<PAGE>
                                                                    EXHIBIT 10.6

                              SEPARATION AGREEMENT

      This Separation Agreement ("Agreement") and the Release, which is attached
and incorporated by reference as Exhibit A (the "Release"), are made, effective
as of September 27, 2001 (the "Effective Date"), by and between Gregory J.
Melsen ("Employee"), and American Medical Systems, Inc. and its parent and/or
subsidiary corporations, affiliates, successors, predecessors, shareholders,
present and/or former officers, directors, agents, employees, and attorneys,
whether in their individual or official capacities, benefit plans and plan
administrators, and insurers (collectively referred to as "Employer").

      The Employer and Employee wish to provide for the terms and conditions of
Employee's separation from employment pursuant to the terms of this Agreement.

      The Employer does not believe that it has any claims against the Employee,
nor do the parties believe that the Employee has any claims against the
Employer. Nevertheless, the parties have agreed upon the following terms
regarding the Employee's separation from employment, and to resolve any actual
and potential claims arising out of the Employee's employment with and
separation from Employer.

      IN CONSIDERATION OF THIS ENTIRE SEPARATION AGREEMENT AND RELEASE, THE
PARTIES AGREE AS FOLLOWS:

1. TERMINATION OF EMPLOYMENT. From the Effective Date through the Salary
Termination Date, as defined below, the Employee will provide such services, on
a part-time basis, as the Employer may reasonably request; provided that such
requests do not interfere with the Employee's other professional or consulting
activities. The Employee's employment with the Employer will terminate effective
as of December 31, 2001; provided, however, that if, prior to December 31, 2001,
Employee becomes a part-time or full-time employee of another for-profit entity
or provides consulting services to another for-profit entity for more than 80
hours per month, then the Employee's employment with the Employer will terminate
as of the date that the Employee becomes so employed or provides such consulting
services (the "Salary Termination Date"). The Employee shall promptly notify the
Employer if he becomes employed by another for-profit entity or provides
consulting services to a for-profit entity for more than 80 hours per month
prior to December 31, 2001. The Employee may become employed by or provide any
amount of consulting services to any not-for-profit entity prior to December 31,
2001 without affecting the Salary Termination Date.

2. RESIGNATION AS OFFICER. Employee hereby confirms his resignation of his
positions as (a) an officer of American Medical Systems Holdings, Inc. ("AMS
Holdings"), (b) an officer and director of all direct and indirect subsidiaries
of AMS Holdings, and (c) a member of the Employer's employee benefits committee.


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3. PRIOR AGREEMENTS. Except as expressly provided herein (a) the Employment
Agreement, dated March 24, 1999, between the Employer and the Employee (the
"Employment Agreement") is terminated effective as of the Effective Date, and
(b) the Secrecy and Non-Competition Agreement, dated March 11, 1999, between the
Employer and the Employee (the "Non-Compete Agreement") will remain in full
force and effect in accordance with its terms. Subject to the last sentence of
Section 4, neither the Employer nor the Employee will have any obligations,
rights or benefits under the Employment Agreement after the Effective Date. The
Restricted Period set forth in Section 1(a) of the Non-Compete Agreement will
expire on July 30, 2002.

4. COMPENSATION AND BENEFITS. In consideration for the Release and provided
Employee does not exercise his right to rescind this Agreement and Release as
set forth in Section 5 of the Release, Employer shall provide the Employee with
the compensation and benefits set forth in Exhibit B, subject to applicable
withholding for income and employment related taxes. The parties agree that the
consideration set forth in Exhibit B is greater than anything owed to Employee
by law, contract (including the Employment Agreement) or under the policies of
Employer and is provided to Employee in exchange for, and specifically
contingent upon, his signing this Agreement and the attached Release. If the
Employee rescinds the Release, the Employee's employment will terminate as of
the effective date of such rescission, and the Employee will be entitled to the
compensation and benefits set forth in Section 6(e) of the Employment Agreement
and will not be entitled to any compensation or benefits under this Agreement.

5. CONFIDENTIALITY. It is the intent of the parties that this Agreement and
Release be and is confidential. The Employee warrants that he has not and will
not disclose the terms of this Agreement and Release to any person other than
his spouse, attorney, tax advisor, financial advisor or representatives of the
E.E.O.C. or the Minnesota Department of Human Rights, who shall be bound by the
same prohibitions against disclosure as bind the Employee, and the Employee
shall be responsible for advising these individuals of this confidentiality
provision and obtaining their commitment to maintain such confidentiality. The
Employee acknowledges that Employer may be required to file this Agreement with
the Securities and Exchange Commission and disclose the material terms of this
Agreement in reports and proxy material filed by the Employer with the
Securities and Exchange Commission. The Employee may disclose the material terms
of this Agreement to the same extent as the Employer has disclosed such terms
pursuant to the foregoing sentence.

6. RELEASE. In consideration of the compensation and other benefits set forth in
this Agreement, the Employee will voluntarily sign the Release at the same time
he signs this Agreement. Except as set forth herein and except for any claims
the Employer may have for breach of this Agreement or the Non-Compete Agreement
occurring after the Effective Date, the Employer releases the Employee from any
and all claims, liabilities, causes of action and rights against the Employee
arising out of and in connection with the employment relationship between
Employee and the Employer.

7. STIPULATION OF NO CHARGES. The Employee affirmatively represents that he has
not filed nor caused to be filed any charges, claims, complaints, or actions
against the Employer before


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any federal, state, or local administrative agency, court, or other forum.

8. NON-DISPARAGEMENT. Each party to this Agreement agrees not to make any
disparaging or defamatory comments regarding the other party. Furthermore, the
Employee agrees not to encourage in any way any individual or group of
individuals to bring or pursue a lawsuit, charge, complaint, or grievance, or
make any other demands against Employer.

9. DAMAGES FOR VIOLATION OF DUTY OF CONFIDENTIALITY AND/OR NON-DISPARAGEMENT.
Any violation by either party of the confidentiality and/or non-disparagement
provisions of this Agreement shall entitle the other party to bring a legal
action for appropriate equitable relief as well as damages, including reasonable
attorneys' fees.

10. NON-ADMISSIONS. The parties expressly deny any and all liability or
wrongdoing and agree that nothing in this Agreement and Release shall be deemed
to represent any concession or admission of such liability or wrongdoing or any
waiver of any defense.

11. INVALIDITY. In case any one or more of the provisions of this Agreement and
Release shall be held invalid, illegal or unenforceable in any respect, the
validity, legality and enforceability of the remaining provisions contained in
this Agreement and Release will not in any way be affected or impaired thereby.

12. RETURN AND RELEASE OF ALL PROPERTY. The Employee agrees to immediately
return any and all of the Employer's property to the Employer.

13. CHOICE OF LAW/VENUE. This Agreement shall be construed and interpreted in
accordance with applicable federal laws and the laws of the State of Minnesota.
If either party brings a legal action pursuant to this Agreement and Release
including, but not limited to, an action to enforce its terms, or to challenge
its validity, such legal action shall be properly filed in a court of competent
jurisdiction located in Hennepin County, Minnesota.

      IN WITNESS WHEREOF, the parties have signed this Agreement on the date set
forth below to be effective as of the Effective Date.

                                       AMERICAN MEDICAL SYSTEMS, INC.


Dated:   October 16, 2001              By:    /s/ Janet L. Dick
                                           -------------------------------------

                                       Its:   Vice President, Human Resources
                                            ------------------------------------


Dated:   October 16, 2001              /s/ Gregory J. Melsen
                                       -----------------------------------------
                                       Gregory J. Melsen


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                                                                       EXHIBIT A

                                     RELEASE

1.    DEFINITIONS. I intend all words used in this Release to have their plain
meanings in ordinary English. Technical legal words are not needed to describe
what I mean. Specific terms I use in this Release have the following meanings:

      (a) "I," "me," and "my" include both me, Gregory J. Melsen and anyone who
      has or obtains any legal rights or claims through me.

      (b) "Employer," as used in this Release, shall at all times mean American
      Medical Systems, Inc., and its respective parent and/or subsidiary
      corporations, affiliates, successors, predecessors, shareholders, present
      and/or former officers, directors, agents, employees, and attorneys,
      whether in their individual or official capacities, benefit plans and plan
      administrators, and insurers.

      (c) "My Claims" mean any and all of the actual or potential claims of any
      kind whatsoever I have now against Employer, regardless of whether I now
      know about those claims, that are in any way related to my employment with
      or separation (termination of employment) from the Employer, including,
      but not limited to, claims for invasion of privacy; breach of written or
      oral, express or implied, contract; fraud or misrepresentation; the Age
      Discrimination in Employment Act of 1967 ("ADEA"), 29 U.S.C. ss. 626, as
      amended, the Older Workers Benefit Protection Act of 1990 ("OWBPA"), 29
      U.S.C. 626(f), Title VII of the Civil Rights Act of 1964 ("Title VII"), 42
      U.S.C. ss. 2000e, et seq., the Americans with Disabilities Act ("ADA"), 29
      U.S.C. ss. 2101, et seq., the Family Medical Leave Act ("FMLA"), 29 U.S.C.
      ss. 2601 et seq., the Employee Retirement Income Security Act of 1978
      ("ERISA"), as amended, 29 U.S.C. ss. ss. 1001, et seq., Equal Pay Act
      ("EPA"), 29 U.S.C. ss. 206(d), the Worker Adjustment and Retraining
      Notification Act ("WARN"), 29 U.S.C. ss. 2101 et seq., the Minnesota Human
      Rights Act, Minn. Stat. ss. 363.01, et seq., Minnesota Statutes ss. 181 et
      seq., and any other federal, state, or local statute, law, rule,
      regulation, ordinance or order. This includes, but is not limited to,
      claims for violation of any civil rights laws based on protected class
      status; claims for assault, battery, defamation, intentional or negligent
      infliction of emotional distress, breach of the covenant of good faith and
      fair dealing, promissory estoppel, negligence, violation of public policy,
      and all other claims for unlawful employment practices, and all other
      common law or statutory claims.

2.    AGREEMENT TO RELEASE MY CLAIMS. Except as stated in Section 4, I agree to
give up all My Claims, waive any rights thereunder, and withdraw any and all of
my charges and lawsuits against Employer. In exchange for my agreement to
release My Claims, I am receiving satisfactory consideration (compensation) from
Employer to which I am not otherwise entitled by law, contract, or under any
Employer policy. The consideration I am receiving is a full and fair payment for
the release of all My Claims. Employer does not owe me anything in addition to
what I will be receiving.


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3.    OLDER WORKERS BENEFIT PROTECTION ACT. I understand and have been advised
that the above release of My Claims is subject to the terms of the Older Workers
Benefit Protection Act ("OWBPA"). The OWBPA provides that an individual cannot
waive a right or claim under the Age Discrimination in Employment Act ("ADEA")
unless the waiver is knowing and voluntary. I have been advised of this law, and
I agree that I am signing this Release voluntarily, and with full knowledge of
its consequences. I understand that the Employer is giving me at least
twenty-one (21) days from the date I received a copy of this Release to decide
whether I want to sign it. I acknowledge that I have been advised to use this
time to consult with an attorney about the effect of this Release. IF I SIGN
THIS RELEASE BEFORE THE END OF THE TWENTY-ONE (21) DAY PERIOD IT WILL BE MY
PERSONAL, VOLUNTARY DECISION TO DO SO, AND WILL BE DONE WITH FULL KNOWLEDGE OF
MY LEGAL RIGHTS. I agree that material and/or immaterial changes to this Release
will not restart the running of this consideration period.

4.    EXCLUSIONS FROM RELEASE.

      (a) My Claims do not include my rights, if any, to claim the following:
      Re-employment Insurance benefits; claims for my vested post-termination
      benefits under any 401(k) or similar retirement benefit plan; my COBRA
      rights; my rights to enforce the terms of this Release; or my rights to
      assert claims that are based on events occurring after this Release
      becomes effective.

      (b) Nothing in this Release interferes with my right to file a charge with
      the Equal Employment Opportunity Commission ("EEOC"), or participate in
      any manner in an EEOC investigation or proceeding under Title VII, the
      ADA, the ADEA, or the EPA. I, however, understand that I am waiving my
      right to recover individual relief including, but not limited to, back
      pay, front pay, reinstatement, attorneys' fees, and/or punitive damages,
      in any administrative or legal action whether brought by the EEOC,
      Employee, or any other party.

      (c) Nothing in this Release interferes with my right to challenge the
      knowing and voluntary nature of this Release under the ADEA and/or OWBPA.

      (d) Nothing in this Release limits any rights that I would otherwise have
      to be indemnified by the Employer, in my capacity as an officer or
      employee of the Employer, under the Employer's Certificate of
      Incorporation, Bylaws, directors' and officers' insurance policy or
      Section 145 of the Delaware General Corporation Law.

      (e) I agree that Employer reserves any and all defenses, which it has or
      might have against any claims brought by me. This includes, but is not
      limited to, Employer's right to seek available costs and attorneys' fees,
      and to have any monetary award granted to me, if any, reduced by the
      amount of money that I received in consideration for this Release.

5.    RIGHT TO RESCIND AND/OR REVOKE. I understand that insofar as this Release
relates to my rights under the Age Discrimination in Employment Act ("ADEA"), it
shall not become effective or enforceable until seven (7) days after I sign it.
I have the right to rescind this Release only


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insofar as it extends to potential claims under the ADEA by written notice to
Employer within seven (7) calendar days following my signing this Release, and
within fifteen (15) calendar days as to waiver of claims under the Minnesota
Human Rights Act. Any such rescission must be in writing and hand-delivered to
Employer or, if sent by mail, postmarked within the applicable time period, sent
by certified mail, return receipt requested, and addressed as follows:

      (a) post-marked within the seven (7) or fifteen (15) day period;

      (b) properly addressed to JANET L. DICK, VICE PRESIDENT OF HUMAN
      RESOURCES, AMERICAN MEDICAL SYSTEMS, INC., 10700 BREN ROAD WEST,
      MINNETONKA, MN 55343-9679, and

      (c) sent by certified mail, return receipt requested.

      I understand that the payment I am receiving for settling and releasing My
      Claims is contingent upon my agreement to be bound by the terms of this
      Release. Accordingly, if I decide to revoke this Release, I understand
      that I am not entitled to the payments offered in the attached Settlement
      Agreement.

6.    I UNDERSTAND THE TERMS OF THIS RELEASE. I have had the opportunity to read
this Release carefully and understand all its terms. I have reviewed this
Release with my own attorney. In agreeing to sign this Release, I have not
relied on any statements or explanations made by Employer or their attorneys. I
understand and agree that this Release and the attached Settlement Agreement
contain all the agreements between Employer and me. We have no other written or
oral agreements.


Dated:   October 16, 2001                   /s/ Gregory J. Melsen
                                            ------------------------------------
                                            Gregory J. Melsen


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                                                                       EXHIBIT B

                            COMPENSATION AND BENEFITS

1.    SALARY CONTINUATION AND CASH PAYMENT. The Employer shall pay the Employee
his current annualized base salary of $168,000 through the earlier of the Salary
Termination Date or December 31, 2001, in accordance with the Employer's normal
payroll practice and subject to applicable withholding taxes. If the Salary
Termination Date is December 31, 2001, then on January 15, 2002, the Employer
shall pay the Employee $130,000 subject to applicable withholding taxes. Upon
execution of the Agreement, the Employer will make a one-time cash payment to
the Employee of $8,000, subject to applicable withholding taxes.

2.    INCENTIVE BONUS. Upon execution of the Agreement, the Employer will pay
the Employee a bonus in the amount of $50,400, subject to applicable withholding
taxes, which represents the Employee's bonus under the Employer's 2001
Management Incentive Plan, assuming the Employer achieves 100% of the revenue
and operating income objectives under the 2001 Management Incentive Plan for the
full year 2001. If the Employer exceeds 100% of the revenue and operating income
objectives under the 2001 Management Incentive Plan for the full year 2001, the
Employer will pay the Employee the additional bonus to which the Employee would
have been entitled under such plan, as if Employee had been an officer of the
Employer on the date such payment is made, in the first calendar quarter of 2002
at the same time that the Employer pays bonuses under the 2001 Management
Incentive Plan to the participants in the plan. If the Employer does not achieve
100% of the revenue and operating income objectives under the 2001 Management
Incentive Plan for the full year 2001, the Employee will be entitled to retain
the full amount of the bonus paid under this Section 2.

3.    STOCK OPTIONS. The Incentive Stock Option Agreement, dated April 23, 1999,
between the Employer and the Employee (the "Option Agreement") shall remain in
full force and effect in accordance with its terms, except as set forth in this
Section 3. The Employer and Employee acknowledge and agree that, as of the
Effective Date, options to purchase 23,450 shares of Common Stock of AMS
Holdings were vested and unexercised under the Option Agreement and shall remain
exercisable for a period of ninety (90) days after the Effective Date, as set
forth in Section 3(e) of the Option Agreement. Options to purchase 56,250 shares
pursuant to the Option Agreement that had not vested as of the Effective Date
shall (a) become vested and exercisable upon expiration, without rescission, of
all rescission periods set forth in Section 5 of the Release and (b) remain
exercisable through January 31, 2003. The Employee acknowledges that the options
that become exercisable pursuant to the preceding sentence will not qualify as
"incentive stock options" under Section 422 of the Internal Revenue Code.

4.    VACATION/FLOATING HOLIDAYS/UNITED WAY DAYS. Upon execution of the
Agreement, the Employer will pay the Employee for all accrued and unused
vacation, floating holidays and United Way Days as of the Effective Date,
calculated using the Employee's current base salary. The Employee will not
accrue any vacation, floating holidays or United Way Days after the Effective
Date.


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5.    MEDICAL, DENTAL AND EMPLOYEE LIFE PLANS. The Employee will have the right
to participate in the Employer's insured group Medical, Dental, and Employee
Life Insurance plans (including dependant coverage under all such plans) that
the Employer maintains for its other employees on the same basis and at the same
cost afforded to "active" employees through the earlier of (a) December 31, 2002
or (b) the date on which the Employee first becomes eligible to participate in
another group plan providing benefits to the Employee and his eligible family
members. The Employer shall withhold and deduct from payments made through the
Salary Termination Date under Section 1 of this Exhibit B all legally required
amounts necessary to satisfy applicable federal, state or local withholding and
employment tax requirements and the Employee's portion of insurance premiums for
the Employer's group Medical, Dental, and Employee Life Insurance plans. After
January 1, 2002, the Employee shall pay his portion of insurance premiums for
the Employer's group Medical, Dental, and Employee Life Insurance plans directly
to the Employer's third party administrator. The Employee's COBRA rights with
respect to the Employer's group Medical, Dental, and Employee Life Insurance
plans shall begin on the earlier of (a) December 31, 2002 or (b) the date on
which the Employee first becomes eligible to participate in another group plan
providing benefits to the Employee and his eligible family members.

6.    OTHER BENEFIT PLANS. The Employee's right to participate in all other
benefit plans of the Employer will cease as set forth below.

      (a) Employee AD&D Insurance. Coverage will cease as of October 1, 2001.
      Continuation coverage is not available for Employee AD&D insurance
      coverage.

      (b) Dependent AD&D Insurance (if applicable). Coverage will cease as of
      October 1, 2001, unless the Employee elects to discontinue the deductions
      earlier. Continuation coverage is not available for Dependent AD&D
      insurance coverage.

      (c) Flexible Spending Accounts. The Employee agrees not to make any
      contributions after December 31, 2001 to the Employer's Dependent Care
      Spending Account or Health Care Spending Account.

      (d) AMS Savings Investment Plan. The Employee agrees not to make any
      contributions to the AMS Savings and Investment Plan (including the
      related non-qualified plan) after the Effective Date. The Employee may
      take a distribution under this plan or roll the account balance into a
      qualified IRA at any time after the Salary Termination Date.

      (e) AMS Retirement Annuity Plan. The Employee's years of creditable
      service under the AMS Retirement Annuity Plan will be calculated based
      upon service as of the Effective Date. As of September 30, 2001, the
      Employee's accrued benefit (assuming the Employee elects a lump sum
      distribution) under the AMS Retirement Annuity Plan was $28,616,07. The
      Employer intends to terminate the plan effective as of December 31, 2001.

      (f) Disability. Short Term Disability and Long Term Disability coverage
      will cease


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      as of the Effective Date.

      (g) Employee Stock Purchase Plan. The Employee's right to participate in
      the Employee Stock Purchase Plan shall cease as of the Effective Date.

      (h) Group Legal Plan (Hyatt Premier Legal Plan). If the Employee is
      currently enrolled in the group legal plan, contributions will cease as of
      as of the Effective Date.

      (i) Other Benefit Plans. The Employee's right to participate in all other
      benefit plans of the Employer shall cease as of the Effective Date.


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