2,571 ** | 1,631  |
|  Other income  (expense), net               | **(29)** | 249  |
| Income before income taxes                       | **71,004 ** | 68,432  |
| Income taxes                                     | **23,667 ** | 21,915  |
| Net income                                       | ** $** | **47,337 ** |  $ | 46,517  |
|                                                  | ** ** |  |
| Basic earnings per share                         | ** $** | **1.10 ** |  $ | 1.10  |
| Diluted earnings per share                       | ** $** | **0.98 ** |  $ | 0.98   |
| Dividends per share                              | ** $** | **0.53 ** |  $ | 0.49  |
|                                                  | ** ** |  |
| Weighted average shares  outstanding             | ** ** |  |
| Basic                                            | **43,016 ** | 42,360  |
| Diluted                                          | **50,962 ** | 50,169   |
|                                                  | ** ** |  |
| See notes to consolidated  financial statements. | ** ** |  |
|                                                  | ** ** |  |

|  

 

6 |
|-------------------|

----

| Mentor Corporation                                              |
|-----------------------------------------------------------------|
| Consolidated Statements of Cash Flows                           |
| Nine Months Ended December 31, 2005 and 2004                    |
| (Unaudited)                                                     |
|                                                                 |  |
| (in thousands)                                                  | **2005    ** | 2004     |
| **Operating Activities:**                                       | ** ** |  |
| Net income                                                      | ** $** | **47,337 ** |  $ | 46,517  |
| Adjustments to derive cash  flows from operating activities:    | ** ** |  |
|   Depreciation                                        | **11,049 ** | 11,222  |
|   Amortization                                        | **3,375 ** | 3,977  |
|   Deferred income  taxes                              | **(703)** | 908  |
|   Deferred compensation                               | **762 ** | -  |
|   Tax benefit  from exercise of stock options         | **24,245 ** | 5,694  |
|   Loss on sale of  assets                             | **279 ** | 1,513  |
|   Imputed  interest on long-term liabilities          | **- ** | 15  |
|  (Gain) loss on long-term  marketable securities           | **(139)** | 14  |
| Changes in operating assets  and liabilities:                   | ** ** |  |
|   Accounts  receivable                                | **6,141 ** | 8,217  |
|   Inventories                                         | **(5,788)** | (5,383) |
|   Prepaid income  taxes and other current assets      | **(7,467)** | (6,316) |
|   Accounts  payable and accrued liabilities           | **3,502 ** | 2,518  |
|   Income taxes  payable                               | **968 ** | (633) |
| Net cash provided by  operating activities                      | **83,561 ** | 68,263  |
|                                                                 | ** ** |  |
| **Investing Activities:**                                       | ** ** |  |
| Purchases of property and  equipment                            | **(8,805)** | (6,818) |
| Purchases of intangibles                                        | **(1,663)** | (1,507) |
| Purchases of marketable  securities                             | **(238,897)** | (144,192) |
| Sales of marketable  securities                                 | **168,205** | 118,587  |
| Net cash used for investing  activities                         | **(81,160)** | (33,930) |
|                                                                 | ** ** |  |
| **Financing Activities:**                                       | ** ** |  |
| Repurchase of common stock                                      | **- ** | (79,773) |
| Proceeds from exercise of  stock options                        | **39,723 ** | 8,990  |
| Dividends paid                                                  | **(24,059)** | (20,623) |
| Repayments under line of  credit agreements, net                | **(3,182)** | (1,167) |
| Net cash (used) provided by  financing activities               | **12,482 ** | (92,573) |
| Effect of currency exchange  rates on cash and cash equivalents | **(2,024)** | 681  |
| Increase (decrease) in cash  and cash equivalents               | **12,859 ** | (57,559) |
| Cash and cash equivalents  at beginning of year                 | **76,666 ** | 118,225  |
| Cash and cash equivalents  at end of period                     | ** $** | **89,525 ** |  $ | 60,666  |
|                                                                 | ** ** |  |
| See notes to consolidated  financial statements.                | ** ** |  |

|  

 

7 |
|-------------------|

----

**MENTOR CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005**

**NoteA - Business Activity**

Mentor Corporation wasincorporated in April 1969.  Unless the context indicates otherwise, whenwe refer to "Mentor," "we," "us,""our," or the "Company" in this Form 10-Q, we are referringto Mentor Corporation and its subsidiaries on a consolidated basis.  Wedevelop, manufacture and market a broad range of products serving the medicalspecialties market.  Our products are utilized by three primary segments:aesthetic and general surgery (plastic and reconstructive surgery), surgicalurology, and clinical and consumer healthcare.  Aesthetic and generalsurgery products include surgically implantable prostheses for plastic andreconstructive surgery, capital equipment and consumables used for soft tissueaspiration or body contouring (liposuction), and a non-animal based hyaluronicacid dermal filler.  Surgical urology products include surgicallyimplantable prostheses for the treatment of impotence, surgically implantableincontinence products, urinary care products and brachytherapy seeds for thetreatment of prostate cancer.  Clinical and consumer healthcare productsinclude catheters and other products for the management of urinary incontinenceand retention. 

**NoteB - Summary of Significant Accounting Policies**

The consolidated financialstatements include the accounts of the Company and all of its subsidiaries inwhich a controlling interest is maintained.  For those subsidiaries wherethe Company owns less than 100%, the outside shareholders' interests aretreated as minority interests.  All inter-company accounts andtransactions have been eliminated.  Certain prior year amounts in previouslyissued financial statements have been reclassified or restated to conform tothe current year presentation.  

**Basis of Presentation**

The financial information forthe three and nine months ended December 31, 2005 and 2004 is unaudited, but includes all adjustments (consisting only of normally recurring accruals,unless otherwise indicated) that the Company considers necessary for a fairpresentation of the results of operations for these periods.  Interimresults are not necessarily indicative of results for the full fiscal year. ** **

**Use of Estimates**

Financial statements preparedin accordance with accounting principles generally accepted in the United States require management to make estimates and judgments that affect amounts anddisclosures reported in the financial statements.  Actual results coulddiffer from those estimates.  A discussion of the Company's significantaccounting policies is described in the "Application of Critical Accounting Policies" section of "Management's Discussion and Analysis of FinancialCondition and Results of Operations."

**Revenue Recognition**

We recognize productrevenue, net of discounts, returns, and rebates in accordance with Statement ofFinancial Accounting Standards ("SFAS") No. 48, "RevenueRecognition When the Right of Return Exists," and Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition."

 

| 8 |
|---|

----

As required by thesestandards, revenue is recorded when persuasive evidence of a sales arrangementexists, delivery has occurred, the buyer's price is fixed or determinable,contractual obligations have been satisfied, and collectibility is reasonablyassured.  These requirements are met, and sales and related cost of salesare recognized upon the shipment of products, or in the case of consignmentinventories, upon the notification of usage by the customer.  We recordestimated reductions to revenue for customer programs and other volume-basedincentives.  Should the actual level of customer participation in theseprograms differ from those estimated, additional adjustments to revenue may berequired.  We also allow credit for products returned within our policyterms.  We record an allowance for estimated returns at the time of salebased on historical experience, recent gross sales levels and any notificationof pending returns.  Should the actual returns differ from thoseestimated, additional adjustments to revenue and cost of sales may be required.

Our deferred revenueconsists of both current and long term and includes funds received inconnection with patent license agreements and sales of our enhanced advantagebreast implant warranty program.   The deferred revenue relating to thelicensing fees received under the patent license agreements will be recognizedas revenue evenly over the product's life expectancy based upon historic productlife cycles for products similar to the licensed product.  The feesreceived in connection with a sale of an enhanced advantage breast implant warrantyare deferred and recognized as revenue evenly over the life of the warrantyterm.

**Warranty Reserves**

We offer two types ofwarranties relating to our breast implants in the United States, Canada, andPuerto Rico: a standard limited warranty which is offered at no additionalcharge and an enhanced limited warranty at an additional charge of $100 in theU.S. and ($100 CAD in Canada), and which provide limited financial assistancein the event of a deflation or rupture.  Our standard limited warranty is alsooffered in certain European and other international countries for siliconegel-filled breast implants.  We provide an accrual for the estimated cost ofbreast implant warranties at the time revenue is recognized.  Theestimated cost of the standard limited warranty is recorded as an expense atthe time of sale, whereas the estimated cost of the enhanced limited warrantyis deferred and recognized over the term of the enhanced limited warranty. Such accruals are based on estimates, which are based on relevant factors suchas unit sales, historical experience, the warranty period, estimated costs,and, to a limited extent, information developed by our insurance company usingactuarial techniques.  These accruals are analyzed periodically foradequacy.  While we engage in extensive product quality programs andprocesses, including actively monitoring and evaluating the quality of ourcomponent suppliers, the warranty obligation is affected by reported rates ofwarranty claims and levels of financial assistance specified in thewarranties.  Should actual patient claim rates reported differ from ourestimates, adjustments to the estimated warranty liability may berequired.  These adjustments would be included in selling, general andadministrative expenses.

**Product LiabilityReserves**

We have product liabilityreserves for product-related claims to the extent those claims may result inlitigation expenses, settlements or judgments within our self-insured retentionlimits.  We have also established additional reserves, through our wholly-ownedcaptive insurance company, for estimated liabilities for product-related claimsbased on actuarially determined estimated liabilities taking into accountour excess insurance coverages.  The actuarial valuations are based onhistorical information and certain assumptions about future events.  Shouldactual product liability experience differ from the estimates and assumptionsused to develop these reserves, subsequent changes in reserves will be recordedin selling, general and administrative expenses, and may affect our operatingresults in future periods.  

**Effects of Recent Accounting Pronouncements**

In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 154, Accounting Changes and Error Corrections, which replaces Accounting Principles Board ("APB") Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements.  This pronouncementapplies to all voluntary changes in accounting principle, and revises therequirements for accounting for, and reporting a change in, accountingprinciple.  SFAS No. 154 requires retrospective application to prior periods'financial statements of a voluntary change in accounting principle, unless itis impracticable to do so.  This pronouncement also requires that a change inthe method of depreciation, amortization, or depletion for long-lived,non-financial assets be accounted for as a change in accounting estimate thatis affected by a change in accounting principle.  SFAS No. 154 retains many provisionsof APB Opinion 20 without change, including those related to reporting a changein accounting estimate, a change in the reporting entity, and correction of anerror.  The pronouncement also carries forward the provisions of SFAS No. 3,which govern reporting accounting changes in interim financial statements.  SFASNo. 154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005.  The Statement does not changethe transition provisions of any existing accounting pronouncements, includingthose that are in a transition phase as of the effective date of SFAS No. 154.  TheCompany intends to apply the provisions of this statement effective April 1, 2006.

| 9 |
|---|

----

In December 2004, the FASBissued FASB Staff Position ("FSP") No. 109-1, Application of SFAS No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided bythe American Jobs Creation Act of 2004.  The FSP provides that the deduction onqualified production activities will be treated as a "specialdeduction" as described in SFAS No. 109, Accounting for IncomeTaxes.  Accordingly, the tax effect of this deduction will be reported asa component of the Company's tax provision and will not have an effect ondeferred tax assets and liabilities.  The Company anticipates that theDepartment of Treasury may issue clarifying guidance with respect to the deductionon qualified production activities.  The adoption of FSP No. 109-1 is notexpected to have a material effect on the Company's consolidated financialstatements; however, the Company will continue to evaluate the tax effect ofthe special deduction as further guidance is issued by the Department ofTreasury. 

In December 2004, the FASBissued SFAS No. 123 (revised 2004), "Share-Based Payment,"("SFAS 123(R)").  SFAS 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.  SFAS 123(R) covers a wide range of share-basedcompensation arrangements and requires that the compensation cost related tothese types of payment transactions be recognized in financialstatements.  Cost will be measured based on the fair value of the equityor liability instruments issued.

In March 2005, the Securitiesand Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 107, which provides guidance regarding the application of SFAS 123(R).  SAB No. 107 expresses views of the Staff regarding the interaction between SFAS 123(R),Share-Based Payment, and certain SEC rules and regulations, and provides theStaff's views regarding the valuation of share-based payment arrangements forpublic companies.  In particular, SAB No. 107 provides guidance related toshare-based payment transactions with nonemployees, the transition fromnonpublic to public entity status, valuation methods (including assumptionssuch as expected volatility and expected term), the accounting for certainredeemable financial instruments issued under share-based payment arrangements,the classification of compensation expense, non-GAAP financial measures,first-time adoption of SFAS 123(R) in an interim period, capitalization ofcompensation cost related to share-based payment arrangements, the accountingfor income tax effects of share-basedpayment arrangements upon adoption of SFAS 123(R), the modification of employeeshare options prior to adoption of SFAS 123(R), and disclosures in Management'sDiscussion and Analysis subsequent to adoption of SFAS 123(R).

On April 14, 2005, the SEC approved a new rule that delays the effective date for SFAS 123(R) to fiscalyears beginning after June 15, 2005, thereby rendering it effective as to theCompany on April 1, 2006.  The adoption of SFAS 123(R) on April 1, 2006 is expected to have a material impact on the Company's consolidated netincome and earnings per share.  The Company has not completed its analysisof the impact of the adoption of 123(R); however, the effect of the adoption isestimated to approximate that shown in Note K, "Stock Options andRestricted Stock" in the Notes to Consolidated Financial Statements.

In November 2004, the FASBissued Statement No. 151, Inventory Costs, which amends the guidance in Accounting Review Board ("ARB") No. 43, Chapter 4, Inventory Pricing.  This amendmentclarifies the accounting for abnormal amounts of idle facility expense,freight, handling costs and wasted material (spoilage).  This Statementrequires that those items be recognized as current-period charges, regardlessof whether they meet the criteria specified in ARB 43 of "soabnormal".  In addition, this Statement requires that allocation offixed production overheads to the costs of conversion be based on normalcapacity of the production facilities.  This Statement is effective forfiscal years beginning after June 15, 2005, thereby rendering it effective asto the Company on April 1, 2006.  The adoption of SFAS No. 151 is notexpected to have a material impact on the results of operations or thefinancial position of the Company. 

| 10 |
|----|

----

In September 2004, the FASBconfirmed Emerging Issues Task Force ("EITF") Issue No. 04-8,"The Effect of Contingently Convertible Debt on Diluted Earnings perShare," with an effective date of December 15, 2004.  The EITF reflects the Task Force's conclusion that contingently convertible debt should beincluded in diluted earnings per share calculations, regardless of whether ornot the trigger price has been reached.  The Company adopted EITF 04-8 inthe quarter ended December 31, 2004 and retroactively applied its provisions tothe interim periods ending June 30 and September 30, 2004 due to the Company's December 2003 issuance of convertible subordinated notes.  The impact of theEITF 04-8 changed the diluted earnings per share calculation by increasing netincome used in the numerator by the after-tax amount of interest expenserelated to the convertible notes (approximately $802,000 per quarter), and byincreasing weighted average shares outstanding used in the denominator by approximately5.1 million shares, the number of shares to be issued upon full conversion ofthe convertible notes.  The effect of the restatement was a decrease indiluted earnings per share of approximately $0.02 per share for the interimperiods ending June 30 and September 30, 2004.

**Note C - Interim Reporting**

The Company's three quarterlyinterim reporting periods are each thirteen-week periods ending on the Fridaynearest the end of the third calendar month of each calendar quarter.  Thefiscal year end remains March 31st.  To facilitate ease ofpresentation, each interim period is shown as if it ended on the last day ofthe appropriate calendar month.  The actual dates for each of the threeinterim quarters-ends are shown below:

|                | Fiscal 2006        | Fiscal 2005       |
|----------------|--------------------|-------------------|
| First Quarter  | July 1, 2005       | July 2, 2004      |
| Second Quarter | September 30, 2005 | October 1, 2004   |
| Third Quarter  | December 30, 2005  | December 31, 2004 |

The accompanying unauditedconsolidated financial statements for the three-month and nine-month periodsended December 31, 2005 and 2004 have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, they do not include all of the informationand footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, alladjustments (consisting only of normally recurring accruals, unless otherwiseindicated) considered necessary for a fair presentation of the results ofoperations for the indicated periods have been included.  Certain amountsrecorded in previous periods have been reclassified or restated to conform tothe current period presentation.  Operating results for the three-month andnine-month periods ended December 31, 2005 are not necessarily indicative ofthe results for the full fiscal year. 

The balance sheet at March 31, 2005 has been derived from the audited financial statements as of that date, butdoes not include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements.

| 11 |
|----|

----

The consolidated financialstatements should be read in conjunction with the Company's Annual Report onForm 10-K for the year ended March 31, 2005.** **

**Note D - Cash Equivalents,Marketable Securities, and Long-Term Marketable Securities and Investments**

All highly liquid investmentswith maturities of three months or less at the date of purchase are consideredto be cash equivalents.

The Company considers itsmarketable securities available-for-sale as defined in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities."  Realized gains andlosses, and declines in value considered to be other than temporary, areincluded in income.  The cost of securities sold is based on the specificidentification method.  Available-for-sale securities are reported at fairmarket value.  Unrealized gains and losses are excluded from income, but,instead are reported as a net amount in Accumulated Other Comprehensive Incomein Shareholders' Equity.  The Company's short-term marketable securitiesconsist primarily of state and municipal government and government agency obligations,Federal Home Loan Bank and Mortgage Association bonds, and investment gradecorporate obligations, including commercial paper. 

**Available-for-saleinvestments at December 31, 2005 were as follows**:

| ** **                                            | ** **   | **Gross**      | **Gross**      | **Estimated** |
|-------------------------------------------------------|--------------|----------------|----------------|---------------|
| ** **                                            | **Adjusted** | **Unrealized** | **Unrealized** | **Fair**      |
| **(in thousands)**                                    | **Cost**     | **Gains**      | **Losses**     | **Value**     |
| **Cash balances**                                     | ** $**  | **83,392**     | ** $**    | **-**         | ** $** | **-** | ** $** | **83,392** |
| **Money market mutual  funds**                        | **6,491**    | **-**          | **-**          | **6,491**     |
| **State and Municipal  agency obligations**           | **67,200**   | **-**          | **-**          | **67,200**    |
| **Mortgage-backed  securities**                       | **39,729**   | **82**         | **(196)**      | **39,615**    |
| **Corporate debt  securities**                        | **281**      | **-**          | **(2)**        | **279**       |
| **  Total  available-for-sale investments** | ** $**  | **197,093**    | ** $**    | **82**        | ** $** | **(198)** | ** $** | **196,977** |
| ** **                                            | ** **   | ** **     | ** **     | ** **    |
| **Included in cash and  cash equivalents**            | ** $**  | **89,525**     | ** $**    | **-**         | ** $** | **-** | ** $** | **89,525** |
| **Included in current  marketable securities**        | **107,568**  | **82**         | **(198)**      | **107,452**   |
| **  Total  available-for-sale investments** | ** $**  | **197,093**    | ** $**    | **82**        | ** $** | **(198)** | ** $** | **196,977** |

Available-for-saleinvestments at March 31, 2005 were as follows:

|                                                   |              | Gross         | Gross      | Estimated    |
|---------------------------------------------------|--------------|---------------|------------|--------------|
|                                                   | Adjusted     | Unrealized    | Unrealized | Fair         |
| (in thousands)                                    | Cost         | Gains         | Losses     | Value        |
| Cash balances                                     |  $      | 68,598   |  $    | -       |  $ | -  |  $ | 68,598  |
| Money market mutual funds                         | 8,068   | -        | -     | 8,068   |
| Marketable equity  securities                     | 161     | -        | (18)       | 143     |
| U.S., State and Municipal agency obligations      | 36,149  | -        | (342)      | 35,807  |
| Corporate debt securities                         | 278     | -        | -     | 278     |
|   Total  available-for-sale investments |  $      | 113,254  |  $    | -       |  $ | (360) |  $ | 112,894  |
|                                                   |              |               |            |              |
| Included in cash and cash  equivalents            |  $      | 76,666   |  $    | -       |  $ | -  |  $ | 76,666  |
| Included in current  marketable securities        | 36,588  | -        | (360)      | 36,228  |
|   Total  available-for-sale investments |  $      | 113,254  |  $    | -       |  $ | (360) |  $ | 112,894  |

 

12

----

**NoteE - Inventories**

Inventories are stated at thelower of cost or market, cost determined by the first-in, first-out (FIFO)method.  The Company writes down its inventory for estimated obsolescenceor unmarketable inventory equal to the difference between the cost of inventoryand the estimated market value based upon assumptions about future demand andmarket conditions.

Inventoriesat December 31, 2005 and March 31, 2005 consisted of:

| (in  thousands)                | **December 31,** | March 31,        |
|--------------------------------|------------------|------------------|
| Raw  materials                 | ** $**      | **15,976 ** |  $ | 14,155  |
| Work  in process               | **10,252 ** | 12,055      |
| Finished  goods on consignment | **14,285 ** | 15,736      |
| Finished  goods                | **35,574 ** | 32,733      |
|                                | ** $**      | **76,087 ** |  $ | 74,679  |

 **NoteF - Property and Equipment**

Property and equipment isstated at cost.  Depreciation is based on the useful lives of theproperties and computed using the straight-line method.  Buildings aredepreciated over 30 years, furniture and equipment over 3 to 10 years andleasehold improvements over the shorter of their estimated remaining lives orlease terms.  Significant improvements and betterments are capitalized,while maintenance and repairs are charged to operations as incurred.

Propertyand equipment at December 31, 2005 and March 31, 2005 consisted of:

|   | (in  thousands)                    | **December 31,**  | March 31,   |
|--------|------------------------------------|-------------------|-----------------------|
|   | Land                               | ** $**       | **556 **         |  $ | 574  |
|   | Buildings                          | **23,767 **  | 24,758           |
|   | Leasehold  improvements            | **27,332 **  | 25,371           |
|   | Furniture,  fixtures and equipment | **109,044 ** | 109,325          |
|   | Construction  in progress          | **4,985 **   | 4,562            |
|   |                                    | **165,684 ** | 164,590          |
|   | Less  accumulated depreciation     | **(99,057)**      | (92,303)              |
|   |                                    | ** $**       | **66,627 **      |  $ | 72,287  |

**NoteG - Product Warranties**

The Company provides anaccrual for the estimated cost of product warranties at the time revenue isrecognized.  The Company offers product replacement and certain financialassistance for surgical procedures that fall within the limited warranties andcoverage period of implantation on its breast implant products.  Such accrualsare based on estimates, taking into consideration relevant factors such as unitsales, historical experience, warranty period, estimated costs, and, to alimited extent, information developed by our insurance company using actuarialtechniques.  The Company assesses the adequacy of these accrualsperiodically and adjusts the amounts as necessary based on actual experienceand changes in future expectations.  In the first quarter of fiscal 2006, theCompany expanded its standard limited warranty programs to provide certainfinancial assistance for surgical procedures within ten years of implantation (increasedfrom five years) and in the third quarter of fiscal 2006 expanded the programcoverage to include silicone gel-filled breast implant sale implanted in certainEuropean and other international countries.  These changes to our warranty programs werenot retroactive, but applicable to implants subsequent to the effective date ofthe enhanced programs.  

| 13 |
|----|

----

Information on changes in theCompany's accrued product warranty reserves are as follows:

|   |                                                                  | Nine Months Ended          |
|--------|------------------------------------------------------------------|----------------------------|
|   |                                                                  | December 31,               |
|   | (in  thousands)                                                  | **2005   ** | 2004    |
|   | Beginning  warranty reserves                                     | ** $**                | **19,245 ** |  $ | 17,783  |
|   | Costs  of warranty claims                                        | **(3,026)**                | (3,037) |
|   | Accruals  for product warranties                                 | **4,888 **            | 4,097  |
|   | Adjustments  made to accruals related to pre-existing warranties | ** **                 | **- ** |  | -  |
|   | Ending  warranty reserves                                        | ** $**                | **21,107 ** |  $ | 18,843  |

**NoteH - Comprehensive Income**

Comprehensive income is netincome adjusted for changes in the value of derivative financial instruments,unrealized gains and losses on marketable securities and foreign currencytranslation.  

Comprehensiveincome for the three and nine-month periods was:

|                                                  | Three Months Ended | Nine Months Ended |
|--------------------------------------------------|--------------------|-------------------|
|                                                  | December 31,       | December 31,      |
| (in thousands)                                   | **2005**           | 2004              | **2005** | 2004 |
| Net income                                       | ** $**        | **12,744 **  |  $ | 16,329  | ** $** | **47,337 ** |  $ | 46,517  |
| Foreign currency  translation adjustment         | **(2,338)**        | 10,356       | **(11,094)** | 11,927  |
| Unrealized (gains) losses  on marketable         | ** **         |                   | ** ** |  |
|  securities and investment  activities, net | **97 **       | (118)             | **100 ** | (162) |
| Comprehensive income                             | ** $**        | **10,503 **  |  $ | 26,567  | ** $** | **36,343 ** |  $ | 58,282  |

**NoteI - Income Taxes**

Generally, the Company doesnot provide for U.S. income taxes on undistributed earnings of its foreigncorporations that are intended to be invested indefinitely outside the UnitedStates; however, on October 22, 2004, the President of the United States signedthe American Jobs Creation Act of 2004 (AJCA).  The AJCA created atemporary incentive for U.S. corporations to repatriate accumulated incomeearned abroad by providing an 85 percent dividends received deduction forcertain dividends from controlled foreign corporations.  In the secondquarter of fiscal 2006, the Company decided to repatriate up to $25.0 millionin foreign profits, and estimated the tax liability on the repatriation wouldbe approximately $1.5 million.

The effective rate ofcorporate income taxes for the three months ended December 31, 2005 was 33.4%, as compared to 32.2% for the same period in the prior year.  The effectiverate of corporate income taxes was 33.3% and 32.0% for the nine-month periodsended December 31, 2005 and 2004, respectively.  The increases in the effectivetax rates during these three and nine-month periods reflect the impact of the repatriationnoted above, and we expect this higher rate to continue for the remainder ofthe fiscal year.

| 14 |
|----|

----

The Company's income taxreturns are routinely audited by federal and various state and foreign taxauthorities. Disputes can arise with these tax authorities involving matters ofthe timing and amount of deductions, and allocations of income among varioustax jurisdictions because of differing interpretations of tax laws and regulations. The Company periodically evaluates our exposures associated with tax filingpositions.  While the Company believes our positions comply with applicablelaws, we record liabilities based upon estimates of the ultimate settled outcomesof these matters.  While it is not possible to accurately predict the eventualoutcome of these matters, the Company does not believe any such items will havea material adverse effect on our annual Consolidated Financial Statements,although an adverse resolution of one or moreof these items could have a material impact on the results of operations.

**Note J - Earnings perShare**

Basic earnings per share iscomputed by dividing net income available to common shareholders by theweighted average number of shares of the Company's common shares outstandingduring the period. Diluted earnings per share is calculated in the same manneras basic earnings per share except that when the effect is dilutive, net incomeis increased by the after-tax interest expense on the Company's convertiblesubordinated notes, and the number of shares outstanding is increased bypotentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of shares issuable under the termsof employee stock options, unvested restricted stock grants, warrants, and the23⁄4% convertible subordinated notes.  A reconciliation of net income forbasic earnings per share to net income for diluted earnings per share and weightedaverage shares outstanding, used to calculate basic earnings per share, toweighted average shares outstanding assuming dilution, used to calculatediluted earnings per share, follows:

|                                                                                           | Three Months Ended | Nine Months Ended |
|-------------------------------------------------------------------------------------------|--------------------|-------------------|
|                                                                                           | December 31,       | December 31,      |
| (in thousands)                                                                            | **2005**           | 2004              | **2005** | 2004 |
| Net income: as reported1                                                                  | ** $**        | **12,744 **  |  $ | 16,329  | ** $** | **47,337 ** |  $ | 46,517  |
| Add back after-tax interest  expense on convertible notes                                 | **802 **      | 802          | **2,406 ** | 2,406  |
| Net income for numerator of  diluted earnings per share                                   | ** $**        | **13,546 **  |  $ | 17,131  | ** $** | **49,743 ** |  $ | 48,923  |
|                                                                                           |                    |                   |  |  |
| 1 Net income as reported  includes no compensation expense associated with stock options. |
|                                                                                      |

|                                                     | Three Months Ended | Nine Months Ended |
|-----------------------------------------------------|--------------------|-------------------|
|                                                     | December 31,       | December 31,      |
| (in thousands, except per  share data)              | **2005**           | 2004              | **2005** | 2004 |
| Weighted average  outstanding shares:  basic   | **43,535 **   | 42,367       | **43,016 ** | 42,360  |
| Shares issuable through  exercise of stock options  | **1,831 **    | 2,492        | **2,011 ** | 2,685  |
| Unvested restricted stock  grants                   | **276 **      | -            | **92 ** | -  |
| Shares issuable through  convertible notes          | **5,139 **    | 5,128        | **5,136 ** | 5,124  |
| Shares issuable through  warrants                   | **1,053 **    | -            | **707 ** | -  |
| Weighted average  outstanding shares:  diluted | **51,834 **   | 49,987       | **50,962 ** | 50,169  |
|                                                     | ** **         |                   | ** ** |  |
| Basic earnings per share                            | ** $**        | **0.29 **    |  $ | 0.39  | ** $** | **1.10 ** |  $ | 1.10  |
| Diluted earnings per share                          | ** $**        | **0.26 **    |  $ | 0.34  | ** $** | **0.98 ** |  $ | 0.98  |

|  

15 |
|------------|

----

Shares issuable through stockoptions are determined using the treasury stock method.  Sharespotentially issuable upon the conversion of the Company's 23⁄4% convertiblesubordinated notes are included in the calculation when the effect of theconversion would be dilutive on diluted earnings per share.  Thisinclusion of potentially issuable shares is required even when the notes arenot actually subject to conversion because the required conditions forconversion (described in Note O - "Long-Term Debt" below) have notbeen satisfied.  The Company purchased a note hedge and sold warrantswhich, in combination, have the effect of reducing the dilutive impact of theconvertible notes by effectively increasing the conversion price of the notesto the warrant strike price of $39.2887 per share.  The convertible notehedge is always excluded from the calculation of diluted earnings per sharebecause its impact will always be anti-dilutive.  However, SFAS 128requires that the dilutive impact of the warrants be included in dilutedearnings per share using the treasury stock method whenever the average priceof the Company's common shares exceeds the strike price of the warrants. For example, using the treasury stock method, if the average price of our stockduring the period ended December 31, 2005 had been $38.00, $43.00 or $49.00,the shares from the warrants to be included in diluted earnings per share wouldhave been zero, 443,000 and 1,018,000 shares, respectively.  The totalnumber of shares that could potentially be included under the warrants is 5.1million.  The average share price of our stock during the quarter ended December 31, 2005 exceeded the $39.2887 conversion price of the warrants; the impact ofthese warrants was that 1.1 million shares were added to the diluted shares anddiluted earnings per share calculation during that period.  The Companyadopted the provisions of EITF 04-8, "The Effect of ContingentlyConvertible Debt on Diluted Earnings per Share," in December 2004. The EITF required the inclusion of contingently issuable shares in thecalculation of diluted earnings per share when the effect would be dilutiveeven if none of the required conditions for conversion were satisfied. Inaddition, the EITF required application on retrospective basis for all periodspresented.  

**NoteK - Stock Options and Restricted Stock**

The Company has grantedoptions to key employees and non-employee directors under its Amended 2000Long-Term Incentive Plan and 1991 Plan.  Options granted under both plansvest in four equal annual installments beginning one year from the date ofgrant, and expire ten years from the date of grant.

In September 2005, theCompany's shareholders approved an amended and restated version of theCompany's Amended 2000 Long-Term Incentive Plan, which is now referred to asthe Mentor Corporation 2005 Long-Term Incentive Plan (the "2005 Plan").  The2005 Plan reflects, among other things, amendments to the earlier plans to: (i)provide the Company with flexibility to grant awards other than stock options,including but not limited to restricted stock, stock bonuses, stock units anddividend equivalents; (ii) allow the Company to grant awards intended toqualify as performance-based compensation within the meaning of Section 162(m)of the U.S. Internal Revenue Code; and (iii) extend the term of the plan to July 24, 2015.  The 2005 Plan does not provide for an increase in the number ofshares of the Company's common stock available for award grants under the plan.

In November 2005, the Boardof Directors of the Company approved certain amendments to the 2005 Plan. These amendments provide as follows:

Grantsof full-value awards under the 2005 Plan generally must satisfy certain minimumvesting requirements.  ("Full-value awards" include all awards granted underthe 2005 Plan other than stock options with an exercise price that is not lessthan the fair market value of the underlying stock on the date the option isgranted.)  Full-value awards subject to time-based vesting may not become fullyvested in less than three years.  Full-value awards subject toperformance-based vesting may not vest in less than one year.  The Companyretains discretion to accelerate vesting of such awards under certaincircumstances such as in connection with a termination of the grantee'semployment, a change in control of the Company or the grantee's employer, or arelease of claims by the grantee.  The Company may also grant full-value awardscovering up to 10% of the total number of shares available for grant purposesunder the 2005 Plan that are not subject to the foregoing vesting andacceleration restrictions.

Shareholderapproval is expressly required for any increase in the number of shares of theCompany's common stock that are available for award grant purposes under the2005 Plan.

These amendments arereflected in Sections 4.2(e), 5.1.4 and 8.6.3 of the restated version of the2005 Plan, which has been filed as an exhibit to this Report.

Persons eligible to receiveawards under the 2005 Plan include directors, officers or employees of theCompany, and certain of its consultants and advisors.  The types of awards thatmay be granted under the 2005 Plan include stock options, restricted stock,stock bonuses, stock units and dividend equivalents, and other forms of awardsgranted or denominated in the Company's common stock or units of the Company'scommon stock, as well as certain cash bonus awards.  Pursuant to the terms ofthe option plans, 164,829 and 2,870,623 common shares were exercised during thethree and nine month period ended December 31, 2005, respectively.  

The maximum number of sharesof the Company's common stock that may be issued or transferred pursuant toawards under the 2005 Plan remains at 6.0 million shares (inclusive ofapproximately 4.6 million options previously granted under the Amended 2000Long-Term Incentive Plan).

In September 2005, theCompany's shareholders approved an Employee Stock Purchase Plan ("ESPP"), whichassists eligible employees in acquiring a stock ownership interest in theCompany, at a favorable price and upon favorable terms, pursuant to a planwhich is intended to qualify as an ESPP under Section 423 of the Code.  Theinitial offering period commenced in November 2005.

| 16 |
|----|

----

On October 5, 2005 (the "Award Date"), the Compensation Committee of the Board of Directors ofthe Company, granted awards in the aggregate amount of 288,856 restrictedshares of Company common stock (the "Restricted Stock") to the Company'sExecutive Officers and other Company Officers, and to members of the Board ofDirectors of the Company.  The Restricted Stock vests, and restrictions lapse,with respect to one-fifth of the total number of shares of Restricted Stock oneach of the first, second, third, fourth and fifth anniversaries of the AwardDate.  The vesting schedule requires continued employment or servicethrough each applicable vesting date as a condition to the vesting of theapplicable installment of the Restricted Stock,and carries specific share holding requirements during such employment orservice.  Mentor has recorded $14.5 million net of amortization, indeferred stock-based compensation in accordance with APB No. 25.  Stockcompensation expense is recognized over the 5-year vesting period of theRestricted Stock grants.  Restricted Stock compensation expense for the three andnine month periods ended December 31, 2005 was $0.8 million and $0,respectively.  There was no Restricted Stock compensation expense in fiscal2005.

Exercise prices for stockoptions are set at fair market value, as determined by the closing price of theCompany's common stock on the New York Stock Exchange on the date of grant, andthe related number of shares granted is fixed at that point in time. Therefore, under the principles of APB Opinion 25, the Company does notrecognize compensation expense associated with the grant of stockoptions.  SFAS 123 "Accounting for Stock-Based Compensation"requires the use of an option valuation model to provide supplementalinformation regarding options granted after fiscal 1995.  Pro formainformation regarding net income and earnings per share shown below weredetermined as if the Company had accounted for its employee stock options underthe fair value method of that statement.  For purposes of pro formadisclosure, the estimated fair value of the options is amortized ratably overthe options' vesting period.

The pro forma effect on netincome may not be representative of the pro forma effect on net income infuture years because compensation expense in future years will reflect theamortization of a different number of stock options granted in succeedingyears, at different fair values.  The Company's pro forma information isas follows:

|                                                                                      | Three Months Ended | Nine Months Ended |
|-------------------------------------------------------------------------------------------|--------------------|-------------------|
|                                                                                           | December 31,       | December 31,      |
| (in thousands except per  share data)                                                     | **2005**           | 2004              | **2005** | 2004 |
| Net income: as reported1                                                                  | ** $**        | **12,744 **  |  $ | 16,329  | ** $** | **47,337 ** |  $ | 46,517  |
| Deduct: compensation  expense fair value method                                      | **(1,233)**        | (1,642)           | **(3,901)** | (5,197) |
| Net income:  pro forma                                                               | ** $**        | **11,511 **  |  $ | 14,687  | ** $** | **43,436 ** |  $ | 41,320  |
|                                                                                           | ** **         |                   | ** ** |  |
| Basic earnings per  share:  as reported                                              | ** $**        | **0.29 **    |  $ | 0.39  | ** $** | **1.10 ** |  $ | 1.10  |
| Basic earnings per  share:  pro forma                                                | ** $**        | **0.26 **    |  $ | 0.35  | ** $** | **1.01 ** |  $ | 0.98  |
|                                                                                           | ** **         |                   | ** ** |  |
| Net income: as  reported1                                                            | ** $**        | **12,744 **  |  $ | 16,329  | ** $** | **47,337 ** |  $ | 46,517  |
| Add back after-tax interest  expense on convertible notes                                 | **802 **      | 802          | **2,406 ** | 2,406  |
| Net income: diluted  earnings per share                                              | **13,546 **   | 17,131       | **49,743 ** | 48,923  |
| Deduct: compensation  expense fair value method                                      | **(1,233)**        | (1,642)           | **(3,901)** | (5,197) |
| Net income: diluted  earnings per share pro forma                                    | ** $**        | **12,313 **  |  $ | 15,489  | ** $** | **45,842 ** |  $ | 43,726  |
|                                                                                           | ** **         |                   | ** ** |  |
| Diluted earnings per  share:  as reported                                            | ** $**        | **0.26 **    |  $ | 0.34  | ** $** | **0.98 ** |  $ | 0.98  |
| Diluted earnings per  share:  pro forma                                              | ** $**        | **0.24 **    |  $ | 0.29  | ** $** | **0.90 ** |  $ | 0.82  |
|                                                                                           | ** **         |                   | ** ** |  |
|                                                                                           | ** **         |                   | ** ** |  |
| 1 Net income as reported  includes no compensation expense associated with stock options. |

|  

 

 

17 |
|----------------------------|

----

In December 2004, theFinancial Accounting Standards Board issued SFAS No. 123(R),"Share-Based Payment".  SFAS No. 123(R) will requirethe Company to account for its stock options using a fair-value-based method asdescribed in such statement and recognize the resulting compensation expense inthe Company's financial statements.  SFAS 123(R) will also require thebenefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow asrequired under current literature. This requirement will reduce net operatingcash flows and increase net financing cash flows in periods after adoption. The Company currently accounts for its employeestock options using the intrinsic value method under APB Opinion No. 25,"Accounting for Stock Issued to Employees" and related interpretations,which generally results in no employee stock option expense.  The Companyplans to adopt SFAS No. 123(R) on April 1, 2006, as required.

**Note L - Share RepurchaseProgram**

The Company has a sharerepurchase program to provide liquidity to the market and to reduce the overallnumber of shares outstanding, which has helped offset the dilutive effect of theCompany's long-term incentive programs and the dilutive effect of EITF IssueNo. 04-8 related to the inclusion of contingently convertible debt in fullydiluted earnings per share calculations.  All shares repurchased under theprogram are retired and are no longer deemed to be outstanding.  Duringfiscal 2005, 2.3 million shares were repurchased for a total of $79.8 million,and 1.3 million shares remained authorized for repurchase as of March 31, 2005 and December 31, 2005.  The timing of repurchases is subject to marketconditions, cash availability, and blackout periods during which the Company isrestricted from repurchasing shares.  There is no guarantee that theremaining shares authorized for repurchase by the Board will ultimately berepurchased.  The Company entered into a Credit Agreement on May 26, 2005, which provides for certain limitations regarding future sharerepurchases.  See Note P - "Credit Agreements" for additionalinformation on the Credit Agreement.

**Note M - Acquisitions**

**South BayMedical LLC**

On January 19, 2001, the Company purchased the assets of South Bay Medical LLC (South Bay), a company focused on the development of a new computer-based workstation and automatedcartridge-based needle loading system for use in brachytherapyprocedures.  The acquisition was accounted for as a purchase with theresults of operations included in the Company's financial statements from thedate of acquisition.  The Company paid $2.0 million in cash and issuedrestricted common stock valued at $4.0 million on the date of purchase. Additional purchase price payments will be made to South Bay over the next two yearsas workstation sales are made.  The net present value of these amounts isrecorded at December 31, 2005, in current accrued liabilities ($0.1 million)and in long-term accrued liabilities ($0.7 million), as the Company believes itis probable these payments will be made.  

**Prosurg, Inc.**

In December 2001, the Companyentered into several agreements with Prosurg, Inc., to acquire certain patentrights and obtain a source of supply of a bio-absorbable co-polymer for $2.0million in cash and up to an additional $2.0 million upon the achievement ofcertain milestones.  The purchase price was allocated to intangibleassets, and the net present value in the amount of $1.0 million is recorded at December 31, 2005, in accrued liabilities, as the Companybelieves it is probable this payment will be made.

**Note N - Goodwill &Intangible Assets**

Goodwill and intangibleassets have been recorded at either incurred or allocated cost.  Goodwill is notamortized, but its value is tested for impairment annually, and intangibleassets are amortized over their useful lives ranging from 3-20 years on astraight line basis.  Allocated costs were based on respective fair valuesat the date of acquisition.  

All goodwill amounts havebeen assigned to reporting units, based upon specific identification, forimpairment testing.  The impairment tests involve the use of bothestimates of fair value for the Company's reporting units as well as discountedcash flow assumptions.  Impairment tests are performed in the fourthquarter of each fiscal year.  No potential impairment issues were notedfor the quarter ended December 31, 2005. 

| 18 |
|----|

----

As of December 31, 2005 and  March 31, 2005, accumulated amortization of intangible assets was $15.5million and $12.7 million, respectively.

**Note O - Long-Term Debt**

On December 22, 2003, the Company completed an offering of $150 million of convertible subordinatednotes due January 1, 2024 pursuant to Rule 144A under the Securities Act of1933.  The notes bear interest at 23⁄4% per annum and are convertible intoshares of the Company's common stock at a conversion price of $29.1859 pershare and are subordinated to all existing and future senior debt. 

Holders of the notes mayconvert their notes only if any one of the following conditions is satisfied:

- 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 calls 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.  

At an initial conversionprice of $29.289, each $1,000 principle amount of notes will be convertibleinto 34.1425 shares of common stock.  As a result of the Company'sdividend payments, the conversion price has been adjusted to $29.1859, and each$1,000 principle amount will be convertible into 34.2631 shares of commonstock.

During the quarter ending December 31, 2005, one of the conditions required for conversion of the notes wassatisfied and, accordingly, the holders of notes have the option to convert thenotes into common shares at the aforementioned adjusted conversion price pershare.  

Concurrent with the issuanceof the convertible subordinated notes, the Company entered into a convertiblenote hedge and a warrants transaction with respect to its common stock, theexposure for which is held by Credit Suisse First Boston LLC.  The notehedge expires on January 1, 2009 and provides for Mentor to purchase a numberof shares equal to those issuable upon conversion of the convertible notes, andat the same price and subject to the same adjustments as the convertiblenotes.  As of December 31, 2005 this hedge provided that Mentor could purchase5.14 million shares at $29.1859 each.  The warrants are European-style callwarrants, which also expire on January 1, 2009 and allow the holder to purchasea number of shares equal to those issuable upon conversion of the convertiblebonds at $39.4275 and subject to adjustment similar to those provided for inthe convertible note indenture.  As of December 31, 2005, the warrants provided that the holder could purchase 5.14 million shares at $39.29. Both the note hedgeand the warrants transaction may be settled at the Company's option either incash or shares.  The convertible note hedge andwarrants transactions combined are intended to reduce the potential dilutionfrom conversion of the notes by effectively increasing the conversion price pershare to approximately $39.2887.  The cost of the note hedge and theproceeds from the sale of warrants have been included in shareholders' equityin accordance with the guidance in EITF No. 00-19, "Accounting forDerivative Financial Instruments Indexed to and Potentially Settled in aCompany's own Stock."  Any proceeds received or payments made upontermination of these instruments will be recorded in shareholders'equity.  

 

| 19 |
|----|

----

**Note P - Credit Agreements**

*Credit Agreement*

On May 26, 2005, the Company entered into a Credit Agreement (the "Credit Agreement") thatprovides a $200 million senior revolving credit facility, subject to a $20million sublimit for the issuance of standby and commercial letters of credit,a $10 million sublimit for swing line loans and a $50 million alternativecurrency sublimit.  The Credit Agreement expires on September 30, 2008.  At the election of the Company, the amount available for borrowings underthe Credit Agreement may be increased by an additional $50 million.  Fundsunder the Credit Agreement are available to the Company to finance permittedacquisitions, for stock repurchases up to certain dollar limitations, and for othergeneral corporate purposes.  

Interest on borrowings (otherthan swing line loans) under the Credit Agreement is at a variable rate that iscalculated, at the Company's option, at either prime rate or LIBOR, plus anadditional percentage that varies depending on the Company's senior leverageratio (as defined in the Credit Agreement) at the time of the borrowing. Swing line loans bear interest at the prime rate plus additional basis points,depending on the Company's senior leverage ratio at the time of the loan. In addition, the Company paid certain fees to the lenders to initiate theCredit Agreement and will pay an unused commitment fee based on the Company'ssenior leverage ratio and unborrowed lender commitments.

Borrowings under the CreditAgreement are guaranteed by two of the Company's domestic subsidiaries and arealso secured by a pledge of 100% of the outstanding capital stock of two otherdomestic subsidiaries and by 65% of the outstanding capital stock of our Frenchsubsidiary.  In addition, if the ratio of total funded debt to adjustedEBITDA exceeds 2.50 to 1.00, the Company is obligated to grant to the lenders afirst priority perfected security interest in essentially all of its domesticassets.

The Credit Agreement imposescertain financial and operational restrictions on the Company and itssubsidiaries, including financial covenants that require the Company tomaintain a maximum consolidated funded debt leverage ratio of not greater than4.00 to 1.00, a senior funded debt ratio of not greater than 2.50 to 1.00,minimum quarterly EBITDA and a minimum fixed charge ratio of greater than 1.25to 1.00. The covenants also restrict the Company's ability, among other things,to make certain investments, incur certain types of indebtedness or liens, makeacquisitions in excess of $20 million except in compliance with certaincriteria, and repurchase shares of common stock, pay dividends or dispose ofassets above specified thresholds.  The Credit Agreement also containscustomary events of default, including payment defaults, material inaccuraciesin its representations and warranties, covenant defaults, bankruptcy andinvoluntary proceedings, monetary judgment defaults in excess of specifiedamounts, cross-defaults to certain other agreements, change of control, andERISA defaults.  If an event of default occurs and is continuing, thecommitments under the Credit Agreement may be terminated and the principalamount and all accrued but unpaid interest and other amounts owed thereundermay be declared immediately due and payable.  As of December 31, 2005, all covenants and restrictions had been satisfied, and there were no borrowingsoutstanding under the Credit Agreement.

*Loan and OverdraftFacility*

On October 4, 2005, Mentor Medical Systems B.V., ("Mentor BV"), a wholly-owned subsidiary of MentorCorporation entered into a Loan and Overdraft Facility (the "Facility") withCooperative RaboBank Leiden, Leiderdorp en Oestgstgeest U.A. ("RaboBank").

 

| 20 |
|----|

----

The Facility provides Mentor BV with an initial €15 million loan and overdraft facility, which decreases by€375,000 quarterly starting in September 2006.  Under the Facility, Mentor BV may borrow up to €12.5 million in fixed amount advances, with terms of three tosix months, and a further sublimit of up to €5 million of loans in fixed amountadvances with a term of up to 5 years.  Up to €10 million of the Facility maybe drawn in the form of U.S. Dollars.  Funds under the Facility are availableto Mentor BV to finance certain dividend payments to Mentor Corporation and forother normal business purposes.  As of February 7, 2006, there were no borrowings outstanding under the Facility.

Interest on borrowings underthe Facility is at a rate equal to 0.55% over the RaboBank base lending rate,Euribor, or LIBOR depending upon the currency and term of each borrowing. Interest rates on borrowings other than overdrafts, are fixed for the term ofthe advance.

Borrowings by Mentor BV under the Facility are guaranteed by Mentor's wholly-owned subsidiary, MentorMedical Systems C.V., through a Joint and Several Debtorship agreement. In addition, borrowings under the Facility are secured by a mortgage on certainreal estate owned by Mentor BV.

The Facility imposes certainfinancial and operational restrictions on Mentor BV, including financialcovenants that require Mentor BV and Mentor Medical Systems CV to maintain aminimum combined defined solvency ratio, a maximum combined debt leverage ratioof not greater than 4 to 1, a senior funded debt ratio of not greater than 2.5to 1, minimum quarterly operational results, and a minimum interest coverageratio of greater than 5 to 1.  The Facility also contains customary eventsof default, including cross default and material or adverse changeprovisions.  If an event of default occurs, the commitments under theFacility may be terminated and the principal amount and all accrued but unpaidinterest and other amounts owed thereunder may be declared immediately due andpayable.  As of December 31, 2005, all covenants and restrictions had beensatisfied.

Mentor BV paid €15,000 in certain fees to the RaboBank uponentry into the Facility, and Mentor BV will be obligated to pay, over the 10year term of the Facility, a commitment fee of 0.25% of the committed andunborrowed balances.  Fees are payable quarterly in arrears.  

**Note Q - Business SegmentInformation**

The Company's operations areprincipally managed and reported on a product basis.  There are threereportable segments:  aesthetic and general surgery, surgical urology, andclinical and consumer healthcare.  The accounting policies of thereportable segments are the same as those described in the summary ofsignificant accounting policies except that certain expenses such as interestand certain corporate expenses are not allocated to the segments.

The aesthetic and generalsurgery products segment consists primarily of breast implants, tissueexpanders, body contouring (liposuction) equipment and disposables, and facialaesthetic products.  The surgical urology segment includes erectiledysfunction products, brachytherapy seeds for cancer treatment, women's healthproducts and disposable urinary care products.  The clinical and consumerhealthcare segment includes catheters and other disposable products for themanagement of urinary incontinence and retention.

| 21 |
|----|

----

Selected financialinformation for the Company's reportable segments for the three-month and nine-monthperiods ended December 31, 2005 and 2004 is as follows:

|                                          | Three Months Ended | Nine Months Ended |
|------------------------------------------|--------------------|-------------------|
|                                          | December 31,       | December 31,      |
| (in thousands)                           | **2005**           | 2004              | **2005** | 2004 |
| **Net sales**                            | ** **         |                   | ** ** |  |
| Aesthetic and General  Surgery           | ** $**        | **63,072 **  |  $ | 63,181  | ** $** | **195,870** |  $ | 183,047  |
| Surgical Urology                         | **30,946 **   | 31,881       | **95,025** | 94,167  |
| Clinical and Consumer  Healthcare        | **26,498 **   | 25,539       | **79,219** | 74,598  |
|   Total  consolidated revenues | ** $**        | **120,516 ** |  $ | 120,601  | ** $** | **370,114** |  $ | 351,812  |
|                                          | ** **         |                   | ** ** |  |
|                                          | Three Months Ended | Nine Months Ended |
|                                          | December 31,       | December 31,      |
| (in thousands)                           | **2005**           | 2004              | **2005** | 2004 |
| **Operating profit**                     | ** **         |                   | ** ** |  |
| Aesthetic and General  Surgery           | ** $**        | **20,714**        |  $ | 23,116  | ** $** | **67,049** |  $ | 67,052  |
| Surgical Urology                         | **2,823**          | 2,602        | **8,820** | 5,950  |
| Clinical and Consumer  Healthcare        | **4,260**          | 2,419        | **14,083** | 8,174  |
|   Total  reportable segments   | ** $**        | **27,797**        |  $ | 28,137  | ** $** | **89,952** |  $ | 81,176  |
|                                          | ** **         |                   | ** ** |  |

|                                        | Three Months Ended | Nine Months Ended |
|----------------------------------------|--------------------|-------------------|
|                                        | December 31,       | December 31,      |
| (in thousands)                         | **2005**           | 2004              | **2005** | 2004 |
| **Operating income**                   | ** **         |                   | ** ** |  |
| Reportable segments                    | ** $**        | **27,797**        |  $ | 28,137  | ** $** | **89,952** |  $ | 81,176  |
| Corporate operating  expenses          | **(8,132)**        | (3,798)           | **(17,196)** | (10,642) |
| Interest expense                       | **(1,408)**        | (1,346)           | **(4,294)** | (3,982) |
| Interest income                        | **952 **      | 683          | **2,571 ** | 1,631  |
| Other income (expense)                 | **(78)**           | 432          | **(29)** | 249  |
| Income before income taxes             | ** $**        | **19,131 **  |  $ | 24,108  | ** $** | **71,004 ** |  $ | 68,432  |
|                                        | ** **         |                   | ** ** |  |
|                                        | As of              | ** **        |  |
|                                        | **December 31,**   | March 31,         | ** ** |  |
| (in thousands)                         | **2005**           | 2005              | ** ** |  |
| **Identifiable assets**                | ** **         |                   | ** ** |  |
| Aesthetic and General  Surgery         | ** $**        | **164,314**       |  $ | 161,207  | ** ** |  |
| Surgical Urology                       | **98,653**         | 111,989      | ** ** |  |
| Clinical and Consumer  Healthcare      | **61,188**         | 53,767       | ** ** |  |
|   Total  reportable segments | ** $**        | **324,155**       |  $ | 326,963  | ** ** |  |

** **

| 22 |
|----|

----

**Item 2.  Management'sDiscussion and Analysis of Financial Condition and Results of Operations**

*CautionaryStatement:*

*Thefollowing discussion and analysis should be read in conjunction with ourUnaudited Consolidated Financial Statements and related Notes thereto containedelsewhere in this Report.  The information contained in this QuarterlyReport on Form 10-Q is not a complete description of our business or therisks associated with an investment in our securities.  We urge you tocarefully review and consider the various disclosures made by us in this Reportand in our other reports filed with the Securities and Exchange Commission("SEC"), including our Annual Report on Form 10-K for the year endedMarch 31, 2005, and subsequent reports on Forms 8‐K and 10-Q, whichdiscuss 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 importantrisk factors that may affect our business, results of operations and financialcondition.  These risks, in addition to the other information in thisReport and in our other filings with the SEC, should be carefully consideredbefore deciding to purchase, hold or sell our securities.*

*All statements included inthis Report, other than statements or characterizations of historical fact, areforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995.  Examples of forward-looking statementsinclude, but are not limited to, statements concerning:*

•    *our announced focus on aesthetic medicine and consideration of strategicalternatives for our urology business for which we are hopeful that we will beable to announce a final decision within the next 90 days*

•     *ourability to satisfy the conditions set forth in the approvable letter wereceived on July 28, 2005 regarding our silicone gel-filled breastimplants and the FDA's recent concerns with respect to post-market patientmonitoring activities and the outcome of the FDA's review and determinationregarding our PMA application;*

•     *thefuture impact on our operating results of patient delays in having breastaugmentation surgery due to a potential approval by the FDA of our siliconegel-filled breast implants;*

•     *theimpact of currency exchange rates on our net sales;*

•     *thesufficiency of our cash balances and access to credit to meet our existing andfuture needs;*

•     *theimpact of seasonality on demand for our products;*

•     *theimpact of our warranty policies on our results of operations;*

•     *ourintention to introduce or seek regulatory approval for new products;*

•     *ourability to continue to meet FDA and other regulatory requirements;*

•     *ouranticipated outcomes of litigation and regulatory reviews;*

•     *ourability to replace sources of supply without disruption or regulatory delay;*

•     *ourability to continue to implement our enterprise resource planning systemsuccessfully;*

•     *ouraccounting estimates, assumptions and judgments, the market acceptance andperformance of our products, the competitive nature of and anticipated growthin our markets;*

•     *ourability to consummate acquisitions and integrate their operations successfully;and*

•     *ouranticipated sales, expenses, and taxes for fiscal 2006.*

 

| 23 |
|----|

----

*These forward-lookingstatements are based on our current expectations, estimates and projectionsabout our industry, management's beliefs, and certain assumptions made byus.  Forward-looking statements can often be identified by words such as"anticipates," "expects," "intends,""plans," "predicts," "projects,""believes," "seeks," "estimates,""may," "will," "should," "would,""could," "potential," "continue," "ongoing", "guidance," and similar expressions, andvariations or negatives of these words.  In addition, any statements thatrefer to expectations, projections, forecasts or other characterizations offuture events or circumstances, including any underlying assumptions, areforward-looking statements.  These forward-looking statements speak onlyas of the date of this Report and are based upon the information available tous at this time.  Such information is subject to change, and we will notnecessarily inform you of such changes.  These statements are notguarantees of future results and are subject to risks, uncertainties andassumptions that are difficult to predict.  Therefore, our actual resultscould differ materially and adversely from those expressed in anyforward-looking statement as a result of various factors, some of which arelisted under the section "Risk Factors" in Item 1A under Part II -Other Information.  We undertake no obligation to revise or updatepublicly any forward-looking statement for any reason.*

CompanyOverview

Founded in 1969, MentorCorporation is a leading supplier of medical products for the global healthcare market.  We develop, manufacture and market a broad range of productsserving the medical specialties market.  Our products are utilized bythree primary segments: aesthetic and general surgery (plastic and reconstructivesurgery), surgical urology, and clinical and consumer healthcare.

Our aesthetic and generalsurgery products include surgically implantable prostheses for plastic andreconstructive surgery and our facial aesthetic products, as well as capital equipmentand consumables used for body contouring (traditional and ultrasonicliposuction).  Our surgical urology products include surgicallyimplantable prostheses for the treatment of impotence, surgically implantableincontinence products, urinary care products and brachytherapy seeds for thetreatment of prostate cancer.  Our clinical and consumer healthcareproducts include catheters and other products for the management of urinaryincontinence and retention. 

We employ approximately 2,000people around the world and are headquartered in Santa Barbara, California, with manufacturing and research operations in the United States, France, The Netherlands and United Kingdom.  We also purchase finished products andcertain raw material components from third party manufacturers andsuppliers.  The cost of goods sold represents raw materials, labor andoverhead, and the cost of third party finished products.  Gross marginsmay fluctuate from period to period due to changes in the selling prices of ourproducts, the mix of products sold, changes in the cost of third party finishedproducts, raw materials, labor and overhead, and changes in manufacturingprocesses and yields. 

In addition to our strongdomestic presence, we export most of our product lines, principally to Canada, Western Europe, Central and South America, and the Pacific Rim.  Products aresold through our direct international sales offices in Canada, United Kingdom, Germany, France, Japan, Benelux, Australia, Spain, Portugal and Italy, as well as through independent distributors in other countries.

We employ specializeddomestic sales forces for our aesthetic surgery, body contouring, and urologicspecialties, which includes our women's health, erectile dysfunction, prostatebrachytherapy and clinical and consumer healthcare product lines.  Eachsales force provides product information or specific data support and relatedservices to physicians, nurses and other health care professionals.  Wealso market certain products, particularly our disposable incontinenceproducts, through a domestic network of independent hospital supply dealers andhealthcare distributors, as well as through retail pharmacies.

| 24 |
|----|

----

Our selling, general andadministrative expense incorporates the expenses of our sales and marketingorganization and the general and administrative expenses necessary to supportthe global organization. Our sales and marketing expenses consist primarily ofsalaries, commissions, and marketing program costs.  General andadministrative expenses incorporate the costs of finance, human resources,information services, legal and insurance costs.

Our research and developmentexpenses are comprised of the following types of costs incurred in performingclinical development and research and development activities: salaries andbenefits, allocated overhead, clinical trial and related clinical manufacturingcosts, regulatory costs, intellectual property procurement, contract services,and other outside costs.  We also conduct research on materialstechnology, product design and product improvement.

Recent Events

On February 6, 2006 we withdrew our financial guidance for fiscal year 2006 due to the uncertaintyregarding the timing of our ongoing strategic initiatives and ongoing FDAreview of our silicone gel PMA.  While we continue to expect our fiscal 2006 salesto increase over fiscal year 2005, we no longer believe that this increase willreach a low double-digit rate over sales in fiscal 2005.

On February 6, 2006, we announced that, with respect to our Puragen PlusTM program in the U.S., we recently identified potential issues with some of the data from our clinical studythat will require further evaluation and will result in a delay to our PMAsubmission timeline.  We are working diligently to more thoroughly understandthese issues and determine our next course of action.  

On November 20, 2005, we announced our proposal to acquire Medicis Pharmaceutical Corporation.  Theproposal was communicated on November 18, 2005 in a letter from Joshua H.Levine, our President and CEO, to Jonah Shacknai, Medicis' Chairman of theBoard and CEO.  On February 6, 2006, we announced that we will not be pursuinga strategic relationship with Medicis at this time.  While we believe that acombined Mentor and Medicis is a strategically sound proposition, there are anumber of attractive opportunities available to us that we are exploring and weremain committed to executing on our strategy to become a company focusedexclusively in aesthetic medicine.  We have incurred approximately $3.3 millionof expense through December 31, 2005 in connection with the proposed Medicis acquisition. 

On October 18, 2005, we announced our strategy to increase our focus on aesthetic medicine, and as aresult, we are evaluating strategic alternatives for our urology business thatwe believe would both enhance shareholder value and enable us to focus morefully on our aesthetics business.  Our urology business, which includes ourSurgical Urology and Clinical and Consumer Healthcare segments, currently contributesapproximately 48% of our consolidated net sales and approximately 26% of ouroperating profit, and comprises approximately 50% of identifiable segmentassets. Following our announcement, we received a number of proposals fromstrategic and financial parties and we concluded that there were a number ofoptions to be considered to support our goal of driving shareholder value.  We arehopeful that we will be able to announce a final decision within the next 90days.  We believe that our third quarter sales for these segments have beennegatively impacted by the uncertainty around our evaluation of strategicalternatives for our urology business.  We incurred approximately $1.7 million ofexpense through December 31, 2005 in connection with our announced strategyrelated to our urology business. 

On July 28, 2005, we received an "approvable letter" with conditions from the FDA on ourPre-Market Approval ("PMA") application for our silicone gel-filledbreast implants.  The approvable letter stipulates a number of conditionswhich we must satisfy in order to receive FDA approval to market and sellsilicone gel-filled breast implants in the United States.  Theseconditions were generally consistent with those conditions that the advisorypanel, composed of outside experts selected by the FDA, had recommended intheir April 2005 review of our PMA application.  In April 2005, theadvisory panel  met to consider questions presented to it by the FDA regardingour PMA application and to make a recommendation to the FDA regarding whetherthe PMA application should be approved.  In a majority 7-to-2 vote, thepanel recommended approval, with conditions, of our PMA application.  Weare currently engaged in discussions with the FDA to address the conditions requiredfor approval and the FDA's recent concerns with respect to post-market patientmonitoring activities and cannot guarantee that the FDA will provide finalapproval, nor can we determine when the FDA's decision regarding approval willbe made. 

| 25 |
|----|

----

**APPLICATION OF CRITICALACCOUNTING POLICIES**

Management's Discussion andAnalysis of Financial Condition and Results of Operations addresses ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States.  Thepreparation of these financial statements requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financial statements,and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments.  Webase our estimates and judgments on historical experience and on various otherfactors that are believed to be reasonable under the circumstances, the resultsof which form the basis for making judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions orconditions.  

Management has identified thecritical accounting policies to be those related to revenue recognition,accounts receivable, inventories, warranty reserves, product liability reserves,and goodwill and intangible asset impairment.  Certain of these accountingpolices are discussed below while the others are discussed in the"Management's Discussion and Analysis of Financial Condition and Resultsof Operations" and notes to the consolidated financial statements includedin the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2005.

Revenue Recognition

We recognize productrevenue, net of discounts, returns, and rebates in accordance with Statement ofFinancial Accounting Standards ("SFAS") No. 48, "RevenueRecognition When the Right of Return Exists," and Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition."

As required by thesestandards, revenue is recorded when persuasive evidence of a sales arrangementexists, delivery has occurred, the buyer's price is fixed or determinable,contractual obligations have been satisfied, and collectibility is reasonablyassured.  These requirements are met, and sales and related cost of salesare recognized upon the shipment of products, or in the case of consignmentinventories, upon the notification of usage by the customer.  We recordestimated reductions to revenue for customer programs and other volume-basedincentives.  Should the actual level of customer participation in theseprograms differ from those estimated, additional adjustments to revenue may berequired.  We also allow credit for products returned within our policyterms.  We record an allowance for estimated returns at the time of salebased on historical experience, recent gross sales levels and any notificationof pending returns.  Should the actual returns differ from thoseestimated, additional adjustments to revenue and cost of sales may be required.

We have current and longterm deferred revenue, which include funds received in connection with patentlicense agreements and purchases of our enhanced advantage breast implant limitedwarranty program.  Deferred revenue relating to the licensing fees receivedfrom the patent licensing agreements is recognized as revenue evenly over theproduct's life expectancy based upon historic product life cycles for productssimilar to the licensed product.  The fees received in connection with our enhancedadvantage breast implant limited warranty are deferred and recognized evenlyover the life of the warranty term.

Warranty Reserves

We offer two types ofwarranties relating to our breast implants in the United States, Canada, andPuerto Rico: a standard limited warranty which is offered at no additionalcharge and an enhanced limited warranty at an additional charge of $100 in theU.S. and ($100 CAD in Canada), and which provide limited financial assistancein the event of a deflation or rupture.  Our standard limited warranty is alsooffered in certain European and other international countries for siliconegel-filled breast implants.  We provide an accrual for the estimated cost ofbreast implant warranties at the time revenue is recognized.  Theestimated cost of the standard limited warranty is recorded as an expense atthe time of sale, whereas the estimated cost of the enhanced limited warrantyis deferred and recognized over the term of the enhanced limited warranty. Such accruals are based on estimates, which are based on relevant factors suchas unit sales, historical experience, the warranty period, estimated costs,and, to a limited extent, information developed by our insurance company usingactuarial techniques.  These accruals are analyzed periodically foradequacy.  While we engage in extensive product quality programs andprocesses, including actively monitoring and evaluating the quality of ourcomponent suppliers, the warranty obligation is affected by reported rates ofwarranty claims and levels of financial assistance specified in thewarranties.  Should actual patient claim rates reported differ from ourestimates, adjustments to the estimated warranty liability may berequired.  These adjustments would be included in selling, general andadministrative expenses.

| 26 |
|----|

----

Product Liability Reserves

We have product liabilityreserves for product-related claims to the extent those claims may result inlitigation expenses, settlements or judgments within our self-insured retentionlimits.  We have also established additional reserves, through our wholly-ownedcaptive insurance company, for estimated liabilities for product-related claimsbased on actuarially determined estimated liabilities, taking also into accountour excess insurance coverages.  The actuarial valuations are based onhistorical information and certain assumptions about future events.  Shouldactual product liability experience differ from the estimates and assumptionsused to develop these reserves, subsequent changes in reserves will be recordedin selling, general and administrative expenses, and may affect our operating resultsin future periods.  

**RESULTS OF OPERATIONS**

The following table setsforth certain data from the Consolidated Statements of Income expressed as apercentage of net sales for the periods indicated:

|                                                    | Three Months Ended         | Nine Months Ended      |
|----------------------------------------------------|----------------------------|------------------------|
| December 31,                                       | December 31,               |
|                                                    | **2005   ** | 2004    | **2005   ** | 2004    |
|                                                    | ** **                 |                        | ** ** |  |
| Net sales                                          | **100.0 %**                | 100.0 %                | **100.0 %** | 100.0 % |
|  Cost of sales                                | **34.0**                   | 35.5                   | **34.4** | 36.2 |
| Gross profit                                       | **66.0**                   | 64.5                   | **65.6** | 63.8 |
|  Selling, general and  administrative expense | **41.8**                   | 37.6                   | **38.7** | 36.7 |
|  Research and  development expense            | **7.8**                    | 6.7                    | **7.2** | 7.0 |
| Operating income                                   | **16.4**                   | 20.2                   | **19.7** | 20.1 |
|   Interest  expense                      | **(1.2)**                  | (1.1)                  | **(1.2)** | (1.1) |
|  Interest income                              | **0.8**                    | 0.6                    | **0.7** | 0.5 |
|   Other income  (expense), net           | **(0.1)**                  | 0.3                    | **-** | - |
| Income before income taxes                         | **15.9**                   | 20.0                   | **19.2** | 19.5 |
| Income taxes                                       | **5.3**                    | 6.5                    | **6.4** | 6.3 |
| Net income                                         | **10.6 %**                 | 13.5 %                 | **12.8 %** | 13.2 % |

 

27

----

**Forthe three-month period ended December 31, 2005 compared to the three-month period ended December 31, 2004:**

**Net Sales**

Net sales for the three-monthperiod ended December 31, 2005 remained flat at $120.5 million, compared to $120.6million for the same period in the prior year.  We believe that net salesfor the three-month period ended December 31, 2005 were negatively impacted by the uncertainty in the breast aesthetics market resulting from the ongoingFDA review of our silicone gel-filled breast implant PMA and from disruptionsrelated to our October 18, 2005 announcement of our evaluation of strategicalternatives for our urology business.  Unfavorable foreign currency exchange variations,principally the weaker Euro, over the same quarter in the prior year had an unfavorableyear-to-year impact on sales of $3.0 million.  Foreign exchange rates haverecently been volatile, and should the dollar to Euro exchange rate remain atthe current level or fall further, we expect that there would continue to be anegative impact on sales in the remainder of the fiscal year when compared tothe prior year. Although we continue to expect our fiscal year 2006 sales toincrease over fiscal year 2005, due to the uncertainty regarding timing of ourongoing strategic initiatives and ongoing FDA review of our silicone gel PMA, weno longer expect such increase to reach the low double-digit growth previouslyexpected.

|                                              | Sales by Principal Product Line |
|----------------------------------------------|---------------------------------|
|                                              | Three Months Ended              |
|                                              | December 31,                    |
| (in thousands)                               | **2005**                        | 2004 | Percent Change |
| Aesthetic and General  Surgery Products      | ** $**                     | **63,072** |  $ | 63,181  | (0.2)% |
| Surgical Urology Products                    | **30,946**                      | 31,881  | (2.9)% |
| Clinical & Consumer  Healthcare Products | **26,498**                      | 25,539  | 3.8 % |
|                                              | ** $**                     | **120,516** |  $ | 120,601  |  (0.1)% |

Net sales of aesthetic andgeneral surgery products remained flat at $63.1 million for the quarter ended December 31, 2005, compared to $63.2 million for the same period in the prior year.  Webelieve domestic sales continue to be negatively impacted by women delayingbreast augmentation in anticipation of the potential U.S. approval of oursilicone gel-filled breast implant products, following our July 28thannouncement that we received an FDA approvable letter.  Sales were also negativelyimpacted by approximately $0.5 million due to unfavorable foreign currencyexchange effects.  Total net sales of breast implant products increased 1% to$55.0 million for the quarter from $54.2 million for the same period in theprior year.  Increased net sales were primarily driven by growth in thereconstruction market both domestically and internationally.  We continue tosee competitive price pressure in both the domestic and international marketsfor breast implants.  Net sales of body contouring products decreased 19% to$3.8 million for the quarter, from $4.6 million for the same period in theprior year. This decrease was primarily a result of lower body contouring capitalequipment purchases during the quarter due to budget constraints at hospitals,surgery center and clinics that generally would be making capital equipment purchasestowards the end of the calendar year.  Other aesthetic products sales remainedflat at $4.3 million for both quarters. 

Net sales of surgical urologyproducts decreased 2.9% to $30.9 million for the quarter ended December 31, 2005, from $31.9 million for the same period in the prior year which webelieve to primarily be a result of temporal disruptions related to the October18th announcement of our intent to evaluate strategic alternativesfor our urology business.  Net sales of penile implants increased 10% to $7.2million, from $6.5 million in the same period in the prior year, due to increasedmarket acceptance of our Titan® penile implant device as a result ofcontinued emphasis on educational seminars, our second quarter launch of our direct-to-consumer"La Bombita" marketing campaign, and the recent release of GenesisTM,our coated malleable penile implant.  Brachytherapy products net salesincreased by 2% to $4.0 million for the quarter ended December 31, 2005, from $3.9 million for the same period in the prior year, primarily as a result ofhigher unit sales and slightly higher average selling prices.  Net sales ofwomen's health products increased 5% to $5.8 million for the three months ended December 31, 2005, compared to $5.6 million for the same period in prioryear.  This growth was due to an increase in sales of our ArisTM productand an increase in licensing revenues from our trans-obturator method patent. Partially offsetting these increases was a decline in sales of ObTape® andtissue based sling products, as surgeons transitioned to other newercompetitive offerings, including our ArisTM product.  Net sales of ourdisposable urinary care products decreased 12% to $13.9 million for the quarterended December 31, 2005, compared to $15.9 million for the same period in theprior year, primarily as a result of unfavorable exchange rate variationsduring the quarter and to a lesser extent, decreasing sales of low margin non-coreOEM products to a contracted international customer.  The unfavorable impact offoreign exchange rate variations for the surgical urology product segment,which primarily impacts our disposable urinary care products, was $1.4 millionfor the quarter ended December 31, 2005.

| 28 |
|----|

----

 

Net sales of clinical andconsumer healthcare products increased 3.8% to $26.5 million for the quarterended December 31, 2005, from $25.5 million for the same period in the prioryear.  Net sales growth was generally aided by an overall increase in unitsales in our domestic markets.  This volume growth was partially offset by anunfavorable foreign currency exchange effect of $1.1 million for the quarter asnearly half of these product sales are invoiced in currencies other than the dollar,and a decrease in sales as a result of the October 18th announcementof our intent to evaluate strategic alternatives for our urology business.

**Gross Profit**

Gross profit increased to 66.0%of net sales for the quarter ended December 31, 2005, compared to 64.5% for the same period in the prior year, primarily due to improved manufacturingefficiencies and to a lesser degree a shift in sales mix towards our highermargin products.  Gross profit for aesthetic and general surgery products remainedflat with the prior year at 76.0% of net sales, or $47.9 million, for thequarter ended December 31, 2005, compared to 76.1% of net sales, or $48.1million, for the same period in the prior year.  Gross profit for surgicalurology products improved to 59.3% of net sales, or $18.4 million, for thequarter ended December 31, 2005, up from 55.4% of net sales, or $17.6 million,for the same period in the prior year.  This improvement was primarily dueto improved manufacturing efficiencies, licensing revenue from ourtrans-obturator method patent, and a shift to higher margin products. Gross profit for healthcare products increased to 49.9% of net sales, or $13.2million, for the quarter ended December 31, 2005, compared to 47.0% of netsales, or $12.0 million, for the same period in the prior year.  Thisincrease was primarily due to improved manufacturing efficiencies.

**Selling, General andAdministrative**

Selling, general andadministrative expenses were $50.4 million, or 41.8% of net sales, for thequarter ended December 31, 2005, compared to $45.4 million, or 37.6% of netsales, in the same period in the prior year.  The increased dollar amountfor the period was due to charges related to our strategic initiativesincluding $3.3 million of legal and professional fees related to our proposalto acquire Medicis and $1.7 million of legal fees and employee retentionexpenses related to our announced strategy related to our urology business, and anincrease of approximately $0.8 million in compensation expense related to theissuance of restricted stock grants.  These increases were partially offset bya lower level of performance related compensation expense of approximately $2.1million as compared to the same period in the prior year.

**Research andDevelopment**

Research and developmentexpense was $9.5 million, or 7.8% of net sales, for the quarter ended December 31, 2005, compared to $8.1 million or 6.7% of net sales, in the same period inthe prior year.  Increased research and development spending for the quarterended December 31, 2005 was primarily related to supporting our siliconegel-filled breast implant regulatory submissions in the United States andCanada, our botulinum toxin project, U.S. clinical studies for our hyaluronicacid-based dermal filler product, Puragen PlusTM, and a charge for theabandonment of an advance payment for services for a manufacturing processunder development.

| 29 |
|----|

----

**Interest and OtherIncome and Expense**

Interest expense was $1.4million for the quarter ended December 31, 2005, compared to $1.3 million inthe same period in the prior year.  These costs include interest on our$150 million convertible subordinated notes at 23⁄4% issued in December 2003, commitmentfees on our credit facilities and amortization of debt issuance costs. The slight increase in interest expense was attributable to higher commitmentfees  and was partially offset by lower borrowings at our internationalfacilities.  Interest income increased to $1.0 million for the quarter ended December 31, 2005, from $0.7 million for the same period in the prior year, as a result ofgenerally higher rates of interest and higher levels of cash and cashequivalents balances available for investment.

**Income Taxes**

The effective rate ofcorporate income taxes for the three months ended December 31, 2005 was 33.4% as compared to 32.3% for the same period in the prior year.  In the secondquarter of fiscal 2006, we decided to repatriate up to $25.0 million in foreignprofits during the balance of fiscal year 2006.  The increase in theeffective tax rate for the quarter reflects the impact of such repatriation. We expect to provide for a slightly higher tax rate for the remainder of thefiscal year as a result of the intended repatriation.

**Net Income and EarningsPer Share**

Net income for the quarterended December 31, 2005 decreased 22% to $12.7 million, from $16.3 million inthe same period in the prior year.  Diluted earnings per share decreased 24%to $0.26 for the quarter, compared to $0.34 for the same period in the prioryear.  Our weighted average shares outstanding for the quarter ended December 31, 2005 increased to 51.8 million from 50.0 million in the same period in prioryear, primarily due to the dilutive impact of our warrants as a result of ourhigher average share price during the quarter, and additional sharesoutstanding as a result of restricted stock grants and stock option exercises.

| 30 |
|----|

----

**For the nine-month period ended December 31, 2005 compared to the nine-month period ended December 31, 2004:**

**Net Sales**

Net sales increased 5.2%, or$18.3 million, to $370.1 million for the nine months ended December 31, 2005, compared to $351.8 million for the same period in the prior year.  Foreign exchangerate movements, primarily the weakening of the Euro, had an unfavorableyear-to-year impact on international net sales of $0.6 million for the nine-monthperiod.  In addition, we believe domestic sales of our breast aestheticsproducts were negatively impacted by women delaying breast augmentation in anticipationof a potential U.S. approval of our silicone gel-filled breast implant productsand urology and healthcare sales were negatively impacted from temporal disruptionsrelated to the October 18, 2005 announcement of our intent to evaluatestrategic alternatives for our urology business. 

|                                              | Sales by Principal Product Line  |
|----------------------------------------------|----------------------------------|
|                                              | Nine Months Ended   December 31, |
| (in thousands)                               | **2005**                         | 2004 | Percent  	Change  |
| Aesthetic & General  Surgery Products    | ** $**                      | **195,870** |  $ | 183,047  | 7.0% |
| Surgical Urology Products                    | **95,025**                       | 94,167  | 0.9% |
| Clinical & Consumer  Healthcare Products | **79,219**                       | 74,598  | 6.2% |
| ** **                                   | ** $**                      | **370,114** |  $ | 351,812  | 5.2% |

 

Net sales of aesthetic and general surgery productsincreased 7.0%, or $12.8 million, to $195.9 million for the nine-month periodended December 31, 2005, compared to $183.0 million for the same period in theprior year.  Approximately $0.5 million of the increase is attributable to thefavorable impact of foreign exchange rates, and the balance is primarily due togrowth in the breast reconstruction market both domestically andinternationally.  Net sales of breast implants increased $11.8 million, or 7%,to $170.3 million for the nine-months ended December 31, 2005, compared to $158.5 million for the same period in the prior year.  Body contouring product netsales decreased 3% to $12.9 million for the nine-month period ended December 31, 2005, from $13.3 million for the comparable period in the prior year.  Otherproduct net sales increased by 13% to $12.7 million for the nine months ended December 31, 2005, compared to $11.2 million the same period in the prior year, primarilyas a result of increased revenue from international sales of our aestheticfacial product, which was launched in a variety of international markets in May2005.

Net sales of surgical urology products increased 0.9%, or $0.9million, to $95.0 million for the nine-month period ended December 31, 2005, compared to $94.2 million for the same period in the prior year.  Net sales ofpenile implants increased 8% to $20.6 million, from $19.0 million in the sameperiod in the prior year due to increased market acceptance of our Titan®penile device, which carries a higher average selling price than its predecessor product, the AlphaI,  continued emphasison educational seminars, our second quarter launch of our direct-to-consumer "LaBombita" marketing campaign and, to a lesser extent, the recent release ofGenesisTM, our coated malleable penile implant.  Brachytherapy product net sales increased 5% to $12.1million for the nine months ended December 31, 2005, compared to $11.6 million for thesame period in the prior year as a result of higher unit sales and slightlyhigher average selling prices.  Net sales of our women's health products remainedflat at $17.2 million for the nine months ended December 31, 2005 and December 31, 2004.  Sales of ObTape® and tissue based sling products decreased assurgeons transitioned to other newer competitive offerings, including our ArisTMproduct.  These decreases were offset by increased sales of our ArisTM productand licensing revenues from our trans-obturator method patent.  Net sales of our disposable urinary care products decreased3% to $45.1 million from $46.4 million in the prior year.  This decrease was primarilyattributable to decreasing sales of low margin non-core OEM products to acontracted international customer and, to a lesser extent, unfavorable exchangerate movements related to sales at our international branches.  Foreignexchange rate fluctuations unfavorably impacted surgical urology product salesby $0.6 million for the nine-month period ended December 31, 2005. 

Net sales of clinical and consumer healthcare productsincreased by 6.2%, or $4.6 million, to $79.2 million for the nine-month periodended December 31, 2005, compared to $74.6 million for the same period in theprior year.  Net sales of our catheter products increased $2.1 million, or 5%,to $42.4 million for the nine-month period ended December 31, 2005, from $40.3 million for the same period of the prior year.  Net sales of other disposablehomecare and ostomy products increased 7% to $36.8 million for the nine-monthperiod ended December 31, 2005, from $34.3 million in the comparable period ofthe prior year.  This increase resulted from an increase in unit sales and ashift to our premium product categories, which have higher pricing, partiallyoffset by an unfavorable impact of foreign exchange rate variations of $0.5million for this segment.

 

| 31 |
|----|

----

**Gross Profit**

Gross profit for the nine-months ended December 31, 2005, improved to 65.6% of net sales from 63.8% for the same period in the prior year,primarily due to lower manufacturing costs and a shift in product mix towardsour higher margin products.  Gross profit for aesthetic and general surgeryproducts improved to 76.4% of net sales, or $149.7 million, for the nine-monthperiod ended December 31, 2005, up from $137.4 million, or 75.1% of net sales,in the comparable nine-month period in the prior year.  This increase in grossprofit as a percentage of net sales is primarily attributable to favorablepricing on raw materials and manufacturing efficiencies at our Texas and Netherlands facilities and a shift to sales of higher margin breast implant products. Gross profit for surgical urology products for the nine-month period ended December 31, 2005 improved to 57.0% of net sales, or $54.1 million, compared to 54.4% ofnet sales, or $51.2 million, for the same period in the prior year.  Thisimprovement in the gross profit percentage was primarily due to improvedmanufacturing efficiencies and licensing revenue from our trans-obturatormethod patent.  Gross profit for clinical and consumer healthcare products forthe nine-month period ended December 31, 2005 increased to 49.2% of net sales, or $39.0 million, compared to 47.9% of net sales, or $35.8 million in the prioryear.  This increase was due to a shift to higher margin products within thesegment.

**Selling, General and Administrative**

Selling, general and administrative expenses increased to 38.7%of net sales, or $143.4 million for the nine-month period ended December 31, 2005, compared to 36.7% or $129.2 million for the same period of the prioryear.  This increase was due to charges related to our strategic initiativesincluding $3.3 million of legal and professional fees related to our proposalto acquire Medicis  and $1.7 million of legal fees and employee retention expensesrelated to pursue our announced strategy related to our urology business, anincrease of approximately $1.0 million in costs associated with our facialaesthetics marketing efforts in support of our hyaluronic acid-based dermalfiller product, PuragenTM, an increase of approximately $1.0 million in our direct-to-consumeradvertising programs, an increase of approximately $0.8 million in compensationexpense related to the issuance of restricted stock grants,  increased patientand physician education programs of approximately $0.7 million, and additionalcosts associated with our expanded breast implant warranty program ofapproximately $0.7 million, which was launched during the first quarter offiscal 2006.  To a lesser extent, increased personnel costs in support of salesand marketing contributed to the year over year increase.  The increase ingeneral and administrative expense was partially offset by lower levels ofperformance related compensation of approximately $1.7 million for the sameperiod in the prior year and lower general and administrative costs at ourmanufacturing facilities. 

**Research and Development**

Research and development expense for the nine-month periodended December 31, 2005 was $26.6 million, or 7.2% of net sales, compared to $24.6million, or 7.0% of net sales, for the comparable period in the prioryear.  The increase in research and development spending primarily supportskey strategic product development programs, including our silicone gel-filledbreast implant regulatory submissions in theUnited States and Canada, our botulinum toxinproject, U.S. clinical studies for our hyaluronic acid-based dermal fillerproduct, PuragenTM, and the continued development of automated manufacturingtechnologies.  

**Interest and Other Income and Expense**

Interest expense for the nine-monthperiod ended December 31, 2005 increased to $4.3 million, from $4.0 million inthe comparable period in the prior year.  These costs included interest on our$150 million convertible subordinated notes at 23⁄4% issued in December 2003,interest expense on balances outstanding under our foreign lines of credit,commitment fees on our credit facilities and amortization of debt issuancecosts.  The increase in interest expense was primarily attributable to highercommitment fees and was partially offset by lower borrowings on ourinternational facilities.  Interest income increased $0.9 million to $2.6million for the nine-month period ended December 31, 2005, from $1.6 million for the same period in the prior year, as a result of generally higherrates of interest and higher balances of cash and cash equivalents availablefor investment.

| 32 |
|----|

----

**Income Taxes**

The effective rate of corporate income taxes for the nine-monthsendedDecember 31, 2005 was 33.3%, compared to 32.0% for the comparable period in the prior year.  In the second fiscal quarterof 2006, we decided to repatriate up to $25.0 million in foreign profits, andestimate the tax liability on the repatriation will be approximately $1.5million.  The increase in the effective tax rate reflects the impact of such intendedrepatriation.  We expect to provide for a slightly higher tax rate for theremainder of the fiscal year as a result of the intended repatriation. 

**Net Income and Earnings Per Share**

Net income for the nine-month period ended December 31, 2005 increased 1.8% to $47.3 million, from $46.5 million in the comparableperiod in the prior year.  Diluted earnings per share remained flat at $0.98for the nine-month periods ending December 31, 2005 and 2004.

**FINANCIAL CONDITION,LIQUIDITY AND CAPITAL RESOURCES**

We believe that existingfunds, cash generated from operations, and existing sources of and access tofinancing are adequate to satisfy our working capital, capital expenditure, anddebt service requirements for the foreseeable future.  As of December 31, 2005, we had cash, cash equivalents and short-term marketable securities of$197.0 million, an increase of $84.1 million or 74%, compared to $112.9 millionas of March 31, 2005.  The principal components of the increase in cash, cashequivalents and marketable securities were cash generated from operating activitiesof $83.6 million and proceeds of $39.7 million from the exercise of employeestock options, offset by $24.1 million in dividends paid, $10.5 million usedfor net capital expenditures, and $3.2 million for repayment of debt on ourforeign lines of credit.

We invest excess cash inmarketable securities that are highly liquid, of high-quality investment grade,and which have varying maturities.  Our short-term marketable securitiesconsist primarily of state and municipal government and government agencyobligations, Federal Home Loan Bank and Mortgage Association bonds, andinvestment grade corporate obligations, including commercial paper. 

|                                                              | As of             |
|--------------------------------------------------------------|-------------------|
| (in thousands)                                               | **December 31,**  | March 31, |
|                                                              | **2005**          | 2005 |
|                                                              | ** **        |  |
| Cash and cash equivalents                                    | ** $**       | **89,525 ** |  $ | 76,666  |
| Marketable debt securities                                   | **107,452 ** | 36,228  |
| Total cash, cash  equivalents and marketable debt securities | ** $**       | **196,977 ** |  $ | 112,894  |
| Percentage of total assets                                   | **36%**           | 24% |

|  

33 |
|------------|

----

**Cash Flow Changes**

The following tablesummarizes our cash flow activity:

|                                                                 | Nine Months Ended          |
|-----------------------------------------------------------------|----------------------------|
|                                                                 | December 31,               |
| (in thousands)                                                  | **2005   ** | 2004    |
|                                                                 | ** **                 |  |
| Net cash provided by  operating activities                      | ** $**                | **83,561 ** |  $ | 68,263  |
| Net cash provided (used) by  investing activities               | **(81,160)**               | (33,930) |
| Net cash provided (used) in  financing activities               | **12,482 **           | (92,573) |
| Effect of currency exchange  rates on cash and cash equivalents | **(2,024)**                | 681  |
| Increase (decrease) in cash  and cash equivalents               | ** $**                | **12,859 ** |  $ | (57,559) |

*Operating*

Cash provided by operatingactivities of $83.6 million and $68.3 million for the nine-month periods ended December 31, 2005 and 2004, respectively, was greater than net income for the same nine-monthperiods in both 2005 and 2004, due to the net impact of non-cash adjustments toincome.  Non-cash adjustments include tax benefits from the exercise ofemployee stock options, depreciation and amortization, deferred income taxesand loss on the disposal of assets.  For the nine-month periods ended December 31, 2005 and 2004, operating cash flows were negatively impacted in the amountof $2.6 million and $1.6 million, respectively, by changes in working capitalbalances.  

Our working capital was $282.2million at December 31, 2005, and $197.0 million at March 31, 2005.  Cash provided by operating activities and from the exercise of employee stock options havebeen our primary recurring source of funds.

*Investing*

Cash used in investingactivities was primarily attributable to purchases and sales of marketable debtand equity securities, as well as capital expenditures on property andequipment and intangibles.  For the nine-month period ended December 31, 2005, total cash used in investing activities was $81.2 million.  Our netpurchases of marketable securities totaled $70.7 million and our capitalexpenditures totaled $10.5 million.  We anticipate our capital expendituresto total approximately $15.0 million in fiscal 2006, as we will continue toinvest in facility improvements, software to support our manufacturingprocesses, and production equipment.  For the nine-month period ended December 31 , 2004, total cash used in investing activities was $33.9 million.  Thisamount in 2004 was comprised of investments of $25.6 million in marketablesecurities and $8.3 million in capital expenditures.

*Financing*

Net cash from financingactivities is primarily related to: dividends, employee stock option exercises,debt financing activities and our share repurchases.

We have a share repurchaseprogram primarily to offset the dilutive effect of our employee stock optionprogram, to provide liquidity to the market, and to reduce the overall numberof shares outstanding.  All shares repurchased under the program are retiredand are no longer deemed to be outstanding.  There were no sharerepurchases during the nine-month period ended December 31, 2005.  At December 31, 2005, 1.3 million shares remained authorized for repurchase. The timing of our repurchases is subject to market conditions, cashavailability, and blackout periods during which we are restricted fromrepurchasing shares.  There is no guarantee that shares authorized forrepurchase by the Board will ultimately be repurchased.  Our CreditAgreement limits the amount that can be used to repurchase shares to net incomefrom the previous four quarters less dividends, although this limitation doesnot apply to any repurchase of the 1.3 million shares currently authorized forrepurchase.

| 34 |
|----|

----

In September 2005, the Boardof Directors increased the quarterly dividend rate from $0.17 per share to $0.18per share.  At the rate of $0.18 per share, the aggregate dividend for thequarter was approximately $7.9 million.  Future payment of dividends will be subjectto, among other things, Board approval, cash availability, debt restrictionsand alternative cash needs. 

We receive cash from theexercise of employee stock options.  Employee stock option exercisesprovided $39.7 million and $9.0 million of cash in the nine-month periodsending December 31, 2005 and 2004, respectively.  Proceeds from theexercise of employee stock options vary from period to period based upon, amongother factors, fluctuations in the market value of our common stock relative tothe exercise price of such options.

**Financing Arrangements**

*Senior Credit Facility*

On May 26, 2005, we entered into a three-year Credit Agreement ("Credit Agreement") thatprovides us with a $200 million senior revolving credit facility.  At ourelection and subject to lender approval, the amount available for borrowingsunder the Credit Agreement may be increased by an additional $50 million. Funds are available under the Credit Agreement to finance permittedacquisitions, share repurchases up to certain dollar limitations, and for othergeneral corporate purposes.  The Company has three standby letters ofcredit totaling $2 million outstanding which are secured by the CreditAgreement.  Accordingly, although there were no borrowings outstanding underthe Credit Agreement at December 31, 2005, only $198 million was available forborrowings.  

Interest on borrowings underthe Credit Agreement is at a variable rate that is calculated, at our option,at the prime rate, or LIBOR, plus an additional percentage that varies between1% and 1.65%, depending on our senior leverage ratio at the time of theborrowing.  We paid certain fees to the lenders to initiate the CreditAgreement and will pay an unused commitment fee based on our senior leverageratio and unborrowed lender commitments.

Borrowings under the CreditAgreement are guaranteed by certain of our subsidiaries or secured by theircapital stock.  In addition, if the ratio of total funded debt to adjustedearnings before interest, taxes, depreciation and amortization (or"adjusted EBITDA"), exceeds 2.50 to 1.00, then we are obligated togrant to the lenders a first priority perfected security interest inessentially all of our domestic assets. 

The Credit Agreement imposesfinancial and operational restrictions regarding certain liquidity and earningsratios, as well as certain investments, types of indebtedness or liens, andacquisitions, repurchases of shares of common stock, and payment of dividendsor disposition of assets above specified thresholds.

*Other Financing*

On October 4, 2005, Mentor Medical Systems B.V., ("Mentor BV"), a wholly-owned subsidiary of MentorCorporation entered into a Loan and Overdraft Facility (the "Facility") with CooperativeRaboBank Leiden, Leiderdorp en Oestgstgeest U.A. ("RaboBank").  The Facilityprovides Mentor BV with an initial €15 million loan and overdraft facility,which decreases by €375,000 quarterly starting in September 2006.  Under theFacility, Mentor BV may borrow up to €12.5 million in fixed amount advances,with terms of three to six months, and a further sublimit of up to €5 millionof loans in fixed amount advances with a term of up to 5 years.  Up to €10million of the Facility may be drawn in the form of dollars.  Funds under theFacility are available to Mentor BV to finance certain dividend payments toMentor Corporation and for other normal business purposes.  Interest onborrowings under the Facility is at a rate equal to 0.55% over the RaboBankbase lending rate, Euribor, or LIBOR depending upon the currency and term ofeach borrowing.  Interest rates on borrowings other than overdrafts, arefixed for the term of the advance.  Borrowings by Mentor BV under the Facilityare guaranteed by Mentor's wholly-owned subsidiary, Mentor Medical SystemsC.V., through a Joint and Several Debtorship agreement.  In addition,borrowings under the Facility are secured by a mortgage on certain real estateowned by Mentor BV. As of December 31, 2005, there were no borrowingsoutstanding and $17.8 million was available under the Facility.

| 35 |
|----|

----

In addition to our RabobankFacility, we previously established several lines of credit with local foreignlenders to facilitate operating cash flow needs at our foreign subsidiaries. These unsecured lines are at market rates of interest, are guaranteed by theCompany, and total $3.6 million.  There were no borrowings under these lines ofcredit as of December 31, 2005.  

The total amount ofborrowings available to us under all lines of credit was $219.4 million at December 31, 2005.

*ConvertibleSubordinated Notes*

On December 22, 2003, we completed an offering of $150 million of convertible subordinated notes due January 1, 2024, pursuant to Rule 144A under the Securities Act of 1933.  The notesbear interest at 23⁄4% per annum and are convertible into shares of our commonstock at a conversion price of $29.1859 per share and are subordinated to allexisting and future senior debt.  Concurrent with the issuance of theconvertible subordinated notes, we entered into a convertible bond hedge andwarrants transactions with respect to our common stock, the exposure for whichis held by Credit Suisse First Boston LLC for a net cash payment of $18.5million.  Both the bond hedge and the warrants transactions may be settledat our option either in cash or net shares and expire January 1, 2009.  The convertible bond hedge and warrants transactions combined are intended toreduce the potential dilution from conversion of the notes by effectivelyincreasing the conversion price per share, from our perspective, toapproximately $39.2887.

One of the conditionsrequired for conversion of the notes was satisfied during the quarter ended December 31, 2005, and accordingly, the holders of notes have the option to convert thenotes into common shares at the aforementioned adjusted conversion price pershare.  

We do not have anyoff-balance sheet arrangements that are currently material or reasonable likelyto be material to our financial position of results of operations.

We believe that fundsgenerated from operations, our cash, cash equivalents and marketable securitiesand funds available under our line of credit agreements will be adequate tomeet our working capital needs and capital expenditure investment requirementsand commitments for the foreseeable future.  However, it is possible thatwe may need to raise additional funds to finance certain requirements or toconsummate acquisitions of other businesses, products or technologies throughthe sale of equity or debt securities to the public or to selected investors,or by borrowing money from financial institutions.  In addition, even ifwe do not need additional funds, we may still elect to sell additional equityor debt securities or borrow for other reasons.  There are no assurancesthat we will be able to obtain additional funds on terms that would befavorable to us, or at all.  If funds are raised by issuing additionalequity securities or convertible debt securities, the ownership percentage ofexisting shareholders would be reduced.  In addition, equity or debtsecurities issued by us may have rights, preferences or privileges senior to those of our common stock.

*Recent Accounting Pronouncements*

In December 2004, theFinancial Accounting Standards Board issued SFAS No. 123(R),"Share-Based Payment".  SFAS No. 123(R) will require usto account for our stock options using a fair-value-based method as describedin such statement and recognize the resulting compensation expense in ourfinancial statements.    The majority of this compensation expense will becaptured in selling, general and administrative expenses.  SFAS 123(R) willalso require the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current literature. This requirement willreduce net operating cash flows and increase net financing cash flows inperiods after adoption.  We currently accounts for our employee stock optionsusing the intrinsic value method under APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations, which generallyresults in no employee stock option expense.  We plan to adoptSFAS No. 123(R) on April 1, 2006, as required.

36

----

 

**Item 3.**    **Quantitative and QualitativeDisclosures about Market Risk**

There have been no materialchanges in our exposure to market risk as reported in Item 7A in our AnnualReport on Form 10-K for the fiscal year ended March 31, 2005.

**Item 4.**    **Controls and Procedures**

Wemaintain disclosure controls and procedures (as defined in Rules 13a-15(e)and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the"Exchange Act")) that are designed to ensure that informationrequired to be disclosed in our reports filed or submitted under the ExchangeAct, is recorded, processed, summarized and reported within the time periodsspecified in the SEC's rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure.  In designing and evaluating the disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

Wecarried out an evaluation under the supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures as of December 31, 2005, the end of the period covered by thisreport.  Based on that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective at the reasonable assurance level as of December 31, 2005.

Therehave been no changes in our internal control over financial reporting (asdefined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during thequarter ended December 31, 2005 that materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

 

 

 

| 37 |
|----|

----

**PART II - OTHERINFORMATION**

**Item1.    Legal Proceedings**

On March 4, 2004, John H. Alico, et. al., d/b/a PTF Royalty Partnership ("PTF") filed a lawsuitagainst us in the Business Litigation Session of the Superior Court ofMassachusetts, Suffolk County in which PTF alleges, among other things, breachof a merger agreement that involved our acquisition of Mentor O&O, Inc.("O&O"), an unrelated entity at that time, which was dated as ofMarch 14, 1990 ("Merger Agreement") (prior to the merger, O&O hadno affiliation with us).  PTF alleges that we breached the terms of theMerger Agreement by failing to exert commercially reasonable and diligentefforts to obtain approval by the FDA for a product used for the treatment ofurinary incontinence and by failing to accurately account for and pay royaltiesdue thereunder.  PTF seeks damages in excess of $18 million, which is themaximum amount of royalties PTF could have received under the Merger Agreement. After almost ten years, in or about January 2001, we elected to discontinuepursuing FDA approval for the product, given the FDA's repeated and ongoingconcerns regarding the product's use for urinary incontinence.  Wecomplied with all of our obligations under the Merger Agreement, whichspecifically provided that we were under no obligation to engage in efforts orexpenditures in respect of the product which we in good faith deemed to beinadvisable based on various factors.  Accordingly, we intend to vigorouslydefend the lawsuit.  Dr. Richard Young, a member of our Board of Directorssince March 1990, was a partner of PTF and was a named plaintiff in the aboveaction.  Dr. Young was a shareholder and principal of O&O prior to themerger and was instrumental in facilitating the transition after the merger.Pursuant to Dr. Young's request, the PTF Partnership Agreement was amended topermit withdrawal of partners from the PTF Royalty Partnership uponnotice.  On June 3, 2005, Dr. Young submitted his notice of withdrawal tothe Partnership, and a joint stipulation removing Dr. Young from the caption ofthe complaint and as a named party to the litigation was entered by the courtin June 2005.

In addition, in the ordinarycourse of our business we experience other varied types of claims thatsometimes result in litigation or other legal proceedings.  Although therecan be no certainty, we do not anticipate that any of these proceedings willhave a material adverse effect on us.

 

 

 

 

| 38 |
|----|

----

**Item 1A.   Risk Factors**

**Forward-LookingInformation Under the Private Securities Litigation Reform Action of 1995**

The Private SecuritiesLitigation Reform Act of 1995 provides a "safe harbor" forforward-looking statements.  The Act was designed to encourage companiesto provide prospective information about them without fear of litigation. The prospective information must be identified as forward-looking and must beaccompanied by meaningful cautionary statements identifying important factorsthat could cause actual results to differ materially from those projected inthe statements.  The statements about our business, plans, strategies,intentions, expectations and prospects contained throughout this document arebased on current expectations.  These statements are forward-looking andactual results may differ materially from those predicted as of the date ofthis report in the forward-looking statements, which involve risks anduncertainties.  In addition, past financial performance is not necessarilya reliable indicator of future performance and investors should not usehistorical performance to anticipate results or future period trends.  Weundertake no obligation to revise or update publicly any forward-lookingstatements for any reason, even if new information becomes available or otherevents occur in the future.

Our business faces manyrisks.  The risks described below may not be the only risks we face. Additional risks that we do not yet know of or that we currently think areimmaterial may also impair our business operations.  If any of the eventsor circumstances described in the following risks actually occurs, ourbusiness, financial condition or results of operations could suffer and thetrading price of our common stock or our convertible notes could decline. Youshould consider the following risks before deciding to invest in our commonstock or convertible notes. 

***Significant product liability claims or product recalls may force us topay substantial damage awards and other expenses that could exceed our accrualsand insurance coverages.***

The manufacture and sale ofmedical devices exposes us to significant risk of product liabilityclaims.  In the past, and currently, we have had a number of productliability claims relating to our products, and we may be subject to additionalproduct liability claims in the future, some of which may have a negativeimpact on our business.  If a product liability claim or series of claimsis brought against us for uninsured liabilities or in excess of our insurancecoverage, our business could suffer.  Some manufacturers that sufferedsuch claims in the past have been forced to cease operations or even to declarebankruptcy. 

Additionally, we offerproduct replacement and certain financial assistance for surgical procedures thatfall within our limited warranty and coverage period of implantation on ourbreast implant products, and we accrue for those limited warranties.  Such accrualsare based on estimates, taking into consideration relevant factors such ashistorical experience, warranty period, estimated costs, existence and levelsof insurance and insurance retentions, identified product quality issues, ifany, and, to a limited extent, information developed by the insurance companyusing actuarial techniques.  We assess the adequacy of these accrualsperiodically and adjust the amounts as necessary based on actual experience andchanges in future expectations.  We also recently expanded our limited warrantyprograms to provide certain financial assistance for surgical procedures withinten years of implantation (increased from five years) and expanded the programcoverage to include breast implant sales in European and certain othercountries, in addition to the United States.  Changes to actual warranty claimsincurred could have a material impact on the actuarial analysis, which in turncould materially impact our reported expenses and results of operations.

In addition to productliability or warranty claims, we could experience a material design ormanufacturing failure, a quality system failure, other safety issues, orheightened regulatory scrutiny that would warrant a recall with products wemanufacture or are manufactured by another company and we distribute. A recallof some of our products could result in exposure to additional productliability claims, significant expense to perform the recall and lost sales.

 

| 39 |
|----|

----

***We are subject tosubstantial government regulation, which could have a material adverse affecton our business.***

The production and marketingof our products and our ongoing research and development activities, includingpre-clinical testing and clinical trial activities, are subject to extensiveregulation and review by numerous governmental authorities both in the U.S. and abroad.  Most of the medical devices we develop must undergo rigorouspre-clinical and clinical testing and an extensive regulatory approval processbefore they can be marketed.  Certain of our products are required toundergo review by a panel of outside experts selected by the FDA, which makes arecommendation to the FDA as to whether the product(s) should or should not beapproved.  This process makes it potentially longer, more difficult and/ormore costly to bring our products to market, and we cannot guarantee that anyof our unapproved products will be approved or how long it may take for any oneparticular product to be approved.  The pre-marketing approval process canbe particularly expensive, uncertain and lengthy, and a number of devices forwhich FDA approval has been sought by other companies have never been approvedfor marketing.  In addition to testing and approval procedures, extensiveregulations also govern manufacturing, packaging, labeling, storage,distribution, record-keeping, and advertising and marketing procedures. If we do not comply with applicable regulatory requirements, such violationscould result in non-approval, suspensions of clinical trials, suspension orwithdrawal of regulatory approvals, product recalls, civil penalties andcriminal fines, product seizures, operating restrictions, injunctions, andcriminal prosecution. 

Delays in, withdrawal, orrejection of the FDA or other government entity approval(s) of our products,including a delay in or rejection of the approval of our silicone gel-filledbreast implant PMA, may also adversely affect our business.  Such delays,withdrawals, or rejections may be encountered due to, among other reasons,government or regulatory delays, lack of demonstrated safety or efficacy duringclinical trials, safety issues, manufacturing issues, slower than expected rateof patient recruitment for clinical trials, inability to follow patients aftertreatment in clinical trials, inconsistencies between early clinical trialresults and results obtained in later clinical trials, varying interpretationsof data generated by clinical trials, or changes in regulatory policy orrequirements in the U.S. and abroad.  In the U.S., there has been acontinuing trend toward more stringent FDA requirements in the areas of productapproval and enforcement, causing medical device manufacturers to experiencelonger research and development timelines, longer approval cycles, greater riskand uncertainty, and higher expenses.  Internationally, there is a risk that wemay not be successful in meeting the quality standards or other certificationrequirements.  Even if regulatory approval of a product is granted, suchapproval may entail limitations on uses for which the product may be labeledand promoted, stringent post-marketing requirements, or may prevent us from broadeningthe uses of our current products for different applications.  In addition,to the extent permissible by law, we may not receive FDA approval to export ourproducts in the future, and countries to which products are to be exported maynot approve them for import.  We may also be required to withdraw or recall ourproducts after we receive approvals and begin commercial sales if we, the FDAor a foreign government agency determines that there is a higher than averageincidence of post-treatment complications with our products as a result ofsubsequent clinical experience and/or data.  From time to time, we are subjectto inquiry by government agencies in this regard.  

Our manufacturing facilitiesalso are subject to continual governmental review and inspection.  The FDAhas stated publicly that compliance with manufacturing regulations will bescrutinized more strictly.  A governmental authority may challenge ourcompliance with applicable federal, state and/or foreign regulations.  Inaddition, any discovery of previously unknown problems with one of our productsor facilities may result in restrictions on the product or the facility,including, but not limited to, product recalls, withdrawal of the product fromthe market or other enforcement actions.

From time to time,legislative or regulatory proposals are introduced that, if implemented, couldalter the review and approval process relating to medical devices, or relatedto the sale of our products.  It is possible that the FDA or other governmentalauthorities will issue additional regulations, which could further reduce orrestrict the sales of our presently marketed products or products underdevelopment.  Any change in legislation or regulations that govern thereview and approval process relating to our current and/or future products, orthat restrict the manner by which we may sell our products, could make it moredifficult and/or costly to obtain approval for new products, and/or to produce,market, and distribute existing products. 

| 40 |
|----|

----

***If we are unable tocontinue to develop and commercialize new technologies and products, we mayexperience a decrease in demand for our products or our products could becomeobsolete.***

The medical device industryis highly competitive and is subject to significant and rapid technologicalchange.  We believe that our ability to develop or acquire newtechnologies is crucial to our success.  We are continually engaged inproduct research and development, product improvement programs, and requiredclinical studies to develop new technologies and to maintain and improve ourcompetitive position.  Any significant delays in the above or terminationor failure of our clinical trials would materially and adversely affect ourresearch, development and commercialization timelines.  We cannotguarantee that we will be successful in enhancing existing products, or indeveloping or acquiring new products or technologies that will timely achieveregulatory approval or success in the marketplace.  

There is also a risk that ourproducts may not gain market acceptance among physicians, patients and themedical community generally.  The degree of market acceptance of anymedical device or other product that we develop will depend on a number offactors, including demonstrated clinical safety and efficacy,cost-effectiveness, potential advantages over alternative products,user/patient acceptance, and our marketing and distribution capabilities.  Physicianswill not recommend our products if clinical and/or other data and/or otherfactors do not demonstrate their safety and efficacy compared to othercompeting products, or if our products do not best meet the particular needs ofthe individual patient.

In December 2003, wecompleted our pre-market approval ("PMA") application to the FDA for oursilicone gel-filled implants for breast augmentation, reconstruction andrevision.  In August 2004, we amended our PMA application based on a reviseddraft guidance released by the FDA in January 2004.  On July 28, 2005, we received an "approvable" letter, with conditions, from the FDA on ourPMA application for our silicone gel-filled breast implants.  Theapprovable letter stipulates a number of conditions which we must satisfy inorder to receive FDA approval to market and sell silicone gel-filled breastimplants in the United States.  Despite the approvable letter, the FDA mayultimately decide to not approve our silicone gel-filled breast implants forsale in the United States, and the FDA will most likely recommend additionalpost-approval conditions or requirements, which could impact our sales andearnings, depending on the scope and complexity of the requirements. Further change in FDA regulatory requirements, including those implementedthrough new or revised FDA guidance, (such as that announced on January 8, 2004 by the FDA), may delay or may otherwise adversely affect our pending PMAapplication as well as its review or approval by the FDA.  A delay ordenial response by the FDA would have a material adverse effect on ourcommercialization timelines and competitive position, and ultimately ourrevenue and operating results.  If our new products do not achievesignificant market acceptance, or if our current products do not continuecompeting successfully in the changing market, our sales and earnings may notgrow as much as expected, or may even decline.

We also have two pendingapplications for Medical Device Licenses in Canada for our silicone gel-filledbreast implants.  An expert advisory panel convened by the Canadiangovernment on March 22, 2005 to review our pending application for MedicalDevice Licenses.  A public forum called by Health Canada on these devices was held September 29, 2005.  We cannot predict the outcome ofthese reviews, nor determine when or if Health Canada will approve our productapplications.  In addition, any approval could be granted with stringentpost-marketing requirements that may impact our sales and earnings, dependingon the scope and complexity of such requirements.

With respect to our PuragenPlusTM program in the U.S., we recently identified potential issues with some ofthe data from our clinical study that will require further evaluation and willresult in a delay to our PMA submission timeline.  We are working diligently tomore thoroughly understand these issues and determine our next course ofaction.  Any further delays in our submission of our PMA or a delay or denialresponse by the FDA would have a material adverse effect on our commercializationtimelines and competitive position, and ultimately our future revenue andoperating results.  

 

| 41 |
|----|

----

Our products compete withsimilar or other competitive medical products manufactured by major companies,and may also compete with new products currently under development by others. Competition in our industry occurs on a variety of levels, including but notlimited to:

-  developing andbringing new products to market before others or to provide benefits superiorto those of existing products;
-  developingnew technologies to improve existing products;
-  developing newproducts at a lower cost to provide the same benefits as existing products atthe same or lower price;
-  creating orentering new markets with existing products;
-  increasingor improving service-related programs; and
-  advertisingin a manner that creates additional awareness and demand.

The competitive environmentrequires an ongoing, extensive search for technological innovations and theability to market products effectively.  Consequently, we must continue toeffectively execute on various competitive levels to properly position ourproducts in the marketplace and maintain our market share, revenue and grossmargins. 

In particular, we facecompetition from Inamed, our only current competitor in the U.S. for our breast aesthetics product line.  On September 21, 2005, Inamed announced that it also received an "approvable" letter, with conditions, from the FDA for itssilicone gel-filled breast implants.  If Inamed gains FDA approval to marketits silicone gel-filled breast implant products before we do, our competitiveposition will likely suffer.  On December 20, 2005, Inamed announced that it had agreed to be acquired by Allergan.  If the Inamed/Allergan merger is completed,we will be competing against a much larger competitor with a substantiallylarger sales force.

***If we suffer negativepublicity concerning the safety of our products, our sales may be harmed and wemay be forced to withdraw products.***

Physicians and potentialpatients may have a number of concerns about the safety of our products,including our breast and other implants, whether or not such concerns have abasis in generally accepted science or peer-reviewed scientific research. Negative publicity, whether accurate or inaccurate, concerning our productscould reduce market or governmental acceptance of our products and could resultin decreased product demand or product withdrawal.  For example, we may berequired to recall or withdraw our products if we, the FDA or a foreigngovernment agency determine that use of our products results in a higher thanaverage rate of post-treatment complications based on clinical experienceand/or data.  If one foreign government agency were to request or require a withdrawalor recall of one or more of our products, the safety concerns leading to thatgovernment agency's request may be investigated by regulatory bodies in othercountries, which could result in additional withdrawals or recalls and couldresult in negative publicity regarding our products.  In addition, significantnegative publicity could result in an increased number of product liabilityclaims, whether or not these claims are supported by applicable law. 

| 42 |
|----|

----

***If changes in theeconomy and consumer spending reduce consumer demand for our products, oursales and profitability could suffer.***

Certain elective procedures,such as breast augmentation, body contouring, and in some cases surgicaltreatment for male impotence are not covered by insurance.  Adversechanges in the economy or other conditions or events may cause consumers toreassess their spending choices and reduce the demand for these surgeries andcould have an adverse effect on consumer spending.  This shift could havean adverse effect on our sales and profitability. 

***If we are unable toimplement new information technology systems, our ability to manufacture andsell products, maintain regulatory compliance and manage and report ourbusiness activities may be impaired, delayed or diminished, which would causesubstantial business interruption and loss of sales, customers and profits.***

In fiscal 2004, weimplemented an enterprise resource planning system at our major locations whichis our primary business management system.  We intend to continue toimplement the system for substantially all of our businesses worldwide. Many other companies have had severe problems with computer systemimplementations of this nature and scope.  We are using a controlledproject plan and we believe we have assigned adequate staffing and otherresources to the projects to ensure its successful implementation; howeverthere is no assurance that the design will meet our current and future businessneeds or that it will operate as designed.  We are heavily dependent onsuch computer systems, and any failure or delay in the system implementationwould cause a substantial interruption to our business, additional expense, andloss of sales, customers, and profits. 

***If we are unable toacquire companies, businesses or technologies as part of our growth strategy orto successfully integrate past acquisitions, our growth, sales andprofitability could suffer.***

A significant portion of ourrecent growth has been the result of acquisitions of other companies,businesses and technologies.  We intend to continue to acquire otherbusinesses and technologies to facilitate our future business strategies. There can be no assurance that we will be able to identify appropriateacquisition candidates, consummate transactions or obtain agreements with termsfavorable to us.  Further, once a business is acquired, any inability tointegrate the business, failure to retain and develop its workforce, orestablish and maintain appropriate communications, performance expectations,regulatory compliance procedures, accounting controls, and reporting procedurescould adversely affect our future sales and earnings.

***Any adverse change toour business as a result of our announced strategy to focus on our aestheticsbusiness and to evaluate our strategic alternatives for our urology businesscould cause our sales and profitability to suffer.***

We announced our strategy to focus on our aestheticsbusiness, and that as a result, we are considering strategic alternatives forour urology business, including a divestiture of the business.  There can be noassurances that our strategic objectives will ultimately be achieved, or thatthe process of evaluating and executing on our strategic objectives will notdisrupt the business.  There can be no assurance that any divestiture of thebusiness would be completed on terms acceptable to us, if at all, and in atimely manner.  We continue to be committed to our urology business, but the divestitureprocess and any subsequent plans could generate potential disruptions to thebusiness, such as negative reactions from our customers, suppliers oremployees, which could materially adversely affect our operating results andfinancial position.  Further, there can be no assurance that the evaluation ofany of these strategic objectives will enable us to focus on our aestheticsbusiness, or that any such strategic focus would enable us to maintain orimprove our operating results or financial position in future periods.  Forexample, we have determined not to pursue our previously announced proposal toacquire Medicis but we incurred substantial expenses before reaching thatconclusion.  Finally, any transaction related to our strategic objectives coulddivert management's attention from effectively managing our existing and ongoingbusiness.

 

 

| 43 |
|----|

----

***State legislatures and taxing authorities may create newlaws or change their interpretation of existing state and local tax laws thatmay affect future product demand or create unforeseen tax liabilities.***

If any state legislature orother government authority creates new laws to assess sales taxes on medicalprocedures determined by them to be cosmetic, our physician and patientcustomers may have to pay more for our products and future demand maydecrease.  In addition, if taxing authorities determine that our productsare cosmetic and thus taxable based on their interpretations of existing taxlaws or that our products are otherwise taxable, they may disallow currentlyavailable exemptions related to medical products and procedures.  Suchtaxing authorities may then determine that we owe additional taxes related toproduct sales from prior periods.  These determinations would have anegative effect on our results of operations.

***If our intellectualproperty rights do not adequately protect our products or technologies, otherscould compete against us more directly, which would hurt our profitability.***

Our success depends in parton our ability to obtain patents or rights to patents, protect trade secrets,operate without infringing upon the proprietary rights of others, and preventothers from infringing on our patents, trademarks and other intellectualproperty rights.  We will be able to protect our intellectual propertyfrom unauthorized use by third parties only to the extent that it is covered byvalid and enforceable patents, trademarks or licenses.  Patent protectiongenerally involves complex legal and factual questions and, therefore,enforceability of patent rights cannot be predicted with certainty; thus, anypatents that we own or license from others may not provide us with adequateprotection against competitors.  Moreover, the laws of certain foreigncountries do not recognize intellectual property rights or protect them to thesame extent as do the laws of the United States.  

In addition to patents andtrademarks, we rely on trade secrets and proprietary know-how.  We seekprotection of these rights, in part, through confidentiality and proprietaryinformation agreements.  These agreements may not provide sufficient protectionor adequate remedies for violation of our rights in the event of unauthorizeduse or disclosure of confidential and proprietary information.  Failure toprotect our proprietary rights could seriously impair our competitive position.

***If third parties claim weare infringing their intellectual property rights, we could suffer significantlitigation or licensing expenses or be prevented from marketing our products.***

Our commercial successdepends significantly on our ability to operate without infringing the patentsand other proprietary rights of others.  However, regardless of ourintent, our technologies may infringe upon the patents or violate otherproprietary rights of third parties.  In the event of such infringement orviolation, we may face expensive litigation and may be prevented from sellingexisting products and pursuing product development or commercialization. 

***We depend on single andsole source suppliers for certain raw materials and licensed or manufacturedproducts and the loss of any supplier could adversely affect our ability tomanufacture or sell many of our products.***

We currently rely on singleor sole source suppliers for raw materials used in many of our products,including silicone.  In the event that they cannot meet our requirements,we cannot guarantee that we would be able to obtain a sufficient amount ofquality raw materials in a timely manner.  We also depend on third partymanufacturers for components and licensed products, including our women'shealth products and our palladium brachytherapy seed product.  If there isa disruption in the supply of these products, our sales and profitability wouldbe adversely affected. 

| 44 |
|----|

----

***Our internationalbusiness exposes us to a number of risks.***

More than one-third of oursales are derived from international operations.  Accordingly, anymaterial decrease in foreign sales would have a material adverse effect on ouroverall sales and profitability. Most of our international sales aredenominated in Euros, British Pounds, Canadian Dollars or U.S. Dollars. Depreciation or devaluation of the local currencies of countries where we sellour products may result in our products becoming more expensive in localcurrency terms, thus reducing demand, which could have an adverse effect on ouroperating results.  Our operations and financial results may be adverselyaffected by other international factors, including: 

•    foreigngovernment regulation of medical products; 

•    productliability, intellectual property and other claims; 

•    new exportlicense requirements; 

•    political oreconomic instability in our target markets; 

•    traderestrictions; 

•    changes intax laws and tariffs; 

•    managingforeign distributors and manufacturers; 

•    managingforeign branch offices and staffing; 

•    competition;and 

•    fluctuationsin foreign currency exchange rates.

***Health carereimbursement or reform legislation could materially affect our business.***

If any national health carereform or other legislation or regulations are passed that imposes limits onthe amount of reimbursement for certain types of medical procedures orproducts, or on the number or type of medical procedures that may be performed,or that has the effect of restricting a physician's ability to select specificproducts for use in patient procedures, such changes could have a materialadverse effect on the demand for our products.  Our revenues dependlargely on U.S. and foreign government health care programs and private healthinsurers reimbursing patients' medical expenses.  Physicians, hospitals,and other health care providers may not purchase our products if they do notreceive satisfactory reimbursement from these third-party payers for the costof procedures using our products.  In the U.S., there have been, and weexpect that there will continue to be, a number of federal and statelegislative and regulatory proposals to implement greater governmental controlover the healthcare industry and its related costs.  These proposalscreate uncertainty as to the future of our industry and may have a materialadverse effect on our ability to raise capital or to form collaborations. In a number of foreign markets, the pricing and profitability of healthcareproducts are subject to governmental influence or control.  In addition, legislationor regulations that impose restrictions on the price that may be charged forhealthcare products or medical devices may adversely affect our sales andprofitability. 

***If our use of hazardousmaterials results in contamination or injury, we could suffer significantfinancial loss.***

We are subject to federal,state, local and foreign environmental laws and regulations.  Our manufacturingand research and development activities involve the controlled use of potentiallyhazardous materials, chemicals and biological materials, which requirecompliance with various laws and regulations regarding the use, storage, anddisposal of such materials.  We believe that our operations comply in allmaterial respects with applicable environmental laws and regulations in eachcountry where we have a business presence. Although we continue to makeexpenditures for environmental protection, we do not anticipate any additionalsignificant expenditures, in complying with such laws and regulations, thatwould have a material impact on our earnings or competitive position.  We arenot aware of any pending litigation or significant financial obligationsarising from current or past environmental practices that are likely to have amaterial adverse effect on our financial position.  We cannot assure,however, that environmental claims relating to our operations, or propertiesowned or operated by us will not develop in the future, nor can we predictwhether any such claims, if they were to develop, would require significant expenditureson our part.  We cannot eliminate the risk of accidental contamination orinjury from these materials.  In the event of an accident or environmentaldischarge, we may be held liable for any resulting damages, which may exceedour financial resources and any applicable insurance coverage.  In addition, weare unable to predict what legislation or regulations may be adopted or enactedin the future with respect to environmental protection and waste disposal.

| 45 |
|----|

----

We are subject to regulationby the United States Environmental Protection Agency and other state and localenvironmental agencies in each of our domestic manufacturing facilities.  Forexample, in Texas, we are subject to regulation by the local Air PollutionControl District as a result of some of the chemicals used in our manufacturingprocesses.  In our Oklahoma facility, we are also subject to regulation bythe United States Nuclear Regulatory Commission (NRC) due to the manufacture anddistribution of brachytherapy seeds using radioactive iodine I-125 andpalladium Pd-103.  In our Wisconsin facility, we are also subject toregulation by the U.S. Department of Health and Human Services, Centers forDisease Control; due to the nature of the biological agent used to manufactureour botulinum toxin product, *Clostridium botulinum* type A, which isstill in the development phase.  Failure to comply with the regulations andrequirements of these various agencies could affect our ability to manufactureproducts and may have a significant negative impact on sales and results ofoperations. 

***Future changes infinancial accounting standards may cause adverse unexpected revenue or expensefluctuations and affect our reported results of operations.***

A change in accountingstandards could have a significant effect on our reported results and may evenaffect our reporting of transactions completed before the change iseffective.  New pronouncements and varying interpretations of existingpronouncements have occurred and may occur in the future.  Changes to existingrules or current practices may adversely affect our reported financial resultsand require restatement of previously issued results for retroactiveapplication of the new accounting standard.  This was evidenced by theadoption of EITF 04-8 which was adopted in the quarter ended December 2004,resulting in the restatement of diluted earnings per share and weighted averageshares outstanding, for fiscal year 2004 and the interim periods ending June30, and September 30, 2004. 

In addition, effective April1, 2006, we will be required to implement FAS 123R, which will have animmediate, negative impact on our operating expenses, net income and earningsper share as reported under GAAP.

***Hedging transactionsand other transactions may affect the value of the notes.***

In connection with theoriginal issuance of our 23⁄4% convertible subordinated notes in December 2003,we entered into convertible note hedge and warrant transactions with respect toour common stock, with Credit Suisse First Boston International, an affiliateof Credit Suisse First Boston LLC, the initial purchaser of the notes, toreduce the potential dilution from conversion of the notes up to a price of ourcommon stock of approximately $39.29 per share.  In connection with thesehedging arrangements, Credit Suisse First Boston International, and/or itsaffiliates, has taken and, we expect, will continue to take positions in ourcommon stock in secondary market transactions and/or will enter into variousderivative transactions.  Such hedging arrangements could adversely affectthe market price of our common stock.  In addition, the existence of thenotes may encourage short selling in our common stock by market participantsbecause the conversion of the notes could depress the price of our commonstock. 

| 46 |
|----|

----

***Litigation may harm ourbusiness or otherwise distract our management.***

Substantial, complex orextended litigation could cause us to incur large expenditures and distract ourmanagement, and could result in significant monetary or equitable judgmentsagainst us.  For example, lawsuits by employees, patients, customers,licensors, licensees, suppliers, business partners, distributors, shareholders,or competitors could be very costly and could substantially disrupt ourbusiness.  Disputes from time to time with such companies or individualsare not uncommon, and we cannot assure that we will always be able to resolvesuch disputes out of court or on terms favorable to us. 

***Our publicly-filed SECreports are reviewed by the SEC from time to time and any significant changesrequired as a result of any such review may result in material liability to usand have a material adverse impact on the trading price of our common stock.***

The reports ofpublicly-traded companies are subject to review by the SEC from time to timefor the purpose of assisting companies in complying with applicable disclosurerequirements and to enhance the overall effectiveness of companies publicfilings, and comprehensive reviews by the SEC of such reports are now requiredat least every three years under the Sarbanes-Oxley Act of 2002.  SECreviews often occur at the time companies file registration statements such asthe registration statement we filed in connection with our convertible noteoffering, but reviews may also be initiated at any time by the SEC.  Whilewe believe that our previously filed SEC reports comply, and we intend that allfuture reports will comply in all material respects with the published rulesand regulations of the SEC, we could be required to modify or reformulateinformation contained in prior filings as a result of an SEC review.  Anymodification or reformulation of information contained in such reports could besignificant and result in material liability to us and have a material adverseimpact on the trading price of our securities, including our common stock orour convertible notes.

***Our operating resultsmay fluctuate substantially, and could precipitate unexpected movement in theprice of our common stock and convertible notes.*** 

Our common stock trades onthe New York Stock Exchange under the symbol "MNT."  On December 31, 2005, the closing price of our common stock on the New York Stock Exchange was$46.08 per share.  On December 22, 2003, we completed an offering of $150million of convertible subordinated notes ("notes") due January 1, 2024 pursuant to Rule 144A under the Securities Act of 1933.  The notesbear interest at 23⁄4% per annum, are convertible into shares of our common stockat an adjusted conversion price of $29.1859 per share and are subordinated toall existing and future senior debt.  The market prices of our stock andconvertible securities are subject to significant fluctuations in response tothe factors set forth above and other factors, many of which are beyond ourcontrol including such factors as changes in pricing policies by ourcompetitors and the timing of significant orders and shipments.

Such factors, as well asother economic conditions, may adversely affect the market price of oursecurities, including our common stock and convertible notes.  There couldbe periods in which we experience shortfalls in revenue and/or earnings fromlevels expected by securities analysts and investors, which could have animmediate and significant adverse effect on the trading price of oursecurities, including our common stock and our convertible notes.

**Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds**

None. 

**Item 3.   Defaults Upon Senior Securities**

None. 

| 47 |
|----|

----

**Item 4.   Submission of Matters to a Vote of Security Holders**

None

**Item 5.    Other Information**

None

 

 

 

 

 

 

 

 

48

----

 

**Item6. Exhibits** 

| 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* |  | Mentor Corporation 2005  Long-Term Incentive Plan - (as amended November 2005)                                                                                                                                                                                                                           |
| 10.2* |  | Mentor Corporation Employee  Stock Purchase Plan - Incorporated by reference to Exhibit 10.9 of the  Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005.                                                                                                                |
| 10.3* |  | Form of Mentor Corporation  2005 Long-Term Incentive Plan Restricted Stock Award Agreement for Awards  Issued to Company Directors and Officers on October 5, 2005 - Incorporated by  reference to Exhibit 10.10 of the Registrant's Quarterly Report on Form 10-Q  for the quarter ended September 30, 2005. |
| 10.4  |  | English translation of  Rabo-Bank Loan and Overdraft Facility dated September 30, 2005 - Incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K  filed on October 11, 2005.                                                                                            |
| 10.5  |  | Mentor Corporation 2005  Long-Term Incentive Plan Restricted Stock Award Agreement - Incorporated by  reference to Exhibit 10.12 of the Registrant's Quarterly Report on Form 10-Q  for the quarter ended September 30, 2005.                                                                            |
| 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.                                                                                                                                                                       |

*Management contract or compensatory plan or arrangement.

| 49 |
|----|

----

**SIGNATURES**

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

**MENTOR CORPORATION**

(Registrant)

| Date:                    | February 8, 2006 | By: | /s/JOSHUA  H. LEVINE             |
|--------------------------|------------------|-----|----------------------------------------------------------------------------------------------|
| Joshua  H. Levine        |
| Chief  Executive Officer |
|                          |                  |     |                                                                                              |
| Date:                    | February 8, 2006 | By: | /s/LOREN  L .MCFARLAND                                         |
| Loren  L. McFarland      |
| Chief  Financial Officer |

|  

 

 

 

 

50 |
|--------------------------------------------|