**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

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**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

**Forthe quarterly period ended June 30, 2006**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

**Forthe transition period from                    **to                    .**

**COMMISSIONFILE NUMBER 001-31257**

**ADVANCED MEDICAL OPTICS, INC.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                              |   | **33-0986820**                        |
|-------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)           |   |                                  |
|                                      |   |                                  |
| **1700 E.  St. Andrew Place**             |   | ** **                            |
| **Santa  Ana, California**                |   | **92705**                             |
| (Address of  principal executive offices) |   | (Zip Code)                            |

 

Registrant’s telephone number, including area code**714/247-8200**

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

Large accelerated filer x            Acceleratedfiler o            Non-acceleratedfiler o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o    No  x

As of July 31, 2006, there were 59,324,607 shares ofcommon stock outstanding.

 

 

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ADVANCED MEDICALOPTICS, INC.FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2006

INDEX

 
| PART I - FINANCIAL  INFORMATION | 3                                                                            |
|--------------------------------------|------------------------------------------------------------------------------|
|                                 |                                                                         |   |   |
|                                 | Item 1.                                                                 | Financial Statements | 3 |
|                                 |                                                                         |   |   |
|                                 | (A).                                                                         | Unaudited Consolidated Statements of Operations -  Three Months and Six Months Ended June 30, 2006 and June 24, 2005 | 3 |
|                                 |                                                                         |   |   |
|                                 | (B).                                                                         | Unaudited Consolidated Balance Sheets — June 30, 2006  and December 31, 2005 | 4 |
|                                 |                                                                         |   |   |
|                                 | (C).                                                                         | Unaudited Consolidated Statements of Cash Flows - Six  Months Ended June 30, 2006 and June 24, 2005 | 5 |
|                                 |                                                                         |   |   |
|                                 | (D).                                                                         | Notes to Unaudited Consolidated Financial Statements | 6 |
|                                 |                                                                         |   |   |
|                                 | Item 2.                                                                      | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 19 |
|                                 |                                                                         |   |   |
|                                 |                                                                         | Certain Factors and Trends Affecting AMO and Its  Businesses | 27 |
|                                 |                                                                         |   |   |
|                                 | Item 3.                                                                      | Quantitative and Qualitative Disclosures About Market Risk | 28 |
|                                 |                                                                         |   |   |
|                                 | Item 4.                                                                      | Controls and Procedures | 31 |
|                                 |                                                                         |   |   |
| PART  II - OTHER INFORMATION    | 31                                                                           |
|                                 |                                                                         |   |   |
|                                 | Item  1.                                                                     | Legal  Proceedings | 31 |
|                                 |                                                                         |   |   |
|                                 | Item 1A.                                                                     | Risk Factors | 31 |
|                                 |                                                                         |   |   |
|                                 | Item 2.                                                                      | Unregistered Sales of Equity Securities and Use of  Proceeds | 32 |
|                                 |                                                                         |   |   |
|                                 | Item 4.                                                                      | Submission of  Matters to a Vote of Security Holders | 32 |
|                                 |                                                                         |   |   |
|                                 | Item 6.                                                                      | Exhibits | 33 |
|                                 |                                                                         |   |   |
|                                 | Note: Items 3 and 5 of Part II are omitted because  they are not applicable. |   |
|                                 |                                                                         |   |   |
| Signatures                           | 34                                                                           |
|                                 |                                                                         |   |   |
| Exhibit Index                        |                                                                         |
| EXHIBIT 10.1                         |                                                                         |
| EXHIBIT 10.2                         |                                                                         |
| EXHIBIT 10.3                         |                                                                         |
| EXHIBIT 10.4                         |                                                                         |
| EXHIBIT 31.1                         |                                                                         |
| EXHIBIT 31.2                         |                                                                         |
| EXHIBIT 32.1                         |                                                                         |
|                                      |                                                                              |  |  |  |  |  |  |

2

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**PART I -FINANCIAL INFORMATION**

**Item 1. Financial Statements**

Advanced MedicalOptics, Inc.Unaudited Consolidated Statements of Operations(In thousands, except per share data)
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                             | ** ** | **June 30,  2006**          | ** ** | **June 24,  2005**        | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
| Net sales                                                              |       | $                                | 257,041    |                           | $          | 227,092 |   | $ | 495,269 |   | $ | 419,610 |   |
| Cost of sales (Note 3)                                                 |       | 92,373                           |       | 87,478                         |       | 179,208 |   | 157,917 |   |
| Gross profit                                                           |       | 164,668                          |       | 139,614                        |       | 316,061 |   | 261,693 |   |
| Selling, general and  administrative                                   |       | 105,389                          |       | 97,596                         |       | 200,828 |   | 181,409 |   |
| Research and  development                                              |       | 16,565                           |       | 13,948                         |       | 33,538 |   | 26,300 |   |
| Business repositioning  (Note 3)                                       |       | 17,720                           |       | —                         |       | 46,974 |   | — |   |
| In-process research and  development                                   |       | —                           |       | 451,450                        |       | — |   | 451,450 |   |
| Operating income (loss)                                                |       | 24,994                           |       | (423,380                       | )          | 34,721 |   | (397,466 | ) |
|                                                                   |       |                             |       |                           |       |   |   |   |   |
| Non-operating expense  (income):                                       |       |                             |       |                           |       |   |   |   |   |
| Interest expense                                                       |       | 8,028                            |       | 8,911                          |       | 12,535 |   | 14,738 |   |
| Unrealized  (gain) loss on derivative instruments                      |       | 2,464                            |       | (458                           | )          | 2,902 |   | (990 | ) |
| Loss due to  early retirement of convertible senior subordinated notes |       | 15,798                           |       | 545                            |       | 15,798 |   | 545 |   |
| Other, net                                                             |       | 544                              |       | (1,413                         | )          | 1,548 |   | (1,742 | ) |
|                                                                   |       | 26,834                           |       | 7,585                          |       | 32,783 |   | 12,551 |   |
| Earning (loss) before  income taxes                                    |       | (1,840                           | )          | (430,965                       | )          | 1,938 |   | (410,017 | ) |
| Provision for income  taxes                                            |       | 863                              |       | 7,150                          |       | 2,012 |   | 14,273 |   |
| Net loss                                                               |       | $                                | (2,703     | )                              | $          | (438,115 | ) | $ | (74 | ) | $ | (424,290 | ) |
|                                                                   |       |                             |       |                           |       |   |   |   |   |
| Net loss per share :                                                   |       |                             |       |                           |       |   |   |   |   |
| Basic and  Diluted                                                     |       | $                                | (0.04      | )                              | $          | (9.53 | ) | $ | — |   | $ | (10.17 | ) |
|                                                                   |       |                             |       |                           |       |   |   |   |   |
| Weighted average number  of shares outstanding:                        |       |                             |       |                           |       |   |   |   |   |
| Basic and  Diluted                                                     |       | 67,166                           |       | 45,965                         |       | 67,694 |   | 41,719 |   |

 

See accompanyingnotes to unaudited consolidated financial statements.

3

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Advanced Medical Optics, Inc.Unaudited Consolidated Balance Sheets(In thousands, except share data)

 
| ** **                                                                                             | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                 |       |                    |       |                        |       |
| Current assets                                                                                         |       |                    |       |                        |       |
| Cash and  equivalents                                                                                  |       | $                       | 40,843     |                        | $          | 40,826 |   |
| Trade  receivables, net                                                                                |       | 231,602                 |       | 238,761                     |       |
| Inventories                                                                                            |       | 118,583                 |       | 104,820                     |       |
| Deferred income  taxes                                                                                 |       | 66,925                  |       | 66,476                      |       |
| Other current  assets                                                                                  |       | 27,129                  |       | 28,122                      |       |
| Income taxes                                                                                           |       | 10,242                  |       | —                      |       |
| Total current  assets                                                                                  |       | 495,324                 |       | 479,005                     |       |
| Property, plant and  equipment, net                                                                    |       | 126,791                 |       | 115,725                     |       |
| Deferred income taxes                                                                                  |       | 12,099                  |       | 12,626                      |       |
| Other assets                                                                                           |       | 63,366                  |       | 52,473                      |       |
| Intangibles assets, net                                                                                |       | 486,125                 |       | 495,609                     |       |
| Goodwill                                                                                               |       | 842,967                 |       | 825,284                     |       |
| Total assets                                                                                           |       | $                       | 2,026,672  |                        | $          | 1,980,722 |   |
|                                                                                                   |       |                    |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                             |       |                    |       |                        |       |
| Current liabilities                                                                                    |       |                    |       |                        |       |
| Short-term  borrowings                                                                                 |       | $                       | 155,000    |                        | $          | 60,000 |   |
| Accounts payable                                                                                       |       | 60,592                  |       | 64,045                      |       |
| Accrued  compensation                                                                                  |       | 43,844                  |       | 43,406                      |       |
| Other accrued  expenses.                                                                               |       | 85,114                  |       | 90,666                      |       |
| Income taxes                                                                                           |       | —                  |       | 1,434                       |       |
| Deferred income  taxes                                                                                 |       | 775                     |       | 565                         |       |
| Total current  liabilities                                                                             |       | 345,325                 |       | 260,116                     |       |
| Long-term debt                                                                                         |       | 871,105                 |       | 500,000                     |       |
| Deferred income taxes                                                                                  |       | 179,427                 |       | 182,179                     |       |
| Other liabilities                                                                                      |       | 30,445                  |       | 28,365                      |       |
| Commitments and  contingencies                                                                         |       |                    |       |                        |       |
| Stockholders’ equity                                                                              |       |                    |       |                        |       |
| Preferred stock,  $.01 par value; 5,000,000 shares authorized; none issued                             |       | —                  |       | —                      |       |
| Common stock,  $.01 par value; 240,000,000 shares authorized; 59,294,365 and 67,832,010  shares issued |       | 593                     |       | 678                         |       |
| Additional  paid-in capital                                                                            |       | 1,394,699               |       | 1,586,864                   |       |
| Accumulated  deficit                                                                                   |       | (819,630                | )          | (557,586                    | )          |
| Accumulated  other comprehensive income (loss)                                                         |       | 24,732                  |       | (19,870                     | )          |
| Less treasury  stock, at cost (1,397 shares)                                                           |       | (24                     | )          | (24                         | )          |
| Total  stockholders’ equity                                                                       |       | 600,370                 |       | 1,010,062                   |       |
| Total liabilities and  stockholders’ equity                                                       |       | $                       | 2,026,672  |                        | $          | 1,980,722 |   |

 

See accompanyingnotes to unaudited consolidated financial statements.

4

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Advanced MedicalOptics, Inc.Unaudited Consolidated Statements of Cash Flows(In thousands)

 
| ** **                                                                                 | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                 | ** ** | **June 30,  2006**        | ** ** | **June 24,  2005** | ** ** |
| Cash flows from  operating activities:                                                     |       |                           |       |   |   |
| Net loss                                                                                   |       | $                              | (74        | ) | $ | (424,290 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                           |       |   |   |
| Amortization of  debt issuance costs                                                       |       | 4,207                          |       | 3,733 |   |
| Depreciation and  amortization                                                             |       | 33,856                         |       | 18,863 |   |
| In-process  research and development                                                       |       | —                         |       | 451,450 |   |
| Loss due to  early retirement of convertible senior subordinated notes                     |       | 15,798                         |       | 545 |   |
| Loss on  investments and assets                                                            |       | 2,481                          |       | 264 |   |
| Tax benefit from  issuance of stock under stock plans                                      |       | —                         |       | 3,520 |   |
| Excess tax  benefits from stock-based compensation                                         |       | (5,458                         | )          | — |   |
| Unrealized loss  (gain) on derivatives                                                     |       | 2,902                          |       | (990 | ) |
| Expense of  compensation plan                                                              |       | 10,262                         |       | 267 |   |
| Changes in  assets and liabilities:                                                        |       |                           |       |   |   |
| Trade  receivables, net                                                                    |       | 13,549                         |       | (15,065 | ) |
| Inventories                                                                                |       | (11,626                        | )          | (24,389 | ) |
| Other current  assets                                                                      |       | (851                           | )          | 3,506 |   |
| Accounts payable                                                                           |       | (6,511                         | )          | (8,631 | ) |
| Accrued expenses  and other liabilities                                                    |       | (3,474                         | )          | (30,039 | ) |
| Income taxes                                                                               |       | (1,110                         | )          | 6,943 |   |
| Other  non-current assets and liabilities                                                  |       | (8,620                         | )          | 4,887 |   |
| Net cash  provided by (used in) operating activities                                       |       | 45,331                         |       | (9,426 | ) |
| Cash flows from  investing activities:                                                     |       |                           |       |   |   |
| Acquisition of  businesses, net of cash acquired                                           |       | —                         |       | (36,867 | ) |
| Additions to  property, plant and equipment                                                |       | (15,140                        | )          | (7,608 | ) |
| Proceeds from  sale of property, plant and equipment                                       |       | —                         |       | 167 |   |
| Additions to  capitalized internal-use software                                            |       | (1,201                         | )          | (7,085 | ) |
| Additions to  demonstration and bundled equipment                                          |       | (5,446                         | )          | (5,391 | ) |
| Net cash used in  investing activities                                                     |       | (21,787                        | )          | (56,784 | ) |
| Cash flows from  financing activities:                                                     |       |                           |       |   |   |
| Short-term  borrowings                                                                     |       | 95,000                         |       | 105,000 |   |
| Repayment of  long-term debt                                                               |       | (144,693                       | )          | (44,495 | ) |
| Financing  related costs                                                                   |       | (10,284                        | )          | (2,959 | ) |
| Proceeds from  issuance of long-term debt                                                  |       | 500,000                        |       | — |   |
| Proceeds from  issuance of common stock                                                    |       | 29,488                         |       | 10,204 |   |
| Net proceeds  from settlement of interest rate swaps                                       |       | —                         |       | 777 |   |
| Repurchase and  retirement of common stock                                                 |       | (500,000                       | )          | — |   |
| Excess tax  benefits from stock-based compensation                                         |       | 5,458                          |       | — |   |
| Net cash (used  in) provided by financing activities                                       |       | (25,031                        | )          | 68,527 |   |
| Effect of exchange  rates on cash and equivalents                                          |       | 1,504                          |       | (2,327 | ) |
| Net increase (decrease)  in cash and equivalents                                           |       | 17                             |       | (10 |   |
| Cash and equivalents at  beginning of period                                               |       | 40,826                         |       | 49,455 |   |
| Cash and equivalents at  end of period                                                     |       | $                              | 40,843     |   | $ | 49,445 |   |
| Supplemental non-cash  investing and financing activities:                                 |       |                           |       |   |   |
| Exchange of  convertible notes into common stock                                           |       | $                              | —     |   | $ | 3,000 |   |
| Acquisition of VISX,  Incorporated                                                         |       | $                              | —     |   | $ | 1,203,185 |   |

 

See accompanyingnotes to unaudited consolidated financial statements.

 

5

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Advanced Medical Optics, Inc.Notes to Unaudited Consolidated Financial Statements

**Note1: Basis of Presentation**

In the opinion ofmanagement, the accompanying unaudited consolidated financial statementscontain all adjustments necessary (consisting only of normal, recurringadjustments) for a fair statement of the financial information containedtherein. These statements do not include all disclosures required byaccounting principles generally accepted in the United States of America forannual financial statements and should be read in conjunction with the auditedconsolidated financial statements of Advanced Medical Optics, Inc. (the “Company”or “AMO”) for the year ended December 31, 2005. The results ofoperations for the three and six months ended June 30, 2006 are not necessarilyindicative of the results to be expected for the year ending December 31,2006.

All material intercompanybalances have been eliminated.

***Stock-BasedCompensation***

AMO has an IncentiveCompensation Plan (“ICP”) that provides for the granting of stock options,restricted stock and restricted stock units to directors, employees andconsultants. The Company has two Employee Stock Purchase Plans (“ESPP”) forUnited States and international employees, respectively, which allow employeesto purchase AMO common stock. A total of 5 million shares of common stock havebeen authorized for issuance under the ICP. Effective January 1, 2006, theCompany adopted Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment” (“SFAS 123R”) as discussed below.

*Adoptionof SFAS 123R*

Prior to January 1, 2006,the Company’s stock-based compensation plans were accounted for under therecognition and measurement provisions of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and thedisclosure only provisions of SFAS 123. Accordingly, no compensationexpense was recorded for stock options granted with exercise prices greaterthan or equal to the fair value of the underlying common stock at the optiongrant date. The fair value, as determined on the date of grant, of restrictedstock awards was recognized as compensation expense ratably over the respectivevesting period. Additionally, the ESPP qualified as non-compensatory plansunder APB 25; therefore, no compensation cost was recorded in relation to thediscount offered to employees for purchases made under the ESPP. In addition,the Company’s unearned compensation balance at January 1, 2006 was reclassifiedto additional paid-in capital upon the adoption of SFAS 123R.

On January 1, 2006, theCompany adopted the fair value recognition provisions of SFAS 123R, requiringrecognition of expenses equivalent to the fair value of stock-basedcompensation awards. The Company has elected to use the modifiedprospective application transition method as permitted by SFAS 123R andtherefore has not restated the financial results reported in priorperiods. Under this transition method, stock-based compensation expensefor the three and six months ended June 30, 2006 includes compensation expensefor all stock-based compensation awards granted prior to, but not yet vested asof January 1, 2006, based on the grant date fair value estimated in accordancewith the original provisions of SFAS 123, as adjusted for estimatedforfeitures. Compensation expense for all stock-based compensation awardsgranted subsequent to January 1, 2006 are based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123R.

Additionally, under SFAS123R, the ESPP is considered a compensatory plan and requires recognition ofcompensation expense for purchases of common stock made under the ESPP. TheCompany recognizes compensation expense for stock option and ESPP awards on astraight-line basis over the vesting period. Compensation expense related tothe restricted stock and restricted stock units is recognized over therequisite service periods of the awards, consistent with the Company’spractices under SFAS 123 prior to January 1, 2006.

6

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*Stock-BasedCompensation Expense*

Total stock-basedcompensation expense included in the unaudited consolidated statements ofoperations for the three and six months ended June 30, 2006 is as follows (inthousands):

 

|                                      | ** ** | **Three Months Ended  June 30, 2006** | ** ** | **Six Months Ended  June 30, 2006** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                                | ** ** | ** **                                              | ** ** |
| Cost of sales                        |       | $                                                         | 617        |                                                    | $          | 1,157 |   |
| Operating  Expenses -                |       |                                                      |       |                                                    |       |
| Research and  development            |       | 577                                                       |       | 1,057                                                   |       |
| Selling, general  and administrative |       | 3,997                                                     |       | 8,048                                                   |       |
|                                 |       | 4,574                                                     |       | 9,105                                                   |       |
| Pre-tax expense                      |       | 5,191                                                     |       | 10,262                                                  |       |
| Income tax benefit                   |       | (1,704                                                    | )          | (3,387                                                  | )          |
| Net of tax expense                   |       | $                                                         | 3,487      |                                                    | $          | 6,875 |   |

 

At June 30, 2006, totalpre-tax compensation costs related to unvested stock-based awards granted toemployees and directors under the Company’s stock option plan, ESPP andrestricted stock awards which are not yet recognized were approximately $36.6million, net of estimated forfeitures. These costs are expected to berecognized over a weighted-average period of 3.0 years.

Net cash proceeds fromthe exercise of stock options were $27.1 million and $8.1 million for the sixmonth periods ended June 30, 2006 and June 24, 2005, respectively. Inaccordance with SFAS 123R, the cash flows resulting from excess tax benefits(tax benefits related to the excess of proceeds from employees exercises of stockoptions over the stock-based compensation cost recognized for those options)are classified as financing cash flows in the Company’s  unaudited consolidated statement of cashflows. During the six months ended June 30, 2006, the Company recorded$5.5 million of excess tax benefits as a financing cash inflow. Prior to theadoption of SFAS 123R, excess tax benefits of $3.5 million during the sixmonths ended June 24, 2005 were classified as an operating cash inflow.

The Company issues newshares to satisfy option exercises.

*Determining Fair Value*

Valuation Method - The Company estimates thefair value of stock options granted and ESPP purchase rights using theBlack-Scholes option-pricing model and a single option award approach.

Expected Term - The expected term representsthe period the Company’s stock-based awards are expected to be outstanding andwas determined based on historical experience with similar awards, givingconsideration to the contractual terms of the stock-based awards, vestingschedules and expectations of future employee behavior as influenced by changesto the terms of its stock-based awards.

Expected Volatility*-*The computation of expected volatility is based on acombination of historical and market-based implied volatility.  Implied volatility is based on publiclytraded options of the Company’s common stock with a term of one year orgreater.

Risk-Free Interest Rate - The risk-freeinterest rate used in the Black-Scholes valuation method is based on theimplied yield currently available on U.S. Treasury securities with anequivalent remaining term.

Expected Dividend - No dividends are expectedto be paid.

Estimated Forfeitures -When estimating forfeitures, the Company considers voluntary terminationbehavior as well as analysis of actual option forfeitures.

7

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The fair value ofthe Company’s stock based compensation granted to employees for the three andsix months ended June 30, 2006 was estimated using the followingweighted-average assumptions:

 

|                              | ** ** | **Incentive  Compensation  Plans** | ** ** | **Employee  Stock  Purchase  Plans** | ** ** |
|------------------------------|------------|------------------------------------|------------|--------------------------------------|------------|
| Expected life in  years      |       | 6.1                                |       | 0.5                                  |       |
| Expected  volatility         |       | 28.9                               | %          | 32.9                                 | %          |
| Risk-free  interest rate     |       | 5.0                                | %          | 5.0                                  | %          |
| Expected  dividends          |       | —                             |       | —                               |       |
| Weighted average fair  value |       | $                                  | 17.66      |                                 | $          | 11.51 |   |
|                              |            |                                    |            |                                      |            |  |  |

 

*Stock Options*

Stock options granted toemployees are generally exercisable at a price equal to the fair market valueof the common stock on the date of the grant and vest at a rate of 25% per yearbeginning twelve months after the date of grant. Grants under these plans expireten years from the date of grant.

The following is asummary of stock option activity (in thousands, except per share amounts):

 

|                                               | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term in Years** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding at  December 31, 2005             |       | 8,858                      |       | $                                          | 22.79      |                                                                   |       |                                |       |   |
| Granted                                       |       | 634                        |       | 45.26                                      |       |                                                                   |       |                                |       |
| Exercised                                     |       | (1,264                     | )          | 21.41                                      |       |                                                                   |       |                                |       |
| Forfeitures and  cancellations                |       | (60                        | )          | 31.44                                      |       |                                                                   |       |                                |       |
| Expirations                                   |       | (6                         | )          | 19.97                                      |       |                                                                   |       |                                |       |
| Outstanding at  June 30, 2006                 |       | 8,162                      |       | $                                          | 24.69      |                                                                   | 6.6        |                                | $          | 212,270 |   |
| Vested and  expected to vest at June 30, 2006 |       | 8,044                      |       | $                                          | 24.57      |                                                                   | 6.7        |                                | $          | 210,188 |   |
| Exercisable at June 30,  2006                 |       | 5,448                      |       | $                                          | 20.58      |                                                                   | 5.9        |                                | $          | 164,083 |   |

 

The aggregate intrinsicvalue in the table above represents the difference between the exercise priceof the underlying awards and the quoted price of the company’s common stock forthe options that were in-the-money at June 30, 2006. During the six monthsended June 30, 2006, the aggregate intrinsic value of options exercised underthe Company’s stock option plans was $30.3 million determined as of the date ofoption exercise.

*Employee Stock Purchase Plans*

Under the ESPP, eligibleemployees may authorize payroll deductions of up to 10% of their regular basesalary to purchase shares at the lower of 85% of the closing price of theCompany’s common stock on the first or last day of the six-month purchaseperiod. In the second quarter of 2006, 78,000 shares of common stock wereissued under the ESPP in the aggregate amount of $2.4 million as the mostrecent purchase period ended on April 28, 2006. As of June 30, 2006 employeewithholdings under the ESPP aggregated $0.8 million.

*Restricted Stock*

Restricted stock awardsare granted at a price equal to the fair market value of the common stock onthe date of the grant, subject to forfeiture if employment terminates prior tothe release of restrictions, which is generally three years from the date ofgrant. During this restriction period, ownership of the shares cannot betransferred. Restricted stock has the same cash dividend and voting rightsas other common stock and is considered to be currently issued andoutstanding. The cost of the awards, determined to be the fair marketvalue of the shares at the date of grant, is expensed ratably over the periodthe restrictions lapse.

8

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The following tablesummarizes the restricted stock award activity for the six months ended June30, 2006 (in thousands, except per share amounts):

 

|                                       | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|---------------------------------------|------------|----------------------------|------------|---------------------------------------------------------|------------|
| Nonvested stock  at December 31, 2005 |       | 101                        |       | $                                                       | 38.79      |   |
| Granted                               |       | 275                        |       | 49.67                                                   |       |
| Vested                                |       | (37                        | )          | 38.23                                                   |       |
| Forfeited                             |       | (2                         | )          | 38.43                                                   |       |
| Nonvested stock at June  30, 2006     |       | 337                        |       | $                                                       | 47.73      |   |

 

*Performance-BasedAwards*

In February 2006, theCompany’s Board of Directors approved a 2006 performance award program underthe Company’s incentive compensation plan (the “2006 Program”), which providesthe opportunity for certain executives to earn long-term incentive compensationawards based upon specified measures. The potential maximum aggregate awardvalue for the 2006 program is $2.7 million. The award determination will bebased upon the Total Shareholder Return (“TSR”) (the increase or decrease inthe Company’s common stock price) over a two-year period beginning January 1,2005 compared to a peer group composed of various entities within thebio-technology and medical device industries. Awards will have been determinedto be earned if the Company’s TSR is in excess of the 50th percentile of thepeer group. When the TSR equals the 75th percentile of the peer group, themaximum amount will have been earned. Awards are to be settled in a number ofrestricted stock shares or units equal to the value of the award amount dividedby the fair market value of the Company’s common stock on the date theperformance criteria is deemed to have been met. The restricted stock shares orunits will have the same terms and conditions as other restricted shares orunits issued under the Company’s ICP. The estimated fair value of the 2006Program was $0.8 million on the grant date using a lattice-based valuationmodel. Compensation expense is being recognized over a four-year period fromthe program approval date through the end of the expected vesting period of therestricted stock awards. The associated compensation expense during the threemonths and six months ended June 30, 2006 was less than $0.1 million.

*Pro-formaDisclosures under SFAS 123 for Periods Prior to Fiscal 2006*

The following tableillustrates the effect on net loss and net loss per share as if the Company hadapplied the fair value recognition provisions of SFAS 123 to stock-basedcompensation during the three and six months period ended June 24, 2005 (inthousands, except per share amounts):

 

|                                                                                        | ** ** | **Three Months Ended  June 24, 2005** | ** ** | **Six Months Ended  June 24, 2005** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Net loss, as  reported                                                                 |       | $                                                         | (438,115   | )                                                       | $          | (424,290 | ) |
| Stock-based  compensation expense included in reported net earnings, net of tax        |       | 119                                                       |       | 163                                                     |       |
| Stock-based  compensation expense determined under fair value based method, net of tax |       | (2,579                                                    | )          | (4,876                                                  | )          |
| Pro forma net  loss                                                                    |       | $                                                         | (440,575   | )                                                       | $          | (429,003 | ) |
| Loss per share  as reported:                                                           |       |                                                      |       |                                                    |       |
| Basic and diluted                                                                      |       | $                                                         | (9.53      | )                                                       | $          | (10.17 | ) |
| Pro forma loss  per share:                                                             |       |                                                      |       |                                                    |       |
| Basic and  diluted                                                                     |       | $                                                         | (9.59      | )                                                       | $          | (10.28 | ) |

 

For the purpose ofthe weighted average estimated fair value calculations, the fair value of theCompany’s stock based compensation granted to employees for the three and sixmonths ended June 24, 2005 was estimated using the following weighted-averageassumptions:

 

|                              | ** ** | **Incentive  Compensation  Plans** | ** ** | **Employee   Stock  Purchase  Plans** | ** ** |
|------------------------------|------------|------------------------------------|------------|--------------------------------------------|------------|
| Expected life in  years      |       | 5.0                                |       | 0.5                                        |       |
| Expected  volatility         |       | 36.0                               | %          | 44.13                                      | %          |
| Risk-free  interest rate     |       | 3.8                                | %          | 3.2                                        | %          |
| Expected  dividends          |       | —                             |       | —                                     |       |
| Weighted average fair  value |       | $                                  | 14.49      |                                       | $          | 9.84 |   |
|                              |            |                                    |            |                                            |            |  |  |

 

9

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**Note 2: Acquisition of VISX,Incorporated (VISX)**

On May 27, 2005,pursuant to the Agreement and Plan of Merger (Merger Agreement), dated as ofNovember 9, 2004, as amended, by and among AMO, Vault Merger Corporation,a wholly owned subsidiary of AMO, and VISX, AMO completed its acquisition ofVISX, for total consideration of approximately $1.38 billion, consisting ofapproximately 27.8 million shares of AMO common stock, the fair value ofVISX stock options converted to AMO stock options and approximately $176.2million in cash (VISX Acquisition). VISX products include the *VISX STAR*Excimer Laser System, the *VISX WaveScan*System and *VISX* treatment cards. As a result of theVISX Acquisition, the Company became a leader in the design and development ofproprietary technologies and systems for laser vision correction of refractivevision disorders.

The VISX Acquisition hasbeen accounted for as a purchase business combination. Under the purchasemethod of accounting, the assets acquired and liabilities assumed are recordedat the date of acquisition at their respective fair values.

The following unauditedpro forma information assumes the VISX Acquisition occurred on January 1,2005. These unaudited pro forma results have been prepared for informationalpurposes only and do not purport to represent what the results of operationswould have been had the VISX Acquisition occurred as of the date indicated, norof future results of operations. The unaudited pro forma results for the threeand six months ended June 24, 2005 are as follows (in thousands, except pershare data):

 

|                         | ** ** | **Three Months Ended  June 24, 2005** | ** ** | **Six Months Ended  June 24, 2005** | ** ** |
|-------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Net sales:              |       |                                                      |       |                                                    |       |
| Cataract/Implant        |       | $                                                         | 127,726    |                                                    | $          | 244,456 |   |
| Laser Vision Correction |       | 45,123                                                    |       | 98,404                                                  |       |
| Eye Care                |       | 83,073                                                    |       | 156,919                                                 |       |
|                    |       | $                                                         | 255,922    |                                                    | $          | 499,779 |   |
| Net earnings (1)        |       | 3,968                                                     |       | 27,235                                                  |       |
| Earnings per  share:    |       |                                                      |       |                                                    |       |
| Basic (2)               |       | $                                                         | 0.06       |                                                    | $          | 0.42 |   |
| Diluted (3)             |       | $                                                         | 0.06       |                                                    | $          | 0.40 |   |

 

----

(1)             Theunaudited pro forma information for the three months and six months ended June24, 2005 includes a $6.6 million and a $13.3 million increase in amortizationrelated to management’s estimate of the fair value of intangible assetsacquired as the result of the VISX Acquisition and a $2.8 million and $5.7million increase in interest expense resulting from additional borrowingsincurred to fund the cash portion of the VISX Acquisition and related costs andamortization of deferred financing costs.

(2)             Theweighted average number of shares outstanding used for the computation of basicearnings per share for the three and six months ended June 24, 2005 reflectsthe issuance of 27.8 million shares of AMO’s common stock to VISXstockholders.

(3)             Theweighted average number of shares outstanding used for the computation ofdiluted earnings per share for the three and six months ended June 24, 2005reflects the issuance of 27.8 million shares of AMO’s common stock to VISXshareholders and the dilutive effect of approximately 3.4 million shares and3.5 million shares of VISX options exchanged for AMO stock options.

**Note3:  Product Rationalization and BusinessRepositioning**

OnOctober 31, 2005, the Company’s Board of Directors approved a productrationalization and repositioning plan covering the discontinuation ofnon-strategic cataract surgical and eye care products and the elimination orredeployment of resources that support these product lines. The plan alsoincludes organizational changes and potential reductions in force inmanufacturing, sales and marketing associated with these product lines, as wellas organizational changes in research and development and other corporatefunctions designed to align the organization with our strategy and strategicbusiness unit organization.

Theplan further calls for increasing the Company’s investment in key growthopportunities, specifically the Company’s refractive implant product line andinternational laser vision correction business, and accelerating theimplementation of productivity initiatives. Following an analysis of itsIOL manufacturing capabilities in the second quarter of 2006, the Company hasdecided to consolidate certain operations. In addition, the Company expandedthe scope of its eye care rationalization initiatives in order to maximize manufacturingcapacity and seize growth opportunities. Total cumulative charges of $99.8 million have been incurred throughJune 30, 2006.

10

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Certainforeign jurisdictions have laws and regulations which require consultations andnegotiations with works councils, labor organizations and local authorities.The outcome of these discussions will determine, in part, the restructuringsteps to be implemented and the associated costs. Therefore, the final costs ofthe business repositioning plan may be significantly different from the Company’sinitial estimates.

Inthe three months ended June 30, 2006, the Company incurred $25.1 million ofpre-tax charges, which included $7.4 million for inventory, manufacturingrelated and other charges included in cost of sales and $17.7 million includedin operating expenses. Charges included in operating expenses comprisedseverance, relocation and other one-time termination benefits of $11.9 million,productivity and brand repositioning costs of $4.9 million, asset write-downsof $0.7 million and contractual obligations of $0.2 million.  In the six months ended June 30, 2006, theCompany incurred $57.5 million of pre-tax charges, which included $10.5 millionfor inventory, manufacturing related and other charges included in cost ofsales and $47.0 million included in operating expenses. Charges included inoperating expenses comprised productivity and brand repositioning costs of$31.1 million, severance, relocation and other one-time termination benefits of$13.5 million, asset write-downs of $2.1 million and contractual obligations of$0.3 million

Businessrepositioning charges and related activity in the accrual balances during thesix months ended June 30, 2006 were as follows (in thousands):

 
| **Business Repositioning Costs Reported In:** | ** ** | **Balance at  December 31,  2005** | ** ** | **Costs  Incurred** | ** ** | **Cash  Payments** | ** ** | **Non-Cash  Adjustments** | ** ** | **Balance at  June 30,  2006** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------------|------------|------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                   | ** ** | ** **          | ** ** | ** **         | ** ** | ** **                | ** ** | ** **                               | ** ** |
| Cost of sales -                                                   | ** ** | ** **                                   | ** ** | ** **          | ** ** | ** **         | ** ** | ** **                | ** ** | ** **                               | ** ** |
| Inventory, manufacturing and other charges                        |       | $                                            | —     |                | $          | 10,513             |       | $                         | —     |                                     | $          | (10,513 | ) | $ | — |   |
| Operating  Expenses -                                             |       |                                         |       |                |       |               |       |                      |       |                                     |       |
| Severance,  relocation and related costs                          |       | 8,779                                        |       | 13,497              |       | (9,972             | )          | —                    |       | 12,304                                   |       |
| Asset  write-downs                                                |       | —                                       |       | 2,096               |       | —             |       | (2,096                    | )          | —                                   |       |
| Contractual  obligations                                          |       | 2,641                                        |       | 250                 |       | (141               | )          | —                    |       | 2,750                                    |       |
| Productivity  initiatives and brand repositioning costs           |       | 883                                          |       | 31,131              |       | (29,641            | )          | —                    |       | 2,373                                    |       |
|                                                              |       | 12,303                                       |       | 46,974              |       | (39,754            | )          | (2,096                    | )          | 17,427                                   |       |
|                                                              |       | $                                            | 12,303     |                | $          | 57,487             |       | $                         | (39,754    | )                                        | $          | (12,609 | ) | $ | 17,427 |   |

 

Productivityinitiatives and brand repositioning costs resulted from the Company’sinvestment in key growth opportunities, specifically the Company’s refractiveimplant product line, international laser vision correction business andexpanded eye care rationalization, and the implementation of productivityimprovements in manufacturing operations, distribution, customer service andcorporate functions. Severance, relocation and related costs were incurred forworldwide workforce reductions due to the Company’s discontinuing certainnon-core products and infrastructure and process improvements associated withthe Company’s productivity initiatives. The majority of these costs in thethree and six months ended June 30, 2006 occurred in Europe. Asset write-downsresulted from the impairment and disposal of long-lived assets from thereduction in expected future cash flows from certain discontinued non-coreproducts and relocation of certain facilities. The fair values of impairedassets were based on probability weighted expected cash flows as determined inaccordance with Statement of Financial Accounting Standards No. 144, “Accountingfor the Impairment or Disposal of Long-lived Assets”.

**Note 4:Composition of Certain Financial Statement Captions**

***Inventories***:

 

| (In thousands)                                                                                     | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Finished goods,  including consignment inventory of $14,956 and $11,890 in 2006 and 2005,  respectively |       | $                       | 79,837     |                        | $          | 66,492 |   |
| Work in process                                                                                         |       | 13,101                  |       | 13,148                      |       |
| Raw materials                                                                                           |       | 25,645                  |       | 25,180                      |       |
|                                                                                                    |       | $                       | 118,583    |                        | $          | 104,820 |   |

 

11

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***Intangible assets, net***

 

|                                  | ** ** | ** **                    | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|-------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **(In thousands)**          | ** ** | **Useful  Life (Years)** | ** ** | **Gross  Amount**           | ** ** | **Accumulated  Amortization**   | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortizable  Intangible Assets:  |       |                          |       |                        |       |                            |       |   |   |   |   |
| Licensing                        |       | 3 — 5                    |       | $                           | 4,590      |                            | $          | (4,178 | ) | $ | 4,590 |   | $ | (4,113 | ) |
| Technology  rights               |       | 8 — 19                   |       | 358,698                     |       | (44,294                         | )          | 348,379 |   | (26,128 | ) |
| Trademarks                       |       | 13.5                          |       | 16,144                      |       | (2,782                          | )          | 14,689 |   | (1,995 | ) |
| Customer  relationships          |       | 5                             |       | 22,400                      |       | (4,853                          | )          | 22,400 |   | (2,613 | ) |
|                             |       |                          |       | 401,832                     |       | (56,107                         | )          | 390,058 |   | (34,849 | ) |
| Nonamortizable  Tradename (VISX) |       | Indefinite                    |       | 140,400                     |       | —                          |       | 140,400 |   | — |   |
|                             |       |                          |       | $                           | 542,232    |                            | $          | (56,107 | ) | $ | 530,458 |   | $ | (34,849 | ) |

 

The amortizable intangible assets balanceincreased due to the impact of foreign currency fluctuation. Amortizationexpense was $10.2 million and $19.9 million for the three and six months endedJune 30, 2006, $4.7 million and $7.6 million for the three and six months endedJune 24, 2005, respectively, and is recorded in selling, general andadministrative in the accompanying unaudited consolidated statements ofoperations. Amortization expense is expected to be $39.7 million in 2006, $38.5million in 2007 and 2008, $38.3 million in 2009 and $35.7 million in 2010.Actual amortization expense may vary due to the impact of foreign currencyfluctuations.

***Goodwill***

| (In thousands)     | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Goodwill:               |       |                    |       |                        |       |
| Eye Care                |       | $                       | 29,555     |                        | $          | 28,817 |   |
| Cataract/Implant        |       | 338,915                 |       | 317,451                     |       |
| Laser Vision Correction |       | 474,497                 |       | 479,016                     |       |
|                    |       | $                       | 842,967    |                        | $          | 825,284 |   |

 

Effective January 1,2006, the Company’s reportable segments are represented by three businessunits: Cataract/Implant, Laser Vision Correction and Eye Care (See Note 9, “BusinessSegment Information”). The changein goodwill during the six months ended June 30, 2006 is due to an adjustmentof Laser Vision Correction goodwill of $4.5 million as a result of excess taxbenefits from the exercise of converted VISX stock options that were fullyvested at the acquisition date and the impact of foreign currency fluctuationson the Eye Care and Cataract/Implant segments. The Company performed its annual impairment test of goodwill during thesecond quarter of 2006 and determined there was no impairment.

**Note 5:Debt**

At June 30, 2006, anaggregate principal amount of $251.1 million of 21⁄2 % convertible seniorsubordinated notes due July 15, 2024 (“21⁄2 % Notes”), an aggregateprincipal amount of $120.0 million of 1.375% convertible senior subordinatednotes due July 1, 2025 (“1.375% Notes”), an aggregate principal amount of$500.0 million of 3.25% of convertible senior subordinated notes due 2026 (“3.25%Notes”), and a balance of $155.0 million under the senior revolving creditfacility were outstanding. The convertible notes may be converted, at theoption of the holders, on or prior to the final maturity date under certaincircumstances, none of which had occurred as of June 30, 2006. Upon conversionof the convertible notes, the Company will satisfy in cash the conversionobligation with respect to the principal amount of the convertible notes, withany remaining amount of the conversion obligation to be satisfied in shares ofcommon stock. As a result of this election, the Company also is required tosatisfy in cash its obligations to repurchase any convertible notes thatholders may put to the Company on January 15, 2010, July 15,2014 and July 15, 2019 for the 21⁄2 % Notes, on July 1, 2011, July 1, 2016and July 1, 2021 for the 1.375% Notes, and on August 1, 2014, August 1, 2017,and August 1, 2021 for the 3.25% Notes.

At June 30, 2006,approximately $8.6 million of the senior revolving credit facility was reservedto support letters of credit issued on the Company’s behalf for normaloperating purposes and the Company has approximately $146.4 million undrawn andavailable revolving loan commitments.

Borrowings under therevolving credit facility, if any, bear interest at current market rates plus amargin based upon the Company’s ratio of debt to EBITDA, as defined. Theincremental interest margin on borrowings under the revolving credit facilitydecreases as the Company’s ratio of debt to EBITDA decreases to specifiedlevels. Under the senior credit facility, certain transactions may triggermandatory prepayment of borrowings, if any. Such transactions may includeequity or debt offerings, certain asset sales and extraordinary receipts. TheCompany pays a quarterly fee (2.95% per annum at June 30, 2006) on the averagebalance of outstanding letters of credit and a quarterly commitment fee (0.50%per annum at June 30, 2006) on the average unused portion of the revolvingcredit facility.

12

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The senior creditfacility provides that the Company will maintain certain financial andoperating covenants which include, among other provisions, maintaining specificleverage and coverage ratios. Certain covenants under the senior creditfacility may limit the incurrence of additional indebtedness. The senior creditfacility prohibits dividend payments. The Company was in compliance with thesecovenants at June 30, 2006. The senior credit facility is collateralized by afirst priority perfected lien on, and pledge of, all of the combined Company’spresent and future property and assets (subject to certain exclusions), 100% ofthe stock of the domestic subsidiaries, 66% of the stock of foreignsubsidiaries and all present and future intercompany debts.

As of June 30, 2006, theaggregate maturities of total long-term debt of $871.1 million are due after2010. Revolving loan borrowings of $155.0 million at June 30, 2006 have beenclassified as current liabilities in the accompanying unaudited  consolidated balance sheet.

***3.25%Convertible Senior Subordinated Notes Due 2026***

In June 2006, theCompany completed a private placement of $500 million aggregate principalamount of its 3.25% Notes due August 1, 2026. Interest on the 3.25% Notes is payable on February 1 and August 1 ofeach year, commencing on February 1, 2007. The 3.25% Notes are convertible into 16.7771 shares of the Company’scommon stock for each $1,000 principal amount of the 3.25% Notes (whichrepresents an initial conversion price of approximately $59.61 per share),subject to adjustment. The 3.25% Notes may be converted, at the option of theholders, into cash or under certain circumstances, cash and shares of theCompany’s common stock at any time on or prior to the trading day precedingJuly 1, 2014, only under the following circumstances:

·                  during the fivebusiness days after any five consecutive trading-day period in which thetrading price per $1,000 principal amount of the 3.25% Notes for each day ofsuch measurement period was less than 98% of the conversion value.  This conversion feature represents anembedded derivative.  However, based onthe de minimis value associated with this feature, no value was assigned atissuance and at June 30, 2006;

·                  during anyfiscal quarter subsequent to September 30, 2006, if the closing sale price ofthe Company’s common stock measured over a specified number of trading days isabove 130% of the conversion  then ineffect;

·                  if a fundamentalchange occurs; or

·                  upon theoccurrence of specified corporate transactions.

On and after July1, 2014, to (and including) the trading day preceding the maturity date,subject to prior redemption or repurchase, the 3.25% Notes will be convertibleinto cash and, if applicable, shares of the Company’s common stock regardlessof the foregoing circumstances.

The Company mayredeem some or all of the 3.25% Notes for cash, on or after August 4, 2014, fora price equal to 100% of the principal amount plus accrued and unpaid interest,including contingent interest, if any, to, but excluding the redemption date.

The 3.25% Notescontain put options, which may require the Company to repurchase in cash all ora portion of the 3.25% Notes on August 1, 2014, August 1, 2017, and August 1,2021 at a repurchase price equal to 100% of the principal amount plus accruedand unpaid interest, including contingent interest, if any, to, but excludingthe repurchase date.

Beginning with thesix-month interest period commencing August 1, 2014, the Company will paycontingent interest during any six-month interest period if the trading priceof the 3.25% Notes for each of the five trading-days ending on the secondtrading day immediately preceding the first day of the applicable six-monthinterest period equals or exceeds 120% of the principal amount of the 3.25%Notes.  The contingent interest payablewill equal 0.25% of the average trading price of $1,000 principal amount of the3.25% Notes during the five trading days immediately preceding the first day ofthe applicable six-month interest period. This contingent interest payment feature represents an embeddedderivative.  However, based on the deminimis value associated with this feature, no value has been assigned atissuance and at June 30, 2006.

On or prior toAugust 1, 2014, upon the occurrence of a fundamental change, under certaincircumstances, the Company will provide for a make whole amount by increasing,for the time period described herein, the conversion rate by a number ofadditional shares for any conversion of the 3.25% Notes in connection with suchfundamental change transactions.  Theamount of additional shares will be determined based on the price paid pershare of the Company’s common stock in the transaction constituting afundamental change and the effective date of such transaction. This make wholepremium feature represents an embedded derivative.  However, based on the de minimis valueassociated with this feature, no value has been assigned at issuance and atJune 30, 2006.

13

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In connection with the sale of the 3.25% Notes, theCompany entered into a registration rights agreement with the initialpurchasers of the 3.25% Notes. Under the registration rights agreement, theCompany has agreed to use its reasonable best efforts to file with theSecurities and Exchange Commission within 90 days of the date thereof a shelfregistration statement with respect to the resale of the 3.25% Notes and theshares of AMO common stock, if any, issuable upon conversion of the Notes, andto have the shelf registration statement declared effective within 180 daysafter the original issuance of the notes. If the Company fails to comply withcertain of its obligations under the registration rights agreement, it will berequired to pay additional interest on the notes.

In addition, theCompany entered into an accelerated share repurchase arrangement with a thirdparty to use the proceeds from the issuance of the 3.25% Notes to purchase$500.0 million of AMO common stock at a volume weighted price per share overthe term of the agreement. As of June 30, 2006, the third party had deliveredto the Company in the aggregate, 10.1 million shares of AMO common stockwith future delivery of up to an additional 1.2 million shares, resulting in atotal of up to 11.3 million shares, depending on the volume weighted averageshare price per share during a calculation period beginning June 14, 2006 andending no later than March 7, 2007. Repurchased shares were retired upondelivery to the Company. The Company also repurchased $128.9 million ofaggregate principal amount of convertible senior subordinated notes ($98.9million of the principal amount of the 2.5% Notes and $30.0 million of theprincipal amount of the 1.375% Notes) utilizing borrowings under its seniorcredit facility. The Company incurred a loss on debt extinguishment of $15.8million and wrote-off debt issuance costs of $2.4 million in the three monthsended June 30, 2006 in conjunction with the note repurchases.

**Note 6: Related PartyTransactions**

As of June 30, 2006, aninterest-free relocation loan of $0.5 million, collateralized by real property,was outstanding from the chief executive officer. The principal amount of theloan is payable upon the earlier to occur of (a) 60 days following the chiefexecutive officer’s termination of employment; (b) the date of the sale orother transfer of the property or (c) July 3, 2007. This relocation loan isevidenced by a promissory note dated July 3, 2002, prior to the adoption of theSarbanes-Oxley Act of 2002.

**Note 7:Earnings Per Share**

Basic earnings per shareis calculated by dividing net earnings by the weighted average number of commonshares outstanding during the period. Diluted earnings per share is calculatedby adjusting net earnings and the weighted average outstanding shares, assumingthe conversion of all potentially dilutive convertible securities, stockoptions and stock purchase plan awards.

Statement of FinancialAccounting Standards No. 128, “Earnings per Share,” requires that stockoptions, nonvested shares and similar equity instruments granted by the Companybe treated as potential common shares outstanding in computing diluted earningsper share. Diluted shares outstanding include the dilutive effect ofin-the-money options which is calculated based on the average market price ofthe Company’s common stock for each fiscal period using the treasury stockmethod. Under the treasury stock method, the amount the employee must pay forexercising stock options, the amount of compensation cost for future servicethat the Company has not yet recognized, and the amount of tax benefits thatwould be recorded in additional paid-in capital when the award becomesdeductible are assumed to be used to repurchase shares.

The three and six monthperiods ended June 30, 2006 exclude the aggregate dilutive effect ofapproximately 2.4 million shares for stock options, ESPP and unvestedrestricted stock as the effect would be antidilutive due to the net loss ineach of these periods.  The three and sixmonth periods ended June 24, 2005 exclude the aggregate dilutive effect ofapproximately 2.7 million shares for stock options, ESPP unvested restrictedstock and 3.5% convertible senior subordinated notes as the effect would beantidilutive due to the net loss in each of these periods.

The Company will settlein cash the principal amount of the 2 1⁄2% Notes, 1.375% Notes, and the3.25% Notes. In addition, there were no potentially dilutive common sharesassociated with the 2 1⁄2% Notes, the 1.375% Notes, and the 3.25% Notes asthe Company’s average stock prices during the three and six months ended June30, 2006 were less than the conversion prices of the respective notes.

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**Note 8: Other ComprehensiveIncome (Loss)**

The following tablesummarizes the components of comprehensive income (loss) (in thousands):

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **June 30, 2006**      | ** ** | **June 24, 2005** | ** ** |
| ** **                                | ** ** | **Before-tax  amount**           | ** ** | **Income  tax** | ** ** | **Net-of-tax  amount** | ** ** | **Before-tax  amount** | ** ** | **Income  Tax** | ** ** | **Net-of-tax  amount** | ** ** |
|                                      |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized loss  on derivatives           |       | $                                | —     |   | $ | — |   | $ | — |   | $ | (563 | ) | $ | 192 |   | $ | (371 | ) |
| Foreign currency  translation adjustments |       | 37,023                           |       | — |   | 37,023 |   | (42,977 | ) | — |   | (42,977 | ) |
| Net loss                                  |       |                             |       |   |   | (2,703 | ) |   |   |   |   | (438,115 | ) |
| Total comprehensive  income (loss)        |       |                             |       |   |   | $ | 34,320 |   |   |   |   |   | $ | (481,463 | ) |
|                                           |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 
| ** **                                | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **June 30, 2006**    | ** ** | **June 24, 2005** | ** ** |
| ** **                                | ** ** | **Before-tax  amount**         | ** ** | **Income  tax** | ** ** | **Net-of-tax  amount** | ** ** | **Before-tax  amount** | ** ** | **Income  Tax** | ** ** | **Net-of-tax  amount** | ** ** |
|                                      |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized gain  on derivatives           |       | $                              | —     |   | $ | — |   | $ | — |   | $ | 454 |   | $ | (151 | ) | $ | 303 |   |
| Foreign currency  translation adjustments |       | 44,603                         |       | — |   | 44,603 |   | (75,565 | ) | — |   | (75,565 | ) |
| Net loss                                  |       |                           |       |   |   | (74 | ) |   |   |   |   | (424,290 | ) |
| Total comprehensive  income (loss)        |       |                           |       |   |   | $ | 44,529 |   |   |   |   |   | $ | (499,552 | ) |
|                                           |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 9:Business Segment Information**

The operating segmentsare segments for which separate financial information is available and uponwhich operating results are evaluated on a timely basis to assess performanceand to allocate resources.

Through 2005, the Company’sreportable segments were based on geographic regions which comprised theAmericas, which included North and South America, Europe/Africa/Middle East,Japan and Asia Pacific, which excluded Japan and included New Zealand andAustralia.

Effective January 1,2006, the Company’s reportable segments are represented by three businessunits: Cataract/Implant, Laser Vision Correction and Eye Care. Sales andoperating results for the prior period have been conformed to reflect thecurrent period presentation of reportable segments. The cataract/implantsegment markets four key products required for cataract surgery — foldableintraocular lenses, or IOLs, implantation systems, phacoemulsification systemsand viscoelastics. The laser vision correction segment markets laser systems,diagnostic devices, treatment cards and microkeratomes for use in laser eyesurgery. The eye care segment provides a full range of contact lens careproducts for use with most types of contact lenses. These products includesingle-bottle, multi-purpose cleaning and disinfecting solutions, hydrogenperoxide-based disinfecting solutions, daily cleaners, enzymatic cleaners,contact lens rewetting drops and, in Europe and Asia, contact lenses.

The Company evaluatessegment performance based on operating income (loss) excluding certain costssuch as business repositioning costs, non-recurring acquisition-related costsand stock-based compensation expense. Research and development costs,manufacturing variances, inventory provision/repricing costs and supply chaincosts are managed on a global basis and are considered corporate costs. TheCompany presents the measure which management believes is determined inaccordance with the measurement principles consistent with those used inmeasuring the corresponding amounts in the unaudited consolidated financialstatements. Because operating segments are generally defined by the productsthey design and sell, they do not make sales to each other. Depreciation andamortization related to the manufacturing of goods is included in gross profit.The Company does not discretely allocate assets to its operating segments, nordoes the Company’s chief operating decision maker evaluate operating segmentsusing discrete asset information.

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**Business Segments**

 
| ** **                | ** ** | **Net Sales**               | ** ** | **Operating Income (Loss)** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **Three Months Ended** | ** ** | **Three Months Ended**      | ** ** |
| **(In thousands)**   | ** ** | **June 30,  2006**          | ** ** | **June 24,  2005**               | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
| Operating  segments:      |       |                             |       |                                  |       |   |   |   |   |
| Cataract/Implant          |       | $                                | 134,421    |                                  | $          | 127,726 |   | $ | 70,440 |   | $ | 55,896 |   |
| Laser Vision Correction   |       | 53,401                           |       | 16,293                                |       | 32,895 |   | 3,925 |   |
| Eye Care                  |       | 69,219                           |       | 83,073                                |       | 28,452 |   | 29,169 |   |
| Total segments            |       | 257,041                          |       | 227,092                               |       | 131,787 |   | 88,990 |   |
| Manufacturing  operations |       | —                           |       | —                                |       | (1,747 | ) | (455,111 | ) |
| Research and  development |       | —                           |       | —                                |       | (15,988 | ) | (14,657 | ) |
| Business  repositioning   |       | —                           |       | —                                |       | (22,187 | ) | — |   |
| Global supply  chain      |       | —                           |       | —                                |       | (15,970 | ) | (11,721 | ) |
| General  corporate        |       | —                           |       | —                                |       | (50,901 | ) | (30,881 | ) |
| Total                     |       | $                                | 257,041    |                                  | $          | 227,092 |   | $ | 24,994 |   | $ | (423,380 | ) |

 

 
| ** **                | ** ** | **Net Sales**             | ** ** | **Operating Income (Loss)** | ** ** |
|---------------------------|------------|--------------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **Six Months Ended** | ** ** | **Six Months Ended**        | ** ** |
| **(In thousands)**   | ** ** | **June 30,  2006**        | ** ** | **June 24,  2005**               | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
| Operating  segments:      |       |                           |       |                                  |       |   |   |   |   |
| Cataract/Implant          |       | $                              | 254,865    |                                  | $          | 244,456 |   | $ | 129,022 |   | $ | 107,869 |   |
| Laser Vision Correction   |       | 114,356                        |       | 18,235                                |       | 73,683 |   | 3,660 |   |
| Eye Care                  |       | 126,048                        |       | 156,919                               |       | 50,211 |   | 56,684 |   |
| Total segments            |       | 495,269                        |       | 419,610                               |       | 252,916 |   | 168,213 |   |
| Manufacturing  operations |       | —                         |       | —                                |       | (4,741 | ) | (455,824 | ) |
| Research and  development |       | —                         |       | —                                |       | (32,961 | ) | (27,009 | ) |
| Business  repositioning   |       | —                         |       | —                                |       | (54,619 | ) | — |   |
| Global supply  chain      |       | —                         |       | —                                |       | (29,782 | ) | (23,234 | ) |
| General  corporate        |       | —                         |       | —                                |       | (96,092 | ) | (59,612 | ) |
| Total                     |       | $                              | 495,269    |                                  | $          | 419,610 |   | $ | 34,721 |   | $ | (397,466 | ) |

 

 

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**Geographic Area Information**

 
| ** **                               | ** ** | **Net Sales**               | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
| **(In thousands)**                  | ** ** | **June 30,  2006**          | ** ** | **June 24,  2005** | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
| United States:                           |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                         |       | $                                | 43,910     |   | $ | 36,070 |   | $ | 82,008 |   | $ | 68,387 |   |
| Laser Vision  Correction                 |       | 40,738                           |       | 13,156 |   | 90,655 |   | 14,613 |   |
| Eye Care                                 |       | 24,863                           |       | 14,276 |   | 39,078 |   | 27,538 |   |
| Total United  States                     |       | 109,511                          |       | 63,502 |   | 211,741 |   | 110,538 |   |
| Americas, excluding  United States:      |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                         |       | 9,077                            |       | 6,955 |   | 17,489 |   | 12,776 |   |
| Laser Vision Correction                  |       | 2,360                            |       | 545 |   | 4,470 |   | 680 |   |
| Eye Care                                 |       | 3,340                            |       | 2,101 |   | 6,025 |   | 4,732 |   |
| Total Americas,  excluding United States |       | 14,777                           |       | 9,601 |   | 27,984 |   | 18,188 |   |
| Europe/Africa/Middle  East:              |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                         |       | 50,515                           |       | 50,541 |   | 96,900 |   | 100,543 |   |
| Laser Vision  Correction                 |       | 3,881                            |       | 1,474 |   | 7,980 |   | 1,726 |   |
| Eye Care                                 |       | 19,795                           |       | 24,841 |   | 35,700 |   | 48,554 |   |
| Total  Europe/Africa/Middle East         |       | 74,191                           |       | 76,856 |   | 140,580 |   | 150,823 |   |
| Japan:                                   |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                         |       | 17,756                           |       | 20,124 |   | 32,714 |   | 37,046 |   |
| Laser Vision  Correction                 |       | 995                              |       | 233 |   | 1,811 |   | 235 |   |
| Eye Care                                 |       | 11,656                           |       | 30,929 |   | 27,785 |   | 54,503 |   |
| Total Japan                              |       | 30,407                           |       | 51,286 |   | 62,310 |   | 91,784 |   |
| Asia Pacific:                            |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                         |       | 13,163                           |       | 14,036 |   | 25,754 |   | 25,704 |   |
| Laser Vision  Correction                 |       | 5,427                            |       | 885 |   | 9,440 |   | 981 |   |
| Eye Care                                 |       | 9,565                            |       | 10,926 |   | 17,460 |   | 21,592 |   |
| Total Asia  Pacific                      |       | 28,155                           |       | 25,847 |   | 52,654 |   | 48,277 |   |
| Total                                    |       | $                                | 257,041    |   | $ | 227,092 |   | $ | 495,269 |   | $ | 419,610 |   |

 

The United Statesinformation is presented separately as it is the Company’s headquarterscountry, and U.S. sales represented 42.6% and 42.8% of total net sales for thethree and six months ended June 30, 2006 and 28.0% and 26.3% of total net salesfor the three and six months ended June 24, 2005, respectively. Additionally,sales in Japan represented 11.8% and 12.6% of total net sales for the three andsix months ended June 30, 2006 and 22.6% and 21.9% of total net sales for thethree and six months ended June 24, 2005, respectively. No other country, orsingle customer, generated over 10% of total net sales in the periodspresented.

**Note 10: Commitments andContingencies**

On July 7, 2006, theCompany entered into a settlement agreement with Alcon, Inc., AlconLaboratories, Inc., and Alcon Manufacturing Ltd. (collectively, “Alcon”)regarding all pending patent litigation between AMO and Alcon. The settlementrequired Alcon to pay AMO a lump-sum payment of $121 million which was receivedin July 2006 and will be accounted for in the third quarter of 2006. Theparties agreed to dismiss all pending patent litigation in Delaware and Texas,agreed not to sue each other regarding the patents at issue in those cases, andcross-licensed patents covering existing features of commercially availablephacoemulsification products. As part of the settlement, the parties agreed toa dispute resolution process for future claims before litigation is commenced.

On January 4, 2005,Dr. James Nielsen filed a complaint against the Company and Allergan, Inc.in the U.S. District Court of the Northern District of Texas, Dallas Division,for infringement of U.S. Patent No. 5,158,572. Dr. Nielsen allegesthat the Company’s *Array*multifocalintraocular lens infringes the patent. He is seeking damages and a permanentinjunction. The trial in this matter is scheduled to begin on November 6, 2006.

The Company does notbelieve, based on current knowledge, that any of the foregoing legalproceedings or claims are likely to have a material adverse effect on itsfinancial position, results of operations or cash flows. However, the Companymay incur substantial expenses in defending against third party claims. In theevent of a determination adverse to the Company or its subsidiaries, theCompany may incur substantial monetary liability, and be required to change itsbusiness practices. Either of these could have a material adverse effect on theCompany’s financial position, results of operations or cash flows.

17

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While the Company isinvolved from time to time in litigation arising in the ordinary course ofbusiness, including product liability claims, the Company is not currentlyaware of any other actions against AMO or Allergan relating to the opticalmedical device business that the Company believes would have a material adverseeffect on the Company’s business, financial condition, results of operations orcash flows. The Company may be subject to future litigation and infringementclaims, which could cause the Company to incur significant expenses or preventthe Company from selling its products. The Company operates in an industrysusceptible to significant product liability claims. Product liability claimsmay be asserted against AMO in the future arising out of events not known tothe Company at the present time. Under the terms of the contribution anddistribution agreement affecting the spin-off, Allergan agreed to assume responsibilityfor, and to indemnify AMO against, all current and future litigation relatingto its retained businesses and the Company agreed to assume responsibility for,and to indemnify Allergan against, all current and future litigation related tothe optical medical device business.

**Note 11: Pension Benefit Plans**

The Company sponsorsdefined benefit pension plans in Japan and in certain European countries.Components of net periodic benefit cost under these plans were (in thousands):

 

|                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **June 30,  2006**          | ** ** | **June 24,  2005**        | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
| Service cost                        |       | $                                | 569        |                           | $          | 491 |   | $ | 1,138 |   | $ | 983 |   |
| Interest cost                       |       | 137                              |       | 128                            |       | 274 |   | 256 |   |
| Expected return  on plan assets     |       | (61                              | )          | (55                            | )          | (122 | ) | (111 | ) |
| Amortization of  prior service cost |       | 15                               |       | 17                             |       | 30 |   | 34 |   |
| Amortization of  net actuarial loss |       | 10                               |       | —                         |       | 20 |   | — |   |
| Net periodic benefit  cost          |       | $                                | 670        |                           | $          | 581 |   | $ | 1,340 |   | $ | 1,162 |   |

 

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ADVANCED MEDICALOPTICS, INC.

**Item 2.**                          Management’sDiscussion and Analysis of Financial Condition and Results of Operations forthe Quarter Ended June30, 2006

*Thefollowing discussion and analysis presents the factors that had a materialeffect on AMO’s cash flows and results of operations during the three and sixmonths ended June 30, 2006, and the Company’s financial position at that date.Except for the historical information contained herein, the followingdiscussion contains forward-looking statements that involve risk anduncertainties. Our actual results may differ significantly from the results discussedin the forward-looking statements. Factors that might cause such differencesinclude, but are not limited to, those discussed in the subsection entitled “CertainFactors and Trends Affecting AMO and Its Businesses.” The following discussionshould be read in conjunction with the 2005 Form 10-K and the unauditedconsolidated financial statements and notes thereto included elsewhere in thisForm 10-Q.*

OVERVIEW 

We are a global leader inthe development, manufacture and marketing of medical devices for the eye.Effective January 1, 2006, our reportable segments are represented by our threebusiness units:  Cataract/Implant, LaserVision Correction and Eye Care. Previously, our reportable segments were basedon geographic regions which comprised the Americas, which included North andSouth America, Europe/Africa/Middle East, Japan and Asia Pacific, whichexcluded Japan and included New Zealand and Australia. Sales and operatingresults for the prior period have been conformed to reflect the current periodpresentation of reportable segments. Our Cataract/Implant business focuses onthe four key products required for cataract surgery — foldable intraocularlenses, or IOLs, implantation systems, phacoemulsification systems andviscoelastics. Our Laser Vision Correction business markets laser systems,diagnostic devices, treatment cards and microkeratomes for use in laser eyesurgery. Our Eye Care business provides a full range of contact lens careproducts for use with most types of contact lenses. These products includesingle-bottle, multi-purpose cleaning and disinfecting solutions, hydrogenperoxide-based disinfecting solutions, daily cleaners, enzymatic cleaners,contact lens rewetting drops, and in Europe and Asia, contact lenses. Ourproducts are sold in approximately 60 countries and we have direct operationsin over 20 countries.

*ProductRationalization and Repositioning Plan*

On October 31, 2005, our Board of Directors approved a productrationalization and repositioning plan covering the discontinuation of non-strategic cataract surgical and eyecare products and the elimination or redeployment of resources that supportthese product lines. The plan also includes organizational changes andpotential reductions in force in manufacturing, sales and marketing associatedwith these product lines, as well as organizational changes in research anddevelopment and other corporate functions designed to align the organizationwith our strategy and strategic business unit organization. A substantialportion of expected operating cost benefits will result from reductions inforce and associated annualized employee compensation of approximately $17.9million.

The plan further calls for increasing ourinvestment in key growth opportunities, specifically our refractive implantproduct line and international laser vision correction business, andaccelerating the implementation of productivity initiatives.

Inthe three months ended June 30, 2006, we incurred $25.1 million of pre-taxcharges, which included $7.4 million for inventory, manufacturing related andother charges included in cost of sales and $17.7 million included in operatingexpenses. Charges included in operating expenses comprised severance,relocation and other one-time termination benefits of $11.9 million,productivity and brand repositioning costs of $4.9 million, asset write-downsof $0.7 million and contractual obligations of $0.2 million. In the six monthsended June 30, 2006, we incurred $54.6 million of pre-tax charges, whichincluded $7.6 million for inventory and manufacturing related charges includedin cost of sales and $47.0 million included in operating expenses. Chargesincluded in operating expenses comprised productivity and brand repositioningcosts of $31.1 million, severance, relocation and other one-time terminationbenefits of $13.5 million, asset write-downs of $2.1 million and contractualobligations of $0.3 million.

Following an analysis ofour IOL manufacturing capabilities in the second quarter of 2006, we havedecided to consolidate certain operations. In addition, we expanded the scopeof our eye care rationalization initiatives in order to maximize manufacturingcapacity and seize growth opportunities. Together, these separate actions areexpected to result in additional charges of approximately $20 million to $25million in 2006.  When combined with theinitial estimated charges of $70 million to $80 million, the estimated totalcharges for the expanded product rationalization and repositioning plan will beapproximately $105 million.  Through June30, 2006, we incurred cumulative charges of $99.8 million.  We expect to incur additional charges ofapproximately $5 million in the remainder of 2006.

19

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Certain foreign jurisdictions have laws andregulations which require consultations and negotiations with works councils,labor organizations and local authorities. The outcome of these discussionswill determine, in part, the restructuring steps to be implemented and theassociated cost. Therefore, the final costs of the business repositioning planmay be significantly different from our initial estimates.

CRITICALACCOUNTING POLICIES AND ESTIMATES 

The preparation ofconsolidated financial statements and related disclosures in conformity withaccounting principles generally accepted in the United States of Americarequires management to make judgments, assumptions and estimates that affectthe amounts reported. Certain of these significant accounting policies areconsidered to be critical accounting policies, as defined below.

A criticalaccounting policy is defined as one that is both material to the presentationof AMO’s consolidated financial statements and requires management to makedifficult, subjective or complex judgments that could have a material effect onAMO’s financial condition or results of operations. Specifically, thesepolicies have the following attributes: (1) AMO is required to make assumptionsabout matters that are highly uncertain at the time of the estimate; and (2)different estimates AMO could reasonably have used, or changes in the estimatethat are reasonably likely to occur, would have a material effect on AMO’sfinancial condition or results of operations.

Estimatesand assumptions about future events and their effects cannot be determined withcertainty. AMO bases its estimates on historical experience and on variousother assumptions believed to be applicable and reasonable under thecircumstances. These estimates may change as new events occur, as additionalinformation is obtained and as AMO’s operating environment changes. Thesechanges have historically been minor and have been included in the consolidatedfinancial statements as soon as they became known. In addition, management isperiodically faced with uncertainties, the outcomes of which are not within itscontrol and will not be known for prolonged periods of time. Theseuncertainties are discussed in the section of our 2005 Form 10-K entitled “RiskFactors” and the section below entitled “Certain Factors and Trends AffectingAMO and Its Businesses.” Based on a critical assessment of its accountingpolicies and the underlying judgments and uncertainties affecting theapplication of those policies, management believes that AMO’s consolidatedfinancial statements are fairly stated in accordance with accounting principlesgenerally accepted in the United States of America, and provide a meaningfulpresentation of AMO’s financial condition and results of operations.

*RevenueRecognition and Accounts Receivable*

Revenue is realized orrealizable and earned when persuasive evidence of an arrangement exists,delivery has occurred, the price to the buyer is fixed or determinable andcollectibility is reasonably assured. We record revenue from product sales whentitle and risk of ownership have been transferred to the customer, which istypically upon delivery to the customer, with the exception of intraocularlenses distributed on a consignment basis, which is upon notification ofimplantation in a patient. We recognize license fees and revenues from the saleof treatment cards to direct customers when we ship the treatment cards as wehave no continuing obligations or involvement subsequent to shipment.

Some customers financethe purchase or rental of their VISX equipment directly from us over periodsranging from one to three years. These financing agreements are classified aseither rental or operating leases or sales type leases as prescribed byStatement of Financial Accounting Standards No. 13, “Accounting forLeases.” Under sales type leases, system revenues are recognized based on thenet present value of the expected cash flow after installation to directcustomers in the United States and Japan or after shipment to internationaldistributors. Under rental or operating lease arrangements, rental revenue is recognizedover the term of the agreement.

We generally permitreturns of product if such product is returned in a timely matter, in goodcondition, and through the normal channels of distribution. However, we do notaccept returns of treatment cards and we do not provide rights of return orexchange, price protection or stock rotation rights to any of our VISX productdistributors. Return policies in certain international markets can be morestringent and are based on the terms of contractual agreements with thecustomers. Allowances for returns are provided for based upon an analysis ofour historical patterns of returns matched against the sales from which theyoriginated. To date, historical product returns have been within our estimates.

When we recognize revenuefrom the sale of our products, certain allowances known and estimable at timeof sale are recorded as a reduction to sales. These items include cashdiscounts, allowances and rebates. These items are reflected as a reduction toaccounts receivable to the extent the customer will or is expected to reduceits payment on the related invoice amounts. In addition, certain items such asrebates provided to customers that meet certain buying targets are paid to thecustomer subsequent to customer payment. Thus, such amounts are recorded asaccrued liabilities. These provisions are estimated based on historical paymentexperience, historical relationship to revenues and estimated customerinventory levels. If the historical data and inventory estimates used tocalculate these provisions do not properly reflect future activity, ourfinancial position, results of operations and cash flows could be impacted. Todate, historical sales allowances have been within our estimates.

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The allowance fordoubtful accounts is determined by analyzing specific customer accounts andassessing the risk of uncollectibility based on insolvency, disputes or othercollection issues. In addition, we routinely analyze the different agingcategories and establish allowances based on the length of time receivables arepast due.

*Inventories*

Inventories are valued atthe lower of first-in, first-out cost or market. On a regular basis, weevaluate inventory balances for excess quantities and obsolescence by analyzingestimated demand, inventory on hand, sales levels and other information. Basedon these evaluations, inventory balances are reduced, if necessary.

*Goodwilland Long-Lived Assets*

On January 1, 2002,we adopted Statement of Financial Accounting Standards No. 142, “Goodwilland Other Intangible Assets”, whereby goodwill is no longer amortized, butinstead is subject to a periodic impairment review performed during the secondquarter of each fiscal year. In a business combination, goodwill is allocatedto our various reporting units based on relative fair value of the assetsacquired and liabilities assumed. We review the recoverability of goodwill bycomparing each unit’s fair value to the net book value of its assets. If thebook value of the reporting unit’s assets exceeds its fair value, the goodwillis written down to its implied fair value.

Additionally, we reviewthe carrying amount of goodwill whenever events and circumstances indicate thatthe carrying amount of goodwill may not be recoverable. Impairment indicatorsinclude, among other conditions, cash flow deficits, historic or anticipateddeclines in annual revenue or operating profit and adverse legal or regulatorydevelopments. If it is determined such indicators are present and the reviewindicates goodwill will not be fully recoverable, based upon discountedestimated cash flows, the carrying value is reduced to implied fair value.

The annual impairmentreview of goodwill was performed in the second quarter of 2006, and noimpairment was indicated based on tests conducted during the review. The nextannual impairment review of goodwill will be performed in the second quarter of2007. Effective January 1, 2006, our operating segments consist of threebusinesses:  Cataract/Implant, LaserVision Correction and Eye Care. Accordingly, the annual impairment review ofgoodwill in the second quarter of 2006 was based on reporting units that arealigned with the current operating segments.

In accordance withStatement of Financial Accounting Standards No. 144 “Accounting for theImpairment or Disposal of Long-lived Assets”, we assess potential impairment toour long-lived assets when events or changes in circumstances indicate that thecarrying amount of an asset may not be fully recoverable. If required, animpairment loss is recognized as the difference between the carrying value andthe fair value of the assets.

*IncomeTaxes*

We account for incometaxes under the asset and liability method, whereby deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply in the yearsin which those temporary differences are expected to be recovered or settled.The effect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. Weevaluate the need to establish a valuation allowance for deferred tax assetsbased upon the amount of existing temporary differences, the period in whichthey are expected to be recovered and expected levels of taxable income. Avaluation allowance to reduce deferred tax assets is established when it is “morelikely than not” that some or all of the deferred tax assets will not berealized.

We record a liability forpotential tax assessments based on our estimate of the potential exposure. Newlaws and new interpretations of laws and rulings by tax authorities may affectthe liability for potential tax assessments. Due to the subjectivity andcomplex nature of the underlying issues, actual payments or assessments maydiffer from estimates. To the extent our estimates differ from actual paymentsor assessments, income tax expense is adjusted. Our income tax returns inseveral locations are being examined by the local taxation authorities.Management believes that adequate amounts of tax and related interest, if any,have been provided for any adjustments that may result from these examinations.

*Stock-Based Compensation*

EffectiveJanuary 1, 2006, we began accounting for stock options and employee stockpurchase plan (ESPP) shares under the provisions of Statement of FinancialAccounting Standards No. 123R, “Share-Based Payment” (SFAS 123R). SFAS 123Rrequires entities to recognize the cost of employee services received inexchange for awards of equity instruments based on the grant-date fair value ofthose awards. The fair value of stock options and ESPP purchase rights are 

21

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estimated using aBlack-Scholes option valuation model. This model requires the input ofsubjective assumptions, including expected stock price volatility, estimatedlife and estimated forfeitures of each award. The fair value of equity-basedawards is amortized over the vesting period of the award, and we have electedto use the straight-line method. We make quarterly assessments of the adequacyof the tax credit pool to determine if there are any deficiencies which requirerecognition in the consolidated statement of operations. Prior to theimplementation of SFAS 123R, we accounted for stock options and ESPP sharesunder the provisions of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” and made pro forma disclosures as required bySFAS No. 148, “Accounting For Stock-Based Compensation — Transition andDisclosure,” which amended SFAS No. 123, “Accounting For Stock-BasedCompensation.” Pro forma net loss and pro forma net loss per share disclosed inthe footnotes to the consolidated financial statements were estimated using aBlack-Scholes option valuation model. The fair value of restricted stock andrestricted stock units was calculated based upon the fair market value of ourcommon stock at the date of grant.

We also have an annualperformance stock incentive program which provides the opportunity for certainexecutives to earn long-term incentive compensation awards based upon specifiedmarket performance measures. Awards are to be settled in a number of restrictedstock shares or units equal to the value of the award amount divided by thefair market value of our common stock on the date the performance criteria isdeemed to have been met. The fair value of the awards on the grant date isestimated using a lattice-based valuation model. The associated expense isrecognized on a straight-line basis over the period which starts from the datethe annual program is approved by the Board of Directors through the end of theexpected vesting period of the restricted stock awards. 

RESULTS OFOPERATIONS 

Thefollowing table presents net sales and operating income by operating segmentfor the three and six months ended June 30, 2006 and June 24, 2005,respectively:

 

|                           | ** ** | **Net Sales**               | ** ** | **Operating Income**        | ** ** |
|---------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
| **(In thousands)**   | ** ** | **June 30,  2006**          | ** ** | **June 24,  2005**          | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
|                      |       |                             |       |                             |       |   |   |   |   |
| Cataract/Implant          |       | $                                | 134,421    |                             | $          | 127,726 |   | $ | 70,440 |   | $ | 55,896 |   |
| Laser Vision  Correction  |       | 53,401                           |       | 16,293                           |       | 32,895 |   | 3,925 |   |
| Eye Care                  |       | 69,219                           |       | 83,073                           |       | 28,452 |   | 29,169 |   |
| Total operating  segments |       | $                                | 257,041    |                             | $          | 227,092 |   | $ | 131,787 |   | $ | 88,990 |   |

 

* *

|                           | ** ** | **Net Sales**             | ** ** | **Operating Income**      | ** ** |
|---------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **Six Months Ended** | ** ** | **Six Months Ended** | ** ** |
| **(In thousands)**   | ** ** | **June 30,  2006**        | ** ** | **June 24,  2005**        | ** ** | **June 30,  2006** | ** ** | **June 24,  2005** | ** ** |
|                      |       |                           |       |                           |       |   |   |   |   |
| Cataract/Implant          |       | $                              | 254,865    |                           | $          | 244,456 |   | $ | 129,022 |   | $ | 107,869 |   |
| Laser Vision  Correction  |       | 114,356                        |       | 18,235                         |       | 73,683 |   | 3,660 |   |
| Eye Care                  |       | 126,048                        |       | 156,919                        |       | 50,211 |   | 56,684 |   |
| Total operating  segments |       | $                              | 495,269    |                           | $          | 419,610 |   | $ | 252,916 |   | $ | 168,213 |   |

 

*Netsales.* Total net sales increased 13.2% and 18.0% in the threeand six months ended June 30, 2006, compared to the same periods last year. Theincreases in net sales were primarily the result of sales of acquired *VISX* products and strong demand for our core brands,partially offset by negative foreign currency impact of 0.4% and 2.5% in thethree and six months ended June 30, 2006, respectively. Our sales and earningsmay be negatively impacted during times of a strengthening U.S. dollar. Totalnet sales in the U.S. and Japan represented 42.6% and 11.8%, respectively, oftotal net sales in the three months ended June 30, 2006. Total net sales in theU.S. and Japan represented 42.8% and 12.6%, respectively, of total net sales inthe six months ended June 30, 2006. No other country, or any single customer,generated over 10% of total net sales in the periods presented.

Net sales from ourCataract/Implant business increased by 5.2% and 4.3% in the three and six monthsended June 30, 2006, compared with the same periods last year. The increases innet sales were primarily the result of sales of our branded promoted products,including*Tecnis*and*ReZoom* intraocular lenses andphacoemulsification systems, partially offset by a decrease in sales ofnon-promoted older-technology intraocular lenses and viscoelastics andreimbursement pressures in 

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certain European markets and in Japan for viscoelasticproducts. Net sales growth in the Americas of 23.2% and 22.6% in the three andsix months ended June 30, 2006, respectively, were due to strong demand for ourcore products, partially offset by decreases in sales of non-promotedolder-technology intraocular lenses and viscoelastics.  Sales in Europe/Africa/Middle East were flatin the three months ended June 30, 2006 and declined by 3.6% in the six monthsended June 30, 2006.  Sales in Japandeclined by 11.8% and 11.7% in the three and six months ended June 30, 2006.  The sales declines in Europe/Africa/MiddleEast and Japan were due to decreasing sales of older generation intraocularlenses, rationalized viscoelastics and reimbursement pressures, as well as thenegative impact of foreign currency fluctuations. The differences in net salesin our Cataract/Implant business reflect unfavorable foreign currency impactsof 0.5% and 2.7% in the three and six months ended June 30, 2006, largely fromfluctuations of the euro and Japanese yen versus the U.S. dollar.

Net sales from our Laser Vision Correction(LVC) business increased by $37.1 million and $96.1 million in the three andsix months ended June 30, 2006, respectively, compared with the same periodslast year.  These increases wereprimarily the result of sales of acquired *VISX* products.Net sales of acquired *VISX* products were$50.8 million and $108.5 million in the three and six months ended June 30,2006, respectively, compared with $13.4 million in the three and six monthsended June 24, 2005. See Note 2 to the unaudited consolidated financialstatements for the proforma impact of VISX net sales for the same period lastyear. Net sales in the Americas increased by $29.4 million and $79.8 million inthe three and six months ended June 30, 2006, respectively, compared with thesame periods last year, due to acquired *VISX* productsand strong demand for our custom LASIK procedures and system sales. As a resultof our international expansion strategy for the LVC business, we saw net salesin Europe/Africa/Middle East of $3.9 million and $8.0 million in the three andsix months ended June 30, 2006, respectively and Asia Pacific sales of $5.4million and $9.4 million in the three and six months ended June 30, 2006,compared to significantly lower amounts in the same periods last year. Thedifference in net sales in our LVC business also includes an unfavorableforeign currency impact of $0.2 million, or 1.3% in the six months ended June30, 2006, largely from fluctuations of the euro and Japanese yen versus theU.S. dollar.  The foreign currency impactin the three months ended June 30, 2006 was negligible.

Net sales from our EyeCare business decreased by 16.7% and 19.7% in the three and six months endedJune 30, 2006, respectively, compared with the same periods last year. Thedecreases in sales of eye care products were primarily due to lower sales ofhydrogen peroxide-based products caused by continued shrinkage of this marketas contact lens wearers gravitate increasingly to more convenient multipurposesolutions, decreased sales of multipurpose products primarily due to rapid growthof daily disposable lenses, particularly in the Japan market, and a provisionof $3.9 million in the current quarter for expected sales returns fordiscontinued products. These factors contributed significantly to net salesdeclines of 62.3% in Japan, 20.3% in Europe/Africa/Middle East and 12.5% inAsia Pacific during the three months ended June 30, 2006 and 49.0% in Japan,26.5% in Europe/Africa/Middle East and 19.1% in Asia Pacific during the sixmonths ended June 30, 2006, compared with the same periods last year. Thesedeclines were partially offset by increases in the Americas of 72.2% and 39.8%in the three and six months ended June 30, 2006, respectively, due toincreasing demand for our multipurpose products, largely attributable to ourstrategy to increase our sampling programs, selling efforts to practitionersand their staffs and the withdrawal of a competitor’s product in the secondquarter of 2006. The difference in net sales in our Eye Care business alsoinclude unfavorable foreign currency impacts of 0.5% and 2.3% in the three andsix months ended June 30, 2006, respectively, largely resulting fromfluctuations of the euro and Japanese yen versus the U.S. dollar.

As part of our productrationalization and repositioning plan to maximize our competitive advantage asthe global refractive leader and improve the global penetration of our corecataract, refractive and eye care brands, we have discontinued a variety ofnon-strategic cataract surgical and eye care products that lack critical revenuemass, have experienced steadily declining sales trends and/or have generatedrelatively unattractive margins. The decreases in total net sales resultingfrom the product rationalization were approximately $13 million and $21 millionin the three and six months ended June 30, 2006.  We expect the growth of our promoted productsto offset the decline in net sales related to these discontinued products.

*Gross**margin and grossprofit.* Our gross margin percentage was 64.1% and 63.8% in the threeand six months ended June 30, 2006, respectively, compared with 61.5% and 62.4%in the same periods last year due to sales growth in the higher margin *Tecnis*and*ReZoom*intraocular lenses and *VISX* products,along with manufacturing productivity improvements. These improvements wereoffset by lower eye care sales, as described above, and approximately $7.4million, or 2.9 percentage points, for inventory, manufacturing related andother charges incurred in connection with our business repositioning plan inthe three months ended June 30, 2006. Total charges included in gross profit that were incurred in connectionwith the business repositioning plan were $10.5 million in the six months endedJune 30, 2006.  Gross profit for thethree and six months ended June 24, 2005 was negatively impacted byapproximately $1.9 million, or 0.8 percentage points and 0.5 percentage points,respectively, related to acquisition and integration-related charges.

As described earlier, weexpect to incur additional charges of approximately $5 million under ourproduct rationalization and repositioning strategy and supplementalconsolidation of certain operations due to IOL manufacturing capabilities andeye care product rationalizations which could have a significant negativeimpact on our gross margin through the remainder of 2006.

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*Selling,general and administrative.* Selling, general and administrative expenses decreased as a percent ofnet sales by 2.0 percentage points to 41.0% and by 2.7 percentage points to40.5% in the three and six months ended June 30, 2006, respectively, comparedwith 43.0% and 43.2% in the three and six months ended June 24, 2005,respectively. These decreases were largely driven by increased leverage fromoverall revenue growth as described previously and efficiency gains from ourbusiness repositioning strategy. Selling, general and administrative expensesfor the three and six months ended June 30, 2006 include approximately $7.0million and $14.1 million, respectively, in amortization expenses related tothe acquired VISX intangible assets. In addition, selling, general andadministrative expenses for the three months ended June 30, 2006 include $7.0million in charges primarily for a contractual obligation associated with theVISX integration and $4.0 million in stock-based compensation expense underSFAS 123R. Selling, general and administrative expenses for the six monthsended June 30, 2006 also includes a $2.3 million charge primarily associatedwith assets acquired in the termination of a distributor agreement inIndia.  Stock-based compensation expenseunder SFAS 123R included in selling, general and administrative expenses was$8.0 million for the six months ended June 30, 2006.  Selling, general and administrative expensesfor the three and six months ended June 24, 2005 include approximately $2.8million in acquisition and integration-related charges.

*Researchand development.* Research and development expendituresincreased as a percent of net sales by 0.3 percentage points to 6.4%, and by0.5 percentage points to 6.8% in the three and six months ended June 30, 2006,respectively, compared with the same periods last year. The increases inresearch and development expenditures as a percentage of net sales wereprimarily the result of an increase in spending for research efforts in theCataract/Implant and LVC businesses. We expect our research and developmentcosts as a percentage of sales to be approximately 6.5% of net sales for 2006as we continue to consolidate research and development costs from the VISX acquisition.Our research and development strategy is to develop proprietary products forvision correction that are safe and effective and address unmet needs. We arecurrently focusing on new advancements that build on our *Tecnis,Healon*and *Sovereign* technologies,corneal and lens-based solutions to presbyopia and dry eye products. Ourresearch and development teams are actively pursuing new *CustomVue*indicationsin order to strengthen our LVC market position, particularly in the area oftreatment for presbyopia.

*In-processresearch and development. *Inthe three and six months ended June 24, 2005, we recorded a $451.5 millionin-process research and development (IPR&D) charge primarily comprised of a$449.2 million charge resulting from the VISX acquisition.  This charge represented the estimated fairvalue of projects that, as of the acquisition date, had not reachedtechnological feasibility and had no alternative future use.

*Business**repositioning costs.* Inthe three months ended June 30, 2006, we incurred $25.1 million of pre-taxcharges, which included $7.4 million for inventory, manufacturing related andother charges included in cost of sales and $17.7 million included in operatingexpenses. Charges included in operating expenses comprised severance,relocation and other one-time termination benefits of $11.9 million,productivity and brand repositioning costs of $4.9 million, asset write-downsof $0.7 million and contractual obligations of $0.2 million. In the six monthsended June 30, 2006, we incurred $57.5 million of pre-tax charges, whichincluded $10.5 million for inventory, manufacturing related and other chargesincluded in cost of sales and $47.0 million included in operating expenses.Charges included in operating expenses comprised productivity and brandrepositioning costs of $31.1 million, severance, relocation and other one-timetermination benefits of $13.5 million, asset write-downs of $2.1 million andcontractual obligations of $0.3 million.

Following an analysis ofour IOL manufacturing capabilities in the second quarter of 2006, we havedecided to consolidate certain operations. In addition, we expanded the scopeof our eye care rationalization initiatives in order to maximize manufacturingcapacity and seize growth opportunities. Together, these separate actions areexpected to result in additional charges of approximately $20 million to $25million in 2006.  When combined with theinitial estimated charges of $70 million to $80 million, the estimated totalcharges for the expanded product rationalization and repositioning plan will beapproximately $105 million.  Through June30, 2006, we incurred cumulative charges of $99.8 million.  We expect to incur additional charges ofapproximately $5 million in the remainder of 2006.

*Operating**Income.*Operating income as a percentage of net sales, oroperating margin, was 9.7% and 7.0% in the three and six months ended June 30,2006, respectively. Operating income of $25.0 million in the three months endedJune 30, 2006 includes $25.1 million of business repositioning charges, $7.0million primarily for a contractual obligation described above and $5.2 millionin stock-based compensation expense under SFAS 123R. These charges reducedoperating margin by 14.5% in the three months ended June 30, 2006.  Operating income of $34.7 million in the sixmonths ended June 30, 2006 includes $57.5 million of business repositioningcharges, $7.0 million primarily for a contractual obligation described above,$2.3 million of asset write-offs described above and $10.3 million instock-based compensation expense under SFAS 123R. These charges reducedoperating margin by 15.6% in the six months ended June 30, 2006.  Operating losses of $423.4 million and $397.5million in the three and six months ended June 24, 2005 were primarily due tothe IPR&D charge of $451.5 million from the VISX acquisition describedabove.

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Operating income from ourCataract/Implant business increased by $14.5 million and $21.2 million in thethree and six months ended June 30, 2006, respectively, due to the increase innet sales and favorable mix of higher margin products discussed above, alongwith the favorable impact of cost containment measures taken in connection withour business repositioning plan. Operating income from our LVC businessincreased by $29.0 million and $70.0 million in the three and six months endedJune 30, 2006, respectively, due to sales of products acquired from VISX in May2005. Operating income from our Eye Care business decreased by $0.7 million and$6.5 million in the three and six months ended June 30, 2006, respectively,primarily due to the unfavorable impact from continued softness in the marketfor hydrogen peroxide based products, partially offset by strong sales ofmulti-purpose products in the Americas.

*Non-operatingexpense.* Interest expense was $8.0 million and $12.5million in the three and six months ended June 30, 2006, respectively, comparedwith $8.9 million and $14.7 million in the three and six months ended June 24,2005, respectively. Interest expense in the three and six months ended June 30,2006 includes a pro-rata write-off of debt issuance costs of $2.4 million.  Interest expense in the three and six monthsended June 24, 2005 includes a pro-rata write-off of debt issuance costs of$1.9 million.  We anticipate interestexpense to increase in 2006 relative to 2005 due to the issuance of $500million of 3.25% convertible senior subordinated notes in June 2006.

During the three and sixmonths ended June 30, 2006, we recorded a loss of $15.8 million associated withthe repurchase of $128.9 million aggregate principal amount of convertiblenotes.

We recorded an unrealized loss onderivative instruments of $2.4 million and $2.9 million in the three and sixmonths ended June 30, 2006, respectively, compared to an unrealized gain of$0.5 million and $1.0 million in the three and six months ended June 24,2005, respectively. We record as “unrealized (gain) loss on derivativeinstruments” the mark to market adjustments on the outstanding foreign currencyoptions and forward contracts which we enter into as part of our overall riskmanagement strategy to reduce the volatility of expected earnings in currenciesother than the U.S. dollar.  The lossesin the first six months of 2006 were largely attributable to euro and Japaneseyen instruments.

*Incometaxes.* We recorded a provision for income taxes of $0.8million and $2.0 million in the three and six months ended June 30, 2006,respectively.  The effective tax ratesfor these periods were significantly impacted by the early retirement ofconvertible senior subordinated notes which resulted in a pre-tax charge of$15.8 million and the recognition of a partial deferred tax benefit of $3.6million.  In addition, the effective taxrates reflect a benefit from stock-based compensation expense currently beingrecognized under SFAS 123R at an effective rate of approximately 33%, and aprovision on all other pre-tax income at an effective rate of 32%.  We recorded a provision for income taxes of$7.2 million and $14.3 million in the three and six months ended June 24, 2005,respectively.  The effective tax ratesfor these periods were significantly impacted by the IPR&D charge of $451.5million and a non-cash charge of $0.5 million related to the exchange ofconvertible notes, for which no tax benefit was provided.  We provided a tax provision at 34% on theremaining income.

The lower rate in 2006 reflectscontinuing implementation of our long-term tax strategies. Our future effectiveincome tax rate may vary depending on our mix of domestic and internationaltaxable income or loss and the various tax and treasury methodologies that weimplement, including our policy regarding repatriation of future accumulatedforeign earnings.

LIQUIDITY ANDCAPITAL RESOURCES 

Management assesses ourliquidity by our ability to generate cash to fund operations. Significantfactors in the management of liquidity are: funds generated by operations;levels of accounts receivable, inventories, accounts payable and capitalexpenditures; adequate lines of credit; and financial flexibility to attractlong-term capital on satisfactory terms. As of June 30, 2006, we had cash andequivalents of $40.8 million.

Historically, we havegenerated cash from operations in excess of working capital requirements, andwe expect to do so in the future. Net cash provided by operating activities was$45.3 million in the six months ended June 30, 2006 compared to cash used inoperating activities of $9.4 million in the six months ended June 24, 2005.Operating cash flow improved in the six months ended June 30, 2006 compared tothe six months ended June 24, 2005 primarily due to timing of accountsreceivable collections, last year’s inventory buildup of “bridging” stock as weprepared for the transition of eye care manufacturing from Allergan andpayments of merger related transaction costs incurred by VISX in 2005,partially offset by  the payment ofannual incentive compensation, severance payments related to the product rationalizationand business repositioning plan and interest payments on the 21⁄2% convertiblesenior subordinated notes and the 1.375% convertible senior subordinated notes.

 

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Net cash used ininvesting activities was $21.8 million and $56.8 million in the six monthsended June 30, 2006 and June 24, 2005, respectively. Expenditures forproperty, plant and equipment totaled $15.1 million and $7.6 million in the sixmonths ended June 30, 2006 and June 24, 2005, respectively. Expenditures in thesix months ended June 30, 2006 primarily comprised expenditures to upgrade ourviscoelastics manufacturing facility in Uppsala, Sweden. Expenditures in thesix months ended June 24, 2005 primarily comprised expansion and remodeling ofour leased headquarters, expenditures at our manufacturing facilities andcomputer replacements. We expect to incur greater capital expenditures withrespect to the Uppsala, Sweden manufacturing facility during 2006 in order toseparate the facility from existing Pfizer operations. Expenditures fordemonstration (demo) and bundled equipment, primarily phacoemulsification andmicrokeratome surgical equipment, were $5.4 million in each of the six monthsended June 30, 2006 and June 24, 2005. We maintain demo and bundledequipment to facilitate future sales of similar equipment and related productsto our customers. Expenditures for capitalized internal-use software were$1.2 million and $7.1 million in the six months ended June 30, 2006 and June24, 2005, respectively, which primarily comprised a company-wide system upgradeas part of the overall expansion of our business. We capitalize internal-usesoftware cost after technical feasibility has been established. In 2006,we expect to invest approximately $55.0 million to $60.0 million in property,plant and equipment, demo and bundled equipment, and capitalized software aspart of the overall expansion of our business. In the six months ended June 24,2005 we paid $36.9 million related to acquisitions, net of $156.8 million cashreceived in connection with the VISX acquisition.

Net cash used infinancing activities was $25.0 million in the six months ended June 30, 2006. Wereceived proceeds of $500 million from the issuance of 3.25% convertible notesthat were used to repurchase and retire 10.1 million shares of AMO commonstock. We also used $144.7 million to repay convertible notes, partially offsetby short-term borrowings of $95.0 million. Net cash provided by financingactivities was $68.5 million in the six months ended June 24, 2005, whichprimarily comprised $105.0 million borrowings under the senior revolving creditfacility, offset by $44.5 million used to repay convertible notes.

At June 30, 2006, we had$155.0 million of borrowings outstanding under the senior revolving creditfacility. Approximately $8.6 million of the senior revolving credit facilitywas reserved to support letters of credit issued on our behalf for normaloperating purposes and we had approximately $146.4 million undrawn andavailable revolving loan commitments. Our senior credit facility provides thatwe will maintain certain financial and operating covenants which include, amongother provisions, maintaining specific leverage and coverage ratios. Certaincovenants under the senior credit facility may limit the incurrence ofadditional indebtedness. The senior credit facility prohibits dividendpayments. We were in compliance with these covenants at June 30, 2006. Oursenior credit facility is collateralized by a first priority perfected lien on,and pledge of, all of the combined company’s present and future property andassets (subject to certain exclusions), 100% of the stock of the domesticsubsidiaries, 66% of the stock of foreign subsidiaries and all present andfuture intercompany debts.

Our cash positionincludes amounts denominated in foreign currencies, and the repatriation ofthose cash balances from some of our non-U.S. subsidiaries may result inadditional tax costs. However, these cash balances are generally availablewithout legal restriction to fund ordinary business operations.

We believe that the netcash provided by our operating activities, supplemented as necessary withborrowings available under our revolving credit facility and existing cash andequivalents, will provide sufficient resources to fund the expected 2006capital expenditures, and to meet our working capital requirements, debtservice and other cash needs over the next year.

We are partiallydependent upon the reimbursement policies of government and private healthinsurance companies. Government and private sector initiatives to limitthe growth of health care costs, including price regulation and competitivepricing, are continuing in many countries where we do business. As aresult of these changes, the marketplace has placed increased emphasis on thedelivery of more cost-effective medical therapies. While we have beenunaware of significant price resistance resulting from the trend toward cost containment,changes in reimbursement policies and other reimbursement methodologies andpayment levels could have an adverse effect on our pricing flexibility.Additionally, the current trend among U.S. hospitals and other customers ofmedical device manufacturers is to consolidate into larger purchasing groups toenhance purchasing power. The enhanced purchasing power of these largercustomers may also increase the pressure on product pricing, although we areunable to estimate the potential impact at this time.

*Inflation. *Althoughat reduced levels in recent years, inflation may cause upward pressure on thecost of goods and services used by us. The competitive and regulatoryenvironments in many markets substantially limit our ability to fully recoverthese higher costs through increased selling prices. We continually seekto mitigate the adverse effects of inflation through cost containment andimproved productivity and manufacturing processes.

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* *

*Foreigncurrency fluctuations. *Approximately 57% of our revenuesfor the six months ended June 30, 2006 were derived from operations outside theUnited States and a significant portion of our cost structure is denominated incurrencies other than the U.S. dollar, primarily the Japanese yen and theeuro. Therefore, we are subject to fluctuations in sales and earningsreported in U.S. dollars as a result of changing currency exchange rates.

The impact of foreigncurrency fluctuations on sales resulted in decreases of $10.4 million and $10.5million for the six months ended June 30, 2006 and June 24, 2005, respectively.The fluctuations were due primarily to the fluctuations of the Japanese yen andthe euro versus the U.S. dollar.

*Off-balancesheet arrangements.* We had no off-balance sheet arrangementsat June 30, 2006 as defined in Regulation S-K Item 303(a)(4).

**RecentAccounting Standards**

In July 2006, the FASB issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement 109” (“FIN 48”). FIN 48 prescribes a comprehensive model forrecognizing, measuring, presenting and disclosing in the financial statementstax positions taken or expected to be taken on a tax return, including adecision whether to file or not to file in a particular jurisdiction. If thereare changes as a result of application of FIN 48, these will be accounted foras an adjustment to retained earnings. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. The Company is currently assessing theimpact, if any, on its consolidated financial statements of adopting FIN 48.

**CertainFactors and Trends Affecting AMO and Its Businesses**

Our disclosure andanalysis in this report contain forward-looking information about our company’sfinancial results and estimates, business prospects and future products thatinvolve substantial risks and uncertainties. These statements constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. From time to time, we also may provide oral or written forward-lookingstatements in other materials we release to the public. Forward-lookingstatements give our current expectations or forecasts of future events. You canidentify these statements by the fact that they do not relate strictly tohistoric or current facts. They use words such as “anticipate,” “estimate,” “expect,”“project,” “intend,” “plan,” “believe,” “will,” and other words and terms ofsimilar meaning in connection with any discussion of future operating orfinancial performance. In particular, these include statements relating tofuture actions, prospective products or product approvals, reimbursement rates,future performance or results of current and anticipated products, salesefforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies,such as legal proceedings, financial results, and the expected results andbenefits of our product rationalization and reorganization. Among the factorsthat could cause actual results to differ materially are the following:

·              Uncertaintiesassociated with the research and development and regulatory processes;

·              Ourability to make and successfully integrate acquisitions or enter into strategicalliances;

·              Exposureto risks associated with doing business outside of the United States, where weconduct a significant amount of our sales and operations;

·              Foreigncurrency risks and fluctuation in interest rates;

·              Ourability to introduce new commercially successful products in a timely andeffective manner;

·              Ourability to maintain a sufficient and timely supply of products we manufacture;

·              Ourreliance on sole source suppliers for raw materials and other products;

·              Intensecompetition from companies with substantially more resources and a greatermarketing scale;

·              Risksand expenses associated with our ability to protect our intellectual propertyrights;

·              Risksand expenses associated with intellectual property litigation and infringementclaims;

·              Unexpectedlosses due to product liability claims, product recalls or corrections, orother litigation;

·              Ourability to maintain our relationships with health care providers and payors;

·              Risks,uncertainties and delays associated with extensive government regulation of ourbusiness, including risks associated with regulatory compliance, quality systemsstandards, and complaint-handling;

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·              Ourability to attract, hire and retain qualified personnel;

·              Oursignificant debt, which contains covenants limiting our business activities;

·              Theimpact of the change in the accounting treatment of stock options upon theadoption of SFAS 123R or other significant changes to generally acceptedaccounting principles;

·              Risksassociated with our ability to realize the benefits and synergies of ouracquisitions;

·              Changesin market acceptance of laser vision correction;

·              Thepossibility of long-term side effects and adverse publicity regarding lasercorrection surgery;

·              Theeffect of weak or uncertain general economic conditions on the ability ofindividuals to afford laser vision correction or presbyopia-correctingintraocular lenses; and

·              Risksassociated with our ability to successfully complete the productrationalization and reorganization in a timely and effective manner.

We cannot guarantee thatany forward-looking statement will be realized. Achievement of future resultsis subject to risks, uncertainties and inaccurate assumptions. Should known orunknown risks or uncertainties materialize, or should underlying assumptionsprove inaccurate, actual results could vary materially from past results and thoseanticipated, estimated or projected. Investors should bear this in mind as theyconsider forward-looking statements.

We undertake noobligation to publicly update forward-looking statements, whether as a resultof new information, future events or otherwise. You are advised, however, toconsult any further disclosures we make on related subjects in our Forms 10-Q,8-K and 10-K reports to the Securities and Exchange Commission. Our Form 10-Kfiling for the 2005 fiscal year listed various important factors that couldcause actual results to differ materially from expected and historic results.We note these factors for investors as permitted by the Private SecuritiesLitigation Reform Act of 1995. Readers can find them in Item 1A of theForm 10-K under the heading “Risk Factors.” We incorporate that section of thatForm 10-K in this filing and encourage investors to refer to it. You shouldunderstand that it is not possible to predict or identify all such factors.Consequently, you should not consider any such list to be a complete set of allpotential risks or uncertainties.

**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

We routinely monitor therisks associated with fluctuations in currency exchange rates and interestrates. We address these risks through controlled risk management that mayinclude the use of derivative financial instruments to economically hedge orreduce these exposures. We do not expect to enter into financial instrumentsfor trading or speculative purposes.

Given the inherentlimitations of forecasting and the anticipatory nature of the exposuresintended to be hedged, there can be no assurance that such programs will offsetmore than a portion of the adverse financial impact resulting from unfavorablemovements in either interest or foreign exchange rates. In addition, thetiming of the accounting for recognition of gains and losses related tomark-to-market instruments for any given period may not coincide with thetiming of gains and losses related to the underlying economic exposures and,therefore, may adversely affect our operating results and financial position.

To ensure the adequacyand effectiveness of our interest rate and foreign exchange hedge positions, wecontinually monitor, from an accounting and economic perspective, our interestrate swap positions and foreign exchange forward and option positions, whenapplicable, both on a stand-alone basis and in conjunction with our underlyinginterest rate and foreign currency exposures.

Interest raterisk. At June 30, 2006, our debt comprises solely domestic borrowings andcomprises $871.1 million of fixed rate debt and $155.0 million of variable ratedebt.

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The tables below presentinformation about our debt obligations as of June 30, 2006 andDecember 31, 2005:

**June 30,2006**
| ** **                      | ** ** | **Maturing in**                                          | ** ** | **Fair  Market** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------|------------|------------------|------------|
| ** **                      | ** ** | **2006**                                                      | ** ** | **2007**         | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Value** | ** ** |
| ** **                      | ** ** | **(in thousands, except interest rates)** | ** ** |
| **LIABILITIES**                 | ** ** | ** **                                                    | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Debt  Obligations:**          | ** ** | ** **                                                    | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed Rate                      |       | $—                                                       |       | $—          |       | $— |   | $— |   | $— |   | $251,105 |   | $251,105 |   | $270,264 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —           |       | — |   | — |   | — |   | 2.50 | % | 2.50 | % |   |   |
| Fixed Rate                      |       | $—                                                       |       | $—          |       | $— |   | $— |   | $— |   | $120,000 |   | $120,000 |   | $137,100 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —           |       | — |   | — |   | — |   | 1.375 | % | 1.375 | % |   |   |
| Fixed Rate                      |       | $—                                                       |       | $—          |       | $— |   | $— |   | $— |   | $500,000 |   | $500,000 |   | $505,650 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —           |       | — |   | — |   | — |   | 3.25 | % | 3.25 | % |   |   |
| Variable Rate                   |       | $35,000                                                       |       | $—          |       | $— |   | $— |   | $— |   | $— |   | $35,000 |   | $35,000 |   |
| Weighted Average  Interest Rate |       | 9.25                                                          | %          | —           |       | — |   | — |   | — |   | — |   | 9.25 | % |   |   |
| Variable Rate                   |       | $20,000                                                       |       | $—          |       | $— |   | $— |   | $— |   | $— |   | $20,000 |   | $20,000 |   |
| Weighted Average  Interest Rate |       | 7.26                                                          | %          | —           |       | — |   | — |   | — |   | — |   | 7.26 | % |   |   |
| Variable Rate                   |       | $50,000                                                       |       | $—          |       | $— |   | $— |   | $— |   | $— |   | $50,000 |   | $50,000 |   |
| Weighted Average  Interest Rate |       | 7.40                                                          | %          | —           |       | — |   | — |   | — |   | — |   | 7.40 | % |   |   |
| Variable Rate                   |       | $50,000                                                       |       | $—          |       | $— |   | $— |   | $— |   | $— |   | $50,000 |   | $50,000 |   |
| Weighted Average  Interest Rate |       | 7.52                                                          | %          | —           |       | — |   | — |   | — |   | — |   | 7.52 | % |   |   |
| Total Debt  Obligations         |       | $155,000                                                      |       | $—          |       | $— |   | $— |   | $— |   | $871,105 |   | $1,026,105 |   | $1,068,014 |   |
| Weighted Average  Interest Rate |       | 7.84                                                          | %          | —           |       | — |   | — |   | — |   | 2.78 | % | 3.54 | % |   |   |

 

**December 31,2005**

 
| ** **                      | ** ** | **Maturing in**                                          | ** ** | ** ** | ** ** | **Fair  Market** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------|------------|------------|------------|------------------|------------|
| ** **                      | ** ** | **2006**                                                      | ** ** | **2007**   | ** ** | **2008**         | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Value** | ** ** |
| ** **                      | ** ** | **(in thousands, except interest rates)** | ** ** |
| **LIABILITIES**                 |       |                                                          |       |       |       |             |       |   |   |   |   |   |   |   |   |   |   |
| **Debt  Obligations:**          |       |                                                          |       |       |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Fixed Rate                      |       | $—                                                       |       | $—    |       | $—          |       | $— |   | $— |   | $350,000 |   | $350,000 |   | $376,705 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —     |       | —           |       | — |   | — |   | 2.50 | % | 2.50 | % |   |   |
| Fixed Rate                      |       | $—                                                       |       | $—    |       | $—          |       | $— |   | $— |   | $150,000 |   | $150,000 |   | $150,948 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —     |       | —           |       | — |   | — |   | 1.375 | % | 1.375 | % |   |   |
| Variable Rate                   |       | $10,000                                                       |       | $—    |       | $—          |       | $— |   | $— |   | $— |   | $10,000 |   | $10,000 |   |
| Weighted Average  Interest Rate |       | 4.61                                                          | %          | —     |       | —           |       | — |   | — |   | — |   | 4.61 | % |   |   |
| Variable Rate                   |       | $50,000                                                       |       | $—    |       | $—          |       | $— |   | $— |   | $— |   | $50,000 |   | $50,000 |   |
| Weighted Average  Interest Rate |       | 6.22                                                          | %          | —     |       | —           |       | — |   | — |   | — |   | 6.22 | % |   |   |
| Total Debt  Obligations         |       | $60,000                                                       |       | $—    |       | $—          |       | $— |   | $— |   | $500,000 |   | $560,000 |   | $587,653 |   |
| Weighted Average  Interest Rate |       | 5.95                                                          | %          | —     |       | —           |       | — |   | — |   | 2.16 | % | 2.57 | % |   |   |

 

*Foreign currency risk. *Overall,we are a net recipient of currencies other than the U.S. dollar and, as such,we benefit from a weaker dollar and are adversely affected by a stronger dollarrelative to major currencies worldwide. Accordingly, changes in exchange rates,and in particular a strengthening of the U.S. dollar, may negatively affect ourconsolidated net sales and gross profit as expressed in U.S. dollars.

We may enter into foreignexchange option and forward contracts to reduce earnings and cash flowvolatility associated with foreign exchange rate changes to allow management tofocus its attention on its core business operations. Accordingly, we enter intocontracts which change in value as foreign exchange rates change toeconomically offset the effect of changes in value of foreign currency assetsand liabilities, commitments and anticipated foreign currency denominated salesand operating expenses. We enter into foreign exchange option and forwardcontracts in amounts between minimum and maximum anticipated foreign exchangeexposures, generally for periods not to exceed one year. We do not enter intoforeign exchange option and forward contracts for trading purpose.

29

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We use foreign currencyoption contracts, which provide for the sale of foreign currencies to offsetforeign currency exposures expected to arise in the normal course of ourbusiness. While these instruments are subject to fluctuations in value, such fluctuationsare anticipated to offset changes in the value of the underlying exposures. Theprincipal currencies subject to this process are the Japanese yen and the euro.The foreign exchange forward contracts are entered into to protect the value offoreign currency denominated monetary assets and liabilities and the changes inthe fair value of the foreign currency forward contracts were economicallydesigned to offset the changes in the revaluation of the foreign currencydenominated monetary assets and liabilities. These forward contracts aredenominated in currencies which represent material exposures. The changes inthe fair value of foreign currency option and forward contracts are recordedthrough earnings as “Unrealized (gain) loss on derivative instruments” whileany realized gains or losses on expired contracts are recorded through earningsas “Other, net” in the accompanying unaudited consolidated statements ofoperations. Any premium cost of purchased foreign exchange option contracts arerecorded in “Other current assets” and amortized over the life of the options.

The following tablesprovide information about our foreign currency derivative financial instrumentsoutstanding as of June 30, 2006 and December 31, 2005, respectively. Theinformation is provided in U.S. dollar amounts, as presented in ourconsolidated financial statements.

 
| ** **                                   | ** ** | **June 30, 2006** | ** ** | **December 31, 2005**             | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **Notional  Amount**        | ** ** | **Average  Contract  or Strike  Rate** | ** ** | **Notional  Amount** | ** ** | **Average  Contract  or Strike  Rate** | ** ** |
| ** **                                   | ** ** | **(in $millions)**     | ** ** | ** **                                  | ** ** | **(in $millions)** | ** ** | ** ** | ** ** |
| **Foreign  currency forward contracts:**     |       |                        |       |                                        |       |   |   |   |   |
| **Pay  US$/Receive Foreign Currency:**       |       |                        |       |                                        |       |   |   |   |   |
| Swedish Krona                                |       | $                           | 24.4       |                                        | 7.18       |   | $ | 31.5 |   | 7.94 |   |
| U.K. Pound                                   |       | —                      |       | —                                      |       | 5.2 |   | 1.72 |   |
| Swiss Franc                                  |       | 1.6                         |       | 1.22                                        |       | 1.5 |   | 1.31 |   |
| Euro                                         |       | —                      |       | —                                      |       | 5.9 |   | 1.19 |   |
| **Receive  US$/Pay Foreign Currency:**       |       |                        |       |                                        |       |   |   |   |   |
| Japanese Yen                                 |       | 6.6                         |       | 114.45                                      |       | 3.0 |   | 117.45 |   |
| Canadian Dollar                              |       | 9.0                         |       | 1.12                                        |       | 3.4 |   | 1.17 |   |
| U.K. Pound                                   |       | 0.9                         |       | 1.85                                        |       | — |   | — |   |
| Australia Dollar                             |       | —                      |       | —                                      |       | 2.9 |   | 0.73 |   |
|                                         |       |                        |       |                                        |       |   |   |   |   |
| **Total  Notional**                          | ** ** | **$**                       | **42.5**   | ** **                                  | ** ** | ** ** | **$** | **53.4** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | ** **                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Estimated  Fair Value**                    | ** ** | **$**                       | **(0.1**   | **)**                                       | ** ** | ** ** | **$** | **—** |   |   |   |
| ** **                                   | ** ** | ** **                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** |   |
| **Foreign  currency purchased put options:** |       |                        |       |                                        |       |   |   |   |   |
| Japanese Yen                                 |       | $                           | 109.5      |                                        | 118.68     |   | $ | 66.2 |   | 117.83 |   |
| Euro                                         |       | 37.6                        |       | 1.19                                        |       | 40.2 |   | 1.18 |   |
|                                         |       |                        |       |                                        |       |   |   |   |   |
| **Foreign  currency sold call options:**     |       |                        |       |                                        |       |   |   |   |   |
| Japanese Yen                                 |       | 123.6                       |       | 105.20                                      |       | 60.0 |   | 106.60 |   |
| Euro                                         |       | 40.7                        |       | 1.29                                        |       | 43.0 |   | 1.26 |   |
|                                         |       |                        |       |                                        |       |   |   |   |   |
| **Total  Notional**                          | ** ** | **$**                       | **311.4**  | ** **                                  | ** ** | ** ** | **$** | **209.4** |   |   |   |
| ** **                                   | ** ** | ** **                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** |   |
| **Estimated Fair Value**                     | ** ** | **$**                       | **(2.2**   | **)**                                       | ** ** | ** ** | **$** | **1.1** |   |   |   |

 

The notional principalamount provides one measure of the transaction volume outstanding as of the endof the period, and does not represent the amount of our exposure to marketloss. The estimate of fair value is based on applicable and commonly usedprevailing financial market information as of June 30, 2006 andDecember 31, 2005, respectively. The amounts ultimately realized uponsettlement of these financial instruments, together with the gains and losseson the underlying exposures, will depend on actual market conditions during theremaining life of the instruments.

30

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**Item 4.Controls and Procedures**

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our principal executive officer andprincipal financial officer, of the effectiveness of the design and operationof our disclosure controls and procedures. Based on this evaluation, ourprincipal executive officer and principal financial officer concluded that ourdisclosure controls and procedures (as defined in Rule 13a-15(e) and Rule15d-15(e) under the Securities Exchange Act of 1934) are effective. Inaddition, our management evaluated our internal control over financialreporting and there have been no changes during the most recent fiscal quarterended June 30, 2006 that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

**PART II -OTHER INFORMATION**

**Item 1. Legal Proceedings**

On July 7, 2006, weentered into a settlement agreement, with an effective date of June 30, 2006,with Alcon, Inc., Alcon Laboratories, Inc., and Alcon Manufacturing Ltd.(collectively, “Alcon”) regarding all pending patent litigation between AMO andAlcon. The settlement required Alcon to pay AMO a lump-sum payment of $121million which we received in July 2006. The parties agreed to dismiss allpending patent litigation in Delaware and Texas, agreed not to sue each otherregarding the patents at issue in those cases, and cross-licensed patentscovering existing features of commercially available phacoemulsificationproducts. As part of the settlement, the parties agreed to a dispute resolutionprocess for future claims before litigation is commenced.

On January 4, 2005, Dr.James Nielsen filed a complaint against us and Allergan, Inc. in the U.S.District Court of the Northern District of Texas, Dallas Division, forinfringement of U.S. Patent No. 5,158,572. Dr. Nielsen alleges that our*Array* multifocal intraocular lensinfringes the patent. He is seeking damages and a permanent injunction. Thetrial in this matter is scheduled to begin on November 6, 2006.

We do not believe, basedon current knowledge, that any of the foregoing legal proceedings or claims arelikely to have a material adverse effect on our financial position, results ofoperations or cash flows. However, we may incur substantial expenses indefending against third party claims. In the event of a determination adverseto us or our subsidiaries, we may incur substantial monetary liability, and berequired to change our business practices. Either of these could have amaterial adverse effect on our financial position, results of operations orcash flows.

While we are involvedfrom time to time in litigation arising in the ordinary course of business,including product liability claims, we are not currently aware of any otheractions against us or Allergan relating to the optical medical device businessthat we believe would have a material adverse effect on our business, financialcondition, results of operations or cash flows. We may be subject to futurelitigation and infringement claims, which could cause us to incur significantexpenses or prevent us from selling our products. We operate in an industrysusceptible to significant product liability claims. Product liability claimsmay be asserted against us in the future arising out of events not known to usat the present time. Under the terms of the contribution and distributionagreement effecting our spin-off, Allergan agreed to assume responsibility for,and to indemnify us against, all current and future litigation relating to itsretained businesses and we agreed to assume responsibility for, and toindemnify Allergan against, all current and future litigation related to theoptical medical device business.

**Item 1A. Risk Factors**

There have been nosignificant changes to the risk factors disclosed in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2005.

31

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

(c)     Purchasesof Equity Securities by the Issuer

 

**ISSUER PURCHASES OF EQUITY SECURITIES**
| Period                                      | ** ** | **(a) Total Number of   Shares or Units Purchased**                         | ** ** | **(b) Average Price Paid  per  Share or Unit** | ** ** | **(c) Total Number of   Shares or Units  Purchased as Part of   Publicly Announced  Plans or Programs** | ** ** | **(d) Maximum Number   (or Approximate Dollar  Value) of Shares or  Units that May Yet Be  Purchased Under the  Plans or Programs** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                        |       |                                                                        |       |                                                |       |                                                                                                    |       |                                                                                                                                |       |
| April 1, 2006 —  April 30, 2006   |       | None                                                                        |       | None                                                |       | None                                                                                                    |       | None                                                                                                                                |       |
|                                        |       |                                                                        |       |                                                |       |                                                                                                    |       |                                                                                                                                |       |
| May 1, 2006 —   May 31, 2006 |       | None                                                                        |       | None                                                |       | None                                                                                                    |       | None                                                                                                                                |       |
|                                        |       |                                                                        |       |                                                |       |                                                                                                    |       |                                                                                                                                |       |
| June 1, 2006 —   June 30, 2006    |       | $30.0 million in  aggregate principal amount of 1.375% convertible notes(1) |       | $1,103 per $1,000 in  principal amount of notes     |       | n/a                                                                                                     |       | n/a                                                                                                                                 |       |
|                                        |       |                                                                        |       |                                                |       |                                                                                                    |       |                                                                                                                                |       |
|                                             |       | $98.9 million in aggregate  principal amount of 2.5% convertible notes(2)   |       | $1,124 per $1,000 in  principal amount of notes     |       | n/a                                                                                                     |       | n/a                                                                                                                                 |       |
|                                        |       |                                                                        |       |                                                |       |                                                                                                    |       |                                                                                                                                |       |
|                                             |       | 10,097,338 shares of  common stock(3)                                       |       | (4)                                                 |       | n/a                                                                                                     |       | n/a                                                                                                                                 |       |

----

(1)             InJune 2006, we repurchased $30.0 million in aggregate principal amount of our1.375% Convertible Senior Subordinated Notes due 2025 (the “1.375% convertiblenotes”) in privately negotiated transactions.

(2)             InJune 2006, we repurchased $98.9 million in aggregate principal amount of our2.5% Convertible Senior Subordinated Notes due 2024 (the “2.5% convertiblenotes”) in privately negotiated transactions.

(3)             Weand Goldman Sachs & Co. (“Goldman Sachs”) have entered into a MasterConfirmation and a Supplemental Confirmation, each dated June 7, 2006 (together,the “ASR”), which evidence an accelerated share repurchase arrangement underwhich we have agreed to purchase shares of our common stock from Goldman Sachsfor an aggregate purchase price of $500 million. Pursuant to the ASR, GoldmanSachs will deliver to us, in the aggregate, a minimum of approximately 10.1million shares and a maximum of approximately 11.3 million shares, depending onthe volume weighted average price per share during a calculation periodbeginning June 14, 2006 and ending not later than March 7, 2007. Under the ASR,Goldman Sachs delivered 10,097,338 shares in June 2006, and will deliver anyadditional shares at the end of the calculation period.

(4)             Theaggregate purchase price under the ASR is $500 million. Assuming no additionalshares are delivered under the ASR, the price per share is $49.52 per share.Any delivery of additional shares under the ASR would effectively reduce theprice per share.

**Item 4. Submission of Matters toa Vote of Security Holders**

Theannual meeting of stockholders of the registrant was held on May 25, 2006at which three directors were re-elected to serve on the Board of Directors fora three-year term until the annual meeting of stockholders to be held in 2009.One other matter was voted on, namely, ratification of the appointment ofPricewaterhouseCoopers LLP as our independent registered public accounting firmfor fiscal year 2006. This was approved by the stockholders.

32

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A summary of the voting at the annual meeting ofstockholders follows:

 
| **Directors**           | ** ** | **For**    | ** ** | **Withheld** | ** ** | **Broker  Non-Votes** | ** ** |
|-------------------------|------------|------------|------------|--------------|------------|-----------------------|------------|
| William J. Link,  Ph.D. |       | 60,814,371 |       | 213,294      |       | —                |       |
| Michael A.  Mussallem   |       | 59,222,669 |       | 1,804,996    |       | —                |       |
| Deborah J. Neff         |       | 60,814,148 |       | 213,517      |       | —                |       |

 
| **Other Matters**                                                                                                            | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker  Non-Votes** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-----------------------|------------|
| Ratification of  appointment of PricewaterhouseCoopers LLP as independent registered public  accounting firm for fiscal year 2006 |       | 60,403,282 |       | 612,100     |       | 12,283      |       | —                |       |

 

**Item 6.Exhibits**

 
| 10.1   |   | Confidential Settlement Agreement, dated as of June  30, 2006, between Advanced Medical Optics, Inc. and Alcon, Inc., Alcon  Laboratories, Inc. and Alcon Manufacturing, Ltd.                                                                                                                                                                                                                                                                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2   |   | Third Amendment to Second Amended and Restated  Credit Agreement, dated as of June 5, 2006, among Advanced Medical Optics,  Inc., certain of its subsidiaries as the Guarantors, the Lenders (as defined  in the Second Amended and Restated Credit Agreement dated as of June 25, 2004  and filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q  filed on August 3, 2004), and Bank of America, N.A., as Administrative Agent  on behalf of itself and the Lenders. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *10.3  |   | Master Confirmation between Advanced Medical Optics,  Inc. and Goldman, Sachs & Co. dated as of June 7, 2006.                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *10.4  |   | Supplemental Confirmation between Advanced Medical  Optics, Inc. and Goldman, Sachs & Co. dated as of June 7, 2006.                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.1   |   | Certification of James V. Mazzo pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.2   |   | Certification of Richard A. Meier pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 32.1   |   | Certification of James V. Mazzo and Richard A. Meier  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                              |

 

----

*                    Portionsof the exhibit have been redacted and are subject to a confidential treatmentrequest filed with the Securities and Exchange Commission pursuant to Rule24b-2 under the Securities and Exchange Act of 1934, as amended.

33

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SIGNATURES

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

Date: August 9, 2006

 
|        | ADVANCED MEDICAL  OPTICS, INC.                                                                                                        |
|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                  |
|   | /s/ RICHARD A.  MEIER                                                                                                                 |
|   | **Richard  A. Meier**                                                                                                                 |
|   | **Executive  Vice President, Operations, President,   Eye Care Business, and Chief Financial Officer  (Principal Financial Officer)** |
|   |                                                                                                                                  |
|   | /s/ ROBERT F.  GALLAGHER                                                                                                              |
|   | **Robert  F. Gallagher**                                                                                                              |
|   | **(Principal  Accounting Officer)**                                                                                                   |

 

34

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EXHIBIT INDEX

 
| 10.1   |   | Confidential Settlement Agreement, dated as of June  30, 2006, between Advanced Medical Optics, Inc. and Alcon, Inc., Alcon  Laboratories, Inc. and Alcon Manufacturing, Ltd.                                                                                                                                                                                                                                                                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2   |   | Third Amendment to Second Amended and Restated  Credit Agreement, dated as of June 5, 2006, among Advanced Medical Optics,  Inc., certain of its subsidiaries as the Guarantors, the Lenders (as defined  in the Second Amended and Restated Credit Agreement dated as of June 25, 2004  and filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q  filed on August 3, 2004), and Bank of America, N.A., as Administrative Agent  on behalf of itself and the Lenders. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *10.3  |   | Master Confirmation between Advanced Medical Optics,  Inc. and Goldman, Sachs & Co. dated as of June 7, 2006.                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *10.4  |   | Supplemental Confirmation between Advanced Medical  Optics, Inc. and Goldman, Sachs & Co. dated as of June 7, 2006.                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.1   |   | Certification of James V. Mazzo pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.2   |   | Certification of Richard A. Meier pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 32.1   |   | Certification of James V. Mazzo and Richard A. Meier  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                              |

 

----

| * |   | Portions of the exhibit have been redacted and are  subject to a confidential treatment request filed with the Securities and  Exchange Commission pursuant to Rule 24b-2 under the Securities and Exchange  Act of 1934, as amended. |
|---|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

35

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