The aggregate market value of the voting stock of the Company held by non-affiliates of the Registrant as based upon the closing National Market System sale price on June 28, 2001 was 635,313,000.

Number of Shares of Common Stock outstanding on June 28, 2001: 23,972,759.

Portions of the Registrant's Proxy Statement for its 2001 Annual Meeting of Shareholders are incorporated by reference in Part III in this Report on Form 10-K.

The Company develops, manufactures, and markets a broad range of products for the medical specialties of Aesthetic and General Surgery (Plastic and Reconstructive Surgery) and Urology. Aesthetic and General Surgery products include surgically implantable prostheses for plastic and reconstructive surgery and capital equipment used in soft tissue aspiration. Urologic products include disposable and surgical products for the management of urinary incontinence, surgically implantable prostheses for the treatment of impotence and brachytherapy seeds for the treatment of prostate cancer.

During fiscal 2000, the Company completed the divestiture of its ophthalmology business. Accordingly, all numbers in this 10-K have been restated to exclude the results of the ophthalmic business as appropriate. All sales, expenses, gains on assets sales, and other financial information of the ophthalmology business are reported, net, as a single line on the financials.

Effective January 19, 2001 Mentor acquired South Bay Medical, a development stage company focused on the development of a new technology for a computer based workstation and automated cartridge-based needle loading system for use in Brachytherapy procedures.

Effective February 9, 2001 Mentor acquired Porges S.A., subsidiary of Sanofi- Synthelabo headquartered in Paris, and manufacturing facilities in Sarlat France. Porges holds a leading market share for urological products in France and has strong market position throughout Europe.

The Company produces a broad line of mammary prostheses, including saline-filled implants and silicone gel-filled implants. Approximately 81% of Aesthetic and General Surgery revenues are sales of mammary prostheses. Saline-filled breast implants accounted for approximately 72% of mammary prostheses sold in fiscal 2001.

Mammary prostheses may be implanted to achieve breast reconstruction following total or partial removal of the breast (mastectomy) or to enhance breast size and shape in plastic surgery. Breast reconstruction is possible for most patients undergoing a mastectomy, either at the time of the original surgery or at a later date.

The Company also offers a line of tissue expanders. Tissue expansion is a technique for growing additional tissue for reconstruction and skin graft procedures. Some of the major applications of tissue expansion developed to date include post-mastectomy reconstruction, and the elimination of disfigurements such as burns, massive scars and facial deformities.

In September 1997, the Company began marketing the Contour Genesis ® System, an ultrasound assisted product used for the liquefaction and aspiration of soft tissues in general surgery and cosmetic surgery applications. The Company has completed clinical trials using the Contour Genesis® System in order to expand the labeling of the product to include ultrasonic assisted liposuction. The Company has submitted an application for approval to the Food and Drug Administration, (FDA), and expects a response in the second quarter of fiscal year 2002.

The Company's Surgical Urology products fall into three general categories of products: erectile dysfunction products, urinary care and pelvic floor products and cancer treatment products.

Erectile Dysfunction Products. The Company's E.D. products consist of a line of penile implants for the treatment of male sexual impotence. Penile prostheses are implanted in men who cannot achieve a natural erection of sufficient rigidity for sexual intercourse. Penile implants have become the standard of care for men who have not responded to less invasive therapies such as Pfizer's Viagra® . In order to respond to various physician and patient preferences, the Company manufactures several types of penile prostheses, including a hydraulic inflatable device and a malleable prosthesis. In fiscal year 2001, the Company introduced a major improvement to its Alpha 1 inflatable device, the Lockout® valve. The Lockout valve was designed to prevent auto-inflation, a complication in this type of treatment.

Urinary Care and Pelvic Floor Products. The Company markets the Suspend® sling for use in pubovaginal sling and pelvic floor reconstruction procedures. Pubovaginal sling procedures provide relief for women suffering from stress incontinence. Pelvic floor reconstruction procedures utilizing Suspend tissue is commonly used to treat women suffering from all types of vaginal prolapse.

Cancer Products. The Company serves as the marketing partner in a strategic alliance focused on the treatment of prostate cancer. The alliance is with North American Scientific, Inc. ("NASI") which produces brachytherapy seeds for the treatment of prostate cancer. NASI manufactures and ships IoGold® I-125 and Pd-Gold™ Pd-103 brachytherapy seeds, while the Company performs all of the sales and marketing functions. In January 2001, the Company announced the acquisition of South Bay Medical, and its new technology for a computer based workstation and automated cartridge-based needle loading system for use in Brachytherapy procedures. Early in fiscal year 2002, the Company submitted a 510k application to the FDA for approval to market the system. The Company expects to receive a response from the FDA in the second fiscal quarter of 2002 and sales of the workstation are expected to begin by the end of the calendar 2001.

The Company markets a line of male external catheters that help men manage their incontinence and a line of intermittent self-catheters for men, women and children that suffer from urinary retention. These products are disposable and are used in homes, hospitals, rehabilitation and extended care facilities.

In February 2001, the Company announced the acquisition of Porges S.A., a French company specializing in urological disposable, including diagnostic tools, and various devices for surgery and postoperative follow-up. The Company expects to introduce these products into the U.S market by the end of fiscal year 2002.

The Company also markets a variety of other disposable products used in the management of urinary incontinence and cancer. These include leg bags and urine collection systems, organic odor eliminators, and moisturizing skin creams and ointments. In February of 2001, the Company announced an exclusive alliance to market and distribute the BTA-Stat® point-of-care bladder cancer screening test manufactured by Polymedco Inc.

Summary of Sales by Principal Product Lines. The following table shows the net sales attributable to each of the Company's principal product lines and the percentage contributions of such sales to total net sales for the periods indicated.

The Company promotes its products through radio, television, magazine and journal advertising, direct mail programs, and participation in, and sponsorship of, medical conferences and seminars. The Company also participates in support organizations that provide counseling and education for persons suffering from specific disease states, and provides patient education materials for some of its products to physicians for use with their patients.

The Company exports most of its products lines, principally to Canada and Western Europe. Products are sold to both independent distributors as well as through the Company's direct international sales offices in Canada, the United Kingdom, Germany, France, Benelux, Australia, Spain and Italy. The recent acquisition of Porges S.A. included eight additional direct sales subsidiaries in Europe and Japan. Other than sales made through the Company's international sales offices, export sales have been made in United States dollars and currency fluctuations have not significantly affected operating earnings. The Company, generally does not use derivative instruments to hedge its foreign currency transactions. In fiscal 2001, sales from the direct international offices accounted for 16% of total sales.

In addition, the Company manufactures mammary implants in Leiden, the Netherlands and through its recent acquisition of Porges, has manufacturing facilities in Sarlat, France where urological disposables distributed throughout Europe are manufactured.

The Company believes it is one of the leading suppliers in the United States of penile implants, cosmetic and reconstructive surgery products, and disposable catheter products. This belief is based upon information developed internally, public information sources and information from independent research studies of market share.

The Company competes primarily with one other company in the domestic breast implant market, McGhan Medical Corporation, a subsidiary of INAMED, Inc. The primary competitive factors currently are range of styles and sizes, product performance and quality, proprietary design, customer service and in certain instances, price.

The Company competes with only one other company in the inflatable penile implant market, American Medical Systems, Inc. Several companies sell competing malleable penile implants. The primary competitive factors are product performance and reliability, ease of implantation and customer service. The Company believes that by providing several types of implants that stress high performance and reliability, it can successfully respond to various physician and patient preferences.

The Company competes with many other companies providing brachytherapy seeds for the treatment of prostate cancer, including Nycomed-Amersham and Theragenics. The primary competitive factors in this market are product delivery, product offering and consistent quality. The Company believes that it has second largest market share for both Iodine and Palladium seeds, and its recent acquisition of South Bay Medical's automated workstation will provide the Company with a strong competitive advantage.

By superior design and active marketing of catheters and other disposable incontinence products, the Company has been able to compete successfully against larger companies. The Company, C.R. Bard, Inc., Hollister, Inc., Kendall, a division of Tyco HealthCare, and Coloplast Corporation are the dominant competitors in the market. As with many of the Company's other product lines, the Company competes primarily on the basis of design and performance, and by providing product orientation, support and related services to health care professionals and consumers. The recent Porges S.A acquisition will provide the Company a dominant position in the European market and will also provide the Company a wide range of new products for the U.S. market

As a manufacturer of medical devices, the Company's manufacturing processes and facilities are subject to continuing review by the FDA and various state and international agencies. These agencies inspect the Company and its facilities from time to time to determine whether the Company is in compliance with various regulations relating to manufacturing practices and other requirements. The FDA has the power to prevent or limit further marketing of products based upon the results of these inspections. These regulations depend heavily on administrative interpretation by the various agencies, and can be influenced by adverse publicity and political pressure. There can be no assurance that future interpretations made by the FDA or other regulatory bodies will not adversely affect the Company. A determination that the Company is in violation of such regulations could lead to imposition of various penalties, including the issuance of warning letters, injunctive relief (whether by adverse court ruling or by consent), product recalls or product seizures.

Under the "Medical Device Amendments of 1976" (the "'76 Amendments"), the FDA has the authority to adopt regulations that: (i) set standards for medical devices; (ii) require proof of safety and effectiveness prior to marketing devices which the FDA believes require pre-market clearance; (iii) require test data approval prior to clinical evaluation of human use; (iv) permit detailed inspections of device manufacturing facilities; (v) establish "good manufacturing practices" ("GMPs") that must be followed in device manufacture; (vi) require reporting of product defects to the FDA; and (vii) prohibit device exports that do not comply with the '76 Amendments unless they comply with established foreign regulations, do not conflict with foreign laws, and the FDA and the health agency of the importing country determine export is not contrary to public health. All of the Company's products are "medical devices intended for human use" within the meaning of the '76 Amendments and are, therefore, subject to FDA regulation.

The '76 Amendments establish complex procedures for FDA regulation of devices in three classes: Class I (general controls to preclude mislabeling or adulteration, compliance with labeling and requirements), Class II (performance standards in addition to general controls) and Class III (pre-market approval application ("PMAA") before commercial marketing). Class III devices are the most extensively regulated. Class III devices require each manufacturer to submit to the FDA a PMAA that includes information on the safety and effectiveness of the device. The majority of the Company's aesthetic surgery and urology implants are in Class III, while most of its disposable incontinence products are in Classes I and II.

In 1991, the Company submitted a PMAA for its silicone gel-filled mammary prostheses to the FDA, pursuant to FDA regulations issued at that time. In 1992, the FDA's outside advisory panel on aesthetic surgery products indicated that although there was insufficient data to establish with reasonable certainty that silicone gel implants were safe and effective, there was a public health need for these types of implants. The FDA adopted the recommendations of the panel.

The FDA denied the pending applications for the use of silicone gel-filled breast implants for augmentation, but provided for the continued availability of the implants for reconstruction purposes on the basis of a public health need. Since 1993, women have been required to enroll in a clinical study for future follow-up in order to receive gel-filled implants for reconstruction. Patients are required to sign an informed consent form and physicians must certify that saline implants are not a satisfactory alternative. The Company continues to ship these products under the terms of this clinical study.

In 1993, the FDA published proposed guidelines for PMAA's on the Company's hydraulic inflatable penile prostheses and saline-filled breast implants. For saline implants, the FDA published a schedule that permitted the data required for the PMAA to be submitted in phases, beginning with preclinical data due in 1995 and ending with final submission of prospective clinical data in 1999. The Company submitted all the required data. The PMA approval process is the means by which the FDA determines the safety and efficacy of a Class III device. On May 10, 2000, the FDA approved the Company's PMAA for saline-filled breast implants. In addition, the FDA audited the Company's manufacturing facility in Irving, Texas and indicated the facility was in substantial compliance with the applicable requirements of the Federal Food and Drug and Cosmetic Act and implementing regulations.

For its penile implants, the Company submitted all required data for the PMAA, and received FDA approval for the Company's penile implants in July 2000.

To comply with the '76 Amendments, the Company has incurred, and will continue to incur, substantial costs relating to laboratory and clinical testing of new and existing products and the preparation and filing of documents in the formats required by the FDA. The process of obtaining marketing clearance and approvals from the FDA for new products and existing products can be time-consuming and expensive, and there is no assurance that such clearances or approvals will be granted. The Company also may encounter delays in bringing new products to market as a result of being required by the FDA to conduct and document additional investigations of product safety and effectiveness, which may adversely affect the Company's ability to commercialize additional products or additional applications for existing products.

As a manufacturer of medical devices, the Company's manufacturing processes and facilities are subject to regulations and review by the FDA and other regulatory agencies. The Company's domestic facilities must comply with the FDA's Quality System Regulation requirements for Good Manufacturing Practices. Also, for products sold internationally, the Company has obtained a CE mark for its products by demonstrating compliance with the ISO 9001, EN46001 and EN12180, international quality system standards. Medical device laws and regulations similar to those described above are also in effect in some of the other countries to which the Company exports its products. These range from comprehensive device approval requirements for some or all of the Company's medical device products to requests for product data or certifications. Failure to comply with these domestic and international regulatory standards and requirements could effect the Company's ability to market and sell its products in these markets and have a significant negative impact on sales and results of operations.

In May 1998, the Company entered into a voluntary consent decree with the FDA, under which the Company agreed, among other things, to complete certain re-validations of the manufacturing processes in agreed upon timeframes that were identified during an FDA audit.

The consent decree required the Company to hire outside expert consultants to assist in strengthening the Company's compliance program and related processes. In July 1998 the consultant reported to Mentor management and the FDA, that, except for the outstanding re-validations, there were no significant areas of GMP noncompliance. The Company and the FDA agreed to timeframes to complete the re-validations of the manufacturing process. The outside expert consultant reviewed the validations and reported to management and to the FDA that all validation projects had been completed within those timeframes.

Additionally, under the terms of the consent decree, an expert consultant is required to conduct an inspection and to issue a report annually. In his first annual report, the consultant stated, "Mentor is in substantial compliance with the current Good Manufacturing Practices."

In April-May, 2000 the expert consultant conducted his second annual comprehensive GMP audit of the Texas facility in accordance with the consent decree. The consultant's report concluded that "Mentor's quality and manufacturing systems fully comply with the GMPs (QSRs)." On May 1-10, 2000 the FDA conducted an audit at the Texas facility to access the procedures under which saline breast implants are manufactured. The inspection was conducted in conjunction with FDA's final decision on Mentor's saline breast implant PMAA. The inspection resulted in the issuance of an FD483 with one item related to validation of a computer system. The PMAA was approved after the FDA investigator reported findings to FDA's Center for Devices and Radiological Health.

In April 2001 the expert consultant conducted his third annual comprehensive GMP audit of the Texas facility in accordance with the consent decree. The consultant's report "found Mentor to be in compliance with cGMP/QSRs." On April 16 to 23, 2001 the FDA conducted an audit at the Texas facility. The inspection was a follow-up inspection related to Mentor's saline breast implant PMAA and the previous inspection. The inspection resulted in the issuance of a FD483 with two items, one related to a manufacturing process and one related to computer software. Mentor has responded to FDA on both items.

The Company believes that it will continue to meet the requirements of the consent decree, although there can be no assurance that it can do so. In addition, although the expert consultants have expressed their opinion as to the satisfactory completion of certain consent decree requirements, FDA inspectors, during some future audit, may disagree with the conclusions of these experts. Should the Company fail to comply with the conditions of the consent decree, under its terms the FDA is allowed to order the Company to stop manufacturing or distributing the breast implants, order a recall or take other corrective actions. The Company may also be subject to penalties of $10,000 per day until compliance is achieved.

If the Company maintains continuous compliance with the terms of the consent decree for a period of 5 years after the completion of the re-validations, the Company can petition the courts to remove the consent decree without opposition from the government.

In certain states, primarily Texas, the Company is also subject to regulation by the local Air Pollution Control District and the United States Environmental Protection Agency as a result of some of the chemicals used in its manufacturing process.

Many of the Company's products are purchased by hospitals, doctors and other health care providers who are reimbursed for the health care services provided to their patients by third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care programs. Third party payors may deny coverage for certain technologies based on assessment criteria as determined by the third-party payor. Also, third-party payors are increasingly challenging the prices charged for medical products and services. Medicare reimbursement systems are under revision in an effort by the government to reduce costs. There can be no assurance that the Company's products will be automatically covered by third-party payers, that reimbursement will be available or, if available, that the third-party payers' coverage policies will not adversely affect the Company's ability to sell its products profitably.

All third-party reimbursement programs, whether government funded or insured commercially, whether inside the United States or outside, are developing increasingly sophisticated methods of controlling health care costs through prospective reimbursement and capitation programs, group purchasing, redesign of benefits, second opinions required prior to major surgery, careful review of bills, encouragement of healthier lifestyles and exploration of more cost-effective methods of delivering health care. These types of programs can potentially limit the amount which health care providers may be willing to pay for medical devices.

The Center for Medicare and Medicaid services (CMS), previously known as U.S. Health Care Financing Administration (HCFA) sets reimbursement policy for the Medicare program in the United States. CMS issued a Final Rule on its Prospective Payment System For Hospital Outpatient Services on April 7, 2000. This rule provides for a new system to reimburse the outpatient services provided in a hospital, and is intended to cover the cost of medical devices used during the procedure.

On April 1, 2001 CMS (HCFA) published a final list of categories of 96 categories covering over 1000 individual devices. Most items previously qualified fit into one of these categories. To qualify for the Hospital Outpatient Prospective Payment System, HOPPS, the device must be a subordinate part of the procedure performed, be used for one patient only, come in contact with human tissue, and be surgically implanted or inserted whether or not it remains with the patient when the patient is released from the hospital outpatient department. Mentor devices that meet these requirements are included in a category and are subject to reimbursement. Most of these categories for reimbursement are scheduled to expire January 1, 2003. At that time, APC (procedure based) payment rates are expected to be adjusted to reflect the cost of the device. With the current changes taking place with Medicare and Medicaid reimbursement systems it is unclear precisely how future reimbursement programs will be structured and how they will effect Mentor's ability to sell it products. Failure to obtain or maintain third party and government reimbursement for our products would have a significant impact on sales and the results of operations.

The Company is focused on the development of new products and improvements to existing products. In addition, research and development expense reflects the Company's efforts to obtain FDA approval of certain products and processes and to maintain the highest quality standards of existing products. During fiscal years 2001, 2000 and 1999, the Company spent a total of $19,632,000, $16,701,000 and $14,820,000 respectively, for research and development.

It is the Company's policy to protect its intellectual property rights related to its products when and where appropriate. The Company's patents include patents relating to its penile prostheses, tissue expanders, combination breast implant and tissue expander, ultrasonic assisted soft tissue aspiration and disposable catheters. The Company licenses technology under exclusive supplier and licensing arrangements for certain products, including brachytherapy seeds and breast implants.

In those instances where the Company has acquired technology from third parties, it has sought to obtain rights of ownership to the technology through the acquisition of underlying patents or licenses. While the Company believes design, development, regulatory and marketing aspects of the medical device business represent the principal barriers to entry into such business, it also recognizes that its patents and license rights may make it more difficult for its competitors to market products similar to those produced by the Company. Mentor can give no assurance that any of its patent rights, whether issued, subject to license, or in process, will not be circumvented or invalidated. Further, there are numerous existing and pending patents on medical products and biomaterials. There can be no assurance that the Company's existing or planned products do not or will not infringe such rights or that others will not claim such infringement. No assurance can be given that the Company will be able to prevent competitors from challenging the Company's patents or entering markets currently served by the Company.

As a condition of employment, the Company requires each of its new employees to execute an agreement relating to confidential information and patent rights.

The Company obtains certain raw materials and components for a number of its products from single suppliers. The Company's sources of supply could be replaced if necessary without undue disruption, but it is possible that the process of qualifying new materials and/or vendors for certain raw materials and components could cause a material interruption in manufacturing or sales. No material interruptions occurred during the last fiscal year.

The Company's inflatable penile prosthesis, saline -filled mammary implants, and catheters are available for sale under FDA approvals and/or clearances. Gel-filled mammary implants are only available as part of the adjunct clinical study. A change in raw material, components or suppliers for these products may require a new FDA submission, subsequent review and approval. There is no assurance that such a submission would be approved without delay. Any delay may have a significant adverse impact on sales and the results of operations.

The Company licenses certain technology under exclusive supplier and licensing arrangements for certain products. Those products include the following: Tutogen® processed fascia lata for the Suspend® sling, radioactive sources for its IoGold and PdGold brachytherapy seeds. In addition, the licensors are source suppliers of these products to the Company. Any interruption in their ability to supply the product to the Company may have an adverse impact on sales and the results of operations.

As of March 31, 2001, the Company employed 1,622 people of whom 969 were in manufacturing, 382 in sales and marketing, 115 in research and development and 156 in finance and administration. There has never been a work stoppage due to labor difficulties, and the Company considers its relations with its employees to be satisfactory.

The Company owns manufacturing, warehouse and office buildings in Minneapolis, Minnesota (161,965 sq. ft), Sarlat, France ( 123,800 sq. ft) and manufacturing facilities in Anoka, Minnesota ( 20,000 sq. ft.). The Company leases additional office, manufacturing and warehouse facilities in Santa Barbara, California (128,000 square feet), Eden Prairie, Minnesota (2,500), Irving, Texas (151,347 square feet), Tucson, Arizona (40,000 square feet) and Leiden, the Netherlands (15,000 square feet). The Company has international sales offices located throughout ten countries where they lease office and warehouse space ranging from 1,000 to 5,500 square feet. All leases have terms ranging from one to fifteen years, renewable on terms the Company considers favorable.

The Company believes its facilities are generally suitable and adequate to accommodate its current operations, and suitable facilities are readily available to accommodate any future expansion as necessary.

In 1998, the Company learned that the FDA's Office of Criminal Investigations (OCI) was conducting an investigation involving the Company. Mentor understood that the investigation was dormant until in April 2000, when OCI issued a letter requesting that the Company provide OCI with manufacturing data and other corporate records, which the Company subsequently provided to OCI. The Company is cooperating fully with the OCI investigation. At this time, OCI has declined to identify the specific focus of its investigation involving Mentor, and Mentor has had no direct contact with OCI regarding the investigation other than contact related to document requests. It is not possible to predict the outcome of this investigation at this time or its potential impact on Mentor. The Company believes that it is in compliance with all applicable laws, rules and regulations.

The Securities and Exchange Commission informed the Company that it is investigating, under a formal order of investigation, the events relating to the March 23, 2000 USA Today article entitled "Breast Implant manufacturer under investigation by the FDA," which was authored by Rita Rubin, and the March 23, 2000 press release issued by Mentor responding to that article, and possibly other matters. The Company is cooperating fully with the SEC's investigation. At this time, the SEC, Division of Enforcement has not identified the specific focus of its investigation involving Mentor. It is not possible to predict the outcome of this investigation at this time or its potential impact on Mentor. An investigation does not indicate that the SEC or its staff has concluded that violations of law have occurred.

Claims related to product liability are a regular and ongoing aspect of the medical device industry. At any one time, the Company is subject to claims asserted against it and is involved in products liability litigation. These actions can be brought by an individual, and/or by a group of patients purported to be a class action. The Company has carried product liability insurance on all its products, including breast implants, subsequent to May 1991 and prior to September 1985. This insurance is subject to certain self-insured retentions and limits on the policies. From September 1985 through April 1991, the Company was self insured for the majority of its surgical implant products, but had product liability insurance on the rest of its products. From June 1992 on, the Company's insurance has excluded silicone gel-filled breast implants.

In February 1999, Mentor was the plaintiff in a jury trial defending a patent exclusively licensed to Mentor by Sonique Surgical Systems, Inc. and used in ultrasonic tissue removal. Although the jury found willful infringement, the court entered a judgement in favor of the defendants, (Medical Device Alliance, Inc., Lysonics, Inc. and Misonix, Inc.). Mentor challenged the court order and in May 2001 a Federal circuit court reversed the lower court ruling and reinstated the jury award of damages. At this time, the defendants are not challenging any substantive issues in the case and only the specifics of final remedies remain to be addressed.

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

None.

The executive officers of the Company as well as their ages as of June 28, 2001, are listed below, followed by brief accounts of their business experience and certain other information.

Mr. Conway is a founder of the Company and Chairman of the Board since 1969. He served as Chief Executive Officer from 1969 to July 29, 1999. He resumed the positions of President and CEO in September 2000.

Mr. Glover is a founder and the position of Vice President, Engineering from 1969 to 1986. On October 2000 he was appointed Senior Vice President, Advanced Development.

Mr. Michael joined the Company in April 2000 as Senior Vice President, Chief Financial Officer and Treasurer. From 1989 to 2000 he was Vice President, Chief Financial Officer of Getz Brothers and Co., Inc. and from 1983 to 1989 he was a Group Controller for the Marmon Group, Inc.

Mr. Purkait joined the Company in February 1986 and has served in various research and development capacities. He was promoted to Vice President of Research and Development in 1988, and Senior Vice President in April 1998.

In May 1999, the Company announced that its Board of Directors decided to divest the ophthalmology business, which accounted for approximately 16% of sales in fiscal 1999. The Company completed the sale of the assets of the Ophthalmology division in three separate transactions throughout fiscal year 2000. Accordingly, results of operations of the ophthalmic business are reported, on a net basis, as a single line on the financials as discontinued operations.

The following table sets forth various items from the Consolidated Statements of Income as a percentage of net sales for the periods indicated:

Sales of aesthetic and general surgery products increased 5% to $157 million from $150 million in the prior year. Sales of products for reconstruction increased 6% while products used in cosmetic augmentation increased 1%. Sales of body contouring (liposuction) products declined by 14% compared to the previous year. The Aesthetic product segment is affected more than the Company's other segments by general economic conditions as a higher proportion of these surgeries are paid directly by the patient.

Sales of Clinical and Consumer Healthcare products increased 7% from the prior year. Strong growth in the sales of intermittent catheters of 12% was offset by a slight decline in male external catheter sales. The results include two months of sales from the February 2001 acquisition of Porges S.A.

Sales of aesthetic and general surgery products increased 22% from the prior year. The sales increase in this segment is attributable, in part, to direct-to-consumer advertising programs in the United States which utilize a combination of television, radio and magazine print ads to encourage consumers to seek information about breast augmentation. In addition to information, the program provides directories of local plastic surgeons that implant Mentor's products. Sales were also aided by the re-introduction of the Becker reconstruction implant into the domestic market in September 1999.

Sales of Clinical and Consumer Healthcare products increased 6% from the prior year. The increase approximates the market growth rate. Domestic sales increased 85% overall but this growth was offset by continued weakness in international markets in which sales declined 9%.

The Company's export sales independent distributors accounted for 5%, 6% and 7% of net sales for fiscal years ended March 31, 2001, 2000 and 1999, respectively. In addition, 16%, 13%, and 15% of sales in each year were from the Company's direct international sales offices.

Over the three fiscal years ended March 31, 2001, sales increases, including the effects of acquisitions, have been primarily the result of increased unit sales. General selling price changes have not been significant in recent years.

Selling, general and administrative expenses, exclusive of the restructuring charge, were 37.3% of net sales in fiscal 2001 compared to 39.5% in fiscal 2000. The decrease reflects lower spending on the Company's direct-to-consumer advertising campaign partially offset by increases in product liability reserves and information technology costs. In addition, cost savings from the Company's restructuring of corporate staff contributed to the improvement.

During fiscal 2001, the Company announced a reduction in corporate staff at its headquarters in Santa Barbara as part of a restructuring move to streamline operations and improve efficiency. Employees affected by the restructuring were provided with a severance package, outplacement counseling and extended benefits to help with the transition. This program resulted in a restructuring charge included in general and administrative expenses of $2.4 million.

Selling, general and administrative expenses decreased to 39.5% of net sales in fiscal 2000, compared to 39.9% in fiscal 1999. The small decrease reflects efficiencies of scale in the Company's selling, general and administrate spending offset by approximately $7 million of spending on the Company's direct-to-consumer advertising campaign targeting the Aesthetic surgery market.

Research and development expenses were 7.3% of net sales in fiscal 2001, an increase from 6.7% in the prior year. The increase is attributable to spending on the Company's ongoing clinical studies related to silicone gel mammary implants. In May 2000, the Company received FDA approval for saline-filled breast implants and, in July 2000, received similar regulatory clearance on our inflatable penile implants. Although the Company has successfully completed these PMAA submissions, the amount of spending on research and development is not expected to decrease as the focus of research and development efforts will shift towards new product development. In addition, the Company is committed to a variety of clinical and laboratory studies in connection with its ultrasonic liposuction equipment, gel-filled mammary implants and other products.

Research and development expenses were 6.7% of net sales in fiscal 2000, a decrease from 7.2% the prior year. The Company completed the work on its saline-filled breast implant and penile implant PMAAs and submitted the data to the FDA in fiscal 2000.

Interest expense increased to $276 thousand in fiscal 2001, from $34 thousand in fiscal 2000. In the first quarter of fiscal 2001, the Company borrowed and repaid $6 million to temporarily fund its stock repurchase program. During the fourth quarter, the Company borrowed $14 million to fund its acquisition of Porges S.A. There were no borrowings in fiscal 2000, and the Company repaid $ 4 million borrowed in 1999 to temporarily fund the stock repurchase program.

Interest income increased to $4.2 million in 2001 from $3.0 million in fiscal year 2000. The increase is a result of higher cash balances from operations and $59 million in proceeds from the sale of the assets of the ophthalmic business reported as discontinued operations which was only available for investment part of fiscal 2000. Further, the Company increased its use of fully taxable investments, which have a higher coupon rate and also benefited from higher prevailing interest rates.

Other income and expense primarily includes gains or losses on sales of marketable securities, disposals of assets, and foreign currency gains or losses related to the Company's foreign operations. In Fiscal 2001, the Company recorded a $1 million realized gain on the disposition of marketable securities recorded as long term marketable securities available for sale. In fiscal 2000, the Company recorded a $3 million permanent impairment of its equity investment in Intracel Corporation. This was offset by realized gains on the disposition of marketable securities recorded as long term marketable securities available for sale.

The effective rate of corporate income taxes was 32% for fiscal 2001 and fiscal 2000, and 34% in 1999. The decrease in the effective tax rate from fiscal 1999 to fiscal 2000 is a result of a higher proportion of income from foreign operations with lower tax rates.

In December 1998, the Company announced a restructuring plan as part of a strategic initiative to improve the profitability and competitiveness of the ophthalmic segment of its business by reducing manufacturing costs and concentrating on those products and markets capable of sustained, long-term profitable growth. During the implementation of this plan, the Board of Directors authorized management to evaluate potential buyers for the product lines of the ophthalmic business segment.

In the first quarter of fiscal 2000, the Company completed the sale of the assets of the intraocular lens business for cash consideration of $38.4 million and recorded a related gain of $7.5 million, net of $3.8 million in income taxes. On October 4, 1999, the Company completed the sale of the remaining assets of the ophthalmic equipment business for cash consideration of $21 million and recorded a related gain after income taxes of $1.1 million. Fiscal 2000 operating loss from discontinued operations, after income taxes of $1.0 million, was $.8 million.

In fiscal 2001, the Company recorded $260 thousand of income from discontinued operations, net of tax of $140 thousand, from the resolution of certain liabilities for amounts less than recorded at the time of the sale of discontinued assets.

Income from continuing operations for fiscal 2001 was $32 million, compared to $29 million for the previous year. Increased sales, lower operating expenses, and increased interest income contributed to the increase. Fiscal 2001 income from discontinued operations, net of income taxes, was $260 thousand related to the resolution of certain liabilities for amounts less than recorded at the time of disposal.

Income from continuing operations for fiscal 2000 was $29 million, compared to $20 million the previous year. Increased sales, lower operating expenses, and increased interest income contributed to the improvement. Fiscal 2000 income from discontinued operations, net of income taxes, is comprised of gains on asset sales related to the ophthalmic business of $8.5 million, net of income taxes, and loss from operations, net of income taxes of $.8 million.

The Company does not believe inflation has had a material impact on the Company's operations over the three-year period ended March 31, 2001.

 LIQUIDITY AND CAPITAL RESOURCES

During the three years ended March 31, 2001, liquidity needs have been satisfied principally by cash flow from operations and borrowings under the Company's line of credit. Despite significant acquisition and stock re-purchase activity, the Company maintained its strong cash and financial position throughout fiscal year 2001.

At March 31, 2001, working capital was $112 million compared to $124 million the previous year. The Company generated $42 million of cash from continuing operations during fiscal 2001, compared to $34 million the previous year. Increased income from continuing operations, and increases in accounts payable and accrued liabilities, and a decrease in accounts receivable contributed to the increased cash flow. These amounts were partially offset by the recognized gain on sales of marketable securities and an increase in inventory.

During fiscal 2001, the Company spent $7.5 million on purchases of manufacturing equipment and information technology. The Company anticipates investing approximately $24 million in a facility acquisition, facility upgrades, production equipment and information technology systems in fiscal 2002.

Certain technologies related to the manufacture of mammary prostheses were developed under a 1983 agreement with a limited partnership whereby the limited partners contributed money towards the development of the technology in exchange for payments based upon a percentage of future sales of the products utilizing the technology. The Company paid approximately $2 million in fiscal 2000 to the partnership. The Company was the general partner for this partnership. The agreement included an option to purchase the technology and thereby terminate the partnership. In fiscal 2001, the Company exercised its option to make a lump sum payment to the Limited Partners in lieu of all future payments and rights according to the Agreement of Purchase and Sale between Mentor Corporation and the Partnership, as amended. The Limited Partners could elect to be paid in cash, the Company's stock, or a combination. This transaction was completed in the second quarter ended September 30, 2000. The limited partners elected to be paid $1.0 million in cash and 434 thousand shares of the Company's common stock. The stock, transfer of which is restricted by rule 144, was valued at the fair market value on the date of issuance, of approximately $9 million. The decrease in payments to the partners will be offset by the increased amortization of the new intangible asset and the additional common shares outstanding, thus having a neutral effect on earnings per share.

In January 2001, the Company completed the acquisition of South Bay Medical, a development stage company focused on the development of a new technology for a computer based workstation and automated cartridge-based needle loading system for use in Brachytherapy procedures. The total consideration recorded included $2 million in cash and 235,293 shares of restricted common stock valued at $4 million, and $11 million in short and long-term payments due over the next several years.

In February 2001, Mentor acquired Porges S.A., subsidiary of Sanofi-Synthelabo headquartered in Paris, and with manufacturing facilities in Sarlat, France. Porges holds a leading market share for urological products in France and has strong market position throughout Europe. The consideration paid for Porges S.A. was $32 million.

The Company has available to it $25 million under a secured line of credit. Borrowings accrue interest at the prevailing prime rate or at a premium to LIBOR, at the Company's discretion. The line of credit includes certain covenants that, among others, limit the dividends the Company may pay and require the maintenance of certain levels of tangible net worth and debt service ratios. In the first quarter of fiscal 2001, the Company borrowed and repaid $6 million under the agreement to temporarily fund its stock repurchase plan. In February 2001, the Company borrowed $14.1 million (15 million euros) to fund the acquisition of Porges S.A. The amount was repaid in May 2001. In addition, there are several lines of credit established to facilitate operating cash flow needs at our foreign subsidiaries. These lines are at market rates of interest, unsecured, guaranteed by Mentor Corporation, and total $3.7 million. At March 31, 2001, $2.5 was outstanding under these foreign lines of credit.

Since 1995, the Company has paid a quarterly cash dividend of $.025 per share. On February 13, 2001, the Board of Directors approved an increase in the quarterly cash dividend to $.03 per share, an increase of 20%. At the indicated rate of $.12 per year, the aggregate annual dividend would equal approximately $2.8 million.

The Company's Board of Directors has authorized an ongoing stock repurchase program. The objectives of the program, among other items, are to offset the issuance of stock options, provide liquidity to the market and to reduce the overall number of shares outstanding. Repurchases are subject to market conditions and cash availability. In May 1999, the Board increased the repurchase authorization by 4 million shares. As a result, during fiscal 2001, the Company repurchased 1,493 thousand shares for consideration of $28 million. The Company intends to continue the share repurchase program in fiscal 2002 and 2.3 million shares remain authorized for repurchase.

The Company's principal source of liquidity at March 31, 2001 consisted of $64 million in cash and short term marketable securities plus $12 million available under the existing lines of credit. The Company believes that funds generated from operations, its cash and marketable securities and funds available under its line of credit will be adequate to meet its working capital and capital expenditure requirements through fiscal 2002.

Except for the historical information contained herein, the matters discussed in this Management's Discussion are forward-looking statements, the accuracy of which is necessarily subject to risks and uncertainties. Actual results may differ significantly from the discussion of such matters in the forward-looking statements.

Due to the nature of the Company's products and business, the Company has been and will be involved in various legal actions arising in the course of business, some of which involve product liability and intellectual property claims. With respect to product liability issues, the litigation and regulatory risks will continue to exist even with respect to those products that have received or in the future may receive regulatory approval for commercial sale. It is possible that adverse results arising from product liability or intellectual property actions, as well as adverse results arising from regulatory or administrative proceedings, could negatively affect the Company's future results of operations.

The Company has been and may be in the future the subject of negative publicity, which can arise from various sources, ranging from the news media to legislative and regulatory investigations. There can be no assurance that such negative publicity will not result in a material adverse effect on the Company's future financial position, its results of operations or the market price of its stock. In addition, significant negative publicity could result in an increase in product liability claims.

The Company's products, development activities and manufacturing processes are subject to extensive and rigorous regulation by the FDA and by comparable agencies in foreign countries. In the United States, the FDA regulates the introduction, manufacturing, labeling and record-keeping procedures for medical devices. The process of obtaining marketing clearance and approval from the FDA for new products and existing products can be time-consuming and expensive, and there is no assurance that such clearances or approvals will be granted or that FDA review will not involve delays that would adversely affect the Company's ability to commercialize additional products or additional applications for existing products. In addition, certain of the Company's products that are in the research and development stage may be subject to a lengthy and expensive pre-market approval ("PMA") process with the FDA. Product approvals by the FDA can also be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial approval. The FDA could also limit or prevent the manufacture or distribution of the Company's products and has the power to require the recall of such products. FDA regulations depend heavily on administrative interpretation, and there can be no assurance that future interpretations made by the FDA or other regulatory bodies will not adversely affect the Company. The FDA, various state agencies and foreign regulatory agencies inspect the Company and its facilities from time to time to determine whether the Company is in compliance with various regulations relating to manufacturing practices, validation, testing, quality control and product labeling. A determination that the Company is in violation of such regulations could lead to imposition of penalties, product recalls, consent decrees or product seizures.

Each of the Company's major business segments operates its manufacturing, warehousing and research and development activities in a single facility. While the Company has some limited protection in the form of basic insurance coverage, the Company's operating results and financial condition would be materially adversely affected in the event of a fire or similar catastrophe.

The following discussion about the Company's market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates and foreign exchange rates. The Company generally does not use derivative instruments.

The Company maintains a portfolio of highly liquid cash equivalents, with maturities of three months or less from the date of purchase. The Company also has current marketable securities consisting primarily of municipal bonds and commercial paper that are of limited credit risk and have contractual maturities of less than two years. Given the short-term nature of these investments, the Company is not subject to significant interest rate risk.

A portion of the Company's operations consists of sales activities in foreign markets. The Company manufactures its products primarily in the United States and Europe and sells them outside the U.S. through a combination of international distributors and wholly owned sales offices. Sales to third party distributors and to the wholly owned sales offices are in U.S. dollars or in Euros. The sales offices invoice their customers in their local currency.

As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in those foreign markets. The principal exposure on sales to third party distributors stems from the potential for weak economic conditions in the foreign market, thus weakening the foreign currency, decreasing the customer's buying power and potentially decreasing the Company's sales. The Company's exposure on sales to its subsidiaries consists of 1) the exposure related to the weakening of local currency when payment of the trade payable is made, thus translating into more local currency needed to pay off the U.S. denominated payable than when it was recorded, lowering the subsidiaries' earnings, and 2) upon translation of the subsidiaries' monthly financial statements, that a weakening local currency would cause lower market sales to be recorded in U.S. dollars that would have occurred had the currency been stable as compared to the U.S. dollar. However, in the latter instance, operating expenses would also be translated at lower amounts and accordingly, the effect on net income would be mitigated. The Company does not currently hedge any of these exposures.

The response to this item is submitted pursuant to Item 14 of this Annual Report on Form 10-K and incorporated herein by reference.

None.

Information concerning the directors of the Company is contained in portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended March 31, 2001 and incorporated herein by reference. For information concerning executive officers, see Item 4A of this Annual Report on Form 10-K.

The information required in this item is incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended March 31, 2001.

The information required in this item is incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended March 31, 2001.

The information required in this item is incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended March 31, 2001.

(a)(1) Consolidated Financial Statements

(a)(2) Consolidated Financial Statement Schedules

(a)(3) Exhibits

(b) Reports on Form 8-K

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

 Board of Directors and Shareholders
Mentor Corporation

We have audited the accompanying consolidated balance sheets of Mentor Corporation as of March 31, 2001 and 2000, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended March 31, 2001. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Mentor Corporation at March 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ERNST & YOUNG LLP

Los Angeles, California
May 7, 2001

The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. For those subsidiaries where the Company owns less than 100%, the outside shareholders' interests are treated as minority interests. All intercompany accounts and transactions have been eliminated. Certain prior year amounts in previously issued financial statements have been reclassified to conform to the current year presentation. Financial information presented in the Notes to Consolidated Financial Statements excludes discontinued operations, except where noted.

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

The Company considers its marketable securities available-for-sale as defined in Statement Financial Accounting Standards No. 115. Realized gains and losses and declines in value considered to be other than temporary are included in income. The cost of securities sold is based on the specific identification method. For short-term marketable securities, there were no material realized or unrealized gains or losses nor any material differences between estimated fair values, based on quoted market prices, and the costs of securities in the investment portfolio as of March 31, 2001 and 2000. The Company's short-term marketable securities consist primarily of commercial paper and municipal bonds that are of limited credit risk and have contractual maturities of less than two years.

The Company's long-term marketable securities and investments includes the Company's equity investments in its manufacturing partners, Intracel Corporation and North American Scientific, Inc. (NASI), and shares of Paradigm Medical Industries, Inc. (Paradigm) received in connection with the sale of assets of discontinued operations. Intracel Corporation is developing a new potential treatment for bladder cancer. The Intracel Corporation investment is valued and recorded at $3 million (cost of $6 million), as quoted market prices are not available. During the year ended March 31, 2000, the Company recorded a $3 million write down as a charge to other income related to its investment in Intracel Corporation. The equity interests in NASI, the Company's manufacturing partner under an exclusive agreement for the distribution of brachytherapy seeds for the treatment of prostate cancer, and in Paradigm are recorded at an aggregate fair market value of $2,704,000, (cost of $1,737,000) and $9,840,000 (cost of $2,122,000) based upon quoted stock market prices at March 31, 2001 and 2000, respectively. The unrealized gain of $629,000 and $5,017,000, net of taxes of $338,000 and $2,701,000, at March 31, 2001 and 2000, respectively, is reported within accumulated other comprehensive income included as a separate component of shareholders' equity.

During the year ended March 31, 2001, the Company sold a portion of its NASI and Paradigm securities and realized a pre-tax gain of $1 million, which is reflected in other income, net.

The Company obtains certain raw materials and components for a number of its products from single suppliers. In most cases the Company's sources of supply could be replaced if necessary without undue disruption, but it is possible that the process of qualifying new materials and/or vendors for certain raw materials and components could cause a material interruption in manufacturing or sales. No material interruptions occurred during the last fiscal year.

The Company grants credit terms in the normal course of business to its customers, primarily hospitals, doctors and distributors. As part of its ongoing control procedures, the Company monitors the credit worthiness of its customers. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. No customer accounted for more than 10% of the Company's revenues or accounts receivable balance for all periods presented.

In the United States and in those countries where the Company has sales offices, the Company employs specialized direct sales employees. The Company also markets its products through distributors in those countries where it does not have a sales office or for certain products, particularly its disposable incontinence products, through a domestic network of independent hospital supply dealers and health care distributors and through retail pharmacies.

Sales and related cost of sales are recognized primarily upon the shipment of products, or in the case of consignment inventories, upon the report of usage by the customer. The Company allows credit for products returned within its policy terms. Such returns are estimated and an allowance provided at the time of sale. The Company provides a warranty on certain of its implants and capital equipment products against defects in workmanship and material. Estimated warranty costs are provided at the time of sale and periodically adjusted to reflect actual experience.

Inventories are stated at the lower of cost or market, cost determined by the first-in, first-out (FIFO) method.

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

Intangible assets consist of values assigned to patents, licenses, and trademarks. These are stated at cost less accumulated amortization and are amortized over their economic useful life ranging from 3 to 20 years using the straight-line method. Accumulated amortization of intangibles was $5,564,000 at March 31, 2001 and $4,425,000 at March 31, 2000. The excess purchase cost over fair value of net identifiable assets acquired, goodwill, is amortized on a straight-line basis over 15 to 40 years. Accumulated amortization of goodwill was $1,882,000 at March 31, 2001 and $1,422,000 at March 31, 2000. The Company assesses on an ongoing basis the recoverability of goodwill and intangibles based on estimates of future undiscounted cash flows for the applicable business compared to net book value. If the future undiscounted cash flow estimates were less than net book value, then the net book value would then be reduced to fair value based on an estimate of discounted cash flow.

Deferred income taxes are provided on the temporary differences between income for financial statement and tax purposes.

Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") encourages but does not require companies to record compensation expense for stock options at fair value. The Company has chosen to continue to account for stock options using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB Opinion 25") and related interpretations. Accordingly, the Company has provided pro forma disclosures of the earnings per share as determined under the provision of SFAS 123.

The Company expenses media advertising costs as incurred or where applicable, upon first showing. Advertising expenses for 2001 were approximately $3.3 million, in 2000 $7.2 million and were not significant in 1999. There were no significant capitalized advertising costs as of March 31, 2001, 2000 and 1999.

Export sales to independent distributors, principally to Canada and Western Europe, were $14,342,000, $16,121,000 and $14,335,000 in 2001, 2000 and 1999, respectively. In addition, $44,182,000, $33,241,000 and $30,713,000 of sales in 2001, 2000 and 1999, respectively, were from the Company's direct international sales offices primarily in Canada and Western Europe. Income before income taxes for foreign operations was $6,445,000, $6,629,000 and 4,707,000 for fiscal 2001, 200 and 1999 respectively.

The financial statements of the Company's non-U.S. subsidiaries are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation." The assets and liabilities of certain non-U.S. subsidiaries whose "functional" currencies are other than the U.S. Dollar are translated at current rates of exchange. Revenue and expense items are translated at the average exchange rate for the year. The resulting translation adjustments are recorded directly into accumulated other comprehensive income (loss). Transaction gains and losses, other than intercompany debt deemed to be of a long-term nature, are included in net income in the period they occur. Transaction exchange gains and losses were immaterial in 2001, 2000 and 1999. The Company generally does not use derivative instruments.

In September 2000, the emerging issues Task Force (EITF) reached a final consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fee and Costs," which addresses the classification of outbound shipping and handling costs and the related revenue. The Company adopted EITF 00-10 in the fourth quarter of fiscal year 2001 resulting in a reclassification of outgoing freight revenue from a deduction from cost of sales to an increase in revenue. In accordance with the guidance, sales and cost of goods sold for all prior periods presented have been reclassified. As a result of the reclassification, fiscal 2001 sales and cost of sales increased by $2,908,000 to $268,894,000 and $104,696,000, respectively, and fiscal 2000 sales and cost of sales increased by $2,001,000 to $249,345,000 and $94,658,000, respectively, and fiscal 1999 increased by $1,793,000 to $204,576,000 and $77,967,000, respectively. These reclassifications had no effect on reported gross profit or results of operations.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101. SAB 101 summarizes certain of the SEC Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. Adoption of SAB No. 101 in the fourth quarter of fiscal 2001 did not have a significant effect on the Company's consolidated results of operations or financial position.

In June 1998, the Financial Accounting Standards Board (FASB) issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). Subsequently, the FASB issued Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133" which deferred the effective date of SFAS 133 for one year. This standard is effective for the quarter ending June 30, 2001. SFAS 133 will require the Company to record all derivatives as assets or liabilities at fair value. Changes in derivative fair values will either be recognized in earnings, offset against changes in the fair value of the related hedged assets, liabilities and firm commitments or, for forecasted transactions, recorded as a component of accumulated other comprehensive income in shareholders' equity until the hedge transactions occur and are recognized in earnings. The ineffective portion of a hedging derivative's change in fair value will depend on a variety of factors, including the extent of the Company's hedging activities, the types of hedging instruments used and the effectiveness of such instruments. Based upon the Company's limited use of derivatives and hedging, management does not anticipate that the adoption of this standard will have a significant effect on earnings or the financial position of the Company.

Financial statements prepared in accordance with generally accepted accounting principles require management to make estimates and judgments that affect amounts and disclosures reported in the financial statements. Actual results could differ from those estimates.

Inventories at March 31 consisted of:

Accumulated other comprehensive income for each classification is as follows:

Note F - Short-Term Bank Borrowings
At March 31, 2001, the Company had a secured line of credit, (the Credit Agreement), for borrowings up to $25 million. Borrowings accrue interest at the prevailing prime rate or at a mark-up over LIBOR at the Company's discretion. The Credit Agreement includes certain covenants, which, among others, limit the dividends the Company may pay and require maintenance of certain levels of tangible net worth and debt service ratios. No amounts were outstanding at March 31, 2000 and accordingly $25 million was available for borrowings.

The Company borrowed and repaid $6 million under the Credit Agreement in the first quarter of fiscal 2001 to temporarily fund its stock repurchase program. In February 2001, the Company borrowed $14.1 million under the Credit Agreement to fund its acquisition of Porges S.A. In addition, In February 2001, several lines of credit were established to facilitate operating cash flow needs at our foreign subsidiaries. These lines are at market rates of interest, unsecured, guaranteed by Mentor Corporation, and total $3.7 million. Outstanding borrowings under these arrangements at March 31, 2001 had a weighted-average interest rate of 5.96%. At March 31, 2001, $2.5 was outstanding under these foreign lines of credit. At March 31, 2001, a total of $12.1 million was available under the Credit Agreement and the foreign lines of credit.

Note G - Stock Options
The Company has granted options to key employees and non-employee directors under a qualified 2000 Plan and 1991 Plan. Options granted under both plans are exercisable in four equal annual installments beginning one year from the date of grant, and expire in ten years. Options are granted at the fair market value on the date of grant. Activity in the stock option plans during fiscal 2001, 2000 and 1999 was as follows:

At March 31, 2001, the Company had two Plans under which stock options were available, including the amended 2000 Long-term Incentive Plan (2000 Plan), approved by the Company's stockholders on October 19, 2000. At March 31, 2001, the 2000 Plan had options for 2,880,000 shares available for grant. The 1991 Plan had options for 780,100 shares and options for 1,590,125 shares available for grant at March 31, 2001 and 2000, respectively.

Stock option exercise prices are set at the closing price of the Company's common stock on the date of grant and the related number of shares granted are fixed at that point in time. Therefore under the principles of APB Opinion 25, the Company does not recognize compensation expense associated with the grant of stock options. SFAS 123 requires the use of an option valuation model to provide supplemental information regarding options granted after fiscal 1995. Pro forma information regarding net income and earnings per share shown below were determined as if the Company had accounted for its employee stock options under the Fair Value method of that statement.

The weighted average fair values of stock option granted were estimated at the date of grant using the Black-Scholes option valuation model and the following assumptions:

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options. The Company's employee stock options have characteristics significantly different from those of traded options such as vesting restrictions and extremely limited transferability. In addition, the assumptions used in option valuation models are highly subjective, particularly the expected stock price volatility of the underlying stock. Because changes in these subjective input assumptions can materially effect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options.

For purposes of pro forma disclosure, the estimated fair value of the options is amortized over the option's vesting period. The pro forma effect on net income for the year ended March 31, 1999 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants prior to 1996. In 2000, however, the pro forma results include a full four years worth of option grants. Pro forma information in future years will reflect the amortization of a larger number of stock options granted in several succeeding years. The Company's pro forma information is as follows (in thousands, except per share information):

Information regarding stock options outstanding as of March 31, 2001 is as follows:

At March 31, 2001, 2000 and 1999 stock options to purchase 1,186,595, 1,202,852 and 1,424,000 shares, respectively, were exercisable at weighted-average prices of $16.27, $13.78 and $10.73, respectively.

Income tax expense from continuing operations consists of the following:

The reconciliation of the federal statutory rate to the Company's effective rate for continuing operations is as follows:

Significant components of the Company's deferred tax liabilities and assets at March 31 are as follows:

At March 31, 2001, foreign earnings of $6,183,000 have been retained indefinitely by subsidiary companies for reinvestment, on which no U.S tax has been provided. If repatriated, additional taxes of approximately $2,164,000 on these earnings, net of applicable foreign tax credit carryforwards, would be due.

Porges S.A.
On February 9, 2001, the Company purchased all of the outstanding shares of Porges S.A. ("Porges") from Sanofi-Synthelabo. Porges is a manufacturer of urological products supplying a complete range of products for the urological surgeon, including diagnostic tools and various devices for surgery and postoperative follow-up. The Company paid $32 million in consideration for all outstanding shares of Porges and all of its foreign sales offices.

The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible net assets acquired on the basis of their respective fair values on the acquisition date. The fair value of assets acquired was determined based upon an internal valuation and by using a combination of methods, including an income approach for the intellectual properties and replacement cost for tangible assets.

The total purchase price was allocated to tangible assets of $46,224,000, intangible assets of $4,241,000, customer base of $895,000, workforce-in-place of $1,885,000 and goodwill of $2,414,000, offset by accrued liabilities of $18,363,000 and deferred income tax liabilities of $4,799,000. This allocation is preliminary and subject to adjustments as the Company completes its review and evaluation of the acquired assets and assumed liabilities.

Goodwill is being amortized over its estimated useful life of fifteen years. The other acquired intangible assets are being amortized over their estimated useful lives of five to fifteen years.

The following unaudited pro forma financial information presents the combined results of continuing operations of the Company and Porges as if the acquisition had occurred as of the beginning of each period presented, after giving effect to certain adjustments, including amortization of goodwill and intangible assets.

The pro forma results are not necessarily indicative of those that would have actually occurred had the acquisitions taken place at the beginning of the periods presented.

South Bay Medical LLC
On January 19, 2001, the Company purchased the assets of South Bay Medical LLC, a company focused on the development of a new computer based workstation and automated cartridge-based needle loading system for use in Brachytherapy procedures. The acquisition was accounted for as a purchase with the results of operations included in the Company's financial statements from the date of acquisition. Pro forma results for fiscal 2001 and 2000, assuming the acquisition occurred at the beginning of the period, would not be materially different from the results reported. The Company paid $2,000,000 in cash and issued restricted common stock valued at $4 million on the date of purchase. Additional purchase price payments will be made over the next several years as the workstation sales are made. The net present value of these amounts are recorded at March 31, 2001, in short term accrued liabilities ($3,675,000) and in long term accrued liabilities ($7,045,000) as the Company believes it is probable these payments will be paid. The purchase price allocation included $16,820,000 allocated to patents and other intangibles which will be amortized over a period not to exceed 15 years using the straight-line method. The related acquisition agreement also provides for certain other contingent amounts to be paid which will be expensed as earned based upon future sales levels.

Partnership Technologies
Certain technologies related to the manufacture of mammary prostheses were developed under a 1983 agreement with a limited partnership whereby the limited partners contributed funds towards the development of the technology in exchange for payments based upon a percentage of future sales of the products utilizing the technology. The Company paid to the partnership approximately $2 million of these payments in fiscal 2000. The Company was the general partner for this partnership. The agreement included an option to purchase the technology and thereby terminate the partnership. In fiscal 2001, the Company exercised its option to make a lump sum payment to the Limited Partners in lieu of all future payments and rights according to the Agreement of Purchase and Sale between Mentor Corporation and the Partnership, as amended. The Limited Partners could elect to be paid in cash, the Company's common stock, or a combination thereof. This transaction was completed on August 14, 2000. The Limited Partners elected to be paid $1 million in cash and 434 thousand shares of the Company's common stock which had a value of $9 million. As a result of this purchase, the Company recorded an intangible asset of $10 million which will be amortized using the straight-line method over its estimated useful life of twenty years.

Note J - Earnings per Share
A reconciliation of weighted average shares outstanding, used to calculate Basic earnings per share, to weighted average shares outstanding assuming dilution, used to calculate Diluted earnings per share, follows:

Shares issuable through options are determined using the treasury stock method.

Options to purchase 1,488,825, 980,525 and 1,114,100 shares with exercise prices greater than the average market prices of common stock were outstanding during the years ended March 31, 2001, 2000 and 1999, respectively. These options were excluded from the respective computations of diluted earnings per share because their effect would be anti-dilutive.

Note K - Commitments
The Company leases certain facilities under non-cancelable operating leases with unexpired terms ranging from one to twelve years. Most leases contain renewal options. Rental expense for these leases was $3.3 million, $3.6 million and $3.4 million for fiscal 2001, 2000 and 1999, respectively.

Future minimum lease payments under lease arrangements at March 31, 2001 are as follows:

Note L - Related Party Transactions
In 1991, the Company entered into an exclusive license agreement with Rochester Medical Corporation (Rochester) to market and distribute certain external catheter products developed by Rochester. The Company purchased $59,000, $101,000 and $1,900,000 of product from Rochester in 2001, 2000 and 1999, respectively. Several officers/founders of Rochester, a public company, are siblings of the Chairman of Mentor Corporation. The Chairman derived no financial or other benefit from transactions between the Company and Rochester.

Note M - Contingencies
Claims related to product liability are a regular and ongoing aspect of the medical device industry. At any one time, the Company is subject to claims against it and is involved in litigation. These actions can be brought by an individual, or by a group of patients purported to be a class action. The Company carries product liability insurance on all its products, except silicone gel-filled implants, which are only available within the United States through a controlled clinical study. This insurance is subject to certain self-insured retention and other limits of the policy, exclusions and deductibles that the Company believes to be appropriate. In addition, the Company also offers warranty coverage on some of its products. The Company has recorded warranty and related reserves ($12,062,000 and $6,563,000 at March 31, 2001 and 2000, respectively) in an amount it believes to be reasonably sufficient to cover the cost of anticipated warranty and product liability claims.

In 1998, the Company learned that the FDA's Office of Criminal Investigations (OCI) was conducting an investigation involving the Company. Mentor understood that the investigation was dormant until in April 2000, when OCI issued a letter requesting that the Company provide OCI with manufacturing data and other corporate records, which the Company subsequently provided to OCI. The Company is cooperating fully with the OCI investigation. At this time, OCI has declined to identify the specific focus of its investigation involving Mentor, and Mentor has had no direct contact with OCI regarding the investigation other than contact related to document requests. It is not possible to predict the outcome of this investigation at this time or its potential impact on Mentor. The Company believes that it is in compliance with all applicable laws, rules and regulations.

The Securities and Exchange Commission informed the Company that it is investigating, under a formal order of investigation, the events relating to the March 23, 2000 USA Today article entitled "Breast Implant manufacturer under investigation by the FDA," which was authored by Rita Rubin, and the March 23, 2000 press release issued by Mentor responding to that article, and possibly other matters. The Company is cooperating fully with the SEC's investigation. At this time, the SEC, Division of Enforcement has not identified the specific focus of its investigation involving Mentor. It is not possible to predict the outcome of this investigation at this time or its potential impact on Mentor. An investigation does not indicate that the SEC or its staff has concluded that violations of law have occurred.

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

Note N - Restructuring Charges and Discontinued Operations
During fiscal 2001, the Company announced a reduction in corporate staff at its headquarters in Santa Barbara as part of a restructuring move to streamline operations and improve efficiency. Employees affected by the restructuring were provided with a severance package, outplacement counseling and extended benefits to help with the transition. This program resulted in a restructuring charge included in general and administrative expenses of $2.4 million. Substantially all amounts related to the restructuring charge were paid by March 31, 2001.

In December 1998, Mentor announced a restructuring plan as part of a strategic initiative to improve the profitability and competitiveness of its ophthalmic business by reducing manufacturing costs and concentrating on those products and markets capable of sustained, long-term profitable growth.

The restructuring plan resulted in a charge to the operating results of the ophthalmic business segment of $14 million in the third quarter of fiscal 1999. The $14 million charge consisted of approximately $1.9 million for employee termination benefits related to the workforce reduction of 150 positions, $800,000 for plant closing costs, $3.3 million for the impairment write down of production assets to their estimated fair value, approximately $1 million for the write down of intangible assets related to discontinued products, and $7 million for the write down of inventory to its estimated net realizable value.

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

Consistent with the plan to dispose of its ophthalmic business segment, the net assets and operations of the ophthalmic segment of the business, comprised of the intraocular lens products and ophthalmic equipment product lines have been classified as discontinued operations.

The results of discontinued operations for the three years ending March 31, 2001, 2000 and 1999 are as follows: