10-K 1 form10-k.htm BAUSCH & LOMB INCORPORATED 10-K PERIOD ENDING DECEMBER 31, 2005 Bausch & Lomb Incorporated 10-K Period Ending December 31, 2005


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)

FORM 10-K


x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005       

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________________ to                                    

Commission file number 1-4105         

BAUSCH & LOMB INCORPORATED
(Exact name of registrant as specified in its charter)
 

 
NEW YORK
16-0345235
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
   
ONE BAUSCH & LOMB PLACE, ROCHESTER, NY
14604-2701
(Address of principal executive offices)
(Zip Code)

Registrant's telephone number, including area code 585.338.6000

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Name of each exchange on which registered
Common Stock, $0.40 par value   
New York Stock Exchange   
   
   

Securities registered pursuant to section 12(g) of the Act:

None                                                                                        
(Title of class)

                                                   
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
o Yes x No




PAGE 2

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
o Yes x No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x   Accelerated filer o   Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
o Yes x No

The aggregate market value of the voting stock, computed using the average bid and asked price of such stock, held by non-affiliates of the registrant as of June 2005 was $4,066,870,420. For the sole purpose of making this calculation, the term "non-affiliate" has been interpreted to exclude directors and officers. Such interpretation is not intended to be and should not be construed to be, an admission by Bausch & Lomb Incorporated or such directors or officers that such directors and officers are "affiliates" of Bausch & Lomb Incorporated, as that term is defined under the Securities Act of 1933.
The number of shares of Voting Stock of the registrant, outstanding as of January 27, 2007, was 54,338,016, consisting of 54,308,836 shares of Common stock and 29,180 shares of Class B stock, which are identical with respect to dividend and liquidation rights and vote together as a single class for all purposes.

DOCUMENTS INCORPORATED BY REFERENCE

Part III

Not applicable.




PAGE 3

Table of Contents
Part I
 
Page
     
Item 1.
Business
4
     
Item 1A.
Risk Factors
9
     
Item 1B.
Unresolved Staff Comments
22
     
Item 2.
Properties
22
     
Item 3.
Legal Proceedings
22
     
Item 4.
Submission of Matters to a Vote of Security Holders
26
     
Part II
   
     
Item 5.
Market for Bausch & Lomb Incorporated's Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities
28
     
Item 6.
Selected Financial Data
29
     
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
29
     
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
60
     
Item 8.
Financial Statements and Supplementary Data
60
     
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
117
     
Item 9A.
Controls and Procedures
117
     
Item 9B.
Other Information
122
     
Part III
   
     
Item 10.
Directors and Executive Officers of Bausch & Lomb Incorporated
123
     
Item 11.
Executive Compensation
130
     
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
138
     
Item 13.
Certain Relationships and Related Transactions
140
     
Item 14.
Principal Accounting Fees and Services
142
     
Part IV
   
     
Item 15.
Exhibits and Financial Statement Schedules
143
     
Signatures
 
144
Exhibit Index
 
149
Exhibits
 
(Attached to the Report on Form 10-K)




PAGE 4

Part I

Item 1.  Business

Unless the context indicates otherwise, the terms "we", "our" "ours" and "the Company" are used herein to refer to Bausch & Lomb Incorporated and its consolidated subsidiaries. All dollar amounts in Part I of this Form 10-K, except for per share data, are expressed in millions unless specified otherwise, and earnings per share are presented on a diluted basis.

(a) Restatement of Previously Issued Financial Statements

The Company restated its consolidated financial statements, as more fully discussed in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement to the consolidated financial statements included in this Annual Report on Form 10-K. The Company restated its consolidated balance sheet, its consolidated statements of income, of changes in shareholders' equity and of cash flows as of December 25, 2004 and for the fiscal years 2003 and 2004. In addition, the Company restated selected financial data as of 2003, 2002 and 2001 and for fiscal years 2002 and 2001. See Item 8. Financial Statements and Supplementary Data under Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K and beginning shareholders' equity for the impact of the restatement for periods prior to 2001. The impact of the restated financial results for the first and second quarterly periods of 2005 and the quarterly periods of 2004 are also presented in Item 8. Financial Statements and Supplementary Data under Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K.
The restatement corrects for errors made in the application of generally accepted accounting principles (GAAP), including revenue recognition, accounting for reserves, accounting for foreign currency adjustments, accounting for income taxes including income taxes payable, tax reserves, deferred income tax assets and liabilities, related valuation allowances and income tax expense, and the accounting for the Company's Long-Term Deferred Compensation Plan. For a discussion of the significant restatement adjustments and the background leading to these adjustments see Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement and Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K.
After filing this report, the Company will work toward filing its Quarterly Reports on Form 10-Q for the third quarter of 2005 and the first, second and third quarters of 2006 and its Annual Report on Form 10-K for 2006. While the Company is working diligently to complete the filings referred to, there can be no assurance as to when the Company will be current in its reporting obligations.

(b) General Development of Business

Founded in 1853 and incorporated in the State of New York in 1908, we are a world leader in the development, manufacture and marketing of eye health products, including contact lenses, contact lens care solutions and ophthalmic surgical and pharmaceutical products.
We made no significant acquisitions or dispositions of businesses in either 2003 or 2004. In the fourth quarter of 2005, we acquired a 70-percent controlling interest in Shandong Chia Tai Freda Pharmaceutical Group (Freda), the leading ophthalmic pharmaceutical company in China, from Sino Biopharmaceutical Ltd. The total purchase price for the Freda acquisition was $255, or $248 net of cash acquired. Freda primarily develops, manufactures and markets medications used to treat ocular inflammation and infection, glaucoma and dry eye. We believe the acquisition has accelerated our expansion into the rapidly growing ophthalmic pharmaceuticals market in China and provides a national pharmaceuticals sales and distribution network, a locally compliant manufacturing facility, and expertise in regulatory affairs and product development.

(c) Financial Information about Operating Segments

Information concerning sales, operating earnings and assets attributable to each of our operating segments is set forth in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K under the section entitled Net Sales and Income by Business Segment and Geographic Region and in Item 8. Financial Statements and Supplementary Data under Note 5 — Business Segment and Geographic Information of this Annual Report on Form 10-K. This information is incorporated herein by reference.




PAGE 5

(d) Narrative Description of Business

Operating Segments We are organized into five business segments: three commercial geographic segments and two additional segments managed globally (Research & Development and Global Operations & Engineering). Commercial regions are responsible for the sale and marketing of our products within their defined geographies (the Americas; Europe, Middle East and Africa [Europe]; and Asia). The Research & Development segment is responsible for activities associated with research, preclinical development, new product development, clinical affairs, medical affairs, regulatory affairs, and product quality. The Global Operations & Engineering segment is responsible for demand planning, engineering, manufacturing, logistics and procurement.

Products In each geographic region, we market products in five product categories: contact lenses, lens care products, ophthalmic pharmaceuticals, cataract and vitreoretinal surgery, and refractive surgery.

Contact Lenses We pioneered the development of soft contact lens technology and are one of the largest manufacturers of contact lenses in the world. Our product portfolio is one of the broadest in the industry and includes traditional, planned replacement disposable, daily disposable, multifocal, and toric soft contact lenses and rigid gas permeable (RGP) materials. These products are marketed by our own sales force and through distributors to licensed eye care professionals and health product retailers under the Bausch & Lomb, Boston, Medalist, PureVision and SofLens brand names. Major competitors in the contact lens market include CIBA Vision Corporation (a subsidiary of Novartis AG) (CIBA); CooperVision (a subsidiary of The Cooper Companies, Inc.); and Vistakon, Inc. (a subsidiary of Johnson & Johnson).
Net sales of contact lenses constituted 31 percent of our total revenues in fiscal year 2005, growing 9 percent from the prior year. This growth rate compares to overall estimated contact lens market growth in the mid-to-upper single digits.
We believe that contact lenses will be a growth driver over the next several years, due to our strong portfolio of specialty contact lenses and the market’s rapid conversion to contact lenses made of silicone hydrogel materials. In the specialty business, our SofLens Toric lens, a planned replacement lens for people with astigmatism, and our SofLens Multi-Focal lens for people with presbyopia, are leading products in their categories worldwide. In 2005, we introduced in the United States and Europe Nike MAXSIGHT sport-tinted contact lenses, specialty lenses designed to aid visual performance in athletic settings. In Japan, we launched Medalist II, a two-week disposable spherical (or non-specialty) lens, and a redesigned version of Medalist One Day daily disposable contact lenses in 2006; and Medalist Multi-Focal contact lenses in the fourth quarter of 2006.
Silicone hydrogel contact lenses are becoming an increasingly larger portion of the overall market. Based on syndicated data and internal estimates, we believe that approximately 40 percent of new fit and refit prescriptions for spherical contact lenses in the United States in the fourth quarter of 2005 were for silicone hydrogel contact lenses, about double the rate in the prior year period. In 2005, we reintroduced our PureVision line of silicone hydrogel contact lenses into the U.S. market and further expanded the geographic reach of PureVision Toric contact lenses in Europe and Asia. In 2006, we introduced PureVision Multi-Focal, the first presbyopia correcting lens made of this new generation of materials. We also received approval to market the PureVision line in Japan, and anticipate a commercial launch in 2007.
Our future development efforts in contact lenses will concentrate on new silicone hydrogel offerings featuring novel materials, surface treatments and optical design characteristics.

Lens Care Our lens care portfolio includes multipurpose solutions, cleaning and conditioning solutions for RGP lenses, re-wetting drops and saline solutions. We are a global leader in market share for lens care products, which we market through our own sales force and distributors to licensed eye care professionals, health product retailers, independent pharmacies, drug stores, food stores and mass merchandisers. Our strategy is to outpace market trends and increase our share through continued leadership in the multipurpose segment, the only growing category in the overall lens care market. Prior to the May 2006 withdrawal of ReNu with MoistureLoc solution (MoistureLoc), our flagship brand, ReNu, had the leading market position in this segment in the United States. Subsequent to the withdrawal, we lost about 10 market share points in the United States, placing us behind Alcon, Inc. in the multipurpose segment of the market. We are currently executing brand rebuilding initiatives to recoup some of that lost market share. Our Boston brand of products for RGP lens care holds a commanding market share worldwide. Major competitors in the lens care category include Advanced Medical Optics, Inc. (AMO); Alcon, Inc.; and CIBA.



PAGE 6

Net sales of lens care products constituted 22 percent of our total revenues in fiscal year 2005, with sales flat from the prior year, and included the impact of the launch of ReNu MultiPlus in Japan, where it is among the most technologically advanced lens care products on the market. In 2005, the global market exhibited no growth to low-single digit declines. Our reported sales include the impact of our recalling MoistureLoc following an increase in reported fungal infections among contact lens wearers in the United States and certain Asian markets. In accordance with GAAP, we recorded certain items associated with the recall in our 2005 financial results. The charges related to: customer returns; consumer rebates; returned products; disposal and write-off of inventory; and costs associated with the notification to customers and consumers required in market withdrawal instances. The adjustments were recorded as third-quarter events, because that is the earliest reporting period for which we have not filed quarterly financial results on Form 10-Q. See further discussion in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K.

Pharmaceuticals Our pharmaceuticals product category includes generic and branded prescription ophthalmic pharmaceuticals, ocular vitamins and over-the-counter (OTC) medications. Pharmaceutical products are marketed by our sales force and distributed through wholesalers, independent pharmacies, drug stores, food stores, mass merchandisers and hospitals. Our key pharmaceutical trademarks are Bausch & Lomb, Alrex, Indocollyre, Liposic, Lotemax, Moisten, Mioclear, Ocuvite, PreserVision, Retisert and Zylet. The ophthalmic pharmaceuticals market is significantly fragmented. Major competitors include Alcon, Inc.; Allergan, Inc.; Merck & Co., Inc.; Novartis AG; Pfizer Inc.; and Santen Incorporated.
Net sales of pharmaceuticals products comprised 25 percent of consolidated revenues in fiscal year 2005, representing growth of 11 percent in a market we estimate to be growing in the mid-to-upper single digits. During the fourth quarter we completed the acquisition of Freda, which accounted for approximately four-percentage points of our reported growth.
Our longer-term strategy in pharmaceuticals is to build a pipeline and launch new proprietary prescription drugs, but that takes time, considering the development, regulatory review and approval process. Nearer term, we are focused on growing the consumer health portion of the business by launching new OTC eye care products, expanding the geographic availability of existing products, and developing and launching new entries in our nutritionals portfolio.
Until recently, our nutritionals business has been aimed toward a specific ocular condition — age-related macular degeneration (AMD), with our PreserVision line of ocular vitamins. Scientific literature suggests that nutritional products can be used to improve or even prevent a variety of other conditions. In 2004, we launched in Europe a nutritional product containing Omega-3 and Omega-6 fatty acids, naturally occurring substances found in fish oils and certain plants. Studies have linked higher intake of fatty acids with a reduction in symptoms of dry eye. We have also identified other potential formulations, and expect to launch a proprietary nutritional formulation for diabetics as early as 2007. A nutritional formulation for people over age 50 was launched in 2006. By the end of 2007, our portfolio of nutritionals products should contain products that target not only general eye health, AMD, diabetes and dry eye; but also other ocular conditions.
Elsewhere in our OTC portfolio, we expect to introduce a long-lasting dry eye product later in 2007. In 2006, we repositioned our lines of general eye care products under the Bausch & Lomb Advanced Eye Relief sub-brand. We are also working on ways to deliver products in a preservative-free multi-dose system to fulfill doctors’ desire for safer, gentler preservative-free products and consumers’ preferences for the convenience of bottled drops over single-use vials.
Turning to prescription pharmaceuticals, in 2005 in the United States we launched Zylet, a combination anti-inflammatory/anti-infective product containing loteprednol etabonate and tobramycin, and Retisert, our drug delivery implant to treat posterior segment uveitis.

Cataract and Vitreoretinal Surgery Cataract surgery is one of the most commonly performed surgical procedures. Our cataract and vitreoretinal offerings include a broad line of intraocular lenses (IOLs) as well as the Millennium and Stellaris lines of phacoemulsification equipment. (Phacoemulsification is the procedure by which the patient's natural lens is extracted during cataract surgery.) We also sell disposable surgical packs and instruments that are used during the procedure. Our cataract and vitreoretinal surgery products and equipment are marketed by our sales force and through distributors to ophthalmic surgeons, hospitals and ambulatory surgery centers. We believe we have developed substantial professional recognition for our products marketed under the Bausch & Lomb, Akreos, AMVISC, Millennium, SofPort and Storz trademarks. We are the third largest manufacturer of cataract and vitreoretinal products. Major competitors in the category include AMO and Alcon, Inc.



PAGE 7

Cataract and vitreoretinal net sales increased 6 percent and comprised 16 percent of our fiscal 2005 revenues. The overall cataract and vitreoretinal market is estimated to be growing in the mid-single digits. Our goal in the cataract and vitreoretinal category is to improve our market share position.
In 2005, we introduced an advanced optics version of our successful Akreos acrylic IOL in markets outside the United States and globally introduced the Easy-Load Lens Delivery System for our SofPort Advanced Optics (AO) silicone IOL. In 2006, we enhanced our SofPort line of IOLs with the introduction of technology that blocks harmful violet light. We also launched in certain markets outside the United States a new acrylic IOL on our Akreos platform that can be inserted through an incision of less than two millimeters — 33 percent smaller than most incisions today. In 2007, we expect to bring our newest Akreos Advance Optics (AO) lens into the large U.S. market. Beyond IOLs, our new phacoemulsification platform, Stellaris, was recently cleared for sale in the United States by the Food and Drug Administration. We expect to launch Stellaris in the first half of 2007. Designed specifically from customer input and feedback, it incorporates ergonomic improvements and better fluidics to facilitate faster turnaround between surgeries. It is also capable of performing cataract surgery using incisions smaller than two millimeters. Finally, we are pursuing surgical solutions for presbyopic correction, targeting our development and external partnering efforts on products designed to allow the eye to focus at all distances.

Refractive Surgery Products in this category include lasers, microkeratomes, diagnostic equipment and other products used in the LASIK (Laser in-situ Keratomileusis) surgical procedure. Our refractive surgery products are marketed by our sales force and through distributors to ophthalmic surgeons, hospitals and ambulatory surgery centers. We believe we have developed substantial professional recognition of our refractive surgery products and equipment marketed under the Hansatome, Technolas and Zyoptix trademarks. We are the second largest manufacturer of refractive surgery products. Major competitors include Alcon, Inc.; AMO; Intralase Corp.; and Moria S.A.
Net sales of refractive surgery products accounted for 6 percent of our 2005 revenues and declined 8 percent from 2004.
Our strategy is to improve our market share of LASIK and other refractive surgical procedures in the United States and to increase the number of custom LASIK procedures in markets outside the United States, which will increase our annuity stream of revenues from procedural fees and microkeratome blades. This would have the added benefit of increasing profitability, as annuity products generally carry higher operating margins than capital equipment. Our Hansatome and Zyoptix XP microkeratomes, the precision cutting tools to create the corneal flap, are the most widely used microkeratomes today. We also manufacture and market the disposable blades that are replaced after each LASIK procedure. The Zyoptix XP microkeratome was launched in 2005 along with networked service solutions for our laser, which allow us to remotely monitor product performance and alert our service team to perform preventive maintenance before a problem occurs. In 2006, we launched enhancements to the algorithms used in our Zyoptix personalized LASIK procedure which will improve procedure efficiency, ease of use, clinical outcome and predictability, and in 2007 we plan to make available an Epi-LASIK option for our Zyoptix microkeratomes.

Suppliers and Customers We purchase the materials and components for each of our product categories from a wide variety of suppliers. We believe that the loss of any one supplier would not adversely affect our business to a significant extent.
Our five product categories have different customer bases, from local drug stores to hospital chains to independent practitioners and group purchasing and other managed care organizations. No material part of our business, taken as a whole, is dependent upon a single or a few customers.

Patents and Licenses We actively pursue technology development and acquisition as a means to enhance our competitive position. In the aggregate our patents are of material importance to our business taken as a whole and no single patent or patent license or group of patent licenses relating to any particular product or process is material to any segment or to the business as a whole, except for our license agreement with CIBA Vision AG related to the sale of our PureVision contact lens products.

Trademarks The trademarks of Bausch & Lomb Incorporated and its subsidiary companies are italicized throughout this report and include: Akreos, Alrex, AMVISC, Bausch & Lomb, Bausch & Lomb Advanced Eye Relief, Boston, Easy-Load, Hansatome, Indocollyre, Liposic, Lotemax, Medalist, Millennium, Mioclear, Moisten, MoistureLoc, Ocuvite, PreserVision, PureVision, ReNu, ReNu MultiPlus, Retisert, SofLens, SofLens59, SofPort, Storz, Technolas, Zylet and Zyoptix. All other brands or product names are trademarks of their respective owners.




PAGE 8

Seasonality and Working Capital Because of the nature of the products sold, we are not significantly impacted by seasonality issues. In general, the working capital requirements in each of our segments are typical of those businesses.

Competition and Markets We market each of our product categories throughout the world. Each category is highly competitive in both U.S. and non-U.S. markets. For all products, we compete on the basis of product performance, quality, technology, price, service, warranty and reliability.

Research and Development Research and development constitutes an important part of our activities. Research and development expenditures included in continuing operations totaled $177 in 2005, $163 in 2004 and $150 in 2003. To ensure we have a robust pipeline of new products to support future growth initiatives, we intend to continue to increase our level of spending for research and development activities.

Government Regulation Our products are subject to regulation by governmental authorities in the United States and other markets. These authorities, including the Food and Drug Administration (FDA) in the United States, generally require extensive testing of new products prior to sale and have jurisdiction over the safety, efficacy and manufacturing of products, as well as product labeling and marketing. In most cases, significant resources must be spent to bring a new product to market in compliance with these regulations. The regulation of pharmaceutical products and medical devices, both in the United States and in other markets, has historically been subject to change. Delays in the regulatory approval process may result in delays in coming to market with new products and extra costs to satisfy regulatory requirements.

Environment Our facilities and operations are subject to federal, state and local environmental and occupational health and safety requirements of the United States and foreign countries, including those relating to discharges of substances into the air, water and land, the handling, storage and disposal of wastes and the cleanup of properties affected by pollutants. While we are unable to predict what legislation or regulations may be adopted or enacted in the future with respect to environmental protection and waste disposal, existing legislation and regulations have had no material adverse effect on our capital expenditures, earnings or competitive position. Capital expenditures for property, plant and equipment for environmental control facilities were not material during 2005 and are not anticipated to be material in 2006.

Employee Relations As of December 31, 2005, we employed approximately 13,700 people throughout the world, including approximately 3,800 in the United States. In general, we believe our employee relations to be very good. Less than five percent of our U.S. employees (mainly in our surgical products manufacturing facilities) are represented by unions.

(d) Financial Information about Foreign and Domestic Operations

Information as to sales and long-lived assets attributable to U.S. and non-U.S. geographic regions is set forth under the section entitled Geographic Region in Item 8. Financial Statements and Supplementary Data under Note 5 — Business Segment and Geographic Information of this Annual Report on Form 10-K and is incorporated herein by reference.

(e) Available Information

Our internet address is http://www.bausch.com. Our filings with the U.S. Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are accessible free of charge on our web site as soon as reasonably practicable after we electronically file or furnish the material to the SEC. The public may read or copy any materials we file or furnish with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549 or may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Moreover, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding reports we file or furnish electronically with them at http://www.sec.gov. Additionally, our Corporate Governance Guidelines, Code of Business Conduct and Ethics and charters of the Executive, Audit, Compensation and Nominating and Governance Committees of our Board of Directors are available at http://www.bausch.com/en_US/corporate/ir/general/board_members.aspx. This information is also available in print to any shareholder requesting it.



PAGE 9

Item 1A.  Risk Factors

The business, prospects and value of the Company are subject to a number of risk factors, which are identified in this filing and have been identified by us in a number of our filings with the SEC, including our Form 12b-25, filed August 8, 2006, and Form 8-K, filed on September 20, 2006.

(a) Risks Related to Our Business and Industry

The markets for our eye care products are intensely competitive and new medical and technological developments may reduce the need for our products. The eye care industry is characterized by continuous product development. Our success and future growth depend, in part, on our ability to develop products which are more effective in treating conditions of the eye or that incorporate the latest technologies. In addition, we must be able to manufacture and effectively market those products and convince a sufficient number of consumers and eye care practitioners to use them. Our existing products face the risk of obsolescence if a new product is introduced by one of our competitors or if we announce a new product that, in either case, represents a substantial improvement over our existing products. Similarly, if we fail to make sufficient investments in research and development programs or if we focus on technologies that do not lead to more effective or acceptable products, our current and planned products may not be accepted in the marketplace or could be surpassed by more effective or advanced products. Conversely, products and new technologies that we develop or that are developed by our competitors may reduce the need for our other existing and future products.
We have numerous competitors in the United States and abroad, including, among others, Alcon, Inc.; Allergan, Inc.; AMO; The Cooper Companies, Inc.; Intralase Corp.; Merck & Co., Inc.; Moria S.A.; Novartis AG; Pfizer Inc.; Santen Incorporated; STAAR Surgical Company; and Vistakon, Inc. (a Johnson & Johnson subsidiary). These competitors may develop technologies and products that are more effective or less costly than any of our current or future products or that could render our products obsolete or noncompetitive. Some of these competitors have substantially more resources and a greater marketing scale than we do. In addition, the medical technology and device industry continues to experience consolidation, resulting in an increasing number of larger and more diversified companies. Among other things, some of these companies can spread their research and development costs over much broader revenue bases and have more resources to influence customer and distributor buying decisions. In addition, some of our competitors may enter into markets in which they do not currently compete with us, such as the announcement of Johnson & Johnson's potential entry into the contact lens solutions business. Our inability to produce and develop products that compete effectively against our competitors' products, or to effectively advertise, promote and market our products against competitors' offerings, could have a material adverse effect on our business.

Resources devoted to research and development may not yield new products that achieve commercial success. We devote substantial resources to research and development. We recently expanded our research and development facilities in Rochester, New York. However, the research and development process is expensive, prolonged and entails considerable uncertainty, especially for companies in the eye care industry. Because of the complexities and uncertainties associated with ophthalmic research and development in particular, and healthcare related research and development in general, products we are currently developing, or that we develop in the future, may not complete the development process or obtain the regulatory approvals required for us to market such products successfully.




PAGE 10

Market acceptance of our products requires, in many cases, that users of our products obtain adequate reimbursement from third-party payers. Managed care organizations and governments continue to place increased emphasis on the delivery of more cost-effective medical therapies. For example, major third-party payers for hospital services, including government insurance plans, Medicare and Medicaid in the United States, and private health care insurers, have substantially revised their payment methodologies during the last few years, resulting in stricter standards for reimbursement of hospital and outpatient charges for some medical procedures, including cataract procedures and intraocular lenses. Managed care organizations restrict the pharmaceutical products that doctors in those organizations can prescribe through the use of formularies (the lists of drugs which physicians are permitted to prescribe to patients in a managed care organization). Failure of our pharmaceutical products to be included on formularies could have an adverse effect on our revenues and profits. This cost-cutting emphasis could adversely affect sales and prices of our products. Physicians, hospitals and other health care providers may be reluctant to purchase our products if they do not receive substantial reimbursement for the cost of our pharmaceutical and surgical products and for procedures performed using our surgical medical device products from third-party payers. Reductions in the prices for our products in response to these trends could reduce our profits.

Federal, state and non-U.S. laws pertaining to healthcare fraud and abuse could materially adversely affect our business and results of operations. Certain of our businesses are subject to various federal, state and non-U.S. laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Violations of these laws are punishable by criminal and civil sanctions, including, in some instances, exclusion from participation in government healthcare programs, including, in the United States, Medicare, Medicaid, Veterans Administration health programs and TRICARE. Such laws and regulations are complex and far-reaching in nature, and, as a result, there can be no assurance that we would not be required in the future to further alter one or more of our practices to be in compliance with these laws. Any violations of these laws or regulations could result in a material adverse effect on our business, financial condition and results of operations. In addition, if there is a change in law, regulation, administrative or judicial interpretation, which renders our practices noncompliant, we may have to change our business practices or our existing business practices could be challenged as unlawful, which could have a material adverse effect on our business, financial condition and results of operations.

Healthcare initiatives and other cost-containment pressures could cause us to sell our products at lower prices, resulting in less revenue to us. Government and private sector initiatives to manage healthcare costs, including price regulation and competitive pricing, are continuing in many countries and regions where we do business, including the United States and Europe. Federal and state programs that reimburse at typically predetermined fixed rates, interpretations of policy and governmental funding restrictions, and legislative proposals restricting payment increases to hospitals and other providers through reimbursement systems, may all decrease or otherwise limit amounts available through reimbursement. We are not able to predict whether new legislation or changes to existing legislation will take effect, whether other changes will be made in the rates prescribed by these governmental programs or, if they are made, what effect that they could have on our business. However, approved governmental rate changes could have a material adverse effect on us, including our prospects for future sales of our products.

Economic conditions and price competition may cause sales of our products used in elective surgical procedures to decline and reduce our profitability. Sales of products used in elective surgical procedures, such as laser refractive surgery, have been and may continue to be adversely impacted by economic conditions. Generally, the costs of elective surgical procedures are borne by individuals without reimbursement from their medical insurance providers or government programs. Accordingly, individuals may be less willing to incur the costs of these procedures in weak or uncertain economic conditions and there may be a decline in the number of these procedures. Sales of our laser refractive surgical equipment and disposable products used in laser refractive surgery have come under pressure during periods of economic uncertainty. A softening in demand for laser refractive surgery could impact us by reducing our profits if customers with whom we have placed laser refractive surgical equipment are unable to make required payments to us.




PAGE 11

If we fail to maintain our relationships with healthcare providers, including ophthalmologists, optometrists, opticians, hospitals, ambulatory surgical centers, corporate optometry chains and group purchasing organizations, customers may not buy our products and our revenue and profitability may decline. We market our products to numerous healthcare providers, including eye care professionals, public and private hospitals, ambulatory surgical centers, corporate optometry chains and group purchasing organizations. We have developed and strive to maintain close relationships with members of each of these groups who assist in product research and development and advise us on how to satisfy the full range of surgeon and patient needs. We rely on these groups to recommend our products to their patients and to other members of their organizations. The failure of our existing products and any new products we may introduce to retain the support of these various groups could have a material adverse effect on our business, financial condition and results of operations.

The majority of our business is conducted outside the United States, subjecting us to additional business risks, including increased costs, market and currency fluctuations, business interruption and changing demands, all of which may result in fluctuations and declines in our sales and profits. Our products are sold in more than 100 countries. We have approximately 13,700 employees in more than 50 countries and more than half of our revenues in 2005 came from customers outside the United States. The results of operations and the financial position of our local operations are generally reported in the relevant local currencies and then translated into U.S. dollars at the applicable exchange rates for inclusion in our consolidated financial statements, exposing us to currency translation risk. In 2005, our most significant currency exposures were to the euro and the Japanese yen. The exchange rates between these and other local currencies and the U.S. dollar may fluctuate substantially. In addition, we are exposed to transaction risk because some of our expenses are incurred in a different currency from the currency in which our revenues are received. Fluctuations in the value of the U.S. dollar against other currencies have had in the past, and may have in the future, an adverse effect on our operating margins and profitability. Economic, social and political conditions, laws, practices and local customs vary widely among the countries in which we sell our products. Our operations outside the United States are subject to a number of risks and potential costs, including lower product margins, less stringent protection of intellectual property and economic, political and social uncertainty in countries in which we operate, especially in emerging markets. Our continued success as a global company depends, in part, on our ability to develop and implement policies and strategies that are effective in anticipating and managing these and other risks in the countries where we do business. These and other risks may have a material adverse effect on our operations in any particular country and on our business as a whole.
Our international operations are, and will continue to be, subject to a number of further risks and potential costs, including:

·  
unexpected changes in foreign regulatory requirements;
·  
differing local product preferences and product requirements;
·  
political and economic instability;
·  
changes in foreign medical reimbursement and coverage policies and programs;
·  
diminished protection of intellectual property in some countries outside the United States;
·  
trade protection measures and import or export licensing requirements;
·  
potential tax costs associated with repatriating cash from our non-U.S. subsidiaries;
·  
difficulty in staffing and managing foreign operations;
·  
differing labor regulations; and
·  
potentially negative consequences from changes in tax laws.

Any of these factors may, individually or as a group, have a material adverse effect on our business and results of operations.

If we were to experience an interruption of our manufacturing operations, our business, financial condition and operating results would be materially harmed. Any prolonged disruption in the operation of our manufacturing facilities or those of our third party manufacturers, whether due to technical, labor or other difficulties, contamination, destruction of or damage to any facility or other reasons, could materially harm our business, financial condition and operating results. In 2006, the FDA completed a regulatory inspection of our Greenville, South Carolina facility and concluded that the facility was non-compliant in a number of areas. We have informed the FDA of our efforts to remedy many of the noted deficiencies, but our inability to address the FDA's concerns with the Greenville facility, or the concerns of any regulatory agency with any of our facilities, could have an adverse impact on our performance, financial condition or operating results.

PAGE 12

We rely on independent suppliers for raw materials and we could experience inventory shortages if we were required to use an alternative supplier on short notice. We rely on independent suppliers for key raw materials, consisting primarily of various chemicals and packaging materials. We generally use raw materials available from more than one source. However, because some products require specialized manufacturing procedures, we could experience inventory shortages if we were required to use an alternative manufacturer on short notice. A disruption in the supply of certain raw materials could disrupt production of certain of our products thereby adversely impacting our ability to market and sell such products and our ability to compete.

If we fail to attract, hire and retain qualified personnel, we may not be able to design, develop, market or sell our products or successfully manage our business. Our ability to attract new customers, retain existing customers and pursue our strategic objectives depends on the continued services of our current management, sales, product development and technical personnel and our ability to identify, attract, train and retain similar personnel. Competition for top management personnel generally, and within the health care industry specifically, is intense and we may not be able to recruit and retain the personnel we need. The loss of any one of our management personnel, or our inability to identify, attract, retain and integrate additional qualified management personnel, could make it difficult for us to manage our business successfully and pursue our strategic objectives.
Similarly, competition for skilled sales, product development and technical personnel is intense and we may not be able to recruit and retain the personnel we need. The loss of the services of any key sales, product development and technical personnel, or our inability to hire new personnel with the requisite skills, could restrict our ability to develop new products or enhance existing products in a timely manner, sell products to our customers or manage our business effectively.
We may not be able to hire or retain qualified personnel if we are unable to offer competitive salaries and benefits, or if our stock does not perform well.

(b) Risks Related to Our Financial Condition

Our indebtedness could adversely affect our financial health. We have now and expect to continue to have indebtedness that could:

·  
increase our vulnerability to general adverse economic and industry conditions;
·  
require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions, research and development efforts and other general corporate purposes;
·  
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
·  
place us at a competitive disadvantage if any of our competitors have less debt;
·  
limit our ability to borrow additional funds; and
·  
make it more difficult for us to satisfy our obligations with respect to our debt, including our obligation to repay amounts borrowed under our credit facilities or repurchase outstanding public debentures under certain circumstances.

Our credit facilities contain representations, warranties and covenants which if breached could lead to an event of default and could, thereby, accelerate payment of our debt. In addition, our credit facilities contain financial and other restrictive covenants that could limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debt.
We have obtained waivers under certain of our bank facilities and with respect to our public debt. Primarily, these waivers are related to our inability to file timely periodic reports with the SEC. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and in Item 8. Financial Statements and Supplementary Data under Note 11 — Debt of this Annual Report on Form 10-K. The bank waivers have been extended until April 30, 2007; but public debt waivers expired on January 31, 2007. In early February, we expect to complete a pending consent solicitation extending the public debt waivers to April 30, 2007.




PAGE 13

We are vulnerable to interest rate risk with respect to our debt. We are subject to interest rate risk in connection with the issuance of debt. In order to maintain our desired mix of fixed-rate and variable-rate debt, we may from time to time use interest rate swap agreements and exchange fixed-rate and variable-rate interest payment obligations over the lives of the arrangements, without exchange of the underlying principal amounts. We may not be successful in structuring such swap agreements to effectively manage our risks, which could adversely affect our business, earnings and financial condition.

The market price of our Common stock has been volatile and may continue to be volatile, and the value of any investment may decline. We have experienced and may continue to experience market volatility that has caused and may cause wide fluctuations in the price of our Common stock, which is listed on the New York Stock Exchange (NYSE). The market price may fluctuate in response to many factors including:

·  
our business performance and financial results;
·  
changes in our markets;
·  
pending and threatened litigation against us;
·  
the recall of MoistureLoc from the market;
·  
our restatement of financial statements for prior periods;
·  
the Audit Committee's and/or other Company investigations; and
·  
our assessment of our internal control over financial reporting.

We incur substantial costs with respect to pension benefits and providing healthcare for our employees. Our estimates of liabilities and expenses for pensions and other post-retirement healthcare benefits require the use of assumptions. They include the rate used to discount the future estimated liability, the rate of return on plan assets and several assumptions relating to the employee workforce (salary increases, medical costs, retirement age and mortality). Actual results may differ which may have a material adverse effect on future results of operations, liquidity or shareholders’ equity. In addition, rising healthcare and retirement benefit costs in the United States may put us under significant cost pressure as compared to our competitors, if they can provide the benefits at lower costs.

Changes in accounting may affect our reported earnings and operating income. Generally accepted accounting principles and accompanying pronouncements, implementation guidelines and interpretations for many aspects of our business, such as revenue recognition, accounting for financial instruments, treatment of goodwill or amortizable intangible assets, and accounting for income taxes are highly complex and involve judgments. Changes in these rules, their interpretation, or changes in our products or business could significantly change our reported earnings and operating income and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations.

Catastrophic events may disrupt our business. We have operations and facilities which sell and distribute our products in many parts of the world. Natural events (such as a hurricane or major earthquake), terrorist attack or other catastrophic events could cause delays in developing, manufacturing or selling our products. Such events that occur in major markets where we sell our products could reduce the need for our products in those areas and, as a result impact our sales into those markets. In either case, any such disruption could have a material adverse effect on our business.




PAGE 14

Acquisitions and joint ventures may have an adverse effect on our business. We expect to continue making acquisitions or entering into joint ventures as part of our long-term business strategy. For example, in 2005 we acquired a 70-percent controlling interest in Freda in order to gain additional access to markets in China. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities and an increase in amortization and/or write-offs of other intangible assets and goodwill, which could have a material adverse effect upon our business, financial condition and results of operations. Risks we could face with respect to acquisitions include, among others:

·  
difficulties in the integration of the operations, technologies, products and personnel of the acquired company and establishment of appropriate accounting controls and reporting procedures and other regulatory compliance procedures;
·  
risks of entering markets in which we have no or limited prior experience;
·  
potential loss of employees;
·  
an inability to identify and consummate future acquisitions on favorable terms or at all;
·  
diversion of management’s attention away from other business concerns;
·  
expenses of any unknown or potential liabilities of the acquired company;
·  
expenses, including restructuring expenses, to shut-down our own locations and/or terminate our employees;
·  
dilution of earnings per share; and
·  
risks inherent in accounting allocations and consequences thereof.

We are in the process of upgrading certain of our management information systems and we cannot ensure that there will not be associated excessive costs or disruption of our business. We have implemented a global management information system at several of our locations and are in the process of implementing that system for most of our businesses worldwide. Many other companies have had significant problems with computer system implementations of this nature and scope. We are using a controlled project plan, and we believe we have assigned adequate staffing and other resources to the project to ensure its successful implementation. However, we cannot provide assurance that the design will meet our current and future business needs or that it will operate as designed. We are heavily dependent on such computer systems, and any failure or delay in the system implementation would cause a substantial interruption to our business, additional expense and loss of sales, customers and profits.

The spending to address the MoistureLoc recall, our investigations and consent solicitations and bank waiver matters could negatively affect our financial performance. Our announced recall of MoistureLoc will result in lost revenues and expenses associated with taking product returns and rebuilding the lens care and non-lens care brands, and has resulted in and may continue to result in market share loss in the lens care category and, potentially, the non-lens care categories. See MoistureLoc risk factors in subsection (d) Risks Related to Regulatory Matters. In addition, we anticipate that higher than normal spending in several areas associated with recent events will negatively impact financial performance. These include, without limitation, (1) higher selling, administrative and general expenses which reflect recall and legal expenses associated with the MoistureLoc situation and pending product liability and shareholder lawsuits, increased marketing expense to support brand rebuilding activities, and professional fees associated with the independent investigations and expanded year-end audit procedures, and (2) higher net financing expenses, which include the consent and waiver fees associated with the consent solicitation and tender offer we completed on June 2, 2006, the consent solicitation completed on September 28, 2006, the consent solicitation we expect to complete in early February 2007 and the several bank waivers obtained in November 2005 and February, May, August and December 2006, and January 2007.
Lens care is the most profitable of our five product categories, and a significant portion of our lens care sales have historically been generated in the United States. As a result, it is anticipated that (1) our U.S. operations will be unprofitable in 2006 and likely beyond, and (2) that no tax benefit will be recorded on U.S. operations as a result of the determination of the need for a valuation allowance that was recorded in 2005 on deferred tax assets (as reported in our Current Report on Form 8-K dated August 7, 2006).
Our 2006 cash flow from operating activities has been negatively impacted by the outflows associated with the MoistureLoc recall, as well as the cost of the investigations and brand rebuilding expenditures. We anticipate that 2006 operating cash flows will be essentially offset by capital expenditures, reflecting costs associated with completing the installation of manufacturing equipment for PureVision contact lenses and expanding our main R&D facility in Rochester, New York.



PAGE 15

We have made certain assumptions and could experience other risks concerning our financial performance. Our financial performance could be adversely impacted if any of our assumptions are incorrect or if we actually experience any of the risks concerning our financial performance that we have identified. Additional specific assumptions and risk factors that could or will impact full year 2007 performance include (1) as it relates to marketing and selling of our products, no significant changes in the competitive landscape; return of our ReNu MultiPlus and ReNu MPS contact lens care products to the Singapore and Hong Kong markets; success of brand rebuilding initiatives, with particular emphasis on Asia, given direct and collateral product line impacts of the MoistureLoc withdrawal in these markets; successful and timely introduction of new products, particularly in our cataract business and in the geographic expansion of contact lens products; lack of further negative price impact from changes in government pricing and reimbursement of our products, including with respect to pharmaceuticals products in Europe; and (2) as it relates to expenses of the business, historical normal expense and spending rates, with moderate increases in actual expenses over prior years; no unusual expense items related to impairment or accelerated depreciation of tangible or intangible assets of the Company; no unusual additional severance or other restructuring expenses associated with changes in our business structure; no unusual additional expenses resulting from investigations or additional review procedures with respect to matters other than those presently outstanding; and no significant settlement of, or judgments adverse to us in contested matters.

(c) Risks Related to Litigation, Actions, Claims, Investigations, Internal Control Deficiencies, the Restatement of Our Financial Statements, the Delay in Filing Our Periodic Reports and Intellectual Property

Unfavorable results in pending and future claims and litigation matters as well as the outcome of pending or future investigations could have an adverse impact on us. We have been named as a party in various lawsuits and are aware of the filing of others. We have identified pending material litigation to which we are a party (or to which our current and certain former officers and directors are parties). See Item 3. Legal Proceedings for further discussion. In some cases, certain present and former officers and directors have also been named as parties in the actions. While we intend to vigorously defend ourselves in these actions, we could be required to pay judgments or settlements in connection with these matters and they could otherwise have a material adverse effect on our business, results of operations, financial condition and liquidity.
In addition to pending litigation matters, we may from time to time learn of alleged non-compliance with laws or regulations or other improprieties through compliance hotlines, communications by employees, former employees or other third parties, as a result of our internal audit procedures, or otherwise. As disclosed in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K, in response to such allegations, the Audit Committee conducted certain investigations during 2005 and 2006, which led, among other things, to the restatement of previously reported financial information, and current charges. The restatement, in turn, resulted in our being unable to file timely certain periodic financial information and our obtaining certain waivers from creditors as well as an extension from the NYSE to permit continued trading notwithstanding the delay in filing our 2005 Annual Report on Form 10-K.
The Audit Committee of the Board of Directors is currently investigating the potential U.S. Foreign Corrupt Practices Act implications of our Spanish subsidiary’s providing free product, principally intraocular lenses used in cataract surgery, and other things of value to doctors performing surgical procedures at public hospitals in Spain. This investigation was initiated following reports of potentially improper sales practices by a former employee. The investigation has been voluntarily reported to the Northeast Regional Office of the SEC. We cannot predict the outcome of this pending investigation, and at this time cannot reasonably estimate the potential liability of the Company or its Spanish subsidiary in connection with these matters.
Our policy is to comply with applicable laws and regulations in each jurisdiction in which we operate and, if we become aware of a potential or alleged violation, to conduct an appropriate investigation, to take appropriate remedial action and to cooperate fully with any related governmental inquiry.
We may become parties to, or the subject of, other claims, lawsuits, investigations or inquiries in the future. See Item 3. Legal Proceedings of this Annual Report on Form 10-K.




PAGE 16

We may not have sufficient insurance to cover our liability in our pending litigation claims and future claims either due to coverage limits or as a result of insurance carriers seeking to deny coverage of such claims, which in either case could have a material adverse effect on our business and financial condition. We maintain third party insurance coverage against various liability risks, including securities, shareholder derivative, ERISA, and product liability claims, as well as other claims that form the basis of litigation matters pending against us. While we believe these arrangements are an effective way to ensure against liability risks, the potential liabilities associated with the litigation matters pending against us, or that could arise in the future, could exceed the coverage provided by such arrangements. In addition, our insurance carriers have sought or may seek to rescind or deny coverage with respect to completed investigations or pending or future investigations and actions. If we do not have sufficient coverage under our policies, or if the insurance companies are successful in rescinding or denying coverage to us, our business, results of operations and financial condition may be materially adversely affected.

Our potential indemnification obligations and limitations of our director and officer liability insurance could have a material adverse effect on our business, results of operations and financial condition. Certain of our present and former directors, officers and employees are the subject of lawsuits. Under New York law and our bylaws, we may have an obligation to indemnify our current and former directors, officers and employees in relation to completed investigations or pending and/or future investigations and actions. Indemnification payments that we make may have a material adverse effect on our business, results of operations and financial condition to the extent insurance does not cover our costs. The insurance carriers that provide our directors’ and officers’ liability policies have sought or may seek to rescind or deny coverage with respect to those completed investigations or pending and future investigations and actions, or we may not have sufficient coverage under such policies. If the insurance companies are successful in rescinding or denying coverage to us and/or some of our current directors, officers and employees, or if we do not have sufficient coverage under our policies, our business, results of operations and financial condition may be materially adversely affected.

Our potential liability relating to a Notice of Final Partnership Administrative Adjustment from the Internal Revenue Service could have a material adverse effect on our financial results. On May 12, 2006, we received a Notice of Final Partnership Administrative Adjustment from the Internal Revenue Service relating to partnership tax periods ended June 4, 1999 and December 25, 1999, for Wilmington Partners L.P. (Wilmington), a partnership formed in 1993 in which the majority of partnership interests are held by certain of our subsidiaries. The Final Partnership Administrative Adjustment (FPAA) proposes adjustments increasing the ordinary income reported by Wilmington for its December 25, 1999 tax year by a total of $10, and increasing a long-term capital gain reported by Wilmington for that tax year by $190. The FPAA also proposes a $550 negative adjustment to Wilmington's basis in a financial asset contributed to it by one of its partners in 1993; this adjustment would also affect the basis of that partner — one of our subsidiaries — in its partnership interest in Wilmington. The asserted adjustments could, if sustained in full, increase the tax liabilities of the partnership's partners for the associated tax periods by more than $200, plus penalties and interest. We have not made any financial provision for the asserted additional taxes, penalties or interest as we believe the asserted adjustments are not probable and estimable.
Since 1999, our consolidated financial statements have included a deferred tax liability relating to the partnership. As of December 31, 2005, this deferred tax liability equaled $157. This deferred tax liability is currently reducing net deferred tax assets for which a valuation allowance has been recorded as of December 31, 2005.
On August 7, 2006, we made a petition to the U.S. Tax Court to challenge the asserted adjustments. Internal Revenue Service's answer was filed on October 4, 2006, and we initiated a motion to strike portions of the answer on November 1, 2006. We believe we have numerous substantive and procedural tax law arguments to dispute the adjustments. Tax, penalties and interest cannot be assessed until a Tax Court determination is made, and an assessment, if any, would likely not be made until some time after 2007. While we intend to vigorously defend against the asserted adjustments, our failure to succeed in such a defense could significantly increase the liability of the partnership's partners for taxes, plus interest and penalties, which in turn would have a material adverse effect on our financial results and cash flows.




PAGE 17

Management has identified a number of material weaknesses in our internal control over financial reporting. Effective internal control over financial reporting is necessary for compliance with the Sarbanes-Oxley Act of 2002 and appropriate financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process, under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with GAAP. As disclosed in this Annual Report on Form 10-K, management’s assessment of our internal control over financial reporting identified material weaknesses in various areas as discussed in Item 9A. Controls and Procedures which resulted in the restatement of the Company's 2004, 2003, 2002 and 2001 annual consolidated financial statements and all quarterly periods of 2004 and the first two quarters of 2005. The impact of restatement adjustments identified relating to fiscal years prior to 2003 decreased beginning retained earnings for that year, by $23 net of tax. Several material weaknesses were remediated in 2006 (see Item 9A. Controls and Procedures of this Annual Report on Form 10-K) and we are working to remediate the others as soon as practicable. While the Company has not completed its 2006 internal control evaluation, it is expected that the Company will report one or more material weaknesses in internal control over financial reporting for 2006 when it files its Annual Report on Form 10-K for the year ended December 30, 2006. Delay in the implementation of remedial actions could affect the accuracy or timing of future filings with the SEC and other regulatory authorities.

We may face risks related to the recent restatement of our financial statements. The Company restated its consolidated financial statements, as more fully discussed in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement to the consolidated financial statements included in this Annual Report on Form 10-K. The Company restated its consolidated balance sheet, its consolidated statements of income, of changes in shareholders' equity and of cash flows as of December 25, 2004 and for the fiscal years 2003 and 2004. In addition, the Company restated selected financial data as of 2003, 2002 and 2001 and for fiscal years 2002 and 2001. See Item 8. Financial Statements and Supplementary Data under Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K and beginning shareholders' equity for the impact of the restatement for periods prior to 2001. The impact of the restated financial results for the first and second quarterly periods of 2005 and the quarterly periods of 2004 are also presented in Item 8. Financial Statements and Supplementary Data under Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K.
Companies that restate their financial statements sometimes face litigation claims, some of which we have already been made aware, and/or SEC proceedings following such a restatement. We could face monetary judgments, penalties or other sanctions which could adversely affect our financial condition and could cause our stock price to decline. See further discussion in Item 3. Legal Proceedings, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and in Item 8. Financial Statements and Supplementary Data under Note 21 — Other Matters of this Annual Report on Form 10-K.

We expect to continue to incur significant expenses related to our internal control over financial reporting and the preparation of our financial statements. We have devoted substantial internal and external resources to the completion of the restatement and our financial statements for the year ended December 31, 2005. As a result of these efforts, along with efforts to complete our assessment of internal control over financial reporting as of December 31, 2005, as required by Section 404 of the Sarbanes-Oxley Act of 2002, we have incurred and expect that we will continue to incur significant incremental fees and expenses for additional auditor services, financial and other consulting services, legal services and debt related waiver fees. While we do not expect fees and expenses relating to the preparation of our financial results in 2007 and future years to be as high as 2005 and 2006, we expect that these fees and expenses will remain significantly higher than historical fees and expenses in this category for the next several quarters. These expenses, as well as the substantial time devoted by our management towards addressing these weaknesses, could have a material adverse effect on our financial condition, results of operations and cash flows.




PAGE 18

We have postponed the filing of this Annual Report and of our Quarterly Reports on Form 10-Q for the quarters ended September 24, 2005, April 1, 2006, July 1, 2006 and September 30, 2006. As a result, we do not have current financial information available and will be limited in our ability to register our securities for offer and sale until we are deemed a current filer with the SEC. As a result, there is a lack of current publicly available financial information concerning the Company. Investors must evaluate whether to purchase or sell our securities in light of the lack of current financial information. We are not in a position to predict at what date current financial information will be available. Accordingly, any investment in our securities involves a high degree of risk. Until current periodic reports and financial statements are filed, we will be precluded from registering our securities with the SEC for offer and sale. This precludes us from raising debt or equity financing in the public markets and will limit our ability to use stock options and other equity-based awards to attract, retain and provide incentives to our employees.

As a result of the delays in filing our periodic reports, we required certain waivers in connection with the delivery of financial statements and related matters under financing arrangements for our public and bank debt. We may require additional waivers in the future, and failure to obtain the necessary waivers could have a material adverse effect on our business, liquidity and financial condition. We have previously obtained certain waivers and may continue to seek additional waivers under our indenture or bank loan agreements. The waivers waive certain potential breaches of representations and covenants under our indenture or bank loan agreements and establish the extended deadlines for the delivery of certain financial reports. Our current waivers under the bank loan agreements expire on April 30, 2007. The waivers applicable to our indenture expired January 31, 2007. In early February, we expect to complete the consent solicitations extending the deadline for expiration of waivers related to our indenture until April 30, 2007. Due to the delays in completing this annual report, we have not been able to issue our 2006 quarterly financial statements within this extended date, which may impact whether we are able to file our 2006 Report on Form 10-K within the extended period, and therefore, we may seek additional waivers under the indenture and the bank loan agreements. It is also uncertain as to whether we can issue our 2007 quarterly financial statements within the deadlines prescribed by the indenture and bank loan agreements.
Under our indenture and certain of our bank loan agreements, the trustee or lenders have the right to notify us if they believe we have breached a representation or covenant under the operative debt instruments and may declare an event of default. If one or more notices of default were to be given, we believe we would have various periods in which to cure such events of default or obtain necessary waivers. If we do not cure the events of default or obtain necessary waivers within the required time periods or certain extended time periods, the maturity of some of our debt could be accelerated and our ability to incur additional indebtedness could be restricted. Moreover, defaults under our indenture and bank loan agreements could trigger cross-default provisions under those and other arrangements. There can be no assurance that any additional waivers will be received on a timely basis, if at all, or that any waivers obtained, including the waivers we have already obtained, will extend for a sufficient period of time to avoid an acceleration event, an event of default or other restrictions on our business operations. The failure to obtain such waivers could have a material adverse effect on our business, liquidity and financial condition.

The delay in filing this Annual Report on Form 10-K with the SEC and any failure to satisfy other NYSE listing requirements could cause the NYSE to commence suspension or delisting procedures with respect to our common stock. As a result of the delay in filing this Annual Report on Form 10-K, we were in breach of certain continued listing requirements of the NYSE. We had received from the NYSE an additional period in which to trade our securities until March 1, 2007 in order for us to file this Annual Report on Form 10-K before that date. Any other failure to satisfy NYSE listing requirements, if not waived by the NYSE, could cause the NYSE to commence suspension or delisting procedures with respect to our common stock. The commencement of any suspension or delisting procedures by the NYSE remains, at all times, at the discretion of the NYSE and would be publicly announced by the NYSE. The delisting of our common stock from the NYSE may have a material adverse effect on us by, among other things, limiting:

·  
the liquidity of our common stock;
·  
the market price of our common stock;
·  
the number of institutional and other investors that will consider investing in our common stock;
·  
the availability of information concerning the trading prices and volume of our common stock;
·  
the number of broker-dealers willing to execute trades in shares of our common stock; and
·  
our ability to obtain equity financing for the continuation of our operations.



PAGE 19

We depend on proprietary technologies, and may not be able to protect our intellectual property rights adequately. We rely on a combination of contractual provisions, confidentiality procedures and patent, trademark, copyright and trade secrecy laws to protect the proprietary aspects of our technology. These legal measures afford limited protection and may not prevent our competitors from gaining access to our intellectual property and proprietary information. Any of our patents may be challenged, invalidated, circumvented or rendered unenforceable. Furthermore, we cannot ensure that any pending patent application held by us will result in an issued patent, or that if patents are issued to us, such patents will provide meaningful protection against competitors or competitive technologies. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of our proprietary rights. Any litigation could result in substantial expense, may reduce our profits and may not adequately protect our intellectual property rights. In addition, we may be exposed to future litigation by third parties based on claims that our products infringe their intellectual property rights. Any litigation or claims against us, whether or not successful, could result in substantial costs and harm our reputation. In addition, intellectual property litigation or claims could force us to do one or more of the following:

·  
cease selling or using any of our products that incorporate the challenged intellectual property, which would adversely affect our revenue;
·  
obtain a license from the holder of the intellectual property right alleged to have been infringed, which license may not be available on reasonable terms, if at all; and
·  
redesign or, in the case of trademark claims, rename our products to avoid infringing the intellectual property rights of third parties, which may not be possible and could be costly and time-consuming if it is possible to do so.

We may license technology from third parties as part of our efforts to develop new products or improve existing products. There can be no assurance that technology, compounds, concepts or other materials that we license will allow us to develop new products or make improvements to existing products, or will result in products available for commercial sale. The failure of licensing arrangements to create new products or make improvements could have a material adverse effect on our business.

Our products could be subject to claims of infringement. Our competitors and others in both the United States and foreign countries, may have applied for or obtained, or may in the future apply for and obtain, patents that will prevent, limit or otherwise interfere with our ability to make and sell our existing and planned products. Claims that our products infringe the proprietary rights of others often are not asserted until after commencement of commercial sales incorporating our technology.
Significant litigation regarding intellectual property rights exists in our industry. Third parties have made, and it is possible that they will make in the future, claims of infringement against us or our contract manufacturers in connection with their use of our technology. Any claims, even those without merit, could:

·  
be expensive and time consuming to defend;
·  
cause us to cease making, licensing or using products that incorporate the challenged intellectual property;
·  
require us to redesign or reengineer our products, if feasible;
·  
divert management’s attention and resources; or
·  
require us to enter into royalty or licensing agreements in order to obtain the right to use a necessary product, component or process.

Any royalty or licensing agreements, if required, may not be available to us on acceptable terms or at all. A successful claim of infringement against us or our contract manufacturers in connection with the use of our technology, in particular if we are unable to manufacture or sell any of our planned products in any major market, could adversely affect our business.




PAGE 20

(d) Risks Related to Regulatory Matters

We are subject to extensive government regulation that increases our costs and could prevent us from selling our products. The research, development, testing, manufacturing and marketing of our products are subject to extensive governmental regulations. Government regulations include inspection of and controls over testing and manufacturing; safety and environmental controls; efficacy; labeling; advertising and promotion; requirements for record keeping, including for various electronic records and electronic signature programs; and regulation of the sale and distribution of pharmaceutical and medical device products and samples. We are also subject to government regulation with respect to the prices we charge and the rebates we offer to customers. Government regulation substantially increases the cost of developing, manufacturing and selling our products.
In the United States, we must obtain approval from the FDA for each pharmaceutical product that we market and FDA approval or clearance for each medical device that we market. The FDA approval process is typically lengthy and expensive, and approval is never certain. Products distributed outside the United States are also subject to government regulation, which may be equally or more demanding than in the United States. Our new products could take a significantly longer time than we expect to gain regulatory approval or may never gain approval. If a regulatory authority delays approval of a potentially significant product, our market value and operating results may decline, which could have a material adverse effect on our business, operations or financial condition. Even if the FDA or another regulatory agency approves a product, the approval may limit its indicated uses, may otherwise limit our ability to promote, sell and distribute it or may require post-marketing studies.
Currently, we are actively pursuing approval for a number of products from regulatory authorities in a number of countries, including, among others, the United States, countries in the European Union and certain countries in Asia. The clinical trials required to obtain such approvals are complex and expensive and their outcomes are uncertain. We incur substantial expense for, and devote significant time to, clinical trials, yet cannot be certain that the trials will ever result in the commercial sale of a product. Positive results from preclinical studies and early clinical trials do not ensure positive results in later clinical trials that form the basis of an application for regulatory approval. We may suffer significant setbacks in clinical trials, even after earlier clinical trials show promising results. Any of our products may produce undesirable side effects that could cause us or regulatory authorities to interrupt, delay or halt clinical trials of a pharmaceutical or medical device candidate or rescind its regulatory approval, even after the product is in the market. We, the FDA or another regulatory authority may suspend or terminate clinical trials at any time if we or they believe the trial participants face unacceptable health risks. Non-compliance with applicable regulatory requirements can result in fines, injunctions, penalties, mandatory recalls or seizures, suspensions of production, denial or withdrawal of pre-marketing approvals, or recommendations by the regulatory body against governmental contracts and criminal prosecution, each of which could have a material adverse effect on our business, operations or financial condition.
The FDA and other regulatory agencies also inspect facilities at which we manufacture our products. Failure to meet FDA and other regulations could result in penalties being assessed against us or, in extreme cases, result in the closure of a facility. For example, the FDA recently cited our Greenville, South Carolina facility, where we manufacture lens care products, for a number of non-compliant issues. While we have mechanisms in place to monitor compliance, we cannot ensure that the FDA or other regulatory agencies will not find indications of non-compliance. Fines or other enforcement responses could have a material adverse effect on our business, operations or financial condition.
Our development and marketing of products may fail or be delayed by many factors relative to the requirements for product approval, including, for example, the following:

·  
inability to attract clinical investigators for trials;
·  
inability to recruit patients at the expected rate;
·  
failure of the trials to demonstrate a product's safety or efficacy;
·  
unavailability of FDA or other regulatory agencies' accelerated approval processes;
·  
inability to follow patients adequately after treatment;
·  
changes in the design or formulation of a product;
·  
inability to manufacture sufficient quantities of materials to use for clinical trials;
·  
unforeseen governmental or regulatory delays;
·  
failure of manufacturing facilities to meet regulatory requirements; or
·  
failure of clinical trial management, oversight or implementation to meet regulatory requirements.




PAGE 21

Any such failure or delay, or the impact of a failure or delay, could have a material adverse effect on our business, operations or financial condition.

We have undertaken, and may in the future implement, a product recall or voluntary market withdrawal, or could be required by a governmental authority to do so, and could be exposed to significant product liability claims; we may have to pay significant amounts to those harmed and may suffer from adverse publicity as a result. The manufacturing and marketing of pharmaceuticals, medical devices and surgical equipment and instruments involve an inherent risk that our products may prove to be defective and cause a health risk. In that event, we may voluntarily implement a recall or market withdrawal or may be required to do so by a regulatory authority. In the past, we have recalled products, such as our MoistureLoc product, voluntarily and we have been required to withdraw products by regulatory authorities and, based on this experience, believe that the occurrence of a recall could result in significant costs to us, potential disruptions in the supply of our products to our customers and adverse publicity, all of which could harm our ability to market our products. A recall of one of our products or a product manufactured by another manufacturer could impair sales of other similar products we market as a result of confusion concerning the scope of the recall. In the event of such actions, we have worked actively with regulatory authorities to coordinate our response and to ensure the health and safety of our customers. We currently rely on a combination of self-insurance and third-party insurance to cover potential product liability exposure. The combination of our insurance coverage, cash flows and reserves may not be adequate to satisfy product liabilities we may incur in the future. Even meritless claims could subject us to adverse publicity, hinder us from securing insurance coverage in the future and require us to incur significant legal fees. Successful product liability claims could have a material adverse effect on our financial condition.

Our worldwide voluntary withdrawal of our ReNu with MoistureLoc product has had an adverse effect on our business, which could continue longer than previously estimated, even permanently. On May 15, 2006, we announced a worldwide voluntary recall of MoistureLoc lens care solution. Our decision was made following an investigation into an increase in fungal infections among contact lens wearers in the United States and certain Asian markets. We have incurred and can be expected to incur substantial costs in connection with the withdrawal of this product, associated investigations, and commercial actions and related legal actions brought against us. Our financial condition has been and will be negatively affected by the impact of sales returns and coupon redemptions estimated with the MoistureLoc recall. Lost MoistureLoc revenues combined with lower revenues for other lens care products, reflecting market share losses caused by trade consumer uncertainty resulting from our investigations into the outbreak of fungal infections among contact lens wearers and subsequent market withdrawal of MoistureLoc, will have an impact on our financial condition. There has been, to date, and could continue to be a negative effect on our non-lens care product categories, primarily in Asia, as a result of the MoistureLoc recall. There can be no assurances that these impacts will not continue in the future. While we intend to vigorously defend ourselves in these actions, as a result of this withdrawal, we have been, and may be in the future, named as a party to claims, lawsuits and other actions that could result in liability exposure, including liability exposure as to which the Company's third party product liability insurance is inadequate, insufficient or unavailable, as highlighted in further detail elsewhere in this report, including in this Item 1A. Risk Factors of this report. Any judgments, settlements or awards of damages could have an adverse effect on our business, earnings and financial condition. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Item 8. Financial Statements and Supplementary Data under Note 21 — Other Matters of this Annual Report on Form 10-K.

Our activities involve hazardous materials and emissions and may subject us to environmental liability. Our manufacturing, research and development practices involve the controlled use of hazardous materials. We are subject to federal, state and local laws and regulations in the various jurisdictions in which we have operations governing the use, manufacturing, storage, handling and disposal of these materials and certain waste products. Although we believe that our safety and environmental procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these materials. We may also be liable for actions of previous owners on properties we acquire. Remedial environmental actions could require us to incur substantial unexpected costs which would materially and adversely affect our results of operations. If we were involved in a major environmental accident or found to be in substantial non-compliance with applicable environmental laws, we could be held liable for damages or penalized with fines.




PAGE 22

We may incur increased costs or suffer competitive disadvantage as a result of recently enacted and proposed changes in laws and regulations. Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules implemented or proposed by the SEC and by the NYSE, have resulted in and are expected to continue to result in increased costs to us as a public company. The new rules could make it more difficult or more costly for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs.


Item 1B.  Unresolved Staff Comments

Not applicable.

Item 2.  Properties

We own and lease a number of important principal physical properties. Our headquarters and one of our manufacturing facilities are located in Rochester, New York. We also have U.S.-based manufacturing facilities in Clearwater, Florida; Greenville, South Carolina; St. Louis, Missouri; and Tampa, Florida. Outside the United States, we have manufacturing facilities in Brazil, China, France, Germany, India, Ireland, Italy and Scotland.
Administrative, marketing, research/laboratory, distribution and warehousing facilities are located in various parts of the world.
We consider our facilities suitable and adequate for the operations involved. All facilities are being productively utilized. The majority of our facilities are being utilized to perform more than one operating function and, as such, may house the functions of multiple segments.


Item 3.  Legal Proceedings

Legal Matters The Company is involved as a party in a number of material matters in litigation, including general litigation related to the restatement of the Company's financial information and the MoistureLoc withdrawal, material intellectual property litigation, and material tax litigation. The Company intends to vigorously defend itself in all of these matters. At this time, the Company is unable to predict the outcome of, and cannot reasonably estimate the impact of, any pending litigation matters, matters concerning allegations of non-compliance with laws or regulations, and matters concerning other allegations of other improprieties. The Company has not made any financial provision for potential liability in connection with these matters.




PAGE 23

Shareholder Securities Class Actions There is a consolidated securities class action, entitled In re Bausch & Lomb Incorporated Securities Litigation, Case Nos. 06-cv-6294 (master file), 06-cv-6295, 06-cv-6296, and 06-cv-6300, pending in Federal District Court for the Western District of New York, Rochester Division, against the Company and certain present and former officers and directors. Initially, four separate shareholder actions were filed between March and May of 2006 in Federal District Court for the Southern District of New York, and these were later transferred to the Western District of New York and consolidated into the above-captioned matter. Plaintiffs in these actions purport to represent a putative class of shareholders who purchased Company stock at allegedly artificially inflated levels between January 27, 2005 and May 3, 2006. Among other things, plaintiffs allege that the defendants issued materially false and misleading public statements regarding the Company's financial condition and operations by failing to disclose negative information relating to the Company's Brazilian and Korean subsidiaries, internal controls, and problems with MoistureLoc, thereby inflating the price of Company stock during the alleged class period. Plaintiffs seek unspecified damages. The cases are currently awaiting appointment of lead plaintiff and lead plaintiff's counsel in accordance with the Private Securities Litigation Reform Act. Pursuant to a stipulated schedule ordered by the Court, the lead plaintiff appointed by the Court must file a consolidated amended complaint by the earlier of (a) 45 days after the Company files its Annual Report on Form 10-K for the year ended December 31, 2005, or (b) 90 days after entry of the Court's order appointing the lead plaintiff, provided, however, that, at a minimum, the lead plaintiff will have 45 days after entry of the Court's order appointing the lead plaintiff to file such consolidated amended complaint.

ERISA-Based Class Actions There is a consolidated ERISA class action, entitled In re Bausch & Lomb Incorporated ERISA Litigation, Case Nos. 06-cv-6297 (master file), 06-cv-6315, and 06-cv-6348, pending in the Federal District Court for the Western District of New York, Rochester Division, against the Company and certain present and former officers and directors. Initially, three separate actions were filed between April and May of 2006 in Federal District Court for the Southern District of New York, and these were later transferred to the Western District of New York and consolidated into the above-captioned matter. Plaintiffs in these actions purport to represent a class of participants in the Company's defined contribution 401(k) Plan for whose individual accounts the plan held an interest in Company stock between May 25, 2000 and the present. Among other things, plaintiffs allege that the defendants breached their fiduciary duties to plan participants by allowing the plan to invest in Company Common stock despite the fact that it was allegedly artificially inflated due to the failure to disclose negative information relating to the Company's Brazilian and Korean subsidiaries, internal controls, and problems with MoistureLoc. Plaintiffs seek unspecified damages as well as certain declaratory and injunctive relief. On August 28, 2006, the Court entered an order appointing co-lead plaintiffs and co-lead plaintiffs' counsel. Pursuant to a stipulated schedule ordered by the Court, plaintiffs in the consolidated ERISA action will have until 10 days after a consolidated amended complaint is filed in the consolidated securities action described above, to file a consolidated amended complaint.

Shareholder Derivative Actions The shareholder derivative actions, in which a shareholder seeks to assert the rights of the Company derivatively against certain present and former officers and directors, fall into two categories: (a) those asserting allegations relating to accounting issues at the Company's Brazilian and Korean subsidiaries; and (b) those asserting allegations relating to the MoistureLoc withdrawal.
There is a consolidated derivative action asserting allegations relating to accounting issues at the Company's Brazilian and Korean subsidiaries, entitled In re Bausch & Lomb Incorporated Derivative Litigation, Case Nos. 06-cv-6298 (master file) and 06-cv-6299, pending in Federal District Court for the Western District of New York, Rochester Division, against certain present and former officers and directors of the Company, and also naming the Company as nominal defendant. Initially, two separate derivative actions were filed in April 2006 in Federal District Court for the Southern District of New York, and were later transferred to the Western District of New York and consolidated. Among other things, plaintiffs allege that the individual defendants breached their fiduciary duties to the Company by causing or allowing the Company to issue materially false and misleading public statements regarding the Company's financial condition and operations that failed to disclose negative information about the Company's Brazilian and Korean subsidiaries and internal controls, thereby inflating the price of Company stock during the relevant time period. Plaintiffs purport to allege damage to the Company as a result of, among other things, a decrease in the Company's market capitalization, exposure to liability in securities fraud actions, and the costs of internal investigations and financial restatements. Plaintiffs seek unspecified damages as well as certain declaratory and injunctive relief, including for misappropriation of inside information for personal benefit by certain of the individual defendants. Pursuant to a stipulated schedule ordered by the Court, plaintiffs in this consolidated derivative action will have until 30 days after a consolidated amended complaint is filed in the consolidated securities action described above, to file a consolidated amended complaint.



PAGE 24

On January 3, 2006, the Company received a demand letter dated December 28, 2005, from a law firm not involved in the now consolidated derivative actions described above, on behalf of a shareholder who also is not involved in the derivative actions, demanding that the Board of Directors bring claims on behalf of the Company based on allegations substantially similar to those that were later alleged in the two derivative actions relating to accounting issues at the Brazilian and Korean subsidiaries. In response to the demand letter, the Board of Directors adopted a board resolution establishing an Evaluation Committee (made up of independent directors) to investigate, review and analyze the facts and circumstances surrounding the allegations made in the demand letter, but reserving to the full Board authority and discretion to exercise its business judgment in respect of the proper disposition of the demand. The Committee has engaged independent outside counsel to advise it.
There are also two purported derivative actions asserting allegations relating to the MoistureLoc withdrawal. The first case, entitled Little v. Zarrella, Case No. 06-cv-6337, was filed in June 2006 in the Federal District Court for the Southern District of New York and was transferred to the Western District of New York, Rochester Division, where it is currently pending against certain directors of the Company, and also naming the Company as nominal defendant. The second case, entitled Pinchuck v. Zarrella, Case No. 06-6377, was filed in June 2006 in the Supreme Court of the State of New York, County of Monroe, where it is currently pending against the directors of the Company, and also naming the Company as nominal defendant. Among other things, plaintiffs in these actions allege that the individual defendants breached their fiduciary duties to the Company in connection with the Company's handling of the MoistureLoc withdrawal. Plaintiffs purport to allege damage to the Company as a result of, among other things, costs of litigating product liability and personal injury lawsuits, costs of the product recall, costs of carrying out internal investigations, and the loss of goodwill and reputation. Plaintiffs seek unspecified damages as well as certain declaratory and injunctive relief.
Pursuant to a stipulated schedule ordered by the Court, plaintiff in the state-court Pinchuck action served an amended complaint on September 15, 2006 and defendants served a motion to dismiss the amended complaint on November 15, 2006; plaintiff's opposition to the motion was served on January 15, 2007, and defendants' reply is due February 15, 2007. Pursuant to a stipulated schedule ordered by the Court in the federal Little action, plaintiff in that case will have until 60 days after a ruling on a motion to dismiss in the consolidated securities action is entered or, if no such motion is filed, 60 days after defendants' answer to a consolidated amended complaint in the consolidated securities action is filed, to file an amended complaint.

Product Liability Lawsuits As of February 1, 2007, the Company has been served or is aware that it has been named as a defendant in approximately 196 product liability lawsuits pending in various federal and state courts as well as certain other non-U.S. jurisdictions. Of the 196 cases, 117 actions have been filed in U.S. federal courts, 77 cases have been filed in various U.S. state courts and two actions have been filed in non-U.S. jurisdictions. These also include 170 individual actions filed on behalf of individuals who claim they suffered personal injury as a result of using a ReNu solution and 26 putative class actions alleging personal injury as a result of using a ReNu solution and/or violations of one or more state consumer protection statutes. In the personal injury actions, plaintiffs allege liability based on, among other things, negligence, strict product liability, failure to warn and breach of warranty. In the consumer protection actions, plaintiffs seek economic damages, claiming that they were misled to purchase products that were not as safe as advertised. Several lawsuits contain a combination of these allegations. On August 14, 2006, the Judicial Panel on Multidistrict Litigation (JPML) created a coordinated proceeding and transferred an initial set of MoistureLoc product liability lawsuits to the U.S. District Court for the District of South Carolina. The Company has advised the JPML of all federal cases available for transfer and has urged the issuance of conditional transfer orders. As of February 1, 2007, 104 of the 117 federal cases noted above have been transferred to the JPML.

Material Intellectual Property Litigation In October 2005, Rembrandt Vision Technologies, L.P. filed a patent infringement lawsuit against the Company and CIBA Vision Corporation. The action is entitled, Rembrandt Vision Technology, L.P. v. Bausch & Lomb Incorporated and CIBA Vision Corporation, bearing case number 2:05 CV 491, and is pending in the U.S. District Court for the Eastern District of Texas (Marshall Division). Rembrandt asserts that the Company and CIBA have infringed certain of Rembrandt’s oxygen permeability and tear-wettability technology that it claims to be protected by a U.S. Patent No. 5,712,327 entitled “Soft Gas Permeable Lens Having Improved Clinical Performance” (the 327 Patent). Rembrandt claims that the Company infringes the 327 Patent by selling soft gas permeable contact lenses that have tear-wettable surfaces in the United States, which would include the Company’s PureVision silicone hydrogel lens products. The Company denies, and intends to vigorously defend itself against, Rembrandt’s claims. The court has issued a scheduling order and has set a trial date of November 5, 2007.




PAGE 25

Material Tax Litigation As disclosed in Item 8. Financial Statements and Supplementary Data under Note 10 — Provision for Income Taxes of this Annual Report on Form 10-K, on May 12, 2006, the Company received a Notice of Final Partnership Administrative Adjustment from the Internal Revenue Service relating to partnership tax periods ended June 4, 1999 and December 25, 1999, for Wilmington Partners L.P. (Wilmington), a partnership formed in 1993 in which the majority of partnership interests are held by certain of our subsidiaries. The Final Partnership Administrative Adjustment (FPAA) proposes adjustments increasing the ordinary income reported by Wilmington for its December 25, 1999 tax year by a total of $10, and increasing a long-term capital gain reported by Wilmington for that tax year by $190. The FPAA also proposes a $550 negative adjustment to Wilmington's basis in a financial asset contributed to it by one of its partners in 1993; this adjustment would also affect the basis of that partner — one of our subsidiaries — in its partnership interest in Wilmington. The asserted adjustments could, if sustained in full, increase the tax liabilities of the partnership's partners for the associated tax periods by more than $200, plus penalties and interest. We have not made any financial provision for the asserted additional taxes, penalties or interest as we believe the asserted adjustments are not probable and estimable.
Since 1999, the Company's consolidated financial statements have included a deferred tax liability relating to the partnership. As of December 31, 2005, this deferred tax liability equaled $157. This deferred tax liability is currently reducing net deferred tax assets for which a valuation allowance has been recorded as of December 31, 2005.
On August 7, 2006, we made a petition to the U.S. Tax Court to challenge the asserted adjustments. Internal Revenue Service's answer was filed on October 4, 2006, and we initiated a motion to strike portions of the answer on November 1, 2006. We believe we have numerous substantive and procedural tax law arguments to dispute the adjustments. Tax, penalties and interest cannot be assessed until a Tax Court determination is made, and an assessment, if any, would likely not be made until some time after 2007. While we intend to vigorously defend against the asserted adjustments, our failure to succeed in such a defense could significantly increase the liability of the partnership's partners for taxes, plus interest and penalties, which in turn would have a material adverse effect on our financial results and cash flows.

General Litigation Statement From time to time, the Company is engaged in, or is the subject of, various lawsuits, claims, investigations and proceedings, including product liability, patent, trademark, commercial and other matters, in the ordinary course of business.
In addition to pending litigation matters, the Company may from time to time learn of alleged non-compliance with laws or regulations or other improprieties through compliance hotlines, communications by employees, former employees or other third parties, as a result of its internal audit procedures, or otherwise. As disclosed in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K, in response to such allegations, the Company's Audit Committee conducted certain investigations during 2005 and 2006, which led, among other things, to the restatement of previously reported financial information and the recording of current charges. The restatement, in turn, resulted in the Company's being unable to file timely certain periodic financial information and the Company's obtaining certain waivers from creditors, as well as an extension from the NYSE to permit continued trading notwithstanding the delay in filing the Company's 2005 Annual Report on Form 10-K.
The Audit Committee of the Board of Directors is currently investigating the potential U.S. Foreign Corrupt Practices Act implications of the Company’s Spanish subsidiary’s providing free product, principally intraocular lenses used in cataract surgery, and other things of value to doctors performing surgical procedures at public hospitals in Spain. This investigation was initiated following reports of potentially improper sales practices by a former employee. The investigation of the Company’s Spanish subsidiary has been voluntarily reported to the Northeast Regional Office of the SEC. We cannot predict the outcome of this pending investigation, and at this time cannot reasonably estimate the potential liability of the Company or its Spanish subsidiary in connection with these matters.
The Company’s policy is to comply with applicable laws and regulations in each jurisdiction in which it operates and, if the Company becomes aware of a potential or alleged violation, to conduct an appropriate investigation, to take appropriate remedial action and to cooperate fully with any related governmental inquiry. There can be no assurance that any pending or future investigation or resulting remedial action will not have a material adverse financial, operational or other effect on the Company.





PAGE 26

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Executive Officers of the Registrant Set forth below are the names, ages (as of December 1, 2006), positions and offices held by and a brief account of the business experience during the past five years of each executive officer.

Name and Age
Position
   
Ronald L. Zarrella (57)
Chairman and Chief Executive Officer since 2001; Executive Vice President and President, General Motors North America, General Motors Corporation (1998-2001).
   
Gerhard Bauer (50)
Senior Vice President, Global Operations and Engineering since May 2006; Vice President, Global Operations and Engineering for Europe (2001-May 2006).
   
Alan H. Farnsworth (54)
Senior Vice President and President, Europe, Middle East and Africa Region since 2001; Corporate Vice President, Pharmaceuticals/Europe (2000-2001).
   
Dwain L. Hahs (54)
Senior Vice President and President Asia Region since May 2006; Senior Vice President, Global Operations and Engineering (2000-2006).
   
Paul G. Howes (52) 1
Senior Vice President and President, Americas Region (2003-2007); Vice President, Mid-Atlantic Business Group, Merck & Co., Inc. (2000-2003); Vice President Sales and Marketing, Specialty Products, Merck & Co., Inc. (1998-2001).
   
John M. Loughlin (56) 2
Senior Vice President since May 2006; Senior Vice President and President Asia Region (2000-2006).
   
Stephen C. McCluski (54)
Senior Vice President and Chief Financial Officer since 1995.
   
David R. Nachbar (44)
Senior Vice President, Human Resources since 2002; Senior Vice President, Human Resources, The St. Paul Companies, Inc. (1998-2002).
   
Robert B. Stiles (57)
Senior Vice President and General Counsel since 1997.
   
Praveen Tyle (46)
Senior Vice President, Research & Development and Chief Scientific Officer since 2004; Group Vice President, Pharmaceutical Sciences and Manufacturing, Biovail Corporation (2003-2004); Vice President, Global Head, Global Pharmaceutical Sciences, Pharmacia Corporation (2001-2003); Vice President, Pharmaceutical Sciences - U.S., Pharmacia Corporation (1999-2001).
   
Evon L. Jones (42)
Corporate Vice President and Chief Information Officer since January 2005; Senior Vice President and Chief Information Officer, The Dial Corporation (2001-2004); Senior Vice President and Chief Information Officer, America West Holdings Corporation (1998-2001).
   
Barbara M. Kelley (60)
Corporate Vice President, Communications and Investor Relations since 2001.
   
Jurij Z. Kushner (56)
Corporate Vice President, Controller since 1995.
   
Brian Levy (55)
Corporate Vice President and Chief Medical Officer since 2004; Vice President, Clinical & Medical Affairs (2000-2004).
   
Angela J. Panzarella (48)
Corporate Vice President, Global Vision Care since 2001.
   



PAGE 27

Gary M. Phillips (40)
Corporate Vice President and Vice President Commercial Operations, U.S. Surgical and Pharmaceuticals since January 2007; Corporate Vice President, Global Pharmaceuticals (2002-2006); Executive Director, Strategic Planning, Novartis Pharmaceuticals (2000-2002).

Efrain Rivera (50)
Corporate Vice President and Treasurer since 2004; Corporate Vice President and Assistant Treasurer (2003-2004); Leave of Absence (2003); Corporate Vice President and President, Latin America and Canada (2002-2003); President, Bausch & Lomb Latin America and General Manager, Bausch & Lomb Mexico (2001-2002); Vice President and Controller, Vision Care (1998-2001).
   
Henry C. Tung (47)
Corporate Vice President, Global Surgical since February 2005; Vice President, New Business Development, Boston Scientific Corporation (2000-February 2005).

1 As announced in our Current Report on Form 8-K, filed January 5, 2007, Paul G. Howes intends to resign from the Company.
2 As announced in April 2006, John M. Loughlin is retiring from the Company.

All officers serve on a year-to-year basis through the day of the annual meeting of shareholders of the Company and there is no arrangement or understanding among any of the officers of the Company and any other persons pursuant to which such officer was selected as an officer.





PAGE 28

Part II

Item 5. Market for Bausch & Lomb Incorporated's Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities

The section entitled Dividends as set forth in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K is incorporated herein by reference.
The table entitled Quarterly Stock Prices as set forth in Item 8. Financial Statements and Supplementary Data under Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K is incorporated herein by reference.

Equity Compensation Plan Information The following table represents options and restricted shares outstanding under the 1990 and 2001 Stock Incentive Plans, the 2003 Long-Term Incentive Plan and the Annual Retainer Stock Plan for Non-Employee Directors as of December 31, 2005:

 
 
Plan Category
Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights
Weighted Average Exercise Price of Outstanding Options, Warrants and Rights
 
Number of Securities Remaining Available for Future Issuance
Options
     
Equity compensation plans approved by shareholders
5,375,970 1
$50.77
6,313,107 1
       
Equity compensation plans not approved by shareholders
448,267 2
$40.28
- 2
       
Total Options
5,824,237  
$49.96
6,313,107  
       
Restricted Stock Awards
     
Equity compensation plans approved by shareholders
566,268 3
 
-  
       
Equity compensation plans not approved by shareholders
- 2
 
-  
       
Total Restricted Stock Awards
566,268  
 
-  

1
Represents awards issued under the 1990 Stock Incentive Plan and the 2003 Long-Term Incentive Plan. Shares remaining available for issuance consist of 6,243,287 from the 2003 Plan of which no more than 1,619,205 shares may be issued as grants other than options and SARs and 69,820 shares under the Annual Retainer Stock Plan for Non-Employee Directors. There are no shares available under the 1990 Stock Incentive Plan.
2
The 2001 Stock Incentive Plan was approved by the Board of Directors on January 22, 2001. The Plan provides for an annual pool of shares for grant of options and restricted shares equal to two percent of outstanding shares. Eligible participants include all employees but not officers or directors. Options granted under the Plan have an option price equal to 100 percent of the fair market value of the stock on the date of grant and a term of ten years. The options typically vest ratably over three years and restricted shares typically vest 50 percent after two years and 50 percent after three years with vesting contingent upon a continued employment relationship with the Company. Effective January 1, 2003, the Board amended this Plan to allow for no further awards under this Plan.
3
Included in this number are performance share awards that were granted under the 1990 Stock Incentive Plan which upon achievement of performance goals may be distributed immediately or deferred under the Restricted Stock Deferred Compensation Plan as elected by the participant. At December 31, 2005, 278,057 shares had been deferred and will be paid out in shares based on the election made by the participant.





PAGE 29

Issuer purchases of equity securities
 
 
 
Period
 
Total Number of Shares Purchased 1
 
 
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Programs 2, 3
Maximum Number of Shares that May Yet Be Purchased Under the Programs 2,3
September 25, 2005 - October 22, 2005
1,040
$78.38
-
2,219,838
October 23, 2005 - November 19, 2005
4,674
$79.86
2,830
2,217,008
November 20, 2005 - December 31, 2005
10,067
$79.10
4,707
2,212,301
Total
15,781
$79.28
7,537
2,212,301

1
Shares purchased during the fourth quarter ended December 31, 2005 include purchases pursuant to a publicly announced repurchase program (see footnote 2 below), stock compensation plans and deferred compensation plans.
2
On January 27, 2004, the Board of Directors authorized a program to repurchase up to two million shares of the Company's outstanding Common stock. There is no expiration date for this program. During the fourth quarter ended December 31, 2005, 7,537 shares were repurchased at an average price of $80.70. Shares repurchased after November 2005 were through private transactions with the rabbi trust for the Company's Deferred Compensation Plan.
3
On July 26, 2005, the Board of Directors approved the purchase of up to an additional two million shares of the Company's outstanding Common stock. There is no expiration date for this program, and since its approval no shares have been repurchased.


Item 6.  Selected Financial Data

The table entitled Selected Financial Data as set forth in Item 8. Financial Statements and Supplementary Data under Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K is incorporated herein by reference.


Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

This management’s discussion and analysis of financial condition and results of operations (MD&A) should be read in conjunction with the accompanying financial statements of Bausch & Lomb Incorporated (“Bausch & Lomb,” “we,” or “the Company”). All dollar amounts in this MD&A, except for per share data, are expressed in millions unless specified otherwise, and earnings per share are presented on a diluted basis.
The MD&A includes a non-GAAP constant-currency measure which we use as a key performance metric in assessing organic business growth trends. Constant-currency results are calculated by translating actual current- and prior-year local currency revenues and expenses at the same predetermined exchange rates. The translated results are then used to determine year-over-year percentage increases or decreases that exclude the impact of currency. Since a significant portion of our revenues are derived in markets outside the United States, we monitor constant-currency performance for Bausch & Lomb in total as well as for each of our business segments. In addition, we use constant-currency results to assess non-U.S. operations' performance against yearly targets for the purpose of calculating bonuses for certain regional employees.
All figures and comparisons in this MD&A reflect restatements of our financial results from 2001 through the second quarter of 2005 that are more fully described in the Recent Developments section below and in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K. The cumulative impact of restatement adjustments increased prior-2001 net earnings by $34.
As more fully described in the Recent Developments section and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event, of this Annual Report on Form 10-K following the close of fiscal year 2005, but prior to the filing of this Annual Report on Form 10-K, we instituted a worldwide recall of ReNu with MoistureLoc contact lens care solution (MoistureLoc). Certain charges associated with this recall were recorded as part of 2005 operating results, while others will be recorded in 2006. In the discussion of 2005 operating performance which follows, we have quantified the charges, and in some cases have provided certain information about growth rates and operating ratios prior to the recording of the charges. We believe this additional disclosure is useful and relevant because it provides a basis for understanding underlying business performance independent of this unusual situation.



PAGE 30

Additionally, during the third quarter of 2005 we disposed of our Woehlk contact lens business in Germany, and in the fourth quarter of 2005 we completed the acquisition of Freda, a Chinese ophthalmic pharmaceuticals company. These events impacted the reported growth rates for our regions and product categories. In certain instances in the discussion of 2005 operating performance which follows, we have disclosed growth rates for the total company, Europe and Asia regions, as well as the contact lens and pharmaceuticals product categories, that are calculated by removing incremental revenues associated with Freda from 2005 and revenues associated with Woehlk from both 2005 and 2004. We believe this additional disclosure is useful and relevant because it provides a basis for understanding and assessing underlying performance of those portions of our business which were fully in place for both periods.


Business Overview

Bausch & Lomb is a global eye health company dedicated to perfecting vision and enhancing life for consumers around the world. We develop, manufacture and sell contact lenses and lens care products, ophthalmic pharmaceuticals and products used in ophthalmic surgery. With products available in more than 100 countries, the Bausch & Lomb name is one of the best known and most respected eye health brands in the world.
Our fiscal quarter consists of 13 weeks, whereby the first and second months of each quarter contain four weeks of results and the third month of each quarter contains five weeks of results. Accordingly, net sales are typically higher in the third month of any given quarter. In addition, the execution of a broad portfolio of our customer incentive programs typically has been higher at the end of each quarter.
We closely monitor and evaluate customer incentives and other customer programs, such as extended credit terms. Should we determine that certain customer programs result in excessive levels of inventory in certain channels of trade (such as retailers, mass merchandisers, wholesalers and distributors) or the risks and rewards have not transferred to the customer, net sales in conjunction with the associated programs would be accounted for as consignment sales. Our revenue recognition policy is further discussed in Item 8. Financial Statements and Supplementary Data under Note 1 — Significant Accounting Policies of this Annual Report on Form 10-K.
We manage the business through five business segments. These include three regional commercial segments (the Americas; Europe, Middle East and Africa [Europe]; and Asia); and two centralized functions (Global Operations & Engineering and Research & Development). The Global Operations & Engineering segment is responsible for manufacturing, distribution, logistics and engineering activities for all product categories in all geographies. The Research & Development segment has global responsibility across all product categories for product research and development, clinical and medical affairs, and regulatory affairs and quality.
Because our products are sold worldwide (with approximately 60 percent of sales derived outside the United States), our reported financial results are impacted by fluctuations in foreign currency exchange rates. At the net sales line, our greatest translation risk exposures are principally to the euro and the Japanese yen. At the earnings level, we are somewhat naturally hedged to the euro because top-line exposures are offset by euro-denominated expenses resulting from manufacturing, research and sales activities in Europe. In general, we do not use financial instruments to hedge translation risk, other than occasionally for the yen. In each of the three years discussed in this MD&A, foreign currency fluctuations have generally provided positive benefits to reported results as compared to constant-currency results, although that trend began to reverse in the second half of 2005.
The eye health market is intensely competitive, characterized by continuous product development, frequent new product introductions and price competition. Our goal is to build upon our already strong presence in this market by:

·  
focusing on research and development programs to yield a robust pipeline;
·  
expanding the geographic reach of key products, especially in under-penetrated markets;
·  
enhancing our organizational capabilities by further implementing disciplined business processes in all areas, particularly sales; and
·  
protecting the equity represented by the Bausch & Lomb brand. In the shorter term, this will include activities to rebuild that equity in certain markets where brand image has suffered following the outbreak of fungal infections among contact lens wearers and the MoistureLoc recall.




PAGE 31

We expect drivers of sales and earnings growth over the next several years to include:

·  
a continued focus on faster growing business segments and the launch of higher-margin new products in each of our product categories;
·  
favorable demographic trends, such as the aging of the population and an increase in the incidence of myopia and presbyopia; and
·  
opportunities to further implement Lean manufacturing techniques and other cost improvements to enhance margins, particularly for contact lenses and intraocular lenses.

We remain focused on bringing innovations to the market to sustain and improve our leading positions and improve overall profitability. Our success and future growth depend, in part, on whether we can develop, efficiently manufacture and effectively market products for the treatment of eye conditions that incorporate the latest technologies.
We devote substantial resources to research and development (R&D). We currently hold approximately 2,100 patents and have approximately 1,900 pending patent applications. The R&D process is expensive, prolonged and entails considerable uncertainty. Because of the complexities and uncertainties associated with ophthalmic R&D, products currently in development may take years to complete, or may not complete the development process or obtain the regulatory approvals required to market them.
Our ability to maintain operating margins (defined as operating income divided by net sales) may be affected by regulatory actions, particularly for pharmaceutical and surgical products. Further, managed care organizations and governments continue to emphasize the delivery of more cost-effective medical therapies. Many third-party payers for hospital services have substantially revised their payment methodologies in recent years, resulting in stricter standards for reimbursement of hospital and outpatient charges.
To offset these developments, we are intensely focused on improving manufacturing efficiency and controlling costs. We believe the profitability improvement initiatives in place since mid-2002 yielded an infrastructure capable of supporting a much higher revenue base than we have historically experienced. Manufacturing initiatives that incorporate Lean principles and automation have yielded gross margin improvements. Our goal also is to manage selling, administrative and general expenses to help support increased levels of R&D spending. Together, these activities are designed to further increase operating margins in the future.


Recent Developments

Restatement of Financial Information As previously disclosed in our Notification of Late Filings on Form 12b-25 with the Securities and Exchange Commission (SEC) on March 17, 2006, May 11, 2006, August 8, 2006 and November 9, 2006, we were unable to file this Annual Report on Form 10-K on a timely basis due to ongoing independent investigations conducted by the Audit Committee of our Board of Directors; expanded year-end procedures that were not complete; expanded procedures with respect to the accounting for income taxes that were not complete; and continued efforts to complete our assessment of our internal control over financial reporting. Our review and evaluation of internal control over financial reporting concluded that we did not maintain effective internal control over financial reporting as of December 31, 2005. For additional information regarding our assessment of internal controls, see Item 9A. Controls and Procedures of this Annual Report on Form 10-K.
As a result of the Audit Committee’s investigations and the expanded year-end procedures and expanded procedures with respect to the accounting for income taxes, we identified errors made in the application of generally accepted accounting principles (GAAP) that impacted previously reported financial statements. Consequently, management determined that our previously issued consolidated financial statements for fiscal years 2003 and 2004 and our financial information for the years ended 2001 and 2002 (including a cumulative increase to 2001 beginning retained earnings of $34) and the first and second quarters of 2005 should be restated to correct for such errors and departures from GAAP. The restated financial statements contained in this Annual Report on Form 10-K contain a number of adjustments associated with revenue recognition, accounting for reserves, accounting for foreign currency adjustments, accounting for income taxes including income taxes payable, tax reserves, deferred income tax assets and liabilities, related valuation allowances and income tax expense, and the accounting for the Company's Long-Term Deferred Compensation Plan. For further details regarding the Audit Committee investigations and restatement of financial results, see Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement and Note 22 — Quarterly Results, Stock Prices and Selected Financial Data (Unaudited) of this Annual Report on Form 10-K.


PAGE 32

Market Withdrawal of MoistureLoc On May 15, 2006, we announced a worldwide voluntary recall of MoistureLoc. Our decision was made following an investigation into increased fungal infections among contact lens wearers in the United States and certain Asian markets. The decision represents a subsequent event occurring prior to filing this Annual Report on Form 10-K, but related to product manufactured and sold in 2005. In accordance with GAAP, we have recorded certain items associated with the recall in our 2005 financial results. The adjustments were recorded as third-quarter events, because that is the earliest reporting period for which we have not filed quarterly financial results on a Quarterly Report on Form 10-Q.
The charges associated with the withdrawal reduced full-year 2005 earnings before income taxes and minority interest by $39, net income by $27, and earnings per share by $0.49. Of the pre-tax amount, $17 related to estimated customer returns and consumer rebates and was recorded as a reduction to net sales; $14 related to costs associated with returned product and the disposal and write-off of inventory, which was recorded as cost of products sold; and $8 related to costs associated with the notification to customers and consumers required in market withdrawal instances, which were recorded as selling, administrative and general expense. Charges include $2 for settled, unlitigated, claims; however, we have not recorded any provisions for potential legal actions related to MoistureLoc because we are not able to predict the outcome of such actions, if any (see further discussion in Item 3. Legal Proceedings, and in Item 8. Financial Statements and Supplementary Data under Note 21 Other Matters of this Annual Report on Form 10-K and the discussion in Legal Matters below).
The decision to withdraw the product will negatively impact 2006 financial performance, and likely beyond. In addition to provisions for sales returns and coupon redemptions that we will record in 2006 associated with the MoistureLoc recall (primarily in Europe), performance will be hampered by the impact from lost MoistureLoc revenues; lower revenues for other lens care products, reflecting market share losses caused by trade and consumer uncertainty; negative collateral effect on our non-lens care product categories, primarily in Asia; and higher expenses associated with the recall, legal expenses associated with product liability lawsuits, and increased promotional expense to regain distribution and brand equity in the lens care category. For an additional discussion on the market withdrawal of MoistureLoc lens care solution, see Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K.

Legal Matters The Company is involved as a party in a number of material matters in litigation, including general litigation related to the restatement of the Company's financial information and the MoistureLoc withdrawal, material intellectual property litigation, and material tax litigation. The Company intends to vigorously defend itself in all of these matters. At this time, the Company is unable to predict the outcome of, and cannot reasonably estimate the impacts of, any pending litigation matters, matters concerning allegations of non-compliance with laws or regulations, and matters concerning other allegations of other improprieties. The Company has not made any financial provision for potential liability in connection with these matters.

Shareholder Securities Class Actions There is a consolidated securities class action, entitled In re Bausch & Lomb Incorporated Securities Litigation, Case Nos. 06-cv-6294 (master file), 06-cv-6295, 06-cv-6296, and 06-cv-6300, pending in Federal District Court for the Western District of New York, Rochester Division, against the Company and certain present and former officers and directors. Initially, four separate shareholder actions were filed between March and May of 2006 in Federal District Court for the Southern District of New York, and these were later transferred to the Western District of New York and consolidated into the above-captioned matter. Plaintiffs in these actions purport to represent a putative class of shareholders who purchased Company stock at allegedly artificially inflated levels between January 27, 2005 and May 3, 2006. Among other things, plaintiffs allege that defendants issued materially false and misleading public statements regarding the Company's financial condition and operations by failing to disclose negative information relating to the Company's Brazilian and Korean subsidiaries, internal controls, and problems with MoistureLoc, thereby inflating the price of Company stock during the class period. Plaintiffs seek unspecified damages. The cases are currently awaiting appointment of lead plaintiff and lead plaintiff's counsel in accordance with the Private Securities Litigation Reform Act. Pursuant to a stipulated schedule ordered by the Court, the lead plaintiff appointed by the Court must file a consolidated amended complaint by the earlier of (a) 45 days after the Company files its Annual Report on Form 10-K for the year ended December 31, 2005, or (b) 90 days after entry of the Court's order appointing the lead plaintiff, provided, however, that, at a minimum, the lead plaintiff will have 45 days after entry of the Court's order appointing the lead plaintiff to file such consolidated amended complaint.




PAGE 33

ERISA-Based Class Actions There is a consolidated ERISA class action, entitled In re Bausch & Lomb Incorporated ERISA Litigation, Case Nos. 06-cv-6297 (master file), 06-cv-6315, and 06-cv-6348, pending in the Federal District Court for the Western District of New York, Rochester Division, against the Company and certain present and former officers and directors. Initially, three separate actions were filed between April and May of 2006 in Federal District Court for the Southern District of New York, and these were later transferred to the Western District of New York and consolidated into the above-captioned matter. Plaintiffs in these actions purport to represent a class of participants in our 401(k) Plan for whose individual accounts the plan held an interest in Company stock between May 25, 2000 and the present. Among other things, plaintiffs allege that the defendants breached their fiduciary duties to plan participants by allowing the plan to invest in Company Common stock despite the fact that it was allegedly artificially inflated due to the failure to disclose negative information relating to the Company's Brazilian and Korean subsidiaries, internal controls, and problems with MoistureLoc. Plaintiffs seek unspecified damages as well as certain declaratory and injunctive relief. On August 28, 2006, the Court entered an order appointing lead plaintiffs and lead plaintiffs' counsel. Pursuant to a stipulated schedule ordered by the Court, plaintiffs in the consolidated ERISA action will have until 10 days after a consolidated amended complaint is filed in the consolidated securities action described above, to file a consolidated amended complaint.

Shareholder Derivative Actions The shareholder derivative actions, in which a shareholder seeks to assert the rights of the Company derivatively against certain present and former officers and directors, fall into two categories: (a) those asserting allegations relating to accounting issues at the Company's Brazilian and Korean subsidiaries; and (b) those asserting allegations relating to the MoistureLoc withdrawal.
There is a consolidated derivative action asserting allegations relating to accounting issues at the Company's Brazilian and Korean subsidiaries, entitled In re Bausch & Lomb Incorporated Derivative Litigation, Case Nos. 06-cv-6298 (master file) and 06-cv-6299, pending in Federal District Court for the Western District of New York, Rochester Division, against certain present and former officers and directors of the Company, and also naming the Company as nominal defendant. Initially, two separate derivative actions were filed in April 2006 in Federal District Court for the Southern District of New York, and were later transferred to the Western District of New York and consolidated. Among other things, plaintiffs allege that the individual defendants breached their fiduciary duties to the Company by causing or allowing the Company to issue materially false and misleading public statements regarding the Company's financial condition and operations that failed to disclose negative information about the Company's Brazilian and Korean subsidiaries and internal controls, thereby inflating the price of Company stock during the relevant time period. Plaintiffs purport to allege damage to the Company as a result of, among other things, a decrease in the Company's market capitalization, exposure to liability in securities fraud actions, and the costs of internal investigations and financial restatements. Plaintiffs seek unspecified damages as well as certain declaratory and injunctive relief, including for misappropriation of inside information for personal benefit by certain of the individual defendants. Pursuant to a stipulated schedule ordered by the Court, plaintiffs in this consolidated derivative action will have until 30 days after a consolidated amended complaint is filed in the consolidated securities action described above, to file a consolidated amended complaint.
On January 3, 2006, we received a demand letter dated December 28, 2005, from a law firm not involved in the now consolidated derivative actions described above, on behalf of a shareholder who also is not involved in the derivative actions, demanding that the Board of Directors bring claims on behalf of the Company based on allegations substantially similar to those that were later alleged in the two derivative actions relating to accounting issues at our Brazilian and Korean subsidiaries. In response to the demand letter, the Board of Directors adopted a board resolution establishing an Evaluation Committee (made up of independent directors) to investigate, review and analyze the facts and circumstances surrounding the allegations made in the demand letter, but reserving to the full Board authority and discretion to exercise its business judgment in respect of the proper disposition of the demand. The Committee has engaged independent outside counsel to advise it.
There are also two purported derivative actions asserting allegations relating to the MoistureLoc withdrawal. The first case, entitled Little v. Zarrella, Case No. 06-cv-6337, was filed in June 2006 in the Federal District Court for the Southern District of New York and was transferred to the Western District of New York, Rochester Division, where it is currently pending against certain directors of the Company, and also naming the Company as nominal defendant. The second case, entitled Pinchuck v. Zarrella, Case No. 06-6377, was filed in June 2006 in the Supreme Court of the State of New York, County of Monroe, where it is currently pending against the directors of the Company, and also naming the Company as nominal defendant. Among other things, plaintiffs in these actions allege that the individual defendants breached their fiduciary duties to the Company in connection with the Company's handling of the MoistureLoc withdrawal. Plaintiffs purport to allege damage to the Company as a result of, among other things, costs of litigating product liability and personal injury lawsuits, costs of the product recall, costs of carrying out internal investigations, and the loss of goodwill and reputation. Plaintiffs seek unspecified damages as well as certain declaratory and injunctive relief.



PAGE 34

Pursuant to a stipulated schedule ordered by the Court, plaintiff in the state-court Pinchuck action served an amended complaint on September 15, 2006 and defendants served a motion to dismiss the amended complaint on November 15, 2006; plaintiff's opposition to the motion was served on January 15, 2007, and defendants' reply is due February 15, 2007. Pursuant to a stipulated schedule ordered by the Court in the federal Little action, plaintiff in that case will have until 60 days after a ruling on a motion to dismiss in the consolidated securities action is entered or, if no such motion is filed, 60 days after defendants' answer to a consolidated amended complaint in the consolidated securities action is filed, to file an amended complaint.

Product Liability Lawsuits As of February 1, 2007, the Company has been served or is aware that it has been named as a defendant in approximately 196 product liability lawsuits pending in various federal and state courts as well as certain other non-U.S. jurisdictions. Of the 196 cases, 117 actions have been filed in U.S. federal courts, 77 cases have been filed in various U.S. state courts and two actions have been filed in non-U.S. jurisdictions. These also include 170 individual actions filed on behalf of individuals who claim they suffered personal injury as a result of using a ReNu solution and 26 putative class actions alleging personal injury as a result of using a ReNu solution and/or violations of one or more state consumer protection statutes. In the personal injury actions, plaintiffs allege liability based on, among other things, negligence, strict product liability, failure to warn and breach of warranty. In the consumer protection actions, plaintiffs seek economic damages, claiming that they were misled to purchase products that were not as safe as advertised. Several lawsuits contain a combination of these allegations. On August 14, 2006, the Judicial Panel on Multidistrict Litigation (JPML) created a coordinated proceeding and transferred an initial set of MoistureLoc product liability lawsuits to the U.S. District Court for the District of South Carolina. The Company has advised the JPML of all federal cases available for transfer and has urged the issuance of conditional transfer orders. As of February 1, 2007, 104 of the 117 federal cases noted above have been transferred to the JPML.

Material Intellectual Property Litigation In October 2005, Rembrandt Vision Technologies, L.P. filed a patent infringement lawsuit against the Company and CIBA Vision Corporation. The action is entitled, Rembrandt Vision Technology, L.P. v. Bausch & Lomb Incorporated and CIBA Vision Corporation, bearing case number 2:05 CV 491, and is pending in the U.S. District Court for the Eastern District of Texas (Marshall Division). Rembrandt asserts that the Company and CIBA have infringed certain of Rembrandt’s oxygen permeability and tear-wettability technology that it claims to be protected by a U.S. Patent No. 5,712,327 entitled “Soft Gas Permeable Lens Having Improved Clinical Performance” (the 327 Patent). Rembrandt claims that the Company infringes the 327 Patent by selling soft gas permeable contact lenses that have tear-wettable surfaces in the United States, which would include the Company’s PureVision silicone hydrogel lens products. The Company denies, and intends to vigorously defend itself against, Rembrandt’s claims. The Court has issued a scheduling order and has set a trial date of November 5, 2007.

Material Tax Litigation As disclosed in Item 8. Financial Statements and Supplementary Data under Note 10 — Provision for Income Taxes of this Annual Report on Form 10-K, on May 12, 2006, the Company received a Notice of Final Partnership Administrative Adjustment from the Internal Revenue Service relating to partnership tax periods ended June 4, 1999 and December 25, 1999, for Wilmington Partners L.P. (Wilmington), a partnership formed in 1993 in which the majority of partnership interests are held by certain of the Company's subsidiaries. The Final Partnership Administrative Adjustment (FPAA) proposes adjustments increasing the ordinary income reported by Wilmington for its December 25, 1999 tax year by a total of $10, and increasing a long-term capital gain reported by Wilmington for that tax year by $190. The FPAA also proposes a $550 negative adjustment to Wilmington's basis in a financial asset contributed to it by one of its partners in 1993; this adjustment would also affect the basis of that partner — one of the Company's subsidiaries — in its partnership interest in Wilmington. The asserted adjustments could, if sustained in full, increase the tax liabilities of the partnership's partners for the associated tax periods by more than $200, plus penalties and interest. The Company has not made any financial provision for the asserted additional taxes, penalties or interest as the Company believes the asserted adjustments are not probable and estimable.
Since 1999, the Company's consolidated financial statements have included a deferred tax liability relating to the partnership. As of December 31, 2005, this deferred tax liability equaled $157. This deferred tax liability is currently reducing net deferred tax assets for which a valuation allowance has been recorded as of December 31, 2005.



PAGE 35

On August 7, 2006, the Company made a petition to the U.S. Tax Court to challenge the asserted adjustments. Internal Revenue Service's answer was filed on October 4, 2006, and the Company initiated a motion to strike portions of the answer on November 1, 2006. The Company believes it has numerous substantive and procedural tax law arguments to dispute the adjustments. Tax, penalties and interest cannot be assessed until a Tax Court determination is made, and an assessment, if any, would likely not be made until some time after 2007. While the Company intends to vigorously defend against the asserted adjustments, its failure to succeed in such a defense could significantly increase the liability of the partnership's partner for taxes, plus interest and penalties, which in turn would have a material adverse effect on the Company's financial results and cash flows.

For additional information on these actions, as well as other litigation matters, matters concerning allegations and/or investigations of non-compliance with laws or regulations, and other matters concerning allegations of improprieties, please refer to Item 3. Legal Proceedings and in Item 8. Financial Statements and Supplementary Data under Note 21 — Other Matters of this Annual Report on Form 10-K.


Financial Overview

Reported net income was $19 or $0.35 per share for the year ended December 31, 2005, compared to 2004 net income of $154 or $2.83 per share and 2003 net income of $106 or $1.98 per share. Net income for the year ended December 27, 2003 includes a charge of $1 or $0.02 per share as a cumulative change in accounting principle related to the adoption of Statement of Financial Accounting Standards (SFAS) No. 143. A reconciliation of net income and earnings per share to income and earnings per share before cumulative effect of change in accounting principle is presented below:
 


   
2005
 
2004 (Restated)
 
2003 (Restated)
 
   
Amount
 
Per Share
 
Amount
 
Per Share
 
Amount
 
Per Share
 
Net income
 
$
19.2
 
$
0.35
 
$
153.9
 
$
2.83
 
$
106.0
 
$
1.98
 
Cumulative effect of change in accounting principle, net of taxes, due to adoption of SFAS No. 143
   
-
   
-
   
-
   
-
   
0.9
   
0.02
 
Income before cumulative effect of  change in accounting principle
 
$
19.2
 
$
0.35
 
$
153.9
 
$
2.83
 
$
106.9
 
$
2.00
 
Average Shares Outstanding - Diluted (000s)
         
55,684
         
54,504
         
53,519
 

Our results for 2005 and 2003 were impacted by several significant events, summarized below. There were no significant events impacting 2004 results.
The 2005 significant events in the aggregate reduced reported net income by $160 or $2.87 per share. They included:

·  
A valuation allowance against deferred income tax assets which reduced reported net income by $149, or $2.67 per share, recorded in the third quarter. The need for the allowance resulted from anticipated losses in early future periods attributed to the U.S. entities to which the deferred tax assets relate and uncertainties surrounding when we will return to U.S. profitability. The expected losses result from, among other things, the costs associated with the MoistureLoc recall and its expected impact on 2006 financial results;
·  
Incremental income tax expense of $9, or $0.17 per share, recorded in the third quarter associated with our repatriating foreign earnings under the American Jobs Creation Act of 2004 (AJCA); and
·  
Amortization of inventory step-up totaling $2 before taxes ($1 or $0.03 per share after taxes) related to purchase accounting adjustments associated with the 2005 acquisition of Freda.

For a further discussion of the two income tax related items, see the section entitled Income Taxes below and in Item 8. Financial Statements and Supplementary Data under Note 10 — Provision for Income Taxes of this Annual Report on Form 10-K.



PAGE 36

The 2003 significant events, excluding the $1 loss on adoption of SFAS No. 143 already reflected in net income, in the aggregate increased reported net income by $0.4 or $0.01 per share. They included:

·  
Reversals of severance-related restructuring charges of $6 before taxes ($4 or $0.07 per share after taxes), when certain anticipated termination actions and plant closures did not occur due to increased demand for certain product lines; and
·  
R&D expense of $6 before taxes ($4 or $0.06 per share after taxes) recorded in the fourth quarter associated with acquiring an early-stage pharmaceutical technology we had previously been developing with a third-party partner.


Net Sales and Income by Business Segment and Geographic Region

Geographic Net Sales The following table summarizes net sales by geographic region.

   
 
 
 
Net Sales
 
Percent
Increase
Actual
Dollars
 
Percent
Increase
Constant
Currency
 
Percent of Total Company Net Sales
 
2005
                 
Non-U.S.
 
$
1,462.8
   
7
%
 
6
%
 
62
%
U.S. 1
   
891.0
   
3
%
 
3
%
 
38
%
Total Company 2
 
$
2,353.8
   
5
%
 
5
%
   
                           
2004 (Restated)
                         
Non-U.S.
 
$
1,370.0
   
14
%
 
6
%
 
61
%
U.S. 1
   
863.5
   
6
%
 
6
%
 
39
%
Total Company
 
$
2,233.5
   
11
%
 
6
%
   
                           
2003 (Restated)
                         
Non-U.S.
 
$
1,204.0
   
15
%
 
3
%
 
60
%
U.S. 1
   
814.5
   
7
%
 
7
%
 
40
%
Total Company
 
$
2,018.5
   
12
%
 
5
%
   

1  U.S. revenues represented approximately 90 percent of the Americas segment revenue in each year.
2
2005 amounts reflect the impact of the voluntary recall of MoistureLoc discussed in Recent Developments above and in Item 8. Financial Statements and Supplementary Data under Note 23 —Subsequent Event of this Annual Report on Form 10-K. Charges associated with the recall reduced U.S. net sales by $12.0 and non-U.S. net sales by $5.1, respectively.

Business Segment Net Sales We are organized on a regionally based management structure for commercial operations, with our research and development and product supply functions managed on a global basis. Beginning in 2005, the engineering function, which had previously been part of the research and development segment, became part of the product supply function. Our business segments (after this realignment of the engineering function) are the Americas region; the Europe, Middle East and Africa region (Europe); the Asia region; the Research & Development organization; and the Global Operations & Engineering organization. In each geographic segment, we market products in five categories: contact lens, lens care, pharmaceuticals, cataract and vitreoretinal, and refractive. The contact lens category includes traditional, planned replacement disposable, daily disposable, multifocal, and toric soft lenses and rigid gas permeable (RGP) lenses and materials. The lens care category includes multipurpose solutions, cleaning and conditioning solutions for RGP lenses, re-wetting drops and saline solutions. The pharmaceuticals category includes generic and proprietary prescription ophthalmic drugs, ocular vitamins and over-the-counter medications. The cataract and vitreoretinal category includes intraocular lenses (IOLs), phacoemulsification and vitreoretinal surgical equipment and related disposable products, hand-held surgical instruments, viscoelastics and other products used in cataract and vitreoretinal surgery. The refractive category includes lasers, microkeratomes, diagnostic equipment and other products and equipment used in refractive surgery. There are no transfers of products between product categories.




PAGE 37

Operating income is the primary measure of segment income. Segment income excludes the significant items noted in the Financial Overview. The following table summarizes net sales and operating income by segment and presents consolidated operating income:

   
2005 1
 
2004
 
2003
 
   
 
As Reported
 
Percent of Total Net Sales
 
 
 
Restated
 
Percent of Total Net Sales
 
 
 
Restated
 
Percent of Total Net Sales
 
Net Sales
                         
Americas
 
$
1,005.3
   
43
%
$
960.2
   
43
%
$
903.3
   
45
%
Europe
   
859.9
   
36
%
 
818.9
   
37
%
 
724.4
   
36
%
Asia
   
488.6
   
21
%
 
454.4
   
20
%
 
390.8
   
19
%
   
$
2,353.8
       
$
2,233.5
       
$
2,018.5
       
                                       
Operating Income (Costs)
                                     
Americas
 
$
333.0
       
$
326.1
       
$
282.6
       
Europe
   
250.8
         
251.2
         
201.5
       
Asia
   
123.6
         
128.5
         
106.1
       
Research & Development
   
(200.5
)
       
(180.6
)
       
(166.1
)
     
Global Operations & Engineering
   
(131.7
)
       
(157.2
)
       
(123.1
)
     
Segment Income
   
375.2
         
368.0
         
301.0
       
Corporate Administration 2
   
(89.8
)
       
(88.9
)
       
(73.5
)
     
Restructuring reversals 3
   
-
         
-
         
6.3
       
Other significant charges 4
   
(1.9
)
       
-
         
(5.6
)
     
Operating Income
 
$
283.5
       
$
279.1
       
$
228.2
       

1
2005 amounts reflect the impact of the voluntary recall of MoistureLoc discussed in Recent Developments above and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K. Charges associated with the recall reduced Americas region net sales and operating income by $12.4 and $25.0, respectively; Asia region net sales and operating income by $4.7 and $11.0, respectively; increased Global Operations & Engineering operating costs by $1.2; and increased corporate administration expense by $1.7.
2  Corporate administration costs are discussed in Operating Costs and Expenses.
3  Income associated with certain restructuring plans, as described in Restructuring Charges and Asset Write-offs.
4
Other significant charges in 2005 represent purchase accounting adjustments related to the acquisition of Freda. Other significant charges in 2003 pertain to R&D expense associated with the acquisition of an early-stage pharmaceutical technology.

The following table summarizes net sales by geographic segment:

           
2005 vs. 2004
     
2004 vs. 2003
 
   
 
 
 
2005 1
 
 
 
2004
(Restated)
 
Percent Change
Actual Dollars
 
Percent
Change
Constant
Currency
 
 
 
2003
(Restated)
 
Percent Change
Actual Dollars
 
Percent Change
Constant
Currency
 
                               
Americas
 
$
1,005.3
 
$
960.2
   
5
%
 
4
%
$
903.3
   
6
%
 
6
%
Europe
   
859.9
   
818.9
   
5
%
 
5
%
 
724.4
   
13
%
 
3
%
Asia
   
488.6
   
454.4
   
8
%
 
7
%
 
390.8
   
16
%
 
12
%
Total Company
 
$
2,353.8
 
$
2,233.5
   
5
%
 
5
%
$
2,018.5
   
11
%
 
6
%

1
2005 amounts reflect the impact of the voluntary recall of MoistureLoc discussed in Recent Developments above and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K. Provisions for sales returns and consumer rebates associated with the recall reduced Americas region net sales by $12.4 and Asia region net sales by $4.7.




PAGE 38

2005 Versus 2004 Consolidated net sales increased 5 percent compared to 2004 on both a reported and constant-currency basis. The 2005 amounts include the impact of approximately $17 in customer returns and rebate provisions associated with the voluntary recall of MoistureLoc in Asia and the Americas (see further discussion in Item 8. Financial Statements and Supplementary Data under Note 23 —Subsequent Event of this Annual Report on Form 10-K), which largely offset $18 in incremental revenues from the acquisition of Freda.

·  
Americas segment net sales increased 5 percent from 2004, or 4 percent in constant currency. Those figures include $12 in sales return and consumer rebate provisions associated with the MoistureLoc recall. Excluding those items, Americas segment net sales grew 6 percent, or 5 percent in constant currency. Gains were led by above-market performance for contact lenses and higher sales of cataract surgery products.
·  
Europe segment net sales increased 5 percent on both a reported and constant-currency basis. Gains were led by higher sales of pharmaceutical and vision care products, which more than offset declines for the refractive surgery category and the impact of divesting our German Woehlk contact lens business in the 2005 third quarter. The MoistureLoc product recalled in Europe was both manufactured and sold in 2006; therefore, sales return and customer rebates of $18 associated with the MoistureLoc recall in the Europe segment were not provided for in 2005, but have been expensed in 2006.
·  
The Asia segment reported net sales gains of 8 percent compared to 2004, or 7 percent in constant currency. Those figures include $5 in sales return and consumer rebate provisions associated with the MoistureLoc recall as well as $18 in incremental sales associated with the acquisition of Freda. Excluding those items, Asia segment net sales grew 5 percent, or 4 percent in constant currency, with gains led by higher sales of contact lenses and cataract surgery products.

2004 Versus 2003 Consolidated net sales increased 11 percent on a reported basis and increased 6 percent in constant currency.

·  
Americas segment net sales grew 6 percent from 2003, with gains in all product categories.
·  
Europe segment net sales increased 13 percent, mainly reflecting favorable currency benefits. Constant-currency sales growth was 3 percent. Gains were driven by the contact lens, surgical and pharmaceutical categories. Constant-currency European lens care sales were flat with the prior year, which was encouraging given overall market dynamics.
·  
Asia segment net sales grew 16 percent, or 12 percent on a constant-currency basis. Growth was experienced in all product categories, but especially our lines of vision care products.

A more detailed discussion of net sales trends by geographic region follows.

Americas

The following table summarizes net sales trends for the Americas region by product category:

   
 
2005 vs. 2004 Restated
Percent Increase (Decrease)
 
 
2004 Restated vs. 2003 Restated
Percent Increase
 
   
Actual Dollars 
 
Constant Currency
 
Actual Dollars 
 
Constant Currency
 
Contact Lens
   
15
%
 
14
%
 
8
%
 
7
%
Lens Care 1
   
-
%
 
(1
)%
 
1
%
 
1
%
Pharmaceuticals
   
3
%
 
3
%
 
11
%
 
11
%
Cataract and Vitreoretinal
   
7
%
 
6
%
 
2
%
 
1
%
Refractive
   
(4
)%
 
(6
)%
 
20
%
 
20
%
Total Americas
   
5
%
 
4
%
 
6
%
 
6
%

1
2005 amounts reflect the impact of the voluntary recall of MoistureLoc discussed in Recent Developments above and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K. Provisions for sales returns and consumer rebates associated with the recall reduced Americas region net sales by $12.4.




PAGE 39

2005 Versus 2004

·  
Contact lens category growth reflected the reintroduction of the PureVision brand of silicone hydrogel contact lenses in the United States as well as continued growth for SofLens Toric and SofLens Multi-Focal contact lenses. Moderating that performance was a continued decline in sales of our older, conventional hydrogel two-week contact lenses, reflecting the overall market shift to silicone hydrogel materials. Sales of SofLens Toric contact lenses for people with astigmatism increased more than 10 percent from 2004. As expected, dollar growth for this product has begun to moderate, reflecting the competitive impact of new silicone hydrogel toric offerings. We launched PureVision Toric contact lenses in the United States on a limited basis in October 2005 and reached full commercial distribution in the second quarter of 2006. Sales of SofLens Multi-Focal contact lenses for people with presbyopia grew more than 30 percent in the Americas region in 2005, reflecting our continued leading market position.
·  
Sales in the lens care category were essentially flat mainly due to sales returns and consumer rebate provisions associated with our voluntary recall of MoistureLoc which was reflected as a subsequent event (see Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K for further discussion). Excluding the impact of the recall, Americas region constant-currency lens care sales increased 3 percent, reflecting U.S. market share gains for our lines of multipurpose solutions and higher sales of Boston lens care solutions for RGP contact lenses. As described above, lens care category sales have declined in 2006 in all regions, due to additional charges associated with the MoistureLoc recall combined with market share losses resulting from customer and trade concerns during our investigation into increased fungal infections among contact lens wearers.
·  
Pharmaceuticals sales increases were mainly attributable to incremental sales of Zylet combination eye drops, as well as higher sales of Lotemax steroid eye drops. Those gains were largely offset by expected declines in sales of two non-ophthalmic drugs in our multisource pharmaceuticals portfolio. Prescriptions for our lines of steroid eye drops containing loteprednol etabonate continued to trend positively throughout 2005, with Lotemax and Alrex prescriptions reaching all-time highs. Our vitamins business grew 1 percent in constant currency. As expected, we faced difficult comparisons to the prior year, when we launched PreserVision soft gels and customers were carrying inventories of both tablets and gel formulations. The underlying dynamics of the vitamins market remain strong, with consumption growing more than 15 percent in dollars, and our PreserVision brand continuing to gain market share.
·  
Sales gains for cataract and vitreoretinal products were led by our lines of silicone IOLs, which increased more than 15 percent. That performance was mainly due to our SofPort lines of silicone IOLs, which grew at an even faster rate and benefited from market share gains and strong market acceptance for the SofPort AO IOL featuring an aspheric optics design. Phacoemulsification product sales increased more than 5 percent, reflecting an increase in revenues for Millennium microsurgical systems and disposable products used in cataract surgery procedures. The increase in Millennium net sales reflects primarily a change in the type of system placements in 2005 as compared to the prior year. We placed more units under direct sales agreements in 2005 compared to 2004, when we placed more units under operating lease arrangements requiring revenue to be recognized over a longer period of time.
·  
Sales declines in the refractive category were mainly due to lower sales of lasers and microkeratome blades. These declines were partially offset by higher sales of per-procedure cards, especially those used for Zyoptix personalized vision correction procedures.

2004 Versus 2003

·  
Contact lens sales growth was led by the SofLens Multi-Focal and SofLens Toric brands. SofLens Multi-Focal contact lens sales nearly doubled, and SofLens Toric contact lens revenues grew slightly less than 20 percent and achieved an all-time high share of patient fits in 2004. Performance for these two lines was somewhat tempered by weakness in U.S. two-week disposable SVS products, reflecting market shifts toward competitive silicone hydrogel offerings and our lack of such a product prior to the U.S. reintroduction of the PureVision brand of contact lenses in 2005.
·  
Lens care sales growth was mainly due to our lines of solutions for soft contact lenses, and reflected incremental sales from the initial shipments of MoistureLoc solution in the third quarter. We maintained our leading position in the U.S. market for both multipurpose solutions and rigid gas permeable solutions in 2004.



PAGE 40

·  
Sales gains in the pharmaceuticals category in the Americas region were led by our lines of ocular vitamins, proprietary pharmaceuticals and multisource products. Ocular vitamin sales grew more than 20 percent, with the PreserVision brand up more than 40 percent. Late in the third quarter, we introduced an easy-to-swallow soft gel version of the original AREDS formula, as well as a line extension containing lutein in place of beta carotene. In the proprietary pharmaceuticals portfolio, sales of Alrex and Lotemax steroid drops each grew more than 20 percent in 2004, reflecting more prescriptions written for both products.
·  
Cataract and vitreoretinal category sales growth was due to our lines of IOLs, which registered overall gains of approximately 10 percent. Sales growth in our lines of silicone IOLs, most notably the SofPort brand, were even stronger, at more than 20 percent. IOL performance was partially offset by lower revenues for phacoemulsification products, reflecting a higher mix of equipment placed under operating lease arrangements than in 2003.
·  
Despite a decline in refractive category net sales in the fourth quarter compared to the same period in 2003, full-year 2004 growth reflected incremental sales of U.S. equipment and higher margin per-procedure cards associated with the Zyoptix system for personalized vision correction. We launched that product late in 2003. Other factors contributing to 2004 performance included higher sales of standard LASIK procedure cards and microkeratome blades.

Europe

The following table summarizes net sales trends for the Europe region by product category:

   
 
2005 vs. 2004 Restated
Percent Increase (Decrease) 
 
 
2004 Restated vs. 2003 Restated
Percent Increase
 
   
Actual Dollars 
 
Constant Currency
 
Actual Dollars 
 
Constant Currency
 
Contact Lens
   
5
%
 
5
%
 
14
%
 
4
%
Lens Care
   
6
%
 
8
%
 
9
%
 
-
%
Pharmaceuticals
   
11
%
 
11
%
 
12
%
 
2
%
Cataract and Vitreoretinal
   
2
%
 
2
%
 
16
%
 
6
%
Refractive
   
(13
)%
 
(13
)%
 
16
%
 
7
%
Total Europe
   
5
%
 
5
%
 
13
%
 
3
%

2005 Versus 2004

·  
Contact lens sales comparisons were impacted by the divestiture of our German Woehlk business in the third quarter of 2005. Excluding that impact, contact lens net sales would have grown approximately 8 percent on a reported basis and 9 percent in constant currency. Gains were mainly due to our lines of specialty products and PureVision silicone hydrogel spherical contact lenses. Monthly replacement toric contact lens revenues increased more than 20 percent, with gains coming from a combination of expanded distribution for the PureVision Toric line and high-single-digit growth for SofLens Toric contact lenses. Our multifocal product also posted strong growth, and we continued to gain market share.
·  
Increased lens care sales reflected market share gains, especially for our lines of multipurpose solutions, which grew approximately 10 percent on the continued market acceptance of MoistureLoc prior to the recall. As described above, lens care category sales have declined in 2006 in all regions, due to additional charges associated with the MoistureLoc recall combined with market share losses resulting from customer and trade concerns during our investigation into increased fungal infections among contact lens wearers. We recorded additional charges associated with the MoistureLoc recall for product manufactured and sold in Europe in 2006.
·  
European pharmaceuticals sales growth was mainly attributable to our lines of dry eye products, ocular nutritionals and anti-infective drugs, coupled with expansion into new geographic markets.
·  
Higher cataract and vitreoretinal sales reflected overall strong performance in most markets with the exception of the United Kingdom, where the number of procedures declined in 2005 following government initiatives in the prior year to decrease the number of patients waiting to have the procedure. On a total region basis, growth was largely due to our Akreos line of acrylic IOLs, as well as higher sales of viscoelastics.



PAGE 41

·  
Declines in sales of refractive surgery products in Europe were consistent with overall market trends. Lower sales of equipment and microkeratome blades more than offset increased sales of Zyoptix treatment cards.

2004 Versus 2003

·  
Contact lens sales growth was primarily due to the continued strength and market leading positions for SofLens Toric and SofLens Multi-Focal lenses, growth for the PureVision brand, as well as favorable currency benefits. The PureVision lens franchise grew more than 20 percent in 2004, benefiting from the introduction of PureVision Toric lenses and strong growth in the PureVision SVS line.
·  
Constant-currency European lens care sales declined through the first three quarters of 2004, but rebounded in the fourth quarter following the launch of MoistureLoc, yielding full-year flat constant-currency performance.
·  
Pharmaceuticals gains in Europe were led by higher sales of ocular vitamins, anti-infective and anti-inflammatory products, as well as favorable exchange rate movements, somewhat offset by general sales declines for most other product lines in Germany, where government pharmaceuticals pricing and reimbursement legislation negatively impacted revenues.
·  
Higher sales of cataract and vitreoretinal products mainly reflected gains for phacoemulsification products and IOLs. Revenues from our Akreos line of acrylic IOLs rose more than 30 percent on a constant-currency basis, as European surgeons continued to use more advanced designs and foldable materials. Sales of phacoemulsification products increased approximately 10 percent for the year, excluding favorable currency benefits.
·  
Growth within the refractive product category reflected higher revenues from Zyoptix system upgrades, per-procedure cards, diagnostic equipment and microkeratome blades, as well as favorable currency movements.

Asia

The following table summarizes net sales trends for the Asia region by product category:

   
2005 vs. 2004 Restated
Percent Increase (Decrease)
 
2004 Restated vs. 2003 Restated
Percent Increase
 
   
Actual Dollars 
 
Constant Currency
 
Actual Dollars 
 
Constant Currency
 
Contact Lens
   
8
%
 
7
%
 
17
%
 
11
%
Lens Care 1
   
(5
)%
 
(7
)%
 
13
%
 
9
%
Pharmaceuticals 2
   
NM
   
NM
   
72
%
 
60
%
Cataract and Vitreoretinal
   
16
%
 
13
%
 
19
%
 
14
%
Refractive
   
(7
)%
 
(9
)%
 
13
%
 
10
%
Total Asia
   
8
%
 
7
%
 
16
%
 
12
%

1
2005 amounts reflect the impact of the voluntary recall of MoistureLoc discussed in Recent Developments above and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K. Provisions for sales returns and consumer rebates associated with the recall reduced Asia region net sales by $4.7.
2
NM denotes "not meaningful." 2005 pharmaceuticals category sales include $17.8 incremental revenues from the acquisition of Freda, resulting in a calculated growth rate of more than 100 percent.

2005 Versus 2004

·  
Contact lens sales growth in Asia reflected gains for our lines of specialty and silicone hydrogel lenses, including incremental sales from the launch in Japan of our latest conventional hydrogel two-week disposable lenses. Throughout much of the year, our Chinese contact lens sales growth was lower than historical trends and internal expectations, reflecting, in part, trade disruption following changes we made in some of our distributor programs early in 2005. That business rebounded in the fourth quarter, posting constant-currency growth of approximately 15 percent compared to the same period in 2004. In 2006, the MoistureLoc recall created negative collateral impacts on our non-lens care product lines, especially contact lenses and pharmaceuticals products in China. As a result, Asia region contact lens sales have moderated from levels experienced in 2005.



PAGE 42

·  
Lens care sales declines reflect the sales returns and customer rebate provisions associated with the voluntary recall of MoistureLoc (see Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K for further discussion). Excluding the impact of the recall, Asian constant-currency lens care sales were down 3 percent. Declines in China, due to the same distributor issues discussed above, more than offset 1 percent constant-currency gains in Japan, reflecting the market introduction of ReNu MultiPlus solution. As described above, lens care category sales have declined in 2006 in all regions, due to additional charges associated with the MoistureLoc recall combined with market share losses resulting from customer and trade concerns during our investigation into increased fungal infections among contact lens wearers. In the Asia region, our Chinese business has been most impacted by these events.
·  
Historically we have not had a significant pharmaceuticals business in Asia. In the fourth quarter of 2005 we acquired a controlling interest in Freda. The acquisition should help accelerate our expansion into the rapidly growing Chinese ophthalmic pharmaceuticals market and provide a national pharmaceuticals sales and distribution network. Further information with respect to the Freda acquisition can be found in Item 8. Financial Statements and Supplementary Data under Note 3 — Acquisitions of this Annual Report on Form 10-K. Excluding the Freda acquisition, our Asian pharmaceuticals revenues grew about 20 percent on a constant-currency basis, led by gains for ocular nutritionals.
·  
Growth in the cataract and vitreoretinal category was mainly driven by gains for our lines of IOL and phacoemulsification products. IOL revenues were up strongly, largely due to the continued rollout of the Akreos line of acrylic IOLs throughout the year.
·  
Lower sales in the refractive category in Asia reflected declines in laser and diagnostic equipment sales. Part of this decline was expected, as prior-year results included revenues associated with initial customer adoption of our Zyoptix laser platform.

2004 Versus 2003

·  
Strong contact lens sales gains were registered in most markets, especially Japan, where constant-currency sales were up nearly 10 percent, reflecting the launch of Medalist One Day contact lenses in the first half of 2004 and continued strong sales growth for disposable toric contact lenses. In markets outside of Japan, constant-currency sales grew approximately 15 percent during 2004.
·  
Lens care sales growth was led by our lines of multipurpose solutions, which were up more than 10 percent for the year on a constant-currency basis. We launched MoistureLoc solution in several markets in the fourth quarter, with encouraging response from the trade. Our other ReNu brand solutions continued to perform well in 2004, particularly in China and Japan.
·  
Net sales of pharmaceuticals in Asia were immaterial to our overall results of operations in 2004 and 2003. Sales gains reflected our efforts to expand and introduce our pharmaceutical products in the region, particularly vitamins.
·  
Increased sales of cataract and vitreoretinal products reflected growth in markets outside of Japan, where sales of the SofPort and Akreos lines of IOLs grew strongly, as well as higher sales of phacoemulsification products.
·  
Refractive surgery product sales gains in 2004 were driven by Zyoptix system upgrades, per-procedure cards and microkeratome blades, somewhat offset by fewer new laser placements, reflecting the launch of the Technolas z100 laser in 2003.




PAGE 43

Net Sales by Product Category

The following table presents total Company net sales by product category for the years 2005, 2004 and 2003:

   
 
 
 
 
Net Sales
 
Percent
Increase
(Decrease)
Actual
Dollars
 
Percent
Increase
(Decrease)
Constant
Currency
 
2005
             
Contact Lens
 
$
728.5
   
9
%
 
9
%
Lens Care 1
   
522.2
   
-
%
 
(1
)%
Pharmaceuticals
   
584.8
   
11
%
 
11
%
Cataract and Vitreoretinal
   
377.8
   
6
%
 
5
%
Refractive
   
140.5
   
(8
)%
 
(9
)%
   
$
2,353.8
   
5
%
 
5
%
                     
2004 (Restated)
                   
Contact Lens
 
$
671.0
   
13
%
 
7
%
Lens Care
   
523.3
   
5
%
 
2
%
Pharmaceuticals
   
528.2
   
12
%
 
7
%
Cataract and Vitreoretinal
   
358.2
   
10
%
 
5
%
Refractive
   
152.8
   
17
%
 
13
%
   
$
2,233.5
   
11
%
 
6
%
                     
2003 (Restated)
                   
Contact Lens
 
$
593.2
   
14
%
 
7
%
Lens Care
   
496.5
   
8
%
 
2
%
Pharmaceuticals
   
471.2
   
19
%
 
10
%
Cataract and Vitreoretinal
   
327.1
   
8
%
 
2
%
Refractive
   
130.5
   
(1
)%
 
(7
)%
   
$
2,018.5
   
12
%
 
5
%

1
2005 lens care amounts reflect the impact of the voluntary recall of MoistureLoc discussed in Recent Developments above and in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K. Provisions for sales returns and consumer rebates associated with the recall reduced full-year lens care net sales by $17.1.

2005 Versus 2004 Net sales in 2005 include the impact of approximately $17 in customer returns and rebate provisions associated with the voluntary recall of MoistureLoc (see further discussion in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K), which mostly offset $18 in incremental sales from the acquisition of Freda.

·  
Contact lens sales growth was led by our specialty and silicone hydrogel spherical offerings, which offset continued declines for older technology products. That growth rate reflects the impact of divesting our German Woehlk contact lens business during the third quarter of 2005. Excluding that impact, contact lens net sales would have grown approximately 10 percent.
·  
Sales in the lens care category, which were flat with the prior year, mainly reflected the impact of the MoistureLoc recall. Excluding that impact, lens care sales grew 3 percent on a reported basis and 2 percent in constant currency, with gains for multipurpose solutions in Europe and the Americas region partially offset by declines in Asia.
·  
Full-year pharmaceutical net sales growth includes the impact of the Freda acquisition. Excluding revenues from Freda, growth was approximately 7 percent on both a reported and constant-currency basis. That reflects incremental sales of Zylet combination ophthalmic drops in the United States, combined with higher global sales of ocular vitamins and Lotemax steroid drops containing loteprednol etabonate. Those gains were somewhat offset by sales declines for two non-ophthalmic drugs in our U.S. multisource (generic) pharmaceuticals portfolio.
·  
Cataract and vitreoretinal product category growth was led by gains in IOLs of more than 10 percent on the strength of our SofPort and Akreos lines of foldable IOLs.



PAGE 44

·  
Net sales declines in the refractive category reflected lower equipment and microkeratome blade sales in all regions, partially offset by higher service revenues and sales of per-procedure cards.
·  
As discussed above, the decision to withdraw MoistureLoc will negatively impact 2006 sales performance. In addition to provisions for sales returns and coupon redemptions that we will record (primarily in Europe), performance will be hampered by the impact from lost MoistureLoc revenues; lower revenues for other lens care products, reflecting market share losses caused by trade and consumer uncertainty; and the negative collateral impact on our non-lens care product categories, primarily in Asia.

2004 Versus 2003 The significant drivers of 2004 net sales gains as compared to 2003 include the following.

·  
Contact lens sales growth was attributable to strong gains for the SofLens Toric, SofLens One Day, SofLens Multi-Focal and SofLens59 brands, as well as the PureVision line of contact lenses. Combined, these products represented more than 50 percent of contact lens revenues, benefiting from continued market expansion and share gains.
·  
Lens care sales growth was mainly due to higher sales of all-in-one solutions, particularly in the Americas and Asia regions.
·  
Pharmaceuticals sales growth mainly reflected the continued market success and geographic expansion of the PreserVision and Ocuvite lines of ocular vitamins. Strong gains were also noted in the Americas region for Lotemax and Alrex prescription steroid eye drops. In Europe, growth was tempered by the continued impact of pharmaceuticals pricing legislation in Germany.
·  
Higher sales of cataract and vitreoretinal surgery products were attributable to our lines of IOLs, phacoemulsification products and viscoelastics as well as service revenues.
·  
Refractive surgery revenues increased due to higher sales of per-procedure cards, lasers and microkeratome blades.

Segment Income Segment income excludes certain significant items such as restructuring charges and reversals, asset write-offs and purchase accounting adjustments, as well as corporate administration expenses.

2005 Versus 2004 Segment income increased 2 percent, including a $37 negative impact associated with customer return and consumer rebate provisions and incremental expenses associated with the MoistureLoc recall. Excluding that impact, segment income increased 12 percent, reflecting gross margin expansion resulting from sales mix shifts.
Research & Development segment operating costs increased 11 percent in 2005, reflecting additional headcount and higher spending in support of projects in late-stage development. We remain committed to investing in research and development activities at a higher rate than sales growth. Global Operations & Engineering segment operating costs decreased 16 percent, primarily reflecting changes in foreign currency exchange rates and cost savings realized through restructuring actions and manufacturing initiatives incorporating Lean principles and automation.

2004 Versus 2003 Segment income increased 22 percent due to favorable sales mix in all commercial segments. Continued manufacturing cost savings initiatives, ongoing administrative savings realized through our profitability improvement programs and changes in foreign currency exchange rates also contributed to improved profitability. The 2004 growth was somewhat offset by increased marketing and advertising costs primarily associated with new product launches and increased information technology (IT) expense associated with global systems integration.
Research & Development segment operating costs increased 9 percent in 2004, reflecting our commitment to new product development. Global Operations & Engineering segment operating costs increased 28 percent, primarily due to changes in foreign currency, partially offset by cost savings realized through restructuring actions and manufacturing initiatives incorporating Lean principles and automation.





PAGE 45

Operating Costs and Expenses

The following tables show operating costs and expenses as a percentage of sales:

   
 
2005
 
2004
(Restated)
 
2003
(Restated)
 
   
Percentage of Net Sales
 
Cost of products sold
   
41.8
%
 
41.6
%
 
42.4
%
Selling, administrative and general expenses
   
38.6
%
 
38.6
%
 
39.1
%
Research and development expenses
   
7.5
%
 
7.3
%
 
7.4
%

Cost of products sold was $983 in 2005, $929 in 2004 and $857 in 2003. The 2005 amount includes the cost of sales impact of the MoistureLoc recall ($14) and inventory step-up charges associated with the Freda acquisition ($2). Excluding both of those items, the ratio of cost of products sold to sales would have improved to 40.8 percent, reflecting a favorable sales mix shift toward higher margin products combined with benefits from our ongoing profitability improvement initiatives. Similar trends were responsible for the 2004 gross margin improvement as compared to 2003. Foreign currency exchange rate changes had a slightly negative impact on gross margin during 2005 and a positive impact on gross margin during 2004.
Selling, administrative and general expenses include corporate administration expenses. Absolute spending totaled $910 in 2005, compared to $863 in 2004 and $790 in 2003. The $47 increase in 2005 primarily reflected higher costs associated with selling and marketing, which includes promoting new products. In addition, approximately $13 of costs associated with the MoistureLoc recall, the Audit Committee's independent investigations, expanded year-end procedures and expanded procedures with respect to the accounting for income taxes were essentially offset by lower performance-based compensation expense and lower mark-to-market expense related to certain deferred compensation liabilities invested in our Common stock. As described in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K, expense associated with these liabilities was recorded as part of the financial restatement, resulting in additional compensation expense of $1, $3 and $4 in 2005, 2004 and 2003, respectively. Due to recent declines in our stock price, $4 of mark-to-market income was recorded in the second half of 2005 and an additional $5 of income was recorded in 2006. The 2004 increase in selling, administrative and general expenses reflected the impact of foreign currency exchange rates, higher investments in marketing and advertising, primarily associated with new product launches, increased IT expense in connection with our global systems integration project, Sarbanes-Oxley compliance costs and higher expenses associated with performance-based compensation plans and other employee benefit program expenses.
R&D expenses totaled $177, $163 and $150 in 2005, 2004 and 2003, respectively. A charge of $6 associated with the acquisition of an early-stage pharmaceutical technology contributed to 2003 expense. We expect to continue investing in R&D at a faster rate than sales to support our goal of consistently bringing new products to market to fuel long-term growth.


Non-Operating Income and Expense

Other Income and Expense Interest and investment income was $20 in 2005, $14 in 2004 and $16 in 2003. The increase in 2005 over 2004 primarily related to higher interest rates (somewhat offset by lower average investment balances in 2005) and interest income associated with income tax refunds. Mark-to-market adjustments on assets held in our nonqualified deferred compensation plan represented the majority of the decrease in 2004 when compared to 2003.
Interest expense was $53 in 2005, $50 in 2004 and $55 in 2003. The 2005 increase reflected higher interest rates on variable-rate debt, incremental borrowings in 2005, and the write-off of $3 in unamortized debt issuance costs associated with our convertible debt instruments which became convertible on July 1, 2005 (see further discussion in Item 8. Financial Statements and Supplementary Data under Note 4 — Earnings Per Share of this Annual Report on Form 10-K and in the section entitled Access to Financial Markets below), partially offset by interest expense savings associated with debt retired in 2004 and 2005. As explained in Item 8. Financial Statements and Supplementary Data under Note 12 — Accounting for Derivatives and Hedging Activities of this Annual Report on Form 10-K, we decided to permanently invest an intercompany loan in the Europe region in the third quarter of 2003. That loan was previously hedged by foreign exchange forward contracts classified as cash flow hedges. The 2004 decline in interest expense resulted primarily from the termination of these cash flow hedges, although lower average debt levels and interest rates were also factors.



PAGE 46

We will report higher interest expense in 2006, primarily as a result of increased debt balances, increased interest rates associated with variable rate debt, costs associated with the purchase of outstanding public debt resulting from a tender offer we completed in 2006, and the payment of consent fees associated with consent solicitations we completed in June and September 2006; as well as waiver fees paid to banks in connection with our syndicated revolving credit facility and the $375 unsecured variable-rate term loan arrangement of our Dutch subsidiary (B.V. Term Loan). The consent solicitations and fees are more fully described in the section below entitled Sources of Liquidity.
Net foreign currency losses were $4 in 2005, $1 in 2004 and $13 in 2003. These amounts were primarily associated with our ongoing foreign exchange hedging programs. However, the 2003 amount includes approximately $4 in foreign exchange losses associated with the sale of a Korean entity to a minority interest partner.

Income Taxes

Our reported tax rate for continuing operations was 89.9 percent in 2005 and included the impact of recording a valuation allowance against our U.S. deferred tax assets as described previously and in Item 8. Financial Statements and Supplementary Data under Note 10 — Provision for Income Taxes of this Annual Report on Form 10-K. The reported tax rates for continuing operations were 34.4 percent and 37.3 percent in 2004 and 2003, respectively.
In the third quarter of 2005, we recorded a valuation allowance of $156 with respect to U.S. deferred tax assets. A valuation allowance against deferred tax assets is required when, based upon the weight of the evidence, we determine that it is more likely than not — a probability level of more than 50 percent — that the assets will not be realized. Likelihood of realization is determined using all available positive and negative evidence such as cumulative losses in prior years, losses expected in early future years, and a history of potential tax benefits expiring unused. In making this assessment, more weight is assigned to objectively verifiable evidence, such as cumulative losses in recent years, than to subjective evidence like future projections. In this case, we anticipate losses in early future periods attributable to the U.S. entities to which the deferred tax assets relate and there are uncertainties surrounding when we will return to U.S. profitability. Specifically, expected losses in our U.S. tax entities resulting from, among other things, costs associated with the MoistureLoc withdrawal and the expected impact of the withdrawal on our 2006 results, led us to conclude that a valuation allowance was necessary. In order to realize our deferred tax assets, it will be necessary for us to significantly increase future U.S. taxable income. This adjustment was recorded as a third quarter event because that is the earliest reporting period for which we have not filed quarterly financial results on Form 10-Q. We will continue to assess realizability of our deferred tax assets, including consideration of the reversal of these and other temporary basis differences, future earnings, and prudent and feasible tax planning strategies. If we make a later determination that it is more likely than not that the deferred tax assets for which there is a valuation allowance would be realized, the related valuation allowance would be reduced and a benefit to earnings would be recorded.
On August 3, 2005, we received approval from the U.S. Joint Committee on Taxation that our income tax refund request for tax years ended 1995 through 1997 was approved, concluding the Internal Revenue Service's examination of such years. In connection with the closure of this examination, we recognized $21 of tax benefits related primarily to favorable resolution of tax positions raised during the examination and the reversal of tax reserves associated with our previously divested oral care business.
In addition, on May 12, 2006, we received a Notice of Final Partnership Administrative Adjustment from the Internal Revenue Service relating to partnership tax periods ended June 4, 1999 and December 25, 1999, for Wilmington Partners L.P. (Wilmington), a partnership formed in 1993 in which the majority of partnership interests are held by certain of our subsidiaries. The Final Partnership Administrative Adjustment (FPAA) proposes adjustments increasing the ordinary income reported by Wilmington for its December 25, 1999 tax year by a total of $10, and increasing a long-term capital gain reported by Wilmington for that tax year by $190. The FPAA also proposes a $550 negative adjustment to Wilmington's basis in a financial asset contributed to it by one of its partners in 1993; this adjustment would also affect the basis of that partner — one of our subsidiaries — in its partnership interest in Wilmington. The asserted adjustments could, if sustained in full, increase the tax liabilities of the partnership’s partners for the associated tax periods by more than $200, plus penalties and interest. We have not made any financial provision for the asserted additional taxes, penalties or interest as we believe the asserted adjustments are not probable and estimable.
Since 1999, our consolidated financial statements have included a deferred tax liability relating to the partnership. As of December 31, 2005, this deferred tax liability equaled $157. This deferred tax liability is currently reducing net deferred tax assets for which a valuation allowance has been recorded as of December 31, 2005.



PAGE 47

On August 7, 2006, we made a petition in U.S. Tax Court to challenge the asserted adjustments. Internal Revenue Service's answer was filed on October 4, 2006 and we initiated a motion to strike portions of the answer on November 1, 2006. We believe we have numerous substantive and procedural tax law arguments to dispute the adjustments. Tax, penalties and interest cannot be assessed until a Tax Court determination is made, and an assessment, if any, would likely not be made until some time after 2007. While we intend to vigorously defend against the asserted adjustments, our failure to succeed in such a defense could significantly increase the liability of the partnership's partners for taxes, plus interest and penalties, which in turn would have a material adverse affect on our financial results and cash flows.

Minority Interest Minority interest expense totaled $6, $5 and $3 in 2005, 2004 and 2003, respectively.


Restructuring Charges and Asset Write-offs

Profitability Improvement Program and Transfer of PureVision Contact Lens Manufacturing In July 2002, we announced plans to improve operating profitability through a comprehensive program which included plant closures and consolidations; manufacturing efficiencies and yield enhancements; procurement process enhancements; the rationalization of certain contact lens and surgical product lines; distribution initiatives; and the development of a global IT platform. These plans included the elimination of approximately 465 jobs worldwide associated with those actions. Restructuring charges and asset write-offs of $23 before taxes associated with these initiatives were recorded in the third quarter of 2002. We also recorded a pre-tax amount of $4 during the third quarter of 2002 for severance associated with the elimination of approximately 145 jobs due to the transfer of PureVision contact lens manufacturing from the United States to Waterford, Ireland following a ruling against us in a U.S. patent law suit. During the fourth quarter of 2003, we reversed $6 in severance charges as certain termination actions and plant closures did not occur due to an increased demand for certain product lines.
At the conclusion of the Profitability Improvement Program and the transfer of PureVision contact lens manufacturing, 468 jobs were eliminated. Related expenses of $17 and $3 of asset write-offs were charged against the liability. Cash payments for severance and other related expenses were $11 and $6 in 2003 and 2002, respectively. All actions related to this restructuring plan were completed by the end of 2003.


Liquidity and Financial Resources

We maintained strong liquidity throughout 2005, ending the year with cash and cash equivalents totaling $721, compared to $502 at the end of 2004. The increase was mainly due to borrowings we made in December as part of our program to repatriate foreign profits under the AJCA and positive cash flows from operations, partially offset by cash used for the Freda acquisition, the retirement of maturing debt and higher capital spending.

Cash Flows from Operating Activities We generated cash of $239 from operating activities in 2005, compared to $285 in 2004. The decrease in 2005 was mainly due to higher inventory levels to accommodate new product launches, increased working capital requirements and higher payments under foreign currency contracts; partially offset by lower net cash payments for income taxes and lower U.S. pension plan funding (funding was $11 and $18 in 2005 and 2004, respectively). Average days sales outstanding (DSO) improved to 71 days in 2005, compared to 74 days in 2004.
Cash provided by operating activities totaled $252 in 2003. The increase in 2004 primarily reflected higher earnings and net cash inflows under foreign currency contracts (versus net cash outflows in 2003), partially offset by an increase of $57 in net cash payments for income taxes and an increase in funding of our U.S. pension plan (funding was $18 and $4 in 2004 and 2003, respectively). Average DSO were 74 days in 2004, a decrease from 77 days in 2003, reflecting our continued focus on asset management, particularly in the area of cash collections.

Cash Flows from Investing Activities In 2005, we used $353 for investing activities. These were primarily $227 associated with the acquisition of a controlling interest in Freda and capital spending of $116, representing continued capacity expansion for PureVision contact lenses as well as initial spending associated with an expansion of our U.S. R&D facility.
Net cash used in investing activities of $122 in 2004 and $94 in 2003 primarily represented capital spending in each of those years.




PAGE 48

Cash Flows from Financing Activities On a net basis, we generated $342 in 2005 through financing activities. Cash inflows were mainly attributable to $677 proceeds from new borrowings and $70 received from employee stock option exercises. The new borrowings mainly reflect $425 borrowings outside the United States as part of our program to repatriate foreign profits under the AJCA and $225 in borrowings under our revolving credit agreement, the majority of which were to partially fund the Freda acquisition. These inflows were partially offset by debt repayments of $326, including repayment of the $225 revolver borrowings described above; $45 to purchase shares of our Common stock under our ongoing share repurchase authorization, stock compensation plans and deferred compensation plans of which $40 was used to purchase 537,537 shares of our Common stock at an average price of $75.06 per share; and dividend payments of $28.
In 2004, net cash outflows for financing activities totaled $229. This amount consisted primarily of debt repayments of $197; $77 to repurchase 1,250,162 shares of our Common stock at an average price of $61.27 per share under our ongoing share repurchase authorization; and $28 of dividend payments, partially offset by proceeds of $78 from employee stock option exercises.
Net cash outflows for financing activities were $84 in 2003, consisting primarily of $201 in debt repayments; $41 to repurchase one million shares of our stock; $31 paid in the first quarter to settle forward equity contracts as described in Item 8. Financial Statements and Supplementary Data under Note 18 — Forward Equity Contracts of this Annual Report on Form 10-K; and $28 for dividends. These cash outflows were partially offset by $210 in proceeds from concurrent offerings of notes and convertible notes.

Sources of Liquidity Our total short- and long-term borrowings totaled $993 at the end of 2005 and $647 at the end of 2004. The ratio of total debt to capital was 43.6 percent and 32.2 percent at year-end 2005 and 2004, respectively.
We believe our existing credit facilities, in conjunction with the financing activities mentioned below, provide adequate liquidity to meet our obligations, fund capital expenditures and invest in potential growth opportunities. However, we note that we have obtained and may need in the future to obtain waivers and/or concessions from lenders under existing credit arrangements, as discussed further below, and we note risk factors associated with contingent obligations of the Company, including as noted under the Legal Matters heading in Recent Developments, in this MD&A.

Credit Facilities In July 2005, we replaced our prior $250 syndicated revolving credit facility scheduled to expire in January 2008 with a new five-year, $400 syndicated revolving credit facility. The terms of the new revolving credit facility include our option to increase the limit to $550 at any time during the five-year term. The interest rate under the agreement is based on our credit rating and, at our option, LIBOR or the base rate of one of the lending banks. The new credit facility includes financial covenants similar in nature to covenants contained in the former, which require us to maintain certain EBITDA to interest and debt ratios. In the event a violation of the financial covenants occurs, the facility would not be available for borrowing until the covenant provisions were waived, amended or satisfied. In November 2005, and subsequently in February, May, August and December 2006, and January 2007, we obtained a waiver from our banks of any breach of representation or covenant under the revolving credit agreement or any default associated with the events related to the Brazil and Korea investigations, or from the impact of such events to the extent that they did not result in reductions in after-tax profits of more than $50 in aggregate. The waivers, in the aggregate, also extended the deadline to file our required financial statements for 2005 (including restatements for certain prior periods) and 2006 year to date until April 30, 2007. Delivery of all required financial statements for 2005 was satisfied by the filing of this Annual Report on Form 10-K and delivery of our Annual Report on Form 10-K for fiscal year ending December 30, 2006 by April 30, 2007 will satisfy our obligation to file all 2006 periodic reports. The impact of the Brazil and Korea investigations did not exceed $50 in aggregate as discussed in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K. There were no violations of our financial covenants during the fiscal years ended December 31, 2005 or December 25, 2004 under either our former or our new syndicated revolving credit facilities. We had no outstanding borrowings under syndicated revolving credit agreements as of December 31, 2005 or December 25, 2004.
A number of subsidiary companies outside the United States have credit facilities to meet their liquidity requirements. There were $27 of outstanding borrowings under these non-U.S. credit facilities as of December 31, 2005. There were no outstanding borrowings as of December 25, 2004. The non-U.S. credit facilities' covenants require our subsidiaries to make payments when due and to comply with local laws. There were no covenant violations under the non-U.S. credit facilities during the fiscal years ended December 31, 2005 or December 25, 2004.




PAGE 49

Bank Term Loans In November 2005, our Dutch subsidiary entered into a $375 Term Loan (BV Term Loan). The facility involves a syndicate of banks and is guaranteed by us. The December 2005 borrowing under this BV Term Loan was a component of our efforts to repatriate foreign earnings from non-U.S. legal entities under the provisions of the AJCA (see Item 8. Financial Statements and Supplementary Data under Note 10 — Provision for Income Taxes of this Annual Report on Form 10-K for further discussion of the AJCA). Borrowings under the BV Term Loan totaled $375 at December 31, 2005, and are due in December 2010, unless otherwise extended under the terms of the agreement. The interest rate is based on six-month LIBOR and is reset on a semiannual basis. The BV Term Loan includes covenants which require us to maintain certain EBITDA to interest and debt ratios. The initial interest rate was set at 5.0 percent. In February, May, August and December 2006, and January 2007 we obtained waivers from our banks of any breach of representation or covenant under the term loan agreement or any default associated with the events related to the Brazil and Korea investigations, or from the impact of such events to the extent that they did not result in reductions in after-tax profits of more than $50 in aggregate. The waivers also extended the deadline to file required financial statements for 2005 (including restatements for certain prior periods) and 2006 year to date, with the most recent extension being until April 30, 2007. Delivery of required financial statements for 2005 was satisfied by filing this Annual Report on Form 10-K and delivery of our Annual Report on Form 10-K for fiscal year ending December 30, 2006 by April 30, 2007 will satisfy our obligation to file all 2006 periodic reports. The impact of the Brazil and Korea investigations did not exceed $50 in aggregate as further discussed in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K. There were no violations of our financial covenants under the BV Term Loan during the fiscal year ended December 31, 2005.
In July 2005, we agreed to guarantee, on behalf of our Japan subsidiary, a variable-rate bank term loan facility denominated in Japanese yen, in an amount approximately equivalent to $50. This term loan was also established in connection with the repatriation of foreign earnings under the provisions of the AJCA. The facility will mature in July 2010. The outstanding borrowings under this Japan term loan at December 31, 2005 were approximately $48. The Japan term loan covenants require our Japan subsidiary to submit their statutory financial statements to the lenders once a year and to maintain a positive balance of net assets. There were no covenant violations under the Japan term loan during the fiscal year ended December 31, 2005.

Capital Markets Offerings We are required to file periodic financial reports with the SEC to comply with certain covenants in the indenture that pertain to our public debt instruments. As a result of our inability to file timely this Annual Report on Form 10-K and certain quarterly financial statements for 2005 and 2006, we sought waivers from holders of our outstanding debt. In September 2006, we announced a solicitation of consents with respect to all series of outstanding debt securities and outstanding convertible debt. The solicitations sought, for a fee, permission from the holders for amendments to the indenture applicable to each series of notes that would, among other things, extend to January 31, 2007 our deadline to file periodic reports with the SEC and to deliver compliance certificates to the Trustee under each indenture. We received the requisite number of consents for all series of outstanding debt securities and outstanding convertible debt. We did not file the periodic reports due for the periods prior to January 31, 2007 by that date. As a result, the Trustee or the holders of 10 percent of the principal amount of any series of our outstanding debt could give us a notice of default. If we do not file the reports within 60 days after that notice is given, and the Trustee or the holders of 25 percent of the principal amount of any series of the debt outstanding give a further notice, all principal and accrued interest on that series of debt would be due and payable. Such an acceleration of any series of our debt may be satisfied by our payment of principal and accrued interest on that series, but if not otherwise waived, may trigger defaults under other series of public debt or other indebtedness of the Company. We have announced a consent solicitation seeking consents to additional limited waivers of the reporting obligations from the holders of our public debt to extend until April 30, 2007 the period during which we may become current on our periodic reports without potential default under the indenture.
In May 2006, we announced a tender offer and consent solicitation with respect to $384 of outstanding debt, and a consent solicitation with respect to $160 of outstanding convertible debt. The consents requested in this solicitation were similar to the consents in the solicitation announced in September, except that our deadline to file periodic reports with the SEC and to deliver compliance certificates to the Trustee was October 2, 2006. On June 5, 2006, we announced that $116 of the $384 aggregate principal amount of debt had been tendered, and these obligations were repaid. Furthermore, we received the requisite number of consents necessary to grant the waivers sought at that time. In October 2006, we retired an additional $18 of this outstanding debt.



PAGE 50

In December 2004, we completed an offer to exchange up to $160 of variable-rate convertible senior notes due in 2023 (the Old Notes) for an equal amount of 2004 Senior Convertible Securities due 2023 (New Securities). The terms of the New Securities are largely consistent with those of the Old Notes except that settlement upon conversion of the New Securities will be paid in cash up to the principal amount of the converted New Securities with any excess of the conversion value settled in shares of our Common stock. An amount equal to $156 of the Old Notes was tendered in exchange for an equal amount of the New Securities. On June 17, 2005, the conversion right was triggered giving the holders the option to convert the Old Notes and the New Securities beginning July 1, 2005. In the event a holder elects to convert its note, we expect to fund a cash settlement of any such conversion from borrowings under our syndicated revolving credit agreement.
Two tranches of our long-term debt due in 2013 and 2015 allowed remarketing agents to call the debt from the holders in 2003 and 2005, respectively, and in certain cases remarket the debt at a higher interest rate than the then-current market rate. Following a downgrade of our debt rating by Moody's Investors Service in March 2002, the agents exercised their right to put the remarketing agreements back to us. As a result of this action, a $100 tranche of long-term debt, originally due in 2013, matured and was repaid in 2003, and an additional $100 tranche of long-term debt, originally due in 2015, matured and was repaid in 2005.

Access to Financial Markets As of December 31, 2005, our long-term debt was rated BBB by Standard & Poor's and Fitch Ratings, and Baa3 by Moody's Investors Service, and all three rating agencies described our outlook as stable.
Subsequently, on March 23, 2006, Moody’s Investors Service placed our credit rating on review for possible downgrade. This action was prompted by our failure to file timely financial statements with the SEC and by concerns related to the Audit Committee investigations into allegations in Brazil and Korea. Moody’s expanded this ongoing review on April 12, 2006 to include our decision to suspend sales of MoistureLoc solution from our U.S. plant. On December 22, 2006, Moody's affirmed that our credit rating continued to be on review. On February 2, 2007, Moody's lowered our credit rating to Ba1 from Baa3 primarily reflecting Moody's belief that revenue growth for 2007 will be lower than their previous expectations.
On April 11, 2006, Standard & Poor’s affirmed its BBB rating on our debt, but revised its rating outlook to negative from stable, reflecting our decision to suspend shipments of MoistureLoc from our U.S. plant.
On April 12, 2006, Fitch Ratings placed our long-term debt ratings on watch negative, following our decision to suspend shipments of MoistureLoc from our U.S. plant and our announcement of a further delay in the filing of our 2005 Annual Report on Form 10-K. On May 12, 2006, Fitch Ratings lowered our credit rating to BBB- from BBB and it remains on watch negative.
Until current periodic reports and financial statements are filed, we will be precluded from registering our securities with the SEC for offer and sale. This precludes us from raising debt or equity financing in the public markets.

Working Capital Working capital was $618 and $528, respectively, at year-end 2005 and 2004. The current ratio was 1.6 for both periods.

Dividends Dividends on Common stock, declared and payable quarterly, totaled $0.52 per share for the years ended 2005, 2004 and 2003. Total cash dividends of $28 were paid in each year.

Return on Equity and Capital Return on average shareholders' equity was 1.4 percent in 2005, compared to 12.6 percent in 2004 and 10.5 percent in 2003. Return on invested capital was 3.5 percent in 2005, 9.9 percent in 2004, and 8.6 percent in 2003. The decline in ratios in 2005 reflects lower net income resulting from the valuation allowance recorded on deferred income tax assets and the costs associated with the MoistureLoc recall.




PAGE 51

Contractual Cash Obligations At December 31, 2005, we had the following contractual cash obligations due by the following periods:
   
 
 
Total
 
Less than 1 Year
 
 
 
1-3 years
 
 
 
3-5 years
 
More than 5 years
 
Contractual Obligations 1
                     
Short- and long-term debt
 
$
992
 
$
161
 
$
184
 
$
423
 
$
224
 
Purchase obligations 2
   
82
   
49
   
18
   
5
   
10
 
Minimum operating lease commitments
   
76
   
23
   
28
   
15
   
10
 
Total
 
$
1,150
 
$
233
 
$
230
 
$
443
 
$
244
 

1
We had no capital lease obligations at December 31, 2005. Other long-term liabilities reflected on our Balance Sheets consisted primarily of obligations associated with employee benefit plans. (See Critical Accounting Policies for a discussion of our estimated future statutory minimum funding requirements.)
2
Purchase obligations include minimum obligation to purchase goods and services, or to make royalty payments, under agreements that are enforceable and legally binding on us. The amounts above include payments due under a utility contract that can be terminated in the tenth year with the payment of $1. If we choose to terminate the utility contract, the total payments due would decrease by $9.


Off-Balance Sheet Arrangements

We have a minority equity interest valued at $0 on the balance sheet that results from a strategic partnering arrangement entered into during 1999 involving implant technology for treating retinal and other back-of-the-eye diseases. Under the original agreement, we remitted payments to the strategic partner for R&D activities and the achievement of certain milestones such as completion of clinical testing, NDA filings and FDA approvals. As described in Item 8. Financial Statements and Supplementary Data under Note 9 — Related Party Transaction of this Annual Report on Form 10-K, a delay of up to three years in U.S. regulatory filings for the Retisert drug delivery product for the diabetic macular edema indication was announced in May 2003. As a result, we reevaluated our role in the ongoing development and approval process, and decided to conduct and supervise directly the day-to-day development and clinical activities. During the fourth quarter of 2003, we negotiated our arrangement to formalize this change.
We also have an equity investment of $0.2 as of December 31, 2005 and December 25, 2004 recorded as an other long-term asset, associated with a licensing agreement signed during 2002 to develop treatments for ocular infections. During the quarter ended June 28, 2003, we recorded an other-than-temporary impairment charge of $2 based on negative earnings and cash flow trends of the licensor, and inconclusive efforts by the licensor to secure interim financing. The licensing agreement and $4 of preferred stock were canceled in December 2003 in conjunction with our decision to invest in and internally develop this ocular infection technology, which is in late-stage clinical development. As such, we are no longer required to remit payments to the licensor originally due upon the achievement of certain milestones. As a result of our restatement of financial results, as further discussed in Item 8. Financial Statements and Supplementary Data under Note 1 —Significant Accounting Policies of this Annual Report on Form 10-K the $2 impairment charge was determined to be out-of-period as the equity investment was first impaired as of 2001. At that time, we believed the decline in market value was temporary. As the investment did not recover, our restated financial statements reflect a $1 impairment charge in 2001 to adjust the equity investment to its market value at that time; and a $1 impairment charge in 2002 to recognize a further decline in market value, as well as a reversal of the $2 impairment charge originally recorded in June 2003.
As a result of the renegotiation and license cancellation described above, future payments for R&D activities and milestone achievements over the next five years are estimated to be immaterial.
We have obligations under certain guarantees, letters of credit, indemnifications (including indemnification obligations with respect to the MoistureLoc matters and for directors, officers and employees with respect to other matters) and other contracts that contingently require us to make payments to guaranteed parties upon the occurrence of specified events. We believe the likelihood is remote that material payments will be required under these contingencies, and that they do not pose potential risk to our future liquidity, capital resources and results of operations. See Item 8. Financial Statements and Supplementary Data under Note 17 — Commitments and Contingencies of this Annual Report on Form 10-K for further descriptions and discussions regarding our obligations.





PAGE 52

Market Risk

As a result of our global operating and financing activities, we are exposed to changes in interest rates and foreign currency exchange rates that may adversely affect our results of operations and financial position. In seeking to minimize the risks and/or costs associated with such activities, we manage exposure to changes in interest rates and foreign currency exchange rates primarily through the use of derivatives. We do not use financial instruments for trading or other speculative purposes, nor do we use leveraged financial instruments.
We primarily use foreign exchange forward contracts to hedge foreign currency transactions and equity investments in non-U.S. subsidiaries. For contracts outstanding at the end of 2005 and 2004, foreign currencies purchased were primarily euros, British pounds, Hong Kong dollars and Swiss francs. Foreign currencies sold in 2005 were primarily euros, Hong Kong dollars, Japanese yen, Korean won and British pounds. In 2004, foreign currencies sold were primarily euros, British pounds, Japanese yen, Hong Kong dollars, Korean won and Swiss francs. The magnitude and nature of our hedging activities are explained further in Item 8. Financial Statements and Supplementary Data under Note 13 — Financial Instruments of this Annual Report on Form 10-K. A sensitivity analysis to measure the potential impact that a change in foreign currency exchange rates would have on our net income indicates that, if the U.S. dollar strengthened against all foreign currencies by 10 percent, we would realize a loss of approximately $23 on foreign exchange forward contracts outstanding at year-end 2005. Similar analysis conducted at the end of 2004 indicated that, had the U.S. dollar then strengthened against all foreign currencies by 10 percent, we would have realized a loss of approximately $6 on foreign exchange forward contracts outstanding at year-end 2004. Such losses would be substantially offset by gains from the revaluation or settlement of the underlying positions hedged.
We may enter into interest rate swap, interest rate lock and cap agreements to effectively limit exposure to interest rate movements within the parameters of our interest rate hedging policy. For foreign currency-denominated borrowing and investing transactions, cross-currency interest rate swap contracts may be used, which, in addition to exchanging cash flows derived from interest rates, exchange currencies at both inception and termination of the contract. There were no cross-currency interest rate swap contracts outstanding at December 31, 2005 or December 25, 2004. A sensitivity analysis to measure the potential impact that a change in interest rates would have on our net income indicates that a one-percentage point decrease in interest rates, which represents a greater than 10 percent change, would increase our net financial expense by approximately $1 and $3 based on 2005 and 2004 year-end positions, respectively.
Counterparties to the financial instruments discussed above expose us to credit risks to the extent of non-performance. The credit ratings of the counterparties, which consist of a diversified group of high quality investment or commercial banks, are regularly monitored and thus credit loss arising from counterparty non-performance is not anticipated. In addition, there can be no assurances that the arrangements described above will protect the Company against or limit its exposure to all market risks.


Critical Accounting Policies

The accompanying consolidated financial statements and notes to consolidated financial statements contain information that is pertinent to this MD&A. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ from these estimates and assumptions.
The Company believes that the critical accounting policies discussed below involve additional management judgment due to the sensitivity of the methods, assumptions and estimates necessary in determining the related asset, liability, revenue and expense amounts. The impact of and any risks related to these policies on its business operations are discussed below. Senior management has discussed the development and selection of the critical accounting estimates and the related disclosure included herein with the Audit Committee of the Company's Board of Directors.




PAGE 53

Revenue Recognition The Company recognizes revenue when it is realized or realizable and earned and when substantially all the risks and rewards of ownership have transferred to the customer. The Company believes its revenue recognition policies are appropriate, and that its policies are reflective of complexities arising from customer arrangements. In certain transactions with distributors and wholesalers, substantially all the risks and rewards of ownership do not transfer upon delivery and, accordingly, such shipments are accounted for as consignment sales. For the sale of multiple-element arrangements whereby equipment is combined with services, including maintenance and other elements, such as supplies, the Company allocates to and recognizes revenue from the various elements based on verifiable objective evidence of fair value. Revisions to these determinants of fair value would affect the timing of revenue allocated to the various elements in the arrangement and would impact the results of operations of the Company.
The Company records estimated reductions to revenue for customer incentive programs offered including cash discounts, promotional and advertising allowances, volume discounts, contractual pricing allowances, rebates and specifically established customer product return programs. If market conditions were to change, the Company may take actions to expand these customer offerings, which may result in incremental reductions to revenue. Also, under certain conditions, the Company may offer other customer programs that do not impact revenue such as extended credit terms.
The Company's fiscal quarter consists of 13 weeks, whereby the first and second months of each quarter contain four weeks of results and the third month of each quarter contains five weeks of results. Accordingly, net sales are typically higher in the third month of any given quarter. In addition, the execution of a broad portfolio of customer incentive programs, particularly volume discounts, certain customer rebates and extended credit terms have been higher at the end of each quarter. As a result, net sales for the third month of each quarter in 2005 and 2004 were higher than average net sales for the third month of a quarter if aligned with the fiscal quarter described above. While this trend was consistent among all regions and all product categories, net sales of lens care products and pharmaceuticals in the United States (which are marketed primarily to health product retailers, mass merchandisers, wholesalers and distributors) and net sales of contact lenses and lens care products in Japan (which are marketed primarily to distributors), were the main drivers.
The Company closely monitors and evaluates customer incentives and other customer programs, such as extended credit terms. Should the Company determine that certain customer programs result in excessive levels of inventory in certain channels of trade (such as retailers, mass merchandisers, wholesalers and distributors) or the risks and rewards have not transferred to the customer, net sales in conjunction with the associated programs would be accounted for as consignment sales. As explained in Item 8. Financial Statements and Supplementary Data under Note 2 — Restatement of this Annual Report on Form 10-K, vision care sales in BL Korea from 2002 through 2005; certain vision care transactions with a single distributor in Thailand; vision care transactions with two large distributors in Japan; and vision care and cataract transactions with the distributor network in India are accounted for as consignment sales. See Item 8. Financial Statements and Supplementary Data under Note 1 — Significant Accounting Policies of this Annual Report on Form 10-K for a further discussion of the Company's revenue recognition policy. Reductions to revenues for customer incentive programs, as restated, represented approximately 12 percent, 10 percent and 9 percent of gross customer sales in 2005, 2004 and 2003, respectively.

Provisions for Uncollectible Trade Receivables The Company maintains provisions for uncollectible accounts for estimated losses resulting from the inability of its customers to remit payments. If the financial condition of customers were to deteriorate, thereby resulting in an inability to make payments, additional allowances could be required. The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon customer payment history and current creditworthiness, as determined by the Company's review of customers' current credit information. The Company continuously monitors collections and payments from customers and maintains a provision for estimated credit losses based upon its historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within the Company's expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and financial health of specific customers. The change in the provision for doubtful accounts increased 2005 operating income by $1. In 2004 and 2003, the change in the provision for doubtful accounts decreased operating income by $4 and $3, respectively.
The Company considers all available information in its quarterly assessments of the adequacy of the reserves for uncollectible accounts. If the provision for uncollectible trade receivables were to change by one-percentage point of the Company's gross trade receivables, operating income is estimated to increase or decrease by less than $6.

PAGE 54

Inventory Allowances The Company provides estimated inventory allowances for excess, slow moving and obsolete inventory as well as inventory whose carrying value is in excess of net realizable value. These reserves are based on current assessments about future demands, market conditions and related management initiatives. If market conditions and actual demands are less favorable than those projected by management, additional inventory write-downs may be required. The Company values its inventory at the lower of cost or net realizable market values. The Company regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on estimated forecasts of product demand and production requirements for the next twelve months. Several factors may influence the realizability of its inventories, including decisions to exit a product line, technological change and new product development. These factors could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, estimates of future product demand may prove to be inaccurate, in which case the provision required for excess and obsolete inventory may be understated or overstated. If in the future, the Company determined that its inventory was overvalued, it would be required to recognize such costs in cost of products sold at the time of such determination. Likewise, if the Company determined that its inventory was undervalued, cost of products sold in previous periods could have been overstated and the Company would be required to recognize such additional operating income at the time of sale. While such inventory losses have historically been within the Company's expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same loss rates that it has in the past. Therefore, although the Company makes every effort to ensure the accuracy of forecasts of future product demand, including the impact of planned future product launches, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of its inventory and its reported operating results. The Company recorded $25, $18 and $11 in provisions to the Statements of Income for excess, slow moving and obsolete inventory in 2005, 2004, and 2003, respectively. At this time, management does not believe that anticipated product launches would have a material adverse effect on the recovery of the Company's existing net inventory balances. If the inventory allowance were to change by one-percentage point of the Company's gross inventory, operating income is estimated to increase or decrease by less than $3.

Fair Value of Assets The Company assesses the carrying value of its identifiable intangible assets, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying amount of the underlying asset may not be recoverable, or at least annually in the case of goodwill. Certain factors which may occur and indicate that an impairment exists include, but are not limited to: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of the Company's use of the underlying assets; and significant adverse industry or market economic trends. In the event that the carrying value of assets is determined to be unrecoverable, the Company would estimate the fair value of the assets or reporting unit and record an impairment charge for the excess of the carrying value over the fair value. The estimate of fair value requires management to make a number of assumptions and projections, which could include, but would not be limited to, future revenues, earnings and the probability of certain outcomes and scenarios. The Company's policy is consistent with the current accounting guidance as prescribed by SFAS No. 142, Goodwill and Intangible Assets and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. See Item 8. Financial Statements and Supplementary Data under Note 1 — Significant Accounting Policies of this Annual Report on Form 10-K for a further discussion of SFAS No. 142 and SFAS No. 144. The Company also assesses the fair value of identifiable intangible assets, long-lived assets, goodwill and purchased in-process research and development at the inception of an acquisition.
On May 15, 2006, the Company announced a worldwide voluntary recall of MoistureLoc lens care solution. As explained in Item 8. Financial Statements and Supplementary Data under Note 23 — Subsequent Event of this Annual Report on Form 10-K, the Company determined that this event would more likely than not reduce the fair value of a reporting unit. The Company revised the fair values of each of the reporting units to reflect the anticipated impact of the MoistureLoc recall and concluded that the probability of the voluntary recall reducing the fair value of any reporting unit below its carrying amount was remote. In addition, the Company performed a separate analysis as it relates to its recent acquisition of Freda and determined that the fair value of Freda exceeded its carrying value.




PAGE 55

Restructuring Actions The Company had no open restructuring programs as of December 31, 2005. Prior to 2003, the Company had engaged in several significant restructuring actions, which required the development of formalized plans as they relate to exit activities based on guidance provided by Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). These plans required the Company to utilize estimates related to severance and other employee separation costs, lease cancellations and other exit costs. Given the significance and the timing of the execution of such actions, this process was complex and involved periodic reassessments of estimates calculated at the time the original decisions were made. The Company's policies for future restructuring actions, based on guidance provided by SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which replaced EITF Issue No. 94-3, require recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Therefore, if employees are not required to render service until they are terminated in order to receive the termination benefits, a liability for the termination benefits would be recognized and measured at its fair value at the communication date. Conversely, if employees are required to render service until they are terminated in order to receive the termination benefits, a liability for the termination benefits would be measured initially at the communication date based on the fair value of the liability as of the termination date. The Company would recognize the liability ratably over the future service period.

Deferred Tax Assets and Reserves The Company evaluates the recoverability of its deferred tax assets on an ongoing basis. This evaluation includes assessing the available positive and negative evidence to determine whether, based on its judgment, the Company believes the assets, or some portion thereof, are more likely than not to be realized. To the extent the Company does not believe the assets will more likely than not be realized, a valuation allowance is recorded. In determining whether, and to what extent, a valuation allowance is required, the Company considers whether it will have sufficient taxable income in the appropriate period and jurisdiction that is also of the appropriate character. Potential sources of taxable income that are evaluated include: (i) future reversals of existing taxable temporary differences; (ii) future taxable income exclusive of reversing temporary differences; (iii) taxable income in prior carryback years; and (iv) tax planning strategies that would be implemented, if necessary. Should the Company determine that it is more likely than not it will realize its deferred tax assets in the future, an adjustment would be required to reduce the existing valuation allowance. Generally, this would result in a corresponding increase to income. Conversely, if the Company determined that it would not be able to realize its deferred tax as