**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 September 29, 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 registrantas 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 telephonenumber, 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 October 31, 2006, there were 59,221,078 shares of common stockoutstanding.

 

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ADVANCED MEDICALOPTICS, INC.FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 29, 2006

INDEX
| PART I -  FINANCIAL INFORMATION |                                                                            | 3                                                                                           |
|--------------------------------------|---------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                 |                                                                            |                                                                                        |   |   |
|                                 | Item 1.                                                                    | Financial  Statements                                                                       |   | 3 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | (A).                                                                            |                                                                                        | Unaudited  Consolidated Statements of Operations - Three Months and Nine Months Ended  September 29, 2006 and September 30, 2005 |   | 3 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | (B).                                                                            |                                                                                        | Unaudited Consolidated  Balance Sheets — September 29, 2006 and December 31, 2005 |   | 4 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | (C).                                                                            |                                                                                        | Unaudited  Consolidated Statements of Cash Flows - Nine Months Ended September 29, 2006  and September 30, 2005 |   | 5 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | (D).                                                                            |                                                                                        | Notes to  Unaudited Consolidated Financial Statements |   | 6 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | Item 2.                                                                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | 20 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 |                                                                            |                                                                                        | Certain  Factors and Trends Affecting AMO and Its Businesses |   | 30 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | Item 3.                                                                         | Quantitative  and Qualitative Disclosures About Market Risk                                 |   | 31 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | Item 4.                                                                         | Controls and  Procedures                                                                    |   | 34 |
|                                 |                                                                            |                                                                                        |   |   |
| PART II - OTHER  INFORMATION    |                                                                            | 34                                                                                          |
|                                 |                                                                            |                                                                                        |   |   |
|                                 | Item 1.                                                                         | Legal Proceedings                                                                           |   | 34 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | Item  1A.                                                                       | Risk  Factors                                                                               |   | 34 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | Item 2.                                                                         | Unregistered  Sales of Equity Securities and Use of Proceeds                                |   | 35 |
|                                 |                                                                            |                                                                                        |   |   |   |
|                                 | Item  6.                                                                        | Exhibits                                                                                    |   | 35 |
|                                 |                                                                            |                                                                                        |   |   |
|                                 | Note: Items 3, 4 and 5 of Part II are omitted  because they are not applicable. |                                                                                        |   |
|                                 |                                                                            |                                                                                        |   |   |
| Signatures                           |                                                                            | 36                                                                                          |
|                                 |                                                                            |                                                                                        |   |   |
| Exhibit  Index                       |                                                                            | 37                                                                                          |
| EXHIBIT 4.1                          |                                                                            |                                                                                        |
| EXHIBIT 31.1                         |                                                                            |                                                                                        |
| EXHIBIT 31.2                         |                                                                            |                                                                                        |
| EXHIBIT 32.1                         |                                                                            |                                                                                        |
|                                      |                                                                                 |                                                                                             |  |  |  |  |

 

2

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** **

**PART I -FINANCIAL INFORMATION**

**Item 1. Financial Statements**

Advanced Medical Optics,Inc.Unaudited Consolidated Statements of Operations(In thousands, except per share data)
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **September 29,  2006**     | ** ** | **September 30,  2005**    | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
| Net sales                                                              |       | $                                | 258,602    |                            | $          | 248,233 |   | $ | 753,871 |   | $ | 667,843 |   |
| Cost of sales (Note 3)                                                 |       | 95,474                           |       | 87,452                          |       | 274,682 |   | 245,369 |   |
| Gross profit                                                           |       | 163,128                          |       | 160,781                         |       | 479,189 |   | 422,474 |   |
| Selling, general and  administrative                                   |       | 96,297                           |       | 117,814                         |       | 291,125 |   | 299,223 |   |
| Research and  development                                              |       | 16,105                           |       | 18,520                          |       | 49,643 |   | 44,820 |   |
| Business repositioning  (credits) costs, net (Note 3)                  |       | (547                             | )          | —                          |       | 46,427 |   | — |   |
| In-process research and  development                                   |       | —                           |       | 39,300                          |       | — |   | 490,750 |   |
| Net gain on legal  contingencies                                       |       | (102,896                         | )          | —                          |       | (96,896 | ) | — |   |
| Operating income (loss)                                                |       | 154,169                          |       | (14,853                         | )          | 188,890 |   | (412,319 | ) |
|                                                                   |       |                             |       |                            |       |   |   |   |   |
| Non-operating expense  (income):                                       |       |                             |       |                            |       |   |   |   |   |
| Interest expense                                                       |       | 9,783                            |       | 8,831                           |       | 22,318 |   | 23,569 |   |
| Unrealized  (gain) loss on derivative instruments                      |       | (2,252                           | )          | (179                            | )          | 650 |   | (1,169 | ) |
| Loss due to  early retirement of convertible senior subordinated notes |       | 2,985                            |       | —                          |       | 18,783 |   | 545 |   |
| Other, net                                                             |       | 1,521                            |       | 1,940                           |       | 3,069 |   | 198 |   |
|                                                                   |       | 12,037                           |       | 10,592                          |       | 44,820 |   | 23,143 |   |
| Earnings (loss) before  income taxes                                   |       | 142,132                          |       | (25,445                         | )          | 144,070 |   | (435,462 | ) |
| Provision for income  taxes                                            |       | 54,978                           |       | 5,770                           |       | 56,990 |   | 20,043 |   |
| Net earnings (loss)                                                    |       | $                                | 87,154     |                            | $          | (31,215 | ) | $ | 87,080 |   | $ | (455,505 | ) |
|                                                                   |       |                             |       |                            |       |   |   |   |   |
| Net earnings (loss) per  share :                                       |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                  |       | $                                | 1.47       |                            | $          | (0.47 | ) | $ | 1.34 |   | $ | (9.01 | ) |
| Diluted                                                                |       | $                                | 1.42       |                            | $          | (0.47 | ) | $ | 1.30 |   | $ | (9.01 | ) |
|                                                                   |       |                             |       |                            |       |   |   |   |   |
| Weighted average number  of shares outstanding:                        |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                  |       | 59,166                           |       | 66,326                          |       | 64,841 |   | 50,552 |   |
| Diluted                                                                |       | 61,531                           |       | 66,326                          |       | 67,228 |   | 50,552 |   |

 

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)
| ** **                                                                                            | ** ** | **September 29,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                |       |                         |       |                        |       |
| Current assets                                                                                        |       |                         |       |                        |       |
| Cash and equivalents                                                                                  |       | $                            | 38,777     |                        | $          | 40,826 |   |
| Trade receivables, net                                                                                |       | 233,574                      |       | 238,761                     |       |
| Inventories                                                                                           |       | 126,619                      |       | 104,820                     |       |
| Deferred income taxes                                                                                 |       | 52,844                       |       | 66,476                      |       |
| Other current assets                                                                                  |       | 31,949                       |       | 28,122                      |       |
| Total current assets                                                                                  |       | 483,763                      |       | 479,005                     |       |
| Property, plant  and equipment, net                                                                   |       | 124,720                      |       | 115,725                     |       |
| Deferred income  taxes                                                                                |       | 11,593                       |       | 12,626                      |       |
| Other assets                                                                                          |       | 61,909                       |       | 52,473                      |       |
| Intangibles  assets, net                                                                              |       | 474,586                      |       | 495,609                     |       |
| Goodwill                                                                                              |       | 836,030                      |       | 825,284                     |       |
| Total assets                                                                                          |       | $                            | 1,992,601  |                        | $          | 1,980,722 |   |
|                                                                                                  |       |                         |       |                        |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                             |       |                         |       |                        |       |
| Current  liabilities                                                                                  |       |                         |       |                        |       |
| Short-term borrowings                                                                                 |       | $                            | 31,700     |                        | $          | 60,000 |   |
| Accounts payable                                                                                      |       | 56,792                       |       | 64,045                      |       |
| Accrued compensation                                                                                  |       | 32,592                       |       | 43,406                      |       |
| Other accrued expenses                                                                                |       | 100,219                      |       | 90,666                      |       |
| Income taxes                                                                                          |       | 23,782                       |       | 1,434                       |       |
| Deferred income taxes                                                                                 |       | 770                          |       | 565                         |       |
| Total current liabilities                                                                             |       | 245,855                      |       | 260,116                     |       |
| Long-term debt                                                                                        |       | 851,105                      |       | 500,000                     |       |
| Deferred income  taxes                                                                                |       | 176,239                      |       | 182,179                     |       |
| Other  liabilities                                                                                    |       | 30,727                       |       | 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; 59,537,431 and 67,832,010 shares issued |       | 595                          |       | 678                         |       |
| Additional paid-in capital                                                                            |       | 1,405,344                    |       | 1,586,864                   |       |
| Accumulated deficit                                                                                   |       | (732,476                     | )          | (557,586                    | )          |
| Accumulated other comprehensive income (loss)                                                         |       | 15,236                       |       | (19,870                     | )          |
| Less treasury stock, at cost (1,397 shares)                                                           |       | (24                          | )          | (24                         | )          |
| Total stockholders’ equity                                                                       |       | 688,675                      |       | 1,010,062                   |       |
| Total  liabilities and stockholders’ equity                                                      |       | $                            | 1,992,601  |                        | $          | 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)
| ** **                                                                                            | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                            | ** ** | **September 29,  2006**    | ** ** | **September 30,  2005** | ** ** |
| Cash flows from  operating activities:                                                                |       |                            |       |   |   |
| Net earnings (loss)                                                                                   |       | $                               | 87,080     |   | $ | (455,505 | ) |
| Adjustments to reconcile net earnings (loss) to net  cash provided by (used in) operating activities: |       |                            |       |   |   |
| Amortization of debt issuance costs                                                                   |       | 6,104                           |       | 8,344 |   |
| Amortization and write-off of realized gain on  interest rate swaps                                   |       | —                          |       | (773 | ) |
| Depreciation and amortization                                                                         |       | 52,609                          |       | 35,469 |   |
| In-process research and development                                                                   |       | —                          |       | 490,750 |   |
| Loss due to early retirement of convertible senior  subordinated notes                                |       | 18,783                          |       | 545 |   |
| Loss on investments and assets                                                                        |       | 1,409                           |       | 329 |   |
| Tax benefit from issuance of stock under stock plans                                                  |       | —                          |       | 11,104 |   |
| Excess tax benefits from stock-based compensation                                                     |       | (5,729                          | )          | — |   |
| Unrealized loss (gain) on derivatives                                                                 |       | 650                             |       | (1,169 | ) |
| Expense of compensation plan                                                                          |       | 14,782                          |       | 708 |   |
| Changes in assets and liabilities:                                                                    |       |                            |       |   |   |
| Trade receivables, net                                                                                |       | 9,749                           |       | (4,737 | ) |
| Inventories                                                                                           |       | (20,386                         | )          | (27,599 | ) |
| Other current assets                                                                                  |       | (7,632                          | )          | (6,995 | ) |
| Accounts payable                                                                                      |       | (7,861                          | )          | (33,423 | ) |
| Accrued expenses and other liabilities                                                                |       | (4,806                          | )          | (27,507 | ) |
| Income taxes                                                                                          |       | 49,675                          |       | (1,869 | ) |
| Other non-current assets and liabilities                                                              |       | (6,183                          | )          | 4,669 |   |
| Net cash (used in) provided by operating activities                                                   |       | 188,244                         |       | (7,659 | ) |
| Cash flows from  investing activities:                                                                |       |                            |       |   |   |
| Acquisition of businesses, net of cash acquired                                                       |       | —                          |       | (36,867 | ) |
| Additions to property, plant and equipment                                                            |       | (20,204                         | )          | (13,197 | ) |
| Proceeds from sale of property, plant and equipment                                                   |       | 2,780                           |       | 23 |   |
| Additions to capitalized internal-use software                                                        |       | (2,146                          | )          | (7,617 | ) |
| Additions to demonstration and bundled equipment                                                      |       | (7,714                          | )          | (8,344 | ) |
| Net cash used in investing activities                                                                 |       | (27,284                         | )          | (66,002 | ) |
| Cash flows from  financing activities:                                                                |       |                            |       |   |   |
| Short-term borrowings                                                                                 |       | (28,300                         | )          | 96,500 |   |
| Repayment of long-term debt                                                                           |       | (167,678                        | )          | (193,993 | ) |
| Financing related costs                                                                               |       | (10,401                         | )          | (8,108 | ) |
| Proceeds from issuance of long-term debt                                                              |       | 500,000                         |       | 150,000 |   |
| Proceeds from issuance of common stock                                                                |       | 34,642                          |       | 30,627 |   |
| Net proceeds from settlement of interest rate swaps                                                   |       | —                          |       | 773 |   |
| Repurchase and retirement of common stock                                                             |       | (500,000                        | )          | — |   |
| Excess tax benefits from stock-based compensation                                                     |       | 5,729                           |       | — |   |
| Net cash (used in) provided by financing activities                                                   |       | (166,008                        | )          | 75,799 |   |
| Effect of  exchange rates on cash and equivalents                                                     |       | 2,999                           |       | (2,651 | ) |
| Net decrease in  cash and equivalents                                                                 |       | (2,049                          | )          | (513 | ) |
| Cash and  equivalents at beginning of period                                                          |       | 40,826                          |       | 49,455 |   |
| Cash and  equivalents at end of period                                                                |       | $                               | 38,777     |   | $ | 48,942 |   |
| 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 resultsof operations for the three and nine months ended September 29, 2006 are notnecessarily indicative of the results to be expected for the year endingDecember 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-Based Payment” (“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 Statement of Financial Accounting Standards No.123 (“SFAS 123”). Accordingly, no compensation expense was recorded forstock options granted with exercise prices greater than or equal to the fairvalue of the underlying common stock at the option grant date. The fair value,as determined on the date of grant, of restricted stock awards was recognizedas compensation expense ratably over the respective vesting period.Additionally, the ESPP qualified as a non-compensatory plan under APB 25;therefore, no compensation cost was recorded in relation to the discountoffered to employees for purchases made under the ESPP.

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 prior periods. Underthis transition method, stock-based compensation expense for the three and ninemonths ended September 29, 2006 includes compensation expense for allstock-based compensation awards granted prior to, but not yet vested as ofJanuary 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 is based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123R. In addition, theCompany’s unearned compensation balance at January 1, 2006 was reclassified toadditional paid-in capital upon the adoption 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 nine months ended September 29, 2006 is as follows(in thousands):
|                                      | ** ** | **Three Months Ended  September 29, 2006** | ** ** | **Nine Months Ended  September 29, 2006** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                                     | ** ** | ** **                                                    | ** ** |
| Cost of sales                        |       | $                                                              | 552        |                                                          | $          | 1,709 |   |
| Operating  Expenses -                |       |                                                           |       |                                                          |       |
| Research and  development            |       | 542                                                            |       | 1,599                                                         |       |
| Selling, general  and administrative |       | 3,426                                                          |       | 11,474                                                        |       |
|                                 |       | 3,968                                                          |       | 13,073                                                        |       |
| Pre-tax expense                      |       | 4,520                                                          |       | 14,782                                                        |       |
| Income tax  benefit                  |       | (1,479                                                         | )          | (4,866                                                        | )          |
| Net of tax expense                   |       | $                                                              | 3,041      |                                                          | $          | 9,916 |   |

 

At September 29, 2006,total pre-tax compensation costs related to unvested stock-based awards grantedto employees and directors under the Company’s ICP and ESPP which are not yetrecognized were approximately $33.4 million, net of estimated forfeitures.These costs are expected to be recognized over a weighted-average period of 2.77years.

Net cash proceeds fromthe exercise of stock options were $5.1 million and $32.2 million for the threeand nine month periods ended September 29, 2006, respectively. In accordancewith SFAS 123R, the cash flows resulting from excess tax benefits (tax benefitsrelated to the excess of proceeds from employee exercises of stock options overthe stock-based compensation cost recognized for those options) are classifiedas financing cash flows in the Company’s unaudited consolidated statement of cash flows. During the ninemonths ended September 29, 2006, the Company recorded $5.7 million of excesstax benefits as a financing cash inflow. Prior to the adoption of SFAS 123R,excess tax benefits of $11.1 million during the nine months ended September 30,2005 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 and ninemonths ended September 29, 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     |       | 29                                 | %          | 33                                   | %          |
| Risk-free  interest rate |       | 5                                  | %          | 5                                    | %          |
| Expected  dividends      |       | —                             |       | —                               |       |

The weighted average fairvalue of options granted under the ICP was $18.99 and $17.72 for the three andnine months ended September 29, 2006. Under the ESPP, the weighted average fairvalue of grants was $11.51 for the nine months ended September 29, 2006. Therewere no ESPP grants during the three months ended September 29, 2006.

*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 plansexpire ten 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                                            |       | 664                        |       | 45.41                                      |       |                                                                   |       |                                |       |
| Exercised                                          |       | (1,503                     | )          | 21.42                                      |       |                                                                   |       |                                |       |
| Forfeitures and  cancellations                     |       | (70                        | )          | 31.75                                      |       |                                                                   |       |                                |       |
| Expirations                                        |       | (11                        | )          | 21.64                                      |       |                                                                   |       |                                |       |
| Outstanding at  September 29, 2006                 |       | 7,938                      |       | 24.87                                      |       | 6.41                                                                   |       | $                                   | 116,535    |   |
| Vested and  expected to vest at September 29, 2006 |       | 7,829                      |       | 24.69                                      |       | 6.46                                                                   |       | $                                   | 116,358    |   |
| Exercisable at  September 29, 2006                 |       | 5,641                      |       | 19.67                                      |       | 5.64                                                                   |       | $                                   | 112,152    |   |
|                                                    |            |                            |            |                                            |            |                                                                        |            |                                     |            |  |  |

 

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 September 29, 2006. During the ninemonths ended September 29, 2006, the aggregate intrinsic value of optionsexercised under the Company’s stock option plans was $36.8 million determinedas of the date of option 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 September 29, 2006 employeewithholdings under the ESPP aggregated $2.1 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 

8

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the date of grant. During this restrictionperiod, ownership of the shares cannot be transferred. Restricted stockhas the same cash dividend and voting rights as other common stock and isconsidered to be currently issued and outstanding. The cost of the awards,determined to be the fair market value of the shares at the date of grant, isexpensed ratably over the period the restrictions lapse.

The following tablesummarizes the restricted stock award activity for the nine months ended September29, 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                                |       | 283                        |       | 49.63                                                   |       |
| Vested                                 |       | (32                        | )          | 38.24                                                   |       |
| Forfeited                              |       | (6                         | )          | 43.75                                                   |       |
| Nonvested stock at  September 29, 2006 |       | 346                        |       | $                                                       | 47.62      |   |

 

*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 of restrictedstock shares or units equal to the value of the award amount divided by thefair market value of the Company’s common stock on the date the performancecriteria is deemed to have been met. The restricted stock shares or units willhave the same terms and conditions as other restricted shares or units issuedunder the Company’s ICP. The estimated fair value of the 2006 Program was $0.8million on the grant date using a lattice-based valuation model. Compensationexpense is being recognized over a four-year period from the program approvaldate through the end of the expected vesting period of the restricted stockawards. The associated compensation expense during the three months and ninemonths ended September 29, 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 nine month periods ended September 30, 2005(in thousands, except per share amounts):
|                                                                                        | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net loss, as  reported                                                                 |       | $                                                              | (31,215    | )                                                             | $          | (455,505 | ) |
| Stock-based  compensation expense included in reported net earnings, net of tax        |       | 314                                                            |       | 477                                                           |       |
| Stock-based  compensation expense determined under fair value based method, net of tax |       | (3,474                                                         | )          | (8,350                                                        | )          |
| Pro forma net  loss                                                                    |       | $                                                              | (34,375    | )                                                             | $          | (463,378 | ) |
| Loss per share  as reported:                                                           |       |                                                           |       |                                                          |       |
| Basic and diluted                                                                      |       | $                                                              | (0.47      | )                                                             | $          | (9.01 | ) |
| Pro forma loss  per share:                                                             |       |                                                           |       |                                                          |       |
| Basic and  diluted                                                                     |       | $                                                              | (0.52      | )                                                             | $          | (9.17 | ) |

 

9

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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 ninemonths ended September 30, 2005 was estimated using the followingweighted-average assumptions:
|                         | ** ** | **Incentive  Compensation  Plans** | ** ** | **Employee   Stock  Purchase  Plans** | ** ** |
|-------------------------|------------|------------------------------------|------------|--------------------------------------------|------------|
| Expected life in years  |       | 5.0                                |       | 0.5                                        |       |
| Expected volatility     |       | 36                                 | %          | 36                                         | %          |
| Risk-free interest rate |       | 4                                  | %          | 3                                          | %          |
| Expected dividends      |       | —                             |       | —                                     |       |

 

The weighted average fairvalue of options granted under the ICP was $15.34 and $14.52 for the three andnine months ended September 30, 2005. Under the ESPP, the weighted average fairvalue of grants was $9.13 for the nine months ended September 30, 2005. Therewere no ESPP grants during the three months ended September 30, 2005.

**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 nine months ended September 30, 2005 are as follows (in thousands, exceptper share data):
|                          | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|--------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net sales:               |       |                                                           |       |                                                          |       |
| Cataract/Implant         |       | $                                                              | 120,425    |                                                          | $          | 364,881 |   |
| Laser Vision  Correction |       | 50,220                                                         |       | 148,624                                                       |       |
| Eye Care                 |       | 77,588                                                         |       | 234,507                                                       |       |
|                     |       | $                                                              | 248,233    |                                                          | $          | 748,012 |   |
| Net earnings (1) (2)     |       | 8,085                                                          |       | 34,878                                                        |       |
| Earnings per share:      |       |                                                           |       |                                                          |       |
| Basic (3)                |       | $                                                              | 0.12       |                                                          | $          | 0.53 |   |
| Diluted (4)              |       | $                                                              | 0.12       |                                                          | $          | 0.51 |   |

 

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(1)             Theunaudited pro forma information for the three months ended September 30, 2005excludes a $39.3 million in-process research and development charge related tothe VISX Acquisition.

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(2)             Theunaudited pro forma information for the nine months ended September 30, 2005 includesan $11.7 million increase in amortization related to management’s estimate ofthe fair value of intangible assets acquired as the result of the VISXAcquisition, a $4.7 million increase in interest expense resulting fromadditional borrowings incurred to fund the cash portion of the VISX Acquisitionand related costs and amortization of deferred financing costs and $11.0million of merger charges incurred by VISX. The unaudited pro forma information excludes the following non-recurringcharges related to the VISX Acquisition: a $488.5 million in-process research and development charge and a $2.0million charge for the amortization and write-off of debt issuance costs.

(3)             Theweighted average number of shares outstanding used for the computation of basicearnings per share for the nine months ended September 30, 2005 reflects theissuance of 27.8 million shares of AMO’s common stock to VISX stockholdersless the 12.8 million weighted-average shares related to the VISX Acquisitionalready included in basic shares outstanding.

(4)             Theweighted-average number of shares outstanding used for the computation ofdiluted earnings per share for the three and nine months ended September 30, 2005include the aggregrate dilutive effect of approximately 3.3 million shares and3.5 million shares, respectively, for stock options and awards, the remaining3.5% Convertible Senior Subordinated Notes and AMO stock options exchanged forVISX 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 itsfoldable intraocular lens (“IOL”) manufacturing capabilities in the secondquarter of 2006, the Company has decided to consolidate certain operations. Inaddition, the Company expanded the scope of its eye care rationalizationinitiatives in order to maximize manufacturing capacity and seize growth opportunities.  Total cumulative charges of $103.8 millionhave been incurred through September 29, 2006.

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 different from the Company’s initialestimates.

Inthe three months ended September 29, 2006, the Company incurred $4.0 million of pre-tax charges, which included $4.5million for inventory, manufacturingrelated and other charges included in cost of sales and net credit of $0.5million included in operatingexpenses. The net credit included in operating expenses comprised severance,relocation and other one-time termination benefits of $0.2 million and productivity and brandrepositioning costs of $6.5 million,offset by net asset disposal gains of $4.9 million and a net credit from settlement of a contractual obligation of$2.3 million.  In the nine months ended September 29, 2006,the Company incurred $61.5 millionof pre-tax charges, which included $15.1 million for inventory, manufacturing related and other charges includedin cost of sales and $46.4 millionincluded in operating expenses. Charges included in operating expensescomprised productivity and brand repositioning costs of $37.6 million and severance, relocation and other one-time termination benefits of $13.7 million,offset by net asset disposal gains of $2.8 million and a net credit from settlement of contractual obligations of$2.1 million.

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Businessrepositioning charges and related activity in the accrual balances during thenine months ended September 29, 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  September 29,  2006** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------------|------------|-----------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                   | ** ** | ** **          | ** ** | ** **         | ** ** | ** **                | ** ** | ** **                                    | ** ** |
| Cost of sales -                                                   | ** ** | ** **                                   | ** ** | ** **          | ** ** | ** **         | ** ** | ** **                | ** ** | ** **                                    | ** ** |
| Inventory,  manufacturing and other charges                       |       | $                                            | —     |                | $          | 15,054             |       | $                         | —     |                                          | $          | (15,054 | ) | $ | — |   |
| Operating Expenses -                                              |       |                                         |       |                |       |               |       |                      |       |                                          |       |
| Severance, relocation  and related costs                          |       | 8,779                                        |       | 13,710              |       | (11,392            | )          | —                    |       | 11,097                                        |       |
| Net gain on asset  disposals                                      |       | —                                       |       | (2,777              | )          | —             |       | 2,777                     |       | —                                        |       |
| Contractual obligations                                           |       | 2,641                                        |       | (2,106              | )          | (285               | )          | —                    |       | 250                                           |       |
| Productivity  initiatives and brand repositioning costs           |       | 883                                          |       | 37,600              |       | (36,844            | )          | —                    |       | 1,639                                         |       |
|                                                              |       | 12,303                                       |       | 46,427              |       | (48,521            | )          | 2,777                     |       | 12,986                                        |       |
|                                                              |       | $                                            | 12,303     |                | $          | 61,481             |       | $                         | (48,521    | )                                             | $          | (12,277 | ) | $ | 12,986 |   |

 

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 discontinuation of  certain non-core products and infrastructureand process improvements associated with the Company’s productivityinitiatives. The majority of these costs in the three and nine months ended September29, 2006 occurred in the United States, Japan and Europe. Net asset gainsresulted from disposals of long-lived assets from certain discontinued non-coreproducts and relocation of certain facilities, offset by asset write-downs whichresulted from the impairment and disposal of long-lived assets from thereduction in expected future cash flows. The fair values of impaired assetswere based on probability weighted expected cash flows as determined inaccordance with Statement of Financial Accounting Standards No. 144,“Accounting for the Impairment or Disposal of Long-lived Assets”.  The net credit from contractual obligationsprimarily resulted from the settlement with a vendor during the third quarterof 2006.

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

***Inventories***:
| (In thousands)                                                                                     | ** ** | **September 29,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Finished goods,  including consignment inventory of $14,524 and $11,890 in 2006 and 2005,  respectively |       | $                            | 88,230     |                        | $          | 66,492 |   |
| Work in process                                                                                         |       | 10,896                       |       | 13,148                      |       |
| Raw materials                                                                                           |       | 27,493                       |       | 25,180                      |       |
|                                                                                                    |       | $                            | 126,619    |                        | $          | 104,820 |   |

*** ***

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***Intangible assets, net***
|                                  | ** ** | ** **                    | ** ** | **September 29, 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      |                            | $          | (4,210 | ) | $ | 4,590 |   | $ | (4,113 | ) |
| Technology rights                |       | 8 — 19                   |       | 356,882                          |       | (52,312                         | )          | 348,379 |   | (26,128 | ) |
| Trademarks                       |       | 13.5                          |       | 15,856                           |       | (3,047                          | )          | 14,689 |   | (1,995 | ) |
| Customer relationships           |       | 5                             |       | 22,400                           |       | (5,973                          | )          | 22,400 |   | (2,613 | ) |
|                             |       |                          |       | 399,728                          |       | (65,542                         | )          | 390,058 |   | (34,849 | ) |
| Nonamortizable  Tradename (VISX) |       | Indefinite                    |       | 140,400                          |       | —                          |       | 140,400 |   | — |   |
|                             |       |                          |       | $                                | 540,128    |                            | $          | (65,542 | ) | $ | 530,458 |   | $ | (34,849 | ) |

 

The amortizable intangible assets balanceincreased due to the impact of foreign currency fluctuation. Amortizationexpense was $9.7 million and $29.6 million for the three and nine months ended September29, 2006, $9.8 million and $17.4   million for the three and nine months ended September30, 2005, respectively, and is recorded in selling, general and administrativein the accompanying unaudited consolidated statements of operations.Amortization expense is expected to be $39.4 million in 2006, $38.4 million in2007 and 2008, $38.2 million in 2009 and $35.5 million in 2010. Actual amortizationexpense may vary due to the impact of foreign currency fluctuations.

***Goodwill***
| (In thousands)      | ** ** | **September 29,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Goodwill:                |       |                         |       |                        |       |
| Eye Care                 |       | $                            | 28,719     |                        | $          | 28,817 |   |
| Cataract/Implant         |       | 334,773                      |       | 317,451                     |       |
| Laser Vision  Correction |       | 472,538                      |       | 479,016                     |       |
|                     |       | $                            | 836,030    |                        | $          | 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,“Business Segment Information”). The changein goodwill during the nine months ended September 29, 2006 is due to anadjustment of Laser Vision Correction goodwill of $6.5 million as a result ofexcess tax benefits from the exercise of converted VISX stock options that werefully vested at the acquisition date and the impact of foreign currencyfluctuations on the Eye Care and Cataract/Implant segments.  The Company performed its annual impairmenttest of goodwill during the second quarter of 2006 and determined there was noimpairment.

**Note 5:Debt**

At September 29, 2006, anaggregate principal amount of $246.1 million of 21⁄2 % convertible seniorsubordinated notes due July 15, 2024 (“21⁄2 % Notes”), an aggregateprincipal amount of $105 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 $31.7 million under the senior revolvingcredit facility were outstanding. The convertible notes may be converted, atthe option of the holders, on or prior to the final maturity date under certaincircumstances, none of which had occurred as of September 29, 2006. Uponconversion of the convertible notes, the Company will satisfy in cash theconversion obligation with respect to the principal amount of the convertiblenotes, with any remaining amount of the conversion obligation to be satisfiedin shares of common stock. As a result of this election, the Company also isrequired to satisfy in cash its obligations to repurchase any convertible notesthat holders may put to the Company on January 15,2010, July 15, 2014 and July 15, 2019 for the 21⁄2 % Notes, onJuly 1, 2011, July 1, 2016 and July 1, 2021 for the 1.375% Notes, and on August1, 2014, August 1, 2017, and August 1, 2021 for the 3.25% Notes.

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At September 29, 2006,approximately $8.6 million of the senior revolving credit facility was reservedto support letters of credit issued on the Company’s behalf for normal operatingpurposes and the Company has approximately $259.7 million undrawn and availablerevolving 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 (2.45% per annum at September 29, 2006) on theaverage balance of outstanding letters of credit and a quarterly commitment fee(0.50% per annum at September 29, 2006) on the average unused portion of therevolving credit facility.

The senior creditfacility provides that the Company will maintain certain financial and operatingcovenants which include, among other provisions, maintaining specific leverageand coverage ratios. Certain covenants under the senior credit facility maylimit the incurrence of additional indebtedness. The senior credit facilityprohibits dividend payments. The Company was in compliance with these covenantsat September 29, 2006. The senior credit facility is collateralized by a firstpriority 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 September 29, 2006,the aggregate maturities of total long-term debt of $851.1 million are dueafter 2010. Revolving loan borrowings of $31.7 million at September 29, 2006 havebeen classified 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 September 29, 2006;

·                  during anyfiscal quarter subsequent to September 29, 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.

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The 3.25% Notes containput options, which may require the Company to repurchase in cash all or aportion 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 the six-monthinterest period commencing August 1, 2014, the Company will pay contingentinterest during any six-month interest period if the trading price of the 3.25%Notes for each of the five trading days ending on the second trading dayimmediately preceding the first day of the applicable six-month interest periodequals or exceeds 120% of the principal amount of the 3.25% Notes.  The contingent interest payable will equal0.25% of the average trading price of $1,000 principal amount of the 3.25%Notes during the five trading days immediately preceding the first day of theapplicable 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 September 29, 2006.

On or prior to August 1,2014, upon the occurrence of a fundamental change, under certain circumstances,the Company will provide for a make whole amount by increasing, for the timeperiod described herein, the conversion rate by a number of additional sharesfor any conversion of the 3.25% Notes in connection with such fundamentalchange transactions.  The amount of additionalshares will be determined based on the price paid per share of the Company’scommon stock in the transaction constituting a fundamental change and theeffective date of such transaction. This make whole premium feature representsan embedded derivative.  However, basedon the de minimis value associated with this feature, no value has beenassigned at issuance and at September 29, 2006.

In addition, the Companyentered into an accelerated share repurchase arrangement with a third party touse the proceeds from the issuance of the 3.25% Notes to purchase $500.0million of AMO common stock at a volume weighted price per share over the termof the agreement. As of September 29, 2006, the third party had delivered tothe Company in the aggregate, 10.1 million shares of AMO common stock withfuture delivery of up to an additional 1.2 million shares, resulting in a totalof up to 11.3 million shares, depending on the volume weighted average shareprice per share during a calculation period beginning June 14, 2006 and endingno later than March 7, 2007. The impact of the shares received under thisarrangement as of September 29, 2006 reduced stockholders’ equity by $500.0million, which included $0.1 million for the par value of Common Stock,additional paid-in capital of $237.9 million and accumulated deficit of $262.0million. Subsequent to the quarter ended September 29, 2006 the Companyreceived on October 11, 2006 an additional 0.4 million shares of AMO commonstock from the third party as final settlement of the accelerated sharerepurchase arrangement. Repurchased shares were retired upon delivery to theCompany. During the nine months ended September 29, 2006, the Company repurchased$148.9 million of aggregate principal amount of convertible senior subordinatednotes ($103.9 million of the principal amount of the 2.5% Notes and $45.0million of the principal amount of the 1.375% Notes) utilizing borrowings underits senior credit facility. The Company incurred a loss on debt extinguishmentof $3.0 million and $18.8 million, and wrote off debt issuance costs of $0.9million and $3.3 million in the three and nine months ended September 29, 2006in conjunction with the note repurchases.

**Note 6: Related Party Transactions**

As of September 29, 2006,an interest-free relocation loan of $0.5 million, collateralized by realproperty, was outstanding from the chief executive officer. The principalamount of the loan is payable upon the earlier to occur of (a) 60 daysfollowing the chief executive officer’s termination of employment; (b) the dateof the sale or other transfer of the property or (c) July 3, 2007. Thisrelocation loan is evidenced by a promissory note dated July 3, 2002, prior tothe adoption of the Sarbanes-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.

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During the three and ninemonth periods ended September 29, 2006, there were 13,900 and 5,000antidilutive stock options excluded from the computation of diluted sharesoutstanding. The three and nine month periods ended September 30, 2005 excludethe aggregate dilutive effect of approximately 3.3 million shares and 3.0million shares, respectively, for stock options, stock purchase plan awards andthe 3.5% convertible senior subordinated notes as the effect would beantidilutive.

The Company will settlein cash the principal amount of the 2 1⁄2% Notes, 1.375% Notes, and the3.25% Notes. The potential dilutive common shares associated with the 1.375%Notes during the three and nine months period ended September 29, 2006 wereinsignificant. There were no potentially dilutive common shares associated withthe 2 1⁄2% Notes and the 3.25% Notes as the Company’s average stock pricesduring the three and nine months ended September 29, 2006 were less than theconversion prices of the respective notes.

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

The following tablesummarizes the components of comprehensive income (loss) (in thousands):
| ** **                                                        | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                        | ** ** | **September 29, 2006** | ** ** | **September 30, 2005** | ** ** |
| ** **                                                        | ** ** | **Before-tax  amount**           | ** ** | **Income  tax** | ** ** | **Net-of-tax  amount** | ** ** | **Before-tax  amount** | ** ** | **Income  Tax** | ** ** | **Net-of-tax  amount** | ** ** |
|                                                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Reclassification of  realized gain on derivatives to net earnings |       | $                                | —     |   | $ | — |   | $ | — |   | $ | (773 | ) | $ | 263 |   | $ | (510 | ) |
| Foreign currency  translation adjustments                         |       | (9,497                           | )          | — |   | (9,497 | ) | (4,485 | ) | — |   | (4,485 | ) |
| Net earnings (loss)                                               |       |                             |       |   |   | 87,154 |   |   |   |   |   | (31,215 | ) |
| Total comprehensive income (loss)                                 |       |                             |       |   |   | $ | 77,657 |   |   |   |   |   | $ | (36,210 | ) |
|                                                                   |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                        | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                        | ** ** | **September 29, 2006** | ** ** | **September 30, 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 |   |
| Reclassification of  realized gain on derivatives to net earnings |       | —                           |       | — |   | — |   | (773 | ) | 263 |   | (510 | ) |
| Foreign currency  translation adjustments                         |       | 35,106                           |       | — |   | 35,106 |   | (80,050 | ) | — |   | (80,050 | ) |
| Net earnings (loss)                                               |       |                             |       |   |   | 87,080 |   |   |   |   |   | (455,505 | ) |
| Total comprehensive income (loss)                                 |       |                             |       |   |   | $ | 122,186 |   |   |   |   |   | $ | (535,762 | ) |
|                                                                   |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**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, theCompany’s reportable segments were based on geographic regions which comprisedthe Americas, which included North and South America, Europe/Africa/MiddleEast, 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 periods 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 

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microkeratomes for use in laser eye surgery. The eyecare segment provides a full range of contact lens care products for use withmost types of contact lenses. These products include single-bottle,multi-purpose cleaning and disinfecting solutions, hydrogen peroxide-baseddisinfecting solutions, daily cleaners, enzymatic cleaners and contact lensrewetting drops.

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. The Companypresents the measure which management believes is determined in accordance withthe measurement principles consistent with those used in measuring thecorresponding amounts in the unaudited consolidated financial statements.Because operating segments are generally defined by the products they designand sell, they do not make sales to each other. Depreciation and amortizationrelated to the manufacturing of goods is included in gross profit. The Companydoes not discretely allocate assets to its operating segments, nor does theCompany’s chief operating decision maker evaluate operating segments usingdiscrete asset information.

**Business Segments**
| ** **                           | ** ** | **Net Sales**               | ** ** | **Operating Income (Loss)** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Three Months Ended**      | ** ** |
| **(In thousands)**              | ** ** | **September 29,  2006**     | ** ** | **September 30,  2005**          | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
| Operating segments:                  |       |                             |       |                                  |       |   |   |   |   |
| Cataract/Implant                     |       | $                                | 125,207    |                                  | $          | 120,425 |   | $ | 64,233 |   | $ | 54,276 |   |
| Laser Vision  Correction             |       | 50,827                           |       | 50,220                                |       | 28,623 |   | 22,605 |   |
| Eye Care                             |       | 82,568                           |       | 77,588                                |       | 41,852 |   | 26,966 |   |
| Total segments                       |       | 258,602                          |       | 248,233                               |       | 134,708 |   | 103,847 |   |
| Manufacturing  operations            |       | —                           |       | —                                |       | (4,753 | ) | (6,991 | ) |
| Research and  development            |       | —                           |       | —                                |       | (15,550 | ) | (18,520 | ) |
| In-process research and  development |       | —                           |       | —                                |       | — |   | (39,300 | ) |
| Business repositioning               |       | —                           |       | —                                |       | (3,994 | ) | — |   |
| Global supply chain                  |       | —                           |       | —                                |       | (16,648 | ) | (12,559 | ) |
| General corporate                    |       | —                           |       | —                                |       | 60,406 |   | (41,330 | ) |
| Total                                |       | $                                | 258,602    |                                  | $          | 248,233 |   | $ | 154,169 |   | $ | (14,853 | ) |

 
| ** **                           | ** ** | **Net Sales**              | ** ** | **Operating Income (Loss)** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **Nine Months Ended** | ** ** | **Nine Months Ended**       | ** ** |
| **(In thousands)**              | ** ** | **September 29,  2006**    | ** ** | **September 30,  2005**          | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
| Operating segments:                  |       |                            |       |                                  |       |   |   |   |   |
| Cataract/Implant                     |       | $                               | 380,081    |                                  | $          | 364,881 |   | $ | 193,264 |   | $ | 162,145 |   |
| Laser Vision  Correction             |       | 165,174                         |       | 68,455                                |       | 102,297 |   | 26,265 |   |
| Eye Care                             |       | 208,616                         |       | 234,507                               |       | 92,063 |   | 83,650 |   |
| Total segments                       |       | 753,871                         |       | 667,843                               |       | 387,624 |   | 272,060 |   |
| Manufacturing  operations            |       | —                          |       | —                                |       | (6,626 | ) | (12,065 | ) |
| Research and  development            |       | —                          |       | —                                |       | (48,511 | ) | (44,820 | ) |
| In-process research and  development |       | —                          |       | —                                |       | — |   | (490,750 | ) |
| Business repositioning               |       | —                          |       | —                                |       | (61,481 | ) | — |   |
| Global supply chain                  |       | —                          |       | —                                |       | (46,430 | ) | (35,793 | ) |
| General corporate                    |       | —                          |       | —                                |       | (35,686 | ) | (100,951 | ) |
| Total                                |       | $                               | 753,871    |                                  | $          | 667,843 |   | $ | 188,890 |   | $ | (412,319 | ) |

 

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**Geographic Area Information**
| ** **                              | ** ** | **Net Sales**               | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
| **(In thousands)**                 | ** ** | **September 29,  2006**     | ** ** | **September 30,  2005** | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
| United States:                          |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                        |       | $                                | 45,513     |   | $ | 38,907 |   | $ | 127,521 |   | $ | 107,294 |   |
| Laser Vision Correction                 |       | 37,886                           |       | 40,347 |   | 128,541 |   | 54,960 |   |
| Eye Care                                |       | 22,040                           |       | 15,614 |   | 61,118 |   | 43,152 |   |
| Total United States                     |       | 105,439                          |       | 94,868 |   | 317,180 |   | 205,406 |   |
| Americas,  excluding United States:     |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                        |       | 8,117                            |       | 6,578 |   | 25,606 |   | 19,354 |   |
| Laser Vision Correction                 |       | 2,359                            |       | 1,475 |   | 6,829 |   | 2,155 |   |
| Eye Care                                |       | 3,477                            |       | 3,601 |   | 9,502 |   | 8,333 |   |
| Total Americas, excluding United States |       | 13,953                           |       | 11,654 |   | 41,937 |   | 29,842 |   |
| Europe/Africa/Middle  East:             |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                        |       | 41,607                           |       | 43,042 |   | 138,507 |   | 143,585 |   |
| Laser Vision Correction                 |       | 4,264                            |       | 3,022 |   | 12,244 |   | 4,748 |   |
| Eye Care                                |       | 22,382                           |       | 25,073 |   | 58,082 |   | 73,627 |   |
| Total Europe/Africa/Middle East         |       | 68,253                           |       | 71,137 |   | 208,833 |   | 221,960 |   |
| Japan:                                  |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                        |       | 18,226                           |       | 18,570 |   | 50,940 |   | 55,616 |   |
| Laser Vision Correction                 |       | 1,153                            |       | 1,698 |   | 2,964 |   | 1,933 |   |
| Eye Care                                |       | 21,678                           |       | 23,453 |   | 49,463 |   | 77,956 |   |
| Total Japan                             |       | 41,057                           |       | 43,721 |   | 103,367 |   | 135,505 |   |
| Asia Pacific:                           |       |                             |       |   |   |   |   |   |   |
| Cataract/Implant                        |       | 11,744                           |       | 13,328 |   | 37,507 |   | 39,032 |   |
| Laser Vision Correction                 |       | 5,165                            |       | 3,678 |   | 14,596 |   | 4,659 |   |
| Eye Care                                |       | 12,991                           |       | 9,847 |   | 30,451 |   | 31,439 |   |
| Total Asia Pacific                      |       | 29,900                           |       | 26,853 |   | 82,554 |   | 75,130 |   |
| Total                                   |       | $                                | 258,602    |   | $ | 248,233 |   | $ | 753,871 |   | $ | 667,843 |   |

 

The United Statesinformation is presented separately as it is the Company’s headquarterscountry, and U.S. sales represented 40.8% and 42.1% of total net sales for thethree and nine months ended September 29, 2006 and 38.2% and 30.8% of total netsales for the three and nine months ended September 30, 2005, respectively.Additionally, sales in Japan represented 15.9% and 13.7% of total net sales forthe three and nine months ended September 29, 2006 and 17.6% and 20.3% of totalnet sales for the three and nine months ended September 30, 2005, respectively.No other country, or single customer, generated over 10% of total net sales inthe periods presented.

**Note 10: Commitments and Contingencies**

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 was accounted for in the third quarter. The parties agreed todismiss all pending patent litigation in Delaware and Texas, agreed not to sueeach other regarding the patents at issue in those cases, and cross-licensedpatents 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 was originally scheduled to begin onNovember 6, 2006, but this trial date has been vacated.  A new trial date has not yet been scheduled.

The Company does notbelieve, based on current knowledge, that any of the foregoing legalproceedings or claims are 

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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.

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 effecting the spin-off, Allergan agreed to assumeresponsibility for, and to indemnify AMO against, all current and futurelitigation relating to its retained businesses and the Company agreed to assumeresponsibility for, and to indemnify Allergan against, all current and futurelitigation related to the 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** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 29,  2006**     | ** ** | **September 30,  2005**    | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
| Service cost                        |       | $                                | 569        |                            | $          | 492 |   | $ | 1,707 |   | $ | 1,475 |   |
| Interest cost                       |       | 137                              |       | 128                             |       | 411 |   | 384 |   |
| Expected return  on plan assets     |       | (61                              | )          | (56                             | )          | (183 | ) | (167 | ) |
| Amortization of  prior service cost |       | 15                               |       | 17                              |       | 45 |   | 51 |   |
| Amortization of  net actuarial loss |       | 10                               |       | —                          |       | 30 |   | — |   |
| Net periodic benefit  cost          |       | $                                | 670        |                            | $          | 581 |   | $ | 2,010 |   | $ | 1,743 |   |

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ADVANCED MEDICALOPTICS, INC.

**Item 2.   Management’s Discussion andAnalysis of Financial Condition and Results of Operations for the Quarter Ended September 29, 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 ninemonths ended September 29, 2006, and the Company’s financial position at thatdate. Except for the historical information contained herein, the followingdiscussion contains forward-looking statements that involve risk and uncertainties.Our actual results may differ significantly from the results discussed in theforward-looking statements. Factors that might cause such differences include,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 operating resultsfor the prior periods 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 andcontact lens rewetting drops. Our products are sold in approximately 60countries and we have direct operations in 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 September 29, 2006, we incurred $4.0 million of pre-tax charges, which included $4.5million for inventory, manufacturingrelated and other charges included in cost of sales and net credit of $0.5million included in operatingexpenses. The net credit included in operating expenses comprised severance,relocation and other one-time termination benefits of $0.2 million and productivity and brandrepositioning costs of $6.5 million,offset by net asset disposal gains of $4.9 million and a net credit from settlement of a contractual obligation of$2.3 million.  In the nine months ended September 29, 2006, weincurred $61.5 million ofpre-tax charges, which included $15.1 million for inventory, manufacturing related and other charges includedin cost of sales and $46.4 millionincluded in operating expenses. Charges included in operating expensescomprised productivity and brand repositioning costs of $37.6 million and severance, relocation and other one-time termination benefits of $13.7  million,offset by net asset disposal gains of $2.8 million and a net credit from settlement of contractual obligations of$2.1 million.

Following an analysis ofour IOL manufacturing capabilities in the second quarter of 2006, we decided toconsolidate certain operations. In addition, we expanded the scope of our eyecare rationalization initiatives in order to maximize manufacturing capacityand seize growth opportunities. Together, these separate actions are expectedto result in additional charges of approximately $25 million in 2006.  When combined with the initial estimatedcharges of $70 million to $80 

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million, the estimated total charges for the expandedproduct rationalization and repositioning plan will be approximately $105million.  Through September 29, 2006, weincurred cumulative charges of $103.8 million. We expect to incur additional charges of approximately $1.2 million inthe fourth quarter of 2006 in connection with the consolidation of our IOLmanufacturing capabilities.

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 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 isrecognized over 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. 

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Allowances for returns are provided for based upon ananalysis of our historical patterns of returns matched against the sales fromwhich they originated. To date, historical product returns have been within ourestimates.

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.

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 to differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin income in the period that includes the enactment date. We evaluate the needto establish a valuation allowance for deferred tax assets based upon theamount of existing 

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temporary differences, the period in which they areexpected to be recovered and expected levels of taxable income. A valuationallowance to reduce deferred tax assets is established when it is “more likelythan not” that some or all of the deferred tax assets will not be realized.

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 areestimated using a Black-Scholes option valuation model. This model requires theinput of subjective assumptions, including expected stock price volatility,estimated life and estimated forfeitures of each award. The fair value ofequity-based awards is amortized over the vesting period of the award, and wehave elected to use the straight-line method. We make quarterly assessments ofthe adequacy of the tax credit pool to determine if there are any deficiencieswhich require recognition in the consolidated statement of operations. Prior tothe implementation 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 nine months ended September 29, 2006 and September 30, 2005,respectively:
|                           | ** ** | **Net Sales**               | ** ** | **Operating Income**        | ** ** |
|---------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
| **(In thousands)**   | ** ** | **September 29,  2006**     | ** ** | **September 30,  2005**     | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
|                      |       |                             |       |                             |       |   |   |   |   |
| Cataract/Implant          |       | $                                | 125,207    |                             | $          | 120,425 |   | $ | 64,233 |   | $ | 54,276 |   |
| Laser Vision  Correction  |       | 50,827                           |       | 50,220                           |       | 28,623 |   | 22,605 |   |
| Eye Care                  |       | 82,568                           |       | 77,588                           |       | 41,852 |   | 26,966 |   |
| Total operating  segments |       | $                                | 258,602    |                             | $          | 248,233 |   | $ | 134,708 |   | $ | 103,847 |   |

 

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|                          | ** ** | **Net Sales**              | ** ** | **Operating Income**       | ** ** |
|--------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **Nine Months Ended** | ** ** | **Nine Months Ended** | ** ** |
| **(In thousands)**  | ** ** | **September 29,  2006**    | ** ** | **September 30,  2005**    | ** ** | **September 29,  2006** | ** ** | **September 30,  2005** | ** ** |
|                     |       |                            |       |                            |       |   |   |   |   |
| Cataract/Implant         |       | $                               | 380,081    |                            | $          | 364,881 |   | $ | 193,264 |   | $ | 162,145 |   |
| Laser Vision Correction  |       | 165,174                         |       | 68,455                          |       | 102,297 |   | 26,265 |   |
| Eye Care                 |       | 208,616                         |       | 234,507                         |       | 92,063 |   | 83,650 |   |
| Total operating segments |       | $                               | 753,871    |                            | $          | 667,843 |   | $ | 387,624 |   | $ | 272,060 |   |

 

*Netsales.* Total net sales increased 4.2% and 12.9% in the threeand nine months ended September 29, 2006, compared to the same periods lastyear. The increase in net sales in the three months ended September 29,2006  primarily resulted from increasedEye Care, international Laser Vision Correction (LVC) and refractive IOL sales,partially offset by lost sales from discontinued non-strategic Cataract/Implantand Eye Care products.  The increase innet sales in the nine months ended September 29, 2006 primarily resulted fromsales of acquired *VISX* products and strong demandfor our core brands, partially offset by lost sales from discontinuednon-strategic Cataract/Implant and Eye Care products.  Net sales include a favorable foreigncurrency impact of 0.6% in the three months ended September 29, 2006 and anunfavorable impact of 1.3% in the nine months ended September 29, 2006. Oursales and earnings may be negatively impacted during times of a strengtheningU.S. dollar. Total net sales in the U.S. and Japan represented 40.8% and 15.9%,respectively, of total net sales in the three months ended September 29, 2006.Total net sales in the U.S. and Japan represented 42.1% and 13.7%,respectively, of total net sales in the nine months ended September 29, 2006.No other country, or any single customer, generated over 10% of total net salesin the periods presented.

Net sales from ourCataract/Implant business increased by 4.0% and 4.2% in the three and ninemonths ended September 29, 2006, compared with the same periods last year. Theincreases in net sales were primarily the result of sales of our brandedpromoted products, including*Tecnis*and*ReZoom* intraocular lenses, partiallyoffset by a decrease in sales of non-promoted older-technology intraocularlenses and viscoelastics and reimbursement pressures in certain European marketsand in Japan for viscoelastic products. Net sales from phacoemulsification systems were down slightly in thethree months ended September 29, 2006 and up by approximately 7% for the ninemonths ended September 29, 2006 as a result of higher unit placements duringthis period compared with the same period last year.  Net sales growth in the Americas of 17.9% and20.9% in the three and nine months ended September 29, 2006, respectively, weredue to strong demand for our core products, partially offset by decreases insales of non-promoted older-technology intraocular lenses andviscoelastics.  Sales inEurope/Africa/Middle East declined by 3.3% and 3.5% in the three and ninemonths ended September 29, 2006.  Salesin Japan declined by 1.9% and 8.4% in the three and nine months ended September29, 2006.  Sales in Asia Pacific declinedby 11.9% and 3.9% in the three and nine months ended September 29, 2006.  The sales declines in Europe/Africa/MiddleEast, Japan and Asia Pacific were due to decreasing sales of older generationintraocular lenses, rationalized viscoelastics and reimbursement pressures,especially in Europe. Net sales in our Cataract/Implant business reflect afavorable foreign currency impact of 0.9% in the three months ended September29, 2006 and an unfavorable foreign currency impact of 1.5% in the nine monthsended September 29, 2006, largely from fluctuations of the euro and Japaneseyen versus the U.S. dollar.

Net sales from our Laser Vision Correctionbusiness increased by $0.6 million and $96.7 million in the three and ninemonths ended September 29, 2006, respectively, compared with the same periodslast year.  The increase in the threemonths ended September 29, 2006 reflect strong international system sales andincreased demand for our *CustomVue*procedures, partially offset by softer US procedure volumes.  The increase in the nine months endedSeptember 29, 2006 primarily resulted from sales of acquired *VISX* products. Net sales of acquired *VISX*products were $48.2 million and $156.6 million in the three and nine monthsended September 29, 2006, respectively, compared with $47.7 million and $61.1 millionin the three and nine months ended September 30, 2005. See Note 2 to theunaudited consolidated financial statements for the proforma impact of VISX netsales for the same period last year. Net sales in the Americas decreased by$1.6 million in the three months ended September 29, 2006 and increased by $78.3million in the nine months ended September 29, 2006, compared with the sameperiods last year, due to acquired *VISX* productsand strong demand for our *CustomVue*procedures and system sales. As a result of our international expansionstrategy for the LVC business, we saw net sales in Europe/Africa/Middle East of$4.3 million and $12.2 million in the three and nine months ended September 29,2006, respectively and Asia Pacific sales of $5.2 million and $14.6 million inthe three and nine months ended September 29, 2006, compared to significantlylower amounts in the same periods last year.  The foreign currency impact in the three andnine months ended September 29, 2006 was negligible.

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Net sales from our EyeCare business increased by 6.4% in the three months ended September 29, 2006and decreased by 11.0% in the nine months ended September 29, 2006, comparedwith the same periods last year. The increase in total net sales of eye careproducts in the three months ended September 29, 2006 were largely driven byhigher sales of multipurpose solution products, partially offset by slightly lowersales of hydrogen peroxide-based products. Net sales increased in the Americas by 32.8% and 37.2% in the three and ninemonths ended September 29, 2006, respectively, due to increased demand for ourmultipurpose products, largely attributable to our strategy to increase oursampling programs, selling efforts to practitioners and their staffs and thewithdrawal of a competitor’s product in the second quarter of 2006. Net salesalso increased in Asia Pacific by 31.9% in the three months ended September 29,2006.  The decrease in total net sales ofeye care products in the nine months ended September 29, 2006 were primarilydue to lower sales of hydrogen peroxide-based products caused by continuedshrinkage of this market as contact lens wearers gravitate increasingly to moreconvenient multipurpose solutions and decreased sales of multipurpose solutionproducts primarily due to rapid growth of daily disposable lenses, particularlyin the Japan market. These factors contributed significantly to net sales declinesof 7.6% in Japan and 10.7% in Europe/Africa/Middle East during the three monthsended September 29, 2006 and 36.6% in Japan, 21.1% in Europe/Africa/Middle Eastand 3.1% in Asia Pacific during the nine months ended September 29, 2006,compared with the same periods last year. Net sales in our Eye Care businessincluded a favorable foreign currency impact of 0.3% in the three months endedSeptember 29, 2006 and an unfavorable foreign currency impact of 1.4% in the ninemonths ended September 29, 2006, largely resulting from fluctuations of theeuro 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 criticalrevenue mass, have experienced steadily declining sales trends and/or havegenerated relatively unattractive margins. The decreases in total net salesresulting from the product rationalization were approximately $6.6 million and$27.7 million in the three and nine months ended September 29, 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 63.1% and 63.6% in the threeand nine months ended September 29, 2006, respectively, compared with 64.8% and63.3% in the same periods last year.   Sales growth in the higher margin *Tecnis*and*ReZoom*intraocular lenses and eye care products, along withmanufacturing productivity improvements were offset by approximately $4.5 million,or 1.7 percentage points, for inventory, manufacturing related and othercharges incurred in connection with our business repositioning plan in thethree months ended September 29, 2006.  Grossprofit for the nine months ended September 29, 2006 included sales growth ofhigher margin *Tecnis*and*ReZoom*intraocular lenses and acquired VISXproducts and manufacturing productivity improvements, partially offset by $15.1million in charges that were incurred in connection with the businessrepositioning plan. Gross profit for the three months ended September 30,2005 was negatively impacted by approximately $1.6 million, or 0.6 percentagepoints, related to actions associated with accelerated manufacturingproductivity improvements. Gross profit for the nine months endedSeptember 30, 2005 was negatively impacted by approximately $3.5 million,or 0.5 percentage points, related to actions associated with accelerated manufacturingproductivity improvements and integration related costs. 

As described earlier, weexpect to incur additional charges in the fourth quarter of 2006 ofapproximately $1.2 million under our product rationalization and repositioningstrategy and supplemental consolidation of certain operations due to IOLmanufacturing capabilities. During the three months ended September 29, 2006,we incurred charges of $0.2 million associated with the write-off of eye careproducts withdrawn from the Japan market due to potential product qualityissues. Our investigation into the scope and extent of this issue is ongoingand we are likely to incur additional charges in future periods.

*Selling, general and administrative.*  Selling, general and administrative expensesdecreased as a percent of net sales by 10.3 percentage points to 37.2% and by 6.2percentage points to 38.6% in the three and nine months ended September 29,2006, respectively, compared with 47.5% and 44.8% in the three and nine monthsended September 30, 2005, respectively. These decreases were largely driven byincreased leverage from overall revenue growth as described previously and efficiencygains from our business repositioning strategy. Selling, general andadministrative expenses for the three and nine months ended September 29, 2006include approximately $7.0 million and $21.1 million, respectively, inamortization expenses related to the acquired VISX intangible assets. Inaddition, selling, general and administrative expenses for the three monthsended September 29, 2006 include $3.4 million in stock-based compensationexpense under SFAS 123R. Selling, general and administrative expenses for the ninemonths ended September 29, 2006 also include $3.3 million of charges primarilyassociated with assets acquired in the termination of a distributor agreementin India and acquisition and integration-related charges.  Stock-based compensation expense under SFAS123R included in selling, general and administrative expenses was $11.5 millionfor the nine months ended September 29, 2006. Selling, general and administrative expenses for the three and ninemonths ended September 30, 2005 include approximately $7.9 million and $10.6million, respectively, in acquisition and integration-related charges andamortization expenses of $7.2 million and $9.4 

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million, respectively related to the acquired VISXintangible assets. In addition, selling, general and administrative expensesfor the three and nine months ended September 30, 2005 also include an $8.6million charge associated with the termination of a distributor agreement inIndia that we had with our former parent, Allergan.

*Researchand development.* Research and development expenditures decreasedas a percent of net sales by 1.2 percentage points to 6.2%, and by 0.1 percentagepoints to 6.6% in the three and nine months ended September 29, 2006,respectively, compared with the same periods last year. The $4.8 million increasein research and development expenditures during the nine months ended September29, 2006 compared with the same period last year  primarily resulted from an increase inspending for research efforts in the Cataract/Implant and LVC businesses. Weexpect our research and development costs as a percentage of sales to beapproximately 6.5% of net sales for 2006 as we continue to consolidate researchand development costs from the VISX acquisition. Our research and developmentstrategy is to develop proprietary products for vision correction that are safeand effective and address unmet needs. We are currently focusing on newadvancements that build on our *Tecnis, Healon*and*Sovereign* technologies, corneal andlens-based solutions to presbyopia and dry eye products. Our research anddevelopment 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 nine months ended September 30, 2005, we recorded a $39.3 million and a $490.8 million in-process researchand development (“IPR&D”) charge, respectively.  Included in this charge is a $39.3 millionand a $488.5 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.

*Operating**Income.*Operating income as a percentage of net sales, oroperating margin, was 59.6% and 25.1% in the three and nine months ended September29, 2006, respectively. Operating income of $154.2 million in the three monthsended September 29, 2006 includes a net gain on legal contingencies of $102.9million offset by charges of $4.0 million for business repositioning costs and$4.5 million in stock-based compensation expense under SFAS 123R. The netimpact from these items improved operating margin by 36.5% in the three monthsended September 29, 2006.  Operatingincome of $188.9 million in the nine months ended September 29, 2006 includes anet gain on legal contingencies of $96.9 million, offset by charges of $61.5million for business repositioning costs, $3.3 million of charges primarily associated with assets acquired in thetermination of a distributor agreement in India and acquisition andintegration-related charges and $14.8 million in stock-based compensationexpense under SFAS 123R. The net impact from these items improved operating marginby 2.3% in the nine months ended September 29, 2006.  The operating loss of $14.9 million in thethree months ended September 30, 2005, included an IPR&D charge of $39.3million from the VISX acquisition, a charge of $8.6 million associated with thetermination of a distributor agreement in India, acquisition andintegration-related expenses of $8.0 million and expenses of $1.6 million foraccelerated manufacturing productivity improvements.  The operating loss of $412.3 million in thenine months ended September 30, 2005 included an IPR&D charge of $490.8million primarily from the VISX acquisition, a charge of $8.6 millionassociated with the termination of a distributor agreement in India,acquisition and integration-related expenses of $12.7 million and expenses of$1.6 million for accelerated manufacturing productivity improvements.  

Operating income from ourCataract/Implant business increased by $10.0 million and $31.1 million in thethree and nine months ended September 29, 2006, respectively, due to theincrease in net sales and favorable mix of higher margin products discussedabove, along with the favorable impact of cost containment measures taken inconnection with our business repositioning plan. Operating income from our LVCbusiness increased by $6.0 million and $76.0 million in the three and ninemonths ended September 29, 2006, respectively, due to sales of productsacquired from VISX in May 2005. Operating income from our Eye Care business increasedby $14.9 million and $8.4 million in the three and nine months ended September29, 2006, respectively, primarily due to strong sales of multi-purpose productsin the Americas and the favorable impact of cost containment measures taken inconnection with our business repositioning plan, partially offset by theunfavorable impact from continued softness in the market for hydrogen peroxidebased products.

*Non-operatingexpense.* Interest expense was $9.8 million and $22.3 millionin the three and nine months ended September 29, 2006, respectively, comparedwith $8.8 million and $23.6 million in the three and nine months ended September30, 2005, respectively. Interest expense in the three and nine months ended September29, 2006 includes a pro-rata write-off of debt issuance costs of $0.9 millionand $3.3 million, respectively. Interest expense in the three and nine monthsended September 30, 2005 includes a pro-rata write-off of debt issuance costsof $3.8 million and $5.7 million, respectively. We anticipate interest expense to increase in 2006 relative to 2005 dueto the issuance of $500 million of 3.25% convertible senior subordinated notesin June 2006.

During the three and ninemonths ended September 29, 2006, we recorded charges of $3.0 million and $18.8million, 

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respectively, associated with the repurchase of $20million and $148.9 million, respectively, aggregate principal amount ofconvertible notes.

We recorded an unrealized gain onderivative instruments of $2.3 million in the three months ended September 29,2006 and an unrealized loss on derivative instruments of $0.7 million in the ninemonths ended September 29, 2006, compared to an unrealized gain of $0.2 millionand $1.2 million in the three and nine months ended September 30, 2005,respectively. We record as “unrealized (gain) loss on derivative instruments”the mark to market adjustments on the outstanding foreign currency options andforward contracts which we enter into as part of our overall risk managementstrategy to reduce the volatility of expected earnings in currencies other thanthe U.S. dollar.  The losses in the firstnine months of 2006 were largely attributable to euro and Japanese yeninstruments.

*Incometaxes.* We recorded a provision for income taxes of $55.0million and $57.0 million in the three and nine months ended September 29, 2006,respectively.  The effective tax rates of38.7% and 39.6% for the respective periods were significantly impacted by the netgain on legal contingencies at an effective rate of approximately 41%.  Pre-tax charges on the early retirement ofconvertible senior subordinated notes of $3.0 million and $18.8 million in thethree and nine months ended September 29, 2006, respectively, resulted in therecognition of partial deferred tax benefits of $0.3 million and $3.9 million,respectively.  In addition, the effectivetax rates reflect a benefit from stock-based compensation expense currentlybeing recognized under SFAS 123R at an effective rate of approximately 33%, anda provision on all other pre-tax income at an effective rate of 32%.  

The effective tax ratefor the three and nine months ended September 30, 2005 was (22.7%) and (4.6%),respectively.  Loss before income taxesfor the three months ended September 30, 2005 included an in-process researchand development charge of $39.3 million and a charge of $8.6 million associatedwith the termination of a distribution agreement in India that we had with ourformer parent, Allergan, for which no tax benefit was provided on these items.We have provided a tax provision of 32% on the remaining income for the threemonths ended September 30, 2005, including an adjustment to reduce the fullyear estimated effective tax rate from 34% to 33%. Loss before income taxes for the nine months ended September 30,2005 included an in-process research and development charge of $490.8 million,a non-cash charge of $0.5 million related to the exchange of 3 1/2% convertiblesenior subordinated notes and a charge of $8.6 million associated with thetermination of a distribution agreement in India with Allergan, for which notax benefit was provided on these items. We have provided a tax provision at 33% on the remaining income for thenine months ended September 30, 2005.  

The lower effective tax rate of 32% onall other pre-tax income in 2006 as described above, compared with 33% in theprior year, reflects continuing implementation of our long-term tax strategies.Our future effective income tax rate may vary depending on our mix of domesticand international taxable income or loss and the various tax and treasurymethodologies that we implement, including our policy regarding repatriation offuture accumulated foreign 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 September 29, 2006, we had cashand equivalents of $38.8 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$188.3 million in the nine months ended September 29, 2006 compared to cashused in operating activities of $7.7 million in the nine months ended September30, 2005. Operating cash flow improved in the nine months ended September 29,2006 compared to the nine months ended September 30, 2005 largely due toreceipt of net cash proceeds of $110.9 million from settlement of litigationcontingencies during the third quarter of 2006. Other improvements included timing of accounts receivable collections,last year’s inventory buildup of “bridging” stock as we prepared for the transitionof eye care manufacturing from Allergan and payments of merger relatedtransaction costs incurred by VISX in 2005, partially offset by  the payment of annual incentive compensation,severance and other cash payments related to the product rationalization andbusiness repositioning plan and interest payments on outstanding convertible seniorsubordinated notes.

Net cash used ininvesting activities was $27.3 million and $66.0 million in the nine monthsended September 29, 2006 and September 30, 2005,respectively. Expenditures for property, plant and equipment totaled $20.2million and $13.2 million in the nine months ended September 29, 2006 and September30, 2005, respectively. Expenditures in the nine months ended September 29,2006 primarily comprised expenditures to upgrade our viscoelasticsmanufacturing facility in Uppsala, 

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Sweden and eye care manufacturing facility in Spain.Expenditures in the nine months ended September 30, 2005 primarily comprisedexpansion and remodeling of our leased headquarters, expenditures at ourmanufacturing facilities and computer replacements. We expect to incur additionalcapital expenditures of approximately $4.0 million to $5.0 million with respectto the Uppsala, Sweden manufacturing facility during 2006 in order to separatethe facility from existing Pfizer operations and for facility upgrades.Expenditures for demonstration (demo) and bundled equipment, primarilyphacoemulsification and microkeratome surgical equipment, were $7.7 million and$8.3 million in the nine months ended September 29, 2006 and September 30,2005. We maintain demo and bundled equipment to facilitate future sales ofsimilar equipment and related products to our customers. Expenditures forcapitalized internal-use software were $2.1 million and $7.6 million in the ninemonths ended September 29, 2006 and September 30, 2005, respectively, whichprimarily comprised a company-wide system upgrade as part of the overallexpansion of our business. We capitalize internal-use software cost aftertechnical feasibility has been established. In 2006, we expect to investapproximately $50.0 million in property, plant and equipment, demo and bundledequipment, and capitalized software as part of the overall expansion of ourbusiness. In the nine months ended September 30, 2005 we paid $176.2 millionrelated to acquisitions, net of $156.8 million cash received in connection withthe VISX acquisition.

Net cash used infinancing activities was $166.1 million in the nine months ended September 29,2006. We received proceeds of $500 million from the issuance of 3.25%convertible notes that were used to repurchase and retire 10.1 million sharesof AMO common stock. We also used $167.7 million to repay convertible notes,partially offset by short-term borrowings of $28.3 million. Net cash providedby financing activities was $75.8 million in the nine months ended September30, 2005, was primarily comprised of $150.0 million of proceeds form theissuance of 1.375% convertible senior subordinated notes, $96.5 million ofborrowings under the senior revolving credit facility, $30.6 million ofproceeds from the sale of stock to employees and $0.8 million proceeds receivedafter settling an interest rate swap agreement, reduced by $194.0 million ofterm loan repayments and $8.1 million of financing related costs.

At September 29, 2006, wehad $31.7 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 $259.7 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 September 29, 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 of thosecash balances from some of our non-U.S. subsidiaries may result in additionaltax costs. However, these cash balances are generally available withoutlegal 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 costcontainment, changes in reimbursement policies and other reimbursementmethodologies and payment levels could have an adverse effect on our pricingflexibility. Additionally, the current trend among U.S. hospitals and othercustomers of medical device manufacturers is to consolidate into largerpurchasing groups to enhance purchasing power. The enhanced purchasingpower of these larger customers may also increase the pressure on productpricing, although we are unable 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 57.9% of ourrevenues for the nine months ended September 29, 2006 were derived fromoperations outside the United States and a significant portion of our coststructure is denominated in currencies other than the U.S. dollar, primarilythe Japanese yen and the euro. Therefore, we are subject to fluctuationsin sales and earnings reported in U.S. dollars as a result of changing currencyexchange rates.

The impact of foreigncurrency fluctuations on sales resulted in an increase of $1.5 million and adecrease of $8.9 million for the three and nine months ended September 29, 2006,respectively. These fluctuations were due primarily to the fluctuations of theJapanese yen and the euro versus the U.S. dollar.  The impact of foreign currency fluctuationson sales resulted in increases of $0.6 million and $11.1 million for the threeand nine months ended September 30, 2005, respectively, These increases weredue primarily to a strengthening of the Japanese yen and the euro versus theU.S. dollar. 

*Off-balancesheet arrangements.* We had no off-balance sheet arrangementsat September 29, 2006 as defined in Regulation S-K Item 303(a)(4).

**RecentAccounting Standards**

In September 2006, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 158, “Employer’s Accounting for DefinedBenefit Pension and Other Postretirement Plans—an amendment of FASB StatementsNo. 87, 88, 106, and 132(R).” SFAS No. 158 requires an employer torecognize in its statement of financial position an asset for a plan’soverfunded status or a liability for a plan’s underfunded status, measure aplan’s assets and its obligations that determine its funded status as of theend of the employer’s fiscal year, and recognize changes in the funded statusof a defined benefit postretirement plan in the year in which the changesoccur. Those changes will be reported in comprehensive income and as a separatecomponent of stockholders’ equity. Additional footnote disclosures will also berequired. SFAS No. 158 is effective for AMO in the fourth quarter offiscal 2006. Had we adopted SFAS No. 158 at the beginning of fiscal year 2006,our net pension obligation recognized on the balance sheet would have beenincreased by $2.1 million with a corresponding reduction in stockholders’equity of $1.3 million, net of deferred income taxes of $0.8 million.  The effect on the balance sheet as ofDecember 31, 2006, which has not yet been determined, from the adoption of SFASNo. 158 will be based on the funded status of our plans as of September 30,2006, the measurement date of our plans’ assets and obligations.  We will be required to change the measurementdate to December 31 in fiscal year 2008. We have not yet determined the impact that the change in the measurementdate will have on the consolidated financial statements.

In September 2006, the SEC issued Staff AccountingBulletin (“SAB”) No. 108, “Considering the Effects of Prior YearMisstatements when Qualifying Misstatements in Current Year FinancialStatements,” which provides interpretive guidance on the consideration of theeffects of prior year misstatements in quantifying current year misstatementsfor the purpose of a materiality assessment. SAB No. 108 is effective forcompanies with fiscal years ending after November 15, 2006 and is requiredto be adopted by the Company in its fiscal year ending December 30, 2006. Weare currently assessing the impact, if any, of the adoption of SABNo. 108. 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurement.” SFAS No. 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. This Statement does notrequire any new fair value measurements. SFAS No. 157 is effective forfiscal years beginning after November 15, 2007 and interim periods withinthose fiscal years. We are currently assessing the impact of SFAS No. 157on its financial statements. 

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. We are currently assessing the impact, ifany, on its consolidated financial statements of adopting FIN 48.

In June 2006, the Emerging Issues Task Force (“EITF”)issued EITF 06-3, “How Taxes Collected from Customers and Remitted toGovernmental Authorities Should Be Presented in the Income Statement (That is,Gross versus Net Presentation)” to clarify diversity in practice on thepresentation of different types of taxes in the financial statements. The TaskForce concluded that, for taxes within the scope of the issue, a company mayadopt a policy of presenting taxes either gross within revenue or net. That is,it may include charges to customers for taxes within revenues and the chargefor the taxes from the taxing authority within cost of sales, or,alternatively, it may net the charge to the customer and the charge from thetaxing authority. If taxes subject to EITF 06-3 are significant, a company isrequired to disclose its accounting policy for presenting taxes and the amountsof such taxes that are recognized on a gross basis. The guidance in thisconsensus is effective for the first interim reporting period beginning afterDecember 15, 2006 (the first quarter of our fiscal year 2007). We do not expectthe adoption of EITF 06-3 will have a material impact on our results ofoperations, financial position or cash flow.

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**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-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995. From time to time, we also may provide oral orwritten forward-looking statements in other materials we release to the public.Forward-looking statements give our current expectations or forecasts of futureevents. You can identify these statements by the fact that they do not relatestrictly to historic or current facts. They use words such as “anticipate,”“estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will,” and otherwords and terms of similar meaning in connection with any discussion of futureoperating or financial performance. In particular, these include statementsrelating to future actions, prospective products, product approvals or approvedindications, reimbursement rates, future performance or results of current andanticipated products, sales efforts, expenses, interest rates, foreign exchangerates, the outcome of contingencies, such as legal proceedings, financialresults, and the expected results and benefits of our strategic initiatives.Among the factors that could cause actual results to differ materially are thefollowing:

·                                          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;

·                                          Our abilityto maintain a sufficient and timely supply of products we manufacture;

·                                          Our relianceon sole source suppliers for raw materials and other products;

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

·                                          Risks andexpenses associated with our ability to protect our intellectual propertyrights;

·                                          Risks andexpenses associated with intellectual property litigation and infringementclaims;

·                                          Unexpectedlosses due to product quality issues, product liability claims, product recallsor corrections, or other litigation;

·                                          Our abilityto 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, qualitysystems standards, and complaint-handling;

·                                          Our abilityto attract, hire and retain qualified personnel;

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

·                                          The impact ofthe change in the accounting treatment of stock options upon the adoption ofSFAS 123R or other significant changes to generally accepted accountingprinciples;

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

·                                          Changes inmarket acceptance of laser vision correction;

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·                                          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-correcting intraocularlenses; 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 andthose anticipated, estimated or projected. Investors should bear this in mindas they consider 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 inherent limitationsof forecasting and the anticipatory nature of the exposures intended to behedged, there can be no assurance that such programs will offset more than aportion of the adverse financial impact resulting from unfavorable movements ineither interest or foreign exchange rates. In addition, the timing of theaccounting for recognition of gains and losses related to mark-to-marketinstruments for any given period may not coincide with the timing of gains andlosses related to the underlying economic exposures and, therefore, mayadversely 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.

*Interestrate risk.* At September 29, 2006, our debt comprisessolely domestic borrowings and comprises $851.1 million of fixed rate debt and$31.7 million of variable rate debt.

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The tables below presentinformation about our debt obligations as of September 29, 2006 andDecember 31, 2005:

**September29, 2006**
| ** **                      | ** ** | **Maturing in**                                          | ** ** | **Fair  Market** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------|------------|------------------|------------|
| ** **                      | ** ** | **2006**                                                      | ** ** | **2007**         | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Value** | ** ** |
| ** **                      | ** ** | **(in thousands, except interest rates)** | ** ** |
| **LIABILITIES**                 | ** ** | ** **                                                    | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Debt  Obligations:**          | ** ** | ** **                                                    | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed Rate                      |       | $                                                             | —     |             | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 246,105 |   | $ | 246,105 |   | $ | 252,430 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —           |       | — |   | — |   | — |   | 2.50 | % | 2.50 | % |   |   |
| Fixed Rate                      |       | $                                                             | —     |             | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 105,000 |   | $ | 105,000 |   | $ | 107,100 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —           |       | — |   | — |   | — |   | 1.375 | % | 1.375 | % |   |   |
| Fixed Rate                      |       | $                                                             | —     |             | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 500,000 |   | $ | 500,000 |   | $ | 483,500 |   |
| Weighted Average  Interest Rate |       | —                                                        |       | —           |       | — |   | — |   | — |   | 3.25 | % | 3.25 | % |   |   |
| Variable Rate                   |       | $                                                             | 1,700      |             | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 1,700 |   | $ | 1 700 |   |
| Weighted Average  Interest Rate |       | 9.50                                                          | %          | —           |       | — |   | — |   | — |   | — |   | 9.50 | % |   |   |
| Variable Rate                   |       | $                                                             | 30,000     |             | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 30,000 |   | $ | 30,000 |   |
| Weighted Average  Interest Rate |       | 7.58                                                          | %          | —           |       | — |   | — |   | — |   | — |   | 7.58 | % |   |   |
| Total Debt  Obligations         |       | $                                                             | 31,700     |             | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 851,105 |   | $ | 882 805 |   | $ | 874 730 |   |
| Weighted Average  Interest Rate |       | 7.68                                                          | %          | —           |       | — |   | — |   | — |   | 2.80 | % | 2.98 | % |   |   |

 

**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 

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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.

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, suchfluctuations are anticipated to offset changes in the value of the underlyingexposures. The principal currencies subject to this process are the Japaneseyen and the euro. The foreign exchange forward contracts are entered into toprotect the value of foreign currency denominated monetary assets andliabilities and the changes in the fair value of the foreign currency forwardcontracts were economically designed to offset the changes in the revaluationof the foreign currency denominated monetary assets and liabilities. Theseforward contracts are denominated in currencies which represent materialexposures. The changes in the fair value of foreign currency option and forwardcontracts are recorded through earnings as “Unrealized (gain) loss onderivative instruments” while any realized gains or losses on expired contractsare recorded through earnings as “Other, net” in the accompanying unauditedconsolidated statements of operations. Any premium cost of purchased foreignexchange option contracts are recorded in “Other current assets” and amortizedover the life of the options.

The following tablesprovide information about our foreign currency derivative financial instrumentsoutstanding as of September 29, 2006 and December 31, 2005, respectively. Theinformation is provided in U.S. dollar amounts, as presented in ourconsolidated financial statements.
| ** **                                   | ** ** | **September 29, 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                                |       | $                                | 24.0       |                                        | 7.30       |   | $ | 31.5 |   | 7.94 |   |
| U.K. Pound                                   |       | —                           |       | —                                      |       | 5.2 |   | 1.72 |   |
| Swiss Franc                                  |       | 1.6                              |       | 1.25                                        |       | 1.5 |   | 1.31 |   |
| Euro                                         |       | —                           |       | —                                      |       | 5.9 |   | 1.19 |   |
| **Receive  US$/Pay Foreign Currency:**       |       |                             |       |                                        |       |   |   |   |   |
| Japanese Yen                                 |       | 6.4                              |       | 116.82                                      |       | 3.0 |   | 117.45 |   |
| Canadian Dollar                              |       | 5.4                              |       | 1.12                                        |       | 3.4 |   | 1.17 |   |
| Australia Dollar                             |       | 1.9                              |       | 0.74                                        |       | 2.9 |   | 0.73 |   |
|                                         |       |                             |       |                                        |       |   |   |   |   |
| **Total  Notional**                          | ** ** | **$**                            | **39.3**   | ** **                                  | ** ** | ** ** | **$** | **53.4** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | ** **                       | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Estimated  Fair Value**                    | ** ** | **$**                            | **—** | ** **                                  | ** ** | ** ** | **$** | **—** |   |   |   |
| ** **                                   | ** ** | ** **                       | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Foreign  currency purchased put options:** |       |                             |       |                                        |       |   |   |   |   |
| Japanese Yen                                 |       | $                                | 91.2       |                                        | 118.42     |   | $ | 66.2 |   | 117.83 |   |
| Euro                                         |       | 40.3                             |       | 1.22                                        |       | 40.2 |   | 1.18 |   |
|                                         |       |                             |       |                                        |       |   |   |   |   |
| **Foreign  currency sold call options:**     |       |                             |       |                                        |       |   |   |   |   |
| Japanese Yen                                 |       | 102.9                            |       | 104.93                                      |       | 60.0 |   | 106.60 |   |
| Euro                                         |       | 42.5                             |       | 1.29                                        |       | 43.0 |   | 1.26 |   |
|                                         |       |                             |       |                                        |       |   |   |   |   |
| **Total  Notional**                          | ** ** | **$**                            | **276.9**  | ** **                                  | ** ** | ** ** | **$** | **209.4** |   |   |   |
| ** **                                   | ** ** | ** **                       | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Estimated Fair Value**                     | ** ** | **$**                            | **—** | ** **                                  | ** ** | ** ** | **$** | **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 September 29, 2006 andDecember 31, 2005, respectively. The 

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amounts ultimately realized upon settlement of thesefinancial instruments, together with the gains and losses on the underlyingexposures, will depend on actual market conditions during the remaining life ofthe instruments.

**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 September 29, 2006 that have materially affected, or are reasonablylikely to materially 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 $121 millionwhich we received in July 2006. The parties agreed to dismiss all pendingpatent litigation in Delaware and Texas, agreed not to sue each other regardingthe patents at issue in those cases, and cross-licensed patents coveringexisting features of commercially available phacoemulsification products. Aspart of the settlement, the parties agreed to a dispute resolution process forfuture 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 was originally scheduled to begin on November 6, 2006, butthis date has been vacated.  A new trialdate has not yet been scheduled.

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 distribution agreementeffecting our spin-off, Allergan agreed to assume responsibility for, and toindemnify 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, except for thefollowing item:

**“We areimplementing a product rationalization and repositioning plan, which willrequire significant financial and personnel resources and may not besuccessful.”**

As of September 29, 2006,we have incurred approximately $103.8 million in cumulative charges under theproduct 

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rationalization and repositioning plan.  We expect to incur additional charges ofapproximately $1.2 million in the fourth quarter of 2006 in connection with theconsolidation of our IOL manufacturing capabilities which represents the finalremaining action under the plan.

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 different from our initial estimates.

Wealso experienced decreases in net sales from product rationalization under theplan of approximately $27.7 million for the nine months ended September29,2006.  Lost sales of discontinuedproducts may not be sufficiently offset by sales from promoted or new products,which could decrease our net sales, margins and cash flows.  

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

(c)     Purchases of Equity Securities by theIssuer

**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** |
|-----------------------------------------------|------------|----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|
|                                          |       |                                                                             |       |                                            |       |                                                                                                  |       |                                                                                                                               |
| July 1, 2006 —  July 31, 2006            |       | None                                                                             |       | None                                            |       | None                                                                                                  |       | None                                                                                                                               |
|                                          |       |                                                                             |       |                                            |       |                                                                                                  |       |                                                                                                                               |
| August 1, 2006 —   August 31, 2006       |       | $15.0 million in  aggregate principal amount of 1.375% convertible notes(1) |       | $1,150 per  $1,000 in principal amount of notes |       | n/a                                                                                                   |       | n/a                                                                                                                                |
|                                          |       |                                                                             |       |                                            |       |                                                                                                  |       |                                                                                                                               |
|                                          |       | $5.0 million in  aggregate principal amount of 2.5% convertible notes(2)         |       | $1,141 per  $1,000 in principal amount of notes |       | n/a                                                                                                   |       | n/a                                                                                                                                |
|                                          |       |                                                                             |       |                                            |       |                                                                                                  |       |                                                                                                                               |
| September 1, 2006 —   September 29, 2006 |       | None                                                                             |       | None                                            |       | None                                                                                                  |       | None                                                                                                                               |
|                                          |       |                                                                             |       |                                            |       |                                                                                                  |       |                                                                                                                               |
|                                          |       |                                                                             |       |                                            |       |                                                                                                  |       |                                                                                                                               |

 

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(1)             In August 2006, werepurchased $15.0 million in aggregate principal amount of our 1.375%Convertible Senior Subordinated Notes due 2025 (the “1.375% convertible notes”)in privately negotiated transactions.

(2)             In August 2006, werepurchased $5.0 million in aggregate principal amount of our 2.5% ConvertibleSenior Subordinated Notes due 2024 (the “2.5% convertible notes”) in privatelynegotiated transactions.

**Item 6.Exhibits**
| 4.1    |   | First Supplemental Indenture, dated as of August 15,  2006, between Advanced Medical Optics, Inc. and U.S. Bank National  Association, as Trustee (incorporated by reference to Exhibit 4.9 to Form  S-3, Automatic Shelf Registration, filed by the Registrant on August 18,  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.                                                                                                                                                                      |

 

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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: November 7, 2006

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

 

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EXHIBIT INDEX
| 4.1    |   | First Supplemental Indenture, dated as of August 15,  2006, between Advanced Medical Optics, Inc. and U.S. Bank National  Association, as Trustee (incorporated by reference to Exhibit 4.9 to Form  S-3, Automatic Shelf Registration, filed by the Registrant on August 18,  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.                                                                                                                                                                      |

 

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