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

**FORM 10-Q**

(Mark One)

x  QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

For the quarterly periodended**September 30, 2006**

or

o  TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

For the transitionperiod from                             to                           

Commission File No. 001-31744

**MENTOR CORPORATION**(ExactName of Registrant as Specified 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)

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  x        No  o

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer.  See definition of "acceleratedfiler and large accelerated filer" in Rule 12b-2 of the Exchange Act.(Checkone):  Large accelerated filer  x          Acceleratedfiler  o          Non-accelerated filer o

Indicateby check mark whether the Registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).  Yes  o    No x

Asof November 6, 2006there were approximately 42,152,718 Common Shares, $.10 par value per share, outstanding.

----

**MENTOR CORPORATION**

**INDEX**

| Part I. Financial Information |
|-------------------------------|
| Item  1.                      | Financial  Statements: |
|                               | Consolidated  Balance Sheets (unaudited) - September 30, 2006 and March 31, 2006 |
|                               | Consolidated  Statements of Income (unaudited) - Three Months Ended September 30, 2006 and 2005 |
|                               | Consolidated  Statements of Income (unaudited) - Six Months Ended September 30, 2006 and 2005 |
|                               | Consolidated  Statements of Cash Flows (unaudited) - Six Months Ended September 30, 2006 and 2005 |
|                               | Notes  to Consolidated Financial Statements - September 30, 2006 |
| 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, Use of Proceeds and Issuer Purchases of Equity  Securities |
| 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 - FINANCIALINFORMATION**

**Item1.         Consolidated Financial Statements**

| Mentor Corporation                               |
|--------------------------------------------------|
| Consolidated Balance  Sheets                     |
| (Unaudited)                                      |
|                                                  |  |
|                                                  | **September 30,** | March 31, |
| (in  thousands)                                  | **2006** | 2006 |
| **Assets**                                       | ** ** |  |
| Current  assets:                                 | ** ** |  |
|    Cash and cash equivalents                | ** $** | **438,168 ** |  $ | 98,713  |
|    Marketable securities                    | **111,031 ** | 102,241  |
|    Accounts receivable, net                 | **53,491 ** | 58,199  |
|    Inventories, net                         | **33,652 ** | 35,139  |
|    Deferred income taxes                    | **23,675 ** | 21,764  |
|    Prepaid expenses and other               | **5,615 ** | 5,721  |
| Current  assets of discontinued operations       | **- ** | 96,070  |
| Total  current assets                            | **665,632 ** | 417,847  |
|                                                  | ** ** |  |
| Property  and equipment, net                     | **35,574 ** | 36,448  |
| Intangible  assets, net                          | **18,099 ** | 15,745  |
| Goodwill,  net                                   | **9,581 ** | 9,243  |
| Other  assets                                    | **7,962 ** | 8,310  |
| Non-current  assets of discontinued operations   | **- ** | 60,264  |
|      Total assets                 | ** $** | **736,848 ** |  $ | 547,857  |
|                                                  | ** ** |  |
| See  notes to consolidated financial statements. | ** ** |  |

| 3 |
|---|

----

| Mentor Corporation                                                               |
|----------------------------------------------------------------------------------|
| Consolidated Balance  Sheets                                                     |
| (Unaudited)                                                                      |
|                                                                                  |  |
|                                                                                  | **September 30,** | March 31, |
| (in  thousands)                                                                  | **2006** | 2006 |
| **Liabilities  and shareholders' equity**                                        | ** ** |  |
| Current  liabilities:                                                            | ** ** |  |
|   Accounts  payable and accrued liabilities                            | ** $** | **28,828 ** |  $ | 27,685  |
|   Accrued  compensation                                                | **17,943 ** | 17,335  |
|   Sales  returns                                                       | **13,808 ** | 15,544  |
|   Deferred  revenue                                                    | **11,793 ** | 10,495  |
|   Dividends  payable                                                   | **7,601 ** | 7,772  |
|   Product  liability reserves                                          | **7,009 ** | 6,701  |
|   Short-term  bank borrowings                                          | **5,000 ** | 14,000  |
|   Warranty  reserves                                                   | **2,797 ** | 3,659  |
|   Interest  payable                                                    | **1,031 ** | 1,031  |
|   Income  taxes payable                                                | **- ** | 1,837  |
|   Accrued  royalties                                                   | **283 ** | 274  |
|   Other                                                                | **16,464 ** | 13,819  |
| Current  liabilities of discontinued operations                                  | **62,649 ** | 29,971  |
| Total  current liabilities                                                       | **175,206 ** | 150,123  |
|                                                                                  | ** ** |  |
| Long-term  accrued liabilities                                                   | **12,519 ** | 10,590  |
| Convertible  subordinated notes                                             | **150,000 ** | 150,000  |
| Non-current  liabilities of discontinued operations                              | **- ** | 10,555  |
| Commitments  and contingencies                                                   | ** ** |  |
|                                                                                  | ** ** |  |
| Shareholders'  equity:                                                           | ** ** |  |
|   Common  stock, $.10 par value:                                       | ** ** |  |
|     Authorized  - 150,000,000 shares; issued and outstanding | ** ** |  |
|     42,253,761  shares at September   30, 2006;              | ** ** |  |
|     43,176,495  shares at March   31, 2006;                  | **4,225 ** | 4,318  |
|   Capital  in excess of par value                                      | **22,396 ** | 36,726  |
|   Accumulated  other comprehensive income                              | **8,455 ** | 16,498  |
|   Retained  earnings                                                   | **364,047 ** | 169,047  |
|     Total  shareholders' equity                              | **399,123 ** | 226,589  |
|       Total  liabilities and shareholders' equity  | ** $** | **736,848 ** |  $ | 547,857  |
|                                                                                  | ** ** |  |
| See  notes to consolidated financial statements.                                 | ** ** |  |

| 4 |
|---|

----

| Mentor  Corporation                                                            |
|--------------------------------------------------------------------------------|
| Consolidated  Statements of Income                                             |
| Three  Months Ended September 30, 2006 and 2005                                |
| (Unaudited)                                                                    |
|                                                                                | ** ** |  |
| (in thousands,  except per share data)                                         | **2006** | 2005 |
| Net sales                                                                      | ** $** | **66,908 ** |  $ | 58,672  |
|                                                                                | ** ** |  |
|   Cost of sales                                                      | **18,521 ** | 14,723  |
| Gross profit                                                                   | **48,387 ** | 43,949  |
|                                                                                | ** ** |  |
|   Selling, general, and  administrative                              | **28,725 ** | 24,269  |
|   Research and development                                           | **8,993 ** | 7,493  |
|                                                                                | **37,718 ** | 31,762  |
|                                                                                | ** ** |  |
| Operating income from continuing operations                                    | **10,669 ** | 12,187  |
|                                                                                | ** ** |  |
|   Interest expense                                                   | **(1,649)** | (1,408) |
|   Interest income                                                    | **6,823 ** | 881  |
|   Other income                                                       | **237 ** | 131  |
|                                                                                | ** ** |  |
| Income from continuing operations before  income taxes                         | **16,080 ** | 11,791  |
|                                                                                | ** ** |  |
| Income taxes                                                                   | **5,257 ** | 3,609  |
| Income from continuing operations                                              | **10,823 ** | 8,182  |
|                                                                                | ** ** |  |
| Income (loss) from discontinued operations,  net of taxes of ($575) and $2,913 | **(922)** | 3,936  |
| Loss on sale of discontinued operations,  net of taxes of ($116)               | **(180)** | -  |
| Net income                                                                     | ** $** | **9,721 ** |  $ | 12,118  |
|                                                                                | ** ** |  |
| Basic earnings (loss) per share                                                | ** ** |  |
|   Continuing operations                                              | ** $** | **0.26 ** |  $ | 0.19  |
|   Discontinued operations                                            | ** $** | **(0.03)** |  $ | 0.09  |
|     Basic earnings per  share                              | ** $** | **0.23 ** |  $ | 0.28  |
|                                                                                | ** ** |  |
| Diluted earnings (loss) per share                                              | ** ** |  |
|   Continuing operations                                              | ** $** | **0.24 ** |  $ | 0.17  |
|   Discontinued operations                                            | ** $** | **(0.02)** |  $ | 0.08  |
|     Diluted earnings  per share                            | ** $** | **0.22 ** |  $ | 0.25  |
|                                                                                | ** ** |  |
|   Dividends per share                                                | ** $** | **0.18 ** |  $ | 0.18  |
|                                                                                | ** ** |  |
| Weighted average shares outstanding                                            | ** ** |  |
|   Basic                                                              | **41,360 ** | 43,253  |
|   Diluted                                                            | **48,546 ** | 51,515  |
|                                                                                |  |  |
| See notes to consolidated financial  statements.                               |  |  |

** **

| 5 |
|---|

----

** **

| Mentor  Corporation                                                     |
|-------------------------------------------------------------------------|
| Consolidated  Statements of Income                                      |
| Six  Months Ended September 30, 2006 and 2005                           |
| (Unaudited)                                                             |
|                                                                         | ** ** |  |
| (in thousands,  except per share data)                                  | **2006** | 2005 |
| Net sales                                                               | ** $** | **146,345 ** |  $ | 132,798  |
|                                                                         | ** ** |  |
|   Cost of sales                                               | **40,566 ** | 33,069  |
| Gross profit                                                            | **105,779 ** | 99,729  |
|                                                                         | ** ** |  |
|   Selling, general, and  administrative                       | **58,436 ** | 49,272  |
|   Research and development                                    | **16,874 ** | 13,833  |
|                                                                         | **75,310 ** | 63,105  |
|                                                                         | ** ** |  |
| Operating income from continuing operations                             | **30,469 ** | 36,624  |
|                                                                         | ** ** |  |
|   Interest expense                                            | **(3,281)** | (2,747) |
|   Interest income                                             | **9,887 ** | 1,582  |
|   Other income                                                | **775 ** | 173  |
|                                                                         | ** ** |  |
| Income from continuing operations before  income taxes                  | **37,850 ** | 35,632  |
|                                                                         | ** ** |  |
| Income taxes                                                            | **11,353 ** | 10,375  |
| Income from continuing operations                                       | **26,497 ** | 25,257  |
|                                                                         | ** ** |  |
| Income from discontinued operations, net of  taxes of $3,356 and $6,905 | **2,444 ** | 9,336  |
| Gain on sale of discontinued operations,  net of taxes of $138,354      | **222,182 ** | -  |
| Net income                                                              | ** $** | **251,123 ** |  $ | 34,593  |
|                                                                         | ** ** |  |
| Basic earnings per share                                                | ** ** |  |
|   Continuing operations                                       | ** $** | **0.63 ** |  $ | 0.59  |
|   Discontinued operations                                     | ** $** | **5.36 ** |  $ | 0.22  |
|     Basic earnings per  share                       | ** $** | **5.99 ** |  $ | 0.81  |
|                                                                         | ** ** |  |
| Diluted earnings per share                                              | ** ** |  |
|   Continuing operations                                       | ** $** | **0.58 ** |  $ | 0.53  |
|   Discontinued operations                                     | ** $** | **4.60 ** |  $ | 0.19  |
|     Diluted earnings  per share                     | ** $** | **5.18 ** |  $ | 0.72  |
|                                                                         | ** ** |  |
|   Dividends per share                                         | ** $** | **0.36 ** |  $ | 0.35  |
|                                                                         | ** ** |  |
| Weighted average shares outstanding                                     | ** ** |  |
|   Basic                                                       | **41,883 ** | 42,748  |
|   Diluted                                                     | **48,824 ** | 50,477  |
|                                                                         |  |  |
| See notes to consolidated financial  statements.                        |  |  |

** **

| 6 |
|---|

----

| Mentor  Corporation                                                                  |
|--------------------------------------------------------------------------------------|
| Consolidated  Statements of Cash Flows                                               |
| Six Months  Ended September 30, 2006 and 2005                                        |
| (Unaudited)                                                                          |
|                                                                                      |
| (in thousands)                                                                       | **2006** | 2005 |
| **Operating  Activities:**                                                           |  |  |
| Income from continuing operations                                                    | ** $** | **26,497 ** |  $ | 25,257  |
| Adjustments to derive cash flows from  continuing operating activities:              | ** ** |  |
|   Depreciation                                                             | **3,740 ** | 3,904  |
|   Amortization                                                             | **1,189 ** | 1,002  |
|   Deferred income taxes                                                    | **4,272** | (290) |
|  Non-cash compensation                                                          | **5,182 ** | -  |
|   Tax benefit from exercise of  stock options                              | **7,345 ** | 22,497  |
|   Loss on sale of assets                                                   | **83 ** | 9  |
|   Loss on long-term marketable  securities and investment write-downs, net | **101 ** | 3  |
|  Cash provided by (used in) changes  in operating assets and liabilities:       | ** ** |  |
|     Accounts receivable                                               | **4,484 ** | 6,129  |
|      Inventories                                                 | **1,193** | (5,352) |
|     Other current assets                                              | **53 ** | (11,798) |
|     Accounts payable and  accrued liabilities                         | **5,982 ** | 4,353  |
|     Income taxes payable                                              | **(5,323)** | (42) |
| Net cash provided by continuing  operating activities                                | **54,798** | 45,672  |
| **Investing Activities:**                                                            | ** ** |  |
| Purchases of property and equipment                                                  | **(2,588)** | (3,916) |
| Purchases of intangibles                                                             | **(3,505)** | (272) |
| Purchases of marketable securities                                                   | **(35,336)** | (221,610) |
| Sales of marketable securities                                                       | **26,779 ** | 145,974  |
| Other, net                                                                           | **3 ** | 5  |
| Net cash used for continuing investing  activities                                   | **(14,647)** | (79,819) |
| **Financing Activities:**                                                            | ** ** |  |
| Repurchase of common stock                                                           | **(84,000)** | -  |
| Proceeds from exercise of stock options  and ESPP                                    | **15,996 ** | 37,327  |
| Dividends paid                                                                       | **(15,241)** | (15,280) |
| Borrowings under line of credit  agreements                                          | **- ** | 510  |
| Repayments under line of credit  agreements                                          | **(9,000)** | (903) |
| Net cash (used for) provided by  continuing financing activities                     | **(92,245)** | 21,654  |
| Effect of currency exchange rates on  cash and cash equivalents                      | **7 ** | (1,177) |
| Net cash (used) provided by discontinued  operating activities                       | **(66,354)** | 9,644  |
| Net cash used for discontinued investing  activities                                 | **(50)** | (1,474) |
| Net cash used for discontinued financing  activities                                 | **- ** | (2,650) |
| Proceeds from the sale of the urology  business                                      | **458,066 ** | -  |
| Effect of currency exchange rates of  discontinued operations                        | **(120)** | (535) |
| Increase (decrease) in cash and cash  equivalents                                    | **339,455 ** | (8,685) |
| Cash and cash equivalents at beginning  of year                                      | **98,713 ** | 76,666  |
| Cash and cash equivalents at end of period                                           | ** $** | **438,168 ** |  $ | 67,981  |
|                                                                                      |  |  |
| See notes to consolidated financial  statements.                                     |  |  |

| 7 |
|---|

----

**MENTORCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTSSeptember 30, 2006**

**Note A - Business Activity**

MentorCorporation was incorporated in April 1969.  Unless the context indicatesotherwise, when we refer to "Mentor," "we," "us,""our," or the "Company" in these notes, we are referring toMentor Corporation and its subsidiaries on a consolidated basis.  The Companydevelops, manufactures and markets a range of products serving the aestheticmarket.  Historically, the Company's products have been utilized by threeprimary segments:  aesthetic and general surgery (plastic and reconstructivesurgery), surgical urology, and clinical and consumer healthcare. Aesthetic and general surgery products include surgically implantableprostheses for plastic and reconstructive surgery, capital equipment andconsumables used for soft tissue aspiration or body contouring (liposuction),and facial aesthetics products. On June 2, 2006, the Company completeda transaction for the sale of the surgical urology and clinical and consumerhealthcare businesses to Coloplast A/S ("Coloplast").  The surgical urologyproducts included surgically implantable prostheses for the treatment ofimpotence, surgically implantable incontinence products, urinary care products,and brachytherapy seeds for the treatment of prostate cancer.  Theclinical and consumer healthcare products included catheters and other productsfor the management of urinary incontinence and retention. 

**Note B - Summary of Significant Accounting Policies**

Theconsolidated financial statements include the accounts of the Company and allof its subsidiaries in which a controlling interest is maintained.  Forthose subsidiaries where the Company owns less than 100%, the outsideshareholders' interests are treated as minority interests.  Allintercompany accounts and transactions have been eliminated.  Certainprior year amounts in previously issued financial statements have beenreclassified to conform to the current year presentation.  The net incomefrom discontinued operations for the three and six months ended September 30, 2006 includes the results ofthe surgical urology and clinical and consumer healthcare segments (collectively,the "Urology Business") for two months from April 1, 2006 to the date of the saleof these two segments on June 2, 2006.  For the prior year,the net income from discontinued operations includes the results of these twosegments for three and six months ended September 30, 2005.  

**Basis of Presentation**

Thefinancial information for the three and six months ended September 30, 2006 and 2005 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 this period.  Interimresults are not necessarily indicative of results for the full fiscal year. ** **

**Use of Estimates**

Financialstatements prepared in accordance with accounting principles generally acceptedin the United  Statesrequire management to make estimates and judgments that affect amounts anddisclosures reported in the financial statements.  Actual results coulddiffer from those estimates.

**RevenueRecognition**

The Company recognizes product revenue, netof discounts, returns, and rebates in accordance with Statement of Financial AccountingStandards ("SFAS") No. 48, "Revenue Recognition When the Rightof Return Exists," and Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition."  Asrequired by these standards, revenue is recorded when persuasive evidence of asales arrangement exists, delivery has occurred, the buyer's price is fixed or determinable, contractual obligations havebeen satisfied, and collectibility is reasonably assured.  Theserequirements are met, and sales and related cost of sales are recognized uponthe shipment of products, or in the case of consignment inventories, upon thenotification of usage by the customer.  The Company records estimatedreductions 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.  The Company also allows credit for products returned within itspolicy terms.  The Company records an allowance for estimated returns atthe time of sale based on historical experience, recent gross sales levels andany notification of pending returns.  Should the actual returns differfrom those estimated, additional adjustments to revenue and cost of sales maybe required.

| 8 |
|---|

----

The Company has current and long termdeferred revenue, which include funds received in connection with purchases ofthe Company's Enhanced Advantage Breast Implant Limited Warranty program.  Thefees received in connection with the Enhanced Advantage Breast Implant LimitedWarranty are deferred and recognized evenly over the life of the warranty term.

**WarrantyReserves**

TheCompany offers two types of warranties relating to its breast implants in theUnited States, Canada, and Puerto Rico:  a standard limited warranty which isoffered at no additional charge and an enhanced limited warranty at anadditional charge of $100 in the U.S. ($100 CAD in Canada), which providelimited financial assistance in the event of a deflation or rupture.  TheCompany's standard limited warranty is also offered in certain European andother international countries for silicone gel-filled breast implants.  TheCompany provides an accrual for the estimated cost of the standard limited breastimplant warranty at the time revenue is recognized.  Costs related towarranties are recorded in cost of sales.  The estimated cost of the standardlimited warranty is recorded as an expense at the time of sale, whereas thecost of the enhanced limited warranty is recognized as costs are incurred.  Theaccrual for the standard limited warranty is based on estimates, which arebased on relevant factors such as unit sales, historical experience, thelimited warranty period, estimated costs, and, to a limited extent, informationdeveloped by the Company's insurance company using actuarial techniques. The accrual is analyzed periodically for adequacy.  While the Companyengages in extensive product quality programs and processes, including activelymonitoring and evaluating the quality of the Company's component suppliers, thewarranty obligation is affected by reported rates of warranty claims and levelsof financial assistance specified in the limited warranties.  Shouldactual patient claim rates reported differ from the Company's estimates,adjustments to the estimated warranty liability may be required.  Theseadjustments would be included in cost of sales.

**ProductLiability Reserves**

TheCompany has product liability reserves for product-related claims to the extentthose claims may result in litigation expenses, settlements or judgments withinour self-insured retention limits.  The Company has also established additionalreserves, through its wholly-owned captive insurance company, for estimatedliabilities for product-related claims based on actuarially determinedestimated liabilities taking into account its excess insurance coverages.  Theactuarial valuations are based on historical information and certainassumptions about future events.  Product liability costs are recorded inselling, general and administrative expenses as they are directly under thecontrol of our General Counsel and other general and administrative staff andare directly impacted by the Company's overall risk management strategy. Should actual product liability experience differ from the estimates andassumptions used to develop these reserves, subsequent changes in reserves willbe recorded in selling, general and administrative expenses, and may affect theCompany's operating results in future periods.  

**EmployeeStock-Based Payments**

The  Company has employee compensation plans under which various types of  stock-based instruments have been granted. These instruments principally  include stock options, restricted stock and performance units.  As of September 30, 2006, these plans have  instruments outstanding that might require the issuance of 3.4 million shares  of common stock to our employees.  Stock-based awards under the Company's  employee compensation plans are made with authorized but unissued shares  reserved for this purpose.

Priorto April 1, 2006, theCompany accounted for the Company's employee stock-based compensation under therecognition and measurement principles of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued toEmployees," and related Interpretations, as permitted by SFAS No. 123, "Accounting for Stock-BasedCompensation".  Under the recognition principles of APB No. 25, compensationexpense related to restricted stock and performance units was recognized in theCompany's financial statements.  However, APB No. 25 generally did not requirethe recognition of compensation expense for the Company's stock options becausethe exercise price of these instruments was equal to the market value of theunderlying common stock on the date of grant, and the related number of sharesgranted were fixed at that point in time.

EffectiveApril 1, 2006, the Company adoptedthe fair value recognition provisions of SFAS No. 123(R), "Share-BasedPayment".  In addition to recognizing compensation expense related torestricted stock and performance units, SFAS No. 123(R) also requires us torecognize compensation expense related to the estimated fair value of stockoptions and other equity based compensation instruments.  The Company adoptedSFAS No. 123(R) using the modified-prospective-transition method.  Under thattransition method, compensation expense recognized subsequent to adoptionincludes: (a) compensation cost for all share-based payments granted prior to,but not yet vested as of April 1, 2006, based on the valuesestimated in accordance with the original provisions of SFAS No. 123, and (b)compensation cost for all share-based payments granted subsequent to April 1, 2006 based on the grant-datefair values estimated in accordance with the provisions of SFAS No. 123(R).Consistent with the modified-prospective-transition method, the Company'sresults of operations for prior periods have not been adjusted to reflect theadoption of SFAS 123(R).

| 9 |
|---|

----

Asa result of recognizing compensation expense for stock options pursuant to theprovisions of SFAS No. 123(R), the Company's income before income taxes and netincome for the three months ended September 30, 2006 were $1.3 and $1.0million lower, respectively, and for the six months ended September 30, 2006, were $2.8 million and$2.3 million lower, respectively, than if we had continued to account for stockoptions under APB No. 25.  In addition, basic earnings per share for the threeand six months ended September 30, 2006were $0.03 and $0.05, lower, respectively, and diluted earnings per share were$0.02 and $0.05 lower, respectively, than if we had continued to account forstock options under APB No. 25.  See Note K - "Stock Options, RestrictedStock and Employee Stock Purchase Plan" in the Notes to ConsolidatedFinancial Statements for additional information.

**Effectsof Recent Accounting Pronouncements**

Effective April 1, 2006, the Company adopted the fair value recognitionprovisions of Statement of Financial Accounting Standards("SFAS") No. 123(R), "Share-Based Payment", using themodified-prospective-transition method.  See Note K - "Stock Options,Restricted Stock and Employee Stock Purchase Plan" for further discussionregarding this accounting pronouncement.

In September 2006, the Securities and Exchange Commission(SEC) issued Staff Accounting Bulletin 108, "Considering the Effects on Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements," ("SAB 108").  SAB 108 requires registrants to quantify errors using both the incomestatement method (i.e. iron curtain method) and the rollover method andrequires adjustment if either method indicates a material error. If acorrection in the current year relating to prior year errors is material to thecurrent year, then the prior year financial information needs to be corrected.  Acorrection to the prior year results that are not material to those years wouldnot require a "restatement process" where prior financials would be amended.  SAB 108 iseffective for fiscal years ending after November 15, 2006.  The Company does not anticipate that SAB 108 willhave a material effect on the Company's consolidated financial statements.

InSeptember 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") No.157, "Fair Value Measurements."  This statement defines fair value, establishesa framework for measuring fair value in generally accepted accounting principles("GAAP"), and expands disclosure about fair value measurements.  This statementapplies under other accounting pronouncements that require or permit fair valuemeasurements.  Accordingly, this statement does not require any new fair valuemeasurements.  This statement is effective for fiscal years beginning after November 15, 2007, and interim periodswithin those fiscal years.  The Company is currently evaluating the requirementsof SFAS No. 157 and has not yet determined the impact on the Company'sconsolidated financial statements.

In July 2006, the Financial AccountingStandards Board ("FASB") issued FASB Interpretation No. 48 ("FIN 48") "Accounting forUncertainty in Income Taxes - an interpretation of FASB Statement No. 109"which prescribes a recognition threshold and measurement process for recordingin the financial statements uncertain tax positions taken or expected to betaken in a tax return.  Additionally, FIN 48 provides guidance on derecognition,classification, accounting in interim periods, and disclosure requirements foruncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006.  TheCompany is currently assessing the impact of FIN 48 on its consolidatedfinancial position and results of operations.

In February 2006, the Financial AccountingStandards Board ("FASB") issued SFAS No. 155, Accounting forCertain Hybrid Financial Instruments - an amendment of FASB StatementsNo. 133 and 140 ("SFAS 155").  This statement amends SFASNo. 133, Accounting for Derivative Instruments and Hedging Activities("SFAS 133"), and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities, and resolves issues addressed in SFAS 133Implementation Issue No. D1, "Application of Statement 133 toBeneficial Interest in Securitized Financial Assets."  This Statement:(a) permits fair value remeasurement for any hybrid financial instrumentthat contains an embedded derivative that otherwise would require bifurcation;(b) clarifies which interest-only strips and principal-only strips are notsubject to the requirements of SFAS 133; (c) establishes arequirement to evaluate beneficial interests in securitized financial assets toidentify interests that are freestanding derivatives or that are hybridfinancial instruments that contain an embedded derivative requiringbifurcation; (d) clarifies that concentrations of credit risk in the formof subordination are not embedded derivatives; and (e) eliminatesrestrictions on a qualifying special-purpose entity's ability to hold passivederivative financial instruments that pertain to beneficial interests that areor contain a derivative financial instrument.  The standard also requirespresentation within the financial statements that identifies those hybridfinancial instruments for which the fair value election has been applied andinformation on the income statement impact of the changes in fair value ofthose instruments.  The Company is required to apply SFAS 155 to allfinancial instruments acquired, issued or subject to a remeasurement eventbeginning January 1, 2007, although early adoption is permitted as of thebeginning of an entity's fiscal year.  The Company is evaluating the provisionsof SFAS 155.  The effects of adopting of SFAS 155 on the Company'sfinancial statements are not known at this time.

| 10 |
|----|

----

**NoteC - Interim Reporting**

TheCompany's three quarterly interim reporting periods are each thirteen-week periodsending on the Friday nearest the end of the third calendar month of eachcalendar quarter.  The fiscal year end remains March 31st. To facilitate ease of presentation, each interim period is shown as if it endedon the last day of the appropriate calendar month.  The actual dates foreach of the three interim quarters-ends are shown below:

|                 | Fiscal 2007        | Fiscal  2006         |
|-----------------|--------------------|----------------------|
| First  Quarter  | June 30, 2006      | July   1, 2005       |
| Second  Quarter | September 29, 2006 | September   30, 2005 |
| Third  Quarter  | December 29, 2006  | December   30, 2005  |

Theaccompanying unaudited consolidated financial statements for the three-monthand six-month periods ended September 30, 2006 and 2005 have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with instructions to Form10-Q and Article 10 of Regulation S-X.  Accordingly, they do not includeall of the information and notes required by accounting principles generallyaccepted in the United  Statesfor 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-monthand six-month periods ended September 30, 2006 are not necessarilyindicative of the results for the full fiscal year. 

Thebalance sheet at March 31, 2006has been derived from the audited financial statements as of that date, butdoes not include all of the information and notes required by accountingprinciples generally accepted in the United States for complete financial statements.

Theconsolidated financial statements should be read in conjunction with theCompany's Annual Report on Form 10-K for the year ended March 31, 2006.** **

**NoteD - Cash Equivalents, Marketable Securities, and Long-Term MarketableSecurities and Investments**

Allhighly liquid investments with maturities of three months or less at the dateof purchase are considered to be cash equivalents.

TheCompany considers its marketable securities available-for-sale as defined inSFAS No. 115, "Accounting for Certain Investmentsin Debt and Equity Securities."  Realized gains and losses, anddeclines in value considered to be other than temporary, are included inincome.  The cost of securities sold is based on the specific identificationmethod.  Available-for-sale securities are reported at fair market value. Unrealized gains and losses are excluded from income, but instead are reportedas a net amount in Accumulated Other Comprehensive Income in Shareholders'Equity.  The Company's short-term marketable securities consist primarily ofstate and municipal government and government agency obligations, Federal HomeLoan Bank and Mortgage Association bonds, and investment grade corporateobligations, including commercial paper. 

| 11 |
|----|

----

Available-for-saleinvestments at September 30, 2006were as follows:

| ** **                                        | ** **        | **Gross**         | **Gross**      | **Estimated**     |
|---------------------------------------------------|-------------------|-------------------|----------------|-------------------|
| ** **                                        | **Adjusted**      | **Unrealized**    | **Unrealized** | **Fair**          |
| (in  thousands)                                   | **Cost**          | **Gains**         | **Losses**     | **Value**         |
| Cash  balances                                    | ** $**       | **426,057 ** | ** $**    | **- **       | ** $** | **- ** | ** $** | **426,057 ** |
| Money  market funds                               | **12,111 **  | **- **       | **- **    | **12,111 **  |
| State  and Municipal agency obligations           | **84,364 **  | **- **       | **- **    | **84,364 **  |
| Mortgage-backed  securities                       | **26,147 **  | **70 **      | **- **    | **26,217 **  |
| Corporate  debt securities                        | **451 **     | **- **       | **(1)**        | **450 **     |
|   Total  available-for-sale investments | ** $**       | **549,130 ** | ** $**    | **70 **      | ** $** | **(1)** | ** $** | **549,199 ** |
|                                                   | ** **        | ** **        | ** **     | ** **        |
| Included  in cash and cash equivalents            | ** $**       | **438,168 ** | ** $**    | **- **       | ** $** | **- ** | ** $** | **438,168 ** |
| Included  in current marketable securities        | **110,962 ** | **70 **      | **(1)**        | **111,031 ** |
|   Total  available-for-sale investments | ** $**       | **549,130 ** | ** $**    | **70 **      | ** $** | **(1)** | ** $** | **549,199 ** |

Available-for-saleinvestments at March 31, 2006were as follows:

|                                                   |               | Gross         | Gross      | Estimated     |
|---------------------------------------------------|---------------|---------------|------------|---------------|
|                                                   | Adjusted      | Unrealized    | Unrealized | Fair          |
| (in thousands)                                    | Cost          | Gains         | Losses     | Value         |
| Cash balances                                     |  $       | 95,054   |  $    | -        |  $ | -  |  $ | 95,054  |
| Money market funds                                | 3,659    | -        | -     | 3,659    |
| State and Municipal agency obligations            | 71,374   | -        | -     | 71,374   |
| Mortgage-backed securities                        | 30,667   | -        | (85)       | 30,582   |
| Corporate debt securities                         | 286      | -        | (1)        | 285      |
|   Total available-for-sale  investments |  $       | 201,040  |  $    | -        |  $ | (86) |  $ | 200,954  |
|                                                   |               |               |            |               |
| Included in cash and cash equivalents             |  $       | 98,713   |  $    | -        |  $ | -  |  $ | 98,713  |
| Included in current marketable securities         | 102,327  | -        | (86)       | 102,241  |
|   Total available-for-sale  investments |  $       | 201,040  |  $    | -        |  $ | (86) |  $ | 200,954  |

**NoteE - Inventories**

Inventoriesare stated at the lower of cost or market, cost determined by the first-in,first-out ("FIFO") method.  The Company writes down its inventory forestimated obsolescence or unmarketable inventory equal to the differencebetween the cost of inventory and the estimated market value based uponassumptions about future demand and market conditions.

Inventories at September 30, 2006 and March 31, 2006 consisted of:

| (in thousands)                | **September 30** | March 31         |
|-------------------------------|------------------|------------------|
| Raw materials                 | ** $**      | **4,494 **  |  $ | 3,994  |
| Work in process               | **5,419 **  | 5,382       |
| Finished goods on consignment | **11,502 ** | 11,052      |
| Finished goods                | **12,237 ** | 14,711      |
|                               | ** $**      | **33,652 ** |  $ | 35,139  |

 12
**Note F - Property and Equipment**

Propertyand equipment is stated at cost.  Depreciation is based on the usefullives of the properties and computed using the straight-line method. Buildings are depreciated over 30 years, furniture and equipment over 3 to 10years and leasehold improvements over the shorter of their estimated remaininglives or lease terms.  Significant improvements and betterments arecapitalized, while maintenance and repairs are charged to operations asincurred.

Property and equipment at September 30, 2006 and March 31, 2006 consisted of:

(in thousands)

**September 30**

March 31

Land

** $**

**55 **

 $

55 

Buildings

**10,443 **

10,053 

Leasehold improvements

**24,070 **

21,952 

Furniture, fixtures and equipment

**56,177 **

60,004 

Construction in progress

**3,242 **

3,481 

**93,987 **

95,545 

Less accumulated depreciation

**(58,413)**

(59,097)

** $**

**35,574 **

 $

36,448 

**Note G - Product Warranties**

TheCompany provides an accrual for the estimated cost of product warranties at thetime revenue is recognized.  The Company offers product replacement andcertain financial assistance for surgical procedures that fall within thelimited warranties and coverage period of implantation on its breast implantproducts.  Such accruals are based on estimates, taking into considerationrelevant factors such as unit sales, historical experience, warranty period,estimated costs, and, to a limited extent, information developed by theCompany's insurance company using actuarial techniques.  The Company assessesthe adequacy of the accrual for product warranties periodically and adjusts theamounts as necessary based on actual experience and changes in futureexpectations.  In the first quarter of fiscal 2006, the Company expanded its standardlimited warranty programs to provide certain financial assistance for surgicalprocedures within ten years of implantation (increased from five years) and inthe third quarter of fiscal 2006 expanded the program coverage to includesilicone gel-filled breast implant sales implanted in certain European andother international countries.  These changes to the Company's warrantyprograms were not retroactive, but applicable to implants implanted subsequentto the effective date of the expanded programs.

Informationon changes in the Company's accrued product warranty reserves are as follows:

Six Months Ended

September 30,

(in thousands)

**2006**

2005

Beginning warranty reserves
** $**
**13,603 **
 $
12,025 

Costs of warranty claims

**(1,756)**

(1,477)

Accruals for product warranties

**2,635 **

2,067 
Adjustments  made to accruals related to pre-    existing warranties
**- **

- 

Ending warranty reserves
** $**
**14,482 **
 $
12,615 

 
13

**Note H - Comprehensive Income**

Comprehensiveincome is net income from continuing operations adjusted for changes in thevalue of derivative financial instruments, unrealized gains and losses onmarketable securities and foreign currency translation.  

Comprehensive income for the three and six-monthperiods was:

Three Months Ended

Six Months Ended

September 30,

September 30,

(in  thousands)

**2006**

2005

**2006**

2005

Net  income 

** $**

**9,721 **

 $

12,118 

** $**

**251,123 **

 $

34,593 

Foreign  currency translation adjustment

**622 **

(781)

**(8,146)**

(8,757)

Unrealized  (gains) losses on marketable    securities and investment activities, net

**49 **

383 

**101 **

2 

Comprehensive  income

** $**

**10,392 **

 $

11,720 

** $**

**243,078 **

 $

25,838 

**Note I - Income Taxes**

Theprovision for income taxes for the 2007 and 2006 interim periods was computedin accordance with FASB Interpretation No. 18, "Accounting for Income Taxes in Interim Periods,"and was based on projections of total year pre-tax income in accordance withSFAS No. 109, "Accounting for IncomeTaxes."  The effective income tax rate attributable to continuingoperations was 32.7 percent and 30.6 percent for the three months ended September 30, 2006 and 2005, respectively.

TheCompany's effective tax rate for the three months ended September 30, 2006has increased when compared to the same period in the prior year due to theexpiration of the U.S. research tax credit, the phase-out of theExtraterritorial Income Exclusion and the book treatment of employee equitycompensation as required under SFAS 123(R).  This increase was partially offsetby a decrease in our rate resulting from the increase in the amount of foreignearnings intended to be invested indefinitely outside of the United Statesand increased investments utilizing tax-free municipal instruments. 

TheCompany's effective tax rate for the six months ended September 30, 2006 was 30.0%, comparedwith 29.1% for the same period in the prior year.  The effective tax rate forthe six months ended September 30, 2006has increased as a result of the expiration of the U.S. research credit, thephase-out of the Extraterritorial Income Exclusion and the book treatment ofemployee equity compensation as required under SFAS 123(R).  This increase waspartially offset by a decrease in the Company's rate due to the increase in theamount of foreign earnings intendedto be invested indefinitely outside of the United States, the recognition oftax on the Company's repatriation of foreign cash pursuant to IRC Section 965in the six month period ended September 30, 2005 and increasedinvestments utilizing tax-free municipal instruments.  The effect of certainitems, such as the U.S. manufacturing deductionis approximately the same in both the six months ending September 30, 2006 and 2005, respectively.

Aspermitted in Accounting Principles BoardOpinion ("APB") No. 23, "Accounting for Income Taxes - Special Areas", the Company does notprovide for U.S. income taxes on undistributed earnings of the Company'sforeign operations that are intended to be invested indefinitely outside theUnited States.

 

14

**NoteJ - Earnings per Share**

A reconciliation of weighted average sharesoutstanding, used to calculate basic earnings per share, to weighted averageshares outstanding assuming dilution, used to calculate diluted earnings pershare, follows:

Three Months Ended

Six Months Ended

September 30,

September 30,

(in thousands, except per share data)

**2006**

2005

**2006**

2005

Net income from continuing operations:  as reported

** $**

**10,823 **

 $

8,182 

** $**

**26,497 **

 $

25,257 

Add back after tax interest expense on convertible  note

**802 **

802 

**1,604 **

1,604 

Net  income from continuing operations for numerator of     diluted earnings per share

** $**

**11,625 **

 $

8,984 

** $**

**28,101 **

 $

26,861 

 
Three Months Ended

Six Months Ended

September 30,

September 30,

(in  thousands, except per share data)

**2006**

2005

**2006**

2005

Weighted  average outstanding shares:  basic

**41,360 **

43,253 

**41,883 **

42,748 

Shares  issuable through stock based compensation arrangements

**1,267 **

2,057 

**1,239 **

2,060 

Shares  issuable through convertible notes

**5,150 **

5,136 

**5,148 **

5,135 

Shares  issuable through warrants

**769 **

1,069 

**554 **

534 

Weighted  average outstanding shares:  diluted

**48,546 **

51,515 

**48,824 **

50,477 

** **

** **

Basic  earnings per share - continuing operations

** $**

**0.26 **

 $

0.19 

** $**

**0.63 **

 $

0.59 

Diluted  earnings per share - continuing operations

** $**

**0.24 **

 $

0.17 

** $**

**0.58 **

 $

0.53 

Employee equity-based compensation

Shares issuable under the Company's Long TermIncentive Plan, including employee stock options, restricted shares andperformance stock units, may be included in the diluted earnings per share calculationusing the treasury stock method.  TheCompany would exclude the potential stock issuances in the diluted earnings pershare calculation when the combined exercise price, average unamortized fairvalues and assumed tax benefits upon exercise are greater than the averagemarket price for the Company's underlying common stock as the inclusion ofthese shares in the diluted shares outstanding would be anti-dilutive.  Thetotal number of shares excluded based on this policy for the three and sixmonth periods ended September 30, 2006 were 2.1 million and 2.2 million, respectively.  Thiscalculation is done on an instrument by instrument basis.

Convertible subordinated notes andwarrants

The terms of the Company's convertiblesubordinated notes include restrictions which prevent the holder fromconverting the notes until the Company's share price exceeds the 120%conversion price on 20 trading days of the 30 consecutive trading day periodending on the first day of such fiscal quarter.  However, EITF issue No. 04-8requires that the Company use the if-converted method to determine the dilutiveimpact of the convertible subordinated notes described below in Note N - LongTerm Debt.  Under the if-converted method, the numerator of the dilutedearnings per share calculation is increased by the after-tax interest expense notrecognized for the period upon conversion and the denominator of thecalculation is increased by approximately 5.1 million shares potentially issuedupon conversion for both that current reporting period and the correspondingyear-to-date reporting period.

As described below in Note N, wepurchased a convertible note hedge and sold warrants which, in combination,have the effect of reducing the dilutive impact of the convertible subordinatednotes by increasing the effective conversion price for the notes from theCompany's perspective to approximately $39.2107.  SFAS 128, however,requires the Company to analyze the impact of the convertible note hedge andwarrants on diluted earnings per share separately.  As a result, the purchaseof the convertible note hedge is excluded because its impact will always beanti-dilutive.  SFAS 128 further requires that the impact of the sale ofthe warrants be computed using the treasury stock method.  
15
Forexample, using the treasury stock method, if the average price of the Company'sstock during the period ended September 30, 2006 had been $38.00, $40.00or $45.00; the shares from the warrants to be included in diluted earnings pershare would have been zero, 86,000 and 649,000 shares, respectively.  The totalmaximum number of shares that could potentially be included under the warrantsis approximately 5.1 million.  The average share price of our stock duringthe quarter ended September 30, 2006exceeded the $39.2107 conversion price of the warrants.  The impact of thesewarrants was that 0.769 million shares were added to the diluted shares anddiluted earnings per share calculation during the quarter ended September 30, 2006.  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.

**Note K - Stock Options, Restricted Stock andEmployee Stock Purchase Plan**

Long-TermIncentive Plans

TheCompany has granted options to key employees and non-employee directors underits Amended 2000 Long-Term Incentive Plan (the "2000 Plan") and its 1991Plan.  In addition, inSeptember 2005, the Company's shareholders approved an amended and restatedversion of the Company's Amended 2000 Long-Term Incentive Plan, which is nowreferred to as the Mentor Corporation 2005 Long-Term Incentive Plan and whichwas further amended in November 2005 (as amended, the "2005 Plan").  InSeptember 2006, the Company's shareholders approved an amendment to the 2005Plan to increase the number of shares of the Company's common stock availablefor award grants under the plan by 1,600,000 shares with the new aggregateshare limit for the 2005 Plan at 7,600,000 shares.  Options granted under eachof the Company's plans vest in four equal annual installments beginning oneyear from the date of grant, and expire ten years from the date of grant.  At September 30, 2006, the Company had oneplan under which stock options were available for future grants, the 2005Plan.  Pursuant to the terms of the option plans, 746,315 and 904,611 commonshares were issued pursuant to exercises during the three-month and six-monthperiods ended September 30, 2006. 

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.  Following theNovember 2005 amendment, the 2005 Plan provides as follows:

Grants of full-value awards under the 2005 Plangenerally must satisfy certain minimum vesting requirements.  ("Full-valueawards" include all awards granted under the 2005 Plan other than stock optionswith an exercise price that is not less than the fair market value of theunderlying stock on the date the option is granted.)  Full-value awards subjectto time-based vesting may not become fully vested in less than three years. Full-value awards subject to performance-based vesting may not vest in lessthan one year.  The Company retains discretion to accelerate vesting of suchawards under certain circumstances such as in connection with a termination ofthe grantee's employment, a change in control of the Company or the grantee'semployer, or a release of claims by the grantee.  The Company may also grantfull-value awards covering up to 10% of the total number of shares availablefor grant purposes under the 2005 Plan that are not subject to the foregoingvesting and acceleration restrictions.

Shareholder approval is expressly required forany increase in the number of shares of the Company's common stock that areavailable for award grant purposes under the 2005 Plan.

Personseligible to receive awards under the 2005 Plan include directors, officers oremployees of the Company, and certain of its consultants and advisors.  Thetypes of awards that may be granted under the 2005 Plan include stock options,restricted stock, stock bonuses, stock units and dividend equivalents, andother forms of awards granted or denominated in the Company's common stock orunits of the Company's common stock, as well as certain cash bonus awards. 

EmployeeStock Purchase Plan

On September 14, 2005,the Company's Board of Directors approved its Employee Stock Purchase Plan("ESPP").  The Stock Purchase Plan is intended to assist the Company insecuring and retaining its employees by allowing them to participate in theownership and growth of the Company through the grant of certain rights to purchaseshares of the Company's common stock at an initial discount of 5% from the fairmarket value of its shares.  The granting of such rights serves as partialconsideration for employment and gives employees an additional inducement toremain in the service of the Company and its subsidiaries and provides themwith an increased incentive to work toward the Company's success.
16
Under the ESPP, each eligible employee ispermitted to purchase shares of common stock through regular payroll deductionsand/or cash payments in amounts ranging from 1% to 15% of the employee'scompensation for each payroll period. The fair market value of the shares ofcommon stock which may be purchased by any employee under this or any otherplan of the Company that is intended to comply with Section 423 of theInternal Revenue Code.

The ESPP provides for a series of consecutiveoffering periods that are three months long commencing on each Grant Date. Offering periods commence on January 1, April 1, July 1 and October 1 of each year. During each offering period, participating employees are able to purchaseshares of common stock at a purchase price equal to 95% of the fair marketvalue of the common stock at the end of each offering period.  Under terms ofthe ESPP, 400,000 shares of common stock have been reserved for issuance toemployees.  As of September 30, 2006, 2,274 shares have been purchased under the plan.

EmployeeStock-Based Payments

Wehave employee compensation plans under which various types of stock-basedinstruments have been granted. These instruments, as more fully describedbelow, principally include stock options, restricted stock and performanceunits.  As of September 30, 2006,these plans have instruments outstanding that might require the issuance of up to3.4 million shares of common stock to our employees.  Stock-based awards underour employee compensation plans are made with newly issued shares reserved forthis purpose. 

Priorto April 1, 2006, weaccounted for our employee stock-based compensation under the recognition andmeasurement principles of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued toEmployees," and related Interpretations, as permitted by SFAS No. 123, "Accounting for Stock-BasedCompensation".  Under the recognition principles of APB No. 25, compensationexpense related to restricted stock and performance units was recognized in ourfinancial statements.  However, APB No. 25 generally did not require therecognition of compensation expense for our stock options because the exerciseprice of these instruments was generally equal to the market value of theunderlying common stock on the date of grant, and the related number of sharesgranted were fixed at that point in time.

EffectiveApril 1, 2006, weadopted the fair value recognition provisions of SFAS No. 123(R), "Share-BasedPayment".  In addition to recognizing compensation expense related torestricted stock and performance units, SFAS No. 123(R) also requires us torecognize compensation expense related to the estimated fair value of stockoptions and other equity-based compensation instruments.  We adopted SFAS No.123(R) using the modified-prospective-transition method.  Under that transitionmethod, compensation expense recognized subsequent to adoption includes: (a)compensation cost for all share-based payments granted prior to, but not yetvested as of April 1, 2006,based on the values estimated in accordance with the original provisions ofSFAS No. 123, and (b) compensation cost for all share-based payments grantedsubsequent to April 1, 2006,based on the grant-date fair values estimated in accordance with the provisionsof SFAS No. 123(R).  Consistent with the modified-prospective-transitionmethod, our results of operations for prior periods have not been adjusted toreflect the adoption of SFAS 123(R).  As a result of recognizing compensationexpense for stock options pursuant to the provisions of SFAS No. 123(R), ourincome before income taxes and net income for the three months ended September 30, 2006 were $1.3 million and $0.4million lower, respectively, and for the six months ended September 30, 2006 were $2.7 million and $1.8million lower, respectively, than if we had continued to account for stockoptions under APB No. 25.  In addition, basic earnings per share for the three andsix months ended September 30, 2006were $0.03 and $0.05 lower, respectively, and diluted earnings per share were$0.02 and $0.05 lower, respectively, than if we had continued to account forstock options under APB No. 25.

Thefollowing table reflects the components of stock-based compensation expenserecognized in our Consolidated Statements of Income for the three and six monthsended September 30, 2006and 2005:

Three Months Ended

Six Months Ended

September 30,

September 30,

(in  thousands)

**2006**

2005

**2006**

2005

Stock options 

** $**

**1,299 **

 $

** $**

**2,770 **

 $

- 

Restricted stock 

**1,005 **

- 

**1,718 **

- 

Performance units plan 

**654 **

- 

**694 **

- 

Total stock-based compensation expense,  pre-tax 

**2,958 **

- 

**5,182 **

- 

Tax benefit from stock-based compensation  expense 

**(877)**

- 

**(1,384)**

- 

Total stock-based compensation expense, net of  tax 

** $**

**2,081 **

 $

** $**

**3,793 **

 $

- 

Theemployee stock-based compensation cost reflected above that would be properly capitalizedas part of inventory and included in research and development expense for thethree-month and six-month periods ended September 30, 2006 was minor.
17
Theabove table does not reflect any stock option compensation expense for thethree-month and six-month periods ended September 30, 2005 as we generally did notrecord stock option compensation expense under APB No. 25, as previouslydiscussed.  The following table illustrates the effect on net income andearnings per share for the three-month and six-month periods ended September 30, 2005 as if we had appliedthe fair value recognition provisions to our stock options as provided underSFAS No. 123:

ProForma Analysis under FAS 123

Three Months Ended

Six Months Ended

(in  thousands, except per share information)

September 30, 2005

Net income from  continuing operations

 $

8,182 

 $

25,257 

Deduct:  compensation  expense fair value method 

(1,222)

(2,668)

Net income:  pro forma  

 $

6,960 

 $

22,589 

Earnings per share  from continuing operations:

Basic:  as reported

 $

0.19 

 $

0.59 

Impact of stock option  expense 

(0.03)

(0.06)

Basic:  pro forma 

 $

0.16 

 $

0.53 

Net  income: as reported

 $

8,182 

 $

25,257 

Add  back after-tax interest expense on convertible notes

802 

1,604 

Net  income: diluted earnings per share

8,984 

26,861 

Deduct: compensation  expense fair value method

(1,222)

(2,668)

Net  income: diluted earnings per share pro forma

 $

7,762 

 $

24,193 

Earnings per share  from continuing operations:

Diluted:  as reported 

 $

0.17 

 $

0.53 

Impact of stock option  expense 

(0.02)

(0.05)

Diluted:  pro forma 

 $

0.15 

 $

0.48 

Forpurposes of this pro forma disclosure, the fair values of stock options wereestimated using the Black-Scholes option valuation model and amortized toexpense over the options' vesting periods.

We expect the impact of stock basedcompensation expenses to be in the range of $0.16 to $0.18 per diluted share infiscal year ending March 31, 2007 compared to $0.08 for fiscal year ended March 31, 2006.  Theestimated impact of stock option expense for fiscal year ending March 31, 2007 isgreater than the corresponding pro forma expense amount for fiscal year ended March 31, 2006principally due to the granting of additional restricted shares and performanceunits.  The estimated effect on diluted earnings per share of the annualcompensation related to restricted shares and performance units is estimated tobe in the range of $.09 to $0.11. 

 
18
EmployeeStock Options, Restricted Stock Grants and Performance Units

Severalof our equity-based compensation plans provide for grants of stock options toemployees.  For executive officers, the option exercise price is set at theclosing price of our common stock on the later of the first day of employment,the date the executive is informed of the grant, or the date our Board ofDirectors approves the grant.  For non-executive officers, the option exerciseprice is set at the closing price of our common stock on the later of the firstday of employment or the date the employee is informed of the grant.  Theseoptions normally vest over a four year period and expire ten years from thedate of grant.  These plans also provide for grants of restricted stock andperformance units.  Restricted stock grants generally have restrictions which lapseover a five year period.   Performance stock units will vest on March 31, 2009 contingent uponachievement of specified pre-established performance goals.  Eligible employeesgenerally receive a grant of stock options and/or restricted stock annuallywith the number of shares and type of instrument generally determined by theemployee's salary grade and performance level.  In addition, certain managementand professional level employees typically receive a stock option grant uponcommencement of employment.  These stock-based plans provide for acceleratedvesting/lapse of restrictions if there is a change in control as defined in theplans.  We use the Black-Scholes option valuation model to estimate the grantdate fair value of employee stock options. The expected volatility takes into considerationthe historical volatility in the price of our common stock to estimate thevolatility in our publicly traded instruments duringthe period the option is granted. We believe the historical volatility in theseinstruments is indicative of expected future volatility in the price of ourcommon stock.  Upon the adoption of SFAS No. 123(R), the expected life of theoption is estimated using the historical data to estimate the expected life ofthe options.  The risk-free interest rates for periods within the expected lifeof the option are based on the U.S. Treasury yield curve in effect during theperiod the options were granted.  Upon adoption of SFAS No. 123(R), we beganusing historical data to estimate forfeiture rates applied to the gross amountof expense determined using the option valuation model.  Prior to adoption ofSFAS No. 123(R), we recognized forfeitures as they occurred.  There was nomaterial impact upon adoption of SFAS No. 123(R) between these methods ofaccounting for forfeitures.  The assumptions used to estimate the fair value ofthe stock options using the Black-Scholes option valuation model were asfollows for the six months ended September 30:

**2006**

2005

Weighted average fair value of common stock	

** $**

**46.24 **

 $

40.41 

Weighted average fair value of stock options  granted 

** $**

**14.00 **

 $

10.37 

Risk-free interest rate 

**5.22%**

3.89%

Expected life (in years) 

**4.94 **

4.93 

Expected volatility 

**0.36% **

0.32% 

Expected dividend yield 

**1.3%**

1.6%

Stockoption information with respect to our stock-based compensation plans duringthe six months ended September 30, 2006is as follows:

(in  thousands, except per share amounts)

**Options**

**Weighted-average  exercise  price**

**Weighted-  average  remaining  contractual  life (Yrs)**

**Aggregate  intrinsic  value**

Balance unexercised at  March 31,   2006 

3,682 
 $24.08 -  $97,418 
Granted 

155 
41.32 - 1,405 
Exercised 

(904)
17.64 - 25,766 
Forfeited/expired 

(260)
32.33 - 5,074 
Balance unexercised at  	September 30,   2006 

2,673 

 $

26.40 

- 

 $

64,119 
                     
Vested at September 30, 2006

1,523 

 $

20.36 

5.61 

 $

45,718 
                     
Exercisable at September 30, 2006

1,523 

 $

20.36 

5.61 

 $

45,718 

Thetotal intrinsic value of options exercised during the three and six monthsended September 30, 2006was approximately $35.4 million and $41.7 million, respectively.

 

19

Thefair values of shares of restricted stock and performance units are determinedbased on the closing price of the Company's common stock on the grant dates.  Informationregarding our restricted stock during the six months ended September 30, 2006 is as follows:
Nonvested shares (in thousands)
**Shares**

**Weighted-  average  grant date  fair value**

Nonvested at March 31, 2006

279,142 

 $

52.71 

Granted

155,960 

42.04 

Vested

- 

- 
Forfeited

(16,170)

52.71 

Nonvested at September 30, 2006

418,932 

 $

49.27 

Asof September 30, 2006,there was $35.3 million of total unrecognized compensation cost related to non-vestedawards of stock options, shares of restricted stock and performance stock units. That cost is expected to be recognized over a weighted-average period of 1.7years.  We recognize the total compensation cost on a straight-line basis overthe service period for the entire award.

PerformanceAward Program

InJune and July 2006, certain management-level employees received grants of PerformanceStock Units ("PSUs").  A PSU gives the recipient the right to receive commonstock that is contingent uponachievement of specified pre-established performance goals over aperformance period ending March 31, 2009.  The performance goalsare based upon Mentor's total shareholderreturn compared to the average total shareholder return reported by the Russell 2500 Growth Index over the performance period.

PSUsare assigned a unit value based on the fair market value of the Company's commonstock on the grant date.  The ultimate level of attainment of performance goalsis determined at the end of the performance period and expressed as apercentage (within a range of 0% to 200%).  This percentage is multiplied bythe number of PSUs initially granted to determine the number of shares ofcommon stock payable to the recipient.  In addition, dividends that would haveaccrued over the performance period attributable to the final share grant underthe program will be payable to the recipients. 

Vestingof the PSUs occurs entirely on March 31, 2009.  Consequently, no PSUs have yet vested and nocommon stock has been issued and no dividends have been accrued or paid to anyrecipient as of September 30, 2006. The fair value of the PSUs at the date of grant is being amortized ascompensation expense over the performance period.  

Informationregarding our Performance Stock Units during the six months ended September 30,2006 is as follows:
Nonvested performance stock units (in thousands)
**Shares**

**Fair market  value date  of grant**

Nonvested at March 31,,  2006 

- 

 $

- 

Granted (maximum  award)

357,420 

7,574 

Vested

- 
- 
Forfeited

- 
- 
Nonvested at September 30, 2006

357,420 

 $

7,574 

 
20

**NoteL - Share Repurchase Program**

The Company has a stock repurchase program toreduce the overall number of shares outstanding, which has helped offset thedilutive effects of our employee stock option programs and the dilutive effectof EITF Issue No. 04-8 related to the inclusion of contingently convertibledebt in fully diluted earnings per share calculations.  During fiscal 2006,approximately 996,000 shares were repurchased from retiring board members forapproximately $42.8 million, and 5.3 million shares remained authorized forrepurchase as of March 31, 2006. During the quarter ended June 30, 2006, the Companyrepurchased 2.0 million shares of its common stock for a total of $84 millionfrom an investment partnership managed by ValueAct Capital.  ValueAct Capital'smanaging director, Mr. Jeff Ubben, is a member of the Company's Board ofDirectors.  The repurchase of these shares was pre-approved by the AuditCommittee and the Board of Directors with interested parties abstaining or notin attendance.  See Note P - "Related Party Transactions" for additionalinformation on the share repurchase.  

On June 16, 2006,we entered into a stock purchase plan with Citigroup Global Markets Inc. forthe purpose of repurchasing up to $166 million worth of our common stock undera Rule 10b5-1 Plan (the "10b5-1 Plan") compliant with Rule 10b-18.  Thefirst repurchase under the 10b5-1 Plan could not take place prior to the thirdtrading day following the Company's announcement of its financial results forthe three months ending June 30, 2006.  In connection with the entry into the 10b5-1Plan, our Board of Directors of the Company increased the authorized number ofshares available for repurchase pursuant to our stock repurchase program from3.3 million to 5.0 million shares.  The timing of purchases and the exactnumber of shares to be purchased will depend on market conditions.  Therepurchase program and the 10b5-1 Plan may be suspended or discontinued at anytime.

As of September 30, 2006, approximately 5.0 millionshares remain authorized for repurchase under the Company's stock repurchaseprogram.  All shares repurchased under the program have been retired andare no longer deemed to be outstanding.  The timing of repurchases issubject to market conditions and cash availability.   There is no guaranteethat the remaining shares authorized for repurchase by the Board willultimately be repurchased.  

The additional shares available for repurchaseare subject to limitations set forth in the Company's Credit Agreementpreviously entered into on May 26, 2005 and amended on May 31, 2006.  The amendedCredit Agreement now permits the repurchase of up to $250,000,000 of equitysecurities, a portion of which was utilized in the repurchase described in the firstparagraph above, leaving a remaining amount of $166,000,000.  In addition,after the $250,000,000 is utilized for such repurchases, the Company mayrepurchase during any four consecutive quarters additional equity securities inan amount limited to the Company's consolidated net income, less dividendspaid, for the preceding four quarters.  See Note O - "Short Term BankBorrowings" for additional information on the Credit Agreement.

**NoteM - Goodwill and Intangible Assets**

Goodwilland intangible assets have been recorded at either incurred or allocated cost. Goodwill is not amortized, but its value is tested for impairment annually, andintangible assets are amortized over their useful lives ranging from 3-20 yearson a straight line basis.  Allocated costs were based on respective fairvalues at the date of acquisition.  

Allgoodwill amounts have been assigned to reporting units, based upon specificidentification, for impairment testing.  The impairment tests involve theuse of both estimates of fair value for the Company's reporting units as wellas discounted cash flow assumptions.  Impairment tests are performed inthe fourth quarter of each fiscalyear.  No potential impairment issues were noted for the quarter ended September 30, 2006.

 

21

**NoteN - 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 an adjusted conversion price of $29.1279per share and are subordinated to all existing and future senior debt. 

Holders of the notes may convert their notesonly if any of the following conditions is satisfied: 
-  during any fiscal quarter prior toJanuary 1, 2019, if the closing price of the Company's common stockfor at least 20 trading days in the 30 consecutive trading day period ending onthe first trading day of such fiscal quarter is more than 120% of theconversion price per share of the Company's common stock on such trading day; 
-  any business day on or after January 1, 2019, ifthe closing price of the Company's common stock on the immediately precedingtrading day is more than 120% of the conversion price per share of theCompany's common stock on such trading day;
-  during the five business dayperiod after any five consecutive trading day period if the average of thetrading prices of the notes for such five consecutive trading day period isless than 98% of the average of the conversion values of the notes during suchperiod, subject to certain limitations;
-  if the Company has called thenotes for redemption; or
-  if the Company makes certainsignificant distributions to holders of its common stock or the Company entersinto specified corporate transactions. 

At an initial conversion price of $29.289, each$1,000 principal amount of notes will be convertible into 34.1425 shares ofcommon stock.  As a result of the Company's recent dividend increase, theconversion price has been adjusted to $29.1279, and each $1,000 principal amount willbe convertible into 34.33 shares of common stock.

During the quarter ending September 30, 2006, one of the conditionsrequired for conversion of the notes was satisfied and, accordingly, theholders of notes have the option to convert the notes into common shares at theaforementioned adjusted conversion price per share.  

Concurrent with the issuance of the convertiblesubordinated notes, the Company purchased a convertible note hedge from CreditSuisse First Boston LLC.  The note hedge expires on January 1, 2009 and gives the Companythe ability to purchase shares of our common stock equal to the number ofshares we are obligated to issue under any convertible notes converted by theholder prior to the hedge expiration date at a purchase price equal to theconversion price of the convertible notes.  

Concurrent with the issuance of the notes, theCompany issued warrants to Credit Suisse First Boston LLC.  The warrants areEuropean-style call warrants, which also expire on January 1, 2009.  The holder of thewarrants is entitled to purchase 5.14 million shares of the Company's commonstock at $39.2107.  The number of shares and exercise price of the warrants aresubject to adjustment from time to time in a similar manner to the convertiblenotes.

Both the note hedge and the warrants may besettled either in cash or shares at the Company's option.  The Company is notobligated under either the warrants or the note hedge to settle its obligationsin cash.  Under no circumstance is the Company obligated to issue shares underthe note hedge.  The warrants do require the Company to settle its obligations thereunderin cash or shares, do permit the Company to settle its obligation inunregistered shares and contain no provision obligating the Company to settleits obligations in freely-tradable shares, and the Company is not required tomake any cash payments under the warrants for failure to have a registrationstatement declared effective.  There are no required cash payments to theholder of the warrants if the shares initially delivered upon settlement aresubsequently sold by the holder and the sales proceeds are insufficient toprovide the holder with an expected return.  The Company has sufficientauthorized shares to settle the warrants and the convertible notes in shares,considering all of its obligations under the instruments for their full terms. The warrants, note hedge, and convertible notes each contain an express limiton the number of shares issuable thereunder.  The warrants and note hedgeexpressly indicate that the holder of the warrants has no rank higher thanthose of a shareholder of the stock underlying the warrants.  Under certaincircumstances in a change of control of the Company we may be required to issueadditional shares under a make-whole provision under the warrant. The Companyhas no obligation to post collateral under the warrants, convertible notes ornote hedge. 

22

The cost of the note hedge and the proceeds fromthe sale of warrants have been included in shareholders' equity in accordancewith the guidance in EITF No. 00-19, "Accounting for Derivative Financial Instruments Indexed toand Potentially Settled in a Company's own Stock."  Any proceeds received orpayments made upon termination of these instruments will be recorded inshareholders' equity.

**NoteO - Short Term Bank Borrowings**

*Credit Agreement*

OnMay 26, 2005, theCompany 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 electionof the Company, and subject to lender approval, the amount available forborrowings under the Credit Agreement may be increased by an additional $50million.  Funds under the Credit Agreement are available to the Company tofinance permitted acquisitions, for stock repurchases up to certain dollarlimitations, and for other general corporate purposes.  The Company has threestandby letters of credit totaling $2 million outstanding which are secured bythe Credit Agreement.  Accordingly, although there were no borrowingsoutstanding under the Credit Agreement at September 30, 2006, only $198 million wasavailable for borrowings.  During the quarter ended June 30, 2006 the Company enteredinto an Amendment to the Credit Agreement ("First Amendment") to permit theCompany to consummate the sale of its surgical urology and clinical andconsumer health care segments.  Additionally, the First Amendment releasesurology subsidiaries as guarantors, releases the pledges of the capital stockof urology subsidiaries, modified the minimum EBITDA, modifies certain covenantsrestricting the Company to enter into certain investments, incur indebtednessand increased the amount of its equity securities the Company is allowed torepurchase.   

Intereston borrowings (other than swing line loans) under the Credit Agreement is at avariable rate that is calculated, at the Company's option, at either prime rateor LIBOR, plus an additional percentage that varies depending on the Company'ssenior leverage ratio (as defined in the Credit Agreement) at the time of theborrowing.  Swing line loans bear interest at the prime rate plusadditional basis points, depending on the Company's senior leverage ratio atthe time of the loan.  In addition, the Company paid certain fees to thelenders to initiate the Credit Agreement and will pay an unused commitment feebased on the Company's senior leverage ratio and unborrowed lender commitments.

Borrowingsunder the Credit Agreement are guaranteed by one of the Company's domesticsubsidiaries and are also secured by a pledge of 100% of the outstandingcapital stock of two other domestic subsidiaries.  In addition, if theratio of total funded debt to adjusted EBITDA exceeds 2.50 to 1.00, the Companyis obligated to grant to the lenders a first priority perfected securityinterest in essentially all of its domestic assets.

TheCredit Agreement imposes certain financial and operational restrictions on theCompany and its subsidiaries, including financial covenants that require theCompany to maintain a maximum consolidated funded debt leverage ratio of notgreater than 4.00 to 1.00, a senior funded debt ratio of not greater than 2.50to 1.00, minimum quarterly EBITDA and a minimum fixed charge ratio of greater than1.25 to 1.00.  The covenants also restrict the Company's ability, among otherthings, to make certain investments, incur certain types of indebtedness orliens, make acquisitions in excess of $20 million except in compliance withcertain criteria, and repurchase shares of common stock, pay dividends ordispose of assets above specified thresholds.  The Credit Agreement alsocontains customary eventsof default, including payment defaults, material inaccuracies in itsrepresentations and warranties, covenant defaults, bankruptcy and involuntaryproceedings, monetary judgment defaults in excess of specified amounts,cross-defaults to certain other agreements, change of control, and ERISAdefaults.  If an event of default occurs and is continuing, the commitmentsunder the Credit Agreement may be terminated and the principal amount and allaccrued but unpaid interest and other amounts owed thereunder may be declaredimmediately due and payable.  As of September 30, 2006, all covenants andrestrictions had been satisfied, and there were no borrowings outstanding underthe Credit Agreement.  

*Loanand Overdraft Facility*

OnOctober 4, 2005,Mentor Medical Systems B.V., ("Mentor BV"), a wholly-owned subsidiary of Mentor Corporation enteredinto a Loan and Overdraft Facility (the "Facility") with Cooperative RaboBankLeiden, Leiderdorp en Oestgstgeest U.A. ("RaboBank").

TheFacility provides Mentor  BV withan initial €15 million loan and overdraft facility, which decreases by €375,000quarterly starting in September 2006.  Under the Facility, Mentor BV may borrow up to €12.5million in fixed amount advances, with terms of three to six months, and afurther sublimit of up to €5 million of loans in fixed amount advances with aterm of up to 5 years.  Up to €10 million of the Facility may be drawn in theform of U.S. Dollars.  Funds under the Facility are available to Mentor BV to finance certaindividend payments to Mentor Corporation and for other normal businesspurposes.  As of November 6, 2006, approximately$5.0 million was outstanding under the Facility. 

23

Intereston borrowings 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.

Borrowingsby Mentor  BV underthe Facility are guaranteed by Mentor's wholly-owned subsidiary, Mentor Medical Systems C.V.,through a Joint and Several Debtorship Agreement.  In addition, borrowingsunder the Facility are secured by certain real estate owned by Mentor BV.

TheFacility imposes certain financial and operational restrictions on Mentor BV,including financial covenants that require Mentor BV and Mentor Medical SystemsC.V. to maintain a minimum combined defined solvency ratio, a maximum combineddebt leverage ratio of not greater than 4 to 1, a senior funded debt ratio ofnot greater than 2.5 to 1, minimum quarterly operational results, and a minimuminterest coverage ratio of greater than 5 to 1.  The Facility alsocontains customary events of default, including cross default and material oradverse change provisions.  If an event of default occurs, the commitmentsunder the Facility may be terminated and the principal amount and all accruedbut unpaid interest and other amounts owed thereunder may be declaredimmediately due and payable.  As of September 30, 2006, all covenants andrestrictions were satisfied.

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

Outstanding borrowings under all creditarrangements had a weighted-average interest rate of 6.1% for the six-month periodended September 30, 2006.  A total of $205.7 million was available underthe senior revolving credit facility and foreign lines of credit at September 30, 2006,and approximately $202.2 million was available under all lines of credit at March 31, 2006.

**Note P - Related Party Transactions**

On June 5, 2006, the Company repurchased 2.0 million shares ofits common stock from an investment partnership managed by ValueAct Capital at$42.00 per share, a discount to the $42.21 closing market on the NYSE on thatdate.  The 2.0 million shares were repurchased for a total of $84million pursuant to the Company's continuing stock repurchase program andrepresent approximately 4.6% of outstanding shares before thetransactions.  After the transactions, ValueAct Capital, through severalof its investment partnerships, continues to own more than 2 million shares ofCommon Stock, or approximately 5% of the outstanding shares of the Company. The repurchase of these shares was pre-approved by the Audit Committee and theBoard of Directors with interested parties abstaining or not in attendance.

**Note Q - Discontinued Operations**

In October, 2005, the Company announced that itwas evaluating strategic alternatives for its Urology Business that would bothenhance shareholder value and enable the Company to focus solely on itsaesthetics business.  On May 17, 2006 the Company executed adefinitive agreement for the sale of the Urology Business to Coloplast for $463million, of which $456 million is in cash and $7 million is in non-cashconsideration consisting of the value of certain foreign tax credits that theCompany expects to realize arising from the transaction prior to the close.  Concurrently,certain assets of a minor urology product line were sold to an unrelated partyfor approximately $2 million at approximately book value.  The sale toColoplast was completed on June 2, 2006.  The Company received$458 million in total proceeds subject to post closing adjustments and recordeda gain of $222 million, net of taxes and transaction related expenses ofapproximately $138 million. Approximately 1,000 employees were transferred toColoplast.  In accordance with SFAS No. 144 "Accounting for the Impairment orDisposal of Long Lived Assets," the assets and liabilities related to thistransaction have been segregated from continuing operations and are reported asassets and liabilities of discontinued operations in the accompanyingconsolidated balance sheet as of March 31, 2006.  In addition, operations associatedwith these segments have been classified as income from discontinued operationsin the accompanying consolidated statements of income and the cash flowsassociated with discontinued operations have been segregated in theconsolidated statements of cash flows.
24
Inconnection with the sale to Coloplast, the Company entered into a TransitionServices Agreement and various supply agreements.  Pursuant to the TransitionServices Agreement, in exchange for specified fees, the Company provides toColoplast and Coloplast provides to the Company, services including accounting,information technology, customer support and use of facilities.  Under thesupply agreements the Company supply various products, including siliconegel-filled testicular implants to Coloplast and Coloplast supplies The Companywith components for the manufacture of our breast implants.  These servicesagreements are expected to extend through a period not to exceed twelve monthsand the supply agreements range from a period of 6 - 36 months.  Costs incurredand services provided will be reimbursed by both parties.  Costs the Companyincurs and reimbursement for services provided will be classified as indiscontinued operations in the consolidated income statement.  These servicesand supply agreements are not expected to have a significant impact on theCompanies future cash flows.

The major classes of assets and the related liabilitiesof discontinued operations included in the Company's Consolidated Balance Sheetat March 31, 2006 and those assets sold and liabilities assumed on June 2, 2006 were asfollows:

(in thousands)

**June 2, 2006**

March 31, 2006

Assets held for sale:

Accounts Receivable, net

** $**

**48,294 **

** $**

50,698 

Inventories

**38,827 **

38,016 

Deferred income taxes

**539 **

4,305 

Prepaid expenses and other current assets

**54,459 **

3,051 

Total current assets held for sale

**142,119 **

96,070 

** **

Property, plant and equipment, net

**30,879 **

29,497 

Intangible assets, net

**14,275 **

14,063 

Goodwill, net

**17,009 **

16,380 

Other assets

**813 **

324 

Total assets held for sale

** $**

**205,095 **

 $

156,334 

** **

Liabilities associated with assets held for sale:

** **

Accounts payable and accrued liabilities

** $**

**31,904 **

 $

27,220 

Income taxes payable

**23,440 **

1,751 

Current portion of purchase price related to acquired technologies  and acquisitions

**1,000 **

1,000 

Total current liabilities associated with assets held for sale

**56,344 **

29,971 

** **

Other long-term liabilities

**9,165 **

10,555 

Total liabilities associated with assets held for sale

** $**

**65,509 **

 $

40,526 

Net sales from discontinued operations were$38.4 million for the two month period ending June 2, 2006 and $55.6 million and$116.8 million for the three-month and six-month periods ending September 30, 2005.  Income(loss) before income taxes from discontinued operations for the three and sixmonths ending September 30, 2006 was ($1.8) million and $366.3 million, (including apre-tax gain of $360.5 million on the sale of our Urology Business) and $6.8million and $16.2 million for the three and six months ending September 30, 2005,respectively.

**Note R - Postretirement Benefit Plan**

The Company's Savings and Investment Plan isa qualified salary-reduction plan under Section 401(k) of the Internal RevenueCode in which substantially all of our U.S. employees may participate by contributing a portionof their compensation.  The Company matches contributions up to specifiedpercentages of each employee's compensation depending on how the employeeallocates his or her contributions.  Charges against income for the matching contributionswere $0.2 million and $0.2 million for the three-month periods ending September 30, 2006and 2005, and $0.5 million and $0.4 million for the six-month periods ending September 30, 2006and 2005.
25
**Note S - Contingencies**

Warranty and product liability claims are aregular and ongoing aspect of the medical device industry.  At any onetime, the Company may be subject to claims against it and may be involved inlitigation.  These actions can be brought by an individual or by a groupof patients purporting to be a class action.  The Company is currentlyinvolved in a number of product liability legal actions, the outcomes of whichare not within its control and may not be known for prolonged periods of time. The Company has retained liabilities associated with warranty and productliability claims arising out of its urology products sold prior to the June 2, 2006 closingdate.  No individual product liability case or group of cases, in which theCompany is currently involved, is considered material and there are nocertified class actions currently pending against the Company.  In accordancewith SFAS No. 5 "Accounting for Contingencies," a liability is recorded inthe consolidated financial statements when a loss is known or consideredprobable and the amount can be reasonably estimated.  If the reasonableestimate of a known or probable loss is a range, and no amount within the rangeis a better estimate, the minimum amount of the range is accrued.  If a loss isnot probable or cannot be reasonably estimated, no liability is recorded in theconsolidated financial statements.

The Company carries product liabilityinsurance on all its products, except its silicone gel-filled breast implants,which in the United States are only available through a controlled clinicalstudy.  This insurance is subject to certain self-insured retention andother limits of the policy, exclusions and deductibles that the Companybelieves to be appropriate.  The Company had established reserves of $2.8million and $2.9 million at September 30, 2006and March 31, 2006, respectively, for product-related claims to theextent that those claims may result in settlements or judgments within itsself-insured retention limits.  In addition, the Company had establishedadditional reserves of $4.2 million and $3.8 million at September 30, 2006and March 31, 2006, respectively, through its wholly-owned captiveinsurance company based on actuarially determined estimates and taking theCompany's excess insurance coverage into account.  Those reserves wereactuarially determined based on historical information, trends and certainassumptions about future claims and are primarily for claims that have beenasserted.  Should actual product liability experience differ from the estimatesand assumptions used to develop these reserves, subsequent changes in thesereserves will be recorded in selling, general and administrative expenses andmay affect the Company's operating results in future periods.

In addition, the Company also offers limitedwarranty coverage on some of its products (see Note G for details). While theCompany engages in extensive product quality programs and processes, includingactively monitoring and evaluating the quality of its component suppliers, thelimited warranty obligation is affected by reported rates of product problemsas well as the costs incurred in correcting product problems.  Should actualwarranty experience differ from the estimates and assumptions used to developthe warranty reserves, subsequent changes in the reserves will be recorded incost of sales and may affect our operating results in future periods. 

In addition, in the ordinary course of itsbusiness, the Company experiences various types of claims that sometimes resultin litigation or other legal proceedings.  The Company does not anticipatethat any of these current proceedings will have a material adverse effect onthe Company.

The Company has also agreed to indemnifyColoplast against specified losses in connection with the June 2006 sale of theCompany's Urology Business.  Generally, the Company has retained responsibilityfor various legal liabilities prior to closing.  The Company also maderepresentations and warranties to Coloplast about the condition of the UrologyBusiness, including matters relating to intellectual property, regulatorycompliance and environmental laws.

**Item2. - Management's Discussion and Analysis of Financial Condition and Results ofOperations**

*Cautionary Statement:*

*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, 2006, Quarterly Report on Form 10-Q for the period ended June 30, 2006, and subsequent reportson Form 8‐K, which discuss our business in greater detail.*

*Thesection entitled "Risk Factors" set forth in Item 1A under Part II -Other Information, and similar discussions in our other SEC filings, discusssome of the important risk factors that may affect our business, results ofoperations and financial condition.  These risks, in addition to the otherinformation in this Report and in our other filings with the SEC, should becarefully considered before deciding to purchase, hold or sell our securities.*

26

*Variousstatements in this Form 10-Q, in future filings by us with the SEC, inour press releases and in our oral statements made by or with the approval ofauthorized personnel, constitute "forward-looking statements" withinthe meaning of the Private Securities Litigation Reform Act of 1995.   Forward-lookingstatements are based on current expectations and are indicated by words orphrases such as "anticipate," "estimate,""expect," "intend," "project," "plan,""believe," "will," "seek," and similar words orphrases and involve known and unknown risks, uncertainties and other factorswhich may cause actual results, performance or achievements to be materiallydifferent from any future results, performance or achievements expressed orimplied by such forward-looking statements.  Some of the factors thatcould affect our financial performance or cause actual results to differ fromour estimates in, or underlying, such forward-looking statements are set forthunder "Item 1A -Risk Factors" or elsewhere in this Form 10-Q. Forward-looking statements include statements regarding, among other things:*
-  *Our anticipated growthstrategies;*
-  *Our intention to introduce orseek approval for new products;*
-  *Our ability to continue to meetUnited States Food and Drug Administration ("FDA") and otherregulatory requirements;*
-  *Our anticipated outcomes oflitigation and regulatory reviews; *
-  *Our ability to replace sourcesof supply without disruption and regulatory delay; and*
-  *Our expectation that selling,general and administrative expenses will increase as a result of the adoptionof SFAS 123(R) - "Share-Based Payment" which requires all share-basedpayments be recognized in the financial statements.*

*These forward-looking statements are basedlargely on our expectations and are subject to a number of risks anduncertainties, many of which are beyond our control.  Actual results coulddiffer materially from these forward-looking statements as a result of thefacts described in "Item 1A - Risk Factors" or elsewhere including,among others, problems with suppliers, changes in the competitive marketplace,significant product liability or other claims, product recalls, difficultieswith new product development, the introduction of new products by ourcompetitors, changes in the economy, FDA or other regulatory delay in approvalor rejection of new or existing products, changes in Medicare, Medicaid orthird-party reimbursement policies, changes in government regulations, use ofhazardous or environmentally sensitive materials, inability to implement newinformation technology systems, inability to integrate new acquisitions, andother events.  We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise.  In light of these risks and uncertainties, we cannotassure you that the forward-looking information contained in this Form 10-Qwill, in fact, transpire.*

CompanyOverview

Foundedin 1969, Mentor Corporation is a leading supplier of products serving theaesthetic market.  We develop, manufacture and market a range of productsserving the aesthetic market.  Our products include surgically implantableprostheses for plastic and reconstructive surgery, as well as capital equipmentand consumables used for soft tissue aspiration for body contouring (liposuction)and facial rejuvenation products including various types of products for skinrestoration..  Historically, we operated in three reportable segments: aesthetic and general surgery, surgical urology, and clinical and consumerhealthcare.  On May 17, 2006, we entered into a definitive purchaseagreement to sell our surgical urology and clinical and consumer healthcarebusiness segments (collectively, the "Urology Business") to Coloplast A/Sfor total consideration of $463 million ($456 million in cash and theremainder consisting of the value of certain foreign tax credits that we expectedto realize arising from the transaction prior to the close).  On June 2, 2006,the sale of the Urology Business was completed.  On June 1, 2006, ourPorges SAS subsidiary sold certain intellectual property to Coloplast for$52 million, which is not included in the total consideration of$463 million.  The purchase price is subject to a post-closing adjustmentbased on the working capital of the Urology Business as of the closing date,and a downward reduction in an amount equal to 50% of the amount of certaintransfer taxes and related fees incurred in connection with the transaction,50% of the cost of severance obligations in respect of certain former employeesof the Urology Business who will not continue with the Urology Businessfollowing the closing of the transaction, and certain other administrativecosts.  The purchaseagreement with Coloplast contains customary representations and warranties andindemnification provisions whereby each party agrees to indemnify the other forbreaches of representations and warranties, breaches of covenants and othermatters, with our liability for breaches of representations and warrantiesgenerally limited to 15% of the purchase price.  Pursuant to the terms of thepurchase agreement, an escrow fund was established with $10 millionwithheld from the purchase price to secure our indemnification obligations withrespect to any breaches of our representations and warranties for a period of18 months.  In addition, the purchase agreement provides that we will not enterinto or engage in a business that competes with the Urology Business, on aworldwide basis, for a period of seven years following the closing of thetransaction.  These restrictions on competition do not apply to (i) thedevelopment, manufacture or sale of any oral pharmaceuticals or any product ortreatments involving dermal fillers or other bulking agents or toxins,including botulinum toxins, or (ii) any business acquired and operated byus or our affiliates for so long as any such businesses generate less than$5 million in aggregate annual revenues from any competing business. These restrictions on competition terminate upon a change in control of Mentor.

27

Inconnection with the sale to Coloplast, we also entered into a TransitionServices Agreement and various supply agreements.  Pursuant to the TransitionServices Agreement, in exchange for specified fees, we provide to Coloplast andColoplast provides to us, services including accounting, informationtechnology, customer support and use of facilities.  Under the supplyagreements we supply various products, including silicone gel-filled testicularimplants to Coloplast and Coloplast supplies us with components for themanufacture of our breast implants.  These services agreements are expected toextend through a period not to exceed twelve months and the supply agreementsrange from a period of 6 - 36 months.  These services and supply agreements arenot expected to have a significant impact on our future cash flows fromcontinuing operations.

OnJune 2, 2006, we also completed the sale of our intellectualproperty, raw materials and tangible assets for the production of silicone maleexternal catheters relating to our catheter production facility in Anoka, Minnesota andour inventory of such catheters to Rochester Medical Corporation, for anaggregate purchase price of approximately $2 million.  

As a result of the sale to Coloplast, theassets and liabilities related to the Urology Business have been segregatedfrom continuing operations and are reported as assets and liabilities ofdiscontinued operations in the accompanying consolidated balance sheets.  Inaddition, operations associated with the Urology Business have been classifiedas income from discontinued operations in the accompanying consolidatedstatements of income.  Prior to being designated as discontinued operations,the Urology Business contributed approximately 47% of our consolidated netsales and approximately 27% of our operating profit in fiscal year 2006.  Werecorded a net gain on the sale of our Urology Business in the first quarter offiscal 2007.  As a result of this sale, we will be able to focus on theaesthetic market.  We intend to leverage our traditional strengths in plasticsurgery and grow our market presence in cosmetic dermatology with products forboth surgical and non-surgical procedures. 

Weemploy approximately 935 people around the world and are headquartered in Santa Barbara, California, with manufacturing andresearch operations in the United States, The Netherlands and the United Kingdom.  We also purchasefinished products and certain raw material components from third partymanufacturers and suppliers.  Our cost of goods sold represents rawmaterials, labor and overhead, the cost of third party finished products,freight expense and the cost associated with our product warranty programs. Gross margins may fluctuate from period to period due to a variety offactors, including changes in the selling prices of our products, the mix ofproducts sold, changes in the cost of third party finished products, rawmaterials, labor and overhead, fluctuations in foreign currency exchange rates,and changes in manufacturing processes and yields. 

Inaddition to our strong domestic 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, Benelux, Australia, Spain and Italy, as well as throughindependent distributors in other countries.

We employ a domestic sales force for ouraesthetic surgery and specialists to support our body contouring product lines. The sales force provides product information and specific data support andrelated services to physicians, nurses and other health careprofessionals.  We promote our products through participation in andsponsorship of medical conferences and educational seminars, television, specializedwebsites, journal advertising, direct mail programs, and a variety of marketingsupport programs.  In addition, we contribute to organizations thatprovide counseling and education for persons suffering from certain conditions,and we provide patient education materials for most of our products tophysicians for use with their patients.  

Ourselling, general and administrative expense incorporates the expenses of oursales and marketing organization and the general and administrative expensesnecessary to support the global organization. Our selling expenses consistprimarily of salaries, commissions, and marketing program costs.  Generaland administrative expenses incorporate the costs of accounting, humanresources, information services, equity compensation expense, intangibleamortization, legal and insurance costs.

Ourresearch and development expenses are comprised of the following types of costsincurred in performing clinical development and research and developmentactivities: salaries and benefits, allocated overhead, clinical trial andrelated clinical manufacturing costs, regulatory costs, intellectual propertyprocurement, contract services, and other outside costs.  We also conductresearch on materials technology, product design and product improvementoptions.

Our quarterly results reflect seasonality, asthe second fiscal quarter ending September 30 tends to have the lowest revenue andprofitability of all of the quarters.  This is primarily due to lower levelsof sales of breast implants for augmentation, an elective procedure, as many surgeonsand patients take vacations during this quarter.
28
RecentEvents

On October 30, 2006, weannounced that we had entered into a commercialization agreement with Genzyme Corporationunder which Genzyme will develop future hyaluronic acid ("HA") dermal fillerproducts which we will market and distribute through our sales channels.

On October 20, 2006, wereceived medical device licenses with terms and conditions from the TherapeuticProducts Directorate ("TPD") of Health Canada to begin marketing and selling our round and contoursilicone gel-filled breast implants in Canada for use in augmentation, reconstruction and revisionprocedures.

On July 28, 2005, we received an  "approvable letter" with conditions from the FDA on our pre-market  approval application for our MemoryGelTM round silicone gel-filled breast  implants.  The approvable letter stipulated a number of conditions which  we must satisfy in order to receive FDA approval to market and sell silicone  gel-filled breast implants in the United States.  These conditions were generally  consistent with those conditions that the FDA Advisory Panel, composed of  outside experts selected by the FDA, had recommended in their April 2005  review of our PMA application.  We remain in discussion with the FDA  regarding the conditions.  We expect to incur additional expenses as a result  of our post-approval conditions, including patient monitoring and data  collection, which could be substantial.  In addition, we cannot guarantee  that the FDA will provide final approval, nor can we determine when the FDA's  decision regarding approval will be made. 

**APPLICATIONOF CRITICAL ACCOUNTING POLICIES**

Management's Discussion and Analysis ofFinancial Condition and Results of Operations addresses our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United  States.  The preparation of thesefinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses during the reporting period.  Onan on-going basis, we evaluate our estimates and judgments.  We base ourestimates and judgments on historical experience and on various other factorsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.  Actualresults may differ from these estimates under different assumptions orconditions.  

We believe the following critical accountingpolicies, among others, affect our more significant judgments and estimatesused in the preparation of our consolidated financial statements. 

Revenue Recognition

We recognize product revenue, net ofdiscounts, returns, and rebates in accordance with Statement of Financial AccountingStandards ("SFAS") No. 48, "Revenue Recognition When the Rightof Return Exists," and Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition."

As required by these standards, revenue isrecorded when persuasive evidence of a sales arrangement exists, delivery hasoccurred, the buyer's price is fixed or determinable, contractual obligationshave been satisfied, and collectibility is reasonably assured.  Theserequirements are met, and sales and related cost of sales are recognized, uponthe shipment of products, or in the case of consignment inventories, upon thenotification of usage by the customer.  We record estimated reductions torevenue for customer programs and other volume-based incentives.  Shouldthe actual level of customer participation in these programs differ from thoseestimated, additional adjustments to revenue may be required.  We alsoallow credit for products returned within our policy terms.  We record anallowance for estimated returns at the time of sale based on historicalexperience, recent gross sales levels and any notification of pendingreturns.  Should the actual returns differ from those estimated,additional adjustments to revenue and cost of sales may be required. 

Our deferred revenue consists of both currentand long term and includes funds received in connection with sales of ourEnhanced Advantage Breast Implant Limited Warranty program.  The fees receivedin connection with a sale of such a warranty are deferred and recognized asrevenue evenly over the life of the warranty term.
29
Accounts Receivable

We market our products to a diverse customerbase, principally throughout the United  States, Canada, Western Europe,Central and South America, and the Pacific Rim.  We grant credit terms in thenormal course of business to our customers, primarily hospitals, doctors anddistributors.  We perform ongoing credit evaluations of our customers andadjust credit limits based upon payment history and the customer's currentcredit worthiness, as determined through review of their current credit information. We continuously monitor collections and payments from customers and maintainallowances for doubtful accounts for estimated losses resulting from theinability of some of our customers to make required payments.  Estimatedlosses are based on historical experience and any specifically identifiedcustomer collection issues.  If the financial condition of our customers,or the economy as a whole, were to deteriorate resulting in an impairment ofour customers' ability to make payments, additional allowances may berequired.  These additional allowances for estimated losses would beincluded in selling, general and administrative expenses. 

Inventories

We value our inventories at the lower ofcost, based on the first-in first-out ("FIFO") cost method, or thecurrent estimated market value of the inventory.  We write down ourinventory for estimated obsolescence or unmarketable inventory equal to thedifference between the cost of inventory and the estimated market value basedupon assumptions about future demand and market conditions.  If actualfuture demand or market conditions differ from those projected by us,additional inventory valuation adjustments may be required.  Theseadditional valuation adjustments would be included in cost of sales.

Warranty Reserves

TheCompany offers two types of warranties relating to its breast implants in theUnited States, Canada, and Puerto Rico:  a standard limited warranty which isoffered at no additional charge and an enhanced limited warranty at anadditional charge of $100 in the U.S. ($100 CAD in Canada), which providelimited financial assistance in the event of a deflation or rupture.  TheCompany's standard limited warranty is also offered in certain European andother international countries for silicone gel-filled breast implants.  TheCompany provides an accrual for the estimated cost of the standard limited breastimplant warranty at the time revenue is recognized.  Costs related towarranties are recorded in cost of sales.  The estimated cost of the standardlimited warranty is recorded as an expense at the time of sale, whereas thecost of the enhanced limited warranty is recognized as costs are incurred.  Theaccrual for the standard limited warranty is based on estimates, which arebased on relevant factors such as unit sales, historical experience, thelimited warranty period, estimated costs, and, to a limited extent, informationdeveloped by the Company's insurance company using actuarial techniques. The accrual is analyzed periodically for adequacy.  While the Companyengages in extensive product quality programs and processes, including activelymonitoring and evaluating the quality of the Company's component suppliers, thewarranty obligation is affected by reported rates of warranty claims and levelsof financial assistance specified in the limited warranties.  Shouldactual patient claim rates reported differ from the Company's estimates,adjustments to the estimated warranty liability may be required.  Theseadjustments would be included in cost of sales.

Product Liability Reserves

We have product liability reserves forproduct-related claims to the extent those claims may result in litigationexpenses, settlements or judgments within our self-insured retention limits. We have also established additional reserves, through our wholly-owned captiveinsurance company, for estimated liabilities for product-related claims basedon actuarially determined estimated liabilities, taking also into account ourexcess insurance coverages.  The actuarial valuations are based on historicalinformation and certain assumptions about future events.  Product liabilitycosts are recorded in selling, general and administrative expenses as they aredirectly under the control of our General Counsel and other general and administrativestaff and are directly impacted by our overall corporate risk managementstrategy.  Should actual product liability experience differ from the estimatesand assumptions used to develop these reserves, subsequent changes in reserveswill be recorded in selling, general and administrative expenses, and mayaffect our operating results in future periods.  

30

Goodwill and Intangible Asset Impairment

We evaluate long-lived assets, includinggoodwill and other intangibles, for impairment whenever events or changes incircumstances indicate that the carrying value of an asset may not berecoverable.  In addition, we evaluate goodwill and other intangiblesannually in the fourth quarter of each fiscal year.  In assessing therecoverability of goodwill and other intangibles, we must make assumptionsregarding estimated future cash flows and other factors to determine the fairvalue of the respective assets.  We adopted SFAS No. 142, "Goodwilland Other Intangible Assets," effective April 1, 2002 and analyzedgoodwill and intangibles for impairment.  Impairment tests were performed atadoption, and in the fourth quarter of fiscal years 2003, 2004 and 2006, and noimpairment was noted as a result of these analyses.  The impairment testsperformed in fiscal 2005 indicated certain impaired assets, for which werecorded impairment charges in the fourth quarter of fiscal 2005. 

Stock-Based Compensation Expense forFiscal 2007 and Thereafter

Effective April 1, 2006we adopted SFAS No. 123 (revised 2004), Share-Based Payment, orSFAS 123(R). SFAS 123(R) requires all share-based payments, includinggrants of stock options, restricted stock units, performance stock units, andemployee stock purchase rights, to be recognized in our financial statementsbased on their respective grant date fair values. Under this standard, the fairvalue of each employee stock option and employee stock purchase right isestimated on the date of grant using an option pricing model that meets certainrequirements. We currently use the Black-Scholes option pricing model toestimate the fair value of our share-based payments.  The Black-Scholes modelmeets the requirements of SFAS 123(R) but the fair values generated by themodel may not be indicative of the actual fair values of our stock-based awardsas it does not consider certain factors important to stock-based awards, suchas continued employment and periodic vesting requirements and limitedtransferability.  The determination of the fair value of share-based paymentawards utilizing the Black-Scholes model is affected by our stock price and anumber of assumptions, including expected volatility, expected life, risk-freeinterest rate and expected dividends. We use the implied volatility for tradedoptions on our stock as the expected volatility assumption is required in theBlack-Scholes model.  Our selection of the implied volatility approach is basedon the availability of data regarding actively traded options on our stock aswe believe that implied volatility is more representative than historicalvolatility.  The expected life of the stock options is based on historical andother economic data trended into the future.  The risk-free interest rateassumption is based on observed interest rates appropriate for the terms of ourstock options and stock purchase rights.  The dividend yield assumption isbased on our history and expectation of dividend payouts.  The fair value ofour restricted stock units is based on the fair market value of our commonstock on the date of grant.  Stock-based compensation expense recognized in ourfinancial statements in fiscal 2006 and thereafter is based on awards that areultimately expected to vest.  The amount of stock-based compensation expense infiscal 2007 and thereafter will be reduced for estimated forfeitures based onhistorical experience.  Forfeitures are required to be estimated at the time ofgrant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates.  We will evaluate the assumptions used to value stockawards on a quarterly basis.  If factors change and we employ differentassumptions, stock-based compensation expense may differ significantly fromwhat we have recorded in the past.  If there are any modifications orcancellations of the underlying unvested securities, we may be required toaccelerate, increase or cancel any remaining unearned stock-based compensationexpense.  To the extent that we grant additional equity securities to employeesor we assume unvested securities in connection with any acquisitions, ourstock-based compensation expense will be increased by the additional amortizationof the compensation over the underlying instruments' remaining vesting periods. Had we adopted SFAS 123(R) in prior periods, the magnitude of the impact ofthat standard on our results of operations would have approximated the impactof SFAS 123 assuming the application of the Black-Scholes option pricingmodel as described in the disclosure of pro forma net income and pro forma netincome per share in Note K of our "Notes to Consolidated FinancialStatements."

Pursuantto SFAS 123( R), the fair values of our Performance Stock Units ("PSUs") wereestimated using a Monte Carlosimulation model.  Similarly, the fair value of our Restricted Stock Grants isbased on the underlying share price on the date of grant.  These calculatedvalues are amortized to expense over their respective vesting periods.

31

**RESULTSOF OPERATIONS**

Thefollowing table sets forth certain data from the Consolidated Statements ofIncome expressed as a percentage of net sales for the periods indicated:

Three Months Ended  September 30,

Six Months Ended  September 30,

**2006**

2005

**2006**

2005

** **

Net  sales

**100.0%**

100.0%

**100.0%**

100.0%

   Cost of sales

**27.7 **

25.1 

**27.7 **

24.9 

Gross  profit

**72.3 **

74.9 

**72.3 **

75.1 

   Selling, general and administrative expense

**42.9 **

41.3 

**39.9 **

37.1 

   Research and development expense

**13.4 **

12.8 

**11.5 **

10.4 

Operating  income

**16.0 **

20.8 

**20.9 **

27.6 

   Interest expense

**(2.5)**

(2.4)

**(2.2)**

(2.1)

   Interest income

**10.2 **

1.5 

**6.7 **

1.2 

   Other income (expense), net

**0.3 **

0.2 

**0.5 **

0.1 

Income  before income taxes

**24.0 **

20.1 

**25.9 **

26.8 

Income  taxes

**7.8 **

6.1 

**7.8 **

7.8 

Net  income from continuing operations

**16.2 **

14.0 

**18.1 **

19.0 

Net  income (loss) from discontinued operations

**(1.4)**

6.7 

**1.7 **

7.0 

Gain  (loss) on sale of discontinued operations

**(0.3)**

- 

**151.8 **

- 

Net  income

**14.5%**

20.7%

**171.6%**

26.0%

**Forthe three-month period ended September 30, 2006 compared to the three-monthperiod ended September 30, 2005**

Net Sales

Netsales for the three-month period ended September 30, 2006 increased 14% to $66.9million, compared to $58.7 million for the same period in the prior year.  Foreign exchange rate movements, primarily the stronger Canadian Dollarand to a lesser extent, the strengthening of the Euro, over the same quarter inthe prior year had a favorable year-to-year impact on sales of $0.5 million.  Totalsales of breast aesthetic products increased 15% to $58.2 million for thequarter from $50.5 million for the same period in the prior year.  Increasedbreast aesthetic sales were driven by growth in both saline and silicone-gelproducts across all markets and resulted in gains in market share.  Weanticipate that our breast aesthetic sales in fiscal 2007 will be driven byexisting products in all markets.  Net sales of body contouring products decreased8% to $3.8 million for the quarter, from $4.1 million for the same period inthe prior year.  This decrease is primarily related to our decision to discontinuesale of a number of low margin products within the body contouring product linein connection with our continuing analysis of the body contouring business.  Weexpect sales of body contouring products will continue to be less than prioryear amounts as a result of our discontinuance of low margin products.  Otheraesthetic products sales increased 21% to $4.9 million for the quarter, from$4.0 million for the same period in the prior year primarily as a result ofincreased revenue from our facial aesthetics products, including Niadyne's NIA24TM line of science-based cosmeceutical products which was launched domesticallyin May 2006.

Cost of Sales and Gross Profit

Grossprofit increased $4.4 million to $48.4 for the quarter from $43.9 million inthe same period prior year; however, the gross profit percentage decreased to72.3% of net sales for the quarter compared to 74.9% for the same period in theprior year.  The decrease in gross profit percentage was a result of increasedcost of sales as a result of slightlyhigher raw material costs over the prior year, a shift in sales mix, shift inthe foreign exchange rate of the Euro to U.S. Dollar, unfavorable manufacturingvariances associated with product modifications, and increased product warrantyexpense of $0.6 million over the same period in the prior year.  We believethat our gross profit as a percentage of net sales will remain within the rangeof low to mid-seventies for the remainder of the fiscal year. 

32

Selling, General and Administrative

Selling,general and administrative expenses increased $4.5 million to $28.7 million, or42.9% of net sales, for the three months ended September 30, 2006, compared to $24.3million, or 41.3% of net sales, in the same period in the prior year.  Theincrease was primarily due to $2.9 million of compensation expense as a resultof our adoption of SFAS 123(R) on April 1, 2006, $1.0 million inadditional commission expenses as a result of higher net sales, and $0.9million in expenses associated with the negotiation of our commercialization agreementwith Genzyme.  The increase in selling, general and administrative expenses waspartially offset by a decrease in sales-and-use tax expense of $1.2 million asa result of resolutions of tax audits in various taxing jurisdictions.

Research and Development

Researchand development expense was $9.0 million, or 13.4% of net sales, for the threemonths ended September 30, 2006,compared to $7.5 million or 12.8% of net sales, in the same period in the prioryear.  The increase in research and development spending includes $1.1million in severance-related costs in connection with our on-going evaluationof our corporate infrastructure and $0.7 million in expenses related to ourhyaluronic acid dermal filler development program with Genzyme.  We recently enteredinto a commercialization agreement for the future development of hyaluronicacid dermal fillers and expect that research and development expenses will continueto increase as a result of the activities contemplated by this agreement. 

Weexpect to continue to incur additional severance-related costs in selling,general and administrative and research and development in the third and fourthquarters of fiscal 2007 as we continue to evaluate our corporate infrastructurein efforts to continue to improve our efficiency and profitability. 

Interest and Other Income and Expense

Interestexpense was $1.6 million for the three months ended September 30, 2006, compared to $1.4million in the same period in the prior year.  These costs includedinterest on our $150 million convertible subordinated notes at 23⁄4% issued inDecember 2003, interest expense on balances outstanding under our foreign linesof credit, commitment fees on our credit facilities and amortization of debtissuance costs.  The increase in interest expense was primarily attributable tohigher commitment fees and increased borrowings on our international credit facilities.

Interestincome increased $5.9 million to $6.8 million for the three months ended September 30, 2006, compared to $0.9 millionin the same period of the prior year as a result of generally higher rates ofinterest and significantly higher balances of cash and cash equivalentsavailable for investment as a result of the $458 million in cash proceedsreceived from the sale of our Urology Business.  Included in the cash balances providinginterest income at September 30, 2006,was a $10.0 million escrow account associated with the sale of the Urology Businessto Coloplast.

Other income primarily includes gains orlosses on sales of marketable securities and foreign currency gains or lossesrelated to our foreign operations.  Other income for the three-monthperiod ending September 30, 2006 increased $0.1 millionfrom the same period in the prior year.

Income Taxes

Our effective tax rate for the three monthsended September 30, 2006 was 32.7%, compared with 30.6% for the same period inthe prior year.  Our effective tax rate for the three months ended September 30, 2006has increased as a result of the expiration of the U.S. researchcredit, the phase-out of the Extraterritorial Income Exclusion and the booktreatment of employee equity compensation as required under SFAS 123(R).  Thisincrease was partially offset by a decrease in our rate for increasedinvestments utilizing tax-free municipal instruments.  The effect of certainitems, such as the U.S. manufacturing deduction is approximately the same inboth the three months ending September 30, 2006and 2005, respectively.

33

Income from Discontinued Operations, Netof Income Taxes

Incomefrom discontinued operations, net of income taxes, includes the results of ourformer surgical urology and clinical and consumer healthcare business segments,which were sold to Coloplast on June 2, 2006.  For the three-month period ended September 30, 2006, we had a loss fromdiscontinued operations, net of income taxes, of $1.1 million compared toincome from discontinued operations, net of income taxes, of $3.9 million forthe three months ended September 30, 2005.  For further detailsregarding discontinued operations, See Note Q of the Notes to ConsolidatedFinancial Statements.  

**Forthe six-month period ended September 30, 2006 compared to the six-monthperiod ended September 30, 2005**

Net Sales

Netsales for the six-month period ended September 30, 2006 increased 10% to $146.3million, compared to $132.8 million for the same period in the prioryear.  Foreign exchange rate movements, primarily the stronger CanadianDollar and to a lesser extent, the strengthening Euro, over the same period inthe prior year had a favorable year-to-year impact on sales of $0.9 million.  Totalsales of breast aesthetic products increased 11% to $127.7 million for the six-monthperiod ended September 30, 2006from $115.3 million for the same period in the prior year.  Increasedbreast aesthetic sales were primarily driven by growth in silicone-gel productsin both the domestic and international markets and to a lesser extent salineimplant products in the domestic market. Net salesof body contouring products decreased 2% to $8.9 million for the six-monthperiod ended September 30, 2006,from $9.1 million for the same period in the prior year.  This decrease is primarilyrelated to our decision to discontinue sale of a number of low margin productswithin the body contouring product line in connection with our continuinganalysis of the body contouring business.  Other aesthetic products salesincreased 17% to $9.7 million for the six-month period ended September 30, 2006, from $8.4 million forthe same period in the prior year primarily as a result of increased revenuefrom our facial aesthetics products, including Niadyne's NIA 24TM line ofscience-based cosmeceutical products which was launched domestically in May2006 and PuragenTM, which was launched in a variety of international markets inMay 2005.

Cost of Sales and Gross Profit

Grossprofit increased $6.1 million to $105.8 for the six months ended September 30, 2006, from $99.7 million inthe same period prior year; however, the gross profit percentage decreased to72.3% of net sales for the six months ended September 30, 2006, compared to 75.1% forthe same period in the prior year.  The decrease in gross profit percentage wasprimarily due to increased cost of sales as a result of increased product warrantyexpense of $1.4 million and additional inventory reserves for thediscontinuation of certain low margin product lines in our body contouringbusiness of $1.2 million over the same period in the prior year.  Alsocontributing to the lower gross profit percentage was an increase in standardcosts over prior year at our facility in The Netherlands and a shift in productmix.  The gross profit percentage in the prior year had the benefit offavorable pricing on raw materials and favorable manufacturing efficiencies dueto the mix of product manufactured.  We believe that our gross profitpercentage will remain within the range of low to mid-seventies percentage ofnet sales for the remainder of the fiscal year. 

Selling,General and Administrative

Selling,general and administrative expenses increased $9.2 million to $58.4 million, or39.9% of net sales, for the six months ended September 30, 2006, compared to $49.3million, or 37.1% of net sales, in the same period in the prior year.  Theincrease was primarily due to $5.2 million of compensation expense as a resultof our adoption of SFAS 123(R) on April 1, 2006, $2.2 million in severancerelated expense related to our ongoing business rationalization initiative,$1.1 million increase in selling and marketing compensation expense as a resultof higher sales, and an increase of $0.6 million in incentive compensationexpenses associated with achieving specific operating targets.  The increase inselling, general and administrative expenses was partially offset by lower sales-and-use-taxexpense of $1.2 million as a result of resolutions of tax audits in varioustaxing jurisdictions and the completion of our direct-to-consumer televisionadvertising program related to our breast implant products, resulting indecreased expenses of approximately $1.3 million. 
34
Research and Development

Researchand development expense was $16.9 million or 11.5% of net sales, for the sixmonths ended September 30, 2006,compared to $13.8 million or 10.4% of net sales, in the same period in theprior year.  The increase in research and development spending includes$1.2 million in severance-related costs in connection with our on-goingevaluation of our corporate infrastructure, expenses of approximately $1.2million associated with Phase II clinical trials for our botulinum toxinproject and $0.7 million in expenses related to our hyaluronic acid dermal fillerdevelopment program with Genzyme.  These increases in research and developmentexpenses were partially offset by a decrease of approximately $1.0 million inexpenses related to support of our silicone gel-filled breast implant regulatorysubmissions in the United  Statesand Canada.  We recently enteredinto a commercialization agreement for the future development of hyaluronicacid dermal fillers and expect that research and development expenses will continueto increase as a result of the activities anticipated to occur under thisagreement.

Weexpect to continue to incur additional severance-related costs in selling,general and administrative and research and development in the third and fourthquarters of fiscal 2007 as we continue to evaluate our corporate infrastructurein efforts to continue to improve our efficiency and profitability. 

Interest and Other Income and Expense

Interestexpense was $3.3 million for the six months ended September 30, 2006, compared to $2.7million in the same period in the prior year.  These costs includedinterest on our $150 million convertible subordinated notes at 23⁄4% issued inDecember 2003, interest expense on balances outstanding under our foreign linesof credit, commitment fees on our credit facilities and amortization of debtissuance costs.  The increase in interest expense was primarily attributable tohigher commitment fees and increased borrowings on our international credit facilities.

Interestincome increased $8.3 million to $9.9 million for the six months ended September 30, 2006 compared to $1.6million in the same period of the prior year as a result of generally higherrates of interest and significantly higher balances of cash and cashequivalents available for investment as a result of the $458 million in cashproceeds received from the sale of our Urology Business.  Included in the cashbalances providing interest income at September 30, 2006 was a $10.0 millionescrow account associated with the sale of the Urology Business to Coloplast.

Other income primarily includes gains orlosses on sales of marketable securities and foreign currency gains or lossesrelated to our foreign operations.  Other income for the six months ended September 30, 2006 increased $0.6 million from the sameperiod in the prior year.  

Income Taxes

Our effective tax rate for the six monthsended September 30, 2006 was 30.0%, compared with 29.1% for the same period inthe prior year.  Our effective tax rate for the six months ended September 30, 2006 increasedprimarily due to the expiration of the U.S. research credit, the phase-out of theExtraterritorial Income Exclusion, and the book treatment of employee equitycompensation as required under SFAS 123(R).

Net Income from Continuing Operations andEarnings Per Share

Netincome from continuing operations for the six months ended September 30, 2006 increased 5% to $26.5million, from $25.3 million in the same period in the prior year.  Dilutedearnings per share increased 9% to $0.58 for the six months ended September 30, 2006, compared to $0.53 forthe same period in the prior year.  

Income from Discontinued Operations, Netof Income Taxes

Incomefrom discontinued operations, net of income taxes, includes the results of ourformer surgical urology and clinical and consumer healthcare business segments,which were sold to Coloplast on June 2, 2006.  For the six months ended September 30,2006, which includes operating activity of two months ending June 2, 2006 andthe six-month period ended September 30, 2005, income from discontinuedoperations, net of income taxes, was $2.4 million and $9.3 million,respectively.  This decrease is primarily the result of the shorter operatingperiod this year.  For further details regarding discontinued operations, SeeNote Q of the Notes to Consolidated Financial Statements.  

35

Gainon Sale of DiscontinuedOperations, Net of Income Taxes

Forthe six months ended September 30, 2006,we recorded a net gain of $222.2 million after taxes and expenses related tothe sale of our Urology Business.  We received proceeds of approximately $458million in cash and the benefit of certain foreign tax credits arising beforethe sale.  The proceeds are subject to customary post-closing adjustments. 

**FINANCIALCONDITION, LIQUIDITY AND CAPITAL RESOURCES**

Cashprovided by operating activities and from the exercise of employee stockoptions have been our primary recurring sources of funds.  We recentlycompleted the sale of our Urology Business to Coloplast for total considerationof $463 million, which is subject to customary post-closing adjustments andincludes non-cash consideration consisting of the value of certain foreign taxcredits that we expect to realize arising from the transaction prior to theclose.  On the closing date of June 2, 2006, we received $446 million in cash fromColoplast, an additional $10 million is held under an escrow agreement inconnection with the transaction and an additional $2 million received from anunrelated third party.  After income taxes and transaction related expenses arepaid in future quarters, we expect net after tax proceeds from the sale to beapproximately $320 million.  Income taxes and related expenses will be paidover the reminder of our fiscal year.  We believe that existing funds includingthe proceeds of this sale, cash generated from continuing operations, andexisting sources of and access to financing are adequate to satisfy our workingcapital, capital expenditure, stock repurchases, and debt service requirementsfor the foreseeable future.  We believe that the loss of future cash flows fromour discontinued surgical urology and clinical and consumer healthcare segmentswill not have a significant negative impact on our future finance levels, termsof financing or covenants.  Cash flows have been segregated between continuingoperations and discontinued operations in the Consolidated Statements of CashFlows.  

As of September 30, 2006, we had cash,cash equivalents and short-term marketable securities of $549.2 million, anincrease of $348.2 million from $201.0 million as of March 31, 2006.  Theprincipal components of the increase in cash, cash equivalents and marketablesecurities were cash proceeds generated from the sale of our Urology Business of$458 million and cash generated from operating activities of continuingoperations of $54.8 million, proceeds of $16.0 million from the exercise ofemployee stock options, and stock purchases under our Employee StockPurchase Plan, partially offset by $84.0 million for shares repurchased, $15.2million in dividends paid, $9.0 million to reduce amounts outstanding onexisting lines of credit, $8.6 million in net purchase of marketable securities,cash used by operating activities of discontinued operations of $66.4 million and$6.1 million used for net capital expenditures of continuing operations.

Weinvest excess cash in marketable securities that are highly liquid, ofhigh-quality investment grade, and which have varying maturities.  Ourshort-term marketable securities consist primarily of state and municipal governmentand government agency obligations, Federal Home Loan Bank and MortgageAssociation bonds, and investment grade corporate obligations, includingcommercial paper. 

(in  thousands)

September 30,   2006

March 31,   2006

Cash  and cash equivalents

** $**

**438,168 **

 $

98,713 

Marketable  debt securities

**111,031 **

102,241 

Total  cash, cash equivalents and marketable debt securities

** $**

**549,199 **

 $

200,954 

Percentage  of total assets

**75%**

37%

  36
**Cash Flow Changes**

The following table summarizes our cash flowactivity:

Six Months Ended  September 30,

(in thousands)

**2006**

2005

Net  cash provided by continuing operating activities

** $**

**54,798 **

$

45,672 

Net cash used for continuing investing  activities 

**(14,647)**

(79,819)

Net  cash (used for) provided by continuing financing activities 

**(92,245)**

21,654 

Net cash (used) provided by discontinued  operations

**(66,524)**

4,985 

Proceeds from the sale of the Urology Business

**458,066 **

- 

Effect of currency exchange rates on cash and  cash equivalents 

**7 **

(1,177)

Increase (decrease) in cash and cash  equivalents

** $**

**339,455 **

$

(8,685)

*Cash Provided by Operating Activities ofContinuing Operations*

Cashprovided by operating activities of continuing operations of $54.8 million and $45.7million for the six months ended September 30, 2006 and 2005, respectively,was greater than net income in those periods, due to the net impact of non-cashadjustments to income.  Non-cash adjustments included tax benefits fromthe exercise of employee stock options, non-cash compensation, depreciation andamortization, deferred income taxes, loss on long term marketable securitiesand loss on the disposal of assets.  For the six-month periods ended September 30, 2006 and 2005, operatingcash flows were positively impacted in the amount of $6.4 million and negativelyimpacted in the amount of $6.7 million, respectively, by changes in workingcapital balances.  Our working capital was $553.1 million at September 30, 2006, and $201.6 million at March 31, 2006. 

*CashUsed for Investing Activities of Continuing Operations*

Cashused in investing activities of continuing operations was primarilyattributable to purchases and sales of marketable debt and equity securities,as well as capital expenditures on property and equipment andintangibles.  For the six months ended September 30, 2006, total cash used ininvesting activities of continuing operations was $14.6 million.  Our netpurchases of marketable securities totaled $8.6 million and our capitalexpenditures totaled $6.1 million.  We anticipate our capital expendituresto total approximately $10.0 million in fiscal 2007, as we will continueto invest in facility improvements, software to support our manufacturingprocesses, and production equipment.  For the six months ended September 30, 2005, total cash used in investingactivities of continuing operations was $79.8 million.  This amount wasprimarily comprised of net purchases of marketable securities of $75.6 million and$4.2 million in capital expenditures. 

*Cash (Used) Provided by DiscontinuedOperations*

Cashused by discontinued operations was $66.5 million for the six months ended September 30, 2006 and cash provided bydiscontinued operations for the six months ended September 30, 2005 was $5.0 million.  Theamount in 2006 was comprised of $66.4 million used by operating activities ofdiscontinued operations, primarily tax payments related to the gain on sale ofthe Urology Business, adjusted for non-cash items and $0.1 million inunfavorable currency exchange rate adjustments.  In 2005, the amount wascomprised of $9.6 million provided by operating activities of discontinuedoperations, less capital expenditures of $1.5 million, $.5 million in unfavorablecurrency exchange rate adjustments, and $2.7 million repaid on lines of credit.

*Cash(Used for) Provided by Financing Activities of Continuing Operations*

Netcash from financing activities is primarily a result of cash provided byemployee stock option exercises, cash used in payments of dividends and ourstock repurchase program, and the net impact of our debt financing activities.
37
We have a stockrepurchase program, primarily to offset the dilutive effect of our employeeequity compensation program and to reduce the overall number of sharesoutstanding.  All shares repurchased under the program are retired and areno longer deemed to be outstanding.   On June 5, 2006, we agreed torepurchase 2 million additional shares from an investment partnership managedby ValueAct Capital at $42.00 per share, a discount from the closing marketprice quoted on the NYSE of $42.21 on that date.  The 2.0 millionshares were repurchased for a total of $84 million pursuant to the Company'scontinuing stock repurchase program.  Mr. Jeff Ubben, managing director ofValueAct Capital, is a member of our Board of Directors.  The repurchase ofthese shares was pre-approved by the Audit Committee and the Board of Directorswith interested parties abstaining or not in attendance. 

On June 16, 2006,we entered into a stock purchase plan for the purpose of repurchasing shares ofthe Company's common stock.  Repurchases will be made under a Rule 10b5-1 Plancompliant with Rule 10b-18.  The first repurchase under the 10b5-1 Plan couldnot take place prior to the third trading day following our announcement of ourfinancial results for the three months ended June 30, 2006.  The timingof purchases and the exact number of shares to be purchased will depend onmarket conditions.  The repurchase program and the 10b5-1 Plan may besuspended or discontinued at any time.  In connection with our entry into the 10b5-1Plan, the Board of Directors increased the authorized number of sharesavailable for repurchase pursuant to our stock repurchase program and under the10b5-1 Plan from 3.3 million to 5.0 million shares.  The Board approvedthe repurchase of shares of our common stock under the 10b5-1 Plan in an amountnot to exceed $166 million in total repurchases (subject also to the 5.0million shares limitation), consistent with the limitations set forth in our$200 million Credit Agreement, dated as of May 25, 2005,as amended on May 31, 2006. 

At November 6, 2006, 4.9 million sharesremained authorized for repurchase.  The timing of our repurchases is subjectto market conditions, and cash availability.  There is no guarantee that sharesauthorized for repurchase by the Board will ultimately be repurchased. Additionally, our Credit Agreement as amended on May 31, 2006 limits the amount ofequity securities we can repurchase to $250 million (of which $163 millionremains available for repurchase) plus a subsequent amount during any fourconsecutive quarters equal to our consolidated net income less dividends paidfor the preceding four quarters.  

On September 1, 2006, the Board of Directorsdeclared a quarterly cash dividend payable on our common stock from $0.17 to $0.18per share.  It is our intent to continue to pay dividends for the foreseeablefuture subject to, among other things, Board approval, cash availability, debtand line of credit restrictions and alternative cash needs.  At the currentannual dividend rate of $0.72 per share, the aggregate annual dividend would beapproximately $30 million.

We receive cash from the exercise of employeestock options and the employee stock purchase plan ("ESPP").  Employeestock option exercises and ESPP purchases provided $16.0 million and $37.3million of cash in the six months ended September 30, 2006and 2005, respectively.  Proceeds from the exercise of employee stockoptions will vary from period to period based upon, among other factors, fluctuationsin the market value of our common stock relative to the exercise price of suchoptions.

**Financing Arrangements**

*Senior Credit Facility*

OnMay 26, 2005, weentered into a three-year Credit Agreement ("Credit Agreement") that providesus with 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.  At our election and subject to lender approval, the amountavailable for borrowings under the Credit Agreement may be increased by anadditional $50 million.  Funds are available under the Credit Agreement tofinance permitted acquisitions, stock repurchases up to certain dollarlimitations, and for other general corporate purposes.  The Company has threestandby letters of credit totaling $2 million outstanding under the CreditAgreement.  Accordingly, although there were no borrowings outstanding underthe Credit Agreement at September 30, 2006, only $198 million wasavailable for borrowings.  

On May 31, 2006,we amended the Credit Agreement to permit the consummation of the sale of ourUrology Business.  Additionally, the amendment modified the minimumAdjusted Consolidated EBITDA covenant that we are required to comply with underthe terms of the Credit Agreement.  The amendment also amends certainnegative covenants contained in the Credit Agreement, including amendments tothe covenants restricting our ability to make investments and incurindebtedness and an amendment increasing the amount of our equity securitiesthat we are permitted to repurchase.  As of November 6, 2006,there were no borrowings outstanding under the Credit Agreement.
38
Interest on borrowings (other than swing lineloans and alternative currency loans) under the Credit Agreement is at avariable rate that is calculated, at our option, at the prime rate, or aEurocurrency rate for deposits denominated in U.S. dollars plus an additionalpercentage that varies between 1.00% and 1.65%, depending on our seniorleverage ratio at the time of the borrowing.  Swing line loans bear interest atthe prime rate.  Alternative currency loans bear interest at the Eurocurrencyrate for deposits denominated in the applicable currency plus the sameadditional percentage.  In addition, we paid certain fees to the lenders toinitiate the Credit Agreement and will pay an unused commitment fee based onour senior leverage ratio and unborrowed lender commitments.

Borrowings under the Credit Agreement areguaranteed by certain of our domestic subsidiaries and are also secured by apledge of 100% of the outstanding capital stock of certain of our otherdomestic subsidiaries.  In addition, if the ratio of total funded debt toadjusted earnings before interest, taxes, depreciation and amortization (or"adjusted EBITDA"), exceeds 2.50 to 1.00, then we are obligated to grant to thelenders a first priority perfected security interest in essentially all of ourand our material domestic subsidiaries' assets. 

The Credit Agreement imposes certainfinancial and operational restrictions, including financial covenants thatrequire us to maintain a maximum consolidated funded debt leverage ratio of notgreater than 4.00 to 1.00, a senior funded debt ratio of not greater than 2.50to 1.00, a minimum quarterly adjusted EBITDA, and a minimum fixed charge ratioof greater than 1.25 to 1.00.  The covenants also restrict our ability, amongother things, to make certain investments, incur certain types of indebtednessor liens, make acquisitions in excess of $20 million except in compliance withcertain criteria, and repurchase shares of common stock, pay dividends ordispose of assets above specified thresholds.  The Credit Agreement alsocontains customary events of default, including payment defaults, materialinaccuracies in our representations and warranties, covenant defaults,bankruptcy and involuntary proceedings, monetary judgment defaults in excess ofspecified amounts, cross-defaults to certain other agreements, change ofcontrol, and ERISA defaults.

*Other Financing*

OnOctober 4, 2005,Mentor Medical Systems B.V. ("Mentor BV"), a wholly-owned subsidiary of Mentor Corporation enteredinto a Loan and Overdraft Facility (the "Facility") with Cooperative RaboBankLeiden, Leiderdorp en Oestgstgeest U.A. ("RaboBank").

TheFacility provides Mentor  BV withan initial €15 million loan and overdraft facility, which decreases by €375,000quarterly starting in September 2006.  Under the Facility, Mentor BV may borrow up to €12.5million in fixed amount advances, with terms of three to six months, and afurther sublimit of up to €5 million of loans in fixed amount advances with aterm of up to 5 years.  Up to €10 million of the Facility may be drawn in theform of U.S. dollars.  Funds under the Facility are available to Mentor BV to finance certaindividend payments to Mentor Corporation and for other normal businesspurposes.  On March 31, 2006we borrowed $14 million under the Facility to partially fund our repatriationof foreign earnings for reinvestment in the U.S. and during the six months ended September 30, 2006, $9.0 million of thisamount was repaid.  Accordingly $5.0 million was outstanding and $7.6 millionwas available under this facility at September 30, 2006.

Intereston borrowings 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.

Borrowingsby Mentor  BV underthe Facility are guaranteed by Mentor's wholly-owned subsidiary, Mentor Medical Systems C.V.,through a Joint and Several Debtorship Agreement.  In addition, borrowingsunder the Facility are secured by a mortgage on certain real estate owned by Mentor BV.

TheFacility imposes certain financial and operational restrictions on Mentor BV,including financial covenants that require Mentor BV and Mentor Medical SystemsCV to maintain a minimum combined defined solvency ratio, a maximum combineddebt leverage ratio of not greater than 4 to 1, a senior funded debt ratio ofnot greater than 2.5 to 1, minimum quarterly operational results, and a minimuminterest coverage ratio of greater than 5 to 1.  The Facility alsocontains customary events of default, including cross default and material oradverse change provisions.  If an event of default occurs, the commitmentsunder the Facility may be terminated and the principal amount and all accruedbut unpaid interest and other amounts owed thereunder may be declaredimmediately due and payable.  As of September 30, 2006, all covenants andrestrictions had been satisfied.  Mentor BV paid €15,000 in certain fees to the RaboBankupon entry into the Facility, and Mentor BV will be obligated to pay, over the 10 year termof the Facility, a commitment fee of 0.25% of the committed and unborrowedbalances.  Fees are payable quarterly in arrears.  
39
Inaddition to our RaboBank Facility, we previously established several lines ofcredit with local foreign lenders to facilitate operating cash flow needs atour foreign Urology subsidiaries.  These unsecured lines had no borrowingsat March 31, 2006and were terminated with the sale of our Urology Business on June 2, 2006.

AtSeptember 30, 2006,our total short-term borrowings under all lines of credit were $5.0 million andthe weighted-average interest rate was 6.1%.  The total amount ofadditional borrowings available to us under all lines of credit was $205.7million at September 30, 2006,and $202.2 million at March 31, 2006.

*ConvertibleSubordinated Notes*

OnDecember 22, 2003,we completed an offering of $150 million of convertible subordinated notes due January 1, 2024, pursuant to Rule 144Aunder the Securities Act of 1933.  The notes bear interest at 23⁄4% perannum and are convertible into shares of our common stock at an initialconversion price of $29.289 per share and are subordinated to all existing andfuture senior debt.  As a result of our recent dividend increase the conversionprice has been adjusted to $29.1279 and each $1,000 principal amount will beconvertible into 34.33 shares of common stock.   Concurrent with theissuance of the convertible subordinated notes, we entered into a convertiblebond hedge and warrantstransactions with respect to our common stock, the exposure for which is heldby 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 convertiblebond hedge and warrants transactions combined are intended to reduce thepotential dilution from conversion of the notes by effectively increasing theconversion price per share, from our perspective, to approximately $39.2107.

Oneof the conditions required for conversion of the notes was satisfied during thequarter ended September 30, 2006,and accordingly, the holders of notes have the option to convert the notes intocommon shares at the aforementioned adjusted conversion price per share. The warrant holder also has the right to purchase 5.1 million shares when theshare price of our common stock as quoted on the NYSE exceeds the currentexercise price of $39.2107 per share.

We do not have any off-balance sheetarrangements that are currently material or reasonably likely to be material toour financial position or results of operations. 

We believe that funds generated fromoperations, our cash, cash equivalents and marketable securities, net after-taxproceeds from our sale of the Urology Business, plus funds available under ourline of credit agreements will be adequate to meet our working capital needsand capital expenditure investment requirements and commitments for theforeseeable future.  However, it is possible that we may need to raiseadditional funds to finance unforeseen requirements or to consummateacquisitions of other businesses, products or technologies through the sale ofequity or debt securities to the public or to selected investors, or byborrowing money from financial institutions.  In addition, even though wemay not need additional funds in the short-term, we may still elect to selladditional equity or debt securities or borrow for other reasons.  Thereare no assurances that we will be able to obtain additional funds on terms thatwould be favorable to us, or at all.  If funds are raised by issuingadditional equity securities or convertible debt securities, the ownershippercentage of existing shareholders would be reduced.  In addition, equityor debt securities issued by us may have rights, preferences or privileges seniorto those of our common stock.

**Item3. - Quantitative and Qualitative Disclosures about Market Risk**

Therehave been no material changes in our exposure to market risk as reported inItem 7A in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006.
40
**Item4. - 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 information requiredto be disclosed in our reports filed or submitted under the Exchange Act, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC's rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.  In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible 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 September 30, 2006,the end of the period covered by this report.  Based on that evaluation,our Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective at the reasonable assurancelevel as of September 30, 2006.

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 September 30, 2006that materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**PARTII - OTHER INFORMATION**

**Item 1. - Legal Proceedings**

OnMarch 4, 2004, JohnH. 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 of March 14, 1990 ("MergerAgreement") (prior to the merger, O&O had no affiliation withus).  PTF alleges that we breached the terms of the Merger Agreement byfailing to exert commercially reasonable and diligent efforts to obtainapproval by the FDA for a product used for the treatment of urinaryincontinence and by failing to accurately account for and pay royalties duethereunder.  PTF seeks damages in excess of $18 million, which is themaximum amount of royalties PTF could have received under the MergerAgreement.  We intend to vigorously defend the lawsuit; however, we canprovide no assurance that we will prevail, and we may be required to pay moniesto resolve the claim..  

Inaddition, in the ordinary course of our business we experience product-relatedand other varied types of claims that sometimes result in litigation or otherlegal proceedings.  Although there can be no certainty, we do notanticipate that any of these proceedings will have a material adverse effect onus.

**Item1A. - Risk Factors**

Ourbusiness faces many risks.  The risks described below include changes fromthe risk factors as previously disclosed set forth in our Annual Report on Form10-K for the fiscal year ending March 31, 2006 and may not be the only risks weface.  Additional risks that we do not yet know of or that we currentlythink are immaterial may also impair our business operations.  If any ofthe events or circumstances described in the following risks actually occurs,our business, 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 together with those set forth in our AnnualReport on Form 10-K before deciding to invest in our common stock orconvertible notes. 

***Significantproduct liability claims or product recalls may force us to pay substantialdamage awards and other expenses that could exceed our accruals and insurancecoverages.***

Themanufacture and sale of medical devices and biologics exposes us to significantrisk of product liability claims.  In the past, and currently, we have hada number of product liability claims relating to our products, and we may besubject to additional product liability claims in the future, some of which mayhave a negative impact on our business.  If a product liability claim orseries of claims is brought against us for uninsured liabilities or in excessof our insurance coverage, our business could suffer.  Some manufacturersthat suffered such claims in the past have been forced to cease operations oreven to declare bankruptcy. 
41
Additionally,we offer product replacement and certain financial assistance for surgicalprocedures that fall within our limited warranties and coverage periods ofimplantation on our breast implant products, and we accrue for those limitedwarranties.  Such accruals are based on estimates, taking into considerationrelevant factors such as historical experience, warranty periods, estimatedcosts, existence and levels of insurance and insurance retentions, identifiedproduct quality issues, if any, and, to a limited extent, information developedby the insurance company using actuarial techniques.  We assess theadequacy of these accruals periodically and adjust the amounts as necessarybased on actual experience and changes in future expectations.  We alsorecently expanded our limited warranty programs to provide certain financialassistance for surgical procedures within ten years of implantation (increasedfrom five years) and expanded the program coverage to include silicone breastimplant sales in European and certain other countries, in addition to the United States.  Changes to actualwarranty claims incurred could have a material impact on the actuarialanalysis, which in turn could materially impact our reported expenses andresults of operations.

Inaddition to product liability or warranty claims, we could experience amaterial design or manufacturing failure, a quality system failure, othersafety issues, or heightened regulatory scrutiny that would warrant a recall ofproducts we manufacture or that are manufactured by another company and wedistribute.  A recall of some of our products could result in exposure toadditional product liability claims, significant expense to perform the recalland lost sales. 

***Weare subject to substantial government regulation, which could have a materialadverse affect on our business.***

Theproduction and marketing of our products and our ongoing research anddevelopment activities, including pre-clinical testing and clinical trialactivities, are subject to extensive regulation and review by numerousgovernmental authorities both in the U.S. and abroad.  Most of the medical devices andbiologics we develop must undergo rigorous pre-clinical and clinical testingand an extensive regulatory approval process before they can be marketed. Certain of our products are required to undergo review by a panel of outsideexperts selected by the FDA, which makes a recommendation to the FDA as towhether the product(s) should or should not be approved.  This processmakes it potentially longer, more difficult and/or more costly to bring ourproducts to market, and we cannot guarantee that any of our unapproved productswill be approved or how long it may take for any one particular product to beapproved.  The pre-marketing approval process can be particularlyexpensive, uncertain and lengthy, and a number of devices, drugs and biologicsfor which FDA approval has been sought by other companies have never beenapproved for marketing.  In addition to testing and approval procedures,extensive regulations also govern manufacturing, packaging, labeling, storage,distribution, record-keeping, advertising, and marketing procedures.  Ifwe do not comply with applicable regulatory requirements, such violations couldresult 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. 

Delaysin, withdrawal of, or rejection by the FDA or other government entity of approval(s)of our products, including a delay in or rejection of the approval of our roundsilicone gel-filled breast implant pre-market approval application ("PMA") or adelay in the review of our Contour Profile Gel PMA, or any significant delaysin our PMA filings, including our Puragen PlusTM PMA, may alsoadversely affect our business.  Such delays, withdrawals, or rejectionsmay be encountered due to, among other reasons, government or regulatorydelays, lack of demonstrated safety or efficacy during clinical trials, safetyissues, manufacturing issues, slower than expected rate of patient recruitmentfor clinical trials, inability to follow patients after treatment in clinicaltrials, inconsistencies between early clinical trial results and resultsobtained in later clinical trials, varying interpretations of data generated byclinical trials, adverse publicity, 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 frombroadening the uses of our current products for different applications. If we incur significant expenses, for example, in connection with post-marketpatient monitoring and data collection activities for our silicone gel-filledbreast implants, this could have a material adverse effect on our results ofoperations.  In addition, to the extent permissible by law, we may not receive governmentalapproval to export our products in the future, and countries to which productsare to be exported may not approve them for import.  We may also be required towithdraw or recall our products after we receive approvals and begin commercialsales if we, the FDA or a foreign government agency determines that there is ahigher than average incidence of post-treatment complications with our productsas a result of subsequent clinical experience and/or data.  From time to time,we are subject to inquiry by government agencies in this regard.  
42
Ourmanufacturing facilities also are subject to continual governmental review andinspection.  The FDA has stated publicly that compliance withmanufacturing regulations will be scrutinized  strictly.  A governmentalauthority may challenge our compliance with applicable federal, state and/orforeign regulations.  In addition, any discovery of previously unknownproblems with one of our products or facilities may result in restrictions onthe product or the facility, including, but not limited to, product recalls,withdrawal of the product from the market or other enforcement actions.

Fromtime to time, legislative or regulatory proposals are introduced that, ifimplemented, could alter the review and approval process relating to medicaldevices, biologics, or related to the sale of our products.  It ispossible that the FDA or other governmental authorities will issue additionalregulations, which could further reduce or restrict the sales of our presentlymarketed products or products under development.

Anychange in legislation or regulations that govern the review and approvalprocess relating to our current and/or future products, or that restrict themanner by which we may sell our products, could make it more difficult and/orcostly to obtain approval for new products, and/or to produce, market, anddistribute existing products. 

***Ifwe are unable to continue to develop and commercialize new technologies andproducts, we may experience a decrease in demand for our products or ourproducts could become obsolete.***

Themedical device and biologics industry is highly competitive and is subject tosignificant and rapid technological change.  We believe that our abilityto develop or acquire new technologies and products is crucial to oursuccess.  We are continually engaged in product research and development,product improvement programs, and required clinical studies to develop newtechnologies and to maintain and improve our competitive position.  Anysignificant delays in the above or termination or failure of our clinicaltrials would materially and adversely affect our research, development andcommercialization timelines.  We cannot guarantee that we will besuccessful in enhancing existing products, or in developing or acquiring newproducts or technologies that will timely achieve regulatory approval orsuccess in the marketplace. 

Thereis also a risk that our products may not gain market acceptance amongphysicians, patients and the medical community generally.  The degree ofmarket acceptance of any medical device or other product that we develop willdepend on a number of factors, including demonstrated clinical safety andefficacy, cost-effectiveness, potential advantages over alternative products,user/patient acceptance, and our marketing and distribution capabilities. Physicians will not recommend our products if clinical and/or other data and/orother factors 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.

InDecember 2003, we completed our PMA application to the FDA for our Memory-Gel TMsilicone gel-filled implants for breast augmentation, reconstruction andrevision.  In August 2004, we amended our PMA application based on arevised draft guidance released by the FDA in January 2004.  On July 28, 2005, we received an"approvable" letter, with conditions, from the FDA on our PMAapplication for our silicone gel-filled breast implants.  The approvableletter stipulated a number of conditions which we must satisfy in order toreceive FDA approval to market and sell silicone gel-filled breast implants inthe United  States. Our current discussions with FDA regarding our MemoryGelTM siliconegel-filled breast implant PMA are primarily focused on labeling and patientmonitoring and data collection.  Despite the approvable letter and ourcurrent discussions, the FDA may ultimately decide to not approve our siliconegel-filled breast implants for sale in the United States, or if they doapprove, the FDA would most likely recommend additional post-approvalconditions or requirements, for which we would incur costs that could besubstantial, and which could potentially impact our sales and earnings,depending on the scope and complexity of the requirements.  Further changein FDA regulatory requirements, including those implemented through new orrevised FDA guidance (such as that announced on January 8, 2004 by the FDA) may delayor may otherwise adversely affect our pending PMA application as well as itsreview or approval by the FDA.  A delay or denial response by the FDAwould have a material adverse effect on our commercialization timelines andcompetitive position, and ultimately our revenue and operating results. If our new products do not achieve significant market acceptance, or if ourcurrent products do not continue competing successfully in the changing market,our sales and earnings may not grow as much as expected, or may even decline.

Duringthe quarter, we filed the first module of the Puragen PlusTM PMA.  Any delaysin the submission of additional modules, or a delay or denial response by theFDA would have a material adverse effect on our commercialization timelines andcompetitive position, and ultimately our future revenue and operating results.

43

***Ifwe are unable to compete effectively with existing or new competitors, we couldexperience price reductions, reduced demand for our products, reduced marginsand loss of market share, and our business, results of operations and financialcondition would be adversely affected.*****

Ourproducts compete with similar or other competitive medical productsmanufactured by major companies, and may also compete with new productscurrently under development by others. 

Competitionin our industry occurs on a variety of levels, including but not limited to:

•         developing and bringing new products to market before others or toprovide benefits superior to those of existing products;

•         developing new technologies to improve existing products;

•         developing new products at a lower cost to provide the samebenefits as existing products at the same or lower price;

•         creating or entering new markets with existing products;

•         increasing or improving service-related programs; and

•         advertising in a manner that creates additional awareness anddemand.

Thecompetitive environment requires an ongoing, extensive search for technologicalinnovations and the ability to market products effectively.  Consequently, wemust continue to effectively execute on various competitive levels to properlyposition our products in the marketplace and maintain our market share, revenueand gross margins. 

Inparticular, we face competition from Allergan, Inc., which acquired InamedCorporation in March 2006, our largest current competitor in the U.S. for our breastaesthetics product line.  On September 21, 2005, Inamed announced that it also received an"approvable" letter, with conditions, from the FDA for its silicone gel-filledbreast implants.  If Allergan gains FDA approval to market its siliconegel-filled breast implant products before we do, our competitive position willlikely suffer.  As a result of Allergan's acquisition of Inamed, we are nowcompeting against a much larger competitor with a substantially larger salesforce.

***Ifwe suffer negative publicity concerning the safety of our products, our salesmay be harmed and we may be forced to withdraw products.***

Physiciansand potential patients may have a number of concerns about the safety of ourproducts, including our breast 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 products couldreduce market or governmental acceptance of our products, delay productapprovals, or could result indecreased 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 awithdrawal or recall of one or more of our products, the safety concernsleading to that government agency's request may be investigated by regulatorybodies in other countries, which could result in additional withdrawals orrecalls and could result in negative publicity regarding our products.  Inaddition, significant negative publicity could result in an increased number ofproduct liability claims, whether or not these claims are supported byapplicable law. 

***Ifwe are unable to implement new information technology systems or upgrade existingsystems, our ability to manufacture and sell products, maintain regulatorycompliance and manage and report our business activities may be impaired,delayed or diminished, which would cause substantial business interruption andloss of sales, customers and profits.***

Weimplemented an enterprise resource planning system at our major locations whichis our primary business management system and are currently in the process ofupgrading to current version releases.  We intend to continue to implementthis system for  all of our businesses worldwide.  Many other companieshave had severe problems with computer system implementations of this natureand scope.  We are using a controlled project plan and we believe we haveassigned adequate staffing and other resources to the projects to ensure itssuccessful implementation; however there is no assurance that the design willmeet our current and future business needs or that it will operate asdesigned.  We are heavily dependent on such computer systems, and anyfailure or delay in the system implementation or upgrades would cause asubstantial interruption to our business, additional expense, and loss ofsales, customers, and profits. 

44

***Ifwe are unable to acquire companies, businesses or technologies as part of ourgrowth strategy or to successfully integrate past acquisitions, our growth,sales and profitability could suffer.***

Asignificant portion of our historic growth has been the result of acquisitionsof other companies, businesses and technologies.  In October 2005, weannounced our intention to refocus our business solely on aesthetic medicineand we sold our surgical urology and clinical and consumer health businesses inJune 2006.  This refocus consumed a significant amount of management attentionand may have distracted and may continue to distract us from pursuingacquisition opportunities in the short term.  We intend to continue to acquireother businesses and technologies to facilitate our future businessstrategies.  There can be no assurance that we will be able to identifyappropriate acquisition candidates, consummate transactions or obtainagreements with terms favorable to us.  For example, in November 2005, wemade an unsolicited offer to acquire Medicis, Inc. (which was at the timesubject to an acquisition agreement with Inamed) that was rejected.  We mayincur substantial expenses in connection with our acquisition activities, evenif the transaction is not completed, such as the approximately $3.4 million inexpenses incurred related to the offer to acquire Medicis.  Once a business isacquired, any inability to integrate the business, failure to retain anddevelop its workforce, or establish and maintain appropriate communications,performance expectations, regulatory compliance procedures, accountingcontrols, and reporting procedures could adversely affect our future sales andearnings.

***Wemay not realize some of the benefits of the Coloplast transaction.***

Weanticipate that we will be able to utilize approximately $14.5 million offoreign tax credits resulting from the Coloplast transaction.  While Coloplasthas agreed to indemnify us for the availability of up to $7.1 million of thesetax credits, we cannot be sure that we will be able to utilize those taxcredits before they expire due to any number of factors including, but not limitedto, whether the credits expire due to changes in ownership in excess of theapplicable tax rules, sufficient income in the jurisdictions in which we havethe credits and other possible reasons the tax credits might be disallowed. Although Coloplast has agreed to indemnify Mentor for $7.1 million of the foreign tax credits, ifthe foreign tax credits are disallowed and we are not able to recover fromColoplast, we may not be able to realize the full amount, or any, of those taxcredits.

***Wemay not be successful in transitioning our business to focus solely on the aestheticsmarket, which may harm our prospects and operating results.***

As of June 2006, we completed the divestitureof our Urology Business, and our continuing business is now focused on the aestheticsmarket.  We may not successfully improve our operating margins and net income despitethe divestiture of our Urology Business to be consistent with those ofcompetitive companies focused solely on the aesthetics market.  In addition, wemay be unsuccessful at broadening the focus of our sales force to physicianspracticing aesthetic medicine other than plastic surgeons.  In order tosuccessfully increase our sales presence to those physicians, we will berequired to develop internally or purchase additional products that will meetthe needs of those physicians and obtain regulatory approval to sell thoseproducts.  As our remaining business is focused solely on the aesthetics market,we may be unable to retain employees who want to work at a company with abroader product emphasis or are uncertain about their future with thecontinuing Company after the urology divestiture.  

***Wedepend upon our key personnel and our ability to attract, train, and retainemployees.***

Our success depends significantly on thecontinued individual and collective contributions of our senior managementteam.  The loss of the services of any member of our senior management or theinability to hire and retain experienced management personnel could adverselyaffect our ability to execute our business plan and harm our operating results.In addition, our future success depends on our ability to hire, train andretain skilled employees. Competition for these employees is intense. 

***State legislatures and taxingauthorities may create new laws or change their interpretation of existingstate and local tax laws that may affect future product demand or createunforeseen tax liabilities.***

Ifany state legislature or other government authority creates new laws to assesssales taxes on medical procedures or products determined by them to becosmetic, our physician and patient customers may have to pay more for ourproducts and future demand may decrease.  In addition, if taxingauthorities determine that our products are cosmetic and thus taxable based ontheir interpretations of existing tax laws or that our products are otherwisetaxable, they may disallow currently available exemptions related to medicalproducts and procedures.  Such taxing authorities may then determine thatwe owe additional taxes, penalties and interest related to product sales fromprior periods.  These determinations would have a negative effect on ourresults of operations.

45

***Wedepend on single and sole source suppliers for certain raw materials andlicensed or manufactured products and the loss of any supplier could adverselyaffect our ability to manufacture or sell many of our products.***

Wecurrently rely on single or sole source suppliers for raw materials used inmany of our products, including silicone.  In the event that they cannotmeet our requirements, we cannot guarantee that we would be able to obtain asufficient amount of quality raw materials in a timely manner from other suppliers. We also depend on third party manufacturers and suppliers for components andlicensed products.  In connection with the sale of our Urology Business toColoplast, we have entered into a supply agreement with Coloplast for certaincomponents of our breast aesthetic products.  For the short-term,Coloplast would be our sole source for these components, and if we were unableto obtain the supply, our business would be harmed.  We may determine thatwe do not want to continue to purchase products from Coloplast or Coloplast maybe unable to meet our needs in a timely manner, either of which maydisrupt our business during the period we negotiate a supply agreement with andqualify the manufacturing process of a third party or begin production of thecomponents ourselves.  In addition, we depend on Niadyne, Inc. for thesupply of NIA-24 and if we were no longer able to satisfy demand for thisproduct through our relationship with Niadyne, our business could beharmed.  If there is a disruption in the supply of any of these single orsole source products, our future sales and profitability would be adverselyaffected.  

***Ifour use of hazardous materials result in contamination or injury, we couldsuffer significant financial loss.***

We are subject to federal, state, local andforeign environmental laws and regulations.  Our manufacturing and research anddevelopment activities involve the controlled use of potentially hazardousmaterials, chemicals and biological materials, which require compliance withvarious laws and regulations regarding the use, storage, and disposal of suchmaterials.  We believe our continuing and discontinued operations comply in allmaterial respects with applicable environmental laws andregulations in each country where we have a business presence.  Although we continueto make expenditures for environmental protection, we do not anticipate anyadditional significant expenditures, in complying with such laws andregulations, that would have a material impact on our earnings or competitiveposition.  We are not aware of any pending litigation or significant financialobligations arising from current or past environmental practices that arelikely to have a material adverse effect on our financial position.  Wecannot assure, however, that environmental claims or indemnificationobligations relating to our continuing or discontinued operations, orproperties currently or previously owned or operated by us will not develop inthe future, nor can we predict whether any such claims, if they were todevelop, would require significant expenditures on our part.  We cannoteliminate the risk of accidental contamination or injury from thesematerials.  In the event of an accident or environmental discharge, we maybe held liable for any resulting damages, which may exceed our financialresources and any applicable insurance coverage.  In addition, we are unable topredict what legislation or regulations may be adopted or enacted in the futurewith respect to environmental protection and waste disposal.

Inthe U.S, we are subject to regulation by the United States EnvironmentalProtection Agency and other state and local environmental agencies in each ofour domestic manufacturing facilities.  For example, in Texas, we are subject toregulation by the local Air Pollution Control District as a result of some ofthe chemicals used in our manufacturing processes.  Prior to the June 2, 2006 Coloplast transaction,we were also subject to regulation by the United States Nuclear RegulatoryCommission in our Oklahoma facility due to the manufacture and distribution ofbrachytherapy seeds using radioactive iodine I-125 and palladium Pd-103. We may have continuing liability for any violations which arose prior to theColoplast transaction.  In our Wisconsin facility, we are also subject to regulation by the U.S.Department of Health and Human Services, Centers for Disease Control, due tothe nature of the biological agent used to manufacture our botulinum toxinproduct, *Clostridium botulinum* type A, which is still in the developmentphase.  Failure to comply with the regulations and requirements of thesevarious agencies could affect our ability to manufacture products and may havea significant negative impact on sales and results of operations. 

***Litigationmay harm our business or otherwise distract our management.***

Substantial,complex or extended litigation could cause us to incur large expenditures anddistract our management, and could result in significant monetary or equitablejudgments against us.  For example, lawsuits by employees, patients,customers, licensors, licensees, suppliers, business partners, distributors,shareholders, or competitors could be very costly and could substantiallydisrupt our business.  Disputes from time to time with such companies orindividuals are not uncommon, and we cannot assure that we will always be ableto resolve such disputes out of court or on terms favorable to us. 

 

46

**Item2. - Unregistered Sales of Equity Securities, Use of Proceeds and IssuerPurchases of Equity Securities**

None.

**Item3. - Defaults Upon Senior Securities**

None.

**Item4. - Submission of Matters to a Vote of Security Holders**

At the Company's 2006 Annual Meeting of  Shareholders held on September 13, 2006, the following proposals  were presented: 

(1)  A proposal to approve a decrease in the  authorized number of members of the Company's Board of Directors from nine to  seven directors. The proposal received 37,689,060 votes for, and 177,982 against  approval.  There were 28,274 abstentions and 0 broker non-votes.  

(2)  A proposal to elect the following  individuals to the Board of Directors of the Company to serve until the next  annual meeting, or until their successors are duly elected and qualified, was  approved as follows: 

Name  of Director

Votes For

Votes Withheld

Joseph  E. Whitters

37,761,179

134,151

Michael  L. Emmons

37,759,245

136,076

Walter  W. Faster

37,548,074

347,247

Joshua  H. Levine

37,698,642

196,679

Michael  Nakonechny

37,544,119

351,202

Ronald  J. Rossi

37,661,140

234,181

Jeffrey  W. Ubben

37,570,896

324,425

(3)  A proposal to approve an amendment  to the 2005 Long-Term Incentive Plan to increase the number of shares of the  Company's common stock available for award grants by an additional 1,600,000  shares with the new aggregate share limit at 7,600,000 shares.  The proposal  received 31,121,210 votes for, and 1,629,765 against approval.  There were 93,710  abstentions and 5,050,636 broker non-votes. 

(4)  A proposal to ratify the appointment of  Ernst & Young LLP to act as independent public accountants of the Company  for the fiscal year ending March 31, 2007 was approved.  The  proposal received 37,777,401 votes for, and 71,300 against ratification.   There were 46,618 abstentions and 0 broker non-votes.

**Item5. - Other Information**

None

 
47
**Item6. Exhibits**

2.1

Revised  Binding Offer Letter from Coloplast A/S regarding purchase of Mentor Urology  Business dated May   5, 2006  Including Appendix A -- Incorporated by reference to Exhibit 2.2 of the  Registrant's Annual Report on Form 10-K for the year ended March 31, 2006. 

2.2

Purchase  Agreement between Coloplast A/S and Mentor Corporation dated May 17, 2006 -- Incorporated by  reference to Exhibit 2.3 of the Registrant's Annual Report on Form 10-K for  the year ended March   31, 2006. 

2.3

Listing  Schedules for Purchase Agreement between Coloplast A/S and Mentor Corporation  dated May   17, 2006  -- Incorporated by reference to Exhibit 2.4 of the Registrant's Annual Report  on Form 10-K for the year ended March 31, 2006. 

2.4

Side  Letter Agreement Between Coloplast A/S and Mentor Corporation dated June 2, 2006 -- Incorporated by  reference to Exhibit 2.5 of the Registrant's Annual Report on Form 10-K for  the year ended March   31, 2006. 

3.1

Composite  Restated Articles of Incorporation of the Company dated December 12, 2002 -- Incorporated by  reference to Exhibit 3.1 of the Registrant's Annual Report on Form 10-K for  the year ended March   31, 2003.   

3.2

Amended  and Restated Bylaws of Mentor Corporation dated September 14, 2005 -- Incorporated by  reference to Exhibit 3.2 of the Registrant's Quarterly Report on Form 10-Q  for the quarter ended September 30, 2005.   

4.1

Indenture  2 3/4 % Convertible Subordinated Notes Due 2024, dated December 22, 2003 -- Incorporated  by reference to Exhibit 4.1 of the Registrant's Quarterly Report on Form 10-Q  for the quarter ended December 31, 2003.   
10.1*Mentor	Corporation Amended 2005 Long-Term Incentive Plan effective September 13,	2006 --	Incorporated.	by ref. to Exhibit 10.1 of the Registrant's Current Report on Form 8-K filed	on September 19, 2006.   
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.

 

48

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

**MENTORCORPORATION**

(Registrant)

** **

**MENTOR CORPORATION**
      
DATE: November	9, 2006

/s/JOSHUA H. LEVINE

Joshua  H. Levine

President  and Chief Executive Officer
      
DATE: November	9, 2006

/s/LOREN L. MCFARLAND

Loren  L. McFarland

Vice  President, Chief Financial Officer and Treasurer

 

 

49