Overview

We research, develop, manufacture, market, sell, distribute, and service lasers and light-based products used to perform aesthetic and cosmetic procedures. We sell our lasers to physicians and personal care practitioners. We market our products directly and through a network of distributors to end-users. Our traditional customer base includes plastic and cosmetic surgeons and dermatologists. More recently, we have expanded our sales to a broader group of practitioners consisting of general practitioners and certain specialists including obstetricians, gynecologists and general and vascular surgeons. We derive our revenue from the sales of lasers, light-based devices, and other products, as well as product-related services.

Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates and judgments on an on-going basis, including those related to revenue recognition, allowance for doubtful accounts, inventory reserves, warranty reserves, contingencies, valuation of long-lived assets, stock-based compensation, restructurings and income taxes. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and judgments under different assumptions or conditions.

A discussion of our critical accounting policies and the related estimates and judgments affecting the preparation of our consolidated financial statements is included in our Annual Report on Form 10-K for fiscal year 2008. Information with respect to changes in our Critical Accounting Policies during the three-month period ended September 27, 2008 may be found in Note 1 of the Notes to Condensed Consolidated Financial Statements (unaudited) in this Form 10-Q, which information is incorporated herein by reference.

Critical Accounting Estimates

There have been no significant changes in our critical accounting estimates during the three months ended September 27, 2008 as compared to the critical accounting estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended June 28, 2008.

Recent Accounting Pronouncements

Information with respect to Recent Accounting Pronouncements may be found in Note 1 of Notes to Condensed Consolidated Financial Statements (unaudited) in this Form 10-Q, which information is incorporated herein by reference.

Results of Operations



Revenue



Revenue source by geographic region is reflected in the following table:



                                            For the three months ended:
                            September 27,       September 29,
(in thousands)                  2008                2007            Increase (Decrease)
U.S.                      $     8,987    33 % $    16,730    47 % $       (7,743 )     -46 %
All other countries            17,886    67 %      18,743    53 %           (857 )      -5 %
Total worldwide revenue   $    26,873   100 % $    35,473   100 % $       (8,600 )     -24 %

Consolidated revenue was $26.9 million for the three-month period ended September 27, 2008, as compared to $35.5 million for the same period ended September 29, 2007. The overall decrease in quarterly revenue of approximately $8.6 million was comprised primarily of revenue declines of $7.7 million in the U.S. and $1.3 million in Europe, offset by slight increases in various other geographic regions. The decrease in U.S. and European revenues was directly related to the slowing economy combined with the tightening credit markets.

Revenue source by type is reflected in the following table:

                                              For the three months ended:
                              September 27,       September 29,
(in thousands)                    2008                2007            Increase (Decrease)
Lasers and other products   $    17,241    64 % $    26,824    76 % $       (9,583 )     -36 %
Product-related services          9,632    36 %       8,649    24 %            983        11 %
Total revenue               $    26,873   100 % $    35,473   100 % $       (8,600 )     -24 %

The decrease in revenue from lasers and other products for the three-month period ended September 27, 2008, compared to the same period ended September 29, 2007, was directly related to the general reduction in sales in the U.S. and European markets due to the slowing economy combined with the tightening credit markets.

Product-related services increased approximately $1.0 million or 11% in the three-month period ended September 27, 2008 as compared to the same period ended September 29, 2007. The increase is primarily related to the increase in the number of service-related contracts sold in addition to an increase in the number of consumables and accessories sold to support our installed base.

Gross Profit. Gross profit was approximately $10.6 million or 39.4% for the three-month period ended September 27, 2008 as compared to $17.3 million or 48.7% for the same period ended September 29, 2007. The decrease in gross profit for the three-month period ended September 27, 2008 as compared to the same period in the previous fiscal year is primarily due to changes in product mix, changes in regional mix, and a greater proportion of revenues being derived from the sale of product-related services in the current period which carry a lower margin than sales of lasers.

Selling, General and Administrative Expense. Selling, general and administrative (SG&A) expenses were approximately $15.0 million for each of the three-month periods ended September 27, 2008 and September 29, 2007, respectively. As a percentage of revenue, SG&A expenses increased to 55.7% from 42.4% of revenues in the comparative prior-year period.

Research and Development Expense. Research and development (R&D) spending decreased to approximately $2.8 million for the three-month period ended September 27, 2008, from approximately $3.0 million for the comparative prior-year period. These expenses are expected to increase in future periods, however, as the Company transitions to new projects.

Other Income/Expense. Other expense was approximately $18,000 for the three-months ended September 27, 2008, as compared to other income of approximately $1.2 million for the same period

ended September 29, 2007. The year-over-year decrease of approximately $1.2 million is due primarily to a decrease in interest income earned during the first quarter of fiscal 2009 combined with the recognition of a non-recurring gain in the prior fiscal period on the actual receipt of additional contingent cash consideration from OccuLogix, Inc. related to its merger agreement with Solx, Inc.

The decrease in interest income earned during the three-month period ended September 27, 2008, as compared to the same period in the prior fiscal year, is related to a decrease in market interest rates combined with an overall decrease in cash and cash equivalents and in marketable securities.

Income Taxes. The (benefit) provision for income taxes results from a combination of activities of the Company and its domestic and foreign subsidiaries. We recorded effective tax rates of approximately 45% and 34% for each of the three-month periods ended September 27, 2008 and September 29, 2007, respectively. The effective tax rate for the period ended September 27, 2008 differs from the statutory rate primarily due to differences in foreign tax rates and other permanent items. The foreign rate difference is due to income reported in a high tax rate jurisdiction combined with losses benefited in a jurisdiction with a lower tax rate. The effective rate for the period ended September 29, 2007 differs from the statutory rate primarily due to differences in foreign tax rates, R&D credits and other permanent items.

The Company also recorded a discrete tax expense item during the three-month period ended September 29, 2007 of $0.1 million resulting from a change in the statutory tax rate in Germany. The effect of the change in the German statutory rate on current earnings is fully reflected in our effective tax rate indicated above.

Liquidity and Capital Resources

Our cash and cash equivalents and our investment in short and long-term marketable securities at September 27, 2008 totaled approximately $29.8 million compared with approximately $45.2 million at September 29, 2007. Principal components of the decrease include growth in our inventory over the trailing twelve months, the use of cash for our stock repurchase program, and the general funding of operations. We continue to have no long-term debt. We believe that the combination of existing cash and cash equivalents, and marketable securities on hand, along with cash to be generated by future operations and amounts available under our line of credit, will be sufficient to meet our ongoing operating and capital expenditure requirements for the foreseeable future. However, we cannot be sure that we will not require additional capital beyond the amounts currently forecasted by us, or that any such required additional capital will be available on reasonable terms, if at all, as it becomes required. Please see Item 2 - Cautionary Statements for additional information.

Cash used by operating activities amounted to approximately $3.6 million for the three-month period ended September 27, 2008 as compared to cash used by operating activities of approximately $1.1 million for the same period in the prior year. The increase in cash used by operating activities is primarily attributable to our year-to-date net loss and growth in our inventory on-hand, offset by changes in accounts receivable and various other operating asset and liability accounts in the normal course of business.

Off-Balance Sheet Arrangements

Our only off-balance sheet arrangements consist of non-cancelable operating leases entered into in the ordinary course of business and the license agreement with the Regents. The table below in the next section titled "Contractual Obligations" shows the amounts of our operating lease commitments and purchase commitments payable by year.

Contractual Obligations



Outstanding contractual obligations of the Company are reflected in the
following table:



                                               Less than                                         After
(in thousands)                     Total        1 year        1 - 3 years      3 - 5 years      5 years
Royalty commitments              $   3,250    $     1,000    $       1,250    $         500    $      500
Operating leases                     3,287          1,618            1,324              229           116
Total contractual obligations    $   6,537    $     2,618    $       2,574    $         729    $      616

Cautionary Statements

Certain statements contained herein may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 ("Reform Act"). We may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases. In addition, our representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as "anticipates," "believes," "expects," "estimates," "intends," "plans," "projects," and similar expressions, may identify such forward-looking statements. Such forward-looking statements include but are not limited to: that we have the necessary infrastructure in place to capitalize on expansion; the affordability of our products will allow for expansion; that we can lower production costs; or that the market will expand beyond baby boomers. We assume no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. The risks and uncertainties that may affect forward-looking statements and/or our business include, among others, those discussed in "Cautionary Statements" in our Annual Report filed on Form 10-K for the fiscal year ended June 28, 2008, as well as other risks and uncertainties referenced in this Quarterly Report on Form 10-Q, and the following:

† On August 9, 2006, one of our competitors, Palomar Medical Technologies, Inc. ("Palomar"), alleged that the manufacture, use and sale of our products for laser hair removal willfully infringe certain United States patents. Public announcements concerning this and related litigation between the two parties that are unfavorable to us may result in significant declines in our stock price. An adverse ruling or judgment in this matter is likely to cause our stock price to decline significantly. Litigation with Palomar is expensive and is likely to be protracted, and our intellectual property position as well as our cash position may be weakened as a result of an adverse ruling or judgment. Whether or not we are successful in the pending lawsuit, litigation may consume substantial amounts of our financial resources and divert management's attention away from our core business. Please see Part II, Item 1 (Legal Proceedings) for a further discussion of the Palomar litigation.

† Claims by others that our products infringe their patents or other intellectual property rights, or that the patents which we own or have licensed rights to are invalid, could prevent us from manufacturing and selling some of our products or require us to incur substantial costs from litigation or development of non-infringing technology.

† Our principal source of liquidity is our current cash and equivalents and marketable investments. Our ability to generate cash from operations is dependant upon our ability to generate revenue from selling our lasers and other products and providing product-related services. A decrease in demand for our products and related services or increases in operating costs would likely have an adverse effect on our liquidity.

† Disappointing quarterly revenue or operating results could cause the price of our common stock to fall.

† Because we typically derive more than half of our revenue from international sales, we are susceptible to currency fluctuations, negative economic changes taking place in foreign marketplaces, and other risks associated with conducting business overseas.

† The failure to obtain alexandrite rods for certain laser systems from our sole supplier would impair our ability to manufacture and sell these laser systems, which has accounted for a substantial portion of our revenue in certain recent periods.

† Our failure to respond to rapid changes in technology and intense competition in the laser industry could make our lasers obsolete.

† Like other companies in our industry, we are subject to a regulatory review process and our failure to receive necessary government clearances or approvals could affect our ability to sell our products and remain competitive.

† We have modified some of our products without FDA clearance. The FDA could retroactively decide the modifications were improper and require us to cease marketing and/or recall the modified products.

† Achieving complete compliance with FDA regulations is difficult, and if we fail to comply, we could be subject to FDA enforcement action.

† We could incur substantial costs as a result of product liability claims, including but not limited to costs as a result of product failures for which we are responsible under warranty obligations and as a result of our customer's potential unavailability of liability insurance coverage.

† We may be unable to attract and retain management and other personnel we need to succeed.

† Our failure to maintain effective internal control over financial reporting could have a material adverse effect on our business, operating results, and stock price.

† Our failure to manage acquisitions and joint ventures effectively may divert management attention from our core business and cause us to incur debt, liabilities or costs.

We caution readers not to place undue reliance upon any forward-looking statements, which speak only as of the date made. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any such statements to reflect any change in our expectations or any change in events, conditions or circumstances on which any such statement is based.