**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterly period endedMarch 31, 2006**

 

**or**

 

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

 

**For the transition period from                    **to                    .**

 

**COMMISSION FILE NUMBER 001-31257**

 

**ADVANCEDMEDICAL OPTICS, INC.**

(Exactname of registrant as specified in its charter)

 

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

 

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

 

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

 

Yes  ý    No  o

 

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

 

Large accelerated filer ý            Acceleratedfiler o            Non-acceleratedfiler o

 

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

 

Yes  o    No  ý

 

As of May 2, 2006,there were 68,682,141 shares of common stock outstanding.

 

 

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ADVANCED MEDICAL OPTICS,INC.

FORM 10-Q FOR THE QUARTERENDED MARCH 31, 2006

 

INDEX

 
| ** **                          | **Page**                                                                           |
|-------------------------------------|------------------------------------------------------------------------------------|
| PART I - FINANCIAL INFORMATION |                                                                               |
|                                |                                                                               |   |
|                                | Item 1.                                                                       | Financial Statements |   |
|                                |                                                                               |   |   |
|                                |                                                                               | (A). | Unaudited Consolidated Statements of Operations - Three Months Ended  March 31, 2006 and March 25, 2005 | 3 |
|                                |                                                                               |   |   |
|                                |                                                                               | (B). | Unaudited Consolidated Balance Sheets — March 31, 2006 and December  31, 2005 | 4 |
|                                |                                                                               |   |   |
|                                |                                                                               | (C). | Unaudited Consolidated Statements of Cash Flows - Three Months Ended  March 31, 2006 and March 25, 2005 | 5 |
|                                |                                                                               |   |   |
|                                |                                                                               | (D). | Notes to Unaudited Consolidated Financial Statements | 6 |
|                                |                                                                               |   |   |
|                                | Item 2.                                                                            | Management’s Discussion and Analysis of Financial Condition and  Results of Operations | 18 |
|                                |                                                                               |   |   |
|                                |                                                                               | Certain Factors and Trends Affecting AMO  and Its Businesses | 25 |
|                                |                                                                               |   |   |
|                                | Item 3.                                                                            | Quantitative and Qualitative Disclosures  About Market Risk | 26 |
|                                |                                                                               |   |   |
|                                | Item 4.                                                                            | Controls and Procedures | 28 |
|                                |                                                                               |   |   |
| PART II - OTHER INFORMATION    | 29                                                                                 |
|                                |                                                                               |   |   |
|                                | Item 1.                                                                            | Legal Proceedings | 29 |
|                                |                                                                               |   |   |
|                                | Item 1A.                                                                           | Risk Factors | 30 |
|                                |                                                                               |   |   |
|                                | Item 6.                                                                            | Exhibits | 30 |
|                                |                                                                               |   |   |
|                                | Note: Items 2, 3, 4 and 5 of Part II are omitted because they are not  applicable. |   |
|                                |                                                                               |
| Signatures                          | 31                                                                                 |
|                                |                                                                               |
| Exhibit Index                       | 32                                                                                 |
| EXHIBIT 31.1                        |                                                                               |
| EXHIBIT 31.2                        |                                                                               |
| EXHIBIT 32.1                        |                                                                               |
|                                     |                                                                                    |  |  |  |  |

 

2

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** **

**PART I - FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

AdvancedMedical Optics, Inc.

Unaudited Consolidated Statements of Operations

(Inthousands, except per share data)

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005** | ** ** |
| Net sales                                         |       | $                                | 238,228    |   | $ | 192,519 |   |
| Cost of sales  (Note 3)                           |       | 86,835                           |       | 70,439 |   |
| Gross profit                                      |       | 151,393                          |       | 122,080 |   |
| Selling, general  and administrative              |       | 95,439                           |       | 83,815 |   |
| Research and  development                         |       | 16,973                           |       | 12,352 |   |
| Business  repositioning (Note 3)                  |       | 29,254                           |       | — |   |
| Operating income                                  |       | 9,727                            |       | 25,913 |   |
| Non-operating  expense (income):                  |       |                             |       |   |   |
| Interest expense                                  |       | 4,507                            |       | 5,827 |   |
| Unrealized loss  (gain) on derivative instruments |       | 438                              |       | (531 | ) |
| Other, net                                        |       | 1,004                            |       | (331 | ) |
|                                              |       | 5,949                            |       | 4,965 |   |
| Earnings before  income taxes                     |       | 3,778                            |       | 20,948 |   |
| Provision for  income taxes                       |       | 1,149                            |       | 7,122 |   |
| Net earnings                                      |       | $                                | 2,629      |   | $ | 13,826 |   |
| Net earnings per  share:                          |       |                             |       |   |   |
| Basic                                             |       | $                                | 0.04       |   | $ | 0.37 |   |
| Diluted                                           |       | $                                | 0.04       |   | $ | 0.35 |   |
| Weighted average  number of shares outstanding:   |       |                             |       |   |   |
| Basic                                             |       | 68,228                           |       | 37,119 |   |
| Diluted                                           |       | 71,026                           |       | 39,815 |   |

 

See accompanying notes tounaudited consolidated financial statements.

 

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Advanced Medical Optics, Inc. 

Unaudited Consolidated BalanceSheets 

(In thousands,except share data) 

 
| ** **                                                                                             | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                 |       |                     |       |                        |       |
| Current assets                                                                                         |       |                     |       |                        |       |
| Cash and  equivalents                                                                                  |       | $                        | 37,607     |                        | $          | 40,826 |   |
| Trade  receivables, net                                                                                |       | 224,702                  |       | 238,761                     |       |
| Inventories                                                                                            |       | 108,271                  |       | 104,820                     |       |
| Deferred income  taxes                                                                                 |       | 66,665                   |       | 66,476                      |       |
| Other current  assets                                                                                  |       | 23,638                   |       | 28,122                      |       |
| Income taxes                                                                                           |       | 7,885                    |       | —                      |       |
| Total current  assets                                                                                  |       | 468,768                  |       | 479,005                     |       |
| Property, plant  and equipment, net                                                                    |       | 118,192                  |       | 115,725                     |       |
| Deferred income  taxes                                                                                 |       | 12,721                   |       | 12,626                      |       |
| Other assets                                                                                           |       | 51,576                   |       | 52,473                      |       |
| Intangibles  assets, net                                                                               |       | 488,079                  |       | 495,609                     |       |
| Goodwill                                                                                               |       | 826,682                  |       | 825,284                     |       |
| Total assets                                                                                           |       | $                        | 1,966,018  |                        | $          | 1,980,722 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                              |       |                     |       |                        |       |
| Current  liabilities                                                                                   |       |                     |       |                        |       |
| Short-term  borrowings                                                                                 |       | $                        | 45,000     |                        | $          | 60,000 |   |
| Accounts payable                                                                                       |       | 55,708                   |       | 64,045                      |       |
| Accrued  compensation                                                                                  |       | 25,377                   |       | 43,406                      |       |
| Other accrued  expenses                                                                                |       | 84,041                   |       | 90,666                      |       |
| Income taxes                                                                                           |       | —                   |       | 1,434                       |       |
| Deferred income  taxes                                                                                 |       | 739                      |       | 565                         |       |
| Total current  liabilities                                                                             |       | 210,865                  |       | 260,116                     |       |
| Long-term debt                                                                                         |       | 500,000                  |       | 500,000                     |       |
| Deferred income  taxes                                                                                 |       | 181,373                  |       | 182,179                     |       |
| Other  liabilities                                                                                     |       | 29,559                   |       | 28,365                      |       |
| Commitments and  contingencies                                                                         |       |                     |       |                        |       |
| Stockholders’  equity                                                                             |       |                     |       |                        |       |
| Preferred stock,  $.01 par value; 5,000,000 shares authorized; none issued                             |       | —                   |       | —                      |       |
| Common stock,  $.01 par value; 240,000,000 shares authorized; 68,598,537 and 67,832,010  shares issued |       | 686                      |       | 678                         |       |
| Additional  paid-in capital                                                                            |       | 1,610,805                |       | 1,586,864                   |       |
| Accumulated  deficit                                                                                   |       | (554,957                 | )          | (557,586                    | )          |
| Accumulated  other comprehensive loss                                                                  |       | (12,289                  | )          | (19,870                     | )          |
| Less treasury  stock, at cost (1,397 shares)                                                           |       | (24                      | )          | (24                         | )          |
| Total  stockholders’ equity                                                                       |       | 1,044,221                |       | 1,010,062                   |       |
| Total  liabilities and stockholders’ equity                                                       |       | $                        | 1,966,018  |                        | $          | 1,980,722 |   |

 

See accompanying notes tounaudited consolidated financial statements.

 

4

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AdvancedMedical Optics, Inc.

Unaudited Consolidated Statements of Cash Flows

(Inthousands)

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                       | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005** | ** ** |
| Cash flows from  operating activities:                                           |       |                             |       |   |   |
| Net earnings                                                                     |       | $                                | 2,629      |   | $ | 13,826 |   |
| Adjustments to  reconcile net earnings to net cash used in operating activities: |       |                             |       |   |   |
| Amortization of  debt issuance costs                                             |       | 839                              |       | 940 |   |
| Depreciation and  amortization                                                   |       | 16,482                           |       | 7,960 |   |
| Loss on  investments and assets                                                  |       | 2,539                            |       | 126 |   |
| Tax benefit from  issuance of stock under stock plans                            |       | —                           |       | 1,128 |   |
| Excess tax  benefits from stock-based compensation                               |       | (5,229                           | )          | — |   |
| Unrealized loss  (gain) on derivatives                                           |       | 438                              |       | (531 | ) |
| Expense of  compensation plan                                                    |       | 5,071                            |       | 66 |   |
| Changes in  assets and liabilities:                                              |       |                             |       |   |   |
| Trade  receivables, net                                                          |       | 15,594                           |       | (14,853 | ) |
| Inventories                                                                      |       | (3,331                           | )          | (14,210 | ) |
| Other current  assets                                                            |       | 2,882                            |       | (1,389 | ) |
| Accounts payable                                                                 |       | (8,260                           | )          | (1,385 | ) |
| Accrued expenses  and other liabilities                                          |       | (24,595                          | )          | (13,002 | ) |
| Income taxes                                                                     |       | (3,626                           | )          | 3,194 |   |
| Other  non-current assets and liabilities                                        |       | (2,219                           | )          | (429 | ) |
| Net cash used in  operating activities                                           |       | (786                             | )          | (18,559 | ) |
| Cash flows from investing  activities:                                           |       |                             |       |   |   |
| Additions to  property, plant and equipment                                      |       | (6,575                           | )          | (2,279 | ) |
| Proceeds from  sale of property, plant and equipment                             |       | —                           |       | 54 |   |
| Additions to  capitalized internal-use software                                  |       | —                           |       | (5,152 | ) |
| Additions to  demonstration and bundled equipment                                |       | (2,406                           | )          | (3,109 | ) |
| Net cash used in  investing activities                                           |       | (8,981                           | )          | (10,486 | ) |
| Cash flows from  financing activities:                                           |       |                             |       |   |   |
| Short-term  borrowings (repayments), net                                         |       | (15,000                          | )          | 7,500 |   |
| Financing  related costs                                                         |       | —                           |       | (2,421 | ) |
| Proceeds from  issuance of common stock                                          |       | 15,918                           |       | 1,344 |   |
| Excess tax  benefits from stock-based compensation                               |       | 5,229                            |       | — |   |
| Net cash  provided by financing activities                                       |       | 6,147                            |       | 6,423 |   |
| Effect of  exchange rates on cash and equivalents                                |       | 401                              |       | (975 | ) |
| Net decrease in  cash and equivalents                                            |       | (3,219                           | )          | (23,597 | ) |
| Cash and  equivalents at beginning of period                                     |       | 40,826                           |       | 49,455 |   |
| Cash and  equivalents at end of period                                           |       | $                                | 37,607     |   | $ | 25,858 |   |

 

See accompanying notes tounaudited consolidated financial statements.

 

5

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Advanced Medical Optics,Inc. 

Notesto Unaudited Consolidated Financial Statements 

 

**Note 1: Basis of Presentation**

 

In the opinion of management, the accompanyingunaudited consolidated financial statements contain all adjustments necessary(consisting only of normal, recurring adjustments) for a fair statement of thefinancial information contained therein. These statements do not includeall disclosures required by accounting principles generally accepted in theUnited States of America for annual financial statements and should be read inconjunction with the audited consolidated financial statements of AdvancedMedical Optics, Inc. (the “Company” or “AMO”) for the year endedDecember 31, 2005. The results of operations for the three monthsended March 31, 2006 are not necessarily indicative of the results to beexpected for the year ending December 31, 2006.

 

All material intercompany balances have beeneliminated.

 

***Stock-Based Compensation***

 

AMO has an Incentive Compensation Plan (“ICP”)that provides for the granting of stock options, restricted stock andrestricted stock units to directors, employees and consultants. The Company hastwo Employee Stock Purchase Plans (“ESPP”) for United States and internationalemployees, respectively, which allow employees to purchase AMO common stock. Atotal of 5 million shares of common stock have been authorized for issuanceunder the ICP. Effective January 1, 2006, the Company adopted Statement ofFinancial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”) asdiscussed below.

 

*Adoption of SFAS 123R*

 

Prior to January 1, 2006, the Company’s stock-based compensationplans were accounted for under the recognition and measurement provisions ofAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB 25”) and the disclosure only provisions of SFAS 123. Accordingly,no compensation expense was recorded for stock options granted with exerciseprices greater than or equal to the fair value of the underlying common stockat the option grant date. The fair value, as determined on the date of grant, ofrestricted stock awards was recognized as compensation expense ratably over therespective vesting period. Additionally, the ESPP qualified as non-compensatoryplans under APB 25; therefore, no compensation cost was recorded in relation tothe discount offered to employees for purchases made under the ESPP. Inaddition, the Company’s unearned compensation balance was reduced in connectionwith the adoption of SFAS 123R, which requires the fair value of employee stockoptions to be recognized as expense and an increase to additional paid-incapital.

 

On January 1, 2006, the Company adopted the fairvalue recognition provisions of SFAS 123R, requiring recognition of expensesequivalent to the fair value of stock-based compensation awards. TheCompany has elected to use the modified prospective application transitionmethod as permitted by SFAS 123R and therefore has not restated the financialresults reported in prior periods. Under this transition method,stock-based compensation expense for the three months ended March 31, 2006includes compensation expense for all stock-based compensation awards grantedprior to, but not yet vested as of January 1, 2006, based on the grant datefair value estimated in accordance with the original provisions of SFAS 123, asadjusted for estimated forfeitures. Compensation expense for allstock-based compensation awards granted subsequent to January 1, 2006 are basedon the grant-date fair value estimated in accordance with the provisions ofSFAS 123R.

 

Additionally, under SFAS 123R, the ESPP isconsidered a compensatory plan and requires recognition of compensation expensefor purchases of common stock made under the ESPP. The Company recognizescompensation expense for stock option and ESPP awards on a straight-line basisover the vesting period. Compensation expense related to the restricted stock andrestricted stock units is recognized over the requisite service periods of theawards, consistent with the Company’s practices under SFAS 123 prior to January1, 2006.

 

6

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*Stock-Based Compensation Expense*

 

Total stock-based compensation expenseincluded in the unaudited consolidated statements of operations for the threemonths ended March 31, 2006 (in thousands) was as follows:

 
| **Stock-Based Compensation  Expense Reported In:** | ** ** | **Stock-Based  Awards (1)** | ** ** | **Restricted  Stock** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **                       | ** ** | ** **            | ** ** | ** ** |       |
| Cost of sales                                                     |       | $                                | 540        |                  | $          | —     |       | $ | 540 |   |
| Operating Expenses  -                                             |       |                             |       |                  |       |       |       |
| Research and  development                                         |       | 480                              |       | —                |       | 480        |       |
| Selling, general  and administrative                              |       | 3,476                            |       | 575                   |       | 4,051      |       |
|                                                              |       | 3,956                            |       | 575                   |       | 4,531      |       |
| Pre-tax expense                                                   |       | 4,496                            |       | 575                   |       | 5,071      |       |
| Income tax  benefit                                               |       | 1,498                            |       | 185                   |       | 1,683      |       |
| After-tax  expense                                                |       | $                                | 2,998      |                  | $          | 390        |       | $ | 3,388 |   |
|                                                                   |            |                                  |            |                       |            |            |            |  |  |  |  |  |  |

 

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(1)           Includes compensationexpense for stock options, ESPP and performance-based awards now being expensedunder SFAS 123R.

 

At March 31, 2006, total pretax compensation costsrelated to unvested stock-based awards granted to employees under the Company’sstock option plan and ESPP which are not yet recognized were approximately$19.3 million, net of estimated forfeitures. These costs are expected to berecognized over a weighted-average period of 2.5 years.

 

Net cash proceeds from the exercise of stock optionswere $15.9 million and $1.3 million for the three month periods ended March 31,2006 and March 25, 2005, respectively. In accordance with SFAS 123R, the cashflows resulting from excess tax benefits (tax benefits related to the excess ofproceeds from employee’s exercises of stock options over the stock-basedcompensation cost recognized for those options) are classified as financingcash flows in the Company’s  unauditedconsolidated statement of cash flows. During the three months ended March31, 2006, the Company recorded $5.2 million of excess tax benefits as afinancing cash inflow. Prior to the adoption of SFAS 123R, excess tax benefitsof $1.1 million during the three months ended March 25, 2005 were classified asan operating cash inflow.

 

The Company issues new shares to satisfy optionexercises.

 

*Determining Fair Value*

 

Valuation Method- The Company estimates the fair value of stock options granted and ESPPpurchase rights using the Black-Scholes option-pricing model and a singleoption award approach.

 

ExpectedTerm - The expected term represents the period the Company’s stock-basedawards are expected to be outstanding and was determined based on historicalexperience with similar awards, giving consideration to the contractual termsof the stock-based awards, vesting schedules and expectations of futureemployee behavior as influenced by changes to the terms of its stock-basedawards.

 

ExpectedVolatility*-*The computationof expected volatility is based on a combination of historical and market-basedimplied volatility.  Implied volatilityis based on publicly traded options of the Company’s common stock with a termof one year or greater.

 

Risk-FreeInterest Rate - The risk-free interest rate used in the Black-Scholes valuationmethod is based on the implied yield currently available on U.S. Treasurysecurities with an equivalent remaining term.

 

ExpectedDividend - No dividends are expected to be paid.

 

Estimated Forfeitures - When estimatingforfeitures, the Company considers voluntary termination behavior as well asanalysis of actual option forfeitures.

 

There were no stock options or ESPP grants duringthe three months ended March 31, 2006; accordingly, there was no determinationof fair value during this period.

 

*Stock Options*

 

Stock options granted to employees aregenerally exercisable at a price equal to the fair market value of the commonstock on the date of the grant and vest at a rate of 25% per year beginningtwelve months after the date of grant. Grants under these plans expireten years from the date of grant.

 

7

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

 
| ** **                                          | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term in Years** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding at  December 31, 2005                   |       | 8,858                      |       | $                                          | 22.79      |                                                                   |       |                                |       |   |
| Granted                                             |       | —                     |       | —                                     |       |                                                                   |       |                                |       |
| Exercised                                           |       | (760                       | )          | 20.88                                      |       |                                                                   |       |                                |       |
| Forfeitures and  cancellations                      |       | (42                        | )          | 31.75                                      |       |                                                                   |       |                                |       |
| Expirations                                         |       | (3                         | )          | 31.68                                      |       |                                                                   |       |                                |       |
| Outstanding at  March 31, 2006                      |       | 8,053                      |       | $                                          | 22.92      |                                                                   | 6.5        |                                | $          | 190,988 |   |
| Vested and  expected to vest at March 31, 2006 |       | 7,928                      |       | $                                          | 22.82      |                                                                   | 6.4        |                                | $          | 188,893 |   |
| Exercisable at  March 31, 2006                      |       | 5,171                      |       | $                                          | 19.07      |                                                                   | 5.4        |                                | $          | 142,549 |   |

 

The aggregate intrinsic value in the table aboverepresents the difference between the exercise price of the underlying awardsand the quoted price of our common stock for the options that were in-the-moneyat March 31, 2006. During the three months ended March 31, 2006 and March25, 2005, the aggregate intrinsic value of options exercised under the Company’sstock option plans was $17.5 million and $3.2 million, respectively, determinedas of the date of option exercise.

 

*Employee Stock Purchase Plans*

 

Under the ESPP, eligible employees may authorizepayroll deductions of up to 10% of their regular base salary to purchase sharesat the lower of 85% of the closing price of the Company’s common stock on thefirst or last day of the six-month purchase period. In the first quarterof 2006, no shares of common stock were issued under the ESPP as the currentpurchase period ends April 30, 2006. As of March 31, 2006 employee withholdingsunder the ESPP aggregated $2.0 million.

 

*Restricted Stock*

 

Restricted stock awards are granted at a price equalto the fair market value of the common stock on the date of the grant, subjectto forfeiture if employment terminates prior to the release of restrictions,which is generally three years from the date of grant. During thisrestriction period, ownership of the shares cannot be transferred. Restrictedstock has the same cash dividend and voting rights as other common stock and isconsidered to be currently issued and outstanding. The cost of the awards,determined to be the fair market value of the shares at the date of grant, isexpensed ratably over the period the restrictions lapse.

 

The following table summarizes the restricted stockaward activity for the three months ended March 31, 2006 (in thousands, exceptper share amounts):

 
| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|---------------------------------------|------------|----------------------------|------------|---------------------------------------------------------|------------|
| Nonvested stock  at December 31, 2005 |       | 101                        |       | $                                                       | 38.79      |   |
| Granted                               |       | 4                          |       | $                                                       | 43.22      |   |
| Vested                                |       | —                     |       | —                                                  |       |
| Forfeited                             |       | (1                         | )          | $                                                       | 38.38      |   |
| Nonvested stock  at March 31, 2006    |       | 104                        |       | $                                                       | 38.97      |   |

* *

*Performance-Based Awards*

 

In February 2006, the Company’s Board of Directorsapproved a 2006 performance award program under the Company’s incentivecompensation plan (the “2006 Program”), which provides the opportunity forcertain executives to earn long-term incentive compensation awards based uponspecified measures. The potential maximum aggregate award value for

 

8

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the 2006 program is $2.7million. The award determination will be based upon the Total ShareholderReturn (“TSR”) (the increase or decrease in the Company’s common stock price)over a two year period beginning January 1, 2005 compared to a peer groupcomposed of various entities within the bio-technology and medical deviceindustries. Awards will have been determined to be earned if the Company’s TSRis in excess of the 50th percentile of the peer group. When the TSR equals the75th percentile of the peer group, the maximum amount will have been earned. Awardsare to be settled in a number of restricted stock shares or units equal to thevalue of the award amount divided by the fair market value of the Company’scommon stock on the date the performance criteria is deemed to have been met. Therestricted stock shares or units will have the same terms and conditions as othershares or units issued under the Company’s ICP. The estimated fair value of the2006 Program was $0.8 million as of March 31, 2006 using a lattice-basedvaluation model. Compensation expense is being recognized over a four yearperiod from the program approval date through the end of the expected vestingperiod of the restricted stock awards. The associated compensation expenseduring the three months ended March 31, 2006 was less than $0.1 million.

 

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

 

The following table illustrates the effect on net earningsand net earnings per share as if we had applied the fair value recognitionprovisions of SFAS 123 to stock-based compensation during the three-monthperiod ended March 25, 2005 (in thousands, except per share amounts):

 
| ** **                                                                             | ** ** | **Three Months Ended  March 25, 2005** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Net earnings, as  reported                                                             |       | $                                                          | 13,826     |   |
| Stock-based  compensation expense included in reported net earnings, net of tax        |       | 44                                                         |       |
| Stock-based  compensation expense determined under fair value based method, net of tax |       | (2,297                                                     | )          |
| Pro forma net  earnings                                                                |       | $                                                          | 11,573     |   |
| Earnings per  share as reported:                                                       |       |                                                       |       |
| Basic                                                                                  |       | $                                                          | 0.37       |   |
| Diluted                                                                                |       | $                                                          | 0.35       |   |
| Pro forma  earnings per share:                                                         |       |                                                       |       |
| Basic                                                                                  |       | $                                                          | 0.31       |   |
| Diluted                                                                                |       | $                                                          | 0.29       |   |

 

There were no stock options or ESPP grants duringthe three months ended March 25, 2005, accordingly, there was no determinationof fair value during this period.

 

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

 

On May 27, 2005, pursuant to the Agreement andPlan of Merger (Merger Agreement), dated as of November 9, 2004, asamended, by and among AMO, Vault Merger Corporation, a wholly owned subsidiaryof AMO, and VISX, AMO completed its acquisition of VISX, for totalconsideration of approximately $1.38 billion, consisting of approximately27.8 million shares of AMO common stock, the fair value of VISX stockoptions converted to AMO stock options and approximately $176.2 million in cash(VISX Acquisition). VISX products include the *VISXSTAR*Excimer Laser System, the *VISXWaveScan*System and *VISX*treatment cards. As a result of the VISX Acquisition, the Company became theleader in the design and development of proprietary technologies and systemsfor laser vision correction of refractive vision disorders.

 

The VISX Acquisition has been accounted for as apurchase business combination. Under the purchase method of accounting, theassets acquired and liabilities assumed are recorded at the date of acquisitionat their respective fair values.

 

9

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The following unaudited pro forma informationassumes the VISX Acquisition occurred on January 1, 2005. These unauditedpro forma results have been prepared for informational purposes only and do notpurport to represent what the results of operations would have been had theVISX Acquisition occurred as of the date indicated, nor of future results ofoperations. The unaudited pro forma results for the three months endedMarch 25, 2005 are as follows (in thousands, except per share data):

 
| ** **               | ** ** | **Three Months Ended  March 25, 2005** | ** ** |
|--------------------------|------------|------------------------------------------------------------|------------|
| Net sales:               |       |                                                       |       |
| Cataract/Implant         |       | $                                                          | 116,730    |   |
| Laser Vision  Correction |       | 53,281                                                     |       |
| Eye Care                 |       | 73,847                                                     |       |
|                     |       | $                                                          | 243,858    |   |
| Net earnings             |       | 23,141                                                     | (1)        |
| Earnings per  share:     |       |                                                       |       |
| Basic (2)                |       | $                                                          | 0.36       |   |
| Diluted (3)              |       | $                                                          | 0.34       |   |

 

----

(1)                   The unaudited pro forma information for thethree months ended March 25, 2005 includes a $7.0 million increase inamortization related to management’s estimate of the fair value of intangibleassets acquired as the result of the VISX Acquisition and a $2.8 million increasein interest expense resulting from additional borrowings incurred to fund thecash portion of the VISX Acquisition and related costs and amortization ofdeferred financing costs.

 

(2)                   The weighted average number of sharesoutstanding used for the computation of basic earnings per share for the threemonths ended March 25, 2005 reflects the issuance of 27.8 millionshares of AMO’s common stock to VISX stockholders.

 

(3)                   The weighted average number of sharesoutstanding used for the computation of diluted earnings per share for thethree months ended March 25, 2005 reflects the issuance of 27.8 millionshares of AMO’s common stock to VISX shareholders and the dilutive effect ofapproximately 1.1 million shares of VISX options exchanged for AMO stock options.

 

**Note 3:  Product Rationalizationand Business Repositioning**

 

On October 31, 2005, theCompany’s Board of Directors approved a product rationalization andrepositioning plan covering the discontinuation of non-strategic cataractsurgical and eye care products and the elimination or redeployment of resourcesthat support these product lines. The plan also includes organizational changesand potential reductions in force in manufacturing, sales and marketingassociated with these product lines, as well as organizational changes inresearch and development and other corporate functions designed to align theorganization with our strategy and strategic business unit organization.

 

The plan further callsfor increasing the Company’s investment in key growth opportunities,specifically the Company’s refractive implant product line and internationallaser vision correction business, and accelerating the implementation ofproductivity initiatives.

 

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

 

Business repositioningcharges and related activity in the accrual balances during the three monthsended March 31, 2006 were as follows (in thousands):

 
| **Business Repositioning Costs Reported In:** | ** ** | **Balance at  December 31,  2005** | ** ** | **Costs  Incurred** | ** ** | **Cash  Payments** | ** ** | **Non-Cash  Adjustments** | ** ** | **Balance at  March 31,  2006** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                   | ** ** | ** **          | ** ** | ** **         | ** ** | ** **                | ** ** | ** **                                | ** ** |
| Cost of sales -  Inventory and manufacturing charges              |       | $                                            | —     |                | $          | 3,178              |       | $                         | —     |                                      | $          | (3,178 | ) | $ | — |   |
| Operating  Expenses -                                             |       |                                         |       |                |       |               |       |                      |       |                                      |       |
| Severance,  relocation and related costs                          |       | 8,779                                        |       | 1,622               |       | (8,352             | )          | —                    |       | 2,049                                     |       |
| Asset  write-downs                                                |       | —                                       |       | 1,410               |       | —             |       | (1,410                    | )          | —                                    |       |
| Contractual  obligations                                          |       | 2,641                                        |       | —              |       | (141               | )          | —                    |       | 2,500                                     |       |
| Productivity  initiatives and brand repositioning costs           |       | 883                                          |       | 26,222              |       | (18,298            | )          | —                    |       | 8,807                                     |       |
|                                                              |       | 12,303                                       |       | 29,254              |       | (26,791            | )          | (1,410                    | )          | 13,356                                    |       |
|                                                              |       | $                                            | 12,303     |                | $          | 32,432             |       | $                         | (26,791    | )                                         | $          | (4,588 | ) | $ | 13,356 |   |

 

10

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Productivity initiativesand brand repositioning costs resulted from the Company’s investment in keygrowth opportunities, specifically the Company’s refractive implant productline and international laser vision correction business, and the implementationof productivity improvements in manufacturing operations, distribution,customer service and corporate functions. Severance, relocation and relatedcosts were incurred for worldwide workforce reductions due to the Company’sdiscontinuing certain non-core products and infrastructure and processimprovements associated with the Company’s productivity initiatives. Themajority of these costs during the current period occurred in Europe. Assetwrite-downs resulted from the impairment and disposal of long-lived assets fromthe reduction in expected future cash flows from certain discontinued non-coreproducts and relocation of certain facilities. The fair values of impairedassets were based on probability weighted expected cash flows as determined inaccordance with Statement of Financial Accounting Standards No. 144, “Accountingfor the Impairment or Disposal of Long-lived Assets”.

 

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

 

***Inventories***:

 
| **(In thousands)**                                                                                 | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Finished goods,  including consignment inventory of $13,885 and $11,890 in 2006 and 2005,  respectively |       | $                        | 71,258     |                        | $          | 66,492 |   |
| Work in process                                                                                         |       | 12,696                   |       | 13,148                      |       |
| Raw materials                                                                                           |       | 24,317                   |       | 25,180                      |       |
|                                                                                                    |       | $                        | 108,271    |                        | $          | 104,820 |   |

*** ***

***Intangible assets, net***

 
| ** **                       | ** ** | ** **                    | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|-------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| **(In thousands)**          | ** ** | **Useful  Life (Years)** | ** ** | **Gross  Amount**            | ** ** | **Accumulated  Amortization**   | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortizable  Intangible Assets:  |       |                          |       |                         |       |                            |       |   |   |   |   |
| Licensing                        |       | 3 – 5                    |       | $                            | 4,590      |                            | $          | (4,145 | ) | $ | 4,590 |   | $ | (4,113 | ) |
| Technology  rights               |       | 8 – 19                   |       | 350,557                      |       | (34,625                         | )          | 348,379 |   | (26,128 | ) |
| Trademarks                       |       | 13.5                          |       | 14,950                       |       | (2,315                          | )          | 14,689 |   | (1,995 | ) |
| Customer  relationships          |       | 5                             |       | 22,400                       |       | (3,733                          | )          | 22,400 |   | (2,613 | ) |
|                             |       |                          |       | 392,497                      |       | (44,818                         | )          | 390,058 |   | (34,849 | ) |
| Nonamortizable  Tradename (VISX) |       | Indefinite                    |       | 140,400                      |       | —                          |       | 140,400 |   | — |   |
|                             |       |                          |       | $                            | 532,897    |                            | $          | (44,818 | ) | $ | 530,458 |   | $ | (34,849 | ) |

 

The amortizableintangible assets balance increased due to the impact of foreign currencyfluctuation. Amortization expense was $9.7 million and $2.9 million for thethree months ended March 31, 2006 and March 25, 2005, respectively, and isrecorded in selling, general and administrative in the accompanying unauditedconsolidated statements of operations. Amortization expense is expected to be $38.7million in 2006, $37.8 million in 2007 and 2008, $37.6 million in 2009 and$35.0 million in 2010. Actual amortization expense may vary due to the impactof foreign currency fluctuations.

 

***Goodwill***

 
| **(In thousands)**  | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Goodwill:                |       |                     |       |                        |       |
| Eye Care                 |       | $                        | 28,808     |                        | $          | 28,817 |   |
| Cataract/Implant         |       | 321,571                  |       | 317,451                     |       |
| Laser Vision  Correction |       | 476,303                  |       | 479,016                     |       |
|                     |       | $                        | 826,682    |                        | $          | 825,284 |   |

 

Effective January 1, 2006, the Company’s reportablesegments are represented by three business units: Cataract/Implant, LaserVision Correction and Eye Care (See Note 9, “Business Segment Information”). Thechange in goodwill during thethree months ended March 31, 2006 is due to adjustment of Laser Vision Correctiongoodwill of $2.7 million as a result of excess tax benefits from exercise ofconverted VISX stock options that were fully vested at the acquisition date andthe impact of foreign currency fluctuations.

 

11

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**Note 5: Debt**

 

At March 31, 2006, an aggregate principalamount of $350.0 million of 21⁄2 % convertible senior subordinated notes dueJuly 15, 2024 (“Notes”), an aggregate principal amount of $150.0 millionof 1.375% convertible senior subordinated notes due July 1, 2025 (“SeniorSubordinated Notes”) and a balance of $45.0 million under the senior revolvingcredit facility were outstanding. The Notes and the Senior Subordinated Notesmay be converted, at the option of the holders, on or prior to the finalmaturity date under certain circumstances, none of which had occurred as ofMarch 31, 2006. Upon conversion of the Notes and the Senior SubordinatedNotes, the Company will satisfy in cash the conversion obligation with respectto the principal amount of the Notes and the Senior Subordinated Notes, withany remaining amount of the conversion obligation to be satisfied in shares ofcommon stock. As a result of this election, the Company also is required tosatisfy in cash its obligations to repurchase any Notes and the SeniorSubordinated Notes that holders may put to the Company on January 15,2010, July 15, 2014 and July 15, 2019 for the Notes and on July1, 2011, July 1, 2016 and July 1, 2021 for the Senior Subordinated Notes.

 

At March 31, 2006, approximately $8.9 millionof the senior revolving credit facility was reserved to support letters ofcredit issued on the Company’s behalf for normal operating purposes and theCompany has approximately $246.1 million undrawn and available revolving loancommitments.

 

Borrowings under the revolving credit facility, ifany, bear interest at current market rates plus a margin based upon the Company’sratio of debt to EBITDA, as defined. The incremental interest margin onborrowings under the revolving credit facility decreases as the Company’s ratioof debt to EBITDA decreases to specified levels. Under the senior creditfacility, certain transactions may trigger mandatory prepayment of borrowings,if any. Such transactions may include equity or debt offerings, certain assetsales and extraordinary receipts. The Company pays a quarterly fee (1.95% perannum at March 31, 2006) on the average balance of outstanding letters ofcredit and a quarterly commitment fee (0.375% per annum at March 31, 2006) onthe average unused portion of the revolving credit facility.

 

The senior credit facility provides that the Companywill maintain certain financial and operating covenants which include, amongother provisions, maintaining specific leverage and coverage ratios. Certaincovenants under the senior credit facility may limit the incurrence of additionalindebtedness. The senior credit facility prohibits dividend payments. TheCompany was in compliance with these covenants at March 31, 2006. Thesenior credit facility is collateralized by a first priority perfected lien on,and pledge of, all of the combined Company’s present and future property andassets (subject to certain exclusions), 100% of the stock of the domesticsubsidiaries, 66% of the stock of foreign subsidiaries and all present andfuture intercompany debts.

 

As of March 31, 2006, the aggregate maturitiesof total long-term debts of $500.0 million are due after 2010. Revolving loanborrowings of $45.0 million have been classified as current liabilities in theaccompanying unaudited  consolidatedbalance sheets.

 

**Note 6: Related Party Transactions**

 

As of March 31, 2006, an interest-freerelocation loan of $0.5 million, collateralized by real property, wasoutstanding from the chief executive officer. The principal amount of the loanis payable upon the earlier to occur of (a) 60 days following the chiefexecutive officer’s termination of employment; (b) the date of the sale orother transfer of the property or (c) July 3, 2007. This relocation loan isevidenced by a promissory note dated July 3, 2002, prior to the adoption of theSarbanes-Oxley Act of 2002.

 

**Note 7: Earnings Per Share**

 

Basic earnings per share is calculated by dividingnet earnings by the weighted average number of common shares outstanding duringthe period. Diluted earnings per share is calculated by adjusting net earningsand the weighted average outstanding shares, assuming the conversion of allpotentially dilutive convertible securities, stock options and stock purchaseplan awards.

 

Statement of Financial Accounting StandardsNo. 128, “Earnings per Share,” requires that stock options, nonvestedshares and similar equity instruments granted by the Company be treated aspotential common shares outstanding in computing diluted earnings per share.Diluted shares outstanding include the dilutive effect of in-the-money options whichis calculated based on the average market price of the Company’s common stockfor each fiscal period using the treasury stock method. Under the treasurystock method, the amount the employee must pay for exercising stock options,the amount of

 

12

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compensation cost for futureservice that the Company has not yet recognized, and the amount of tax benefitsthat would be recorded in additional paid-in capital when the award becomesdeductible are assumed to be used to repurchase shares.

 

During the three months ended March 31, 2006, therewere no antidilutive stock options. During the three months ended March 25,2005, there were 0.3 million shares of stock options that were not included inthe computation of diluted earnings per share because the exercise price wasgreater than the average market price of the Company’s common stock during thatperiod, thereby resulting in an antidilutive effect.

 

The table below presents a reconciliation from basicearnings per share to diluted earnings per share (in thousands, except pershare data):

 
| ** **                                                                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                    | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005** | ** ** |
| Net earnings –  basic                                                                    |       | $                                | 2,629      |   | $ | 13,826 |   |
| Tax-effected  interest expense attributable to 31⁄2% convertible senior subordinated notes |       | —                           |       | 55 |   |
| Net earnings –  diluted                                                                  |       | $                                | 2,629      |   | $ | 13,881 |   |
|                                                                                          |       |                             |       |   |   |
| Basic shares  outstanding                                                                     |       | 68,228                           |       | 37,119 |   |
| Dilutive effect  of 31⁄2% convertible senior subordinated notes                            |       | —                           |       | 419 |   |
| Dilutive effect  of stock options and stock purchase plan awards                              |       | 2,798                            |       | 2,277 |   |
| Diluted shares  outstanding                                                                   |       | 71,026                           |       | 39,815 |   |
|                                                                                          |       |                             |       |   |   |
| Basic earnings  per share                                                                     |       | $                                | 0.04       |   | $ | 0.37 |   |
| Diluted earnings  per share                                                                   |       | $                                | 0.04       |   | $ | 0.35 |   |

 

The Company will settle in cash the principal amountof the 2 1⁄2% convertible senior subordinated notes and the 1.375% convertiblesenior subordinated notes. In addition, there were no potentially dilutedcommon shares associated with the 2 1⁄2% convertible senior subordinatednotes and the 1.375% convertible senior subordinated notes as the Company’s averagestock price during the current quarter was less than the conversion prices ofthe notes.

 

**Note 8: Other Comprehensive Income (Loss)**

 

The following table summarizes components ofcomprehensive income (loss) (in thousands):

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **March 31, 2006**     | ** ** | **March 25, 2005** | ** ** |
| ** **                                | ** ** | **Before-tax  amount**           | ** ** | **Income  tax** | ** ** | **Net-of-tax  amount** | ** ** | **Before-tax  amount** | ** ** | **Income****Tax** | ** ** | **Net-of-tax  amount** | ** ** |
|                                      |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized gain  on derivatives           |       | $                                | —     |   | $ | — |   | $ | — |   | $ | 1,017 |   | $ | (343 | ) | $ | 674 |   |
| Foreign currency  translation adjustments |       | 7,581                            |       | — |   | 7,581 |   | (32,588 | ) | — |   | (32,588 | ) |
| Net earnings                              |       |                             |       |   |   | 2,629 |   |   |   |   |   | 13,826 |   |
| Total  comprehensive income (loss)        |       |                             |       |   |   | $ | 10,210 |   |   |   |   |   | $ | (18,088 | ) |
|                                           |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 9: Business Segment Information**

 

The operating segments are segments for whichseparate financial information is available and upon which operating resultsare evaluated on a timely basis to assess performance and to allocateresources.

 

Through 2005, the Company’s reportable segments werebased on geographic regions which comprised the Americas, which included Northand South America, Europe/Africa/Middle East, Japan and Asia Pacific, whichexcluded Japan and included New Zealand and Australia.

 

Effective January 1, 2006, the Company’s reportablesegments are represented by three business units: Cataract/Implant, LaserVision Correction and Eye Care. Sales and operating results for the priorperiod have been

 

13

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conformed to reflect thecurrent period presentation of reportable segments. The cataract/implantsegment markets four key products required for cataract surgery – foldableintraocular lenses, or IOLs, implantation systems, phacoemulsification systemsand viscoelastics. The laser vision correction segment markets laser systems,diagnostic devices, treatment cards and microkeratomes for use in laser eyesurgery. The eye care segment provides a full range of contact lens careproducts for use with most types of contact lenses. These products includesingle-bottle, multi-purpose cleaning and disinfecting solutions, hydrogenperoxide-based disinfecting solutions, daily cleaners, enzymatic cleaners, contactlens rewetting drops and, in Europe and Asia, contact lenses.

 

The Company evaluates segment performance based onoperating income (loss) excluding certain costs such as business repositioningcosts, non-recurring acquisition related costs and stock-based compensationexpense. Research and development costs, manufacturing variances, inventoryprovision/repricing costs and supply chain costs are managed on the globalbasis and are considered corporate costs. The Company presents the measurewhich management believes is determined in accordance with the measurementprinciples consistent with those used in measuring the corresponding amounts inthe consolidated financial statements. Because operating segments are generallydefined by the products they design and sell, they do not make sales to eachother. Depreciation and amortization related to the manufacturing of goods isincluded in gross profit. Due to the Company’s methodology for cost build up atthe product level it is impractical to determine the amount of depreciation andamortization included in each segment’s gross profit. The Company does notdiscretely allocate assets to its operating segments, nor does the Company’schief operating decision maker evaluate operating segments using discrete assetinformation.

 

**Business Segments**

 
| ** **                | ** ** | **Net Sales**               | ** ** | **Operating Income**        | ** ** |
|---------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
| **(In thousands)**   | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005**         | ** ** | **March 31,  2006** | ** ** | **March 25,  2005** | ** ** |
| Operating  segments:      |       |                             |       |                             |       |   |   |   |   |
| Cataract/Implant          |       | $                                | 120,444    |                             | $          | 116,730 |   | $ | 58,582 |   | $ | 51,973 |   |
| Laser Vision  Correction  |       | 60,955                           |       | 1,942                            |       | 40,788 |   | (265 | ) |
| Eye Care                  |       | 56,829                           |       | 73,847                           |       | 21,759 |   | 27,515 |   |
| Total segments            |       | 238,228                          |       | 192,519                          |       | 121,129 |   | 79,223 |   |
| Manufacturing  operations |       | —                           |       | —                           |       | (2,994 | ) | (713 | ) |
| Research and  development |       | —                           |       | —                           |       | (16,973 | ) | (12,352 | ) |
| Business  repositioning   |       | —                           |       | —                           |       | (32,432 | ) | — |   |
| Global supply  chain      |       | —                           |       | —                           |       | (13,812 | ) | (11,513 | ) |
| General  corporate        |       | —                           |       | —                           |       | (45,191 | ) | (28,732 | ) |
| Total                     |       | $                                | 238,228    |                             | $          | 192,519 |   | $ | 9,727 |   | $ | 25,913 |   |

 

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**Geographic Area Information**

 
| ** **                               | ** ** | **Net Sales**               | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended** | ** ** |
| **(In thousands)**                  | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005** | ** ** |
| United States:                           |       |                             |       |   |   |
| Cataract/Implant                         |       | $                                | 38,098     |   | $ | 32,317 |   |
| Laser Vision  Correction                 |       | 49,917                           |       | 1,457 |   |
| Eye Care                                 |       | 14,215                           |       | 13,262 |   |
| Total United  States                     |       | 102,230                          |       | 47,036 |   |
| Americas,  excluding United States:      |       |                             |       |   |   |
| Cataract/Implant                         |       | 8,412                            |       | 5,821 |   |
| Laser Vision  Correction                 |       | 2,110                            |       | 135 |   |
| Eye Care                                 |       | 2,685                            |       | 2,631 |   |
| Total Americas,  excluding United States |       | 13,207                           |       | 8,587 |   |
| Europe/Africa/Middle  East:              |       |                             |       |   |   |
| Cataract/Implant                         |       | 46,385                           |       | 50,002 |   |
| Laser Vision  Correction                 |       | 4,099                            |       | 252 |   |
| Eye Care                                 |       | 15,905                           |       | 23,713 |   |
| Total  Europe/Africa/Middle East         |       | 66,389                           |       | 73,967 |   |
| Japan:                                   |       |                             |       |   |   |
| Cataract/Implant                         |       | 14,958                           |       | 16,922 |   |
| Laser Vision  Correction                 |       | 816                              |       | 2 |   |
| Eye Care                                 |       | 16,129                           |       | 23,574 |   |
| Total Japan                              |       | 31,903                           |       | 40,498 |   |
| Asia Pacific:                            |       |                             |       |   |   |
| Cataract/Implant                         |       | 12,591                           |       | 11,668 |   |
| Laser Vision  Correction                 |       | 4,013                            |       | 96 |   |
| Eye Care                                 |       | 7,895                            |       | 10,667 |   |
| Total Asia  Pacific                      |       | 24,499                           |       | 22,431 |   |
| Total                                    |       | $                                | 238,228    |   | $ | 192,519 |   |

 

The United States information is presentedseparately as it is the Company’s headquarters country, and U.S. salesrepresented 42.9% and 24.4% of total net sales for the three months endedMarch 31, 2006 and March 25, 2005, respectively. Additionally, salesin Japan represented 13.4% and 21.0% of total net sales for the three monthsended March 31, 2006 and March 25, 2005, respectively. No othercountry, or single customer, generated over 10% of total net sales in theperiods presented.

 

**Note 10: Commitments and Contingencies**

 

On December 3, 2003, the Company filed a complaintin the U.S. District Court for the District of Delaware against Alcon, Inc. andAlcon Laboratories, Inc. for infringement of U.S. Patent Nos. 5,700,240(Barwick Patent) and 6,059,765 (Cole/Sutton Patent). The Company alleged thatAlcon’s “Infiniti” and “Series 20000 Legacy” phacoemulsification machinesinfringed the patents. The Company sought damages and a permanent injunction.The trial of this matter began on April 25, 2005 and concluded onMay 6, 2005. The jury found both of AMO’s patents to be valid andinfringed by Alcon, and awarded AMO $94.8 million in damages. The jury furtherfound that Alcon had willfully infringed both of AMO’s patents. OnJune 21, 2005, a bench trial was conducted by the Court to determine ifthe Company had sufficiently marked the Company’s equipment with the patentnumbers and to determine if Alcon had waived any argument relating thereto. OnDecember 16, 2005, the Court ruled that the Company did not sufficiently markits patents and reduced the jury award from $94.8 million to $71.3 million. However,the Court further ruled that Alcon had willfully infringed the Company’spatents and trebled the $71.3 million damage award to $213.9 million. The Courtalso granted the Company’s request for a permanent injunction on both patents. However,the Court stayed the injunction on the Cole/Sutton Patent pending appeal. OnJanuary 20, 2006, judgment was entered including additional damages from March2005 through December 31, 2005 and interest based thereon, resulting in final damagesof $234.5 million. The Court further ordered Alcon to pay all of the Company’sattorney fees and costs, estimated at $4 million. Alcon filed an appeal of thefinal judgment on January 20, 2006. AMO cross appealed on February 3, 2006. OnFebruary, 3, 2006, Alcon filed a motion for a new trial with the U.S. DistrictCourt for the District

 

15

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of Delaware. AMO opposedthis motion on February 24, 2006. The Court of Appeal has deactivated theappeal until the motion for new trial has been decided by the U.S. DistrictCourt.

 

On January 28, 2004, Alcon Manufacturing, Ltd.filed a complaint against AMO and Allergan, Inc. in the U.S. District Court forthe Northern District of Texas, Fort Worth Division, for infringement of U.S.Patent Nos. 4,832,685 and 4,935,005 (Haines Patents). Alcon alleged that AMO’s *Prestige* and *Sovereign* phacoemulsification systems and replacementcassettes infringe the patents. Alcon is seeking damages and a permanentinjunction. At Alcon’s request, the case has been stayed in Texas while theparties seek re-examination by the U.S. Patent and Trademark Office on theHaines Patents in light of another patent the Company alleges invalidates theHaines Patents.

 

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

 

On August 8, 2005, Alcon Manufacturing, Ltd andAlcon Laboratories, Inc. filed a complaint against the Company in the U.S.District Court for the Northern District of Texas, Fort Worth Division, forinfringement of U.S. Patent Nos. 4,921,477 (relating to a surgical irrigationand aspiration system with a dampening device); 5,199,943 (relating to anultrasonic surgical handpiece); 5,188,589 (relating to a textured sleeve in aphacoemulsification handpiece); and 5,876,016 and 6,109,572 (both of whichrelate to an apparatus and method to elevate an infusion source in anophthalmic surgical procedure). Alcon alleged that the Company infringed thesepatents in the course of selling the Company’s phacoemulsification systems oraccessories, and is seeking damages and a permanent injunction. The trialin this matter is scheduled to begin on August 14, 2006.

 

On September 13, 2005, Alcon Manufacturing,Ltd. filed a complaint against the Company in the U.S. District Court for theNorthern District of Texas, Dallas Division, for infringement of U.S PatentNo. 5,273,056 relating to the use of a combination of viscoelastics duringophthalmic surgery. Alcon alleged that the Company infringed, contributorilyinfringed, and/or induced infringement of this patent, and is seeking damagesand a permanent injunction.

 

The Company does not believe, based on currentknowledge, that any of the foregoing legal proceedings or claims are likely tohave a material adverse effect on its financial position, results of operationsor cash flows. However, the Company may incur substantial expenses in defendingagainst third party claims. In the event of a determination adverse to theCompany or its subsidiaries, the Company may incur substantial monetaryliability, and be required to change its business practices. Either of thesecould have a material adverse effect on the Company’s financial position,results of operations or cash flows.

 

While the Company is involved from time to time inlitigation arising in the ordinary course of business, including productliability claims, the Company is not currently aware of any other actionsagainst AMO or Allergan relating to the optical medical device business thatthe Company believes would have a material adverse effect on the Company’sbusiness, financial condition, results of operations or cash flows. The Companymay be subject to future litigation and infringement claims, which could causethe Company to incur significant expenses or prevent the Company from sellingits products. The Company operates in an industry susceptible to significantproduct liability claims. Product liability claims may be asserted against AMOin the future arising out of events not known to the Company at the presenttime. Under the terms of the contribution and distribution agreement affectingthe spin-off, Allergan agreed to assume responsibility for, and to indemnify AMOagainst, all current and future litigation relating to its retained businessesand the Company agreed to assume responsibility for, and to indemnify Allerganagainst, all current and future litigation related to the optical medicaldevice business.

 

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**Note 11: Pension Benefit Plans**

 

The Company sponsors defined benefit pension plansin Japan and in certain European countries. Components of net periodic benefitcost under these plans were (in thousands):

 
| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005** | ** ** |
| Service cost                        |       | $                                | 569        |   | $ | 492 |   |
| Interest cost                       |       | 137                              |       | 128 |   |
| Expected return  on plan assets     |       | (61                              | )          | (56 | ) |
| Amortization of  prior service cost |       | 15                               |       | 17 |   |
| Amortization of  net actuarial loss |       | 10                               |       | — |   |
| Net periodic  benefit cost          |       | $                                | 670        |   | $ | 581 |   |

 

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ADVANCED MEDICAL OPTICS,INC.

 

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

**Ended March31, 2006**

 

*The following discussion andanalysis presents the factors that had a material effect on AMO’s cash flowsand results of operations during the three months ended March 31, 2006,and the Company’s financial position at that date. Except for the historical informationcontained herein, the following discussion contains forward-looking statementsthat involve risk and uncertainties. Our actual results may differsignificantly 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 TrendsAffecting AMO and Its Businesses.” The following discussion should be read inconjunction with the 2005 Form 10-K and the unaudited consolidated financialstatements 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. Effective January 1,2006, our reportable segments are represented by our three business units:  Cataract/Implant, Laser Vision Correction andEye Care. Previously, our reportable segments were based on geographic regionswhich comprised the Americas, which included North and South America,Europe/Africa/Middle East, Japan and Asia Pacific, which excluded Japan andincluded New Zealand and Australia. Sales and operating results for the priorperiod have been conformed to reflect the current period presentation of reportablesegments. Our Cataract/Implant business focuses on the four key productsrequired for cataract surgery – foldable intraocular lenses, or IOLs,implantation systems, phacoemulsification systems and viscoelastics. Our LaserVision Correction business markets laser systems, diagnostic devices, treatmentcards and microkeratomes for use in laser eye surgery. Our Eye Care businessprovides a full range of contact lens care products for use with most types ofcontact lenses. These products include single-bottle, multi-purpose cleaningand disinfecting solutions, hydrogen peroxide-based disinfecting solutions,daily cleaners, enzymatic cleaners, contact lens rewetting drops, and in Europeand Asia, contact lenses. Our products are sold in approximately 60 countriesand we have direct operations in over 20 countries.

 

*Product Rationalization and Repositioning Plan*

 

On October31, 2005, our Board of Directors approved a product rationalization andrepositioning plan covering the discontinuation of non-strategic cataract surgical and eye care products and theelimination or redeployment of resources that support these product lines. Theplan also includes organizational changes and potential reductions in force inmanufacturing, sales and marketing associated with these product lines, as wellas organizational changes in research and development and other corporatefunctions designed to align the organization with our strategy and strategicbusiness unit organization. A substantial portion of expected operating costbenefits will result from reductions in force and associated annualizedemployee compensation of approximately $14.2 million.

 

The planfurther calls for increasing our investment in key growth opportunities,specifically our refractive implant product line and international laser visioncorrection business, and accelerating the implementation of productivityinitiatives.

 

In the first quarter of2006, we incurred $32.4 million of pre-tax charges, which included $3.2 millionfor inventory and manufacturing related charges included in cost of sales and$29.2 million included in operating expenses. Charges included in operatingexpenses comprised productivity and brand repositioning costs of $26.2 million,severance, relocation and other one-time termination benefits of $1.6 millionand  asset write-downs of $1.4 million. Inconnection with the approved product rationalization and repositioning plan, weexpect to incur an additional $3 million to $5 million of charges in the secondquarter of 2006, which willbe recognized as the services are performed and actions occur. The totalcharges that are expected to be incurred are within the range previouslyannounced.

 

Following an analysis of our IOL manufacturingcapabilities, we have decided to consolidate certain operations. In addition, wehave decided to further expand the scope of our eye care rationalizationinitiatives in order to maximize manufacturing capacity and seize growthopportunities. Together, these separate actions are expected to result in additionalcharges of approximately $20 million to $25 million in the remainder of 2006.The estimated total charges for the expanded product rationalization andrepositioning plan will be approximately $90 million to $105 million.

 

Certainforeign jurisdictions have laws and regulations which require consultations andnegotiations with works councils, labor organizations and local authorities.The outcome of these discussions will determine, in part, the restructuring

 

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stepsto be implemented and the associated cost. Therefore, the final costs of thebusiness repositioning plan may be significantly different from our initialestimates.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES 

 

The preparation of consolidated financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesof America requires management to make judgments, assumptions and estimatesthat affect the amounts reported. Certain of these significant accountingpolicies are considered to be critical accounting policies, as defined below.

 

A critical accounting policy is defined as one that is both material to thepresentation of AMO’s consolidated financial statements and requires managementto make difficult, subjective or complex judgments that could have a materialeffect on AMO’s financial condition or results of operations. Specifically,these policies have the following attributes: (1) AMO is required to makeassumptions about matters that are highly uncertain at the time of theestimate; and (2) different estimates AMO could reasonably have used, orchanges in the estimate that are reasonably likely to occur, would have amaterial effect on AMO’s financial condition or results of operations.

 

Estimates and assumptionsabout future events and their effects cannot be determined with certainty. AMObases its estimates on historical experience and on various other assumptionsbelieved to be applicable and reasonable under the circumstances. These estimatesmay change as new events occur, as additional information is obtained and asAMO’s operating environment changes. These changes have historically been minorand have been included in the consolidated financial statements as soon as theybecame known. In addition, management is periodically faced with uncertainties,the outcomes of which are not within its control and will not be known forprolonged periods of time. These uncertainties are discussed in the section ofour 2005 Form 10-K entitled “Risk Factors” and the section below entitled“Certain Factors and Trends Affecting AMO and Its Businesses.” Based on acritical assessment of its accounting policies and the underlying judgments anduncertainties affecting the application of those policies, management believesthat AMO’s consolidated financial statements are fairly stated in accordancewith accounting principles generally accepted in the United States of America,and provide a meaningful presentation of AMO’s financial condition and resultsof operations.

 

*Revenue Recognition and Accounts Receivable*

 

Revenue is realized or realizable and earned whenpersuasive evidence of an arrangement exists, delivery has occurred, the priceto the buyer is fixed or determinable and collectibility is reasonably assured.We record revenue from product sales when title and risk of ownership have beentransferred to the customer, which is typically upon delivery to the customer,with the exception of intraocular lenses distributed on a consignment basis,which is upon notification of implantation in a patient. We recognize licensefees and revenues from the sale of treatment cards to direct customers when weship the treatment cards as we have no continuing obligations or involvementsubsequent to shipment.

 

Some customers finance the purchase or rental oftheir VISX equipment directly from us over periods ranging from one to threeyears. These financing agreements are classified as either rental or operatingleases or sales type leases as prescribed by Statement of Financial AccountingStandards No. 13, “Accounting for Leases.” Under sales type leases, systemrevenues are recognized based on the net present value of the expected cashflow after installation to direct customers in the United States and Japan orafter shipment to international distributors. Under rental or operating leasearrangements, rental revenue is recognized over the term of the agreement.

 

We generally permit returns of product if suchproduct is returned in a timely matter, in good condition, and through thenormal channels of distribution. However, we do not accept returns of treatmentcards and we do not provide rights of return or exchange, price protection orstock rotation rights to any of our VISX product distributors. Return policiesin certain international markets can be more stringent and are based on theterms of contractual agreements with the customers. Allowances for returns areprovided for based upon an analysis of our historical patterns of returnsmatched against the sales from which they originated. To date, historicalproduct returns have been within our estimates.

 

When we recognize revenue from the sale of ourproducts, certain allowances known and estimable at time of sale are recordedas a reduction to sales. These items include cash discounts, allowances andrebates. These items are reflected as a reduction to accounts receivable to theextent the customer will or is expected to reduce its payment on the relatedinvoice amounts. In addition, certain items such as rebates provided tocustomers that meet certain buying targets are paid to the customer subsequentto customer payment. Thus, such amounts are recorded as accrued liabilities.These provisions are estimated based on historical payment experience,historical relationship to revenues and estimated customer inventory levels. Ifthe historical data and inventory estimates used to calculate these provisionsdo not properly reflect future activity,

 

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our financial position,results of operations and cash flows could be impacted. To date, historicalsales allowances have been within our estimates.

 

The allowance for doubtful accounts is determined byanalyzing specific customer accounts and assessing the risk of uncollectibilitybased on insolvency, disputes or other collection issues. In addition, weroutinely analyze the different aging categories and establish allowances basedon 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 inventorybalances for excess quantities and obsolescence by analyzing estimated demand,inventory on hand, sales levels and other information. Based on theseevaluations, inventory balances are reduced, if necessary.

 

*Goodwill and Long-Lived Assets*

 

On January 1, 2002, we adopted Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other IntangibleAssets”, whereby goodwill is no longer amortized, but instead is subject to aperiodic impairment review performed during the second quarter of each fiscalyear. In a business combination, goodwill is allocated to our various reportingunits based on relative fair value of the assets acquired and liabilitiesassumed. We review the recoverability of goodwill by comparing each unit’s fairvalue to the net book value of its assets. If the book value of the reportingunit’s assets exceeds its fair value, the goodwill is written down to itsimplied fair value.

 

Additionally, we review the carrying amount ofgoodwill whenever events and circumstances indicate that the carrying amount ofgoodwill may not be recoverable. Impairment indicators include, among otherconditions, cash flow deficits, historic or anticipated declines in annualrevenue or operating profit and adverse legal or regulatory developments. If itis determined such indicators are present and the review indicates goodwillwill not be fully recoverable, based upon discounted estimated cash flows, thecarrying value is reduced to implied fair value.

 

The most recent annual impairment review of goodwillwas performed in the second quarter of 2005, and no impairment was indicatedbased on tests conducted during the review. The next annual impairment reviewof goodwill will be performed in the second quarter of 2006. Effective January1, 2006, our operating segments consist of three businesses:  Cataract/Implant, Laser Vision Correction andEye Care. Accordingly, the annual impairment review of goodwill in the secondquarter of 2006 will be based on reporting units that are aligned with thecurrent operating segments.

 

In accordance with Statement of Financial AccountingStandards No. 144 “Accounting for the Impairment or Disposal of Long-livedAssets”, we assess potential impairment to our long-lived assets when events orchanges in circumstances indicate that the carrying amount of an asset may notbe fully recoverable. If required, an impairment loss is recognized as thedifference between the carrying value and the fair value of the assets.

 

*Income Taxes*

 

We account for income taxes under the asset andliability method, whereby deferred tax assets and liabilities are recognizedfor the future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date. We evaluate the need to establish avaluation allowance for deferred tax assets based upon the amount of existingtemporary differences, the period in which they are expected to be recoveredand expected levels of taxable income. A valuation allowance to reduce deferredtax assets is established when it is “more likely than not” that some or all ofthe deferred tax assets will not be realized.

 

We record a liability for potential tax assessmentsbased on our estimate of the potential exposure. New laws and newinterpretations of laws and rulings by tax authorities may affect the liabilityfor potential tax assessments. Due to the subjectivity and complex nature ofthe underlying issues, actual payments or assessments may differ fromestimates. To the extent our estimates differ from actual payments orassessments, income tax expense is adjusted. Our income tax returns in severallocations are being examined by the local taxation authorities. Managementbelieves that adequate amounts of tax and related interest, if any, have beenprovided for any adjustments that may result from these examinations.

 

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*Stock-Based Compensation*

 

Effective January1, 2006, we began accounting for stock options and employee stock purchase plan(ESPP) shares under the provisions of Statement of Financial AccountingStandards No. 123R, “Share-Based Payment” (SFAS 123R). SFAS 123R requiresentities to recognize the cost of employee services received in exchange forawards of equity instruments based on the grant-date fair value of those awards. The fair value of stock options and ESPPpurchase rights are estimated using a Black-Scholes option valuation model.This model requires the input of subjective assumptions, including expectedstock price volatility, estimated life and estimated forfeitures of each award.The fair value of equity-based awards is amortized over the vesting period ofthe award, and we have elected to use the straight-line method. We makequarterly assessments of the adequacy of the tax credit pool to determine ifthere are any deficiencies which require recognition in the consolidatedstatement of operations. Prior to the implementation of SFAS 123R, we accountedfor stock options and ESPP shares under the provisions of Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” and made pro formadisclosures as required by SFAS No. 148, “Accounting For Stock-BasedCompensation — Transition and Disclosure,” which amended SFAS No. 123,“Accounting For Stock-Based Compensation.” Pro forma net income and pro formanet income per share disclosed in the footnotes to the consolidated financialstatements were estimated using a Black-Scholes option valuation model. Thefair value of restricted stock and restricted stock units was calculated basedupon the fair market value of our common stock at the date of grant.

 

We also have an annualperformance stock incentive program which provides the opportunity for certain executives to earnlong-term incentive compensation awards based upon specified market performancemeasures. Awards are to be settled in a number of restricted stock shares orunits equal to the value of the award amount divided by the fair market valueof our common stock on the date the performance criteria is deemed to have beenmet. These awards are accounted for as a liability until the date theperformance criteria is determined. The fair value of the liability at eachbalance sheet date is estimated using a lattice-based valuation model. Theassociated expense is recognized on a straight-line basis, as adjusted forchanges in fair value, over the period which starts from the date the annualprogram is approved by the Board of Directors through the end of the expectedvesting period, which assumes restricted stock shares or units will be issued.If an award of restricted stock share or units is made, the fair value of theaward becomes fixed on the grant date and recognized as an expense over theremaining vesting period.

 

RESULTS OF OPERATIONS 

 

The following tablepresents net sales and operating income by operating segment for the three monthsended March 31, 2006 and March 25, 2005, respectively:

 
| ** **               | ** ** | **Net Sales**               | ** ** | **Operating Income (Loss)** | ** ** |
|--------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
| **(In thousands)**  | ** ** | **March 31,  2006**         | ** ** | **March 25,  2005**         | ** ** | **March 31,  2006** | ** ** | **March 25,  2005** | ** ** |
|                     |       |                             |       |                             |       |   |   |   |   |
| Cataract/Implant         |       | $                                | 120,444    |                             | $          | 116,730 |   | $ | 58,582 |   | $ | 51,973 |   |
| Laser Vision Correction  |       | 60,955                           |       | 1,942                            |       | 40,788 |   | (265 | ) |
| Eye Care                 |       | 56,829                           |       | 73,847                           |       | 21,759 |   | 27,515 |   |
| Total operating segments |       | $                                | 238,228    |                             | $          | 192,519 |   | $ | 121,129 |   | $ | 79,223 |   |

* *

*Net**sales**.* Total net sales increased 23.7% in the threemonths ended March 31, 2006, compared to the same period last year. Theincrease in net sales was primarily the result of sales of products acquired inthe VISX Acquisition and strong demand for our core brands, partially offset bya negative foreign currency impact of 4.9%. Our sales and earnings may benegatively impacted during times of a strengthening U.S. dollar. Total netsales in the U.S. and Japan represented 42.9% and 13.4%, respectively, of totalnet sales in the three months ended March 31, 2006. No other country, or anysingle customer, generated over 10% of total net sales in the periodspresented.

 

Net sales from our Cataract/Implant businessincreased by 3.2% in the three months ended March 31, 2006, compared with thesame period last year. The increase in net sales was primarily the result ofsales of our branded promoted products, including*Tecnis*and*ReZoom*intraocular lenses and phacoemulsification systems, partially offset by adecrease in sales of non-promoted older-technology intraocular lenses andviscoelastics and reimbursement pressures in certain European markets and inJapan for viscoelastic products. Net sales growth in the Americas of 22.0% wasdue to strong demand for our core products and was offset by a decline of 7.2%in Europe/Africa/Middle East and 11.6% in Japan due to decreasing sales ofolder generation intraocular lenses, rationalized viscoelastics andreimbursement pressures, as well as the negative impact

 

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of foreign currencyfluctuations. The difference in net sales in our Cataract/Implant business alsoincludes an unfavorable foreign currency impact of $5.9 million, or 5.1%,largely from fluctuations of the euro and Japanese yen versus the U.S. dollar.

 

Net sales fromour Laser Vision Correction (LVC) business increased by $59.0 million to $61.0million in the three months ended March 31, 2006, compared with the same periodlast year. This increase was primarily the result of sales of products acquiredin the VISX Acquisition. Net sales of acquired VISX products were $57.7 millionin the three months ended March 31, 2006. See Note 2 to the unauditedconsolidated financial statements for the proforma impact of VISX net sales forthe same period last year. Net sales in the Americas increased by $50.4 milliondue to strong demand for our custom LASIK procedures and system sales. As aresult of our international expansion strategy for the LVC business, we saw netsales in Europe/Africa/Middle East of $4.1 million and Asia Pacific Sales of$4.0 million, compared to negligible amounts in the same period last year. Thedifference in net sales in our LVC business also includes an unfavorableforeign currency impact of $0.3 million, or 14.8%, largely from fluctuations ofthe euro and Japanese yen versus the U.S. dollar.

 

Net sales from our Eye Care business decreased by23.0% in the three months ended March 31, 2006, compared with the sameperiod last year. The decrease in sales of eye care products was primarily dueto lower sales of hydrogen peroxide-based products caused by continuedshrinkage of this market as contact lens wearers gravitate increasingly to moreconvenient multipurpose solutions, as well as decreased sales of multipurposeproducts primarily due to rapid growth of daily disposable lenses. Theshrinkage in the market contributed significantly to net sales declines inEurope/Africa/Middle East, Asia Pacific and Japan of 32.9%, 26.0% and 31.6%,respectively. These declines were partially offset by an increase of 6.3% inthe Americas due to increasing demand for our multipurpose products. Thedifference in net sales in our Eye Care business also includes an unfavorableforeign currency impact of $3.2 million, or 4.3%, largely resulting from fluctuationsof the euro and Japanese yen versus the U.S. dollar.

 

As part of our product rationalization andrepositioning plan to maximize our competitive advantage as the globalrefractive leader and improve the global penetration of our core cataract, refractiveand eye care brands, we have discontinued a variety of non-strategic cataractsurgical and eye care products that lack critical revenue mass, haveexperienced steadily declining sales trends and/or have generated relativelyunattractive margins. We expect the growth of our promoted products to offsetthe revenue decline related to these discontinued products.

 

*Gross**margin**and gross profit.* Our gross margin percentage was 63.5% in thethree months ended March 31, 2006, compared with 63.4% in the same periodlast year due to sales growth in the higher margin *Tecnis*and*ReZoom*intraocularlenses and VISX products, along with manufacturing productivity improvements.This improvement was offset by approximately $3.2 million, or 1.3 percentagepoints, inventory and manufacturing related charges incurred in connection withour business repositioning plan.

 

As described earlier, we expect our productrationalization and repositioning strategy and supplemental consolidation ofcertain operations due to IOL manufacturing capabilities and eye care productrationalizations to have a significant impact on our gross margin through theremainder of 2006.

 

*Selling**, general and administrative.*Selling, general and administrative expensesdecreased as a percent of net sales by 3.5 percentage points to 40.0% in thethree months ended March 31, 2006, compared with 43.5% in the same periodlast year. This decrease was largely driven by increased leverage from revenuegrowth and efficiency gains. Selling, general and administrative expenses forthe three months ended March 31, 2006 include approximately $7.0 millionin amortization expenses related to the acquired VISX intangible assets. Inaddition, selling, general and administrative expenses for the three monthsended March 31, 2006 include a $2.3 million charge primarily associated withassets acquired in the termination of a distributor agreement in India and $3.5million in stock-based compensation expense from the adoption of SFAS 123R.

 

*Research and development.* Research and development expendituresincreased as a percent of net sales by 0.7 percentage points to 7.1%, in thethree months ended March 31, 2006, compared with the same period lastyear. The increase in research and development expenditures as a percentage ofnet sales was primarily the result of an increase in spending for researchefforts in the Cataract/Implant and LVC businesses. We expect our research anddevelopment cost as a percentage of sales to decrease moderately for theremainder of 2006 as we continue to consolidate research and development costfrom the VISX acquisition. Our research and development strategy is to developproprietary products for vision correction that are safe and effective andaddress unmet needs. We are currently focusing on new advancements that buildon our *Tecnis, Healon*and *WhiteStar*technology, corneal and lens-based solutions to presbyopia and dry eyeproducts. Our research and development teams are actively pursuing newCustomVue indications in order to strengthen our LVC market position. We areworking to secure FDA approval for a multi-focal CustomVue treatment forpresbyopia.

 

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*Business**repositioning costs.* Inthe three months ended March 31, 2006, we incurred $32.4 million of pre-taxcharges, which included $3.2 million for inventory and manufacturing relatedcharges included in cost of sales and $29.2 million included in operatingexpenses. Charges included in operating expenses comprised productivity andbrand repositioning costs of $26.2 million, severance, relocation and otherone-time termination benefits of $1.6 million and asset write-downs of $1.4million. In connection with the approved product rationalization andrepositioning plan, we expect to incur an additional $3 million to $5 millionof charges in the first half of 2006, which will be recognized as theservices are performed and actions occur. The total charges that are expectedto be incurred are within the range previously announced.

 

Following an analysis of our IOL manufacturingcapabilities, we have decided to consolidate certain operations. In addition,we have decided to further expand the scope of our eye care rationalizationinitiatives in order to maximize manufacturing capacity and seize growthopportunities. Together, these separate actions are expected to result inadditional charges of approximately $20 million to $25 million in the remainderof 2006. The estimated total charges for the expanded product rationalizationand repositioning plan will be approximately $90 million to $105 million.

 

*Operating**Income.*Operating income as a percentage of netsales, or operating margin, was 4.1% in the three months ended March 31, 2006,compared with 13.5% in the same period last year. Operating income of $9.7million in the three months ended March 31, 2006 includes $32.4 million ofbusiness repositioning charges, $2.3 million of asset write-offs describedabove and $4.5 million in incremental stock-based compensation expense from theadoption of SFAS 123R. These charges reduced operating margin by 16.5% in thethree months ended March 31, 2006.

 

Operating income from our Cataract/Implant businessincreased by $6.6 million due to the increase in net sales and favorable mix ofhigher margin products discussed above, along with the favorable impact of costcontainment measures taken in connection with our business repositioning plan.Operating income from our LVC business increased by $41.1 million due to salesof products acquired from VISX in May 2005. Operating income from our Eye Carebusiness decreased primarily due to the unfavorable impact from continuedsoftness in the market for hydrogen peroxide based products.

 

*Non-operating expense.* Interest expense was $4.5 million and$5.8 million in the three months ended March 31, 2006 and March 25, 2005,respectively. We anticipate interest expense to decrease in 2006 relative to2005 due to the anticipated overall reduction in average borrowings outstandingduring 2006 as well as the higher percentage of our relatively low fixed rateconvertible debt versus our higher variable rate debt. The anticipated increasein interest rates throughout 2006 would slightly offset these benefits.

 

We recordedan unrealized loss on derivative instruments of $0.4 million in the threemonths ended March 31, 2006 compared to an unrealized gain of $0.5 million inthe three months ended March 25, 2005. We record as “unrealized (gain)loss on derivative instruments” the mark to market adjustments on theoutstanding foreign currency options and forward contracts which we enter intoas part of our overall risk management strategy to reduce the volatility ofexpected earnings in currencies other than the U.S. dollar.

 

*Income taxes.* The effective tax rate for the threemonths ended March 31, 2006 was 30.4%, compared with the effective tax rate of34% for the same period last year. The effective tax rate in the currentperiod reflects a benefit from stock-based compensation expense currently beingrecognized under SFAS 123R at an effective rate of 33.3%, and a provision onall other pre-tax income at an effective rate of 32.0%.

 

The lowerrate in the current period reflects continuing implementation of our long-termtax strategies. Our future effective income tax rate may vary depending on ourmix of domestic and international taxable income or loss and the various taxand treasury methodologies that we implement, including our policy regardingrepatriation of future accumulated foreign earnings.

 

LIQUIDITY AND CAPITAL RESOURCES 

 

Management assesses our liquidity by our ability togenerate cash to fund operations. Significant factors in the management ofliquidity are: funds generated by operations; levels of accounts receivable,inventories, accounts payable and capital expenditures; adequate lines ofcredit; and financial flexibility to attract long-term capital on satisfactoryterms. As of March 31, 2006, we had cash and equivalents of $37.6 million.

 

Historically, we have generated cash from operationsin excess of working capital requirements, and we expect to do so in thefuture. Net cash used in operating activities was $0.8 million in the threemonths ended March 31, 2006 compared to $18.6 million in the three monthsended March 25, 2005. Operating cash flow improved in the three monthsended March 31, 2006 compared to the three months ended March 25,2005 primarily due to timing of accounts receivable collections and last year’sinventory buildup of “bridging” stock as we prepared for the transition of eyecare manufacturing from Allergan, partially offset by decreased accruedexpenses and other liabilities due to the payment of annual incentivecompensation, severance payments related to the product rationalization andbusiness repositioning plan and interest payments on the 21⁄2% convertiblesenior subordinated notes and the 1.375% convertible senior subordinated notes.

 

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Net cash used in investing activities was $9.0million and $10.5 million in the three months ended March 31, 2006 andMarch 25, 2005, respectively. Expenditures for property, plant andequipment totaled $6.6 million and $2.3 million in the three months endedMarch 31, 2006 and March 25, 2005, respectively. Expenditures in thethree months ended March 31, 2006 primarily comprised expenditures toupgrade our viscoelastics manufacturing facility in Uppsala, Sweden.Expenditures in the three months ended March 25, 2005 primarily comprisedexpansion and remodeling of our leased headquarters, expenditures at our manufacturingfacilities and computer replacements. We expect to incur greater capitalexpenditures with respect to the Uppsala, Sweden manufacturing facility during2006 in order to separate the facility from existing Pfizer operations.Expenditures for demonstration (demo) and bundled equipment, primarilyphacoemulsification and microkeratome surgical equipment, were $2.4 million and$3.1 million in the three months ended March 31, 2006 and March 25,2005, respectively. We maintain demo and bundled equipment to facilitatefuture sales of similar equipment and related products to ourcustomers. Expenditures for capitalized internal-use software were $5.2million in the three months ended March 25, 2005, which primarilycomprised a company-wide system upgrade as part of the overall expansion of ourbusiness. We capitalize internal-use software cost after technical feasibilityhas been established. In 2006, we expect to invest approximately $55.0million to $60.0 million in property, plant and equipment, demo and bundledequipment, and capitalized software as part of the overall expansion of ourbusiness.

 

Net cash provided by financing activities was $6.1million in the three months ended March 31, 2006, which comprised $15.9million of proceeds from the sale of stock to employees and $5.2 million excesstax benefits from stock-based compensation, reduced by $15.0 million ofrepayments under the senior revolving credit facility. Net cash provided byfinancing activities was $6.4 million in the three months ended March 25,2005, which comprised $7.5 million borrowings under the senior revolving creditfacility and $1.3 million of proceeds from the sale of stock to employees,reduced by $2.4 million of financing related costs.

 

At March 31, 2006, we had $45.0 million of borrowingsoutstanding under the senior revolving credit facility. Approximately $8.9million of the senior revolving credit facility was reserved to support lettersof credit issued on our behalf for normal operating purposes and we hadapproximately $246.1 million undrawn and available revolving loan commitments.Our senior credit facility provides that we will maintain certain financial andoperating covenants which include, among other provisions, maintaining specificleverage and coverage ratios. Certain covenants under the senior creditfacility may limit the incurrence of additional indebtedness. The senior creditfacility prohibits dividend payments. We were in compliance with thesecovenants at March 31, 2006. Our senior credit facility is collateralizedby a first priority perfected lien on, and pledge of, all of the combinedcompany’s present and future property and assets (subject to certainexclusions), 100% of the stock of the domestic subsidiaries, 66% of the stockof foreign subsidiaries and all present and future intercompany debts.

 

Our cash position includes amounts denominated inforeign currencies, and the repatriation of those cash balances from some ofour non-U.S. subsidiaries may result in additional tax costs. However,these cash balances are generally available without legal restriction to fundordinary business operations.

 

We believe that the net cash provided by ouroperating activities, supplemented as necessary with borrowings available underour revolving credit facility and existing cash and equivalents, will providesufficient resources to fund the expected 2006 capital expenditures, and tomeet our working capital requirements, debt service and other cash needs overthe next year.

 

We are partially dependent upon the reimbursementpolicies of government and private health insurance companies. Governmentand private sector initiatives to limit the growth of health care costs,including price regulation and competitive pricing, are continuing in manycountries where we do business. As a result of these changes, themarketplace has placed increased emphasis on the delivery of morecost-effective medical therapies. While we have been unaware ofsignificant price resistance resulting from the trend toward cost containment,changes in reimbursement policies and other reimbursement methodologies andpayment levels could have an adverse effect on our pricing flexibility.Additionally, the current trend among U.S. hospitals and other customers ofmedical device manufacturers is to consolidate into larger purchasing groups toenhance purchasing power. The enhanced purchasing power of these largercustomers may also increase the pressure on product pricing, although we areunable to estimate the potential impact at this time.

 

*Inflation. *Although at reduced levels in recent years,inflation may cause upward pressure on the cost of goods and services used byus. The competitive and regulatory environments in many marketssubstantially limit our ability to fully recover these higher costs through increasedselling prices. We continually seek to mitigate the adverse effects ofinflation through cost containment and improved productivity and manufacturingprocesses.

 

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*Foreign currencyfluctuations. *Approximately57% of our revenues for the three months ended March 31, 2006 were derivedfrom operations outside the United States and a significant portion of our coststructure is denominated in currencies other than the U.S. dollar, primarilythe Japanese yen and the euro. Therefore, we are subject to fluctuationsin sales and earnings reported in U.S. dollars as a result of changing currencyexchange rates.

 

The impact of foreign currency fluctuations on saleswas a $9.4 million decrease and a $5.6 million increase for the three monthsended March 31, 2006 and March 25, 2005, respectively. The fluctuationswere due primarily to the fluctuations of the Japanese yen and the euro versusthe U.S. dollar.

 

*Off-balance sheet arrangements.* We had no off-balance sheet arrangements atMarch 31, 2006.

 

**Certain Factors and TrendsAffecting AMO and Its Businesses**

 

Our disclosure and analysis in this report containforward-looking information about our company’s financial results andestimates, business prospects and future products that involve substantialrisks and uncertainties. These statements constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. From time to time, we also may provide oral or written forward-lookingstatements in other materials we release to the public. Forward-lookingstatements give our current expectations or forecasts of future events. You canidentify these statements by the fact that they do not relate strictly tohistoric or current facts. They use words such as “anticipate,” “estimate,”“expect,” “project,” “intend,” “plan,” “believe,” “will,” and other words andterms of similar meaning in connection with any discussion of future operatingor financial performance. In particular, these include statements relating tofuture actions, prospective products or product approvals, future performanceor results of current and anticipated products, sales efforts, expenses,interest rates, foreign exchange rates, the outcome of contingencies, such aslegal proceedings, financial results, and the expected results and benefits ofour acquisition of VISX, Incorporated and the product rationalization andreorganization. Among the factors that could cause actual results to differmaterially are the following:

 

•                                          Uncertainties associated with the researchand development and regulatory processes;

 

•                                          Our ability to make and successfullyintegrate acquisitions or enter into strategic alliances;

 

•                                          Exposure to risks associated with doingbusiness outside of the United States, where we conduct a significant amount ofour sales and operations;

 

•                                          Foreign currency risks and fluctuation ininterest rates;

 

•                                          Our ability to introduce new commerciallysuccessful products in a timely and effective manner;

 

•                                          Our ability to maintain a sufficient andtimely supply of products we manufacture;

 

•                                          Our reliance on sole source suppliers for rawmaterials and other products;

 

•                                          Intense competition from companies withsubstantially more resources and a greater marketing scale;

 

•                                          Risks and expenses associated with ourability to protect our intellectual property rights;

 

•                                          Risks and expenses associated withintellectual property litigation and infringement claims;

 

•                                          Unexpected losses due to product liabilityclaims, product recalls or corrections, or other litigation;

 

•                                          Our ability to maintain our relationshipswith health care providers;

 

•                                          Risks, uncertainties and delays associatedwith extensive government regulation of our business, including risksassociated with regulatory compliance, quality systems standards, andcomplaint-handling;

 

•                                          Our ability to attract, hire and retainqualified personnel;

 

•                                          Risks associated with indemnificationobligations and potential tax liabilities associated with our spin-off from Allergan;

 

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•                                          Our significant debt, which containscovenants limiting ourbusiness activities;

 

•                                          The impact of the change in the accountingtreatment of stock options upon the adoption of SFAS 123R or other significantchanges to generally accepted accounting principles;

 

•                                          Risks associated with our ability to realizethe benefits of the VISX acquisition;

 

•                                          Changes in market acceptance of laser visioncorrection;

 

•                                          The possibility of long-term side effects andadverse publicity regarding laser correction surgery;

 

•                                          The effect of weak or uncertain generaleconomic conditions on the ability of individuals to afford laser visioncorrection; and

 

•                                          Risks associated with our ability tosuccessfully execute the product rationalization and reorganization in a timelyand effective manner.

 

We cannot guarantee that any forward-lookingstatement will be realized. Achievement of future results is subject to risks,uncertainties and inaccurate assumptions. Should known or unknown risks oruncertainties materialize, or should underlying assumptions prove inaccurate,actual results could vary materially from past results and those anticipated,estimated or projected. Investors should bear this in mind as they consider forward-lookingstatements.

 

We undertake no obligation to publicly updateforward-looking statements, whether as a result of new information, futureevents or otherwise. You are advised, however, to consult any furtherdisclosures we make on related subjects in our Forms 10-Q, 8-K and 10-K reportsto the Securities and Exchange Commission. Our Form 10-K filing for the 2005fiscal year listed various important factors that could cause actual results todiffer materially from expected and historic results. We note these factors forinvestors as permitted by the Private Securities Litigation Reform Act of 1995.Readers can find them in Item 1A of the Form 10-K under the heading “RiskFactors.”  We incorporate that section ofthat Form 10-K in this filing and encourage investors to refer to it. Youshould understand that it is not possible to predict or identify all suchfactors. Consequently, you should not consider any such list to be a completeset of all potential risks or uncertainties.

 

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

 

We routinely monitor the risks associated withfluctuations in currency exchange rates and interest rates. We address theserisks through controlled risk management that may include the use of derivativefinancial instruments to economically hedge or reduce these exposures. We donot expect to enter into financial instruments for trading or speculativepurposes.

 

Given the inherent limitations of forecasting andthe anticipatory nature of the exposures intended to be hedged, there can be noassurance that such programs will offset more than a portion of the adversefinancial impact resulting from unfavorable movements in either interest orforeign exchange rates. In addition, the timing of the accounting for recognitionof gains and losses related to mark-to-market instruments for any given periodmay not coincide with the timing of gains and losses related to the underlyingeconomic exposures and, therefore, may adversely affect our operating resultsand financial position.

 

To ensure the adequacy and effectiveness of ourinterest rate and foreign exchange hedge positions, we continually monitor,from an accounting and economic perspective, our interest rate swap positionsand foreign exchange forward and option positions, when applicable, both on astand-alone basis and in conjunction with our underlying interest rate andforeign currency exposures.

 

Interest rate risk. At March 31, 2006, ourdebt comprises solely domestic borrowings and comprises $500.0 million of fixedrate debt and $45.0 million of variable rate debt.

 

26

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The tables below present information about our debtobligations as of March 31, 2006 and December 31, 2005:

 

**March 31, 2006**

 
| ** **                      | ** ** | **Maturing in** | ** ** | ** ** | ** ** | **Fair Market**                                          | ** ** |
|---------------------------------|------------|----------------------|------------|------------|------------|---------------------------------------------------------------|------------|
| ** **                      | ** ** | **2006**             | ** ** | **2007**   | ** ** | **2008**                                                      | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Value** | ** ** |
| ** **                      | ** ** | ** **           | ** ** | ** ** | ** ** | **(in thousands, except interest rates)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **LIABILITIES**                 |       |                 |       |       |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| **Debt  Obligations:**          |       |                 |       |       |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Fixed Rate                      |       | $                    | —     |       | $          | —                                                        |       | $ | — |   | $ | — |   | $ | — |   | $ | 350,000 |   | $ | 350,000 |   | $ | 376,705 |   |
| Weighted Average  Interest Rate |       | —               |       | —     |       | —                                                        |       | — |   | — |   | 2.50 | % | 2.50 | % |   |   |
| Fixed Rate                      |       | $                    | —     |       | $          | —                                                        |       | $ | — |   | $ | — |   | $ | — |   | $ | 150,000 |   | $ | 150,000 |   | $ | 164,028 |   |
| Weighted Average  Interest Rate |       | —               |       | —     |       | —                                                        |       | — |   | — |   | 1.375 | % | 1.375 | % |   |   |
| Variable Rate                   |       | $                    | 45,000     |       | $          | —                                                        |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 45,000 |   | $ | 45,000 |   |
| Weighted Average  Interest Rate |       | 6.50                 | %          | —     |       | —                                                        |       | — |   | — |   | — |   | 6.50 | % |   |   |
| Total Debt  Obligations         |       | $                    | 45,000     |       | $          | —                                                        |       | $ | — |   | $ | — |   | $ | — |   | $ | 500,000 |   | $ | 545,000 |   | $ | 585,733 |   |
| Weighted Average  Interest Rate |       | 6.50                 | %          | —     |       | —                                                        |       | — |   | — |   | 2.16 | % | 2.52 | % |   |   |

** **

**December 31,2005**

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

* *

*Foreign**currency risk. *Overall, we are a net recipient of currencies other than the U.S.dollar and, as such, we benefit from a weaker dollar and are adversely affectedby 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 asexpressed in U.S. dollars.

 

We may enter into foreign exchange option and forwardcontracts to reduce earnings and cash flow volatility associated with foreignexchange rate changes to allow management to focus its attention on its corebusiness operations. Accordingly, we enter into contracts which change in valueas foreign exchange rates change to economically offset the effect of changesin value of foreign currency assets and liabilities, commitments andanticipated foreign currency denominated sales and operating expenses. We enterinto foreign exchange option and forward contracts in amounts between minimumand maximum anticipated foreign exchange exposures, generally for periods notto exceed one year. We do not enter into foreign exchange option and forwardcontracts for trading purpose.

 

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

 

The following tables provide information about ourforeign currency derivative financial instruments outstanding as ofMarch 31, 2006 and December 31, 2005, respectively. The information isprovided in U.S. dollar amounts, as presented in our consolidated financialstatements.

 
| ** **                                  | ** ** | **March 31, 2006**  | ** ** | **December 31, 2005**             | ** ** |
|---------------------------------------------|------------|-------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **Notional  Amount**          | ** ** | **Average  Contract  or Strike  Rate** | ** ** | **Notional  Amount** | ** ** | **Average  Contract  or Strike  Rate** | ** ** |
| ** **                                  | ** ** | **(in $ millions)** | ** ** | ** **                                  | ** ** | **(in $ millions)** | ** ** | ** ** | ** ** |
| **Foreign currency forward contracts:**     |       |                          |       |                                        |       |   |   |   |   |
| **Pay US$/Receive Foreign Currency:**       |       |                          |       |                                        |       |   |   |   |   |
| Swedish Krona                               |       | $                             | 25.8       |                                        | 7.75       |   | $ | 31.5 |   | 7.94 |   |
| U.K. Pound                                  |       | 3.5                           |       | 1.74                                        |       | 5.2 |   | 1.72 |   |
| Swiss Franc                                 |       | 1.5                           |       | 1.30                                        |       | 1.5 |   | 1.31 |   |
| Euro                                        |       | —                        |       | —                                      |       | 5.9 |   | 1.19 |   |
| **Receive US$/Pay Foreign Currency:**       |       |                          |       |                                        |       |   |   |   |   |
| Japanese Yen                                |       | 8.5                           |       | 117.42                                      |       | 3.0 |   | 117.45 |   |
| Canadian Dollar                             |       | 5.1                           |       | 1.17                                        |       | 3.4 |   | 1.17 |   |
| Australia Dollar                            |       | 4.3                           |       | 0.72                                        |       | 2.9 |   | 0.73 |   |
|                                        |       |                          |       |                                        |       |   |   |   |   |
| **Total Notional**                          | ** ** | **$**                         | **48.7**   | ** **                                  | ** ** | ** ** | **$** | **53.4** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **                    | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Estimated Fair Value**                    | ** ** | **$**                         | **(0.1**   | **)**                                       | ** ** |   | **$** | — |   |   |   |
| ** **                                  | ** ** | ** **                    | ** ** | ** **                                  | ** ** |   | ** ** |   |   |   |   |
| **Foreign currency purchased put options:** |       |                          |       |                                        |       |   |   |   |   |
| Japanese Yen                                |       | $                             | 54.0       |                                        | 118.47     |   | $ | 66.2 |   | 117.83 |   |
| Euro                                        |       | 39.5                          |       | 1.18                                        |       | 40.2 |   | 1.18 |   |
|                                        |       |                          |       |                                        |       |   |   |   |   |
| **Foreign currency sold call options:**     |       |                          |       |                                        |       |   |   |   |   |
| Japanese Yen                                |       | 60.0                          |       | 106.60                                      |       | 60.0 |   | 106.60 |   |
| Euro                                        |       | 42.8                          |       | 1.28                                        |       | 43.0 |   | 1.26 |   |
|                                        |       |                          |       |                                        |       |   |   |   |   |
| **Total Notional**                          | ** ** | **$**                         | **196.3**  | ** **                                  | ** ** |   | **$** | **209.4** |   |   |   |
| ** **                                  | ** ** | ** **                    | ** ** | ** **                                  | ** ** |   | ** ** |   |   |   |   |
| **Estimated Fair Value**                    | ** ** | **$**                         | **0.3**    | ** **                                  | ** ** |   | **$** | **1.1** |   |   |   |

 

The notional principal amount provides one measureof the transaction volume outstanding as of the end of the period, and does notrepresent the amount of our exposure to market loss. The estimate of fair valueis based on applicable and commonly used prevailing financial marketinformation as of March 31, 2006 and December 31, 2005, respectively. Theamounts ultimately realized upon settlement of these financial instruments,together with the gains and losses on the underlying exposures, will depend onactual market conditions during the remaining life of the instruments.

 

**Item 4. Controls andProcedures**

 

As of the end of the period covered by this report,we carried out an evaluation, under the supervision and with the participationof our principal executive officer and principal financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based on this evaluation, our principal executive officer andprincipal financial officer concluded that our disclosure controls andprocedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under theSecurities Exchange Act of 1934) are effective. In addition, our managementevaluated our internal control over financial

 

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reporting and there havebeen no changes during the most recent fiscal quarter ended March 31, 2006that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

On December 3, 2003, we filed a complaint in theU.S. District Court for the District of Delaware against Alcon, Inc. and AlconLaboratories, Inc. for infringement of U.S. Patent Nos. 5,700,240 (BarwickPatent) and 6,059,765 (Cole/Sutton Patent). We alleged that Alcon’s “Infiniti”and “Series 20000 Legacy” phacoemulsification machines infringed the patents.We sought damages and a permanent injunction. The trial of this matter began onApril 25, 2005 and concluded on May 6, 2005. The jury found both of our patentsto be valid and infringed by Alcon, and awarded us $94.8 million in damages.The jury further found that Alcon had willfully infringed both of our patents.On June 21, 2005, a bench trial was conducted by the Court to determine if wehad sufficiently marked our equipment with the patent numbers and to determineif Alcon had waived any argument relating thereto. On December 16, 2005, theCourt ruled that we did not sufficiently mark our patents and reduced the juryaward from $94.8 million to $71.3 million. However, the Court further ruledthat Alcon had willfully infringed our patents and trebled the $71.3 milliondamage award to $213.9 million. The Court also granted our request for apermanent injunction on both patents. However, the Court stayed the injunctionon the Cole/Sutton Patent pending appeal. On January 20, 2006, judgmentwas entered including additional damages from March 2005 throughDecember 31, 2005 and interest based thereon, resulting in final damagesof $234.5 million. The Court further ordered Alcon to pay all of our attorneyfees and costs, estimated at $4 million. Alcon filed an appeal of the finaljudgment on January 20, 2006. We cross appealed on February 3, 2006. OnFebruary 3, 2006, Alcon filed a motion for a new trial with the U.S. DistrictCourt for the District of Delaware. We opposed this motion on February 24,2006. The Court of Appeal has deactivated the appeal until the motion for newtrial has been decided by the U.S. District Court.

 

On January 28, 2004, Alcon Manufacturing, Ltd. fileda complaint against us and Allergan, Inc. in the U.S. District Court for theNorthern District of Texas, Fort Worth Division, for infringement of U.S.Patent Nos. 4,832,685 and 4,935,005 (Haines Patents). Alcon alleged that our*Prestige* and*Sovereign* phacoemulsification systems and replacementcassettes infringe the patents. Alcon is seeking damages and a permanentinjunction. At Alcon’s request, the case has been stayed in Texas while theparties seek re-examination by the U.S. Patent and Trademark Office on theHaines Patents in light of another patent we allege invalidates the HainesPatents.

 

On January 4, 2005, Dr. James Nielsen filed acomplaint against us and Allergan, Inc. in the U.S. District Court of theNorthern District of Texas, Dallas Division, for infringement of U.S. PatentNo. 5,158,572. Dr. Nielsen alleges that our*Array* multifocal intraocular lens infringes the patent. He isseeking damages and a permanent injunction. The trial in this matter isscheduled to begin on November 6, 2006.

 

On August 8, 2005, Alcon Manufacturing, Ltd andAlcon Laboratories, Inc. filed a complaint against us in the U.S. DistrictCourt for the Northern District of Texas, Fort Worth Division, for infringementof U.S. Patent Nos. 4,921,477 (relating to a surgical irrigation and aspirationsystem with a dampening device); 5,199,943 (relating to an ultrasonic surgicalhandpiece); 5,188,589 (relating to a textured sleeve in a phacoemulsificationhandpiece); and 5,876,016 and 6,109,572 (both of which relate to an apparatusand method to elevate an infusion source in an ophthalmic surgical procedure).Alcon alleged that we infringe these patents in the course of selling ourphacoemulsification systems or accessories, and is seeking damages and apermanent injunction. The trial in this matter is scheduled to begin on August14, 2006.

 

On September 13, 2005, Alcon Manufacturing, Ltd.filed a complaint against us in the U.S. District Court for the NorthernDistrict of Texas, Dallas Division, for infringement of U.S Patent No.5,273,056 relating to the use of a combination of viscoelastics duringophthalmic surgery. Alcon alleged that we infringed, contributorily infringed,and/or induced infringement of this patent, and is seeking damages and apermanent injunction.

 

We do not believe, based on current knowledge, thatany of the foregoing legal proceedings or claims are likely to have a materialadverse effect on our financial position, results of operations or cash flows.However, we may incur substantial expenses in defending against third partyclaims. In the event of a determination adverse to us or our subsidiaries, wemay incur substantial monetary liability, and be required to change ourbusiness practices. Either of these could have a material adverse effect on ourfinancial position, results of operations or cash flows.

 

While we are involved from time to time inlitigation arising in the ordinary course of business, including productliability claims, we are not currently aware of any other actions against us orAllergan relating to the optical medical device

 

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business that we believewould have a material adverse effect on our business, financial condition,results of operations or cash flows. We may be subject to future litigation andinfringement claims, which could cause us to incur significant expenses orprevent us from selling our products. We operate in an industry susceptible tosignificant product liability claims. Product liability claims may be assertedagainst us in the future arising out of events not known to us at the presenttime. Under the terms of the contribution and distribution agreement effectingour spin-off, Allergan agreed to assume responsibility for, and to indemnify usagainst, all current and future litigation relating to its retained businessesand we agreed to assume responsibility for, and to indemnify Allergan against,all current and future litigation related to the optical medical devicebusiness.

 

**Item 1A. Risk Factors**

** **

There have been no significant changes to therisk factors disclosed in the Company’s Annual Report on Form 10-K for the yearended December 31, 2005.

 

**Item 6. Exhibits** 

 
| 31.1   |   | Certification of James V. Mazzo pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                             |
| 31.2   |   | Certification of Richard A. Meier pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                    |
|   |   |                                                                                                             |
| 32.1   |   | Certification of James V. Mazzo and Richard A. Meier pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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SIGNATURES

 

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

 

Date:May 9, 2006

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

 

31

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EXHIBIT INDEX

 
| 31.1   |   | Certification of James V. Mazzo pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                             |
| 31.2   |   | Certification of Richard A. Meier pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                    |
|   |   |                                                                                                             |
| 32.1   |   | Certification of James V. Mazzo and Richard A. Meier pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

32

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