**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**Washington,D.C. 20549

**FORM 10-K**

                                                         (Mark One)

[x]   ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year endedMarch 31, 2003or

[  ]   TRANSITION REPORT PURSUANT TO SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition periodfrom ____ to _____

Commission File No. 0-7955**MENTOR CORPORATION**(Exact Name of Registrant as Specified in its Charter)

                                                                                                         Minnesota                                           41-0950791                                                                                         (State ofother jurisdiction of                (IRSEmployer Identification No.)                                                                                           incorporationor organization)                      

201 Mentor Drive, SantaBarbara, California 93111(Address of Principal Executive Offices) (Zip Code)Registrant's telephone number including area code:  805/879-6000

Securities registeredpursuant to Section 12(b) of the Act:  NONE

Securities registeredpursuant to Section 12(g) of the Act:

Common Shares, par value$.10 per share

                Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes [x]  No[  ]

                Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof the Registrant's knowledge, in a definitive proxy or information statementincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K  [  ]

                Indicateby check mark if whether the Registrant is an accelerated filer (as defined inExchange Act Rule 12b-2).  Yes [x]  No[  ]

                Basedon the closing sale price on the Nasdaq National Market as of the last businessday of the Registrant's most recently completed second fiscal quarter(September 30, 2002), the aggregate market value of the Common Shares of theRegistrant held by non-affiliates of the Registrant was approximately$660,153,000.  For purposes of thiscalculation, shares held by each executive officer, director and holder of 10%or more of the outstanding shares of the Registrant have been excluded in thatsuch persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusivedetermination for other purposes.

As of June 25, 2003 there were approximately 46,654,512 Common Shares outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

                Portions of the Registrant'sProxy Statement for its 2003 Annual Meeting of Shareholders are incorporated byreference into Part III of this Report on Form 10-K. 

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**Table of Contents**

| **ITEM** | **PART I**                                                                                      |
|----------|-------------------------------------------------------------------------------------------------|
| 1.       | Business                                                                                        |
|          | General                                                                                         |
|          | Principal Products and Markets                                                                  |
|          | Sales by Principal Product Lines                                                                |
|          | Marketing                                                                                       |
|          | International Operations                                                                        |
|          | Competition                                                                                     |
|          | Government Regulations                                                                          |
|          | Medicare, Medicaid and Third Party Reimbursement                                                |
|          | Product Development                                                                             |
|          | Patents and Licenses                                                                            |
|          | Raw Material Supply  and Single Source Suppliers                                                |
|          | Seasonality                                                                                     |
|     | Working Capital                                                                                 |
|     | Employees                                                                                       |
|     | Risk Factors                                                                                    |
|          | Executive Officers of the Registrant                                                            |
| 2.       | Properties                                                                                      |
| 3.       | Legal Proceedings                                                                               |
| 4.       | Submission of Matters to a Vote of Security Holders                                             |
|          |                                                                                            |
|          | **PART II**                                                                                     |
| 5.       | Market for Registrant's Common Equity and  Related Stockholder Matters                          |
| 6.       | Selected Financial Data                                                                         |
| 7.       | Management's Discussion and Analysis of Financial  Condition and Results of Operations          |
| 7A.      | Quantitative and Qualitative Disclosures About  Market Risk                                     |
| 8.       | Financial Statements and Supplementary Data                                                     |
| 9.       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure           |
|          |                                                                                            |
|          | **PART  III**                                                                                   |
| 10.      | Directors and Executive Officers of the Registrant                                              |
| 11.      | Executive Compensation                                                                          |
| 12.      | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters |
| 13.      | Certain Relationships and Related Transactions                                                  |
| 14.      | Controls and Procedures                                                                         |
| 15.      | Principal Accountant Fees and Services                                                          |
|          |                                                                                            |
|          | **PART IV**                                                                                     |
| 16.      | Exhibits, Financial Statement Schedules and Reports  on Form 8-K                                |
|          | Report of Independent Auditors                                                                  |
|          | Consolidated Financial Statements                                                               |
|          | Signatures                                                                                      |
|          | Certifications Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                       |
|          | Exhibit Index                                                                                   |

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**PART I**

** FORWARD-LOOKINGSTATEMENTS**

Various statements in this Form 10-K orincorporated by reference into this Form 10-K, in future filings by us with theSEC, in our press releases and in our oral statements made by or with theapproval of authorized personnel, constitute "forward-lookingstatements" within the meaning of the Private Securities Litigation ReformAct of 1995.  Forward-looking statementsare based on current expectations and are indicated by words or phrases such as"anticipate," "estimate," "expect,""intend," "project," "plan," "we believe,""will," "seek," and similar words or phrases and involve known andunknown risks, uncertainties and other factors which may cause actual results,performance or achievements to be materially different from any future results,performance or achievements expressed or implied by such forward-lookingstatements.  Some of the factors thatcould affect our financial performance or cause actual results to differ fromour estimates in, or underlying, such forward-looking statements are set forthunder the heading of "Risk Factors" or elsewhere in this Form10-K.  Forward-looking statements includestatements regarding, among other things:

- Our anticipatedgrowth strategies;  
- Our intention tointroduce or seek approval for new products;  
- Our ability tocontinue to meet FDA and other regulatory requirements;  
- Our anticipatedoutcomes of litigation and regulatory reviews; and  
- Our ability to replace sources of supply without disruption and regulatory delay.

These forward-looking statements arebased largely on our expectations and are subject to a number of risks anduncertainties, many of which are beyond our control.  Actual results could differ materially fromthese forward-looking statements as a result of the facts described in "RiskFactors" or elsewhere including, among others, problems with suppliers, changes in thecompetitive marketplace, significant product liability or other claims,difficulties with new product development, theintroduction of new products by our competitors, changes in the economy, UnitedStates Food Drug and Administration (FDA) delay in approval or rejection of newor existing products, changes in Medicare, Medicaid or third-partyreimbursement policies, changes in government regulations, use of hazardous orenvironmentally sensitive materials, inability to implement new informationtechnology systems, inability to integrate new acquisitions, and other events.  We undertake no obligation to publicly updateor revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. In light of these risks and uncertainties, we cannot assure you that theforward-looking information contained in this Form 10-K will, in fact,transpire.

| **ITEM  1.** | **BUSINESS.** |
|--------------|---------------|

Unless the context indicates otherwise,when we refer to "Mentor," "we," "us,""our," or the "Company" in this Form 10-K, we are referringto Mentor Corporation and its subsidiaries on a consolidated basis.  Mentor Corporation was incorporated inMinnesota in 1969.  Our fiscal year endson March 31 and references to fiscal 2003, fiscal 2002 or fiscal 2001 refer tothe years ended March 31, 2003, 2002 or 2001, respectively.

General

We develop, manufacture and market abroad range of products for the medical specialties of aesthetic and generalsurgery (plastic and reconstructive surgery) and surgical urology, and for clinicaland consumer healthcare.  Aesthetic andgeneral surgery products include surgically implantable prostheses for plasticand reconstructive surgery and capital equipment and consumables used for softtissue aspiration (liposuction). Surgical urology products include surgically implantable prostheses forthe treatment of impotence, surgically implantable incontinence products,urinary care products and brachytherapy seeds for the treatment of prostatecancer.  Clinical and consumer healthcareproducts include catheters and other products for the management of urinaryincontinence and retention. 

Effective January 19, 2001, we acquiredthe assets of South Bay Medical, LLC, a development-stage company focused onthe development of a new technology for a computer-based workstation andautomated cartridge-based needle loading system for use in brachytherapyprocedures.

Effective February 9, 2001, we acquiredPorges S.A., a subsidiary of Sanofi-Synthelabo,headquartered in Paris with manufacturing facilities in Sarlat, France.  Porges holds a leading market share forurological products in France and has a strong market position throughoutEurope. 

Effective December 31, 2001, weacquired the remaining 51% of the shares of Byron Medical, Inc.  We now own 100% of the shares.  Byron Medical is located in Tucson, Arizonaand specializes in the distribution of liposuction equipment and supplies. 

In December 2001, we entered intoseveral agreements with ProSurg, Inc. to acquire certain patent rights, and to obtain a source of supply of a bio-absorbableco-polymer product to be used in the surgical treatment of female stressurinary incontinence.  We introduced thisnew product, SabreTM in June 2002. 

Effective May 6, 2002, weacquired the urology and ostomy businesses of Portex Ltd., a subsidiary ofSmiths Group plc including Smith's Medical Deutschland, GmbH, which manufactureand market incontinence and ostomy products primarily for the home healthcaremarket.  

Effective February 1, 2003, weacquired Mills Biopharmaceuticals Inc. located in Oklahoma City, Oklahoma.  Mills manufactures radioactive brachytherapyseeds for the treatment of prostate cancer. 

We maintain a web site atwww.mentorcorp.com.  Our annual report onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and anyamendments to those reports, are available, without charge, on our web site,www.mentorcorp/about/investor.htm, as soon as reasonably practicable after theyare filed electronically with the Securities and Exchange Commission.  Paper copies are also available, withoutcharge, from Mentor Corporation, 201 Mentor Drive, Santa Barbara, CA 93111, Attention:  InvestorRelations.

Principal Products and Markets

*Aestheticand General Surgery Products*

We produce a broad line of mammaryprostheses, including saline-filled implants and silicone gel-filledimplants.  In fiscal 2003, approximately83% of our aesthetic and general surgery revenues were from sales of mammaryprostheses.  Saline-filled breastimplants accounted for approximately 65% of the mammary prostheses we sold infiscal 2003.

Mammary prostheses have applications inboth cosmetic and reconstructive plastic surgery procedures. These prosthesesare used in cosmetic augmentation procedures to enhance breast size and shape.  In the reconstruction procedure market,mammary prostheses are utilized as a surgical solution to reform the breastfollowing a mastectomy.  Breastreconstruction is a surgical option for many women following mastectomy eitherat the time of surgery or a later date. 

We also offer a line of tissueexpanders.  Tissue expansion is atechnique for growing additional tissue for reconstruction and skin graftprocedures.  Some of the major applicationsof tissue expansion developed to date include post-mastectomy breastreconstruction and the improvement of disfigurements such as burns, large scarsand congenital deformities.

In September 1997, we began marketingan ultrasound-assisted product used for the aspiration of soft tissues ingeneral surgery and cosmetic surgery applications.  We have completed clinical trials in order toexpand the labeling of the product to include ultrasonic-assisted liposuctionand received approval from the FDA to expand the labeling in October 2001.  Our acquisition of Byron Medical, Inc. andthe acquisition of certain assets of LySonix, Inc., a former competitor in theultrasonic liposuction equipment and supplies market hasexpanded our offering of liposuction products to include traditional, powerassisted and ultrasonic liposuction product offerings.  As a result of these acquisitions, we arepositioned as a broad line supplier to the entire body contouring (liposuction)market.

*SurgicalUrology Products*

Our surgical urology products fall intofour general categories: erectile dysfunction products, urinary care products,pelvic floor products, and cancer treatment products.  

Erectile Dysfunction Products:  Our erectiledysfunction products consist of a line of penile implants for the treatment ofmale sexual impotence.  Penile prosthesesare implanted in men who cannot achieve a natural erection of sufficientrigidity for sexual intercourse.  Penileimplants have become the standard of care for men who have not responded toless invasive therapies, the best known of which is Pfizer's Viagra®.  In order torespond to various physician and patient preferences, we manufacture severaltypes of penile prostheses, including hydraulic inflatable devices and amalleable prosthesis.  Late in fiscal2000, we introduced a major improvement to our Alpha 1 inflatable device - theLockout® valve.  TheLockout valve is designed to prevent auto-inflation, a potential complicationin this type of treatment.  In May 2002,we received Canadian and Conformite Europeene("CE") approval for the sale and marketing of penile implantsutilizing our new ResistTM coating designed to reduce bacterial adherence.  In August 2002, we received FDA approval tomarket the TitanTM inflatable penile prosthesis with a hydrophilic coating thatadds a number of advantages for the physician and patient alike.

Urinary Care:  Our productsconsist of disposable urological devices for use in the hospital and outpatientsetting.  These devices consist ofendourological stents, catheters, urinary drainage systems, stone baskets,wound drainage products and other specialty urological items, most of which weacquired in the Porges acquisition. These products are used during and following surgery for the treatmentof upper urinary tract disease such as kidney stones, ureteralstones and tumors and for the treatment of lower urinary track diseases such asBPH, prostate cancer, bladder cancer and other urinary bladder relatedproblems.

Pelvic Floor Products:  We market theSuspend® Sling for use in pubovaginal sling and pelvic floorreconstruction procedures.  Pubovaginalsling procedures provide relief for women suffering from urinary stressincontinence.  Late in fiscal 2002, weintroduced the following new products for pelvic floor reconstruction andstress incontinence:

-  AxisTM, a dermalbased tissue which, like Suspend®, istreated using the patented Tutoplast®process to provide the surgeon with additional tissue choices for the treatmentof pelvic floor prolaspe as well as incontinence;- SabreTM, a bio-absorbable synthetic co-polymer sling for anadditional choice in the surgical treatment of incontinence; and   
- Uratape ®  and ObTapeTM, polypropylenesynthetic slings sold in Europe through an exclusive supply and distributionarrangement.  In fiscal 2004, wepurchased the rights to these products and have submitted a 510(k) applicationto the FDA to seek approval to market ObTapeTM intothe United States.  The two products usea unique surgical procedure that offers benefit to physicians and patients.  

Cancer Treatment Products:  Our cancertreatment products consist primarily of two types of brachytherapy seeds,(iodine and palladium), for the treatment of prostate cancer, associatedsupplies and delivery systems. Previously, we sold these products under an exclusive worldwide distributionagreement with North American Scientific, Inc. ("NASI"), a producerof brachytherapy seeds for the treatment of prostate cancer.  NASI manufactured and shipped the seeds,while we performed of the sales and marketing functions.  In January 2003, NASI discontinued the supplyof both iodine and palladium seeds to our customers, and the agreementexpired.  We then began to supplycustomers with ProstaSeed® iodine seeds manufactured by our newly acquiredsubsidiary, Mills Biopharmaceuticals, Inc. In addition, on January 7, 2003, we reached a nonexclusive agreement todistribute BestTM Palladium-103 brachytherapy seeds, and began to distributethose seeds shortly thereafter.  However,due to difficulties in increasing manufacturing capacity in a short time frame,we have been unable to secure adequate supply from the vendor to fulfillcustomer demand.  We believe that othersatisfactory sources for similar radioactive seeds for use in brachytherapytreatment of the prostate can be manufactured or obtained, although there is noassurance that such seeds can be manufactured or obtained on terms satisfactoryto us.  Nor is there any assurance thatwe can obtain palladium seeds without interruption or regulatory delay, or thatthose seeds will ultimately be acceptable to customers.  Interruption of the supply of seeds,additional competition, regulatory delay, additional costs to procure seeds, orloss of customers and market share may have a negative effect on revenues andthe results of operations.  

In January 2001, we announced theacquisition of South Bay Medical, LLC and its new technology for acomputer-based workstation and automated cartridge-based needle loading systemIsoloaderTM, for use in brachytherapy procedures.  Early in fiscal 2002, we submitted a 510(k)application to the FDA for approval to market the system.  The FDA had requested additional informationregarding the application.  We haveresponded to all of the FDA's requests, and received FDA approval in October2002 and began to market the workstation in the United States late in fiscal2003.  We had also received the necessaryapprovals from the Canadian Therapeutic Products Directorate to market and sellthe Isoloader workstation and needle loading system in Canada in April2002.  

*Clinicaland Consumer Healthcare Products*

We market a line of male externalcatheters that help men manage their incontinence, and a line of intermittentself-catheters for men, women and children who suffer from urinaryretention.  These products are disposableand are used in homes, hospitals, and rehabilitation and extended carefacilities.

In February 2001, we announced theacquisition of Porges S.A., a French company specializing in urologicaldisposables, including diagnostic tools and various devices for surgery andpostoperative follow-up.  We introducedthe first of these products into the U.S. market in fiscal 2002.  

We also market a variety of otherdisposable products used in the management of urinary incontinence andcancer.  These include leg bags and urinecollection systems, the BTA *Stat*® cancer test, organic odor eliminators, andmoisturizing skin creams and ointments. In April 2001, we began to distribute the BTA *Stat*® point-of-care bladdercancer screening test manufactured by Polymedco, Inc. under an exclusive supplyand distribution agreement.

We introduced the Self-Cath PlusTM, a lubricious coated intermittentcatheter, along with a closed system sterile intermittent catheter in fiscal2002.  Effective May 6, 2002, we acquiredthe urology and ostomy businesses of Portex Ltd., which manufacture and marketincontinence and ostomy products primarily for the home healthcare market suchas drain bags, ostomy pouches, intermittent catheters, male external catheters,and Foley catheters.  

Sales by Principal Product Lines

The following table shows the net salesattributable to each of our principal product lines and the percentagecontributions of such sales to total net sales for the periods indicated.

Year Ended March 31,

**2003**

2002

2001

(in thousands)

**Amount**

**%**

Amount

%

Amount

%

Aesthetic and General Surgery

**$191,405**

**50%**

$163,091

51%

$157,122

    59%

Surgical Urology 

**106,675**

**28    **

94,341

29   

    62,264

    23   

Clinical and Consumer Healthcare

**84,304**

**22    **

63,630

20   

    49,508

    18   

**$382,384**

**     100%**

$321,062

    100%

$268,894

  100%

For additional information regardingour revenues, operating profits and identifiable assets attributable to ourbusiness segments as well as domestic and foreign operations, see "Note P-BusinessSegment Information" of the"Notes to Consolidated Financial Statements."

Marketing

We employ specialized domestic salesforces for our aesthetic surgery, body contouring, surgical urology,brachytherapy and clinical and consumer healthcare product lines.  Each sales force provides product informationor specific data support and related services to physicians, nurses and otherhealth care professionals.  We alsomarket certain products, particularly our disposable incontinence products,through a domestic network of independent hospital supply dealers and healthcaredistributors, and through retail pharmacies.

We promote our products throughparticipation in and sponsorship of medical conferences and educationalseminars, radio, newspaper and journal advertising, direct mail programs, and avariety of marketing support programs. We also participate in support organizations that provide counseling andeducation for persons suffering from specific disease states, and providepatient education materials for some of our products to physicians for use withtheir patients.

International Operations 

We export most of our product lines,principally to Canada, Western Europe, Central and South America, and thePacific Rim.  Products are sold both toindependent distributors as well as through our direct international salesoffices in Canada, the United Kingdom, Germany, France, Japan, Benelux,Australia, Spain, Portugal and Italy. Total foreign sales through distributors and direct international salesoffices were $138 million, $101 million, and $59 million in fiscal 2003, 2002and 2001, respectively.  Other than salesmade through our international sales offices, which are denominated in thelocal currency of the sales office, export sales are made in United Statesdollars.  

In addition, we manufacture mammaryimplants in The Netherlands, and disposable urology products in France, and through recent acquisitions have acquiredmanufacturing facilities in the United Kingdom where urologic disposables arealso manufactured and warehoused.  Totallong-lived assets located in a foreign country were $48 million, $30 million,and $23 million in fiscal 2003, 2002 and 2001, respectively.  

For additional information regardingour international operations, see "Risk Factors - Our International BusinessExposes Us to a Number of Risks" and "Note P-Business SegmentInformation" of the"Notes to the Consolidated Financial Statements." 

Competition

We believe we are one of the leadingsuppliers of penile implants, cosmetic and reconstructive surgery products, anddisposable catheter products.  Thisbelief is based upon information developed internally, public informationsources, and information from independent research studies of market share. 

In the domestic breast implant market,we compete primarily with one other company, McGhan Medical Corporation, asubsidiary of INAMED, Inc.  The primarycompetitive factors in this market currently are product performance andquality, range of styles and sizes, proprietary design, customer service and,in certain instances, price.  In Europe,we compete with INAMED, Inc., as well as numerous smaller competitors.

We compete with only one other companyworldwide in the inflatable penile implant market, American Medical Systems,Inc.  Several companies sell competingmalleable penile implants.  The primarycompetitive factors are product performance and reliability, ease ofimplantation, and customer service.  Webelieve that by providing several types of implants that emphasize highperformance and reliability, we can successfully respond to various physicianand patient preferences.  

We compete with many other companies inthe United States providing brachytherapy seeds for the treatment of prostatecancer, including Amersham Health Care, C.R. Bard, Inc., TheragenicsCorporation, North American Scientific, Inc., and others.  The primary competitive factors in thismarket are technologies that support efficient preparation and implantation ofradioactive sources through improved product delivery, product offering,customer service, delivery technologies, and consistent quality.  We believe that we have the second largestmarket share for iodine seeds, and that the recent approval of our automatedworkstation, Isoloader®, will provide us with a competitiveadvantage.

We compete with a number of othercompanies in the pubovaginal sling and pelvic floor reconstruction market,including J&J Gynecare, C.R. Bard, Inc., American Medical Systems, Inc.,Boston Scientific Microvasive division, andothers.  As a first line treatment, thedemand factors for this market include having a wide selection of materials andoffering the surgeon multiple choices of procedure options to meet specificpatient requirements.  We believe weoffer the widest selection of choices including allograft, bioresorbable andsynthetic materials that may be placed through a number of surgicaltechniques.  We also believe that weoffer the least invasive treatment for stress urinary incontinence. 

By superior design and active marketingof catheters and other disposable incontinence products, we have been able tocompete successfully against larger companies in this market.  C.R. Bard, Inc., Hollister, Inc., Kendall (adivision of Tyco HealthCare), and Coloplast Corporation are the dominant competitorsin the worldwide market.  As with many ofour other product lines, we compete primarily on the basis of design andperformance, and by providing product orientation, support and related servicesto health care professionals and consumers. The fiscal 2001 Porges S.A. acquisition and the fiscal 2003 acquisitionof the urology and ostomy businesses of Portex provide us with significantmarket share in the European market.

Government Regulations

* General*

Asa manufacturer of medical devices, our manufacturing processes and facilitiesare subject to continuing review by the FDA and various state and internationalagencies.  These agencies inspect us andour facilities from time to time to determine whether we are in compliance withvarious regulations relating to manufacturing practices and otherrequirements.  The FDA has the power toprevent or limit further marketing of products based upon the results of theseinspections.  These regulations dependheavily on administrative interpretation by various agencies.  There can be no assurance that futureinterpretations made by the FDA or other regulatory bodies will not adverselyaffect us.  A determination that we arein violation of such regulations could lead to imposition of various penalties,including the issuance of warning letters, injunctive relief (whether byadverse court ruling or by consent), product recalls, civil penalties, productseizures, or criminal prosecution.

Advertising and promotion ofmedical devices is regulated by the FDA and the Federal Trade Commission(FTC).  A determination that we are in violation of such regulations couldlead to imposition of various penalties, including warning letters, productrecalls, injunctive relief, civil penalties, or prosecution.

Products and materialsmanufactured internationally which may come under Homeland Security statutesfrom time to time and could be restricted entry into the United States by FDAand US Customs.  The restricted entry of such products and materials couldaffect the manufacturing and sale of product domestically and internationally.

*Medical DeviceAmendments of 1976*

Underthe "Medical Device Amendments of 1976" as amended, the FDA has theauthority to adopt regulations that: (i) set standards for medical devices;(ii) require proof of safety and effectiveness prior to marketing devices whichthe FDA believes require pre-market clearance; (iii) require test data to besubmitted to the FDA prior to clinical evaluation in individuals; (iv) permitdetailed inspections of device manufacturing facilities; (v) establish GoodManufacturing Practices ("GMPs") that must be followed in devicemanufacture; (vi) require reporting of certain adverse events and devicemalfunctions  to the FDA; and (vii)prohibit device exports that do not meet certain requirements.  The FDA also can regulate promotionalactivities by device companies.  All ofour products are medical devices and are therefore subject to FDAregulation.

Theamendments establish complex procedures for FDA regulation of devices.  Devices are placed in three classes:  Class I (general controls to precludemisbranding or adulteration, compliance with labeling and other requirements),Class II (special controls and the FDA clearance in addition to generalcontrols), and Class III (pre-market approval application ("PMAA")before commercial marketing).  Class IIIdevices are the most extensively regulated. Class III devices require each manufacturer to submit to the FDA a PMAAthat includes information on the safety and effectiveness of the device.  The majority of our aesthetic surgery andurology implants are in Class III, while most of our disposable incontinenceproducts are in Classes I and II.

In1991, we submitted a pre-market approval application for our siliconegel-filled mammary prostheses to the FDA.  In 1992, the FDA's outside advisory panel onaesthetic surgery products indicated that although there was insufficient datato establish with reasonable certainty that silicone gel implants were safe andeffective, there was a public health need for these types of implants.  The FDA adopted the recommendations of thepanel.

TheFDA denied the pending applications for the use of silicone gel-filled breastimplants for augmentation, but provided for the continued availability of theimplants for reconstruction purposes on the basis of a public health need.  Since 1993, women have been required toenroll in a clinical study for future follow-up in order to receive gel-filledimplants for reconstruction.  Patientsare required to sign an informed consent form and physicians must certify thatsaline implants are not a satisfactory alternative.  We continue to ship these products under theterms of this clinical study.

In1993, the FDA published proposed guidelines for pre-market approvalapplications applicable to our hydraulic inflatable penile prostheses andsaline-filled breast implants.  Wesubmitted all the required data for our saline implants, and the FDA approvedour application on May 10, 2000.  Inconjunction with their review of the data, the FDA inspected our manufacturingfacility in Irving, Texas and indicated the facility was in substantialcompliance with the applicable regulations. We also submitted all required data for our penile implants, andreceived FDA approval on July 14, 2000.

Wehave incurred, and will continue to incur, substantial costs relating tolaboratory and clinical testing of new and existing products and thepreparation and filing of documents in the formats required by the FDA.  The process of obtaining marketing clearanceand approvals from the FDA for new products and existing products can be timeconsuming and expensive, and there is no assurance that such clearances orapprovals will be granted.  We also mayencounter delays in bringing new products to market as a result of beingrequired by the FDA to conduct and document additional investigations ofproduct safety and effectiveness, which may adversely affect our ability tocommercialize additional products or additional applications for existingproducts.

*Additional Regulations*

Asa manufacturer of medical devices, our manufacturing processes and facilitiesare subject to regulation and review by international regulatory agencies forproducts sold internationally.  We haveobtained a Conformite Europeene or CE Mark for our products sold in Europe bydemonstrating compliance with the ISO 9001, EN46001 and ISO13485 internationalquality system standards.  Medical devicelaws and regulations are also in effect in some of the other countries to whichwe export our products.  These range fromcomprehensive device approval requirements for some or all of our medicaldevice products to requests for product data or certifications.  Failure to comply with these internationalregulatory standards and requirements could affect our ability to market andsell products in these markets and may have a significant negative impact onsales and results of operations.  Ourpresent and future business has been and will continue to be subject to variousother laws and regulations. 

*Texas FacilityReview*

InMay 1998, we entered into a voluntary consent decree with the FDA, under whichwe agreed, among other things, to complete certain re-validations of themanufacturing processes in agreed upon timeframes that were identified duringan FDA inspection.

Theconsent decree required us to hire expert consultants to assist instrengthening our compliance program and related processes.  In July 1998, the consultant reported to usand the FDA that, except for the outstanding re-validations, there were nosignificant areas of Good Manufacturing Practices or GMP non-compliance.  The expert consultant reviewed there-validations and reported to us and to the FDA that all re-validationprojects had been completed within the agreed timeframes. 

Additionally,under the terms of the consent decree, a separate expert consultant is requiredto conduct annual inspections of the Texas facility and issue a report annuallyto the FDA.  The expert consultant hasconducted the required annual comprehensive GMP inspections.  In each of the annual inspections, 1999 to2003, the expert consultant has found the Texas facility to be in substantialcompliance with FDA Good Manufacturing Practice regulations.  

Duringthe period May 1 - 10, 2000, the FDA conducted an inspection at the Texasfacility to assess the procedures under which saline breast implants aremanufactured.  The inspection wasconducted in conjunction with the FDA's final decision on our saline breastimplant pre-market approval application. The inspection resulted in the issuance of an FD483 (form used to reportFDA inspection findings) with one observation related to validation of acomputer system, which we addressed.  Oursaline breast implant application was subsequently approved.

Betweenthe period April 16 - 23, 2001, the FDA conducted aninspection at the Texas facility.  Theinspection was a follow-up inspection related to our saline breast implantapplication and the previous inspection. The inspection resulted in the issuance of an FD483 with twoobservations, one related to a manufacturing process and one related tocomputer software.  We have responded tothe FDA on both observations.

InFebruary 2002, the FDA performed a comprehensive GMP/QSR (Good ManufacturingPractice/Quality System Requirements) inspection of the Texas facility.  This inspection covered all aspects of theTexas quality systems for gel and saline breast implants and tissueexpanders.  The inspection resulted inthe issuance of an FD483 with three observations: one related to themanufacturing shell dipping process, one related to complaint analysis and onerelated to gowning practices.  We haveaddressed each of these issues.

In April 2003, the FDAperformed a saline breast implant post-PMA GMP/QSR (Good Manufacturing Practice/QualitySystem Requirements) inspection of the Texas facility.  The inspectionresulted in the issuance of an FD483 with one observation, which relatedto complaint handling.  We have addressed the issue with FDA.

Webelieve that we will continue to meet the requirements of the consent decree,although there can be no assurance that we can do so.  In addition, although the expert consultantshave expressed their opinions as to the satisfactory completion of consentdecree requirements, FDA inspectors during some future inspections may reach adifferent conclusion.  Should we fail tocontinue to comply with the conditions of the consent decree, under its termsthe FDA is allowed to order us to stop manufacturing or distributing breastimplants, order a recall or take other corrective actions.  We may also be subject to penalties of$10,000 per day until compliance is achieved.

Ifwe maintain continuous compliance with the terms of the consent decree for aperiod of five years after the completion of the re-validations, we canpetition the courts to remove the consent decree without opposition from thegovernment.  We expect to submit thispetition in fiscal year 2004.  

*EnvironmentalRegulation*

We are subject to regulationby the United States Environmental Protection Agency in each of our domesticmanufacturing facilities.  In addition, in Texas, we are subject toregulation by the local Air Pollution Control District as a result of some ofthe chemicals used in our manufacturing processes.  In our Oklahomafacility, we are also subject to regulation by the United States NuclearRegulatory Commission (NRC) due to the manufacture of brachytherapy seeds usingradioactive iodine I-125.  Failure to comply with the regulations andrequirements of these various agencies could affect our ability to manufactureproducts and may have a significant negative impact on sales and results ofoperations.

Medicare, Medicaid andThird-Party Reimbursement

Healthcareproviders that purchase medical devices, such as our products, generally relyon third-party payers, including the Medicare and Medicaid programs and privatepayers, such as indemnity insurers, employer group health insurance programsand managed care plans, to reimburse all or part of the cost of the products.  Our products are sold principally tohospitals, physicians, home healthcare suppliers, and others that receivereimbursement from these third-party payers for products and services theyprovide.  We estimate that as much as 40%or more of our product sales could be reimbursed by third-party payers.  As a result, demand for our products isdependent in part on the coverage and reimbursement policies of thesepayers.  The manner in whichreimbursement is sought and obtained for any our products varies based upon thetype of payer involved and the setting in which the product is furnished andutilized by patients.

Discussedbelow are certain factors which could have a significant impact on our futureoperations and financial condition.  Itis difficult to predict the effect of these factors on our operations; however,the effect could be negative and material. 

*Medicare*

Medicareis a federal program administered by the Centers for Medicare and MedicaidServices ("CMS"), formerly known as HCFA, through fiscalintermediaries and carriers.  Availableto individuals age 65 or over, and certain other classes of individuals, theMedicare program provides, among other things, health care benefits that cover,within prescribed limits, the major costs of most medically necessary care forsuch individuals, subject to certain deductibles and co-payments.  There are three components to the Medicareprogram:  Part A, which covers inpatientservices, home healthcare and hospice care; Part B which covers physician services,other healthcare professional services and outpatient services; and Part C orMedicare+Choice, which is a program for managed care plans.  

TheMedicare program has established guidelines for the coverage and reimbursementof certain equipment, supplies and services. In general, in order to be reimbursed by Medicare, a healthcare item orservice furnished to a Medicare beneficiary must be reasonable and necessaryfor the diagnosis or treatment of an illness or injury or to improve thefunctioning of a malformed body part. The methodology for determining (1) the coverage status of our products;and (2) the amount of Medicare reimbursement for our products, varies basedupon, among other factors, the setting in which a Medicare beneficiary receivedhealth care items and services.  Anychanges in federal legislation, regulations and policy affecting Medicarecoverage and reimbursement relative to our products could have a materialeffect on our performance.  As discussedin greater detail below, the Balanced Budget Act of 1997, the Balanced BudgetRefinement Act of 1999, and the Benefits Improvement and Protection Act of 2000also have impacted Medicare reimbursement for our products.  

*In-Patient Hospital Setting*

Withthe establishment of the prospective payment system in 1983, acute carehospitals are generally reimbursed by Medicare for inpatient operating costsbased upon prospectively determined rates. Under the Prospective Payment System, or PPS, acute care hospitalsreceive a predetermined payment rate based upon the Diagnosis-Related Group, orDRG, into which each Medicare beneficiary stay is assigned, regardless of theactual cost of the services provided. Certain additional or "outlier" payments may be made to ahospital for cases involving unusually high costs.  Accordingly, acute care hospitals generallydo not receive direct Medicare reimbursement under PPS for the distinct costsincurred in purchasing our products. Rather, reimbursement for these costs is deemed to be included withinthe DRG-based payments made to hospitals for the services furnished toMedicare-eligible inpatients in which our products are utilized.  Because PPS payments are based onpredetermined rates and are often less than a hospital's actual costs infurnishing care, acute care hospitals have incentives to lower their inpatientoperating costs by utilizing equipment, devices and supplies, including thosesold by us, that will reduce the length of inpatient stays, decrease labor orotherwise lower their costs.  Our productrevenue could be affected negatively if acute care hospitals discontinueproduct use due to insufficient reimbursement, or if other treatment optionsare perceived to be more profitable. 

*Outpatient Hospital Setting*

CMSimplemented the hospital Outpatient Prospective Payment System, or OPPS,effective July 1, 2000.  OPPS is thecurrent payment methodology for hospital outpatient services, certain Part Bservices furnished to hospital inpatients who have noPart A coverage and partial hospitalization services furnished by communitymental health centers.  All services paidunder the OPPS are classified into groups called Ambulatory PaymentClassifications, or APC.  Services ineach APC are similar clinically and in terms of the resources theyrequire.  Depending on the servicesprovided, hospitals may be paid for more than one APC for a patient visit.  A payment rate is established for each APCthrough the application of a conversion factor that CMS updates on an annualbasis.  OPPS may cause providers ofoutpatient services with costs above the payment rate to incur losses on suchservices provided to Medicare beneficiaries.  

TheBalanced Budget Refinement Act of 1999 provides for temporary financial relieffrom the effects of OPPS through the payment of additional outlier payments andtransitional pass-through payments to outpatient providers reimbursed throughOPPS who qualify for such assistance. Transitional pass-through payments are required for new or innovativemedical devices, drugs, and biological agents. The purpose of transitionalpass-through payments is to allow for adequate payment of new and innovativetechnology until there is enough data to incorporate cost for these items intothe base APC group.  The qualification ofa device for transitional pass-through payments is temporary.  Most of the categories established under thepass-through system expired on January 1, 2003. At that time, APC payment rates were adjusted to reflect the costs ofdevices (and drugs and biologicals) that receivedtransitional pass-through payments.  

Annually,and most recently in August 2002, the CMS proposed certain changes to OPPS andpayment rates for the next calendar year. The OPPS methodology determines the amount hospitals will be reimbursedfor procedures performed on an outpatient basis and is important, as itdetermines the profitability of certain procedures for the hospital and mayimpact hospital purchasing decisions.  Wecommented directly and through industry groups on the proposed reimbursement ofoutpatient procedures that include our products.  The products affected include, among others,penile implants for the treatment of impotence and for iodine and palladiumbrachytherapy seeds for the treatment of prostate cancer.  On November 1, 2002, CMS issued its finalrule concerning reimbursement of outpatient procedures for 2003.  CMS increased reimbursement for certainprocedures using our products, and committed to address certain otherreimbursement issues related to our products. However, the final rule results in an overall reduction in the amount ofreimbursement for outpatient procedures which include our penile implants forerectile dysfunction and made certain changes to the reimbursement forbrachytherapy procedures which include our radioactive seed products.  Most of our domestic sales of brachytherapyseeds are reimbursed under these rules; however the effect of the changes inreimbursement procedures and amounts is expected to be minimal.  We estimate that approximately $14 million ofannual revenue for our penile implants for the treatment of erectiledysfunction is reimbursed under this rule, or approximately 4% of our totalsales.  The overall reduction inreimbursement may negatively impact our results.

Wecannot predict the final effect that these changes in OPPS regulations, itsannual updates to the regulation and/or the potential retirement of any of itsproducts from Pass-Through status will have on us or our customers.  Any such effect, however, could be negativedue to loss of revenue for some products. 

*Home Setting*

Ourdisposable urological products are also provided to Medicare beneficiaries inhome care settings.  Medicare, under thePart B program, reimburses beneficiaries, or suppliers accepting assignment,for the purchase or rental of covered Durable Medical Equipment for use in thebeneficiary's home or a home for the aged (as opposed to use in a hospital orskilled nursing facility setting).  Aslong as the Medicare Part B coverage criteria are met, certain of our productsare reimbursed in the home setting pursuant to a fee schedule paymentmethodology.  

TheHome Health Prospective Payment System was implemented on October 1, 2000.  Under Home Health PPS, most of the serviceswhich a Medicare patient receives under a home health plan of care are coveredby a single payment received by the home health agency for each 60-day episodeof care.  After a physician prescribes ahome health plan of care, the home health agency assesses the patient'scondition and likely skilled nursing care, therapy, and certain other serviceneeds, at the beginning of each episode of care.  Home Health Resource Groups are used toclassify patients for purposes of determining payment rates.  The amount of the payment will ultimatelydepend upon the group category of the patient and is subject to a variety ofadjustments.  Durable medical equipmentis excluded from Home Health PPS. However, certain medical supplies currently provided by us in a homecare environment could be subject to Home Health PPS and the effect of suchregulation on future product revenues and results of operations cannot bepredicted.

*Skilled NursingFacility Setting*

Skillednursing facilities, or SNFs, which purchase our products have traditionallybeen reimbursed directly under Medicare Part A for some portion of theirincurred costs.  On July 1, 1998, themanner in which SNFs were reimbursed under Medicare Part A changeddramatically.  On that date,reimbursement for SNFs under Medicare Part A changed from a cost-based systemto a prospective payment system.  The newpayment system is based on resource utilization groups, or RUGs.  Under the RUGs system, a Medicare patient ina SNF is assigned to a RUGs category upon admission to the facility.  The RUGs category to which the patient isassigned depends upon the medical services and functional support the patientis expected to require.  The SNF receivesa prospectively determined daily payment based upon the RUGs category assignedto each Medicare patient.  These paymentsare intended generally to cover all inpatient services for Medicare patients,including routine nursing care, most capital-related costs associated with theinpatient stay and ancillary services. The daily payments made to the SNFs during a transition period are basedupon a blend of their actual costs from 1995 and a national average cost from1995 (which is subject to local wage-based adjustments). Initially, 75% of an SNF's per diem was based on its costs and 25% of the perdiem was based on national average cost. At the end of the four-year phase-in period, all daily payments will bebased on the national average cost. Although payments for certain RUGs categories increased in 1999 and2000, these payment increases expired on September 30, 2002.  Because the RUGs system provides SNFs withfixed daily cost reimbursement, SNFs have become less inclined than in the pastto use products which had previously been reimbursed as variable ancillarycosts.  Our revenue from SNF customersmay be negatively affected by the RUGs system.

*Medicaid*

TheMedicaid program is a cooperative federal/state program that provides medicalassistance benefits to qualifying low income and medically needy persons.  State participation in Medicaid is optionaland each state is given discretion in developing and administering its ownMedicaid program, subject to certain federal requirements pertaining to paymentlevels, eligibility criteria and minimum categories of services.  The coverage, method and level ofreimbursement varies from state to state and issubject to each state's budget restraints. Changes to the coverage, method or level of reimbursement for ourproducts may affect future revenue negatively if reimbursement amounts are decreasedor discontinued. 

*Private Payers*

Manythird-party private payers, including indemnity insurers, employer group healthinsurance programs and managed care plans, presently provide coverage for thepurchase of our products.  The scope ofcoverage and payment policies varies among third-party private payers.  Furthermore, many such payers areinvestigating or implementing methods for reducing health care costs, such asthe establishment of capitated or prospective payment systems.  Future changes in reimbursement methods andcost control strategies may limit or discontinue reimbursement for our productsand could have a negative effect on revenues and results of operations. 

*Fraud andAbuse Laws*

Inaddition to Medicare coverage and reimbursement limitations, other aspects ofthe Medicare program may negatively affect the Company.  In 1977, Congress adopted the Medicare andMedicaid Anti-Fraud and Abuse Amendments of 1977, which have been strengthenedby subsequent amendments and the creation of the Office of Inspector General toenforce compliance with the statute. This statute prohibits the knowing and willful offer, payment,solicitation, or receipt of any remuneration in any form as an inducement orreward for either the referral of patients or the arranging for reimbursableservices or products.  A violation of thestatute is a felony and could result in civil penalties, including exclusionfrom the Medicare or Medicaid program, even if no criminal prosecution isinitiated.

TheDepartment of Health and Human Services has issued regulations from time totime setting forth so-called "safe harbors," which would guaranteeprotection of certain limited types of arrangements from prosecution under thestatute if all elements of a particular safe harbor are met.  To date, 21 final safe harbors have beendeveloped.  However, failure to fallwithin a safe harbor or within each element of a particular safe harbor doesnot mean that an arrangement is *per se*inviolation of the Anti-Fraud and Abuse statute. As the comments to the safe harbors indicate, the purpose of the safeharbors is not to describe all illegal conduct, but to set forth standards forcertain non-violative arrangements.  Ifan arrangement violates the Anti-Fraud and Abuse statute and full compliancewith a safe harbor cannot be achieved, we risk greater scrutiny by theInspector General and, potentially, civil and/or criminal sanctions.  We believe our arrangements are in compliancewith the federal Anti-Fraud and Abuse statute, and analogous state laws;however, regulatory authorities may take a contrary position.

Product Development

We are focused on the development ofnew products and improvements to existing products, as well as obtaining FDAapproval of certain products and processes, and maintain the highest qualitystandards of existing products.  Duringfiscal 2003, 2002 and 2001, we spent a total of $22,978,000, $21,806,000 and$19,632,000, respectively, for research and development.

Patents and Licenses

It is our policy to protect ourintellectual property rights relating to our products when and where possibleand appropriate.  Our patents includethose relating to penile prostheses, tissue expanders, combination breastimplant and tissue expander, pelvic floor, ultrasonic-assisted soft tissueaspiration (liposuction) and disposable catheters.  We license technology under exclusivesupplier and licensing arrangements for certain products, includingbrachytherapy seeds and breast implants. 

In those instances where we haveacquired technology from third parties, we have sought to obtain rights ofownership to the technology through the acquisition of underlying patents orlicenses.  While we believe design,development, regulatory and marketing aspects of the medical device businessrepresent the principal barriers to entry into such business, we also recognizethat our patents and license rights may make it more difficult for ourcompetitors to market products similar to those we produce.  We can give no assurance that our patentrights, whether issued, subject to license, or in process, will not becircumvented, terminated, or invalidated. Further, there are numerous existing and pending patents on medicalproducts and biomaterials.  We can giveno assurance that our existing or planned products do not or will not infringesuch rights or that others will not claim such infringement or that we will beable to prevent competitors from challenging our patents or entering marketscurrently served us. 

Raw Material Supply and SingleSource Suppliers

We obtain certain raw materials andcomponents for a number of our products from single suppliers.  We believe our sources of supply could bereplaced if necessary without undue disruption, but it is possible that theprocess of qualifying new materials and/or vendors for certain raw materialsand components could cause an interruption in our ability to manufacture ourproducts and potentially have a negative impact on sales.  No significant interruptions to raw materialsupplies occurred during fiscal 2003.

Our inflatable penile prostheses,saline-filled mammary implants, catheters and other products are available forsale under FDA approvals and/or clearances. Gel-filled mammary implants are only available as part of the adjunctclinical study.  A change in rawmaterial, components or suppliers for these products may require a new FDAsubmission, and subsequent review and approval. There is no assurance that such a submission would be approved withoutdelay, or at all.  Any delay or failureto obtain approval may have a significant adverse impact on our sales andresults of operations.  

We license technology under exclusivesupplier and licensing arrangements for certain products.  Those products include Tutogen® processed fascia lata for the Suspend® Sling, and Tutogen®processed dermis for AxisTM, both for use in pelvic floor reconstruction, BTA *Stat*®bladder cancer test, and radioactive sources for our palladium brachytherapyseeds.  In addition, the licensors areour sole-source suppliers of these products. Any interruption in their ability to supply the product may have anadverse impact on our sales and results of operations. 

Seasonality

Ourquarterly results reflect slight seasonality, as the second fiscal quarterending September 30 tends to have the lowest revenue of all of thequarters.  This is primarily due to lowerlevels of sales of breast implants for augmentation, an elective procedure, assurgeons and patients tend to take vacation, particularly in Europe, duringthis quarter.   

Working Capital

Wemaintain normal industry levels of inventory in each of the three segments ofour business.  This includes significantconsignment inventories of our aesthetics products to aid the surgeon incorrectly sizing an implant to meet patient needs and reduce the rate ofreturns of product purchased in order to facilitate sizing options.  Otherwise, inventories are managed to levelsconsistent with high levels of customer service.  Additionally, new product introductionsrequire inventory build-ups to ensure success. 

Ouraccounts receivable credit terms are consistent with normal industry practicesin each of the markets that we sell our products.  Aesthetic surgery product return policiesallow for product returns for full or partial credit for up to six months.  It is common practice to order additionalquantities and sizes to facilitate correctly sizing to meet patient needs.  Consequently, product return rates are highbut are considered to be consistent with the industry.  See "Application of Critical Accounting Policies- Revenue Recognition" of "Management's Discussion and Analysis of FinancialCondition and Results of Operations." 

Employees

As of March 31, 2003, we employedapproximately 2,022 people, of whom 1,186 were in manufacturing, 521 in salesand marketing, 141 in research and development and 174 in finance andadministration.  We have never had a workstoppage due to labor difficulties, and we consider our relations with ouremployees to be satisfactory.

Risk Factors

*SIGNIFICANTPRODUCT LIABILITY CLAIMS OR PRODUCT RECALLS MAY FORCE US TO PAY SUBSTANTIALDAMAGE AWARDS AND OTHER EXPENSES THAT COULD EXCEED OUR ACCRUALS AND INSURANCECOVERAGE.*

The manufacture and sale ofmedical devices exposes us to significant risk of product liabilityclaims.  In the past, and currently, wehave had a number of product liability claims relating to our products, and wemay be subject to additional product liability claims in the future, some ofwhich may have a negative impact on our business.  Additionally, we could experience a materialdesign or manufacturing failure in our products, a quality system failure,other safety issues, or heightened regulatory scrutiny that would warrant arecall of some of our products.  Ourexisting product liability insurance coverage may be inadequate to protect usfrom any liabilities we might incur.  Ifa product liability claim or series of claims is brought against us foruninsured liabilities or in excess of our insurance coverage, our businesscould suffer.  Some manufacturers thatsuffered such claims in the past have been forced to cease operations or evento declare bankruptcy.  In addition, arecall of some of our products could result in significant costs to us.  

*IF WE SUFFER NEGATIVE PUBLICITY CONCERNING THE SAFETY OF OURPRODUCTS, OUR SALES MAY BE HARMED AND WE MAY BE FORCED TO WITHDRAW PRODUCTS.*

Physicians and potential patients may have a number ofconcerns about the safety of our products, including our breast and otherimplants, whether or not such concerns have a basis in generally acceptedscience or peer-reviewed scientific research. Negative publicity - whether accurate or inaccurate -concerning ourproducts could reduce market or governmental acceptance of our products andcould result in decreased product demand or product withdrawal.  In addition, significant negative publicitycould result in an increased number of product liability claims, whether or notthese claims are supported by applicable law.

*IF CHANGESIN THE ECONOMY AND CONSUMER SPENDING REDUCE CONSUMER DEMAND FOR OUR PRODUCTS,OUR SALES AND PROFITABILITY WOULD SUFFER.*

Certain elective procedures, such as breast augmentation,body contouring, and surgical treatment for male impotence are typically notcovered by insurance.  Adverse changes inthe economy may cause consumers to reassess their spending choices and reducethe demand for these surgeries and could have an adverse effect on consumerspending.   This shift could have anadverse effect on our sales and profitability.  

*IF WE AREUNABLE TO CONTINUE TO DEVELOP AND COMMERCIALIZE NEW TECHNOLOGIES AND PRODUCTS,WE MAY EXPERIENCE A DECREASE IN DEMAND FOR OUR PRODUCTS OR OUR PRODUCTS COULDBECOME OBSOLETE.*

The medical device industry is highly competitive and issubject to significant and rapid technological change.  We believe that our ability to develop oracquire new technologies is crucial to our success.  We are continually engaged in productdevelopment, improvement programs and required clinical studies to maintain andimprove our competitive position.  Any significantdelays in the above or termination of our clinical trials would materially andadversely affect our development and commercialization timelines.  We cannot guarantee that we will besuccessful in enhancing existing products to develop or acquire new products ortechnologies that will timely achieve regulatory approval or receive marketacceptance. 

There is also a risk that our products may not gain marketacceptance among physicians, patients and the medical community generally.  The degree of market acceptance of anymedical device or other product that we develop will depend on a number offactors, including demonstrated clinical safety and efficacy,cost-effectiveness, potential advantages over alternative products, and ourmarketing and distribution capabilities. Physicians will not recommend our products if clinical and other data orother factors do not demonstrate their safety and efficacy compared to othercompeting products, or if our products do not best meet the particular needs ofthe individual patient.  

Our products compete with a number of other medical productsmanufactured by major companies, and may also compete with new productscurrently under development by others. If our new products do not achieve significant market acceptance, or ifour current products are not able to continue competing successfully in thechanging market, our sales and earnings may not grow as much as expected, ormay even decline. 

*IF WE AREUNABLE TO IMPLEMENT NEW INFORMATION TECHNOLOGY SYSTEMS, OUR ABILITY TOMANUFACTURE AND SELL PRODUCTS, MAINTAIN REGULATORY COMPLIANCE AND MANAGE ANDREPORT OUR BUSINESS ACTIVITIES MAY BE IMPAIRED, DELAYED OR DIMINISHED, WHICHWOULD CAUSE SUBSTANTIAL BUSINESS INTERRUPTION AND LOSS OF SALES, CUSTOMERS ANDPROFITS.** *

We are in the process of designing and implementing anenterprise resource planning system that will be our primary businessmanagement system for nearly all of our businesses worldwide.  Many other companies have had severe problemswith computer system implementation of this nature and scope.  We are using a controlled project plan andhave assigned adequate staffing and other resources to the project to ensureits successful implementation; however there is no assurance that the designwill meet our current and future business needs or that it will operate asdesigned.  We are heavily dependent onsuch computer systems, and any failure or delay in the system implementationwould cause a substantial interruption to our business, additional expense, andloss of sales, customers, and profits. 

** ***IF WE AREUNABLE TO ACQUIRE COMPANIES, BUSINESSES OR TECHNOLOGIES AS PART OF OUR GROWTHSTRATEGY OR TO SUCCESSFULLY INTEGRATE PAST ACQUISITIONS, OUR GROWTH, SALES ANDPROFITABILITY WILL SUFFER.*

A significant portion of our recent growth has been theresult of acquisitions of other companies, businesses and technologies.  We intend to continue to acquire otherbusinesses and technologies to facilitate our future business strategies,although there can be no assurance that we will be able to identify appropriateacquisition candidates, consummate transactions or obtain agreements with termsfavorable to us.  Further, once abusiness is acquired, any inability to integrate the business, failure toretain and develop their workforce, or establish and maintain appropriatecommunications, performance expectations, regulatory compliance procedures,accounting controls, and reporting procedures could adversely affect our futuresales and earnings. 

*IF OURINTELLECTUAL PROPERTY RIGHTS DO NOT ADEQUATELY PROTECT OUR PRODUCTS ORTECHNOLOGIES, OTHERS COULD COMPETE AGAINST US MORE DIRECTLY, WHICH WOULD HURTOUR PROFITABILITY.*

Our success depends in part on our ability to obtain patentsor rights to patents, protect trade secrets, operate without infringing uponthe proprietary rights of others, and prevent others from infringing on ourpatents, trademarks and other intellectual property rights.  We will be able to protect our intellectualproperty from unauthorized use by third parties only to the extent that it iscovered by valid and enforceable patents, trademarks or licenses.  Patent protection generally involves complexlegal and factual questions and, therefore, enforceability of patent rightscannot be predicted with certainty; thus, any patents that we own or licensefrom others may not provide us with adequate protection againstcompetitors.  Moreover, the laws ofcertain foreign countries do not recognize intellectual property rights orprotect them to the same extent as do the laws of the United States. 

In addition to patents and trademarks, we rely on tradesecrets and proprietary know-how.  Weseek protection of these rights, in part, through confidentiality andproprietary information agreements. These agreements may not provide sufficient protection or adequateremedies for violation of our rights in the event of unauthorized use ordisclosure of confidential and proprietary information.  Failure to protect our proprietary rightscould seriously impair our competitive position. 

* IF THIRDPARTIES CLAIM WE ARE INFRINGING THEIR INTELLECTUAL PROPERTY RIGHTS, WE COULDSUFFER SIGNIFICANT LITIGATION OR LICENSING EXPENSES OR BE PREVENTED FROMMARKETING OUR PRODUCTS.*

Our commercial success depends significantly on our abilityto operate without infringing the patents and other proprietary rights of others.  However, regardless of our intent, ourtechnologies may infringe upon the patents or violate other proprietary rightsof third parties.  In the event of suchinfringement or violation, we may face expensive litigation and may beprevented from selling existing products and pursuing product development orcommercialization.

*WE DEPENDON SINGLE AND SOLE SOURCE SUPPLIERS FOR CERTAIN RAW MATERIALS AND LICENSEDPRODUCTS AND THE LOSS OF ANY SUPPLIER COULD ADVERSELY AFFECT OUR ABILITY TOMANUFACTURE OR SELL MANY OF OUR PRODUCTS.*

We currentlyrely on single or sole source suppliers for raw materials, including silicone,used in many of our products.   In theevent that they cannot meet our requirements, we cannot guarantee that we wouldbe able to produce a sufficient amount of quality raw materials in a timelymanner.  We also depend on third partymanufacturers for components and licensed products.  If there is a disruption in the supply ofthese products, our sales and profitability would be adversely affected.   

*OURINTERNATIONAL BUSINESS EXPOSES US TO A NUMBER OF RISKS.*

More than one-third of our sales are derived frominternational operations.  Accordingly,any material decrease in foreign sales would have a material adverse effect onour overall sales and profitability. Most of our international sales are denominated in Euros, CanadianDollars or U.S. Dollars.  Depreciation ordevaluation of the local currencies of countries where we sell our products mayresult in our products becoming more expensive in local currency terms, thusreducing demand, which could have an adverse effect on our operatingresults.  Our operations and financialresults also may be significantly affected by other international factors,including: 
- foreign government regulation of medical devices; 
- product liability, intellectual property and other claims; 
- new export license requirements; 
- political or economic instability in our target markets; 
- trade restrictions; 
- changes in tax laws and tariffs; 
- managing foreign distributors and manufacturers; 
- managing foreign branch offices and staffing; and 
- competition

If these risks actually materialize, our sales tointernational customers may decrease. 

*WE ARESUBJECT TO SUBSTANTIAL GOVERNMENT REGULATION, WHICH COULD MATERIALLY ADVERSELYAFFECT OUR BUSINESS.*

The production and marketing of our products and our ongoingresearch and development, pre-clinical testing and clinical trial activitiesare subject to extensive regulation and review by numerous governmentalauthorities both in the U.S. and abroad. Most of the medical devices we develop must undergo rigorouspre-clinical and clinical testing and an extensive regulatory approval processbefore they can be marketed.  Thisprocess makes it longer, harder and more costly to bring our products tomarket, and we cannot guarantee that any of our products will be approved.  The pre-marketing approval process can beparticularly expensive, uncertain and lengthy, and a number of devices forwhich FDA approval has been sought by other companies have never been approvedfor marketing.  In addition to testingand approval procedures, extensive regulations also govern marketing,manufacturing, distribution, labeling, and record-keeping procedures.  If we do not comply with applicableregulatory requirements, such violations could result in warning letters,non-approval, suspensions of regulatory approvals, civil penalties and criminalfines, product seizures and recalls, operating restrictions, injunctions, andcriminal prosecution. 

Delays in, withdrawal, or rejection of FDA or othergovernment entity approval of our products may also adversely affect ourbusiness.  Such delays or rejection maybe encountered due to, among other reasons, government or regulatory delays,lack of efficacy during clinical trials, unforeseen safety issues, slower thanexpected rate of patient recruitment for clinical trials, inability to followpatients after treatment in clinical trials, inconsistencies between earlyclinical trial results and results obtained in later clinical trials, varyinginterpretations of data generated by clinical trials, or changes in regulatorypolicy during the period of product development in the U.S. and abroad.  In the U.S., there has been a continuingtrend of more stringent FDA oversight in product clearance and enforcementactivities, causing medical device manufacturers to experience longer approvalcycles, greater risk and uncertainty, and higher expenses.  Internationally, there is a risk that we maynot be successful in meeting the quality standards or other certificationrequirements.  Even if regulatoryapproval of a product is granted, this approval may entail limitations on usesfor which the product may be labeled and promoted, or may prevent us frombroadening the uses of our current products for different applications.  In addition, we may not receive FDA approvalto export our products in the future, and countries to which products are to beexported may not approve them for import. 

Our manufacturing facilities also are subject to continualgovernmental review and inspection.  TheFDA has stated publicly that compliance with manufacturing regulations will bescrutinized more strictly. A governmental authoritymay challenge our compliance with applicable federal, state and foreignregulations.  In addition, any discoveryof previously unknown problems with one of our products or facilities mayresult in restrictions on the product or the facility, including withdrawal ofthe product from the market or other enforcement actions. 

From time to time, legislative or regulatory proposals areintroduced that could alter the review and approval process relating to medicaldevices.  It is possible that the FDA orother governmental authorities will issue additional regulations which wouldfurther reduce or restrict the sales of our present or proposed products.  Any change in legislation or regulations thatgovern the review and approval process relating to our current and futureproducts could make it more difficult and costly to obtain approval for newproducts, or to produce, market, and distribute existing products. 

*HEALTHCAREREIMBURSEMENT OR REFORM LEGISLATION COULD MATERIALLY AFFECT OUR BUSINESS.*

If any national healthcare reform or other legislation orregulations are passed that imposes limits on the amount of reimbursement forcertain types of medical procedures or products, the number or type of medicalprocedures that may be performed, or that has the effect of restricting aphysician's ability to select specific products for use in patient procedures,such changes could have a material adverse effect on the demand for ourproducts.  Our revenues depend largely onU.S. and foreign government health care programs and private health insurers reimbursingpatients' medical expenses.  Physicians,hospitals, and other health care providers may not purchase our products ifthey do not receive satisfactory reimbursement from these third-party payersfor the cost of procedures using our products. In the U.S., there have been, and we expect that there will continue tobe, a number of federal and state legislative and regulatory proposals toimplement greater governmental control over the healthcare industry and itsrelated costs.  These proposals createuncertainty as to the future of our industry and may have a material adverseeffect on our ability to raise capital or to form collaborations.  In a number of foreign markets, the pricingand profitability of healthcare products are subject to governmental influenceor control.  In addition, legislation orregulations that impose restrictions on the price that may be charged forhealthcare products or medical devices may adversely affect our sales andprofitability. 

*IF OUR USEOF HAZARDOUS MATERIALS RESULTS IN CONTAMINATION OR INJURY, WE COULD SUFFERSIGNIFICANT FINANCIAL LOSS.*

Our manufacturing and research activities involve thecontrolled use of hazardous materials. We cannot eliminate the risk of accidental contamination or injury fromthese materials.  In the event of anaccident or environmental discharge, we may be held liable for any resultingdamages, which may exceed our financial resources and any applicable insurance coverages. 

* FUTURECHANGES IN FINANCIAL ACCOUNTING STANDARDS MAY CAUSE ADVERSE UNEXPECTED REVENUEOR EXPENSE FLUCTUATIONS AND AFFECT OUR REPORTED RESULTS OF OPERATIONS.*

A change in accounting standards could have a significanteffect on our reported results and may even affect our reporting oftransactions completed before the change is effective.  Any changes requiring that we recordcompensation expense in the statement of operations for employee stock optionsusing the fair value method could have a significant negative effect on our reportedresults.  New pronouncements and varyinginterpretations of existing pronouncements have occurred and may occur in thefuture.  Changes to existing rules orcurrent practices may adversely affect our reported financial results of ourbusiness. 

*LITIGATIONMAY HARM OUR BUSINESS OR OTHERWISE DISTRACT OUR MANAGEMENT.*

Substantial, complex or extended litigation could cause usto incur large expenditures and distract our management, and could result insignificant monetary or equitable judgments against us.  For example, lawsuits by employees, patients,customers, licensors, licensees, suppliers, distributors, or stockholders couldbe very costly and substantially disrupt our business.  Disputes from time to time with suchcompanies or individuals are not uncommon, and we cannot assure that we willalways be able to resolve such disputes out of court or on terms favorable tous. 

ExecutiveOfficers of the Registrant

Ourexecutive officers are listed below, followed by brief accounts of theirbusiness experience and certain other information.

Name

Age

Position

Christopher  J. Conway

64

President,  Chief Executive Officer, Chairman of the Board

Eugene  G. Glover

60

Senior  Vice President, Advanced Development

Joshua  Levine

45

Senior  Vice President, Global Sales and Marketing, Aesthetics Products

Adel  Michael

59

Executive  Vice President, Chief Financial Officer, Treasurer and Secretary

Maher  Michael, M.D.

51

Vice  President, Medical Director

Bobby  K. Purkait

53

Senior  Vice President, Science and Technology and New Business Development

Clarke  Scherff

56

Vice  President, Regulatory Compliance

Peter  Shepard

57

Senior  Vice President, Global Sales and Marketing, Urology Products

Cathy  Ullery

50

Vice  President, Human Resources

Mr.Conway is a founder of the Company and has served as Chairman of the Boardsince 1969.  He served as Chief ExecutiveOfficer from 1969 to July 29, 1999.  Heresumed the positions of Chief Executive Officer and President in September2000. 

Mr.Glover is a founder of the Company and held the position of Vice President, Engineeringfrom 1969 to 1986.  In October 2000, hewas appointed Senior Vice President, Advanced Development. 

Mr. Levine joined us inOctober of 1996 as Vice President, Sales, AestheticProducts.  In September of 1998, he waspromoted to domestic Vice President Sales and Marketing AestheticProducts.  In January 2000, Mr. Levineresigned to join a start-up practice management organization, The PlasticSurgery Company where he was Chief Development Officer.  He resigned that position in September 2000to rejoin us as our Vice President Sales & Marketing.  Subsequent to this resignation, PlasticSurgery Company filed a voluntary petition for bankruptcy under Chapter 11 ofthe U.S. Bankruptcy Code in March 2002. In November of 2001, Mr. Levine assumed global responsibilities for allof our aesthetic sales and marketing activities and was promoted to Senior VicePresident Global Sales & Marketing in June of 2002.  

Mr.Adel Michael joined us in April 2000 as Senior Vice President, Chief FinancialOfficer and Treasurer.  He was promotedto Executive Vice President on September 14, 2001.  From 1989 to 2000 he was Vice President,Chief Financial Officer of Getz Brothers and Co., Inc., and from 1983 to 1989he was a Group Controller for the Marmon Group, Inc.  From 1972 to 1983 he was Controller of Amphenol Corporation, a subsidiary of Allied Corporationand from 1969 to 1972 with Bell and Howell.

Dr. Maher Michael, M.D., joined us in February 2002as Vice President of Clinical and Regulatory Submissions and Medical Directorand in September 2002, he was made an executive officer.  From 1997 to 2002 he was Director of CorporateRegulatory Affairs and Medical Director for APIC, USA, Inc. and from 1988 to1996 he was Medical Director for ARZCO Medical Systems, Inc., a subsidiary ofMarmon Group, Inc.

Mr.Purkait joined us in February 1986 and has served in various research anddevelopment capacities.  He was promotedto Vice President Science and Technology in 1988, and Senior Vice President inApril 1998.  In January 2002, hisresponsibilities were changed to focus on identifying and assessing the valueand feasibility of new technologies.

Mr. Scherff joined us in July 1995 as Director ofRegulatory Affairs through the acquisition of Optical Radiation Corporation,where he held the position of Group Vice President Quality Assurance/RegulatoryAffairs from April 1993 to June 1995.  Hewas promoted to Vice President Quality and Regulatory Assurance in June 1997and to Vice President of Regulatory Compliance/Compliance Officer in October2000.  From 1980 to 1993, Mr. Scherffheld various positions of increasing responsibility for American HospitalCorporation/Baxter Healthcare Corporation, ultimately serving as the Directorof Quality Assurance.

Mr. Shepard joined us in 1976 as a salesrepresentative.  In 1982, he was promotedto Vice President Sales and in 1992 to Vice President Sales and Marketing forthe Surgical Urology and Healthcare products. Beginning 1996, he was appointed as Vice President Business Development.  In October 2000, Mr. Shepard resumed theposition of Vice President Sales and Marketing for the Surgical Urology andHealthcare product lines.  He waspromoted to Senior Vice President Global Sales and Marketing, Urology andHealthcare Products in May 2002.  

Ms. Ullery joined us in 1998 and served in severalcapacities in the Human Resources Department. She was promoted to Director of Human Resources in July 1999, and Vice President of Human Resources in May2002.  From 1993 to 1997, Ms. Ullery wasthe Director of Organizational Effectiveness for the City of Tucson.  From 1982 to 1993, she held various positionsof increasing responsibility for the Arizona Education Association, anaffiliate of the National Education Association, ultimately serving as theExecutive Manager for Field Services and Member Programs.

**ITEM 2.**

**PROPERTIES.**

At March 31, 2003, we ownedand leased the following facilities:

**Location**

**Total Sq. Ft.**

**Principle Segment and Use**

 

 

 

Owned Properties

 

 

Minnesota

185,000

  Surgical Urology, Clinical  and Consumer Healthcare     manufacturing, warehousing and administrative offices

Oklahoma

25,000

  Surgical Urology      manufacturing, warehousing and administrative offices

France

124,000

  Surgical Urology, Clinical  and Consumer Healthcare     manufacturing, warehousing and administrative offices

Netherlands

65,000

  Aesthetic and General  Surgery      manufacturing, warehousing and administrative offices

United Kingdom

13,000

  Clinical and Consumer  Healthcare     manufacturing, warehousing and administrative offices
     412,000   
Leased Properties

California

124,000

  Services all Segments     Corporate offices, research and development, and sales and marketing

Minnesota

20,000

  Surgical Urology, Clinical  and Consumer Healthcare     manufacturing, warehousing and administrative offices

France

59,000

  Surgical Urology, Clinical  and Consumer Healthcare     manufacturing, warehousing and administrative offices

Texas

134,000

  Aesthetic and General  Surgery      manufacturing, warehousing and administrative offices

Arizona

20,000

  Aesthetic and General  Surgery      manufacturing, warehousing and administrative offices

United Kingdom

81,000

  Clinical and Consumer  Healthcare      manufacturing, warehousing and administrative offices
     438,000   
Our leases have termsranging from 1 to 125 years, many of which have options to renew on terms weconsider favorable.  In addition to thefacilities mentioned above, we have international sales offices throughout tencountries where we lease office and warehouse space ranging from 1,000 to 8,000square feet.  We anticipate that we willbe able to extend or renew the leases that expire in the near future on termssatisfactory to us, or if necessary, locate substitute facilities on acceptableterms.    

We believe our facilitiesare generally suitable and adequate to accommodate our current operations andadditional suitable facilities are readily available to accommodate futureexpansion as necessary.

For information regardinglease obligations see "Note L-Commitments" under "Notes to theConsolidated FinancialStatements."

**ITEM 3.**

**LEGAL PROCEEDINGS.**

In 1998, welearned that the FDA's Office of Criminal Investigations was conducting aninvestigation involving us.  Weunderstood that the investigation was dormant until April 2000 when a letterwas issued requesting that we provide manufacturing data and other corporaterecords, which we did.  We cooperatedfully with the investigation.  

On July 9,2002, we presented the five-year follow-up data to the FDA advisory panelrelated to its saline mammary implant clinical studies.  The presentation of this data was a conditionof the PMA approval received in May of 2000. Subsequent to the presentation, we became aware through the media thatthe Chairman of the Committee on Energy and Commerce and the Chairman of theSubcommittee on Oversight and Investigations sent a letter to the DeputyCommissioner of the FDA requesting data related to the saline breast implantstudies and records related to Mentor and the OCI investigation.  On September 27, 2002, media articlesannounced that the FDA had completed and closed its criminalinvestigation.  We have receivedconfirmation from the FDA Office of Criminal investigation that the criminalinvestigation had been closed.  

We believethat we are in compliance with all applicable laws, rules and regulations.   

TheSecurities and Exchange Commission informed us that it was investigating, undera formal order of investigation, the events relating to the March 23, 2000 *USA Today* article entitled "BreastImplant Manufacturer Under Investigation by the FDA," which was authoredby Rita Rubin, and the March 23, 2000 press release issued by us responding tothat article, and possibly other matters. We cooperated fully with the SEC's investigation.  In May 2002, we received notification fromthe SEC's Division of Enforcement that "This investigation has beenterminated and no enforcement action has been recommended to theCommission."

In November 2002, we fileda lawsuit against North American Scientific, Inc., ("NASI") for, amongother things, breach of the exclusive distribution agreement, which expired onJanuary 31, 2003.  In response, NASIfiled a counterclaim against us alleging various breaches and other actions. Mentor decided to resolve all claims in order to avoid the costs of litigation,and the other parties mutually agreed to dismiss all claims and counterclaimsagainst each other without admitting any wrongdoing.  Both parties aresatisfied with the result of the settlement.

Claimsrelated to product liability are a regular and ongoing aspect of the medical deviceindustry.  At any one time, we aresubject to claims asserted against us and are involved in product liabilitylitigation.  These actions can be broughtby an individual, by a group of patients purported to be a class action.  We have carried product liability insuranceon all our products, including breast implants, subsequent to May 1991 andprior to September 1985.  This insuranceis subject to certain self-insured retentions and limits on the policies.  From September 1985 through April 1991, we wereself insured for the majority of our surgical implant products, but had productliability insurance on the rest of our products.  From June 1992 on, our insurance has excludedsilicone gel-filled breast implants.

In February1999, we were the plaintiff in a jury trial defending a patent exclusivelylicensed to us by Sonique Surgical Systems, Inc., and used in ultrasonic tissueremoval.  Although the jury found willfulinfringement, the court nonetheless entered a judgment in favor of thedefendants (Medical Device Alliance, Inc., Lysonics,Inc. and Misonix, Inc.).  We challenged the court order and in May2001, a Federal circuit court reversed the lower court's ruling and reinstatedthe jury award of damages.  In April2002, we received $5.4 million in full settlement of the jury award. 

In addition,in the ordinary course of our business we experience other varied types ofclaims that sometimes result in litigation or other legal proceedings.  We do not anticipate that any of theseproceedings will have a material adverse effect on us.

**ITEM  4.**

**SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

No matters were submitted for a vote ofour shareholders during the fourth quarter of the fiscal year ended March 31,2003.

**PART II**

**ITEM  5.**

**MARKET  FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**

Our commonstock trades on the Nasdaq National Market under the symbol"MNTR".  The high and low salesprices of our common stock, as reported on the Nasdaq National Market for thetwo most recent fiscal years, are set forth below.  

**Year Ended  March 31, 2002**

High

Low

Quarter  ended June 30, 2001

$14.17

$11.07

Quarter  ended September 30, 2001

15.72

11.97

Quarter  ended December 31, 2001

15.10

11.53

Quarter  ended March 31, 2002

18.04

14.04

 
   
 

**Year Ended  March 31, 2003**

High

Low

Quarter  ended June 30, 2002

$18.64

$18.15

Quarter  ended September 30, 2002

16.88

14.80

Quarter  ended December 31, 2002

19.52

19.09

Quarter  ended March 31, 2003

17.54

16.81

According to the records of ourtransfer agent, there were approximately 964 holders of record of our commonstock on June 18, 2003.  However, themajority of shares are held by brokers and other institutions on behalf ofshareholders in approximately 6,600 accounts. The actual number of total shareholders may be less due to shareholdersholding accounts at more than one institution.

In fiscal 2002, we declared and paid aquarterly dividend of $.03 per share of common stock for all four fiscalquarters.  In fiscal 2003, we declared aquarterly dividend of $.03 per share of common stock for the first and secondquarters.  On December 13, 2002 the Boardof Directors authorized a two-for-one stock split in the form of a 100% stockdividend to be distributed on or about January 17, 2003 to shareholders ofrecord on December 31, 2002.  A cashdividend for the third quarter equivalent to that in the first and secondquarters, but reflecting the two-for-one split, wouldhave resulted in a dividend of $.015 per share. However, the dividend wasdeclared as $.02 per share payable to shareholders after the distribution ofthe additional shares issued in the stock split. The fourth quarter dividend of$.02 per common share was declared on February 28,2003 toshareholders of record on March 31, 2003 and payable on April 21, 2003.  It is our intent to continue to pay dividendsfor the foreseeable future subject to, among other things, Board approval, cashavailability and alternative cash needs. Our existing credit agreement limits the aggregate amount of dividends payablein any year to one-half of our net income of the preceding year.

 
**ITEM  6.**
**SELECTED  FINANCIAL DATA.**

Statement of income and balance sheetdata shown below were derived from our Consolidated Financial Statements as ofMarch 31, 2003 and 2002 and for each of the three years in the periods endedMarch 31, 2003, included herein, which have been audited by Ernst & YoungLLP, our independent auditors.  Youshould read this selected financial data together with our consolidatedfinancial statements and related notes, as well as the discussion under thecaption "Management's Discussion and Analysis of Financial Condition andResults of Operations."

 

Year Ended March 31,

(in thousands, except per share data)

**2003**(2)

2002(1)

2001**(1)**

2000

1999

**Statement of Income Data:**

** **

 

** **

** **

** **

Net sales

** $382,384**

 $321,062 

 $268,894 

 $249,345 

 $204,576 

Gross profit

**229,507**

190,607 

164,198 

154,687 

126,609 

Operating income

**76,977**

57,516 

41,787 

39,431 

30,141 

Income before income taxes - 

** **

 

 

 

 

    Continuing operations

**79,039**

59,216 

46,549 

42,389 

30,888 

Income taxes - continuing operations

**23,219**

17,396 

14,731 

13,563 

10,447 

Income from continuing operations

**55,820**

41,820 

31,818 

28,826 

20,441 

Discontinued operations, net of income tax

**-**

-

260 

7,713 

(6,479)

Net income

** $  55,820**

 $  41,820 

 $  32,078 

 $  36,539 

 $ 13,962 

Basic earnings (loss) per share(3):

** **

 

 

 

 

    Continuing operations

** $  1.20**

 $ 0.88 

 $ 0.67 

 $ 0.59 

 $ 0.42 

    Discontinued operations

**-**

-

0.01 

0.16

(0.14)

      Basic earnings per share

** $ 1.20**

 $ 0.88 

 $ 0.68 

 $ 0.75 

 $ 0.28 

Diluted earnings (loss) per share(3):

** **

 

 

 

 

    Continuing operations

** $  1.15**

 $ 0.85 

$ 0.66 

 $ 0.57 

 $ 0.40 

    Discontinued operations

**-**

**-**

**-**

0.16 

(0.13)

      Diluted earnings per share

** $ 1.15**

 $ 0.85 

 $ 0.66 

 $  0.73 

 $ 0.27 

Dividends per common share

** $  0.07**

 $ 0.06 

$  0.0525

 $  0.05 

 $ 0.05 

Average outstanding shares(3):

** **

 

 

 

 

    Basic

**46,428**

47,278 

47,254 

48,768 

49,100 

    Diluted

**48,388**

48,926 

48,372 

50,168 

50,788 

**Balance Sheet Data:**

** **

 

** **

** **

** **

Working capital

** $167,996**

 $126,556 

 $112,461 

 $124,141 

 $106,532 

Total assets

**398,088**

324,636 

290,837 

230,706 

196,011 

Long-term accrued liabilities, less  current     portion

**       13,970**

     12,873 

      10,691 

               -   

               -   

Shareholders' equity

**   276,710**

  224,178 

   196,306 

   183,642 

 158,618 

(1)   Results afterfiscal 2000 include the impact of the Porges S.A. acquisition in February 2001.(2)   Results infiscal 2003 include the impact of the Portex acquisition in May 2002.(3)   Per share amounts and shares outstanding havebeen adjusted to reflect a two-for-one stock split effected January 21, 2003.

**ITEM  7.**

**MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

The following discussion shouldbe read together with our consolidated financial statements and related notes,which are included in this report, and the "Risk Factors" informationin the "Business" section of this report.

**APPLICATION OFCRITICAL ACCOUNTING POLICIES**

Management's Discussion and Analysis of FinancialCondition and Results of Operations addresses our consolidated financialstatements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statementsrequires us to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.  On an on-going basis, we evaluate ourestimates and judgments.  We base ourestimates and judgments on historical experience and on various other factorsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions.  

We believe the following critical accountingpolicies, among others, affect its more significant judgments and estimatesused in the preparation of our consolidated financial statements. 

Revenue Recognition

Werecognize product revenue, net of discounts, returns, and rebates in accordancewith Statement of Financial Accounting Standards ("SFAS") No. 48,"Revenue Recognition When the Right of Return Exists," and StaffAccounting Bulletin ("SAB") No. 101, "Revenue Recognition inFinancial Statements."  As requiredby these standards, revenue is recorded when persuasive evidence of a salesarrangement exists, delivery has occurred, the buyer's price is fixed ordeterminable, contractual obligations have been satisfied, and collectibilityis reasonably assured.  Theserequirements are met, and sales and related cost of sales are recognizedprimarily upon the shipment of products, or in the case of consignmentinventories, upon the notification of usage by the customer.  We record estimated reductions to revenue forcustomer programs and other volume-based incentives.  Should the actual level of customerparticipation in these programs differ from those estimated, additionaladjustments to revenue are recorded.  Wealso allow credit for products returned within our policy terms.  We record an allowance for estimated returnsat the time of sale based on historical experience, recent gross sales levelsand any notification of pending returns. Should the actual returns differ from those estimated, additionaladjustments to revenue and cost of sales may be required. 

Accounts Receivable

We market our products to a diverse customerbase, principally throughout the United States, Canada and Western Europe.  We grant credit terms in the normal course ofbusiness to our customers, primarily hospitals, doctors and distributors.  We perform ongoing credit evaluations of ourcustomers and adjusts credit limits based upon paymenthistory and the customer's current credit worthiness, as determined throughreview of their current credit information. We continuously monitor collections and payments from customers andmaintain allowances for doubtful accounts for estimated losses resulting fromthe inability of some of our customers to make required payments.  Estimated losses are based on historicalexperience and any specifically identified customer collection issues.  If the financial condition of our customers,or the economy as whole, were to deteriorate, resulting in an impairment of ourcustomers' ability to make payments, additional allowances may berequired.  These adjustments would beincluded in selling, general and administrative expenses. 

Inventories

We value our inventory at the lower of cost,based on the first-in first-out ("FIFO") cost method, or the currentestimated market value of the inventory. We write down our inventory for estimated obsolescence or unmarketableinventory equal to the difference between the cost of inventory and theestimated market value based upon assumptions about future demand and marketconditions.  If actual future demand ormarket conditions differ from those projected by us, additional inventoryvaluation adjustments may be required. These valuation adjustments would be included in cost of goods sold.

Warranties and Related Reserves

We provide an accrual for the estimated cost ofproduct warranties and product liability claims at the time revenue isrecognized.  Such accruals are based onestimates, which are based on relevant factors such as historical experience,the warranty period, estimated costs, levels of insurance and insuranceretentions, identified product quality issues, if any, and, to a limitedextent, information developed by the insurance company using actuarialtechniques.  These accruals are analyzedperiodically for adequacy.  While weengage in extensive product quality programs andprocesses, including actively monitoring and evaluating the quality of ourcomponent suppliers, the warranty obligation is affected by reported rates ofproduct problems and costs incurred in correcting product problems.  Should actual reported problem rates or theresulting costs differ from our estimates, adjustments to the estimatedwarranty liability may be required. These adjustments would be included in selling, general and administrativeexpenses. 

Goodwill and Intangible Asset Impairment

Weevaluate long-lived assets, including goodwill and other intangibles, forimpairment whenever events or changes in circumstances indicate that thecarrying value of an asset may not be recoverable.  In assessing the recoverability of goodwilland other intangibles, we must make assumptions regarding estimated future cashflows and other factors to determine the fair value of the respectiveassets.  We adopted SFAS No. 142("SFAS 142"), "Goodwill and Other Intangible Assets,"effective April 1, 2002 and analyzed goodwill and intangibles for impairmentand no impairment was noted as a result of thisanalysis.  If these assumptions and theirrelated estimates change in the future, we may be required to record impairmentcharges for these assets.  Theseimpairment charges would be included in the results of operations. 

**RESULTS OF OPERATIONS**

The following table sets forth variousitems from the Consolidated Statements of Income as a percentage of net salesfor the periods indicated:
   
Year Ended March 31,
**2003**

2002

2001

Net sales

**100.0%**

100.0%

100.0%

Costs and expenses

** **

 

 

   Cost of sales

**40.0  **

40.6  

38.9  

   Selling, general, and administrative

**33.9  **

34.7  

37.3  

   Research and development

**6.0  **

6.8  

7.3  

   Restructuring charge

**-  **

-  

0.9  

 

** **

 

 

Operating income from continuing  operations

**20.1  **

17.9  

15.6  

   Interest expense

**(0.3) **

(0.3) 

(0.1) 

   Interest income

**0.6  **

0.7  

1.6  

   Other income, net

**0.2  **

0.1  

0.3  

** **

 

** **

Income from continuing operations before income  taxes

**20.7  **

18.4  

17.4  

Income taxes

**6.1  **

5.4  

5.5  

Income from continuing operations 

**14.6  **

13.0  

11.9  

Income from discontinued operations, net  of income  taxes

**-  **

  -  

  0.1  

 

** **

 

 

Net income

**14.6%**

13.0%

12.0%
**YEARS ENDED MARCH 31, 2003 AND 2002**
**Sales**Sales for fiscal 2003 increased to $382million from $321 million in fiscal 2002, an increase of 19%.  Included in fiscal 2003 sales are elevenmonths of clinical and consumer healthcare product sales relating to our May2002 acquisition of the urology and ostomy business of Portex Ltd.  Sales of products acquired in the Portextransaction accounted for five percentage points of the year-to-yeargrowth.  The increase in sales was inboth domestic and international markets. Foreign exchange rate movements, primarily the stronger Euro, had afavorable year-to-year impact on international sales of $12 million, orapproximately four percentage points of the year-to-year growth. 

Salesof aesthetic and general surgery products increased 17% to $191 million from$163 million in the prior year.  Totalsales of breast implants products increased 16% to $158 million from $137million in the prior year.  Sales of bodycontouring products increased $2.8 million or 28% over the prior year.  We believe that sales growth was primarilyattributable to strong product demand both domestically and internationally,the introduction of an improved tissue expander in the fourth quarter of fiscal2002, a resurgence of demand including surgeries that were postponed after theevents of September 11th and the benefit from the effect of thestrong Euro.  Sales of aesthetic andgeneral surgery are expected to increase at a slower rate in fiscal 2004.

Salesof surgical urology products increased 13% to $107 million from $94 million inthe prior year. The   growth primarilyresulted from strong sales of products acquired in our February 2001acquisition of Porges S.A., included new product sales and the effect of astronger Euro.  Penile implant salesincreased $1.5 million, due in part to incremental sales from the TitanTMinflatable device introduced in the third quarter of fiscal 2003 and marketingprogram efforts to increase consumer awareness. Sales of pelvic floor reconstruction products increased $2.5 million dueto new product introductions late in fiscal 2002.  Brachytherapy sales decreased $1.0 million,or 4% from the prior year as unit sales increases were partially offset ascompetitive pressures decreased average selling prices. In addition, interruptionof our supply of palladium radioactive seeds due to the expiration of ourexclusive distribution agreement with NASI and difficulties in securing newvendor supply to fulfill customer orders resulted in lost sales, and thesedifficulties have continued into fiscal 2004.

Sales of clinical and consumerhealthcare products increased 32% to $84 million from $64 million in the prioryear.  This growth primarily resultedfrom our May 2002 acquisition of the urology and ostomy businesses of PortexLtd., whose product sales are included for eleven months of fiscal 2003 andaccounted for approximately $16 million of the sales growth over fiscal 2002.  Sales growthwas generally aided by the effect of the stronger Euro as nearly half of theseproduct sales are invoiced in currencies other than the U.S. Dollar.  In addition, sales of male externalcatheters grew 15%, primarily in international markets, offsetting a slightdecline in sales of other healthcare products. Sales of intermittent self-catheters increased 7% following theintroduction of the Self-Cath PlusTM lubricious catheter in fiscal 2002. 

**Costof Sales**

Cost of sales was 40.0% of net salesfor fiscal 2003, compared to 40.6% in fiscal 2002.  Cost of sales for the aesthetic and generalsurgery products decreased from 30.0% of net sales to 28.1%, primarily due toefficiencies of scale and improved manufacturing efficiencies at our Texasfacility partially offset by startup costs at our new manufacturing facility inthe Netherlands.  Cost of sales for surgicalurology products decreased from 51.7% of net sales to 51.2% primarily due toimproved manufacturing efficiencies and the recent acquisition of MillsBiopharmaceutical to manufacture our own iodine brachytherapy seeds.  Cost of sales for clinical and consumerhealthcare products increased from 50.2% of net sales to 52.7% primarily due tothe May 2002 acquisition of the urology and ostomy businesses of Portex whoseproducts have lower margins than our previously existing products.

**Selling, General andAdministrative**

Selling,general and administrative expenses were 33.9% of net sales in fiscal 2003compared to 34.7% in fiscal 2002.  Thedecrease as a percentage of net sales reflects efficiencies of scale asselling, general and administrative costs grew at rates slower than overallrevenue growth.  These economies of scalewere offset slightly by the non-recurring general and administrative expensesassociated with the recent acquisition of the urology and ostomy business ofPortex and non-capitalizable expenses related to theimplementation of information technology systems to modernize and integraterecent acquisitions.   

**Researchand Development**Research and development expenses were 6.0% of netsales in fiscal 2003, a slight decrease from 6.8% in fiscal 2002.  Overall spending on research and developmentincreased by 5.4% from the prior year. The decrease in research and development as a percentage of net sales ispartially attributable to several recent acquisitions, and associated revenuegrowth, in the clinical and consumer healthcare segment. This segment has agenerally lower level of research and development spending on new productdevelopment than the long term implantable products in the aesthetics andsurgical urology segments.  Fiscal 2003development costs relate primarily to our clinical studies and acceleratedproduct enhancement projects for existing products and new productdevelopment.  Although we havesuccessfully completed several pre-market approval application submissionsrelated to mammary and penile implants in recent years, the amount of spendingon research and development is not expected to decrease as the focus of ourresearch and development efforts shifts towards product enhancements and newproduct development.  In addition, we arecommitted to several post FDA approval follow up studies, and a variety ofclinical and laboratory studies in connection with our gel-filled and salinefilled mammary implants and other products.  

**Interest and Other Income and Expense**

Interest expense increased to $1.0million in fiscal 2003, from $859 thousand in fiscal 2002.  In January 2001, we acquired the assets ofSouth Bay Medical LLC.  Approximately $7million of the purchase price was recorded as a long-term accrued liability atnet present value.  In December 2001, werecorded an additional $1.7 million of long-term accrued liability at netpresent value related to the acquisition of certain intangible rights fromProSurg, Inc.  Imputed interest on theseliabilities is charged to interest expense. This imputed interest and balances outstanding on several lines ofcredit established to facilitate operating cash flow needs at our foreignsubsidiaries, slightly offset by lower prevailing borrowing rates of interest,  accounted for theincrease in interest expense over the prior year.  

Interest income increased to $2.5 million in fiscal2003 from $2.2 million in fiscal 2002. The increase is due to higher cash and marketable security balancespartially offset by lower prevailing interest rates on short-term investmentsand a change in our investment strategy. Our new investment strategy involves a shift to taxable money marketinvestments which have a higher pretax yield, from tax free municipal bonds andsimilar tax advantaged investment vehicles, which have a lower pre-tax yield. 

Other income, net primarily includesgains or losses on sales of marketable securities, disposal of assets, foreigncurrency gains or losses related to our foreign operations and impairmentcharges on long term investments.  Bothyears include income from the sale of marketable securities, net foreignexchange transaction and remeasurement gains andloss, offset by impairment charges on long term investments. In fiscal 2000, werecorded a $3 million permanent impairment of our equity investment in IntracelCorporation.  During fiscal 2002, werecorded an additional $3 million to completely write-off our investment inIntracel Corporation upon its bankruptcy filing.  During the fiscal 2003, we sold our remaininginvestment in North American Scientific, Inc. and recorded a pre-tax gain of$403,000.  We determined the investmentin Paradigm Medical Industries Inc. (Paradigm), was impaired and recorded aone-time pre-tax impairment charge of $1,857,000. Other income, net for fiscal 2002, also includes a one-time gain of$700,000 related to the settlement of a dispute with Paradigm, a one-timeforeign exchange gain of $720,000 on the repayment of our 15 million Euro loanto partially fund the acquisition of Porges S.A. and the realized gains on thedisposition of long-term marketable securities available-for-sale of $1.3million. 

**IncomeTaxes**

The effective rate of corporate income taxes was 29.4%for both fiscal 2003 and fiscal 2002. The decrease in the effective tax rate from historical levels is aresult of a higher proportion of income from foreign operations with lower taxrates and tax refunds received in the first and second quarters of fiscal year2003 related to the amendment of tax returns for our foreign salescorporation.  As a result these taxrefunds, the tax rate for the first half of fiscal 2003 was 27.7% whereas thetax rate in the second half of fiscal 2003 was 31.1%.

**Income From Continuing Operations**Income from continuing operations forfiscal 2003 was $56 million, compared to $42 million for the previous year, anincrease of $14 million or 33%. Increased sales, primarily of aesthetics products, lower cost of goodssold and lower operating expenses as a percentage of net sales, and a taxrefund increased net income, while the write-down of our investment in Paradigmreduced net income. 
**YEARS ENDED MARCH 31, 2002 AND 2001**
**Sales**

Sales for fiscal 2002 increased to $321million from $269 million in 2001, an increase of 19%.  Included in fiscal 2002 sales are 12 monthsof surgical urology and clinical and consumer healthcare product sales relatingto our February 2001 acquisition of Porges S.A., compared to two months ofsales included in fiscal 2001.  Porges productsales accounted for 15 percentage points of the year-to-year growth.  Sales were negatively affected by thecontinued strength of the U.S. Dollar versus other currencies and the generaleconomic slowdown in the economy. Foreign exchange rate movements had an unfavorable year-to-year impacton international sales of $1.4 million, or less than 1% of consolidated sales. 

Sales of aesthetic and general surgeryproducts increased 4% to $163 million from $157 million in the prior year.  We believe that the modest growth inaesthetic product sales was primarily the result of the general economicslowdown in fiscal 2002, and the events of September 11, 2001.  The sales of aesthetic products used incosmetic surgeries were substantially even with prior year sales, as theseproduct sales are affected more than our other aesthetic products and segmentsby general economic conditions, as a higher proportion of these cosmeticsurgeries are paid directly by the patient. However, the sales of aesthetic products used in reconstructivesurgeries increased 21% over prior year sales, as a high proportion of theseproduct sales are reimbursed by third party payers.  

Sales of surgical urology productsincreased 52% to $94 million from $62 million in the prior year.  This growth primarily resulted from our February2001 acquisition of Porges S.A., whose product sales are included in fiscal2002 sales for the whole year.  Porgesproduct sales accounted for 48 percentage points of the year-to-year growth.  Penile implant sales included incrementalsales of the Alpha 1 Inflatable device with the new Lockout® valve introducedlate in fiscal 2000.  Brachytherapy salesincreased slightly over the prior year as unit sales increases were partiallyoffset as competitive pressures decreased average selling prices.  

Sales of clinical and consumerhealthcare products increased 29% to $64 million from $50 million in the prioryear.  This growth primarily resultedfrom our February 2001 acquisition of Porges S.A., whose product sales areincluded for all of fiscal 2002.  Porges productsales accounted for 24 percentage points of the year-to-year growth.  In addition, sales of intermittentself-catheters grew 12% with the introduction of the Self-CathPlusTM lubricious catheter in fiscal 2002, while there was a slight decline inmale external catheter sales of 7%.  

**Costof Sales**

Cost of sales was 40.6% of net salesfor fiscal 2002, compared to 38.9% in fiscal 2001.  Fiscal 2002 included Porges product sales forthe entire year as opposed to two months in fiscal year 2001.  Porges products have an average cost of salesof approximately 60% as compared to a historic average of 38% for the rest ofour products and, consequently, the additional Porges product sales havediluted the gross margin product mix. This dilution was partially offset by manufacturing efficiencies in ouraesthetic and clinical and consumer healthcare products. 

**Selling, General andAdministrative**

Selling,general and administrative expenses were 34.7% of net sales in fiscal 2002compared to 37.3%, exclusive of the restructuring charge, in fiscal 2001.  The decrease as a percentage of net salesreflects cost savings from our restructuring of corporate staff during thesecond and third quarters of fiscal 2001 and the acquisition of Porges whichhas a lower percentage of selling, general and administrative expenses to netsales than the rest of the Company.  

**Research and Development**

Research and development expenses were 6.8% of netsales in fiscal 2002, a slight decrease from 7.3% in fiscal 2001.  Overall spending on research and developmentincreased by 11% from the prior year. Fiscal 2002 development costs relate primarily to our automated brachytherapyworkstation, accelerated product enhancement projects for existing products andnew product development.  Fiscal 2002also includes research and development costs related to Porges products, forwhich research and development expenses as a percentage of net sales havehistorically been lower than those for our other products.  Although we have successfully completedseveral pre-market approval application submissions related to mammary andpenile implants in recent years, the amount of spending on research anddevelopment is not expected to decrease as the focus of our research anddevelopment efforts shifts towards product enhancements and new productdevelopment.  In addition, we arecommitted to a variety of clinical and laboratory studies in connection withour gel-filled and saline filled mammary implants and other products.

**Interest and Other Income and Expense**

Interest expense increased to $859,000in fiscal 2002, from $276,000 in fiscal 2001. In January 2001, we acquired the assets of South Bay Medical LLC.  Approximately $7 million of the purchaseprice was recorded as a long-term accrued liability at net present value.  In December 2001, we recorded an additional $1.7million of long-term accrued liability at net present value related to theacquisition of certain intangible rights from ProSurg, Inc.  Imputed interest on these liabilities ischarged to interest expense.  Thisimputed interest and balances outstanding on several lines of creditestablished to facilitate operating cash flow needs at our foreign subsidiariesaccounted for the increase in interest expense over the prior year.  In fiscal 2002, $196,000 of interest incurredon a line of credit to finance the construction of a new foreign manufacturingfacility was capitalized.  

Interest income decreased from $4.2 million in 2001 to$2.2 million in fiscal 2002.  Thedecrease is due to lower cash and marketable security balances, lowerprevailing interest rates on short-term investments, and a shift in ourinvestment strategy from taxable commercial paper which has a higher pretaxyield to tax free municipal bonds and similar tax advantaged investmentvehicles, which currently have a higher after-tax yield. 

Other income, net primarily includesgains or losses on sales of marketable securities, disposal of assets, andforeign currency gains or losses related to our foreign operations.  In fiscal 2000, we recorded a $3 millionpermanent impairment of our equity investment in Intracel Corporation.  This impairment charge was offset by realizedgains on the disposition of marketable securities recorded as long-termmarketable securities available for sale. During fiscal 2002, we recorded an additional $3 million write-down ofour investment in Intracel Corporation upon its bankruptcy filing.  At March 31, 2002 the investment in IntracelCorporation is carried at no value. Other income, net for fiscal 2002, also includes a one-time gain of$700,000 related to the settlement of a dispute with Paradigm MedicalIndustries, a one-time foreign exchange gain of $720,000 on the repayment ofthe 15 million Euro loan to partially fund the acquisition of Porges S.A. andthe realized gains on the disposition of long-term marketable securitiesavailable-for-sale of $1.3 million. 

**Income Taxes**

The effective rate of corporate income taxes was 29.4%for fiscal 2002 and 31.6% for fiscal 2001. The decrease in the effective tax rate from fiscal 2001 to fiscal 2002is a result of a higher proportion of income from foreign operations with lowertax rates, increased tax-exempt interest income, tax credits related toresearch and development, and a refund received in the fourth quarter of fiscalyear 2002 related to the amendment of prior year tax returns for our foreignsales corporation.  

**IncomeFrom Continuing Operations**

Income from continuing operations forfiscal 2002 was $42 million, compared to $32 million for the previous year, anincrease of $10 million or 30%. Increased sales, primarily from our Porges S.A. acquisition in February2001, lower cost of goods sold and lower operating expenses as a percentage ofnet sales, and a tax refund increased net income, while the write-down of ourinvestment in Intracel Corporation and lower investment income reduced netincome. 

**Inflation**

We do not believe inflation has had amaterial impact on our operations over the three-year period ended March 31,2003.

**LIQUIDITY AND CAPITAL RESOURCES**

We had cash,cash equivalents and short-term marketable securities of $106 million and $75million at March 31, 2003 and 2002, respectively.  During the three years ended March 31, 2003,liquidity needs have been satisfied principally by cash flow from operationsand, to a lesser extent from borrowings under our line of credit.  Despite significant acquisition and stock repurchaseactivities; we maintained our strong cash and financial position throughoutfiscal 2003. 

At March 31, 2003, working capital was$168 million compared to $127 million the previous year.  We generated $76 million of cash fromcontinuing operations during fiscal 2003, compared to $58 million the previousyear.  Increased income from continuingoperations, and increases in accounts payable and accrued liabilitiescontributed to the increased cash flow. These amounts were partially offset by an increase in accountsreceivable and inventory. 

During fiscal 2003, we invested $17million in manufacturing equipment, information technology systems, and in abuilding at our manufacturing facility in Oklahoma.  We anticipate investing approximately $20million in fiscal 2004 to complete facility improvements, purchase productionequipment and continue the implementation of information technology systems.

Wereceived cash from the exercise of employee stock options.  Employee stock option exercises provided $6.7million and $6.8 million of cash in fiscal 2003 and fiscal 2002,respectively.  Proceeds from the exerciseof employee stock options will vary from period to period based upon, amongother factors, fluctuations in the market value of our common stock relative tothe exercise price of such options. 

Our Board of Directors has authorizedan ongoing stock repurchase program.  Theobjectives of the program, among other items, are to offset the dilutive effectof our employee stock option program, provide liquidity to the market and toreduce the overall number of shares outstanding.  Repurchases are subject to market conditionsand cash availability.  During fiscal2003, we repurchased 1.4 million shares for consideration of $22.3million.  We intend to continue the sharerepurchase program in fiscal 2004 and 1.8 million shares remain authorized forrepurchase.  

Certain technologies related to themanufacture of mammary prostheses were developed under a 1983 agreement with alimited partnership whereby the limited partners contributed funds towards thedevelopment of the technology in exchange for payments based upon a percentageof future sales of the products utilizing the technology.  We paid approximately $2 million in suchpayments in fiscal 2000 to the partnership. We were the general partner for this partnership.  The agreement included an option to purchasethe technology and thereby terminate the partnership.  In fiscal 2001, we exercised our option tomake a lump sum payment to the limited partners in lieu of all future paymentsand rights according to the Agreement of Purchase and Sale between us and thepartnership, as amended.  The limitedpartners could elect to be paid in cash, our common stock, or a combination.  This transaction was completed in the secondquarter ended September 30, 2000.  Thelimited partners elected to be paid $1.0 million in cash and 434,000 (868,000post split) shares of our common stock. The stock, transfer of which is restricted by Rule 144, was valued atits fair market value on the date of issuance, of approximately $9million.  The decrease in payments to thepartners is offset by the increased amortization of the new intangible assetand the additional common shares outstanding, thus having a neutral effect onearnings per share.

In January 2001, we completed theacquisition of South Bay Medical, a development stage company focused on thedevelopment of a new technology for a computer-based workstation and automatedcartridge-based needle loading system for use in brachytherapy procedures.  The total consideration included $2 millionin cash, 235,293 restricted shares of our common stock having a fair marketvalue of $4 million, and $13.6 million to be paid in cash or our common stockover the next several years.  Thesefuture payments have been recorded as an acquisition obligation liability atnet present value ($12.6 million at March 31, 2003), and will continue toincrease as imputed interest is recorded. Approximately $5.9 million of the acquisition obligation liability is tobe paid in shares of our common stock valued at fair market value on the dateof issuance. 

In February 2001, we acquired PorgesS.A., a subsidiary of Sanofi-Synthelabo headquarteredin Paris, and with manufacturing facilities in Sarlat, France.  The consideration paid for Porges S.A. was$32 million.  

In December 2001, we entered intoseveral agreements with ProSurg, Inc. to purchase certain patent rights and asupply of a bio-absorbable co-polymer product. The total consideration included $2.0 million in cash and $2.7 millionin short and long-term payments due over the next several years. The futurepayments have been recorded as an acquisition obligation liability at netpresent value and will increase with imputed interest to $3.0 million due overthe next several years.  

On May 6, 2002, we announced that wehad completed the acquisition of the urology business of Portex Ltd., asubsidiary of Smiths Group plc.  Theconsideration paid for Portex was $10.6 million in cash.  

In January 2003, we completed theacquisition of Mills Biopharmaceuticals, Inc., a manufacturer of iodinebrachytherapy seeds for the treatment of prostate cancer.  The consideration was $4.1 million in cash.  

We have a secured line of credit forborrowings up to $25 million ("Credit Agreement"), which accrueinterest at the prevailing prime rate or at a mark-up over LIBOR at ourdiscretion.  The Credit Agreementincludes certain covenants that, among other things, limit the dividends we maypay and requires maintenance of certain levels of tangible net worth and debtservice ratios.  During fiscal 2002, weused the Credit Agreement to guarantee the secured loan of a vendor, in theamount of $5.3 million, and to facilitate the ramp up of production capacityrelated to a new product.  This loan wasrepaid in 2003 and the guarantee expired. In addition, two commercial letters of credit totaling $3.0 million areoutstanding at March 31, 2003. Accordingly, although there were no borrowings outstanding under theCredit Agreement at March 31, 2003, only $22.0 million was available foradditional borrowings.

In addition,in February 2001, we established several lines of credit with local foreignlenders to facilitate operating cash flow needs at our foreign subsidiaries.  These lines are at market rates of interest,unsecured, guaranteed by Mentor Corporation, and total $5.8 million, of which$3.3 million was outstanding, and $2.5 million was available at March 31, 2003.  

In fiscal2002, a line of credit of $6.6 million was established to finance theconstruction of a new facility in Leiden, the Netherlands.  The borrowings accrue interest at EURIBORplus 0.75% and are secured by the new facility and other assets in theNetherlands.  At March 31, 2003, $4.9million was outstanding and $1.7 million was available under this line.  The line of credit provides for conversion toa term loan at prevailing interest rates when construction of the new facilityis completed. 

At March 31,2003, our total short-term borrowings under all lines ofcredit was $8.7 million and the weighted-average interest rate was3.00%.  The total amount of additionalborrowings available to us under all lines of credit was $26.3 million and$21.1 million at March 31, 2003 and 2002, respectively.  At March 31, 2002, $9.5 million wasoutstanding under these lines of credit at a weighted average borrowing rate of4.10%.

Wehave historically paid a quarterly cash dividend of $.03 per share.  In December 2002, our Board of Directorsauthorized a 2-for-1 stock split and increased the quarterly dividend on apost-split basis from $.015 per share to $.02 per share.  At the new annual rate of $.08 per share, theaggregate annual dividend would equal approximately $3.7 million.  It is our intent to continue to pay dividendsfor the foreseeable future subject to among other things, Board approval, cashavailability and alternative cash needs. The Credit Agreement limits the aggregate amount of dividends payable inany year to one-half of the net income of the preceding year. 

The following table summarizes ourcontractual cash and other commercial commitments at March 31, 2003:

(in thousands)

 

Less Than

1-3

4-5

After 5

**Contractual  Cash Obligations**

Total

1 Year

Years

Years

Years

Operating leases

$45,698

$4,797

$14,410

$ 9,022

$17,470
    Total Contractual Cash Obligations  $45,698  $4,797  $14,410  $9,022  $17,470
 

 

 

 

 

**Commercial  Commitments**

 

 

 

 

 

Lines of credit

$   8,176

$   8,176

$         -

$         -

$         -

Other commercial commitments

19,827

6,080

 9,475

1,275

2,997

  Total Commercial  Commitments

$ 28,003

$ 14,256

$ 9,475

$ 1,275

$  2,997

In addition, in the ordinary course ofbusiness, we have at any one time, outstanding purchase orders for rawmaterials and other supplies, which may in aggregate be significant but forwhich usage does not exceed one year. 

Our principal source of liquidity atMarch 31, 2003 consisted of $106 million in cash, cash equivalents andshort-term marketable securities, plus $26 million available under our existinglines of credit.  We believe that fundsgenerated from operations, our cash, cash equivalents and marketable securitiesand funds available under our line of credit agreements will be adequate tomeet our working capital needs and capital expenditure investment requirementsand commitments for the foreseeable future. However, it is possible that we may need to raise additional funds tofinance our unforeseen requirements or to consummate acquisitions of otherbusiness, products or technologies. Additional funds could be raised by selling equity or debt securities tothe public or to selected investors, or by borrowing money from financialinstitutions.  In addition, even thoughwe may not need additional funds, we may still elect to sell additional equityor debt securities or obtain credit facilities for other reasons.  We may not be able to obtain additional fundson terms that would be favorable to us, or at all.  If funds are raised by issuing additionalequity securities or convertible debt securities, the ownership percentage ofexisting shareholders would be reduced. In addition, the equity or debt securities issued by us may have rights,preferences or privileges senior to those of our common stock. 

**FORWARD-LOOKING STATEMENTS**

Certain words in this report like"believe," "intend," "anticipate,""expect," "estimate," "seek," and similar expressionsare intended to identify, in certain cases, forward-looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995.  Thesestatements involve known and unknown risks, uncertainties and other factors thatmay cause actual results to differ materially from the predicted results. Such factors which may affect forward-looking statements include, among others, thefollowing:
- Significant product liability, warranty claims, or other claims;
- Errors in estimates, assumptions and judgments used inaccounting;
- Non-compliance with FDA and other regulatory agencies;
- Inadequate reimbursement by government agencies and othersfor our products;
- Difficulties implementing and integrating new informationtechnologies systems; and
- Other factors outlined in our previously filed publicdocuments, copies of which may be obtained without cost from us.

Given these uncertainties, investorsare cautioned not to place too much weight on such statements.  We are not obligated to update theseforward-looking statements.

**ITEM  7A.**

**QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

The following discussion about ourmarket risks involves forward-looking statements.  Actual results could differ materially fromthose projected in the forward-looking statements.  We are exposed to market risk related tochanges in interest rates and foreign exchange rates.  We generally do not use derivativeinstruments. 

We maintain a portfolio of highly liquidcash equivalents, with maturities of three months or less from the date ofpurchase.  We also have currentmarketable securities, consisting primarily of money market mutual funds, U.S.state and municipal bonds, and commercial paper that are of limited credit riskand have contractual maturities of less than two years.  Given the short-term nature of theseinvestments, we are not subject to significant interest rate risk.

A portion of our operations consist ofsales activities in foreign markets.  Wemanufacture our products primarily in the United States and Europe and sellthem outside the U.S. through a combination of international distributors andwholly owned sales offices.  Sales tothird-party distributors and to the wholly owned sales offices are transactedin U.S. Dollars or in Euros.  Our salesoffices invoice customers in their local currency.

As a result, our financial resultscould be significantly affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in those foreign markets.  The principal exposure on sales tothird-party distributors stems from the potential for weak economic conditionsin the foreign market, thus weakening the foreign currency, decreasing thecustomer's buying power and potentially decreasing our sales.  Our exposure on sales to our subsidiariesconsists of (1) the exposure related to a weakening local currency when paymentof the related payables are made resulting in more local currency to pay offthe U.S. denominated payable than when it was originally recorded, thuslowering the subsidiaries' earnings, and (2) the exposure that upon translationof the subsidiaries' monthly financial statements, a weakening local currencywould cause sales made in local currency to be recorded in a lower amount ofU.S. dollars than if the currency had been stable as compared to the U.S.dollar.  However, in the latter instance,operating expenses would also be translated at lower amounts and, accordingly,the effect on net income would be mitigated. We do not currently hedge any of these exposures.

**ITEM  8.**

**FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA.**

The information required by this itemis submitted pursuant to Item 16 of this Annual Report on Form 10-K andincorporated herein by reference.

**ITEM  9.**

**CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.**

None.

**PART III**

**ITEM  10.**

**DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT.**

The information required by this item,other than the information regarding Executive Officers set forth in Item 1,Business, is herein incorporated by reference to portions of the ProxyStatement for the Annual Meeting of Shareholders to be filed with theSecurities and Exchange Commission within 120 days of the close of the fiscalyear ended March 31, 2003. 

**ITEM  11.**

**EXECUTIVE  COMPENSATION.**

The information required by this itemis herein incorporated by reference to portions of the Proxy Statement for theAnnual Meeting of Shareholders to be filed with the Securities and ExchangeCommission within 120 days of the close of the fiscal year ended March 31,2003. 

**ITEM  12.**

**SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS.**

The information required by this itemis herein incorporated by reference to portions of the Proxy Statement for theAnnual Meeting of Shareholders to be filed with the Securities and ExchangeCommission within 120 days of the close of the fiscal year ended March 31,2003. 

**ITEM  13.**

**CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS.**

The information required by this itemis herein incorporated by reference to portions of the Proxy Statement for theAnnual Meeting of Shareholders to be filed with the Securities and ExchangeCommission within 120 days of the close of the fiscal year ended March 31,2003. 

**ITEM  14.**

**CONTROLS  AND PROCEDURES.**

Evaluation of Disclosure Controls andProcedures

Within the 90-day period prior to thefiling of this Annual Report on Form 10-K, we carried out an evaluation underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, of the design andoperation of our disclosure controls and procedures (as defined in theSecurities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)).  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that the design andoperation of our disclosure controls and procedures were effective to ensurethat information required to be disclosed by us in the reports that we file orsubmit under the Securities and Exchange Act are recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission's rules and forms.

Changes in Internal Controls

There were no significant changes inour internal controls or in other factors that could significantly affect suchcontrols subsequent to the date of our Chief Executive Officer's and ChiefFinancial Officer's most recent evaluation, includingany corrective actions with regard to significant deficiencies and materialweaknesses.

**ITEM  15.**

**PRINCIPAL  ACCOUNTANT FEES AND SERVICES.**

The information required by this itemis herein incorporated by reference to portions of the Proxy Statement for theAnnual Meeting of Shareholders to be filed with the Securities and ExchangeCommission within 120 days of the close of the fiscal year ended March 31,2003. 

**PART IV**

**ITEM  16.**

**EXHIBITS,  FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.**

(a)(1)

Consolidated Financial  Statements

Report of Ernst & Young  LLP, Independent Auditors

Consolidated Balance Sheets as  of March 31, 2003 and 2002

Consolidated Statements of  Income for the Years Ended March 31, 2003, 2002 and 2001

Consolidated Statements of  Changes in Shareholders' Equity for the Years Ended March 31, 2003, 2002 and  2001

Consolidated Statements of Cash  Flows for the Years Ended March 31, 2003, 2002 and 2001

Notes to Consolidated Financial  Statements

(a)(2)

Consolidated Financial  Statement Schedules

Schedule II - Valuation and  Qualifying Accounts and Reserves

All other schedules are omitted  because they are not required, inapplicable, or the information is otherwise  shown in the consolidated financial statements or notes thereto.

(a)(3)

Exhibits

The information required by  this item is incorporated by reference to the Exhibit Index..

(b)

Reports on Form 8-K

We filed a report on Form 8-K  on May 13, 2003 regarding our press release announcing our fourth quarter and  fiscal 2003 results.                                                                                                                                                                                    

**REPORT OF ERNST & YOUNG LLP,INDEPENDENT AUDITORS**

Board of Directors andShareholdersMentor Corporation

We haveaudited the accompanying consolidated balance sheets of Mentor Corporation asof March 31, 2003 and 2002, and the related consolidated statements of income,changes in shareholders' equity and cash flows for each of the three years inthe period ended March 31, 2003.  Ouraudits also included the financial statement schedule listed in the Index atItem 16(a)(2). These financial statements and schedule are the responsibility of theCompany's management.  Our responsibilityis to express an opinion on these financial statements and schedule based onour audits.

We conductedour audits in accordance with auditing standards generally accepted in theUnited States.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

In our opinion, the financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of Mentor Corporation at March 31, 2003 and2002, and the consolidated results of its operations and its cash flows foreach of the three years in the period ended March 31, 2003, in conformity withaccounting principles generally accepted in the United States.  Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

/s/ERNST &YOUNG LLPLos Angeles,CaliforniaMay 13, 2003

**MENTOR CORPORATIONConsolidated Balance Sheets**

 

March 31,

 
(in thousands)

**2003**

2002

 
**Assets**

** **

 

 
Current assets:

** **

 
   Cash and cash equivalents

**$   105,840 **

$    60,398 

 
   Marketable securities

**184 **

14,106 

 Accounts receivable, net of allowance for doubtful accounts      of $5,406 in 2003 and $3,870 in  2002
**79,784 **

  64,786 

 
   Inventories

**61,269 **

47,404 

 
   Deferred income taxes

**15,253 **

11,950 

 
   Prepaid expenses and other

**10,858 **

12,488 

 
Total current assets

**273,188 **

211,132 

 
 

** **

 

 
Property and equipment, net

**68,671 **

54,656 

 
Intangible assets, net

**35,570 **

37,588 

 
Goodwill, net

**16,520 **

9,155 

 
Long-term marketable securities and  investments

**3,741 **

11,752 

 
Other assets

**398 **

353 

 
 

**$   398,088 **

$   324,636 

 
**Liabilities and shareholders' equity**

** **

 

 
Current liabilities:

** **

 

 
   Account payable and accrued liabilities

**$    95,638 **

$    70,423 

 
   Income taxes payable

**453 **

3,979 

 
   Dividends payable

**925 **

704 

 
   Short-term bank borrowings

**8,176 **

9,470 

 
Total current liabilities

**105,192 **

84,576 

 
 

** **

 

 
Deferred income taxes

**2,216 **

3,009 

 
Long-term accrued liabilities

**13,970 **

12,873 

 
 

** **

 

 
Commitments and contingencies

** **

 

 
 

** **

 

 
Shareholders' equity:

** **

 

 
   Common Stock, $.10 par value:

** **

 

 
      Authorized - 150,000,000 shares; Issued and outstanding--

** **

 

 
      46,237,324 shares in 2003;

** **

 

 
      46,945,904 shares in 2002;

**4,624 **

4,695 

 
   Capital in excess of par value

**-   **

-    

 
   Accumulated other comprehensive income (loss)

**6,399 **

(6,487)

 
   Retained earnings

**265,687 **

225,970 

 
 

**276,710 **

224,178 

 
 

**$  398,088 **

$  324,636 

 
See notes to consolidated financial  statements.

 

 

 
 
**MENTOR CORPORATIONConsolidated Statements of Income**

 

Year Ended March 31,

(in thousands, except per share data)

**2003**

2002

2001

Net sales

**$ 382,384 **

$ 321,062 

$ 268,894 

Costs and expenses:

** **

 

 

   Cost of sales

**152,877 **

130,455 

104,696 

   Selling, general, and administrative

**129,552 **

111,285 

100,379  

   Research and development

**22,978 **

21,806 

19,632 

   Restructuring charge

**-   **

-    

2,400 

 

**305,407 **

263,546 

227,107 

 

** **

 

 

Operating income

**76,977 **

57,516 

41,787  

   Interest expense

**(1,022)**

(859)

(276)

   Interest income

**2,456 **

2,217 

4,209 

   Other income, net

**628 **

342 

829  

 

** **

 

 

Income from continuing operations before  income taxes

**79,039 **

59,216 

46,549 

 

** **

 

 

Income taxes

**23,219 **

17,396 

14,731  

Income from continuing operations 

**55,820 **

41,820 

31,818 

Income from discontinued operations, net  of income taxes

**-   **

-    

260  

Net income

**$  55,820 **

$  41,820 

 $    32,078 

 

** **

 

 

Basic earnings per share:

** **

 

 

    Continuing operations

**$  1.20 **

$  0.88 

 $   0.67  

    Discontinued operations

**-   **

-    

0.01 

      Basic earnings per share

**$  1.20 **

$  0.88 

 $   0.68  

 

** **

 

 

Diluted earnings per share:

** **

 

 

    Continuing operations

**$  1.15 **

$  0.85 

$   0.66 

    Discontinued operations

**-   **

-    

-  

      Diluted earnings per share

**$  1.15 **

$  0.85 

 $   0.66  

 

** **

 

 

See notes to consolidated financial  statements.

 

 

 
**MENTOR CORPORATIONConsolidated Statements of Changesin Shareholders' Equity **
  (in thousands except per share data)

  Common  Shares  Outstanding

  Common  Stock $.10  Par Value

  Capital in  Excess of  Par Value

  Accumu-  lated Other  Compre-  hensive  Income (loss)

  Retained  Earnings

  Total

**Balance March 31, 2000**

**       24,209 **

** $   2,421 **

**$    9,876 **

**$   2,323 **

**$169,022 **

**$183,642 **

Comprehensive income:

 

 

 

 

 

 

   Net income

             - 

             - 

             - 

             -

      32,078 

    32,078 

      Foreign currency       translation adjustment

            - 

            - 

            - 

                  (2,217)

  -

                  (2,217)

      Unrealized loss on       investments

            - 

            - 

            - 

                  (4,388)

  -

                  (4,388)

Comprehensive income

 

 

 

 

 

      25,473 

Exercise of stock options

            286  

        29 

    2,458 

             -

             -

        2,487 

Issuance of common stock  in acquisition of  intangible assets

           435  

           43 

       9,079  

 

-

 

-

     9,122 

Issuance of common stock  in acquisition of South   Bay Medical LLC

                      235  

                         24  

                   3,976  

 

-

 

-

                   4,000  

Income tax benefit arising  from the exercise of  stock options

                          -    

                          -    

                   2,133  

                          -  

                           -  

                   2,133  

Repurchase of common    stock

       (1,493)

     (150)

 (19,897)

    -

 (8,022)

   (28,069)

Dividends declared  ($.105 per share)

            - 

            - 

            - 

             -

      (2,482)

      (2,482)

**Balance March 31, 2001**

**    23,672 **

** $ 2,367 **

** $  7,625 **

** $   (4,282)**

** $190,596 **

** $196,306 **

Comprehensive income:

 

 

 

 

 

 

   Net income

             - 

             - 

             - 

             -

      41,820 

    41,820 

      Foreign currency       translation adjustment

            - 

            - 

            - 

                  (2,015)

  -

                  (2,015)

      Unrealized loss on       investments

            - 

            - 

            - 

                  (190)

  -

                  (190)

Comprehensive income

 

 

 

 

 

      39,615 

Exercise of stock options

            533  

        53 

    6,777 

             -

             -

        6,830 

Income tax benefit arising  from the exercise of  stock options

                          -    

                          -    

                   2,975 

                          - 

                          -  

                   2,975  

Repurchase of common    stock

      (732)

       (73)

  (17,377)

       -

  (1,265)

   (18,715)

Dividends declared  ($.12 per share)

            - 

            - 

            - 

             -

      (2,833)

      (2,833)

**Balance March 31, 2002**

**    23,473 **

**$  2,347 **

**$              - **

**$ (6,487)**

**$228,318 **

**$224,178 **

**MENTOR CORPORATIONConsolidated Statements of Changes in Shareholders' Equity(continued)**

  (in thousands except per share data)

  Common  Shares  Outstanding

  Common  Stock $.10  Par Value

  Capital in  Excess of  Par Value

  Accumu-  lated Other  Compre-  hensive  Income (loss)

  Retained  Earnings

  Total

**Balance March 31, 2002**

**       23,473 **

** $   2,347 **

**$          - **

**$ (6,487) **

**$228,318 **

**$224,178  **

Comprehensive income:

 

 

 

 

 

 

   Net income

             - 

             - 

             - 

             - 

      55,820 

    55,820 

      Foreign currency       translation adjustment

            - 

            - 

            - 

                  13,437 

  -

                  13,437 

      Unrealized loss on       investments

            - 

            - 

            - 

                  (551)

  -

              (551)

Comprehensive income

 

 

 

 

 

      68,706 

Exercise of stock options

            374  

        37 

    6,621 

             - 

             - 

        6,658 

Stock split

   23,171  

       2,318 

      (2,318)  

-

-

- 

Income tax benefit arising  from the exercise of  stock options

                          -    

                          -    

                   2,699  

                          -    

                          -    

                   2,699   

Repurchase of common    stock

       (781)

        (78)

      (7,002)

    - 

   (15,194)

   (22,274)

Dividends declared  ($.07 per share)

            - 

            - 

            - 

            - 

      (3,257)

      (3,257)
**Balance March 31, 2003**
**46,237 **
**$ 4,624 **
**$          - **
**  $  6,399 **
**$265,687 **
**$276,710 **
**MENTOR CORPORATIONConsolidated Statements of CashFlows**

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Operating Activities:**

** **

 

 

Income from continuing operations

**$55,820 **

$41,820 

$31,818 

Adjustments to derive cash flows from  continuing operating activities:

** **

 

 

  Depreciation 

**11,397 **

9,982 

8,528 

  Amortization

**3,336 **

3,866 

1,812  

  Deferred income taxes 

**(4,183)**

(4,799)

(1,438)

  Tax benefit from exercise of  stock options

**2,699 **

2,975 

2,133 

  Loss (gain) on sale of assets

**(433)**

456 

(64)

  Imputed interest on long-term  liabilities

**576 **

512 

-

  Loss on long-term marketable  securities and investment    write-downs, net

**1,454 **

  301 

  (1,142)

   Changes in operating assets and liabilities:

** **

 

 

      Accounts receivable

**(9,577)**

(8,366)

2,144  

      Inventories and other current assets

**(4,276)**

(5,338)

(3,063)

      Accounts payable and accrued liabilities

**22,946 **

16,025 

3,173  

      Income taxes payable

**(3,467)**

997 

(1,810) 

      Foreign currency transaction (gain)

**(509)**

- 

- 

Net cash provided by continuing operating  activities

**75,783 **

58,431 

42,091  

Net cash provided by discontinued  operating activities

-

- 

260  

Net cash provided by operating activities

**75,783 **

58,431 

42,351  

**Investing Activities:**

** **

 

 

Purchases of property and equipment

**(16,441)**

(15,094)

(7,457)

Purchases of intangibles

**(302)**

(166)

(2,710)

Purchases of marketable securities

**(23,789)**

(161,200)

(75,552)

Sales of marketable securities

**44,750 **

140,329 

129,870  

Acquisitions, net of cash acquired

**(14,666)**

(4,347)

(32,896)

Other, net

**500 **

(46)

(56)

Net cash provided by (used for) investing  activities

**(9,948)**

(40,524)

11,199  

**Financing Activities:**

** **

 

 

Repurchase of common stock

**(22,274)**

(18,715)

 (28,069)

Proceeds from exercise of stock options

**6,658 **

6,830 

    2,487  

Dividends paid

**(3,037)**

(2,839)

  (2,380)

Borrowings under line of credit agreements

**29 **

6,825 

  19,953  

Repayments under line of credit agreements

**(3,488)**

(13,372)

   (6,000)

Reduction in long-term debt

**(14)**

- 

- 

Net cash used for financing activities

**(22,126)**

(21,271)

(14,009)

Effect of currency exchange rates on cash  and cash equivalents

**1,734 **

(92)

-    

Increase (decrease) in cash and cash  equivalents

**45,442 **

(3,456)

   39,541  

Cash and cash equivalents at beginning of  year

**60,398 **

63,854 

24,313  

Cash and cash equivalents at end of year

**$105,840 **

$60,398 

 $63,854  

**Supplemental cash flow information**

 

 

 

   Cash paid during the year for:

 

 

 

      Income taxes

**$30,506**

   $18,945   

$14,009 

      Interest

**       447**

          645  

     152 

**Supplemental non-cash investing and financing  activities**

** **

 

 

   Issuance of common stock in acquisition of South Bay Medical

            - 

            - 

   4,000 

  Issuance  of common stock in acquisition of intangible assets

            - 

            - 

     9,122  

   Liabilities accrued related to the acquisition of intangible assets

            - 

   2,685

 10,720 

See notes to consolidated financial  statements.

** **

 

 
**MENTORCORPORATIONNOTES TO CONSOLIDATED FINANCIALSTATEMENTSMARCH 31, 2003**
**NoteA - Summary of Significant Accounting Policies**

**BusinessActivity**

MentorCorporation was incorporated in April 1969.  We develop, manufacture and market a broadrange of products for the medical specialties of aesthetic and general surgery(plastic and reconstructive surgery), surgical urology and for clinical andconsumer healthcare.  The Company'sproducts are sold to hospitals, physicians and through various healthcaredealers, wholesalers, and retail outlets. The results of operations for the discontinued ophthalmic segment of thebusiness are presented as discontinued operations and not included incontinuing operations.

**Principlesof Consolidation**

The consolidatedfinancial statements include the accounts of the Company and all of itssubsidiaries in which a controlling interest is maintained.  For those subsidiaries where the Company ownsless than 100%, the outside shareholders' interests are treated as minorityinterests.  All intercompany accounts andtransactions have been eliminated. Certain prior year amounts in previously issued financial statementshave been reclassified to conform to the current year presentation.  Financial information presented in the Notesto Consolidated Financial Statements excludes discontinued operations, exceptwhere noted.  

**CashEquivalents, Marketable Securities, and Long-Term Marketable Securities andInvestments**

All highlyliquid investments with maturities of three months or less at the date ofpurchase are considered to be cash equivalents.

The Company considers itsmarketable securities available-for-sale as defined in SFAS No. 115,"Accounting for Certain Investments in Debt and EquitySecurities."  Realized gains andlosses and declines in value considered to be other than temporary are includedin income.  The cost of securities soldis based on the specific identification method. For short-term marketable securities, there were nomaterial realized or unrealized gains or losses, nor any materialdifferences between estimated fair values, based on quoted market prices, andthe costs of securities in the investment portfolio as of March 31, 2003 and2002.  Short-term investments, exceptauction rate securities, mature between three months and one year from thepurchase date.  The Company's short-termmarketable securities consist primarily of money market mutual funds, U.S.,state and municipal government obligations, auction rate securities, andinvestment grade corporate obligations including commercial paper.  Auction rate securities carry interest ordividend rates that reset every 28 days but have contractual maturities ofgreater than one year. 

The Company's long-term marketable securities andinvestments include investments in Federal Home Loan Bank and MortgageAssociation bonds (FHLA bonds) with maturities of two to four years.  During fiscal 1998, the Company made a $6million equity investment in Intracel Corporation as part of an agreement todevelop a bladder cancer treatment.  Theinvestment was valued at cost as quoted market prices were not available.  During fiscal 2000, the Company recorded a $3million charge to other income related to the investment.  In September 2001, Intracel filed forprotection under Chapter 11 of the Bankruptcy Code.  After evaluation of the filing, the Companyrecorded an additional $3 million write-down as a charge to other income in thequarter ending December 31, 2001.  As aresult of these two write-downs, the investment in Intracel is now recorded atno value.  The Company recorded aone-time gain in other income for the quarter ending December 31, 2001 upon thereceipt of 350,000 shares of Paradigm Medical Industries, Inc. ("Paradigm")in settlement of a stock registration dispute. The shares were valued at $700,000 based upon the quoted price on thedate received.  

During the year ended March 31,2002, the Company sold a portion of its North American Scientific, Inc.("NASI") and Paradigm securities and realized a pre-tax gain of $1.3million, which is reflected in other income, net.  During the year ended March 31, 2003, theCompany sold its remaining investment in NASI and recorded a pre-tax gain of$403,000, which is reflected in other income, net.  Paradigm reported financial and operationaldifficulties and its quoted market prices decreased substantially during theyear ended March 31, 2003.  In the fourthquarter the Company determined the decrease in market prices were more thantemporary and recorded a one-time impairment charge of $1,857,000 pre-tax in otherincome, net.  The remaining investment inParadigm is recorded at $122,000.

Available-for-sale investments atMarch 31, 2003 were as follows:

** **

** **

** **

**Gross**

**Gross**

**Estimated**

** **

** **

**Adjusted**

**Unrealized**

**Unrealized**

**Fair**

**(in thousands)**

**Cost**

**Gains**

**Losses**

**Value**

**Cash balances**

**$ 16,733**

**$      -**

**$          -**

**$  16,733**

**Bank time deposits**

**-**

**-**

**-**

**-**

**Money market mutual  funds**

**89,107**

**-**

**-**

**89,107**

**Marketable equity  securities**

**3,493**

**7**

**(2,040)**

**1,460**

**U.S., State and  Municipal agency      obligations**

**2,184**

**3**

**-**

**2,187**

**Corporate debt  securities**

**278**

**-**

**-**

**278**

**   Total  available-for-sale investments**

**$111,795**

**$   10**

**$ (2,040)**

**$109,765**

** **

** **

** **

** **

** **

**Included in cash and  cash equivalents**

**$105,840**

**$      -**

**$           -**

**$105,840**

**Included in current  marketable securities**

**184**

**-**

**-**

**184**

**Included in long-term  marketable      securities and investments**

**5,771**

**10**

**(2,040)**

**3,741**

**   Total  available-for-sale investments**

**$111,795**

**$   10**

**$(2,040)**

**$109,765**

** **Available-for-sale investments atMarch 31, 2002 were as follows:

 

 

 

Gross

Gross

Estimated

 

 

Adjusted

Unrealized

Unrealized

Fair

(in thousands)

Cost

Gains

Losses

Value

Cash balances

$11,417

$    -

$    -

$11,417

Bank time deposits

1,175

-

-

1,175

Money market mutual funds

48,981

-

-

48,981

Marketable equity securities

2,076

774

-

2,850

U.S., State and Municipal agency      obligations

  21,653

  -

  (98)

  21,555

Corporate debt securities

278

-

-

278

   Total available-for-sale  investments

$85,580

$774

$(98)

$86,256

 

 

 

 

Included in cash and cash equivalents

$60,398

$     -

$     -

$60,398

Included in current marketable securities

14,106

-

-

14,106

Included in long-term marketable      securities and investments

  11,076

  774

  (98)

  11,752

   Total available-for-sale  investments

$85,580

$774

$(98)

$86,256

**Concentrationsand Credit Risk**

The Company obtains certain rawmaterials and components for a number of its products from singlesuppliers.  In most cases the Company'ssources of supply could be replaced if necessary without undue disruption, butit is possible that the process of qualifying new materials and/or vendors forcertain raw materials and components could cause a material interruption inmanufacturing or sales.  No material interruptionsin raw material supply occurred during the last fiscal year.

The Company grants credit terms in thenormal course of business to its customers, primarily hospitals, doctors anddistributors.  The Company performsongoing credit evaluations of its customers and adjusts credit limits basedupon payment history and the customer's current credit worthiness, asdetermined through review of their current credit information.  The Company continuously monitors collectionsand payments from customers and maintains allowances for doubtful accounts forestimated losses resulting from the inability of its customers to make requiredpayments.  Estimated losses are based onhistorical experience and any specific customer collection issuesidentified.  Bad debts have beenminimal.  The Company does not normallyrequire collateral or other security to support credit sales.  No customer accounted for more than 10% ofthe Company's revenues or accounts receivable balance for any periodspresented.

**Revenue Recognition**

In the UnitedStates and in those countries where the Company has sales offices, the Companyemploys specialized direct sales employees. The Company also markets its products through distributors in thosecountries where it does not have a sales office or for certain products,particularly its disposable incontinence products, through a domestic networkof independent hospital supply dealers and healthcare distributors and throughretail pharmacies.

TheCompany recognizes product revenue, net of discounts, returns, and rebates inaccordance with SFAS 48, "Revenue Recognition When the Right of ReturnExists," and SAB No. 101, "Revenue Recognition in FinancialStatements."  As required by thesestandards, revenue can be recorded when persuasive evidence of a salesarrangement exists, delivery has occurred, the buyer's price is fixed ordeterminable, contractual obligations have been satisfied, and collectibilityis reasonably assured.  Theserequirements are met, and sales and related cost of sales are recognizedprimarily upon the shipment of products, or in the case of consignmentinventories, upon the notification of usage by the customer.  The Company records estimated reductions torevenue for customer programs and other volume-based incentives.  Should customer participation in theseprograms exceed that estimated by the Company, additional reductions to revenuemay be required. The Company also allows credit for products returned within its policyterms.  The Company records an allowancefor estimated returns, based on historical experience, recent gross saleslevels and any notification of pending returns, at the time of sale.  Should the actual returns exceed thoseestimated by the Company, additional reductions to revenue and cost of salesmay be required. 

**Inventories**

Inventoriesare stated at the lower of cost or market, cost determined by the first-in,first-out ("FIFO") method.  The Companywrites down its inventory for estimated obsolescence or unmarketable inventoryequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions.

**Propertyand Equipment**

Property andequipment is stated at cost. Depreciation is based on the useful lives of the properties and computedusing the straight-line method. Buildings are depreciated over 30 years, furniture and equipment over 3to 10 years and leasehold improvements over the shorter of their estimatedremaining lives or lease term. Significant improvements and betterments are capitalized whilemaintenance and repairs are charged to operations as incurred.

**IntangibleAssets and Goodwill**

Intangibleassets consist of values assigned to patents, licenses, trademarks and otherintangibles.  These are stated at costless accumulated amortization and are amortized over their economic useful liferanging from 3 to 20 years using the straight-line method.  Goodwill, the excess purchase cost over fair value ofnet identifiable assets acquired, is amortized using the straight-line method infiscal years 2001 and 2002.  Goodwill amortization was discontinued in fiscal 2003 inaccordance with SFAS 142, Goodwill and Other Intangible Assets.  As required bySFAS 142, the Company has reassessed the remaining amortization periods ofintangible assets acquired on or before June 30, 2001 and assigned all goodwillto reporting units for impairment testing. The impairment tests involved the useof both estimates of fair value for the Company's reporting units as well asdiscounted cash flow assumptions.If the fair value exceeds the book value, then the net book value would then be reduced to fair value based on anestimate of discounted cash flow.

**IncomeTaxes**

Deferredincome taxes are provided on the temporary differences between income forfinancial statement and tax purposes. The Company has not recorded a valuation allowance on its deferred taxassets as management believes that it is more likely than not that all deferredtax assets will be realized.

**StockBased Compensation**

SFAS No. 123 ("SFAS 123"), "Accountingfor Stock-Based Compensation," encourages but does not require companiesto record compensation expense for stock options at fair value.  The Company has chosen to continue to accountfor stock options using the intrinsic value method prescribed in AccountingPrinciples Board Opinion No. 25 ("APB Opinion 25"), "Accountingfor Stock Issued to Employees," and related interpretations.  Accordingly, the Company has provided proforma disclosures of the earnings per share as determined under the provisionof SFAS 123, in Note G Stock Options.

**Advertising Expenses**

The Company expenses media advertisingcosts as incurred or where applicable, upon first showing.  Advertising expenses of $1.2 million, $1.4million and $3.3 million were recorded in 2003, 2002, and 2001, respectively.  There were no significant capitalizedadvertising costs as of March 31, 2003, 2002 and 2001.  

**ForeignOperations**

Export salesto independent distributors, were $13,281,000, $11,765,000 and $13,992,000 in2003, 2002 and 2001, respectively.  Inaddition, $124,883,000, $89,033,000 and $44,532,000 of sales in 2003, 2002 and2001, respectively, were from the company's direct international sales officesprimarily in Canada and Western Europe. Income before income taxes for foreign operations was $7,240,000, $7,391,000and $6,384,000 for fiscal 2003, 2002 and 2001, respectively.

**ForeignCurrency Translation**

Thefinancial statements of the Company's non-U.S. subsidiaries are translated intoU.S. dollars in accordance with SFAS No. 52, "Foreign Currency Translation."  The assets and liabilities of certainnon-U.S. subsidiaries whose "functional" currencies are other thanthe U.S. Dollar are translated at current rates of exchange.  Revenue and expense items are translated atthe average exchange rate for the year. The resulting translation adjustments are recorded directly intoaccumulated other comprehensive income (loss). Transaction gains and losses, other than intercompany debt deemed to beof a long-term nature, are included in net income in the period theyoccur.  Transaction exchange gains andlosses were immaterial in 2003, 2002 and 2001. 

**Derivative Instruments**

TheCompany accounts for derivative instruments and hedging activities inaccordance with SFAS No. 133 ("SFAS 133"), "Accounting forDerivative Instruments and Hedging Activities."  SFAS 133 requires all derivatives to berecorded as assets or liabilities at fair value.  Changes in derivative fair values will eitherbe recognized in earnings, offset against changes in the fair value of the relatedhedged assets, liabilities and firm commitments or, for forecastedtransactions, recorded as a component of accumulated other comprehensive incomein shareholders' equity until the hedge transactions occur and are recognizedin earnings.  The Company's use ofderivatives is not significant and is only on a limited basis.  

**Effectsof Recent Accounting Pronouncements**

In 2001, the FASB issued SFAS 143, Accounting for AssetRetirement Obligations. SFAS 143 requires companies to record the fair value ofa liability for an asset retirement obligation in the period in which it isincurred, which is adjusted to its present value each subsequent period. Inaddition, companies must capitalize a corresponding amount by increasing thecarrying amount of the related long-lived asset, which is depreciated over theuseful life of the related long-lived asset. We will adopt SFAS 143 effectiveas of April 1, 2003, and do not expect that this statement will have amaterial impact on our consolidated financial position or results ofoperations. 

In 2001, the FASB issued SFAS 144, Accounting for the Impairmentor Disposal of Long-Lived Assets. SFAS 144 provides additional restrictivecriteria that are required to be met to classify an asset asheld-for-sale.  This statement alsorequires expected future operating losses from discontinued operations to berecorded in the period in which the losses are incurred (rather than as of thedate management commits to a formal plan to dispose of a segment as previouslyrequired).  In addition, moredispositions will qualify for discontinued operations treatment in the incomestatement.  We adopted SFAS 144 beginningin the quarter ending June 30, 2002.  Ouradoption of SFAS 144 did not have a material impact on our financial positionor results of operations. 

In 2002, the FASB issued SFAS 146, Accounting for CostsAssociated with Exit or Disposal Activities. SFAS 146 requires that a liabilityfor a cost associated with an exit or disposal activity be recognized when theliability is incurred.  Severance payunder SFAS 146, in many cases, would be recognized over the remaining serviceperiod rather than at the time the plan is communicated.  The provisions of SFAS 146 are effective forexit or disposal activities that are initiated after December 31, 2002.  We will adopt SFAS 146 for any actionsinitiated after April 1, 2003, and any future exit costs or disposal activitieswill be subject to this statement. 

In 2002, the FASB issued SFAS 148, Accounting forStock-Based Compensation-Transition and Disclosure.  SFAS 148 amends SFAS 123, Accounting forStock-Based Compensation, to provide alternative methods of transition for avoluntary change to the fair value method of accounting for stock-basedemployee compensation.  In addition, SFAS148 amends the disclosure requirement of SFAS 123 to require more prominentdisclosures in both annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results.  The additionaldisclosure requirements of SFAS 148 are effective for fiscal years ending afterDecember 15, 2002.  We have elected tocontinue to follow the intrinsic value method of accounting as prescribed byAccounting Principles Board Opinion No. 25 (or APB 25), Accounting for StockIssued to Employees, to account for employee stock options.

In 2002, the FASB issued FASB Interpretation (FIN) 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others. FIN 45 requires an issuer of aguarantee to recognize an initial liability for the fair value of theobligations covered by the guarantee. FIN 45 also addresses the disclosuresrequired by a guarantor in interim and annual financial statements regardingobligations under guarantees. We will adopt the requirement for recognition ofthe liability for the fair value of guaranteed obligations prospectively forguarantees entered into after April 1, 2003. We adopted the disclosureprovisions as of March 31, 2003. 

In 2003, the FASB issued FIN 46, Consolidation of VariableInterest Entities. FIN 46 defines a variable interest entity (VIE) as acorporation, partnership, trust, or any other legal structure that does nothave equity investors with a controlling financial interest orhas equity investors that do not provide sufficient financial resources for theentity to support its activities.  FIN 46requires consolidation of a VIE by the primary beneficiary of the assets,liabilities, and results of activities effective in 2003. FIN 46 also requirescertain disclosures by all holders of a significant variable interest in a VIEthat are not the primary beneficiary.  Wedo not have any investments in variable interest entities; therefore, theadoption of this interpretation will have no impact on our consolidatedfinancial position or results of operations. 

**Stock Split**

On December13, 2002 the Board of Directors authorized a two-for-one stock split in theform of a 100% stock dividend to be distributed on or about January 17, 2003 toshareholders of record on December 31, 2002. All references in the financial statements to number of shares, pershare amounts and market prices of the Company's common stock have beenretroactively restated to reflect the increased number of common sharesoutstanding.

At the annualmeeting of shareholders held on September 12, 2002, the shareholders approved aproposal to amend the Company's Restated Articles of Incorporation to increaseauthorized shares from 50,000,000 to 150,000,000.

**Use of Estimates**

Financial statements prepared inaccordance with accounting principles generally accepted in the United Statesrequire management to make estimates and judgments that affect amounts anddisclosures reported in the financial statements.  Actual results could differ from thoseestimates.

**Note B - Inventories**

Inventoriesat March 31 consisted of:

(in thousands)

**2003**

2002

Raw materials

**$     12,175**

$     10,194

Work in process

**      10,894**

       9,908

Finished goods

**     38,200**

     27,302

 

**$     61,269**

$     47,404

**Note C - Property and Equipment**

Property and equipment at March 31consisted of:

(in thousands)

**2003**

2002

Land

**$        538 **

$        429 

Buildings

**      24,595 **

      14,601 

Leasehold improvements

**    23,551 **

    24,030 

Furniture, fixtures and  equipment

**    79,032 **

    63,860 

Construction in progress

**      6,620 **

      6,032 

**   134,336 **

   108,952 

Less accumulated  depreciation and amortization

**    (65,665)**

    (54,296)

 

**$   68,671 **

$   54,656 

**NoteD - Other Comprehensive Income**

Other comprehensive income includes thenet change in unrealized gains (losses) on available-for-sale securities asfollows:

 

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001
  Unrealized gains (losses) arising during period,   net of taxes of $225, $347 and  ($1,963), Respectively**$      421**  $     641    $  (3,646)  Reclassification adjustments for gains realized in   net income, net of taxes of $523, $448 and    $400, Respectively**(972)**  (831)  (742)
Change in net unrealized gains (losses) on  securities

**$    (551)**

$   (190)

$  (4,388)

Accumulated other comprehensive incomewhich is included in the Company's shareholders' equity at March 31 consistedof:

(in thousands)

**2003**

2002

Net unrealized (losses) gains on  securities

**$    (112)**

$       439 

Foreign currency translation adjustments

**6,511 **

(6,926)

Accumulated other comprehensive income  (loss)

**$  6,399 **

$  (6,487)
**NoteE - Accounts Payable and Accrued Liabilities and Long-Term Accrued Liabilities**
Accounts payable andaccrued liabilities at March 31 consisted of:

(in thousands)

**2003**

2002

Trade accounts payable

** $  26,759**

 $  17,558 

Warranty and related reserves

**      19,989**

     16,252 

Accrued compensation

**      18,753**

     15,129 

Sales returns

**       10,455**

       7,806 

Deferred revenue

**4,441**

2,138

Current portion of purchase price  related to     acquired technologies and acquisitions

**       5,698**

       4,675 

Accrued royalties

**          770**

         637 

Other

**        8,773**

       6,228 

 

** $  95,638**

 $  70,423 

Long-term accruedliabilities at March 31 consisted of:

(in thousands)

**2003**

2002

Accrued acquisition liabilities - South  Bay Medical

**$    7,934**

 $    7,517 

Accrued acquisition liabilities - ProSurg, Inc.

**884**

1,726

Deferred compensation

**5,025**

3,579

Other

**127**

51

 

** $  13,970**

 $  12,873 

**NoteF - Short-Term Bank Borrowings**

**Credit Agreement**

As of March31, 2002 and 2003, the Company had a secured line of credit ("$25M CreditAgreement") for borrowings up to $25 million, which accrue interest at theprevailing prime rate or at a mark-up over LIBOR at the Company'sdiscretion.  The $25M Credit Agreementincludes certain covenants that, among others, limit the dividends the Companymay pay and requires maintenance of certain levels of tangible net worth anddebt service ratios.  In February 2001,the Company borrowed $14.1 million under the $25M Credit Agreement at an effectiveinterest rate of 6.4% annually, to partially fund its acquisition of PorgesS.A.  In May 2001, the Company repaid the$14.1 million borrowing under the $25M Credit Agreement.  During fiscal year 2002, the Company used the$25M Credit Agreement to guarantee the secured loan of a vendor to facilitatethe ramp up of production capacity related to a new product in the amount of$5.3 million.  This loan was repaid in2003 and the guarantee expired.  Twoletters of credit totaling $3.0 million are outstanding at March 31, 2003,which reduced the amount available under the $25M Credit Agreement.  Accordingly, although there were noborrowings outstanding under the $25M Credit Agreement at March 31, 2003, only$22 million was available for additional borrowings. 

**Foreign Lines of Credit**

In addition,in February 2001, several lines of credit were established at a local level tofacilitate operating cash flow needs at our foreign subsidiaries.  These lines are at market rates of interest,unsecured, guaranteed by Mentor Corporation and total $5.8 million and $5.0million at March 31, 2003 and 2002, respectively.  Total borrowed and outstanding under theselines were $3.3 million and $4.4 million at March 31, 2003 and 2002,respectively.  The amount available foradditional borrowing was $2.5 million and $0.6 million at March 31, 2003 and2002, respectively.

In fiscal year2002, a line of credit of $6.6 million to finance the construction of a newfacility in the Netherlands was established. The borrowings accrue interest at EURIBOR plus 0.75% and are secured bythe new facility and other assets in the Netherlands.  Total borrowed and outstanding under thisline was $4.9 million and $4.8 million at March 31, 2003 and 2002,respectively.  The amount available foradditional borrowing was $1.8 million and $0.8 million was available foradditional borrowings at March 31, 2003 and 2002, respectively.

Outstandingborrowings under all credit arrangements had a weighted-average interest rateof 3.00% and 4.10% at March 31, 2003 and 2002, respectively.  A total of $22.0 million and $21.1 million was available under the $25M Credit Agreement and theforeign lines of credit at March 31, 2003 and 2002, respectively.  

**Note G - Stock Options**

The Companyhas granted options to key employees and non-employee directors under its 2000Plan and 1991 Plan.  Options grantedunder both plans are exercisable in four equal annual installments beginningone year from the date of grant, and expire ten years from the date of grant.  Options are granted at the fair market valueon the date of grant.  Activity in thestock option plans during fiscal 2003, 2002 and 2001 was as follows:

 

At March 31
   
Options Outstanding
 

  Number of Shares

Weighted  Average Price  per Share

Balance March 31, 2000

 4,460,754   

 $      8.060

 

 

 

Granted 

 2,907,100   

        8.195 

Exercised

   (572,238)

         4.345 

Canceled or terminated

   (1,047,054)

        9.350 

Balance March 31, 2001

 5,748,562   

     8.265 

 

 

 

Granted 

1,931,500 

13.435

Exercised

(1,198,034)

7.405

Canceled or terminated

(453,560)

8.940

Balance March 31, 2002

6,028,468 

   10.025

 

 

 

**Granted**

**1,270,140 **

**19.010**

**Exercised**

**(711,877)**

**9.350**

**Canceled or terminated**

**(150,206)**

**12.750**

**Balance March 31, 2003**

**6,436,525 **

**$   11.840**
 
At March 31,2003, the Company had one Plan under which stock options were available, theAmended 2000 Long-term Incentive Plan (2000 Plan), approved by the Company'sshareholders on October 19, 2000 and amended by vote of the shareholdersSeptember 14, 2001.  At March 31, 2003,the 2000 Plan had options for 1,635,740 shares granted and outstanding,and 4,364,260 shares available for grant. The 1991 Plan had options for 4,800,785 shares granted and outstandingat March 31, 2003.  No additional optionscan be granted under the 1991 Plan. 

Informationregarding stock options outstanding at March 31, 2003 is as follows:

Options  Outstanding

Options  Exercisable

  Price Range

  Number of  Shares

Weighted-Average  Remaining Contractual Life

Weighted-Average  Exercise Price

  Number of Shares

Weighted-Average Exercise Price

Under $8.31

2,490,339

6.06 years

$  7.33

1,380,579

$  6.77

$8.16 to  $13.31

2,458,446

6.79 years

$12.46

1,136,225

$11.62

$13.31-$19.01

1,487,740

8.83 years

$18.37

  128,000

$14.85

At March 31, 2003, 2002 and 2001, stockoptions to purchase 2,644,804, 2,160,248 and 2,373,190 shares, respectively,were exercisable at weighted-average prices of $9.24, $8.64 and $8.14,respectively.  

Stock optionexercise prices are set at the closing price of the Company's common stock onthe date of grant and the related number of shares granted is fixed at thatpoint in time.  Therefore, under theprinciples of APB Opinion 25, the Company does not recognize compensationexpense associated with the grant of stock options.  SFAS 123 requires the use of an optionvaluation model to provide supplemental information regarding options grantedafter fiscal 1995.  Pro forma informationregarding net income and earnings per share shown below were determined as ifthe Company had accounted for its employee stock options under the fair valuemethod of that statement.

The weighted average fair values of stock option grantedwere estimated at the date of grant using the Black-Scholes option valuationmodel and the following assumptions:

 

Year Ended March 31,

 

**2003**

2002

2001

Weighted average fair value of stock     options granted

** $ 11.01**

 $ 7.92       

 $ 5.06       

Risk-free interest rate

**         4.5%   **

            4.6%     

            6.4%    

Expected life (in years)

**7.0       **

7.2        

7.5        

Expected volatility

**0.557**

0.550       

0.557       

Expected dividend yield

**            0.5%   **

            0.4%     

            0.6%    

TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded options.  TheCompany's employee stock options have characteristics significantly differentfrom those of traded options such as vesting restrictions and extremely limitedtransferability.  In addition, theassumptions used in option valuation models are highly subjective, particularlythe expected stock price volatility of the underlying stock.  Because changes in these subjective inputassumptions can materially affect the fair value estimate, in management's opinion,the existing models do not provide a reliable single measure of the fair valueof its employee stock options. 

For purposes of pro forma disclosure, the estimated fair value of the optionsis amortized ratably over the option's vesting period.  The pro formaeffect on net income is not representative of the pro forma effect on net incomein future years because compensation expense in future years will reflect theamortization of a larger number of stock options granted in several succeedingyears.  The Company's pro forma information is as follows:

 

Year Ended March 31, 

(in thousands, except per share information)

**2003**

  2002

  2001

Net income:  as reported

**$ 55,820 **

$ 41,820  

$ 32,078  

Deduct:  compensation expense fair   value method

** (6,408)**

   (4,376)

    (3,240)

Net income: pro forma

**$ 49,412 **

$ 37,444 

$ 28,838  

 

** **

 

 

Basic earnings per share:  as reported

**$     1.20 **

$       .88  

$       .68  

Basic earnings per share:  pro forma

**     1.06 **

       .79  

      .61  

 

** **

 

 

Diluted earnings per share:  as reported

**$     1.15 **

$       .85  

$       .66  

Diluted earnings per share:  pro forma

**              1.04 **

       .78  

      .59  

**NoteH - Income Taxes**

Income tax expense fromcontinuing operations consists of the following:

 

Year Ended March 31, 

(in thousands)

**2003**

2002

2001

Current:

 

 

 

   Federal

** $22,414 **

 $17,763  

 $15,605  

   Foreign

**       2,478 **

       1,621  

       1,411  

   State

**       2,125 **

       1,617  

       1,166  

 

**      27,017 **

      21,001  

    18,182  

Deferred:

** **

 

 

   Federal

**      (3,256)**

     (2,796)

     (2,936)

   Foreign

**(55)**

(467)

 

   State

**         (487)**

        (342)

        (515)

 

**      (3,798)**

     (3,605)

     (3,451)

 

** $23,219 **

 $17,396  

 $14,731  

Thereconciliation of the federal statutory rate to the Company's effective ratefor continuing operations is as follows:

 

Year Ended March 31, 

 

**2003**

2002

2001

Federal statutory rate

**35.0%**

35.0%

35.0%

Increase (decrease) resulting from:

** **

 

 

   State taxes net of federal tax benefit

**          1.3   **

         1.4   

          1.6   

   Non-taxable interest and dividends

**        (0.1)  **

        (0.1)  

        (0.1)  

   Research and development credit

**        (2.0)  **

        (2.1)  

        (2.1)  

   Foreign Sales Corporation/ETI

**         (2.8)  **

        (2.4)  

         (1.0)  

   Foreign operations

**         (2.1)  **

         (2.5)  

         (2.0)  

   Non-deductible goodwill

**         -   **

          0.1   

          0.1   

   Other

**          0.1   **

        -    

          0.1    

 

**29.4%**

29.4%

31.6%

Significantcomponents of the Company's deferred tax liabilities and assets at March 31 areas follows:

(in thousands)

**2003**

2002

Deferred tax liabilities:

 

 

   Tax over book depreciation

** $      (20)**

 $   (445) 

   Unrealized gain on long-term marketable securities

**     61 **

     (237) 

   Porges book over tax basis/net deferred liabilities

**      (2,257)**

      (3,680) 

 

**      (2,216)**

      (4,362) 

Deferred tax assets:

** **

 

   Book liabilities not deductible for tax

**     11,898 **

      10,656  

   Inventory

**      891 **

      890  

   Profit in inventory of foreign subsidiaries

**      2,464 **

       1,757  

 

**     15,253 **

      13,303  

Net deferred tax assets

** $ 13,037 **

 $  8,941  

At March 31, 2003, foreign earnings of $15,600,000 havebeen retained indefinitely by subsidiary companies for reinvestment, on whichno U.S. tax has been provided.  Ifrepatriated, additional taxes of approximately $5,460,000 on these earnings,net of applicable foreign tax credit carry-forwards, would be due. 

**NoteI - Intangible Assets and Goodwill**

In2001, the FASB issued Statements of Financial Accounting Standard No. 142,"Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 was effective for the Company as of April 1, 2002.SFAS 142 specifies the financial accounting and reporting for acquired goodwilland other intangible assets. Goodwill and intangible assets that haveindefinite useful lives are no longer to be amortized but rather are to betested for impairment annually or more frequently if impairment indicatorsarise. None of the Company's intangible assets have an indefinite life.Intangible assets with finite lives continue to be amortized on a straight-linebasis over their useful lives. Goodwill and intangible assets have beenrecorded at either incurred or allocated cost. Allocated costs were based onrespective fair values at the date of acquisition. In prior year periods,goodwill amortization was recorded in selling, general and administrativeexpense and was immaterial 

As required bySFAS 142, the Company has reassessed the remaining amortization periods ofintangible assets acquired on or before June 30, 2001 and assigned all goodwillto reporting units for impairment testing. The impairment tests involved theuse of both estimates of fair value for the Company's reporting units as wellas discounted cash flow assumptions. Impairment tests were performed at adoption and in the fourth quarterof fiscal year 2003 and no impairment was noted as a result of these analyses. 

Balances ofacquired intangible assets were as follows:

Year Ended  March 31, 2003

  (in thousands)

  Original Cost

Accumulated  Amortization

Carrying  Value

  Useful Life

Patents

$11,624

$  (4,323)

$  7,301

5-20

Licenses

5,984

(2,976)

3,008

3-17

Trademarks

2,140

(292)

1,848

10-20

Other  intangibles

28,151

(4,738)

23,413

3-20

Subtotal  intangibles

47,899

(12,329)

35,570
   
Goodwill

19,136

(2,616)

16,520

 

Total  intangibles and      goodwill

  $67,035

  $(14,945)

  $52,090

   

 

Year Ended  March 31, 2002

  (in thousands)

  Original Cost

Accumulated  Amortization

Carrying  Value

  Useful Life

Patents

$11,211

$  (3,724)

$  7,487

5-20

Licenses

6,002

(2,549)

3,453

3-17

Trademarks

1,699

(178)

1,521

10-20

Other  intangibles

27,282

(2,155)

25,127

3-20

Subtotal  intangibles

46,194

(8,606)

37,588

 

Goodwill

11,778

(2,623)

9,155

 

Total  intangibles and      goodwill

  $57,972

  $(11,229)

  $46,743

   

**Note J - Acquisitions**

**Porges S.A.**

OnFebruary 9, 2001, the Company purchased all of the outstanding shares of PorgesS.A. ("Porges") from Sanofi-Synthelabo.  Porges is a manufacturer of urologicalproducts supplying a complete range of products for the urological surgeon,including diagnostic tools and various devices for surgery and postoperativefollow-up.  The Company paid $32 millionin consideration for all outstanding shares of Porges and all of its foreignsales offices.

Theacquisition was accounted for using the purchase method of accounting and,accordingly, the purchase price was allocated to the tangible and intangiblenet assets acquired on the basis of their respective fair values on theacquisition date.  The fair value ofassets acquired was determined based upon an internal valuation and by using acombination of methods, including an income approach for the intellectualproperties and replacement cost for tangible assets.  

Thetotal purchase price was preliminarily allocated during fiscal year 2001 totangible assets of $46,224,000, intangible assets of $4,241,000, customer baseof $895,000, workforce-in-place of $1,885,000 and goodwill of $2,414,000,offset by accrued liabilities of $18,363,000 and deferred income taxliabilities of $4,799,000.  In fiscalyear 2002, the Company completed its review and evaluation of the technologyand received a purchase price adjustment of $653,000 upon resolution of certainfinancial measurements.  As a result ofthe completion of the Company's review and purchase price adjustment, thepurchase price allocation was adjusted as follows:  tangible assets decreased $656,000 to$45,568,000, goodwill was increased by $1,237,000 to $3,651,000, deferred taxeswere increased by $651,000 to $4,148,000 and workforce-in-place was decreasedby $1,885,000 to zero as it has been included in goodwill. 

Goodwillhad been amortized over its estimated useful life of 15 yearspriorto the adoption of FAS 142.  The other acquired intangible assets arebeing amortized over their estimated useful lives of 5 to 15 years.  In accordance with SFAS142, the Company no longer amortizes goodwill beginning April 1, 2002. 

Thefollowing unaudited pro forma financial informationpresents the combined results of continuing operations of the Company andPorges as if the acquisition had occurred as of the beginning of fiscal 2001,after giving effect to certain adjustments, including amortization of goodwilland intangible assets. 

* *

Year  Ended March 31,
  (in thousands except per share amounts)
2001

Net sales

$  307,674

Net income

    31,055

Pro forma earnings per share:     Basic     Diluted

  $        0.66          0.64

Thepro forma results are not necessarily indicative of those that would haveactually occurred had the acquisitions taken place at the beginning of theperiod presented.

**South Bay Medical LLC**

OnJanuary 19, 2001, the Company purchased the assets of South Bay Medical LLC(South Bay), a company focused on the development of a new computer-basedworkstation and automated cartridge-based needle loading system for use inbrachytherapy procedures.  Theacquisition was accounted for as a purchase with the results of operationsincluded in the Company's financial statements from the date ofacquisition.  Pro forma results forfiscal 2001, assuming the acquisition occurred at the beginning of the period,would not be materially different from the results reported.  The Company paid $2,000,000 in cash andissued restricted common stock valued at $4 million on the date ofpurchase.  Additional purchase pricepayments will be made to South Bay over the next several years as theworkstation sales are made.  The netpresent value of these amounts is recorded at March 31, 2003, in accruedliabilities ($3,675,000) and in long-term accrued liabilities ($7,934,000) asthe Company believes it is probable these payments will be paid.  The purchase price allocation included$16,820,000 allocated to patents and other intangibles that will be amortizedover a period not to exceed 15 years using the straight-line method.  The related acquisition agreement alsoprovides for certain other contingent amounts to be paid to South Bay whichwill be expensed as earned based upon future sales levels.

Themajority of the shares of South Bay are owned by individuals, who are nowemployees of the Company, and their spouses. These employees have directly benefited from the past payments of cashand common stock to South Bay and will benefit as future payments are madebased on workstation and brachytherapy seed sales.  No amounts were paid in fiscal year 2003 and2002. 

**Partnership Technologies**

Certain technologies related to themanufacture of mammary prostheses were developed under a 1983 agreement with alimited partnership whereby the limited partners contributed funds towards thedevelopment of the technology in exchange for payments based upon a percentageof future sales of the products utilizing the technology.  The Company paid to the partnershipapproximately $2 million of these payments in fiscal 2000.  The Company was the general partner for thispartnership.  The agreement included anoption to purchase the technology and thereby terminate the partnership.  During the year ended March 31, 2001, theCompany exercised its option to make a lump sum payment to the limited partnersin lieu of all future payments and rights according to the Agreement ofPurchase and Sale between Mentor Corporation and the Partnership, asamended.  The limited partners couldelect to be paid in cash, the Company's common stock, or a combinationthereof.  This transaction was completedon August 14, 2000.  The limited partnerselected to be paid $1 million in cash and 434,000 (868,000 post split) sharesof the Company's common stock that had a value of $9 million.  As a result of this purchase, the Companyrecorded an intangible asset of $10 million that will be amortized using thestraight-line method over its estimated useful life of 20 years.

**Byron Medical, Inc.**

In December 2001, the Companypaid $3 million for 51% of the outstanding shares of Byron Medical, Inc.  The Company had previously purchased 49% ofthe shares in 1998, and now owns all outstanding shares.  The purchase price allocation includedgoodwill of $2.1 million and net assets of $900,000.  Byron Medical, Inc. is located in Tucson,Arizona and specializes in the distribution of liposuction equipment anddisposables. 

**ProSurg, Inc.**

In December 2001, the Companyentered into several agreements with ProSurg, Inc. to acquire certain patentrights and obtain a source of supply of a bio-absorbable co-polymer for $2million in cash and an obligation to pay an additional $3 million upon theachievement of certain milestones.  Thepurchase price was allocated to intangible assets and the net present value ofthese amounts is recorded at March 31, 2003, in accrued liabilities($2,000,000) and in long-term accrued liabilities ($884,000) as the Companybelieves it is probable these payments will be paid.

**Portex Ltd.**

OnMay 6, 2002, the Company purchased the assets of the urology and ostomybusinesses of Portex Ltd., a subsidiary of Smiths Group plc.  The acquired businesses, now named MentorMedical, Ltd., manufactures and markets incontinence and ostomy productsprimarily for the home healthcare market. The products are sold mainly in the UK, Germany and theNetherlands.  The acquisition was valuedat $11,232,000, of which $10,603,000 was paid in cash, plus an acquiredliability of $629,000.  The acquisitionwas accounted for using SFAS No. 141, "Business Combinations," usingthe purchase method of accounting, and the purchase price was preliminarilyallocated to the tangible and intangible net assets acquired on the basis of theirrespective fair values on the acquisition date. The total purchase price was preliminarily allocated to inventory of$3,150,000, buildings of $739,000, production equipment of $1,185,000,leasehold improvements of $621,000, patents, trademarks and licenses of$731,000 and goodwill and other intangibles with indefinite lives of$4,806,000. 

**Mills Biopharmaceuticals, Inc.**

OnFebruary 1, 2003, the Company completed the acquisition of MillsBiopharmaceuticals, Inc., a manufacturer of iodine brachytherapy seeds for thetreatment of prostate cancer.   Theacquisition will be accounted for using SFAS No. 141, "BusinessCombinations," using the purchase method of accounting, and the purchaseprice will be allocated to the tangible and intangible net assets acquired onthe basis of their respective fair values on the acquisition date.   The acquisition was valued at $4,063,000, net of cash acquired, and was paid from existingcash balances.  The purchase price waspreliminarily allocated to accounts receivable $626,000, inventory of$322,000, other assets of  $36,000,production equipment of $830,000, long-term investments of $1,100,000 net ofacquired accrued liabilities of $261,000 and goodwill and other intangibleswith indefinite lives of $1,410,000. 

**NoteK - Earnings per Share**

A reconciliation of weighted averageshares outstanding, used to calculate basic earnings per share, to weightedaverage shares outstanding assuming dilution, used to calculate dilutedearnings per share, follows:

 

Year Ended March 31, 

(in thousands)

**2003**

2002

2001

Weighted average outstanding shares:  basic

**46,428**

47,278

    47,254 

Shares issuable through exercise of stock     options

**1,960**

  1,648

      1,118 

Weighted average outstanding shares:  diluted

**48,388**

48,926

    48,372 

Shares issuable through optionsare determined using the treasury stock method.

Options to purchase 1,089,478, 129,534and 2,977,650 shares with exercise prices greater than the average marketprices of common stock were outstanding during the years ended March 31, 2003,2002 and 2001, respectively.  Theseoptions were excluded from the respective computations of diluted earnings pershare because their effect would be anti-dilutive.

**NoteL - Commitments**

The Companyleases certain facilities under non-cancelable operating leases with unexpiredterms ranging from 1 to 111 years.  Mostleases contain renewal options.  Rentalexpense for these leases was $4.5 million, $4.1 million and $3.3 million forfiscal 2003, 2002 and 2001, respectively.

Future minimumlease payments under lease arrangements at March 31, 2003 are as follows:

(in thousands)

2004

$ 4,797

2005

4,851

2006

4,872

2007

4,686

2008

4,554

Thereafter

21,937

Total

$45,698

**NoteM - Related Party Transactions**

Since 1991,the Company has had an exclusive license agreement with Rochester MedicalCorporation ("Rochester") to market and distribute certain externalcatheter products developed by Rochester. The Company purchased $3,443,000, $860,000 and $59,000 of product fromRochester in 2003, 2002 and 2001, respectively. Several officers/founders of Rochester, a public company, are siblingsof the Chairman of Mentor Corporation. The Chairman derived no financial or other benefit from transactionsbetween the Company and Rochester.  

In December2001, the Company purchased the remaining 51% of the outstanding shares ofByron Medical, Inc. and currently owns all outstanding shares.  During 2003, the Company paid $115,000 inrent and $270,000 to retire a note payable to Byron Economidy, President ofByron Medical, Inc. and an employee of the Company.

In February2003, the Company purchased Mills Biopharmaceuticals, Inc. (see Note JAcquisitions for more information) and as part of the acquisition, purchasedthe building owned by Dr. Stan Mills, who is currently an employee of theCompany, and his wife for $525,000.

**South BayMedical LLC**

SeeSouth Bay Medical LLC included in "Note J-Acquisitions" for a description of amounts owed to certainemployees of the Company related to the acquisition of South Bay.

**NoteN - Contingencies**

Warrantyand product liability claims are a regular and ongoing aspect of the medicaldevice industry.  At any one time, theCompany is subject to claims against it and is involved in litigation.  These actions can be brought by an individual, or by a group of patients purported to be aclass action.  The Company carriesproduct liability insurance on all its products, except silicone gel-filledimplants, which are only available within the United States through acontrolled clinical study.  Thisinsurance is subject to certain self-insured retention and other limits of thepolicy, exclusions and deductibles that the Company believes to beappropriate.  

Inaddition, the Company also offers warranty coverage on some of its products.  The Company provides an accrual for theestimated cost of product warranties and product liability claims at the timerevenue is recognized.  Such accruals arebased on estimates, which are based on relevant factors such as historicalexperience, the warranty period, estimated costs, levels of insurance andinsurance retentions, identified product quality issues, if any, and to alimited extent, information developed by the insurance company using actuarialtechniques.  These accruals are analyzedperiodically for adequacy.  While theCompany engages in extensive product quality programs and processes, includingactively monitoring and evaluating the quality of its component suppliers, thewarranty obligation is affected by reported rates of product problems as wellas the costs incurred in correcting product problems.  The Company has recorded warranty and relatedreserves of $19,989,000 and $16,252,000 at March 31, 2003 and 2002,respectively, to cover the cost of anticipated warranty and product liabilityclaims. 

In addition,in the ordinary course of its business, the Company experiences various typesof claims that sometimes result in litigation or other legal proceedings.  The Company does not anticipate that any ofthese proceedings will have a material adverse effect on the Company.

**Note O - Restructuring Charges and DiscontinuedOperations**

During fiscal 2001, the Companyannounced a reduction in corporate staff at its headquarters in Santa Barbaraas part of a restructuring move to streamline operations and improveefficiency.  Employees affected by therestructuring were provided with a severance package, outplacement counselingand extended benefits to help with the transition.  This program resulted in a restructuringcharge included in general and administrative expenses of $2.4 million.  Substantially all amounts related to therestructuring charge were paid by March 31, 2001. 

In December 1998, Mentor announced arestructuring plan as part of a strategic initiative to improve theprofitability and competitiveness of its ophthalmic business by reducingmanufacturing costs and concentrating on those products and markets capable ofsustained, long-term profitable growth.  

During the implementation of this plan,the Board of Directors authorized management to evaluate potential buyers forthe product lines of the ophthalmic business segment.  In March 1999, the Company adopted a plan todispose of its ophthalmic business segment. During the quarter ended June 30, 1999, the Company completed the saleof the assets of the intraocular lens business, for cash consideration of $38.4million and recorded a related gain of $7.5 million, net of $3.8 million inincome taxes.  On October 4, 1999, theCompany completed the sale of the remaining assets of the ophthalmic equipmentbusiness for cash consideration of $21 million and recorded a related gainafter income taxes of $1.1 million.

Consistent with the plan to dispose ofits ophthalmic business segment, the net assets and operations of theophthalmic segment of the business, comprised of the intraocular lens productsand ophthalmic equipment product lines, have been classified as discontinuedoperations.  

The results of discontinued operationsfor the year ended March 31, 2001 is as follows:

  (in thousands)

Year Ended  March 31, 2001

Revenues

$           - 

Income before income taxes

400 

Income tax expense

(140)

Income from discontinued operations

$      260 

Remaining assets and liabilitiesrelated to discontinued operations at March 31, 2003 and 2002 are nominal. 

**Note P - Business Segment Information**

The Company'soperations are principally managed and reported on a product basis.  There are three reportable segments:  aesthetic and general surgery, surgicalurology, and clinical and consumer healthcare. The accounting policies of the reportable segments are the same as thosedescribed in the summary of significant accounting policies except that certainexpenses such as interest and certain corporate expenses are not allocated tothe segments.

The aestheticand general surgery products segment consists primarily of breast implants,tissue expanders and the Company's body contouring equipment anddisposables.  The surgical urologysegment includes penile implants, surgical incontinence products andbrachytherapy seeds for the treatment of prostate cancer.  The clinical and consumer healthcare segmentincludes catheters and other products for the management of urinaryincontinence and retention.

Selectedfinancial information for the Company's reportable segments for the years endedMarch 31, is as follows:

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Net Sales**

** **

 

 

Aesthetic and General Surgery

** $ 191,405 **

 $ 163,091 

 $ 157,122 

Surgical Urology

**            106,675**

             94,341

             62,264

Clinical and Consumer Healthcare 

**             84,304 **

             63,630  

             49,508  

  Total consolidated revenues

** $ 382,384 **

 $ 321,062  

 $ 268,894  

 

** **

 

 

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Operating profit**

** **

 

 

Aesthetic and General Surgery

**$   67,631 **

 $  49,516 

 $  34,792  

Surgical Urology

**             6,851 **

              6,945  

               6,405  

Clinical and Consumer Healthcare

**             12,854 **

             11,927  

               8,897  

  Total reportable segments

**$   87,336 **

 $  68,388  

 $  50,094  

 

 

 

 

 

At March 31,

(in thousands)

**2003**

2002

2001

**Identifiable assets**

** **

 

 

Aesthetic and General Surgery

** $ 102,570**

 $   95,675

 $   84,363  

Surgical Urology

**            105,415**

             87,482

             82,152

Clinical and Consumer Healthcare

**             62,155 **

             43,101  

             41,302  

  Total reportable segments

** $  270,140 **

 $ 226,258  

 $ 207,817  

 

 

 

 

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Depreciation and amortization**

** **

 

 

Aesthetic and General Surgery

** $    3,852 **

 $   3,617  

 $   3,160  

Surgical Urology

**              4,865 **

               4,400  

               1,676  

Clinical and Consumer Healthcare

**              3,261 **

               2,808  

               2,599  
    Total reportable segments
**11,978**
10,825
7,435
Corporate and other

**              2,755 **

               3,023  

               2,905  

 

** $  14,733 **

 $  13,848  

 $ 10,340  

 

 

 

 

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Capital expenditures**

** **

 

 

Aesthetic and General Surgery

**$     4,995 **

 $   10,669  

 $    3,644  

Surgical Urology

**              7,420 **

               2,705  

               1,385  

Clinical and Consumer Healthcare

**             2,576 **

               1,393  

              2,105  

   Total reportable segments

**            14,991 **

            14,767  

             7,134  

Corporate and other

**              1,752 **

                 493  

               3,033  

 

** $   16,743 **

 $   15,260  

 $  10,167  

  The following tables reconcile segment  information to the amounts shown on the consolidated financial statements.

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Operating profit from continuing     operations**

** **

 

 

Reportable segments

** $     87,336 **

 $    68,388  

 $  50,094  

Corporate operating loss

**          (10,359)**

           (10,872)

             (8,307)

Interest expense

**           (1,022)**

                (859)

                (276)

Interest income

**              2,456 **

               2,217  

               4,209  

Other income

**                 628 **

                  342  

                  829  

Income from continuing operations     before taxes

** $   79,039 **

 $   59,216  

 $  46,549  

 

 

 

 

 

At March 31,

(in thousands)

**2003**

2002

2001

**Identifiable assets**

** **

 

 

Reportable segments

** $  270,140**

 $ 226,258

 $  207,817

Corporate and other

**            127,948**

             98,378

             83,020

Consolidated assets

** $   398,088 **

 $ 324,636  

 $  290,837  

 

 

 

 

Selected financial information for the  Company's operations by geographic area is as follows:

 

Year Ended March 31,

(in thousands)

**2003**

2002

2001

**Geographic area revenue**

** **

 

 

United States

** $ 244,220 **

 $ 220,264  

 $ 210,370  

France

**39,436**

33,061

7,253

All other countries

**            98,728**

            67,737

             51,271

Consolidated total

** $ 382,384 **

 $ 321,062  

 $ 268,894  

 

 

 

 

 

At March 31,

(in thousands)

**2003**

2002

2001

**Geographic area long-lived assets**

** **

 

 

United States

** $   72,649 **

 $  71,627  

 $  72,272  

France

**24,532**

18,698

20,516

Netherlands

**14,052**

10,064

1,383

All other countries

**             9,528 **

            1,009  

              1,298  

Consolidated total

** $  120,761 **

 $ 101,398  

 $  95,469  
**NoteQ - Quarterly Financial Data (Unaudited)**
Thefollowing is a summary of unaudited quarterly results of operations. 

(in thousands, except per share data)

** **

**Quarter**

**Year Ended March 31, 2003**

**First**

**Second**

**Third**

**Fourth**

**Net sales**

**$   97,677**

**$   89,586**

**$  94,039**

**$ 101,082**

**Gross profit**

**        59,432**

**        51,917**

**        55,872**

**        62,286**

**Net income**

**     16,749**

**     12,506**

**     12,982**

**     13,583**

**Earnings per share:**

** **

** **

** **

** **

**   Basic  earnings per share**

**$     0.36**

**$     0.27**

**$    0.28**

**$   0.29**

**   Diluted  earnings per share**

**$     0.34**

**$     0.26**

**$    0.27**

**$   0.28**

** **

** **

**Quarter**

Year Ended March 31,  2002

First

Second

Third

Fourth

Net sales

$  81,144 

$  74,347 

$  78,975 

$  86,596

Gross profit

       48,413 

       42,729 

       46,870 

       52,595

Net income

     10,290

       8,489

       9,817

     13,224

Basic earnings per share:

 

 

 

 

    Basic earnings per share

$    0.21

$    0.18

$    0.21

$    0.28

    Diluted earnings per share

$    0.21

$    0.17

$    0.20

$    0.27

**SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS AND RESERVES**(inthousands)

COL. A

COL. B

COL. C

COL. D

COL. E

 

 

Additions

 

 

  Description

  Balance at  Beginning  of Period

Charged   to Costs and  Expenses

  Charged   to Other  Accounts

  Deductions

  Balance at  End of  Period

 

 

 

 

 

 

**Year Ended March 31, 2003**

** **

** **

** **

** **

** **

**Deducted from asset accounts:**

** **

** **

** **

** **

** **

**  Allowance for  doubtful accounts**

**$   3,870**

**$   3,605**

**$         -**

**$   2,069**

**$  5,406**

** **

** **

** **

** **

** **

** **

**Liability Reserves:**

** **

** **

** **

** **

** **

**  Warranty and  related reserves**

**$  16,252**

**$   7,630**

**$         -**

**$   3,893**

**$ 19,989**

**  Accrued sales  returns and allowances**

**7,806**

**2,649**

**-**

**-**

**10,455**

** **

**$  24,058**

**$ 10,279**

**$         -**

**$   3,893**

**$ 30,444**

Year Ended March 31,  2002

 

 

 

 

 

Deducted from asset accounts:

 

 

 

 

 

   Allowance for doubtful accounts

$   3,578

$   2,374

$  (259)

$  1,823

$   3,870

 

 

 

 

 

 

Liability Reserves:

 

 

 

 

 

   Warranty and related reserves

$ 12,062

$   8,337

$         -

$  4,147

$  16,252

   Accrued sales returns and allowances

4,913

2,893

-

-

7,806

 

$ 16,975

$ 11,230

$         -

$  4,147

$  24,058

Year Ended March 31,  2001

 

 

 

 

 

Deducted from asset accounts:

 

 

 

 

 

   Allowance for doubtful accounts

 $   2,976 

 $  1,569 

$   219    

 $  1,186 

 $   3,578 

 

 

 

 

 

 

Liability Reserves:

 

 

 

 

 

   Warranty and related reserves

 $   6,563 

 $  9,463 

 $        -

 $  3,964 

 $ 12,062 

   Accrued sales returns and allowances

       6,401 

             - 

            - 

     1,488 

       4,913 
   **$ 12,964****$  9,463****$        -****$  5,452****$ 16,975**
**Signatures**

                 Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

                                                            MENTORCORPORATION

                                                            /s/CHRISTOPHERJ. CONWAY                                                            ChristopherJ. Conway                                                           President and Chief Executive Officer

DATE:       June 26, 2003

                 Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant, and inthe capacities and on the dates indicated:
**Signatures****Title****Date Signed**
/s/CHRISTOPHER J. CONWAY

President  and Chief Executive Officer

June  26, 2003

Christopher  J. Conway

(Principal  Executive Officer) 

/s/ADEL MICHAEL

Executive  Vice President

June  26, 2003

Adel  Michael

Chief  Financial Officer, Treasurer and Secretary (Principal Financial and Accounting  Officer) 

/s/WALTER W. FASTER

Director

June  26, 2003

Walter  W. Faster 

/s/EUGENE G. GLOVER

Director

June  26, 2003

Eugene  G. Glover 

/s/MICHAEL NAKONECHNY

Director

June  26, 2003

Michael  Nakonechny 

/s/DR. RICHARD W. YOUNG

Director

June  26, 2003

Dr.  Richard W. Young 

/s/RONALD J. ROSSI

Director

June  24, 2003

Ronald  J. Rossi
****
**SECTION 302CERTIFICATION**

 I, Christopher J.Conway, certify that:

1.       I have reviewed this annual reporton Form 10-K of Mentor Corporation;

2.       Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

3.       Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

4.       The registrant's other certifyingofficers and I am responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

        (a)          designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

        (b)          evaluatedthe effectiveness of the registrant's disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the"Evaluation Date"); and

        (c)          presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

5.       The registrant's other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant's auditors and the audit committee of registrant's board ofdirectors (or persons performing the equivalent functions):

        (a)          allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant's ability to record, process, summarizeand report financial data and have identified for the registrant's auditors anymaterial weaknesses in internal controls; and

        (b)          anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant's internal controls; and

6.       The registrant's other certifyingofficers and I have indicated in this annual report whether there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date:  June 25, 2003                                                      /S/CHRISTOPHERJ. CONWAY

                                                                                    ChristopherJ. Conway

                                                                                    Presidentand Chief Executive Officer
****
**SECTION 302CERTIFICATION**

I, AdelMichael, certify that:

1.         Ihave reviewed this annual report on Form 10-K of Mentor Corporation;

2.         Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

3.         Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

4.         The registrant's other certifyingofficers and I am responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

        (a)                designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

        (b)                evaluatedthe effectiveness of the registrant's disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the"Evaluation Date"); and

        (c)                presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

5.         The registrant's other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant's auditors and the audit committee of registrant's board ofdirectors (or persons performing the equivalent functions):

        (a)         all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant's ability to record, process, summarize andreport financial data and have identified for the registrant's auditors anymaterial weaknesses in internal controls; and

        (b)         anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant's internal controls; and

6.         The registrant's other certifyingofficers and I have indicated in this annual report whether there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

Date:  June 25, 2003                                                      /S/ADELMICHAEL

                                                                                    AdelMichael

                                                                                    ChiefFinancial Officer

**EXHIBIT INDEX**

Regulation S-K Exhibit Table Item  Number

  Description of Exhibit

3(a)

Composite Restated Articles of  Incorporation of the Company dated December 12, 2002.

3(b)

Composite Restated By-Laws of the  Company dated October 1, 1987 -- Incorporated by reference to Exhibit 3(b) of  the Registrant's Annual Report on Form 10-K for the year ended March 31,  2002.

10(a)*

Mentor Corporation 1991 Stock Option Plan  -- Incorporated by reference to Registration Statement on Form S-8,  Registration No. 33-48815, filed June 24, 1992.

10(b)*

Mentor Corporation 1991 Stock Option  Plan -- Incorporated by reference to Registration Statement on Form S-8,  Registration No. 33-100841, filed October 30, 2002.

10(c)*

Mentor Corporation 2000 Stock Option  Plan -- Incorporated by reference to Registration Statement on Form S-8,  Registration No. 33-73306, filed November 14, 2001.

10(d)

Lease Agreement, dated November 1989,  between Mentor Corporation and Skyway Business Center Joint Venture --  Incorporated by reference to Exhibit 10(b) of the Registrant's  Annual Report on Form 10-K for the year  ended March 31, 2002.

10(e)

First Amendment to Lease Agreement,  dated December 1, 1993, between Mentor Corporation and Skyway Business Center  Joint Venture -- Incorporated by reference to Exhibit 10(c) of the  Registrant's  Annual Report on Form  10-K for the year ended March 31, 2002.

10(f)

Lease Agreement, dated July 23, 1990, between Mentor Corporation and SB  Corporate Center, Ltd., covering 201 Mentor Drive, Santa Barbara, CA 93111. 

10(g)

Lease Agreement, dated August 19,  1998, between Mentor Corporation and SB Corporate Center, LLC, covering 301  Mentor Drive -- Incorporated by reference to Exhibit 10(n) of the  Registrant's Annual Report on Form 10-K for the year ended March 31, 1999.

10(h)*

Transition Agreement, dated August 1, 1999, between Mentor  Corporation and Christopher Conway -- Incorporated by reference to Exhibit  10(s) of the Registrant's Annual Report on Form 10-K for the year ended March  31, 2000. 

10(i)*             

Employment Agreement, dated April 1,  2000, between Mentor Corporation and Adel Michael -- Incorporated by  reference to Exhibit 10(u) of the Registrant's Annual Report on Form 10-K for  the year ended March 31, 2000.

10(j)*             

Transition and Non-Compete Agreement,  dated September 28, 2000, between Mentor Corporation and Anthony R. Gette --  Incorporated by reference to Exhibit 10(r) of the Registrant's Annual Report  on Form 10-K for the year ended March 31, 2001.

10(k)*

Employment Agreement, dated October  16, 2000, between Mentor Corporation and Eugene G. Glover -- Incorporated by  reference to Exhibit 10(a) of the Registrant's Quarterly Report on Form 10-Q  for the quarter ended December 31, 2000.

 

**EXHIBITINDEX (continued)**

Regulation S-K Exhibit Table Item  Number

  Description of Exhibit

10(m)*

Employment Agreement, dated November  28, 2000, between Mentor Corporation and Bobby K. Purkait -- Incorporated by  reference to Exhibit 10(c) of the Registrant's Quarterly Report on Form 10-Q  for the quarter ended December 31, 2000.

10(n)

Purchase Agreement, dated February 8,  2001, between Mentor Corporation and Sanofi-Synthelabo and Synthelabo  Biomedical -- Incorporated by reference to Exhibit 10(v) of the Registrant's  Annual Report on Form 10-K for the year ended March 31, 2001. 

10(o)

Purchase Agreement, dated January 19,  2001, between Mentor Corporation and South Bay Medical LLC -- Incorporated by  reference to Exhibit 10(w) of the Registrant's Annual Report on Form 10-K for  the year ended March 31, 2001.

10(p)

Amended and Restated Credit  Agreement, dated October 25, 2000, between Mentor Corporation and Sanwa Bank  California -- Incorporated by reference to Exhibit 10(x) of the Registrant's  Annual Report on Form 10-K for the year ended March 31, 2001.

10(q)

First Amendment to Amended and Restated  Credit Agreement, dated February 2, 2001, between Mentor Corporation and  Sanwa Bank California -- Incorporated by reference to Exhibit 10(y) of the  Registrant's Annual Report on Form 10-K for the year ended March 31, 2001. 

10(r)

Second Amendment to Amended and  Restated Credit Agreement, dated February 14, 2001, between Mentor  Corporation and Sanwa Bank California -- Incorporated by reference to Exhibit  10(z) of the Registrant's Annual Report on Form 10-K for the year ended March  31, 2001.

10(s)

Third Amendment to Amended and  Restated Credit Agreement, dated December 14, 2001, between Mentor  Corporation and Sanwa Bank California.

10(t)

Fourth Amendment to Amended and  Restated Credit Agreement, dated March 25, 2003, between Mentor Corporation and  Sanwa Bank California.

10(u)*           

Employment Agreement, dated August 3,  2000, between Mentor Corporation and Joshua Levine -- Incorporated by  reference to Exhibit 10(t) of the Registrant's Annual Report on Form 10-K for  the year ended March 31, 2002.

10(v)*          

Employment Agreement, dated November 28, 2000, between Mentor Corporation  and Peter Shepard -- Incorporated by reference to Exhibit 10(u) of the  Registrant's Annual Report on Form 10-K for the year ended March 31, 2002.

10(w)*           

Employment Agreement, dated November 28, 2000, between Mentor Corporation  and Clarke Scherff -- Incorporated by reference to Exhibit 10(v) of the  Registrant's Annual Report on Form 10-K for the year ended March 31, 2002.

10(x)*          

Employment Agreement, dated August  30, 2002, between Mentor Corporation and Cathy Ullery.

10(y)*          

Employment Agreement, dated August  30, 2002, between Mentor Corporation and Maher Michael, M.D.

21

Subsidiaries of the Company

23

Consent of Ernst & Young  LLP, Independent Auditors

99.1

Certification Pursuant to 18  U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 - Christopher J. Conway

99.2

Certification Pursuant to 18  U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 - Adel Michael

***** Managementcontract or compensatory plan or arrangement.