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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q (Mark One) x
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended June 25, 2004 or  o
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
 EXCHANGE ACT OF 1934. For the transition period from         to         . COMMISSION FILE NUMBER 001-31257 ADVANCED MEDICAL OPTICS, INC.  DELAWARE
(State or other jurisdiction of
incorporation or organization)
    
    33-0986820
(I.R.S. Employer Identification No.)1700 E. St. Andrew Place
Santa Ana, California
(Address of principal executive offices)
    
    92705
(Zip Code)
 Registrants telephone number, including area code 714/247-8200 Indicate by a 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 for such 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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes   x      No   o As of July 21, 2004, there were 35,654,700 shares of common stock outstanding.




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ADVANCED MEDICAL OPTICS, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 25, 2004 INDEX  
 PagePART I - FINANCIAL INFORMATIONITEM 1 -
    
    FINANCIAL STATEMENTS(A)
    
    Unaudited Condensed Consolidated Statements of Operations - Three Months and Six Months Ended June 25, 2004 and June 27, 2003
    
    
    3(B)
    
    Unaudited Condensed Consolidated Balance Sheets - June 25, 2004 and December 31, 2003
    
    
    4(C)
    
    Unaudited Condensed Consolidated Statements of Cash Flows - Six Months Ended June 25, 2004 and June 27, 2003
    
    
    5(D)
    
    Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6-14ITEM 2 -
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    15-21CERTAIN FACTORS AND TRENDS AFFECTING ADVANCED MEDICAL OPTICS AND ITS BUSINESSES
    
    
    21-23ITEM 3 -
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    24-25ITEM 4 -
    
    CONTROLS AND PROCEDURES
    
    
    26PART II - OTHER INFORMATIONITEM 2 -
    
    CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES
    
    
    26-27ITEM 4 -
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    27ITEM 6 -
    
    EXHIBITS AND REPORTS ON FORM 8-K
    
    
    28-29Signature
    
    
    30Certifications
    
    
    31-33EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 10.3EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 2




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PART I - FINANCIAL INFORMATION 
 Item 1. Financial Statements Advanced Medical Optics, Inc. 
  (In thousands, except per share data) Three Months Ended
    
    Six Months EndedJune 25,
    
    June 27,
    
    June 25,
    
    June 27,2004
    
    2003
    
    2004
    
    2003Net sales
    
    $
    168,741
    
    
    $
    152,136
    
    
    $
    319,048
    
    
    $
    283,312Cost of sales
    
    
    64,011
    
    
    
    56,697
    
    
    
    123,683
    
    
    
    106,717Gross profit
    
    
    104,730
    
    
    
    95,439
    
    
    
    195,365
    
    
    
    176,595Selling, general and administrative
    
    
    76,947
    
    
    
    69,899
    
    
    
    148,086
    
    
    
    137,507Research and development
    
    
    10,196
    
    
    
    8,956
    
    
    
    19,213
    
    
    
    17,740Operating income
    
    
    17,587
    
    
    
    16,584
    
    
    
    28,066
    
    
    
    21,348Non-operating expense (income):Interest expense
    
    
    7,208
    
    
    
    9,703
    
    
    
    10,951
    
    
    
    14,554Unrealized (gain) loss on derivative instruments
    
    
    (250
    )
    
    
    (19
    )
    
    
    (526
    )
    
    
    282Other, net
    
    
    123,673
    
    
    
    (499
    )
    
    
    123,268
    
    
    
    (735
    )130,631
    
    
    
    9,185
    
    
    
    133,693
    
    
    
    14,101Earnings (loss) before income taxes
    
    
    (113,044
    )
    
    
    7,399
    
    
    
    (105,627
    )
    
    
    7,247Provision (benefit) for income taxes
    
    
    (503
    )
    
    
    3,030
    
    
    
    2,167
    
    
    
    2,971Net earnings (loss)
    
    $
    (112,541
    )
    
    $
    4,369
    
    
    $
    (107,794
    )
    
    $
    4,276Net earnings (loss) per share :Basic
    
    $
    (3.67
    )
    
    $
    0.15
    
    
    $
    (3.59
    )
    
    $
    0.15Diluted
    
    $
    (3.67
    )
    
    $
    0.15
    
    
    $
    (3.59
    )
    
    $
    0.14Weighted average number of shares outstanding:Basic
    
    
    30,675
    
    
    
    29,018
    
    
    
    30,065
    
    
    
    28,887Diluted
    
    
    30,675
    
    
    
    29,955
    
    
    
    30,065
    
    
    
    29,824
 See accompanying notes to unaudited condensed consolidated financial
statements. 3




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Advanced Medical Optics, Inc. 
 
 June 25,
    
    December 31,2004
    
    2003ASSETSCurrent assetsCash and equivalents
    
    $
    77,120
    
    
    $
    46,104Trade receivables, net
    
    
    143,423
    
    
    
    130,423Inventories
    
    
    44,386
    
    
    
    41,596Deposit for acquisition (note 11)
    
    
    45,631
    
    
    
    Other current assets
    
    
    32,761
    
    
    
    34,369Total current assets
    
    
    343,321
    
    
    
    252,492Property, plant and equipment, net
    
    
    69,890
    
    
    
    68,136Other assets
    
    
    47,656
    
    
    
    34,635Deposit for acquisition (note 11)
    
    
    404,369
    
    
    
    Goodwill and intangibles, net
    
    
    106,102
    
    
    
    106,082Total assets
    
    $
    971,338
    
    
    $
    461,345LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent portion of long-term debt
    
    $
    1,875
    
    
    $
    2,328Accounts payable
    
    
    50,300
    
    
    
    35,605Accrued compensation
    
    
    19,847
    
    
    
    24,507Other accrued expenses
    
    
    43,429
    
    
    
    52,861Total current liabilities
    
    
    115,451
    
    
    
    115,301Long-term debt, net of current portion
    
    
    629,563
    
    
    
    233,611Other liabilities
    
    
    20,142
    
    
    
    19,241Stockholders equity:Preferred stock, $.01 par value; authorized 5,000,000 shares; none issued
    
    
    
    
    
    
    Common stock, $.01 par value; authorized 120,000,000 shares; issued 35,486,646 and
29,378,599 shares
    
    
    355
    
    
    
    294Additional paid-in capital
    
    
    275,666
    
    
    
    54,064Retained earnings (accumulated deficit)
    
    
    (82,813
    )
    
    
    24,981Accumulated other comprehensive income
    
    
    12,997
    
    
    
    13,868Less treasury stock, at cost (1,379 and 997 shares)
    
    
    (23
    )
    
    
    (15
    )Total stockholders equity
    
    
    206,182
    
    
    
    93,192Total liabilities and stockholders equity
    
    $
    971,338
    
    
    $
    461,345
 See accompanying notes to unaudited condensed consolidated financial
statements. 4




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Advanced Medical Optics, Inc. 
 
 Six Months EndedJune 25,
    
    June 27,2004
    
    2003Cash flows provided by operating activities:Net earnings (loss)
    
    $
    (107,794
    )
    
    $
    4,276Non cash items included in net earnings (loss):Amortization and write-off of original issue discount and debt issuance costs
    
    
    7,416
    
    
    
    3,299Amortization and write-off of net realized (gain) loss on interest rate swaps
    
    
    (3,466
    )
    
    
    1,829Depreciation and amortization
    
    
    7,408
    
    
    
    7,624Loss on exchange of convertible senior subordinated notes
    
    
    107,240
    
    
    
    Loss on investments and assets
    
    
    509
    
    
    
    613Unrealized (gain) loss on derivatives
    
    
    (526
    )
    
    
    282Expense of compensation plan
    
    
    86
    
    
    
    25Changes in assets and liabilities:Trade receivables
    
    
    (14,258
    )
    
    
    (6,193
    )Inventories
    
    
    (3,011
    )
    
    
    1,907Other current assets
    
    
    2,213
    
    
    
    6,568Accounts payable
    
    
    14,648
    
    
    
    (5,885
    )Accrued expenses and other liabilities
    
    
    (14,085
    )
    
    
    (429
    )Other non-current assets
    
    
    (1,085
    )
    
    
    (815
    )Net cash provided by (used in) operating activities
    
    
    (4,705
    )
    
    
    13,101Cash flows from investing activities:Deposit for acquisition
    
    
    (450,000
    )
    
    
    Additions to property, plant and equipment
    
    
    (6,775
    )
    
    
    (4,379
    )Proceeds from the sale of property, plant and equipment
    
    
    
    
    
    
    199Additions to capitalized internal-use software
    
    
    (245
    )
    
    
    (33
    )Additions to demonstration and bundled equipment
    
    
    (3,256
    )
    
    
    (3,706
    )Net cash used in investing activities
    
    
    (460,276
    )
    
    
    (7,919
    )Cash flows from financing activities:Proceeds from issuance of convertible senior subordinated notes
    
    
    350,000
    
    
    
    140,000Borrowings under term loan
    
    
    250,000
    
    
    
    Repayment of long-term debt
    
    
    (93,236
    )
    
    
    (75,000
    )Financing related costs
    
    
    (15,811
    )
    
    
    (6,196
    )Proceeds from the issuance of common stock
    
    
    3,763
    
    
    
    2,438Net proceeds from settlement of interest rate swaps
    
    
    
    
    
    
    582Purchase of treasury stock
    
    
    (8
    )
    
    
    (120
    )Net cash provided by financing activities
    
    
    494,708
    
    
    
    61,704Effect of exchange rates on cash and equivalents
    
    
    1,289
    
    
    
    656Net increase in cash and equivalents
    
    
    31,016
    
    
    
    67,542Cash and equivalents at beginning of period
    
    
    46,104
    
    
    
    80,578Cash and equivalents at end of period
    
    $
    77,120
    
    
    $
    148,120Supplemental non-cash financing activityExchange of convertible notes into common stock
    
    $
    108,562
    
    
    $
    
 See accompanying notes to unaudited condensed consolidated financial
statements. 5




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Advanced Medical Optics, Inc. 
  Note 1: Basis of Presentation In the opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments necessary (consisting only of
normal recurring accruals) to present fairly the financial information
contained therein. These statements do not include all disclosures required by
accounting principles generally accepted in the United States of America for
annual financial statements and should be read in conjunction with the audited
consolidated financial statements of the Company for the year ended December
31, 2003. The results of operations for the three and six months ended June
25, 2004 are not necessarily indicative of the results to be expected for the
year ending December 31, 2004. All material intercompany balances have been eliminated. Certain reclassifications of prior year amounts have been made to conform with
current year presentation. Stock-Based Compensation The Company measures stock-based compensation for option grants to employees
and members of the board of directors using the intrinsic value method.
Restricted stock awards are valued based on the market price of a share of
nonrestricted stock on the grant date. No compensation expense has been
recognized for stock-based incentive compensation plans other than for
restricted stock awards. Had compensation expense for the Companys stock
options and employee stock purchase plans been recognized based upon the fair
value for awards granted, the Companys net earnings (loss) would have been

decreased (increased) to the following pro forma amounts (in thousands, except
per share data): Three Months Ended
    
    Six Months EndedJune 25, 2004
    
    June 27, 2003
    
    June 25, 2004
    
    June 27, 2003Net earnings (loss):As reported
    
    $
    (112,541
    )
    
    $
    4,369
    
    
    $
    (107,794
    )
    
    $
    4,276Stock-based compensation
expense included in reported
net earnings (loss), net of
tax
    
    
    31
    
    
    
    15
    
    
    
    56
    
    
    
    15Stock-based compensation
expense determined under
fair value based method, net
of tax
    
    
    (1,388
    )
    
    
    (1,217
    )
    
    
    (2,301
    )
    
    
    (2,597
    )Pro forma
    
    $
    (113,898
    )
    
    $
    3,167
    
    
    $
    (110,039
    )
    
    $
    1,694Earnings (loss) per share:As reported:Basic
    
    $
    (3.67
    )
    
    $
    0.15
    
    
    $
    (3.59
    )
    
    $
    0.15Diluted
    
    $
    (3.67
    )
    
    $
    0.15
    
    
    $
    (3.59
    )
    
    $
    0.14Pro forma  Basic and Diluted
    
    $
    (3.71
    )
    
    $
    0.11
    
    
    $
    (3.66
    )
    
    $
    0.06
 These pro forma effects are not indicative of future amounts. The Company
expects to grant additional awards in the future. 6




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) Note 2: Composition of Certain Financial Statement Captions The components of inventories were as follows: June 25,
    
    December 31,(In thousands)
    
    2004
    
    2003Finished goods, including inventory on consignment with customers of $6,384 and
$6,696 in 2004 and 2003, respectively
    
    $
    39,249
    
    
    $
    37,255Work in process
    
    
    1,115
    
    
    
    1,056Raw materials
    
    
    4,022
    
    
    
    3,285$
    44,386
    
    
    $
    41,596
 The components of amortizable intangibles and goodwill were as follows: Intangibles June 25, 2004
    
    December 31, 2003Gross
    
    Accumulated
    
    Gross
    
    Accumulated(In thousands)
    
    Amount
    
    Amortization
    
    Amount
    
    AmortizationAmortized Intangible Assets:Licensing
    
    $
    4,090
    
    
    $
    (3,943
    )
    
    $
    3,940
    
    
    $
    (3,940
    )Trademarks
    
    
    572
    
    
    
    (262
    )
    
    
    572
    
    
    
    (203
    )$
    4,662
    
    
    $
    (4,205
    )
    
    $
    4,512
    
    
    $
    (4,143
    )
 Amortization expense of intangible assets for the three and six months ended
June 25, 2004 and June 27, 2003 was immaterial. Goodwill (In thousands)
    
    June 25, 2004
    
    December 31, 2003Goodwill:United States
    
    $
    12,783
    
    
    $
    12,783Japan
    
    
    28,076
    
    
    
    28,144Manufacturing operations
    
    
    64,786
    
    
    
    64,786$
    105,645
    
    
    $
    105,713
 There was no activity related to goodwill during the three and six months ended
June 25, 2004, except for the impact of foreign currency fluctuations. Note 3: Debt and Interest Rate Swap Agreements On June 22, 2004, the
Company issued $350.0 million of 21⁄2% convertible
senior subordinated notes due July 15, 2024 (Notes). Interest on the Notes is
payable on January 15 and July 15 of each year, commencing on January 15, 2005.
The Notes are convertible into 19.9045 shares of AMOs common stock for each
$1,000 principal amount of Notes (conversion price of approximately $50.24 per
share), subject to adjustment. The Notes may be converted, at the option of
the holders, on or prior to the final maturity date under certain
circumstances, including:  
    
    during any fiscal quarter commencing after September 24, 2004 if the
closing sale price per share of AMOs common stock exceeds 130% of the
conversion price for at least 20 trading days in the 30 consecutive
trading-day period ending on the last trading day of the preceding
fiscal quarter; 7




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued)  
    
    during the five business days after any five consecutive trading day
period in which the trading price of the Notes for each day was less
than 95% of the conversion value of the Notes; provided that holders may
not convert their Notes in reliance on this provision after July 15,
2019 if on any trading day during such trading period the closing sale
price per share of AMOs common stock was between 100% and 130% of the
then current conversion price;
    
    during any period, following the earlier of (a) the date the Notes
are rated by both Standard & Poors Rating Services and Moodys Investor
Services and (b) 30 business days from the date the notes are issued,
when the credit rating assigned to the Notes by Standard & Poors or
Moodys is below CCC+ or Caa2, respectively, or when either of these
rating agencies does not rate or no longer rates the Notes, or suspends
or withdraws the rating assigned to the Notes. This conversion feature
represents an embedded derivative. However, based on the de minimis
value associated with this feature, no value has been assigned at
issuance and at June 25, 2004;
    
    if the Notes have been called for redemption;
    
    if a fundamental change occurs; or
    
    upon the occurrence of specified corporate events. Upon conversion, the Company has the right to deliver, in lieu of shares of
common stock, cash or a combination of cash and shares of common stock. The Company may redeem some or all of the Notes for cash, on or after January
20, 2010 for a price equal to 100% of the principal amount plus accrued and
unpaid interest, including contingent interest, if any, to, but excluding, the
redemption date. The Notes contain put options which may require the Company to repurchase all
or a portion of the Notes on January 15, 2010, July 15, 2014, and July 15, 2019
at a repurchase price of 100% of the principal amount plus accrued and unpaid
interest, including contingent interest, if any, to, but excluding the
repurchase date. The Company may choose to pay the repurchase price in cash,
shares of common stock or a combination of cash and shares of common stock. Beginning with the six-month interest period commencing January 15, 2010,
holders of the Notes will receive contingent interest payments during any
six-month interest period if the trading price of the Notes for each of the
five trading days ending on the second trading day immediately preceding the
first day of the applicable six-month interest period equals or exceeds 120% of
the principal amount of the Notes. The contingent interest payable will equal
0.25% of the average trading price of $1,000 principal amount of Notes during
the five trading days immediately preceding the first day of the applicable
six-month interest period. This contingent interest payment feature represents
an embedded derivative. However, based on the de minimis value associated with
this feature, no value has been assigned at issuance and at June 25, 2004. On or prior to January 15, 2010, upon the occurrence of a fundamental change,
under certain circumstances, the Company will pay a make whole premium on notes
converted in connection with, or tendered for repurchase upon, the fundamental
change. The make whole premium will be payable, in the same form of
consideration into which the Companys common stock has been exchanged or
converted, on the repurchase date for the notes after the fundamental change,
both for notes tendered for repurchase and for notes converted in connection
with the fundamental change. The amount of the make whole premium, if any,
will be based on the Companys stock price on the effective date of the
fundamental change. This make whole premium feature represents an embedded
derivative. However, based on the de minimis value associated with this
feature, no value has been assigned at issuance and at June 25, 2004. On June 25, 2004, the Company amended and restated its senior credit facility
to provide a $250.0 million term loan and a $100.0 million revolving credit
facility. The amended and restated senior credit facility matures on June 25,
2009. At June 25, 2004, the Company did not have any borrowings outstanding
under the revolving credit facility. Approximately $9.6 million of the
revolving credit facility has been reserved to support letters of credit issued
on the Companys behalf. The Company recorded a charge for and paid a $0.5
million fee to the senior credit facility lenders for their commitment to
provide $450.0 million to fund the Companys acquisition of Pfizer Inc.s
surgical ophthalmic business (Acquisition) in the event certain other financing
transactions were not completed in a timely manner. The term loan bears interest at current market rates plus a 2.25% margin (3.83%
per annum at June 25, 2004). Borrowings under the revolving credit facility,
if any, bear interest at current market rates plus a margin based upon the
Companys ratio of debt to EBITDA, 8




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) as defined. The incremental interest margin on borrowings under the revolving
credit facility decreases as the Companys ratio of debt to EBITDA decreases to
specified
levels. Under the senior credit facility, certain transactions may trigger
mandatory prepayment of borrowings, if any. Such transactions may include
equity or debt offerings, certain asset sales and extraordinary receipts. The
Company pays a quarterly fee (2.25% per annum at June 25, 2004) on the average
balance of outstanding letters of credit and a quarterly commitment fee (0.50%
per annum at June 25, 2004) on the average unused portion of the revolving
credit facility. The senior credit facility provides that the Company will maintain certain
financial and operating covenants which include, among other provisions,
maintaining specific leverage and coverage ratios. These covenants are
effective beginning with the quarter ending September 24, 2004. Certain
covenants under the senior credit facility and the indentures relating to the
31/2% convertible senior subordinated notes due April 15, 2023 (Existing
Notes) and the Notes may limit the incurrence of additional indebtedness. The
senior credit facility prohibits dividend payments. The proceeds from the term loan and a portion of the net proceeds from the
Notes aggregating $450.0 million were used to fund the Acquisition, which was
completed on June 26, 2004. In addition, approximately $80.8 million of the
net proceeds from the Notes were used to consummate the June 2004 tender offer
to purchase the remaining $70.0 million aggregate outstanding principal amount
of the 91/4% senior subordinated notes due 2010 (Senior Subordinated Notes)
and pay the related premium and consent fees. As a result of the purchase of
the Senior Subordinated Notes, the Company recorded a charge of approximately
$10.8 million for the premium and consent fees paid and a net gain of $0.7
million for the write-off of capitalized debt related costs and recognition of
the realized gain on interest rate swaps. On June 2, 2004, the Companys Japan subsidiary repaid its ¥2.5 billion term
loan facility. As a result of the prepayment of the term loan, a charge of
$0.7 million for the write-off of capitalized debt related costs was recorded. In June 2004 prior to the end of the second quarter, the Company exchanged
approximately 5.8 million shares of common stock and approximately $4.6 million
in cash for approximately $108.6 million in aggregate principal amount of
Existing Notes in privately negotiated transactions with a limited number of
holders (Exchanges). The Exchanges resulted in an aggregate increase of $216.4
million to common stock and additional paid in capital. Because the Existing
Notes were not convertible into equity at the time of the Exchanges, a non-cash
charge of approximately $107.2 million and a cash charge of approximately $4.6
million was recorded. The Company also recorded a charge of approximately $3.2
million for the write-off of the pro-rata portion of capitalized debt related
costs. Subsequent to quarter end, the Company exchanged approximately 0.2
million shares of common stock for approximately $3.0 million aggregate
principal amount of Existing Notes. At June 25, 2004, an aggregate principal amount of $350.0 million of Notes, an
aggregate principal amount of $31.4 million of Existing Notes and a balance of
$250.0 million on the term loan were outstanding. The aggregate maturities of total long-term debt as of June 25, 2004 are as
follows: $1.3 million in 2004; $2.5 million in 2005, 2006 and 2007; $121.2
million in 2008; and $501.4 million after 2008. In 2003 and 2002, the Company realized the value of certain interest rate swaps
qualifying as fair value hedges. The unamortized gain was recorded as an
adjustment to the carrying amount of the Senior Subordinated Notes as a premium
and was being amortized over the remaining life of the Senior Subordinated
Notes. As a result of the purchase of the Senior Subordinated Notes, the
remaining unamortized gain on the interest rate swaps was fully recognized. At June 25, 2004, the Company did not have any interest rate swap agreements
outstanding. Note 4: Arrangements with Allergan Prior to the June 29, 2002 spin-off from Allergan, Inc. (Allergan), the Company
entered into several agreements with Allergan in connection with, among other
things, transitional services, employee matters, manufacturing and tax sharing.
These agreements generally require the Company to indefinitely indemnify
Allergan from liabilities related to the business contributed to AMO. The
transitional services agreement set forth charges generally intended to allow
Allergan to fully recover the allocated costs of providing certain services,
plus all out-of-pocket expenses, except that AMO paid to Allergan a commission
related to AMO products that were sold by Allergan during the transition
period. The Company recovered costs from Allergan in a similar manner for
services provided by AMO. All transitional services with the exception of
limited facility leases terminated in June 2003. 9




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) Under the manufacturing agreement, Allergan manufactures certain eye care
products and VITRAX® viscoelastics for a period of up to three years from the
date of the spin-off. The Company purchases these products from Allergan at a
price equal to Allergans fully allocated costs plus 10%. During the three
months ended June 25, 2004 and June 27, 2003 and during the six months ended
June 25, 2004 and June 27, 2003, the Company purchased $24.1 million and $18.2
million, respectively, and $43.5 million and $36.8 million, respectively, of product from Allergan. On an annual basis, a pricing true
up calculation is to be performed during the first calendar quarter. This
true up calculation is based upon the actual volume of products shipped by
Allergan to AMO during the preceding year versus the forecasted volume
submitted by AMO that was used to calculate the invoiced prices. During the
year, the Company periodically reviews the volume of purchases and accrues for
estimated shortfalls, if any. The following table summarizes the charges from Allergan for the
above-mentioned services (in thousands): Three Months Ended
    
    Six Months EndedJune 25, 2004
    
    June 27, 2003
    
    June 25, 2004
    
    June 27, 2003Selling, general and
administrative
expenses, net of $135,
$255, $432 and $551
charged to Allergan
    
    $
    409
    
    
    $
    680
    
    
    $
    201
    
    
    $
    1,862Research and development
    
    
    62
    
    
    
    65
    
    
    
    154
    
    
    
    269Manufacturing true up
payment (receipt)
    
    
    233
    
    
    
    
    
    
    
    233
    
    
    
    (629
    )
 Note 5: Income Taxes Income taxes are provided using an estimated annual effective tax rate, which
includes, in addition to foreign income taxes, U.S. federal income taxes and
foreign withholding taxes on the undistributed earnings of non-U.S.
subsidiaries. No income tax benefit has been recognized for the non-cash charge of
approximately $107.2 million and the cash charge of approximately $4.6 million
related to the Exchanges. Note 6: Earnings (Loss) Per Share Basic earnings (loss) per share are calculated by dividing net earnings (loss)
by the weighted average number of common shares outstanding during the period.
Diluted earnings (loss) per share are calculated by adjusting weighted average
outstanding shares, assuming the conversion of all potentially dilutive stock
options and awards. The following represents a reconciliation from basic earnings (loss) per share
to diluted earnings (loss) per share (in thousands, except per share data): Three Months Ended
    
    Six Months EndedJune 25, 2004
    
    June 27, 2003
    
    June 25, 2004
    
    June 27, 2003Net earnings (loss)
    
    $
    (112,541
    )
    
    $
    4,369
    
    
    $
    (107,794
    )
    
    $
    4,276Basic shares outstanding
    
    
    30,675
    
    
    
    29,018
    
    
    
    30,065
    
    
    
    28,887Dilutive effect of stock options and awards
    
    
    
    
    
    
    937
    
    
    
    
    
    
    
    937Diluted shares outstanding
    
    
    30,675
    
    
    
    29,955
    
    
    
    30,065
    
    
    
    29,824Basic earnings (loss) per share
    
    $
    (3.67
    )
    
    $
    0.15
    
    
    $
    (3.59
    )
    
    $
    0.15Diluted earnings (loss) per share
    
    $
    (3.67
    )
    
    $
    0.15
    
    
    $
    (3.59
    )
    
    $
    0.14
 The effect of approximately 7.0 million common shares related to the assumed
conversion of the Notes has been excluded from the computation of diluted
earnings per share for both 2004 periods presented because none of the
conditions that would permit conversion had been satisfied during the periods.
Options to purchase 6.1 million shares of common stock and the effect of
approximately 1.5 million common shares related to the assumed conversion of
the Existing Notes have been excluded from the computation of diluted earnings
per share for both 2004 periods as the effect would be anti-dilutive. 10




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) Note 7: Other Comprehensive Income The following table summarizes components of comprehensive income (loss) (in
thousands): Three Months EndedJune 25, 2004
    
    June 27, 2003Tax
    
    
    
    
    
    
    
    
    
    TaxBefore-tax
    
    (expense)
    
    Net-of-tax
    
    Before-tax
    
    (expense)
    
    Net-of-taxamount
    
    or benefit
    
    amount
    
    amount
    
    or benefit
    
    amountUnrealized gain on derivatives
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    4,354
    
    
    $
    (1,785
    )
    
    $
    2,569Reclassification adjustment for realized loss on
derivatives included in net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,263
    )
    
    
    928
    
    
    
    (1,335
    )Foreign currency translation adjustments
    
    
    1,723
    
    
    
    (651
    )
    
    
    1,072
    
    
    
    1,819
    
    
    
    (814
    )
    
    
    1,005Net earnings (loss)
    
    
    
    
    
    
    
    
    
    
    (112,541
    )
    
    
    
    
    
    
    
    
    
    
    4,369Total comprehensive income (loss)
    
    
    
    
    
    
    
    
    
    $
    (111,469
    )
    
    
    
    
    
    
    
    
    
    $
    6,608
 Six Months EndedJune 25, 2004
    
    June 27, 2003Tax
    
    
    
    
    
    
    
    
    
    TaxBefore-tax
    
    (expense)
    
    Net-of-tax
    
    Before-tax
    
    (expense)
    
    Net-of-taxamount
    
    or benefit
    
    amount
    
    amount
    
    or benefit
    
    amountUnrealized gain on derivatives
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    4,252
    
    
    $
    (1,745
    )
    
    $
    2,507Reclassification adjustment for realized loss on
derivatives included in net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,263
    )
    
    
    928
    
    
    
    (1,335
    )Foreign currency translation adjustments
    
    
    (1,313
    )
    
    
    442
    
    
    
    (871
    )
    
    
    5,242
    
    
    
    (2,149
    )
    
    
    3,093Net earnings (loss)
    
    
    
    
    
    
    
    
    
    
    (107,794
    )
    
    
    
    
    
    
    
    
    
    
    4,276Total comprehensive income (loss)
    
    
    
    
    
    
    
    
    
    $
    (108,665
    )
    
    
    
    
    
    
    
    
    
    $
    8,541
 Note 8: Business Segment Information Effective January 1, 2004, the Company organized its operations into four
geographic operating segments or regions: the Americas, which is comprised of
North and South America, Europe/Africa/Middle East, Japan and Asia Pacific
(excluding Japan, but including Australia and New Zealand). Previously,
Europe/Africa/Middle East and Asia Pacific were combined into one geographic
region. Prior period property, plant and equipment, net sales and operating
income (loss) have been reclassified to reflect the four operating segments. The United States information is presented separately as it is the Companys
headquarters country, and U.S. sales represented 24.9% and 25.1% of total net
sales for the three months ended June 25, 2004 and June 27, 2003, respectively,
and 25.2% and 25.7% of total net sales for the six months ended June 25, 2004
and June 27, 2003, respectively. Additionally, sales in Japan represented 25.7%
and 27.5% of total net sales for the three months ended June 25, 2004 and June
27, 2003, respectively, and 25.2% and 27.0% of total net sales for the six
months ended June 25, 2004 and June 27, 2003, respectively. No other country,
or single customer, generates over 10% of total net sales. Operating income attributable to each operating segment is based upon the
management assignment of costs to such regions, which includes the
manufacturing standard cost of goods produced by the Companys manufacturing
operations (or the cost to acquire goods from third parties), freight, duty and
local distribution costs, and royalties. 11




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) Income from manufacturing operations is not assigned to geographic regions
because most manufacturing operations produce products for more than one
region. Research and development costs are corporate costs. Geographic Operating Segments Property, Plant and Equipment(In thousands)
    
    June 25, 2004
    
    December 31, 2003United States
    
    $
    14,506
    
    
    $
    13,732Europe/Africa/Middle East
    
    
    3,055
    
    
    
    3,457Japan
    
    
    1,780
    
    
    
    1,930Asia Pacific
    
    
    465
    
    
    
    652Americas, excluding United States
    
    
    74
    
    
    
    96Segments total
    
    
    19,880
    
    
    
    19,867Manufacturing operations
    
    
    50,010
    
    
    
    48,269Total
    
    $
    69,890
    
    
    $
    68,136
 Net Sales
    
    Operating Income (Loss)Three Months EndedJune 25,
    
    June 27,
    
    June 25,
    
    June 27,(In thousands)
    
    2004
    
    2003
    
    2004
    
    2003United States
    
    $
    41,985
    
    
    $
    38,218
    
    
    $
    14,272
    
    
    $
    9,995Europe/Africa/Middle East
    
    
    60,294
    
    
    
    54,980
    
    
    
    21,252
    
    
    
    13,692Japan
    
    
    43,432
    
    
    
    41,815
    
    
    
    17,074
    
    
    
    13,538Asia Pacific
    
    
    16,041
    
    
    
    10,851
    
    
    
    3,759
    
    
    
    (44
    )Americas, excluding United States
    
    
    6,989
    
    
    
    6,272
    
    
    
    1,304
    
    
    
    503Segments total
    
    
    168,741
    
    
    
    152,136
    
    
    
    57,661
    
    
    
    37,684Manufacturing operations
    
    
    
    
    
    
    
    
    
    
    522
    
    
    
    7,735Research and development
    
    
    
    
    
    
    
    
    
    
    (10,196
    )
    
    
    (8,956
    )Elimination of inter-company profit
    
    
    
    
    
    
    
    
    
    
    (5,032
    )
    
    
    (9,365
    )General corporate
    
    
    
    
    
    
    
    
    
    
    (25,368
    )
    
    
    (10,514
    )Total
    
    $
    168,741
    
    
    $
    152,136
    
    
    $
    17,587
    
    
    $
    16,584
 Net Sales
    
    Operating Income (Loss)Six Months EndedJune 25,
    
    June 27,
    
    June 25,
    
    June 27,(In thousands)
    
    2004
    
    2003
    
    2004
    
    2003United States
    
    $
    80,465
    
    
    $
    72,948
    
    
    $
    23,140
    
    
    $
    16,252Europe/Africa/Middle East
    
    
    115,203
    
    
    
    101,751
    
    
    
    32,987
    
    
    
    22,185Japan
    
    
    80,319
    
    
    
    76,597
    
    
    
    28,209
    
    
    
    22,282Asia Pacific
    
    
    29,259
    
    
    
    19,988
    
    
    
    5,014
    
    
    
    73Americas, excluding United States
    
    
    13,802
    
    
    
    12,028
    
    
    
    1,988
    
    
    
    904Segments total
    
    
    319,048
    
    
    
    283,312
    
    
    
    91,338
    
    
    
    61,696Manufacturing operations
    
    
    
    
    
    
    
    
    
    
    1,256
    
    
    
    15,193Research and development
    
    
    
    
    
    
    
    
    
    
    (19,213
    )
    
    
    (17,740
    )Elimination of inter-company profit
    
    
    
    
    
    
    
    
    
    
    (10,036
    )
    
    
    (18,673
    )General corporate
    
    
    
    
    
    
    
    
    
    
    (35,279
    )
    
    
    (19,128
    )Total
    
    $
    319,048
    
    
    $
    283,312
    
    
    $
    28,066
    
    
    $
    21,348
 12




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) In each geographic segment, the Company markets products in two product lines:
Ophthalmic Surgical and Eye Care. The Ophthalmic Surgical product line markets
intraocular lenses, phacoemulsification equipment, viscoelastics, and other
products related to cataract and refractive surgery. The Eye Care product line
markets cleaning, storage and disinfection products for the consumer contact
lens market. The Company provides global marketing strategy teams to ensure
development and execution of a consistent marketing strategy for products in
all geographic operating segments. There are no transfers between product
lines. Net Sales by Product Line Three Months Ended
    
    Six Months EndedJune 25,
    
    June 27,
    
    June 25,
    
    June 27,(In thousands)
    
    2004
    
    2003
    
    2004
    
    2003Ophthalmic Surgical
    
    $
    86,670
    
    
    $
    78,308
    
    
    $
    164,935
    
    
    $
    145,825Eye Care
    
    
    82,071
    
    
    
    73,828
    
    
    
    154,113
    
    
    

    137,487Total Net Sales
    
    $
    168,741
    
    
    $
    152,136
    
    
    $
    319,048
    
    
    $
    283,312
 Note 9: Commitments and Contingencies On December 3, 2003, the Company filed a complaint in the U.S. District Court
for the District of Delaware against Alcon, Inc. and Alcon Laboratories, Inc.
for infringement of U.S. Patent Nos. 5,700,240 and 6,059,765. The Company
alleged that Alcons Infiniti and Series 2000 Legacy phacoemulsification
machines infringe the patents. The Company is seeking damages and a permanent
injunction. On January 28, 2004, Alcon Manufacturing, Ltd. filed a complaint against the
Company and Allergan, Inc. in the U.S. District Court for the Northern District
of Texas, Fort Worth Division, for infringement of U.S. Patent Nos. 4,832,685
and 4,935,005. Alcon alleged that the Companys Prestige®and Sovereign®
phacoemulsification systems and replacement cassettes infringe the patents.
Alcon is seeking damages and a permanent injunction. The Company is involved in various litigation and claims arising in the normal
course of business. Management believes that recovery or liability with
respect to any other pending lawsuits or asserted claims will not have a
material adverse effect on the Companys consolidated financial position,
results of operations or cash flows. Note 10: Pension Benefit Plans The Company sponsors defined benefit pension plans in Japan and in certain
European countries. Components of net periodic benefit cost under these plans
were (in thousands): Three Months Ended
    
    Six Months EndedJune 25,
    
    June 27,
    
    June 25,
    
    June 27,2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    445
    
    
    $
    345
    
    
    $
    902
    
    
    $
    690Interest cost
    
    
    114
    
    
    
    91
    
    
    
    231
    
    
    
    183Expected return on plan assets
    
    
    (49
    )
    
    
    (28
    )
    
    
    (99
    )
    
    
    (56
    )Amortization of transition amount
    
    
    1
    
    
    
    1
    
    
    
    2
    
    
    
    2Amortization of prior service cost
    
    
    15
    
    
    
    15
    
    
    
    31
    
    
    
    30Recognized net actuarial loss
    
    
    9
    
    
    
    6
    
    
    
    18
    
    
    
    11Net periodic benefit cost
    
    $
    535
    
    
    $
    430
    
    
    $
    1,085
    
    
    $
    860
 Note 11: Subsequent Events On June 26, 2004, the Company completed the Acquisition for $450 million in
cash. The Company acquired ophthalmic surgical products and certain
manufacturing and research and development facilities located in Uppsala,
Sweden, Groningen, Netherlands and 13




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Advanced Medical Optics, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued) Bangalore, India. The products acquired include the Healon®line of
viscoelastic products used in ocular surgery, the CeeOn®and Tecnis®
intraocular lenses and the Baerveldt®glaucoma shunt. These assets generated
sales of approximately $150 million in 2003. The total estimated cost of the Acquisition is as follows (in thousands): Cash consideration to Pfizer Inc.
    
    $
    450,000Estimated direct costs
    
    
    5,916Estimated total purchase price
    
    $
    455,916
 The allocation of the above purchase price is estimated to be as follows (in
thousands): Fair value of net tangible assets acquired, current
    
    $
    45,631Non-current:Fair value of net tangible assets acquired
    
    
    87,208Deferred tax liability
    
    
    (86,010
    )Fair value of identifiable intangible assets acquired
    
    
    250,525Goodwill and in-process research and development
    
    
    158,562Estimated total purchase price
    
    $
    455,916
 The preliminary purchase price allocation above is based upon balances as of
March 28, 2004 as more current information is not yet available. A final
determination of fair values may differ materially from the preliminary
estimates above and will include managements consideration of a final
valuation prepared by independent valuation specialists. This final valuation
will be based on the actual net tangible assets acquired on June 26, 2004 and
will likely include a significant charge to in-process research and
development. 14




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ADVANCED MEDICAL OPTICS 
  The following discussion and analysis presents the factors that had a material
effect on AMOs cash flows and results of operations during the three and six
months ended June 25, 2004, and the Companys financial position at that date.
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risk and
uncertainties. Our actual results may differ significantly from the results
discussed in the forward-looking statements. Factors that might cause such
differences include, but are not limited to, those discussed in the subsection
entitled Certain Factors and Trends Affecting AMO and Its Businesses. The
following discussion should be read in conjunction with the 2003 Form 10-K and
the condensed consolidated financial statements and notes thereto included
elsewhere in this Form 10-Q. OVERVIEW We are a global leader in the development, manufacture and marketing of medical
devices for the eye and contact lens care products. Our products in the
ophthalmic surgical market include intraocular lenses, phacoemulsification
systems, viscoelastics and surgical packs used in cataract surgery, and
microkeratomes used in refractive surgery. Our eye care products include
disinfecting solutions to destroy harmful microorganisms in and on the surface
of contact lenses, daily cleaners to remove undesirable film and deposits from
contact lenses, enzymatic cleaners to remove protein deposits from contact
lenses and lens rewetting drops to provide added wearing comfort. We have operations in approximately 20 countries, sell our products in
approximately 60 countries and have organized our operations into four regions:  
    
    Americas (North and South America);
    
    Europe, Africa and Middle East;
    
    Japan; and
    
    Asia Pacific (excluding Japan, but including Australia and New Zealand). Acquisition of Pfizer Inc. Surgical Ophthalmic Business On June 26, 2004, we completed the acquisition of the Pfizer Inc. Surgical
Ophthalmic Business for $450 million in cash (Acquisition). We acquired
ophthalmic surgical products and certain manufacturing and research and
development facilities located in Uppsala, Sweden, Groningen, Netherlands and
Bangalore, India. The products acquired include the Healon®line of
viscoelastic products used in ocular surgery, the CeeOn®and Tecnis®
intraocular lenses and the Baerveldt®glaucoma shunt. These assets generated
sales of approximately $150 million in 2003. Separation from Allergan On June 29, 2002, Allergan, Inc. (Allergan) transferred its optical medical
device business consisting of the ophthalmic surgical and eye care product
lines to us in connection with a tax-free spin-off. Prior to the spin-off, we
entered into several agreements with Allergan in connection with, among other
things, transitional services, employee matters, manufacturing and tax sharing. Under the manufacturing agreement, Allergan manufactures certain eye care
products and VITRAX® viscoelastics for a period of up to three years from the
date of the spin-off. The Company purchases these products from Allergan at a
price equal to Allergans fully allocated costs plus 10%. During the three
months ended June 25, 2004 and June 27, 2003 and during the six months ended
June 25, 2004 and June 27, 2003, the Company purchased $24.1 million and $18.2
million, respectively, and $43.5 million and $36.8 million, respectively, of
product from Allergan. On an annual basis, a pricing true up calculation is
to be performed during the first calendar quarter. This true up calculation
is based upon the actual volume of products shipped by Allergan to AMO during
the preceding year versus the forecasted volume submitted by AMO that was used
to calculate the invoiced prices. During the year, the Company periodically
reviews the volume of purchases and accrues for estimated shortfalls, if any. 15




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 CRITICAL ACCOUNTING POLICIES Revenue and Accounts Receivable We recognize revenue from product sales when title and risk of loss transfers,
delivery has occurred, the price to the buyer is determinable and
collectibility is reasonably assured, with the exception of intraocular lenses,
which are generally distributed on a consignment basis and recognized as
revenue upon implantation in a patient and fulfillment of the other revenue
recognition criteria. We generally permit returns of product from a customer
if the product is returned in a timely manner, in good condition, and through
the normal channels of distribution. Return policies in certain international
markets can be more stringent and are based on the terms of contractual
agreements with customers. Allowances for returns are provided for based upon
an analysis of our historical patterns of returns matched against the sales
from which they originated. Historically, product returns have been within the
amounts estimated. The allowance for doubtful accounts is determined by analyzing specific
customer accounts and assessing the risk of uncollectibility based on
insolvency, disputes or other collection issues. In addition, we routinely
analyze the different receivable aging categories and establish allowances
based on the length of time receivables are past due. Inventories Inventories are valued at the lower of first-in, first-out cost or market. On
a regular basis, we evaluate inventory balances for excess quantities and
obsolescence by analyzing estimated demand, inventory on hand, sales levels and
other information. Based on these evaluations, inventory balances are reduced,
if necessary. Impairment of Long-Lived Assets On January 1, 2002, we adopted Statement of Financial Accounting Standards No.
142, Goodwill and Other Intangible Assets, whereby goodwill is no longer
amortized, but instead is subject to a periodic impairment review. As our
operations are comprised of four reporting units, we review the recoverability
of our goodwill at the end of the second fiscal quarter of each year by
comparing each reporting units fair value to the net book value of its assets.
If the book value of the reporting units assets exceeds its fair value, the
goodwill is written down to its implied fair value. Additionally, we review the carrying amounts of goodwill and other intangibles
whenever events and circumstances indicate that the carrying amount of an asset
may not be recoverable. Impairment indicators include, among other conditions,
cash flow deficits, historic or anticipated declines in revenue or operating
profit and adverse legal or regulatory developments. If it is determined that
such indicators are present and the review indicates that the assets will not
be fully recoverable, based upon undiscounted estimated cash flows over the
remaining amortization periods for other intangibles and fair value for
goodwill, their carrying values are reduced to estimated fair market value.
Estimated fair market value is determined primarily using the anticipated cash
flows discounted at a rate commensurate with the risk involved. For the
purposes of identifying and measuring impairment, long-lived assets are grouped
with other assets and liabilities at the lowest level for which identifiable
cash flows are largely independent of the cash flows of other assets and
liabilities. Deferred Taxes We account for income taxes under the asset and liability method, whereby
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. We evaluate the need to establish a valuation
allowance for deferred tax assets based upon the amount of existing temporary
differences, the period in which they are expected to be recovered and expected
levels of taxable income. A valuation allowance to reduce deferred tax assets
is established when it is more likely than not that some or all of the
deferred tax assets will not be realized. 16




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 CRITICAL ACCOUNTING POLICIES (Continued) Stock-Based Compensation We measure stock-based compensation for option grants to employees and members
of the board of directors using the intrinsic value method. RESULTS OF OPERATIONS Net Sales.The following table compares net sales by product line for the three
months and six months ended June 25, 2004 and June 27, 2003: Three Months Ended
    
    Six Months Ended(in thousands)
    
    June 25, 2004
    
    June 27, 2003
    
    June 25, 2004
    
    June 27, 2003Ophthalmic Surgical
    
    $
    86,670
    
    
    $
    78,308
    
    
    $
    164,935
    
    
    $
    145,825Eye Care
    
    
    82,071
    
    
    
    73,828
    
    
    
    154,113
    
    
    
    137,487Total Net Sales
    
    $
    168,741
    
    
    $
    152,136
    
    
    $
    319,048
    
    
    $
    283,312Domestic
    
    
    24.9
    %
    
    
    25.1
    %
    
    
    25.2
    %
    
    
    25.7
    %International
    
    
    75.1
    %
    
    
    74.9
    %
    
    
    74.8
    %
    
    
    74.3
    %
 Net sales increased $16.6 million, or 10.9%, to $168.7 million in the three
months ended June 25, 2004 from $152.1 million in the three months ended June
27, 2003. Net sales for the six months ended June 25, 2004 were $319.0
million, a 12.6% increase from the comparable 2003 amount. The increase in net
sales in the three and six months ended June 25, 2004 compared with the same
periods last year was the result of sales gains in both product lines and
favorable foreign currency changes. Foreign currency fluctuations increased
sales by $7.7 million, or 5.0%, and $19.7 million, or 7.0%, in the three and
six months ended June 25, 2004, respectively, as compared to average rates in
effect in the prior year periods. Global sales of our ophthalmic surgical products increased $8.4 million, or
10.7%, and increased $19.1 million, or 13.1%, in the three and six months ended
June 25, 2004, respectively, compared with the same periods last year. In the
United States, sales of our ophthalmic surgical products increased $1.3
million, or 4.5%, in the three months ended June 25, 2004 and increased $3.2
million, or 6.1%, in the six months ended June 25, 2004 compared with the same
periods last year, primarily due to increased sales of phacoemulsification
equipment and the SENSAR®and CLARIFLEX®intraocular lenses, both with the
OPTIEDGEdesign. International sales of our ophthalmic surgical products
increased $7.1 million, or 14.0%, and increased $15.9 million, or 17.0%, in the
three and six months ended June 25, 2004, respectively, compared with the same
periods last year, primarily due to increases in sales of the SENSAR®
intraocular lens and phacoemulsification equipment and favorable currency
changes. Foreign currency fluctuations increased international ophthalmic
surgical sales by $3.5 million, or 4.4%, and by $9.4 million, or 6.5%, in the
three and six months ended June 25, 2004, respectively. We believe that global
sales of ophthalmic surgical products will continue to grow due to increased
sales of our SOVEREIGN® COMPACTwith WHITESTARphacoemulsification system and
the SENSAR® and the CLARIFLEX®intraocular lenses, both with the OPTIEDGE
design. Beginning in the third quarter of 2004, our sales will also include sales of
products acquired in the Acquisition including, the Healon®family of
viscoelastics, the CeeOn®and Tecnis®intraocular lenses and the Baerveldt®
glaucoma shunt. Global sales of our eye care products increased $8.2 million, or 11.2%, and
increased $16.6 million, or 12.1%, in the three and six months ended June 25,
2004, respectively, as compared with the same periods last year. Sales of our
eye care products in the United States increased $2.5 million, or 23.6%, and
increased $4.3 million, or 20.8%, in the three and six months ended June 25,
2004, respectively, as compared with the same periods last year primarily due
to an increase in sales of COMPLETE®branded products. International sales of
our eye care products increased $5.7 million, or 9.1%, and increased $12.3
million, or 10.5%, in the three and six months ended June 25, 2004,
respectively, as compared with the same periods last year primarily due to an
increase in sales of our 17




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 RESULTS OF OPERATIONS (continued) COMPLETE®branded and hydrogen peroxide-based products and favorable currency
changes. Foreign currency fluctuations increased international eye care sales
by $4.2 million, or 5.7%, and by $10.3 million, or 7.5%, in the three and six
months ended June 25, 2004, respectively. We believe that global eye care
sales will continue to grow due to increased sales of our COMPLETE® branded and
hydrogen peroxide-based products and continued sales growth in Europe, Asia
Pacific and Japan. The market for eye care products is impacted by trends in
the contact lens market such as advances in surgical procedures for vision
correction and the growth of the market for daily and extended wear lenses.
These trends could reduce demand for lens care products generally, which we may
not be able to completely mitigate. Gross margin.Our gross margin was 62.1% of net sales in the three months
ended June 25, 2004, a decrease of 0.6 percentage points from the comparable
prior year period. Our gross margin was 61.2% of net sales in the six months
ended June 25, 2004, a decrease of 1.1 percentage points from the comparable
prior year period. The decrease in gross margin as a percent of net sales in
the three and six months ended June 25, 2004 as compared to the same periods
last year was primarily due to pre-production costs incurred at our
manufacturing facility in Madrid, Spain, costs incurred for expansion of our
manufacturing facility in Hangzhou, China and higher costs of product supplied
by Allergan, partially offset by sales growth in the higher margin COMPLETE®
branded line of eye care products. During the remainder of 2004, we expect our
eye care product gross margin percentage will continue to be unfavorably
impacted by higher costs of product supplied by Allergan and pre-production
costs incurred at the Spain manufacturing facility. Selling, general and administrative.Selling, general and administrative
expenses were $76.9 million, or 45.6% of net sales, and $148.1 million, or
46.4% of net sales, in the three and six months ended June 25, 2004,
respectively, compared to $69.9 million, or 45.9% of net sales, and $137.5
million, or 48.5% of net sales, in the three and six months ended June 27,
2003. The increase in selling, general and administrative expenses was
partially due to expenses incurred in preparation for the integration of the
acquired business. Additionally, we increased our allowance for doubtful
accounts by $1.4 million during the three months ended June 25, 2004 as a
result of the termination of a distributor contract in Europe and the likely
uncollectibility of amounts due from this former distributor. Research and development.Research and development expenses were $10.2 million,
or 6.0% of net sales, and $19.2 million, or 6.0% of net sales, in the three and
six months ended June 25, 2004, respectively, compared to $9.0 million, or 5.9%
of net sales, and $17.7 million, or 6.3% of net sales, in the three and six
months ended June 27, 2003. The increase in research and development dollars
was primarily the result of an increase in spending for research efforts in the
ophthalmic surgical business. As a result of our continued investment in
research and development and other business development activities, we launched
our new vitreal retinal system, AMO GEMINIin Europe, a capsular tension ring
in North America, the ARRAY®IIintraocular lens in Europe and an
advanced formulation of our blinkcontact lens rewetter in the U.S. and Europe
and expect to bring to market later this year our next generation
microkeratome, the VERISYSEphakic intraocular lens for correction of myopia
in the U.S. and enhancements to our phacoemulsification platform. Non-operating expense.Interest expense was $7.2 million and $11.0 million in
the three and six months ended June 25, 2004, respectively, compared to $9.7
million and $14.6 million in the three and six months ended June 27, 2003,
respectively. Interest expense decreased due to a lower average debt balance
and a lower weighted average interest rate. Interest expense in both 2004
periods includes aggregate costs of $3.6 million comprised of the pro-rata
write-off of debt issuance costs and one-time commitment fee of $6.1 million,
write-off of original issue discount of $0.7 million and recognition of net
realized gains on interest rate swaps of $3.2 million associated with the
prepayment of the Japan term loan in June 2004, the consummation of the June
2004 tender offer for
$70.0 million aggregate principal amount of 91⁄4% senior subordinated notes
(Senior Subordinated Notes) and the exchange of $108.6 million aggregate
principal amount of 31⁄2% convertible senior subordinated notes for common
stock and cash in June 2004 (Exchanges). Interest expense in both 2003 periods
includes aggregate costs of $4.6 million comprised of the write-off of debt
issuance costs and a realized loss on an interest rate swap associated with the
prepayment of the term loan in June 2003 We recorded an unrealized gain on derivative instruments of $0.3 million and
$0.5 million in the three and six months ended June 25, 2004, respectively,
compared to an immaterial unrealized gain and an unrealized loss of $0.3
million in the three and six months ended June 27, 2003. We record as
unrealized (gain) loss on derivative instruments the mark to market
adjustments on the outstanding foreign currency options which we enter into as
part of our overall risk management strategy to reduce the volatility of
expected earnings in currencies other than the U.S. dollar. 18




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 RESULTS OF OPERATIONS (continued) Other non-operating expense in both 2004 periods includes early debt
extinguishment costs aggregating $122.7 million associated with the debt
transactions noted above. Income taxes.The effective tax rate for the three and six months ended June
25, 2004 was zero and 2.0%, respectively, compared to the effective tax rate of
41.0% for the three and six months ended June 27, 2003. Excluding the non-cash
charge of approximately $107.2 million and the cash charge of approximately
$4.6 million related to the Exchanges as no tax benefit has been recognized,
the 2004 effective tax rate would have been 35.0%. The lower rate in 2004 is
due to a shift in income to lower tax jurisdictions. Income taxes are provided
on taxable income at the statutory rates applicable to such income. We have
provided for U.S. federal income taxes and foreign withholding taxes on the
undistributed earnings of non-U.S. subsidiaries. We believe our future effective income tax rate may vary depending on our mix
of domestic and international taxable income or loss and the various tax and
treasury methodologies that we implement, including our policy regarding
repatriation of future accumulated foreign earnings. LIQUIDITY AND CAPITAL RESOURCES Management assesses our liquidity by our ability to generate cash to fund
operations. Significant factors in the management of liquidity are: funds
generated by operations; levels of accounts receivable, inventories, accounts
payable and capital expenditures; adequate lines of credit; and financial
flexibility to attract long-term capital on satisfactory terms. Historically, we have generated cash from operations in excess of working
capital requirements, and we expect to do so in the future. Net cash used in
operating activities was $4.7 million in the six months ended June 25, 2004
compared to net cash provided by operating activities of $13.1 million in the
six months ended June 27, 2003. Operating cash flow decreased in the six months
ended June 25, 2004 compared to the six months ended June 27, 2003 primarily
due to the approximately $10.0 million after tax effect of cash payments for
early debt extinguishment costs, an increase in accounts receivable and a
decrease in accrued expenses and other liabilities partially offset by an
increase in accounts payable. Net cash used in investing activities was $460.3 million and $7.9 million in
the six months ended June 25, 2004 and June 27, 2003, respectively. The 2004
amount includes a $450.0 million advance to Pfizer Inc. for the Acquisition,
which was completed on June 26, 2004. Expenditures for property, plant and
equipment totaled $6.8 million and $4.4 million in the six months ended June
25, 2004 and June 27, 2003, respectively. The 2004 expenditures are primarily
comprised of expansion of our manufacturing facilities and construction of
research and development facilities at our leased headquarters. The 2003
expenditures are primarily comprised of improvements to our leased
headquarters, expansion of manufacturing facilities and a variety of other
projects designed to improve productivity. We expect to invest approximately
$20.0 million to $25.0 million in property, plant and equipment in 2004.
Expenditures for demonstration (demo) and bundled equipment, primarily
phacoemulsification and microkeratome surgical equipment, were $3.3 million and
$3.7 million in the six months ended June 25, 2004 and June 27, 2003,
respectively. We maintain demo and bundled equipment to facilitate future
sales of similar equipment and related products to our customers. We expect to
invest approximately $6.0 million to $8.0 million in demo and bundled equipment
in 2004. Expenditures for capitalized internal-use software were $0.2 million
and immaterial in the six months ended June 25, 2004 and June 27, 2003,
respectively. We expect to invest approximately $1.0 million to $2.0 million
in capitalized internal-use software in 2004. Net cash provided by financing activities was $494.7 million in the six months
ended June 25, 2004, which was primarily comprised of $350.0 million of
proceeds from the issuance of 21⁄2% convertible senior subordinated notes and
a $250.0 term loan partially offset by repayment of debt of $93.2 million and
financing related costs of $15.8 million. Net cash provided by financing
activities was $61.7 million in the six months ended June 27, 2003, which was
primarily comprised of $140.0 million of long-term borrowings partially offset
by long-term debt repayments of $75.0 million and financing related costs of
$6.2 million. 19




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 LIQUIDITY AND CAPITAL RESOURCES (continued) In June 2004 prior to the end of the second quarter, we exchanged approximately
$108.6 million aggregate principal amount of 31⁄2% convertible senior
subordinated notes for common stock and cash. Because these notes were not
convertible into equity at the time of the exchanges, a non-cash charge of
approximately $107.2 million and a cash charge of approximately $4.6 million
were recorded. Also in June 2004, our Japan subsidiary repaid its ¥2.5 billion
term loan facility. Subsequent to quarter end, we exchanged an additional $3.0
million of 31⁄2% convertible senior subordinated notes for common stock. On June 22, 2004, we consummated the private offering of $350.0 million of
21⁄2% convertible senior subordinated notes due 2024. On June 25, 2004, we amended and restated our senior credit facility to provide
a $250.0 million term loan and a $100.0 million revolving credit facility. The
amended and restated senior credit facility matures on June 25, 2009. As of
June 25, 2004, we did not have any borrowings outstanding under the revolving
credit facility. The proceeds from the term loan and a portion of the net proceeds from the
private offering aggregating $450.0 million were used to fund the Acquisition.
In addition, approximately $80.8 million of the net proceeds from the private
offering were used to consummate the June 2004 tender offer to purchase the
remaining $70.0 million aggregate outstanding principal amount of the Senior
Subordinated Notes and pay the related premium and consent fees. Our cash position includes amounts denominated in foreign currencies, and the
repatriation of those cash balances from some of our non-U.S. subsidiaries will
result in additional tax costs. However, these cash balances are generally
available without legal restriction to fund ordinary business operations. We believe that the expected net cash provided by our operating activities,
supplemented as necessary with borrowings available under our senior credit
facility and existing cash and equivalents, will provide sufficient resources
to meet our working capital requirements, debt service and other cash needs
over the next year. We are partially dependent upon the reimbursement policies of government and
private health insurance companies. Government and private sector initiatives
to limit the growth of health care costs, including price regulation and
competitive pricing, are continuing in many countries where we do business. As
a result of these changes, the marketplace has placed increased emphasis on the
delivery of more cost-effective medical therapies. While we have been unaware
of significant price resistance resulting from the trend toward cost
containment, changes in reimbursement policies and other reimbursement
methodologies and payment levels could have an adverse effect on our pricing
flexibility. Additionally, the current trend among U.S. hospitals and other customers of
medical device manufacturers is to consolidate into larger purchasing groups to
enhance purchasing power. The enhanced purchasing power of these larger
customers may also increase the pressure on product pricing, although we are
unable to estimate the potential impact at this time. Inflation.Although at reduced levels in recent years, inflation may cause
upward pressure on the cost of goods and services used by us. The competitive
and regulatory environments in many markets substantially limit our ability to
fully recover these higher costs through increased selling prices. We
continually seek to mitigate the adverse effects of inflation through cost
containment and improved productivity and manufacturing processes. Foreign currency fluctuations.Approximately 75% of our revenues for the six
months ended June 25, 2004 were derived from operations outside the United
States, and a significant portion of our cost structure is denominated in
currencies other than the U.S. dollar, primarily the Japanese yen and the euro.
Therefore, we are subject to fluctuations in sales and earnings reported in
U.S. dollars as a result of changing currency exchange rates. The impact of foreign currency fluctuations on sales was a $7.7 million
increase and a $19.7 million increase for the three and six months ended June
25, 2004, respectively, and a $13.1 million increase and a $25.1 million
increase for the three and six months ended June 27, 2003, respectively. 20




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 LIQUIDITY AND CAPITAL RESOURCES (continued) Contractual obligations.The following represents a list of our material
contractual obligations and commitments as of June 25, 2004: Payments Due by Year(In millions)
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    TotalLong-term debt
    
    $
    1.3
    
    
    $
    2.5
    
    
    $
    2.5
    
    
    $
    2.5
    
    
    $
    121.2
    
    
    $
    501.4
    
    
    $
    631.4Lease obligations
    
    
    8.1
    
    
    
    11.2
    
    
    
    6.1
    
    
    
    4.3
    
    
    
    3.9
    
    
    
    25.3
    
    
    
    58.9IT services
    
    
    2.7
    
    
    
    5.4
    
    
    
    5.2
    
    
    
    4.7
    
    
    
    
    
    
    
    
    
    
    
    18.0Purchase of Pfizer
Inc. surgical
ophthalmic business
    
    
    450.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    450.0Other purchase
obligations,
primarily purchases
of inventory and
capital equipment
    
    
    58.0
    
    
    
    2.0
    
    
    
    0.4
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    
    
    
    
    60.6
 
 CERTAIN FACTORS AND TRENDS AFFECTING AMO AND ITS BUSINESSES Certain statements we made in this report and in other reports and statements
released by us constitute forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, such as comments which
express our opinions about trends and factors which may impact future operating
results. Disclosures that use words such as we believe, anticipate,
expect and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks and uncertainties
that could cause actual results to differ materially from expectations. Any
such forward-looking statements, whether made in this report or elsewhere,
should be considered in context with the various disclosures made by us about
our businesses including, without limitation, the factors discussed below:  
    
    WE MAY NOT SUCCESSFULLY MAKE OR INTEGRATE ACQUISITIONS OR ENTER INTO
STRATEGIC ALLIANCES. As part of our business strategy, we intend to
pursue selected acquisitions and strategic alliances and partnerships.
We compete with other ophthalmic surgical products and eye care
companies, among others, for these opportunities and we cannot assure
you that we will be able to effect strategic alliances, partnerships
or acquisitions on commercially reasonable terms or at all. Even if we
enter into these transactions, we may experience: delays in realizing
the benefits we anticipate or we may not realize the benefits we
anticipate at all; difficulties in integrating any acquired companies
and products into our existing business; attrition of key personnel
from acquired businesses; costs or charges; difficulties or delays in
obtaining regulatory approvals; higher costs of integration than we
anticipated; or unforeseen operating difficulties that require
significant financial and managerial resources that would otherwise be
available for the ongoing development or expansion of our existing
operations. Consummating these transactions could also result in the
incurrence of additional debt and related interest expense, as well as
unforeseen contingent liabilities, all of which could have a material
adverse effect on our business, financial condition and results of
operations. We may also issue additional equity in connection with
these transactions, which would dilute our existing shareholders.
    
    WE HAVE A SIGNIFICANT AMOUNT OF DEBT WHICH CONTAINS COVENANTS THAT MAY
LIMIT OUR ACTIVITIES. This level of debt could limit cash flows
available for working capital, capital expenditures, acquisitions and
other corporate purposes, could limit our ability to obtain additional
financing and could limit our flexibility to react to competitive or
other changes in our industry, and to economic conditions generally.
Our ability to comply with loan covenants and to repay or refinance
our indebtedness will depend upon our future operating performance,
which will be affected by general economic, financial, competitive,
legislative, regulatory and other factors beyond our control. 21




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 CERTAIN FACTORS AND TRENDS AFFECTING AMO AND ITS BUSINESSES (Continued)  
    
    WE MAY BE REQUIRED TO SATISFY CERTAIN INDEMNIFICATION OBLIGATIONS TO
ALLERGAN, OR MAY NOT BE ABLE TO COLLECT ON INDEMNIFICATION RIGHTS FROM
ALLERGAN. Under the terms of the contribution and distribution
agreement, we and Allergan have each agreed to indemnify each other
from and after the spin-off with respect to the indebtedness,
liabilities and obligations retained by our respective companies.
These indemnification obligations could be significant. The ability to
satisfy these indemnities, if required to do so, will depend upon the
future financial strength of each of our companies. We cannot
determine whether we will have to indemnify Allergan for any
substantial obligations, and we do not have control over or clear
visibility to the settlement of certain claims and lawsuits which
require partial indemnification by us, such as employment-related
claims. We also cannot assure you that if Allergan is obligated to
indemnify us for any substantial obligations, Allergan will have the
ability to satisfy those obligations.
    
    WE MAY BE RESPONSIBLE FOR FEDERAL INCOME TAX LIABILITIES THAT RELATE
TO THE DISTRIBUTION OF OUR COMMON STOCK BY ALLERGAN. Allergan has
received a ruling from the Internal Revenue Service to the effect that
the spin-off qualified as a tax-free transaction. If either we or
Allergan breach representations to each other or to the Internal
Revenue Service, or if we or Allergan take or fail to take, as the
case may be, actions that result in the spin-off failing to meet the
requirements of a tax-free spin-off pursuant to Section 355 of the
Internal Revenue Code, the party in breach will indemnify the other
party for any and all resulting taxes. If we were required to pay any
of the potential taxes described above, the payment would have a
material adverse effect on our financial position.
    
    WE FACE INTENSE COMPETITION AND OUR FAILURE TO COMPETE EFFECTIVELY
COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR PROFITABILITY AND RESULTS
OF OPERATIONS. The markets for our ophthalmic surgical device and eye
care products are intensely competitive and are subject to rapid and
significant technological change. Many of our competitors have
substantially more resources and a greater marketing scale than we do.
If we are unable to develop and produce or market our products to
effectively compete against our competitors, our operating results
will materially suffer.
    
    OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION.
Compliance with these regulations is expensive and time-consuming;
and, if we fail to comply, we may be subject to fines, injunctions and
penalties that could harm our business. Failure to obtain regulatory
clearance or approvals of new products we develop, any limitations
imposed by regulatory agencies on the use of new products or the costs
of obtaining regulatory clearance or approvals could have a material
adverse effect on our business, financial condition and results of
operations. In addition, if we or our subcontractors fail to comply
with applicable manufacturing regulations, our business could be
harmed. Health care initiatives and other cost-containment pressures
could cause us to sell our products at lower prices, resulting in less
revenue to us.
    
    WE COULD EXPERIENCE LOSSES DUE TO PRODUCT LIABILITY CLAIMS OR PRODUCT
RECALLS OR CORRECTIONS. We have in the past been, and continue to be,
subject to recalls and product liability claims. We have assumed the
defense of any litigation involving claims related to our business and
will indemnify Allergan for all related losses, costs and expenses. As
part of our risk management policy, we have obtained third-party
product liability insurance coverage. Product liability claims
against us may exceed the coverage limits of our insurance policies or
cause us to record a self-insured loss. Even if any product liability
loss is covered by an insurance policy, these policies have
substantial retentions or deductibles that provide that we will not
receive insurance proceeds until the losses incurred exceed the amount
of those retentions or deductibles. To the extent that any losses are
below these retentions or deductibles, we will be responsible for
paying these losses. A product liability claim in excess of applicable
insurance could have a material adverse effect on our reputation,
business, financial position and results of operations. 22




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Advanced Medical Optics, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE QUARTER ENDED JUNE 25, 2004 CERTAIN FACTORS AND TRENDS AFFECTING AMO AND ITS BUSINESSES (Continued)  
    
    WE CONDUCT A SIGNIFICANT AMOUNT OF OUR SALES AND OPERATIONS OUTSIDE OF
THE UNITED STATES, WHICH SUBJECTS US TO ADDITIONAL BUSINESS RISKS,
SUCH AS BUSINESS INTERRUPTION, INCREASED COSTS AND CURRENCY EXCHANGE
RATE FLUCTUATIONS, WHICH MAY CAUSE OUR PROFITABILITY TO DECLINE. Our
three manufacturing sites are located outside the continental United
States, in Añasco, Puerto Rico, Madrid, Spain, and Hangzhou, China. As
a result of the Acquisition, we also have manufacturing and R&D
facilities in Groningen, Netherlands, Uppsala, Sweden and Bangalore,
India. In the first half of 2004 and in fiscal year 2003, we derived
approximately $238.6 million, or 75% of our net sales, and $448.0
million, or 74% of our total net sales, respectively, from sales of
our products outside of the United States. In addition, in the first
half of 2004 and in fiscal year 2003 we derived approximately 25% and
27%, respectively, of our net sales in Japan. Our international
operations are, and will continue to be, subject to a number of risks
and potential costs, including: unexpected changes in foreign
regulatory requirements; differing local product preferences and
product requirements; fluctuations in foreign currency exchange rates;
political and economic instability; changes in foreign medical
reimbursement and coverage policies and programs; diminished
protection of intellectual property in some countries outside of the
United States; trade protection measures and import or export
licensing requirements; difficulty in staffing and managing foreign
operations; differing labor regulations; and potentially negative
consequences from changes in foreign tax laws. Any of these factors
may, individually or as a group, have a material adverse effect on our
business and results of operations. In addition, we are particularly
susceptible to the occurrence of any of these risks in Japan due to
our high concentration of sales in Japan.
    
    IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR
BUSINESS AND PROSPECTS MAY BE HARMED. Our ability to compete
effectively is dependent upon the proprietary nature of the designs,
processes, technologies and materials owned, used by or licensed to
us. Although we attempt to protect our proprietary property,
technologies and processes through a combination of patent law, trade
secrets and non-disclosure agreements, these may be insufficient.
    
    WE ARE SUBJECT TO INTELLECTUAL PROPERTY LITIGATION AND INFRINGEMENT
CLAIMS, WHICH COULD CAUSE US TO INCUR SIGNIFICANT EXPENSES OR PREVENT
US FROM SELLING OUR PRODUCTS. There is a substantial amount of
litigation over patent and other intellectual property rights in the
eye care industry, and in the ophthalmic surgical device and contact
lens care markets particularly. The fact that we have patents issued
to us for our products does not mean that we will always be able to
successfully defend our patents and proprietary rights against
challenges or claims of infringement by our competitors.
    
    OUR MANUFACTURING CAPACITY MAY NOT BE ADEQUATE TO MEET THE DEMANDS OF
OUR BUSINESS. We manufacture our products or contract with third
parties to manufacture our products. Our products are manufactured in
quantities sufficient to satisfy our current level of product sales.
If we experience increases in sales, we will need to increase our
production beyond our present manufacturing capacity. Additionally, in
June 2005 our manufacturing agreement with Allergan will terminate and
we will be required to increase our manufacturing capacities or to
contract with additional parties to manufacture our products. The
process to transfer manufacturing of our products to new facilities is
lengthy and requires regulatory approval. We cannot assure you that we
can successfully increase our capacity on a profitable basis, complete
the regulatory approval process in a timely manner, or contract with
additional parties on terms acceptable to us, if at all. Until we have
transitioned all products manufactured by Allergan, our supply of eye
care products is largely dependent on Allergan as a sole source
supplier for our European and North American markets. Any prolonged
disruption in the operation of our manufacturing facilities or those
of our third party manufacturers could materially harm our business. 23




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##### Table of Contents



Advanced Medical Optics, Inc. 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We routinely monitor our risks associated with fluctuations in currency
exchange rates and interest rates. We address these risks through controlled
risk management that may include the use of derivative financial instruments to
economically hedge or reduce these exposures. We do not expect to enter into
financial instruments for trading or speculative purposes. Given the inherent limitations of forecasting and the anticipatory nature of
the exposures intended to be hedged, there can be no assurance that such
programs will offset more than a portion of the adverse financial impact
resulting from unfavorable movements in either interest or foreign exchange
rates. In addition, the timing of the accounting for recognition of gains and
losses related to mark-to-market instruments for any given period may not
coincide with the timing of gains and losses related to the underlying economic
exposures and, therefore, may adversely affect our operating results and
financial position. To ensure the adequacy and effectiveness of our interest rate and foreign
exchange hedge positions, we continually monitor, from an accounting and
economic perspective, our interest rate swap positions and foreign exchange
forward and option positions, when applicable, both on a stand-alone basis and
in conjunction with our underlying interest rate and foreign currency
exposures. Interest rate risk.Our debt is comprised solely of domestic borrowings and is
comprised of $381.4 million of fixed rate debt and $250.0 million of variable
rate debt. In 2003 and 2002, the Company realized the value of certain interest rate swaps
qualifying as fair value hedges. The unamortized gain was recorded as an
adjustment to the carrying amount of the Senior Subordinated Notes as a premium
and was being amortized over the remaining life of the Senior Subordinated
Notes. As a result of the purchase of the Senior Subordinated Notes, the
remaining unamortized gain on the interest rate swaps was fully recognized. At June 25, 2004, the Company did not have any interest rate swap agreements
outstanding. If interest rates were to increase or decrease by 1.0% for the year, annual
interest expense would increase or decrease by approximately $2.5 million. The table below presents information about our debt obligations as of June 25,
2004: June 25, 2004Maturing in
    
    
    
    
    
    
    
    
    
    
    
    
    
    FairMarket2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Total
    
    Value(in thousands, except interest rates)LIABILITIESDebt Obligations:Fixed Rate
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    350,000
    
    
    
    350,000
    
    
    
    350,000Weighted Average Interest Rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.50
    %
    
    
    2.50
    %Fixed Rate
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    31,438
    
    
    
    31,438
    
    
    
    42,068Weighted Average Interest Rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.50
    %
    
    
    3.50
    %Variable Rate
    
    $
    1,250
    
    
    $
    2,500
    
    
    $
    2,500
    
    
    $
    2,500
    
    
    $
    121,250
    
    
    
    120,000
    
    
    
    250,000
    
    
    
    250,000Weighted Average Interest Rate
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %Total Debt Obligations
    
    $
    1,250
    
    
    $
    2,500
    
    
    $
    2,500
    
    
    $
    2,500
    
    
    $
    121,250
    
    
    
    501,438
    
    
    
    631,438
    
    
    
    642,068Weighted Average Interest Rate
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    3.83
    %
    
    
    2.88
    %
    
    
    3.08
    %
 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 dollar relative to major currencies worldwide.
Accordingly, changes in exchange rates, and in particular a strengthening of
the U.S. dollar, may negatively affect our consolidated net sales and gross
profit as expressed in U.S. dollars. 24




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##### Table of Contents



Advanced Medical Optics, Inc. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (continued) We may enter into foreign exchange option and forward contracts to reduce
earnings and cash flow volatility associated with foreign exchange rate changes
to allow management to focus its attention on its core business operations.
Accordingly, we enter into contracts which change in value as foreign exchange
rates change to economically offset the effect of changes in value of foreign
currency assets and liabilities, commitments and anticipated foreign currency
denominated sales and operating expenses. We enter into foreign exchange
option contracts in amounts between minimum and maximum anticipated foreign
exchange exposures, generally for periods not to exceed one year. We use foreign currency option contracts, which provide for the sale of foreign
currencies to offset foreign currency exposures expected to arise in the normal
course of our business. While these instruments are subject to fluctuations in
value, such fluctuations are anticipated to offset changes in the value of the
underlying exposures. The principal currencies subject to this process are the
Japanese yen and the euro. The foreign currency options are entered into to reduce the volatility of
earnings generated in currencies other than the U.S. dollar, primarily earnings
denominated in Japanese yen and the euro. As a result, the changes in the fair
value of foreign currency option contracts are recorded through earnings as
Unrealized (gain) loss on derivative instruments while any realized gains or
losses on expired contracts are recorded through earnings as Other, net in
the accompanying unaudited condensed consolidated statements of operations.
The premium cost of purchased foreign exchange option contracts are recorded in
Other current assets and amortized over the life of the options. At June 25, 2004, the aggregate notional amounts and strike amounts of our
outstanding yen and euro currency option contracts were $38.8 million and
121.04 and $26.2 million and 1.09, respectively. The notional principal amount
provides one measure of the transaction volume outstanding as of the end of the
period, and does not represent the amount of our exposure to market loss. The
fair value of these foreign currency option contracts was $0.1 million at June
25, 2004. The estimate of fair value is based on applicable and commonly used
prevailing financial market information as of June 25, 2004. The amounts
ultimately realized upon settlement of these financial instruments, together
with the gains and losses on the underlying exposures, will depend on actual
market conditions during the remaining life of the instruments. NEW ACCOUNTING STANDARDS In March 2004, the Emerging Issues Task Force finalized it consensus on EITF
Issue 03-6, Participating Securities and the Two-Class Method Under FASB
Statement No. 128, Earnings Per Share (EITF 03-6). EITF 03-6 clarifies what
constitutes a participating security and requires the use of the two-class
method for computing basic earnings per share when participating convertible
securities exist. EITF 03-6 is effective for fiscal periods beginning after
March 31, 2004. Adoption of EITF 03-6 is not expected to have a material
effect on our consolidated financial statements. At its June 2004 meeting, the Emerging Issues Task Force (EITF) reached a
tentative conclusion on EITF Issue No. 04-8, The Effect of Contingently
Convertible Debt on Diluted Earnings Per Share (EITF 04-8). EITF No. 04-8
addresses when the dilutive effect of contingently convertible debt with a
market price trigger should be included in diluted earnings per share (EPS).
The EITF reached a tentative conclusion that the market price contingency
should be ignored and that these securities should be treated as noncontingent,
convertible securities and always included in the diluted EPS computation. The
tentative conclusion would result in these securities being included in diluted
EPS using either the if-converted method or the net share settlement method,
depending on the conversion terms of the security. The EITF agreed that the
tentative conclusion would be applied by retroactively restating previously
reported EPS. Conclusions are expected to be finalized at the September 2004
EITF meeting and EITF No. 04-8 is expected to be effective for fiscal periods
ending after December 15, 2004, with restatement of previously reported EPS
required. If the tentative conclusion is adopted by the EITF, we expect to
irrevocably elect to cash settle the principal amount of the 21/2%
convertible senior subordinated notes and thus, the dilutive effect of these
notes would be calculated under the net share settlement method. If the
tentative conclusion is adopted by the EITF, it would not have a material
impact on reported EPS for the three and six months ended June 27, 2003 as the
contingent convertible securities outstanding as of June 27, 2003 were issued
on June 24, 2003. The tentative conclusion would not have an
impact on reported EPS for the year ended December 31, 2003, as
the impact of the contingent convertible securities is antidilutive. The tentative conclusion would not have an impact on
reported EPS for the three and six months ended June 25, 2004 as we have
reported a net loss for both periods. 25




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##### Table of Contents



Advanced Medical Optics, Inc. 
 Item 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be disclosed in our periodic
reports filed with the SEC. In addition, we evaluated our internal control over
financial reporting and there have been no changes during the most recent
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting. 
 PART II - OTHER INFORMATION 
 Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity
Securities (c) Recent Sales of Unregistered Securities 2.50% Convertible Notes On June 22, 2004, we consummated a
private offering of $350 million aggregate principal amount of 2.50%
convertible senior subordinated notes due 2024 (the 2.50% convertible notes)
at an offering price equal to 100% of the principal amount. We received
approximately $340.5 million in net proceeds from the offering after deducting
underwriters fees and offering expenses. The 2.50% convertible notes were
issued by us to certain institutional investors (the initial purchasers) in
reliance on the exemption from registration afforded by Section 4(2) of the
Securities Act of 1933 (the Act) and were subsequently resold by the initial
purchasers in the United States in reliance on Rule 144A under the Act only to
qualified institutional buyers (as defined in Rule 144A) in transactions
exempt from the registration requirements of the Act. Each $1,000 principal amount of the 2.50% convertible notes will be
convertible at each holders option into 19.9045 shares of our common stock
(which represents an initial conversion price of approximately $50.24 per
share), subject to adjustment as provided in the indenture governing the notes,
only during specified periods under the following circumstances: (i) during any
fiscal quarter commencing after September 24, 2004 if the closing sale price of
our common stock for at least 20 trading days in the 30 consecutive
trading-day period ending on the last trading day of the preceding fiscal
quarter exceeds 130% of the conversion price in effect on that 30th trading
day; (ii) subject to certain exceptions, during the five business days after
any five consecutive trading day period in which the trading price per $1,000
principal amount of 2.50% convertible notes for each day of such measurement
period was less than 95% of the product of the closing sale price of
our
common stock and the conversion rate then in effect; (iii) if after the earlier
of (A) the date the 2.50% convertible notes are rated by both Standard & Poors
Ratings Services and Moodys Investor Services and (B) thirty business days
from the date the 2.50% convertible notes are issued, during any period in
which the credit rating assigned to the notes by either agency falls below a
specified level, or if either of these rating agencies does not rate or no
longer rates the notes, or if either of these rating agencies suspends or
withdraws the rating assigned to the notes; (iv) we have called the 2.50%
convertible notes for redemption; (v) a fundamental change has occurred; or
(vi) during prescribed periods upon the occurrence of certain corporate events.
Upon conversion, we will have the right to deliver, in lieu of shares
of our common stock, cash or a combination of cash and shares of our common
stock. We
also will have the right on or prior to the 26th trading day preceding the
maturity date to irrevocably elect to satisfy our conversion obligation with
respect to the principal amount of the 2.50% convertible notes to be converted
in cash, with any remaining amount to be satisfied in shares of our common
stock. Common Stock During the quarter ended
June 25, 2004, we issued an aggregate of
5,786,775 shares of common stock and paid approximately $4.6 million in cash to
a limited number of holders of our 31⁄2% Convertible Senior Subordinated
Notes due 2023 (the 31⁄2% convertible notes) in exchange for approximately
$108.6 million aggregate principal amount of the 31⁄2% convertible notes in
privately negotiated transactions (the Private Exchanges). The issuance of
the shares of common stock was made in reliance on Section 3(a)(9) of the Act. 26




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##### Table of Contents



Advanced Medical Optics, Inc. PART II - OTHER INFORMATION (continued) (d) Purchases of Equity Securities by the Issuer The following sets forth the amount of 31⁄2% convertible notes acquired by
AMO in the Private Exchanges during the quarter ended June 25, 2004: ISSUER PURCHASES OF EQUITY SECURITIES (d) Maximum Number(c) Total Number of
    
    (or ApproximateShares or Units
    
    Dollar Value) ofPurchased as Part
    
    Shares or Units(a) Total Number of
    
    (b) Average Price
    
    of Publicly
    
    that May Yet BeShares or Units
    
    Paid per Share or
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Purchased
    
    Unit
    
    Programs
    
    Plans or ProgramsMarch 27, 2004 
April 30, 2004
    
    
    0
    
    
    
    
    
    
    May 1, 2004  May
28, 2004
    
    
    0
    
    
    
    
    
    
    May 29, 2004  June
25, 2004
    
    $
    108,562,000
    
    
    48.69 shares of
common stock and
$42.19 in cash for
each $1,000
principal amount of
notes and accrued
and unpaid interest
thereon
    
    None
    
    None
 
 Item 4: Submission of Matters to a Vote of Security Holders The annual meeting of stockholders of the registrant was held on May 20, 2004
at which two directors were re-elected to serve on the Board of Directors for a
three-year term until the annual meeting of stockholders to be held in 2007.
One other matter was voted on, namely, approval of an amendment to the Advanced
Medical Optics, Inc. 2002 Incentive Compensation Plan. This was approved by
the stockholders. A summary of the voting follows: Directors
    
    For
    
    Withheld
    
    Broker Non-VotesWilliam R. Grant.
    
    
    24,163,825
    
    
    
    2,704,381
    
    
    
    0Christopher G. Chavez
    
    
    24,769,601
    
    
    
    2,098,605
    
    
    
    0
 Other Matters
    
    For
    
    Against
    
    Abstain
    
    Broker Non-VotesAdvanced Medical Optics, Inc.
2002 Incentive Compensation Amendment
    
    
    16,174,779
    
    
    
    5,103,019
    
    
    
    274,751
    
    
    
    5,315,657
 27




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##### Table of Contents



Advanced Medical Optics, Inc. PART II - OTHER INFORMATION (continued) 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits  10.1
    
    Amendment No. 3 to June 17, 2003 Amended and Restated Credit Agreement, dated as of May 28, 2004.10.2
    
    Amendment No. 4 to June 17, 2003 Amended and Restated Credit Agreement, dated as of June 15, 2004.10.3
    
    Second Amended and Restated Credit Agreement dated as of June 25, 2004, among Advanced Medical
Optics, Inc., as the Borrower, certain of its subsidiaries, as the Guarantors, Lehman Commercial
Paper Inc., as Syndication Agent, General Electric Capital Corporation and Bank One, NA, as
Co-Documentation Agents, Bank of America, N.A., as Administrative Agent, Swing Line Lender, Foreign
Currency Fronting Lender and L/C Issuer, and the other lenders party thereto, and Banc of America
Securities LLC and Lehman Brothers Inc., as Joint Lead Arrangers and Joint Book Runners.31.1
    
    Certification of James V. Mazzo pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.312
    
    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.  (b)
    
    Reports on Form 8-K  On April 22, 2004, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
furnishing the Companys press release regarding financial results for the quarter ended March 26, 2004.On April 22, 2004, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
attaching a press release reporting that the Company had entered into a definitive agreement to acquire from Pfizer
Inc. Pfizers surgical ophthalmology business.On June 4, 2004, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
attaching the Companys press release announcing that it expects to exchange approximately $83 million aggregate
principal amount of its 3 1/2% convertible senior subordinated notes due 2023 for approximately 4.4 million
shares of its common stock and approximately $4.6 million in cash.On June 15, 2004, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
attaching the Companys press release announcing that it intended to offer, in a private offering, $275 million of
convertible senior subordinated notes due 2024, plus an additional $55 million of notes subject to the initial
purchasers option.On June 16, 2004 the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
regarding certain supplemental information concerning AMO and its business and its acquisition of the ophthalmic
surgical business of Pfizer Inc.On June 17, 2004, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
attaching the Companys press release announcing that it had priced a private offering of $300 million of 21/2%
convertible senior subordinated notes due 2024, plus up to an additional $50 million of notes subject to the
initial purchasers option.On June 22, 2004, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K
attaching the Companys press release announcing the results of its tender offer and consent solicitation for any
and all of the $70 million aggregate outstanding principal amount of 91/4% Senior Subordinated Notes due 2010. 28




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##### Table of Contents



Advanced Medical Optics, Inc. PART II - OTHER INFORMATION (continued)  On June 23, 2004, the Company filed with the Securities and Exchange Commission
a Current Report on Form 8-K reporting the Company had consummated its
previously announced private offering of $350 million aggregate principal
amount of 21⁄2% convertible senior subordinated notes due 2024, including $50
million issued pursuant to the initial purchasers option.On June 23, 2004, the Company filed with the Securities and Exchange Commission
a Current Report on Form 8-K attaching the Companys press release announcing
the determination of pricing in connection with the previously announced tender
offer and consent solicitation for its 9 1/4% Senior Subordinated Notes due
2010. 29




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##### Table of Contents



SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Date: August 2, 2004
    
    ADVANCED MEDICAL OPTICS, INC./s/ RICHARD A. MEIERRichard A. Meier
(Principal Financial Officer)/s/ ROBERT F. GALLAGHERRobert F. Gallagher
(Principal Accounting Officer)
 30




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##### Table of Contents



EXHIBIT INDEX ExhibitNo.
    
    Description10.1
    
    
    Amendment No. 3 to June 17, 2003 Amended and Restated Credit Agreement, dated as of May 28, 2004.10.2
    
    
    Amendment No. 4 to June 17, 2003 Amended and Restated Credit Agreement, dated as of June 15, 2004.10.3
    
    
    Second Amended and Restated Credit Agreement dated as of June 25, 2004, among Advanced Medical
Optics, Inc., as the Borrower, certain of its subsidiaries, as the Guarantors, Lehman Commercial
Paper Inc., as Syndication Agent, General Electric Capital Corporation and Bank One, NA, as
Co-Documentation Agents, Bank of America, N.A., as Administrative Agent, Swing Line Lender, Foreign
Currency Fronting Lender and L/C Issuer, and the other lenders party thereto, and Banc of America
Securities LLC and Lehman Brothers Inc., as Joint Lead Arrangers and Joint Book Runners.31.1
    
    
    Certification of James V. Mazzo pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.312
    
    
    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.