|UNITED STATES
                                                  SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

                                                               FORM 10-Q
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|ý | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
           For the Quarter Ended March 31, 2008
|- | ---------------------------------------------------------------------------------------------------------------------------------------

|o | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
              For the transition period from ______ to ______
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|Commission file number: 0-22340






PALOMAR MEDICAL TECHNOLOGIES, INC.
|------------------------------------------------------------------------

|A Delaware Corporation | I.R.S Employer Identification No. 04-3128178
|---------------------- | --------------------------------------------

|82 Cambridge Street, Burlington, Massachusetts 01803
Registrant's telephone number, including area code: (781) 993-2300
Securities registered pursuant to Section 12(b) of the Act:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Title of each class
Common Stock, $0.01 par value | Name of each exchange on which registered
NASDAQ -Global Select Market
|------------------------------------------------- | ----------------------------------------------------------------------
|Preferred Stock Purchase Rights                  

|Securities registered pursuant to Section 12(g) of the Act:
|-----------------------------------------------------------
|None.                                                      

|Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
  YesýNo
o


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b(2) of the Exchange Act. (Check one).
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Large accelerated filer o  Accelerated filer  ý   Non-accelerated filer  o  Smaller reporting company  o
(Do not check if a smaller                 reporting company)

Indicate by check mark if the registrant is a shell company, in Rule 12b(2) of the Exchange Act.    Yes  o    No   ý

The number of shares outstanding of the
registrants common stock as of the close of business on May 2, 2008 was 18,248,012.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|Palomar Medical
Technologies, Inc. and Subsidiaries

Table of Contents
|----------------------------------------------------------------------

|                               |                                                                                                                              |  | Page No.
|------------------------------ | ---------------------------------------------------------------------------------------------------------------------------- |  | --------
|PART I - Financial Information |                                                                                                                              |  |         
|                               |                                                                                                                              |  |         
|                               |                                                                                                                              |  |         
|Item 1.                        | Financial Statements                                                                                                         |  |         
|                               | Unaudited Condensed Consolidated Balance Sheets as of
         March 31, 2008 and December 31, 2007                          |  | 3       
|                               | Unaudited Condensed Consolidated Statements of Income for the periods ending
         March 31, 2008 and March 31, 2007      |  | 4       
|                               | Unaudited Condensed Consolidated Statements of Cash Flows for the periods ending
          March 31, 2008 and March 31, 2007 |  | 5       
|                               | Notes to Unaudited Condensed Consolidated Financial Statements                                                               |  | 6       
|Item 2.                        | Management's Discussion and Analysis of Financial Condition and the
              Results of Operations                      |  | 17      
|                               | Cautionary Statements                                                                                                        |  | 24      
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                                                                   |  | 35      
|Item 4.                        | Controls and Procedures                                                                                                      |  | 35      
|                               |                                                                                                                              |  |         
|PART II - Other Information    |                                                                                                                              |  |         
|                               |                                                                                                                              |  |         
|Item 1.                        | Legal Proceedings                                                                                                            |  | 36      
|Item 2.                        | Changes in Securities, Use of Proceeds and Issuer Purchases of Securities                                                    |  | 38      
|Item 3.                        | Defaults Upon Senior Securities                                                                                              |  | 38      
|Item 4.                        | Submission of Matters to a Vote of Security Holders                                                                          |  | 38      
|Item 5.                        | Other Information                                                                                                            |  | 38      
|Item 6.                        | Exhibits                                                                                                                     |  | 39      
|SIGNATURES                     |                                                                                                                              |  | 40      

|
|

|
|

|Palomar Medical
Technologies, Inc. and Subsidiaries
Condensed Consolidated
Balance Sheets (Unaudited)
|-----------------------------------------------------------------------------------------------------

|                                                                        | March 31,
2008 | December 31,
2007
|----------------------------------------------------------------------- | -------------- | -----------------
|Assets                                                                  |                |                  
|                                                                        |                |                  
|Current assets                                                          |                |                  
|Cash and cash equivalents                                               |                |                  
|Available-for-sale investments                                          |                |                  
|Accounts receivable, net                                                |                |                  
|Inventories                                                             |                |                  
|Deferred tax assets                                                     |                |                  
|Other current assets                                                    |                |                  
|                                                                        |                |                  
|Total current assets                                                    |                |                  
|                                                                        |                |                  
|Marketable securities                                                   |                |                  
|                                                                        |                |                  
|Property and equipment, net                                             |                |                  
|                                                                        |                |                  
|Other assets                                                            |                |                  
|                                                                        |                |                  
|Total assets                                                            |                |                  
|                                                                        |                |                  
|Liabilities and Stockholders' Equity                                    |                |                  
|                                                                        |                |                  
|Current liabilities                                                     |                |                  
|Accounts payable                                                        |                |                  
|Accrued liabilities                                                     |                |                  
|Deferred revenue                                                        |                |                  
|                                                                        |                |                  
|Total current liabilities                                               |                |                  
|                                                                        |                |                  
|Deferred income taxes                                                   |                |                  
|                                                                        |                |                  
|Total liabilities                                                       |                |                  
|                                                                        |                |                  
|Stockholders' equity                                                    |                |                  
|Preferred stock, $0.01 par value-                                       |                |                  
|Authorized - 1,500,000 shares                                           |                |                  
|Issued -  none                                                          |                |                  
|Common stock, $0.01 par value-                                          |                |                  
|Authorized - 45,000,000 shares                                          |                |                  
|Issued and outstanding - 18,453,012 and 18,442,846 shares, respectively |                |                  
|Additional paid-in capital                                              |                |                  
|Accumulated other comprehensive income                                  |                |                  
|Accumulated deficit                                                     |                |                  
|Treasury stock, at cost - 205,000 and 105,000 shares, respectively      |                |                  
|                                                                        |                |                  
|Total stockholders' equity                                              |                |                  
|                                                                        |                |                  
|Total liabilities and stockholders equity                              |                |                  
|                                                                        |                |                  

|See accompanying notes to condensed
consolidated financial statements.
3







Palomar Medical Technologies, Inc. and Subsidiaries
                               Condensed Consolidated Statements of Income
                                                (Unaudited)
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                     | Three Months Ended
March 31, | 
|-------------------------------------------------------------------- | ---------------------------- | 
|
|Revenues                                                             |                              | 
|Product revenues                                                     |                              | 
|Royalty revenues                                                     |                              | 
|Funded product development revenues                                  |                              | 
|Other revenues                                                       |                              | 
|                                                                     |                              | 
|Total revenues                                                       |                              | 
|                                                                     |                              | 
|Costs and expenses                                                   |                              | 
|Cost of product revenues                                             |                              | 
|Cost of royalty revenues                                             |                              | 
|Research and development                                             |                              | 
|Selling and marketing                                                |                              | 
|General and administrative                                           |                              | 
|                                                                     |                              | 
|Total costs and expenses                                             |                              | 
|                                                                     |                              | 
|(Loss) income from operations                                        |                              | 
|                                                                     |                              | 
|Interest income                                                      |                              | 
|Other income                                                         |                              | 
|                                                                     |                              | 
|(Loss) income before income taxes                                    |                              | 
|                                                                     |                              | 
|(Benefit from) provision for income taxes                            |                              | 
|                                                                     |                              | 
|Net (loss) income                                                    |                              | 
|                                                                     |                              | 
|                                                                     |                              | 
|Net (loss) income per share                                          |                              | 
|Basic                                                                |                              | 
|                                                                     |                              | 
|Diluted                                                              |                              | 
|                                                                     |                              | 
|Weighted average number of shares outstanding                        |                              | 
|Basic                                                                |                              | 
|                                                                     |                              | 
|Diluted                                                              |                              | 
|                                                                     |                              | 
|                                                                     |                              | 
|Comprehensive (loss) income:                                         |                              | 
|Net (loss) income                                                    |                              | 
|Unrealized loss from marketable securities, net of taxes of $219,752 |                              | 
|Foreign currency translation adjustment                              |                              | 
|                                                                     |                              | 
|Comprehensive (loss) income                                          |                              | 
|                                                                     |                              | 

|See accompanying notes to condensed
consolidated financial statements.



4



Palomar Medical Technologies, Inc. and Subsidiaries
                             Condensed Consolidated Statements of Cash Flows
                                                (Unaudited)
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                                            | Three Months Ended
March 31, | 
|------------------------------------------------------------------------------------------- | ---------------------------- | 
|
|Operating activities                                                                        |                              | 
|Net (loss) income                                                                           |                              | 
|                                                                                            |                              | 
|Adjustments to reconcile net (loss) income to net cash (used in) from operating activities: |                              | 
|Depreciation and amortization                                                               |                              | 
|Stock-based compensation expense                                                            |                              | 
|Provision for bad debt                                                                      |                              | 
|Inventory write-off                                                                         |                              | 
|Tax benefit from the exercise of stock options                                              |                              | 
|Other non-cash items                                                                        |                              | 
|Changes in assets and liabilities:                                                          |                              | 
|Accounts receivable                                                                         |                              | 
|Inventories                                                                                 |                              | 
|Deferred tax assets                                                                         |                              | 
|Other current assets                                                                        |                              | 
|Accounts payable                                                                            |                              | 
|Accrued liabilities                                                                         |                              | 
|Deferred revenue                                                                            |                              | 
|Deferred income taxes                                                                       |                              | 
|                                                                                            |                              | 
|Net cash (used in) from operating activities                                                |                              | 
|                                                                                            |                              | 
|Investing activities                                                                        |                              | 
|Capital expenditures                                                                        |                              | 
|Purchases of available-for-sale investments                                                 |                              | 
|Proceeds from sale of available-for-sale investments                                        |                              | 
|                                                                                            |                              | 
|Net cash from (used in) investing activities                                                |                              | 
|                                                                                            |                              | 
|                                                                                            |                              | 
|Financing activities                                                                        |                              | 
|Proceeds from the exercise of stock options                                                 |                              | 
|Tax benefit from the exercise of stock options                                              |                              | 
|Purchases of common stock                                                                   |                              | 
|Costs incurred related to issuance of common stock                                          |                              | 
|                                                                                            |                              | 
|Net cash (used in) from financing activities                                                |                              | 
|                                                                                            |                              | 
|Net increase in cash and cash equivalents                                                   |                              | 
|Cash and cash equivalents, beginning of the period                                          |                              | 
|                                                                                            |                              | 
|Cash and cash equivalents, end of the period                                                |                              | 
|                                                                                            |                              | 
|Supplemental disclosure of cash flow information                                            |                              | 
|Cash paid for income taxes                                                                  |                              | 
|                                                                                            |                              | 

|See accompanying notes to condensed
consolidated financial statements.

5
|-------------------------------------------------------------------------

|Palomar Medical
Technologies, Inc. and Subsidiaries Notes to Condensed
Consolidated Financial Statements (Unaudited)


 Note 1 
Basis of presentation


The
accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States for interim
information. The consolidated balance sheet at December 31, 2007 has been derived from the
audited balance sheet at that date; however, the accompanying financial statements do not
include all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The results of operations
for the interim periods shown in this report are not necessarily indicative of expected
results for any future interim period or for the entire fiscal year. We believe that the
quarterly information presented includes all adjustments (consisting of normal, recurring
adjustments) necessary for a fair presentation in accordance with accounting principles
generally accepted in the United States. The accompanying condensed consolidated financial
statements and notes should be read in conjunction with our Form 10-K for the year ended
December 31, 2007.


Beginning
in 2007, certain balance sheet reclassifications have been made. Accordingly, such amounts
related to fiscal 2007 have been reclassified in the accompanying Condensed Consolidated
Statements of Cash Flows to conform to the current year presentation.



Note 2 
Stock-based compensation


During
the three months ended March 31, 2008, we granted 1,315,500 stock options. The options
granted to employees and directors have exercise prices equal to the fair market value on
the date of grant of $13.31, and which expire ten years from the date of grant. 700,000 of
these options vested immediately on the date of grant while the remaining 615,000 vest
annually over a three-year period.


Our
loss before taxes and net loss were increased by $3.3 million for the three months ended
March 31, 2008 and our income before taxes and net income were increased by $15,000 for
the three months ended March 31, 2007, as a result of the SFAS 123(R) stock-based
compensation expense or benefit, respectively. The compensation expense for the three months ended March 31, 2008
decreased basic and diluted earnings per share by $0.18 while the compensation benefit for
the three months ended March 31, 2007 had no effect on basic and diluted earnings per
share. As of March 31, 2008, there was $8.7 million of unrecognized compensation expense
related to non-vested market-based share awards. The expense is expected to be recognized
over a weighted-average period of 3.2 years.


6


Stock Options


The
following table summarizes our stock option activity since December 31, 2007:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | Number of
Shares | Exercise Price | Weighted
Average
Exercise
Price | Weighted
Average
Remaining
Contractual
Term
(in Years) | Aggregate
Intrinsic
Value
|------------------------------ | ---------------- | -------------- | ------------------------------- | ------------------------------------------------------ | -------------------------
|Outstanding, December 31, 2007 | 3,480,489        | $0.90 - $26.00 | $     16.44                     | 6.05                                                   | $5,148,147               
|                               |                  |                |                                 |                                                        |                          
|                               |                  |                |                                 |                                                        |                          
|Granted                        | 1,315,000        | $13.31         | $     13.31                     |                                                        |                          
|Exercised                      | (166)            | $  4.50        | $       4.50                    |                                                        |                          
|Canceled                       | (1,366,600)      | $1.00 - $16.53 | $     16.52                    
|                               |                  |                |                                 |                                                        |                          
|Outstanding, March 31, 2008    | 3,428,723        | $0.90 - $26.00 | $     15.20                     | 7.34                                                   | $7,402,986               
|                               |                  |                |                                 |                                                        |                          
|Exercisable, March 31, 2008    | 2,813,723        | $0.90 - $26.00 | $     15.62                     | 6.78                                                   | $6,302,136               
|                               |                  |                |                                 |                                                        |                          
|                              

|The total
intrinsic value for stock options exercised during the three months ended March 31, 2008
and 2007 was $1,474 and $7,330,361, respectively.


The
following table summarizes information about stock options outstanding as of March 31,
2008:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Options Outstanding | Options Exercisable |            |        |           |       
|------------------- | ------------------- | ---------- | ------ | --------- | ------
|
|$0.90   -   $1.00   | 224,161             | 2.89 years | $0.97  | 224,161   | $0.97 
|1.97   -      2.19  | 39,300              | 1.56 years | 1.98   | 39,300    | 1.98  
|3.19   -     4.50   | 49,289              | 2.29 years | 3.52   | 49,289    | 3.52  
|5.05   -     7.28   | 75,382              | 4.20 years | 5.07   | 75,382    | 5.07  
|8.11   -   10.72    | 4,433               | 2.45 years | 10.09  | 4,433     | 10.09 
|13.66   -   16.00   | 1,331,333           | 9.86 years | 13.32  | 716,333   | 13.33 
|16.53   -   16.53   | 1,049,325           | 5.94 years | 16.53  | 1,049,325 | 16.53 
|23.61   -   26.00   | 655,500             | 7.09 years | 24.64  | 655,500   | 24.64 
|                    |                     |            |        |           |       
|$0.90   - $26.00    | 3,428,723           | 7.34 years | $15.20 | 2,813,723 | $15.62
|                    |                     |            |        |           |       

|We
granted 1,440,000 performance based stock options in 2004 to employees and directors with
exercise prices equal to the fair market value on the date of grant of $16.53, and which
expire ten years from the date of grant. 815,000 of these options would vest upon Gillette
making a Launch Decision as defined under the original Development and License
Agreement, and the remaining 625,000 of these options would vest twelve months after the
Launch Decision. On December 21, 2007, we announced an agreement with Gillette to extend
the Launch Decision until no later than February 29, 2008. During this extension, we
negotiated with Gillette and its parent company, The Procter and Gamble Company (P&G),
for a new agreement to replace the existing one. On February 29, 2008, we entered into a
License Agreement with P&G under which we granted a non-exclusive license to certain
patents and technology to commercialize home-use, light-based hair removal devices for
women. As a Launch Decision did not occur under the original Development and License
Agreement, on February 29, 2008, the 1,365,000 performance based stock options which
remained outstanding were cancelled and the related stock-based payment expense was never
incurred.



7






On
February 29, 2008, we granted 1,315,000 stock options to employees and directors with
exercise prices equal to the fair market value on the date of grant of $13.31, and which
expire ten years from the date of grant. 700,000 of these options vested immediately on
the date of grant while the remaining 615,000 vest annually over a three-year period.
Starting Q2 2008, we expect our stock-based payment expense related to these options to be
approximately $200,000 a quarter through February 27, 2011. The total compensation expense
for the options granted on February 29, 2008 is expected to be approximately $5.2 million,
of which $3.0 million was recorded in Q1 2008.



Stock-Settled Stock
Appreciation Rights


The
granted stock-settled stock appreciation rights (SARs) are awards that allow the recipient
to receive an amount of our common stock equal to the appreciation (if any) in the fair
market value of our common stock on the date of exercise over the initial SAR valuation
set on the date of grant per share of common stock for the number of shares vested. In
2007, stock-settled SARs were granted and the initial SAR valuation per share of the
common stock was set at 50 percent of the fair market value of our common stock on the
date of grant, and the holders right to receive shares of common stock under these
grants occurs automatically on the vesting date. No stock-settled SARs were granted in the
three months ended March 31, 2008.


The
following table summarizes our stock-settled stock appreciation rights activity since
December 31, 2007:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | Number of
Shares | Weighted
Average
Conversion
Price | Weighted
Average
Remaining
Contractual
Term
(in Years) | Aggregate
Intrinsic Value
|------------------------------ | ---------------- | --------------------------------- | ------------------------------------------------------ | -------------------------
|
|Outstanding, December 31, 2007 |                  |                                   |                                                        |                          
|                               | 477,500          | $     14.40                       | 3.59                                                   | --                       
|                               |                  |                                   |                                                        |                          
|Granted                        | --               | --                                | --                                                    
|Converted                      | --               | --                                | --                                                    
|Canceled                       | (6,000)          | $     14.40                       | --                                                    
|                               |                  |                                   |                                                        |                          
|Outstanding, March 31, 2008    | 471,500          | $     14.40                       | 3.36                                                   | $330,050                 
|                               |                  |                                   |                                                        |                          
|Vested, March 31, 2008         | --               | --                                | --                                                     | --                       
|                               |                  |                                   |                                                        |                          
|                              

|Warrants


The
following table summarizes our warrant activity since December 31, 2007:
|---------------------------------------------------------------------------------------

|                               | Number of
Shares | Exercise Price | Weighted
Average
Exercise
Price | Weighted
Average
Remaining
Contractual
Term | Aggregate
Intrinsic Value
|------------------------------ | ---------------- | -------------- | ------------------------------- | ------------------------------------------- | -------------------------
|Outstanding, December 31, 2007 | 75,000           | $1.97 - $3.19  | $     2.76                      | 1.86                                        | $941,812                 
|                               |                  |                |                                 |                                             |                          
|Exercised                      | (10,000)         | $2.81          | $     2.81                      |                                             |                          
|                               |                  |                |                                 |                                             |                          
|Outstanding, March 31, 2008    | 65,000           | $1.97 - $3.19  | $     2.75                      | 1.53                                        | $802,437                 
|                               |                  |                |                                 |                                             |                          
|Exercisable, March 31, 2008    | 65,000           | $1.97 - $3.19  | $     2.75                      | 1.53                                        | $802,437                 
|                               |                  |                |                                 |                                             |                          
|                              

|The total
intrinsic value for warrants exercised for the three months ended March 31, 2008 and 2007
were $111,175 and $0, respectively.


8






The
following table summarizes information about warrants outstanding as of March 31, 2008:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Warrants Outstanding | Warrants Exercisable |            |       |        |      
|-------------------- | -------------------- | ---------- | ----- | ------ | -----
|
|$1.97 - $1.97        | 20,000               | 1.84 years | $1.97 | 20,000 | $1.97
|2.81 -   2.81        | 10,000               | 2.18 years | 2.81  | 10,000 | 2.81 
|3.19 -    3.19       | 35,000               | 1.17 years | 3.19  | 35,000 | 3.19 
|                     |                      |            |       |        |      
|$1.97 - $3.19        | 65,000               | 1.53 years | $2.75 | 65,000 | $2.75
|                     |                      |            |       |        |      

|Note 3  Inventories


Inventories
are valued at the lower of cost (first-in, first-out method) or market, and include
material, labor and manufacturing overhead. At March 31, 2008 and December 31, 2007,
inventories consisted of the following:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                | March 31,
2008 | December 31,
2007
|--------------- | -------------- | -----------------
|
|Raw materials   | $  6,153,273   | $  5,541,725     
|Work in process | 2,155,590      | 1,383,689        
|Finished goods  | 6,829,617      | 5,970,740        
|                |                |                  
|Total           | $15,138,480    | $12,896,154      
|                |                |                  

|Note 4  Property
and equipment


Property
and equipment are recorded at cost. Repairs and maintenance costs are expensed as
incurred. Depreciation and amortization are provided using the straight-line method over
the estimated useful lives of property and equipment. At March 31, 2008 and December 31,
2007, property and equipment consisted of the following:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         | March 31, 2008 | December 31, 2007 | Estimated
useful life                            
|------------------------ | -------------- | ----------------- | -------------------------------------------------
|Machinery and equipment  | $   1,974,609  | $   1,902,425     | 3-8 years                                        
|Furniture and fixtures   | 3,092,435      | 2,956,610         | 5 years                                          
|Leasehold improvements   | 537,648        | 517,673           | Shorter of estimated useful life or term of lease
|                         |               
|                         | 5,604,692      | 5,376,708        
|Accumulated depreciation | (4,287,221)    | (4,126,271)       |                                                  
|                         |               
|Total                    | $    1,317,471 | $     1,250,437  
|                         |               

|Note 5  Warranty
costs


We
typically offer a one-year warranty for all of our base units. We provide for the
estimated cost of product warranties at the time product revenue is recognized. Factors
that affect our warranty reserves include the number of units sold, historical and
anticipated rates of warranty repairs, and the cost per repair. We assess the adequacy of
the warranty provision and we may adjust this provision if necessary.


9






The
following table provides the detail of the change in our product warranty accrual, which
is a component of accrued liabilities on the condensed Consolidated Balance Sheets for the
three months ended March 31, 2008 and 2007:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                   | Three Months Ended
March 31, | 
|-------------------------------------------------- | ---------------------------- | 
|
|Warranty accrual, beginning of period              |                              | 
|Charges to cost and expenses relating to new sales |                              | 
|Costs of product warranty claims                   |                              | 
|                                                   |                              | 
|Warranty accrual, end of period                    |                              | 
|                                                   |                              | 

|Note 6  Fair Value
of Financial Instruments


In
September 2006, the Financial Accounting Standards Board issued Statement on Financial
Accounting Standards No. 157, Fair Value Measurements (SFAS 157). This
standard establishes a single authoritative definition of fair value, sets out a framework
for measuring fair value and requires additional disclosures about fair value
measurements. SFAS 157 applies to fair value measurements already required or
permitted by existing standards. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and interim periods within
those fiscal years. The changes to current generally accepted accounting principles from
the application of this Statement relate to the definition of fair value, the methods used
to measure fair value, and the expanded disclosures about fair value measurements.



As
of January 1, 2008, we adopted SFAS 157. We performed an analysis of our investments held
at March 31, 2008 to determine the significance and character of all inputs to their fair
value determination. The adoption of the standard requires additional disclosures about
the inputs used to develop the measurements and the effect of certain measurements on
changes in fair value for each reporting period.


SFAS 157
establishes a fair value hierarchy that prioritizes the inputs to valuation techniques
used to measure fair value into the following three broad categories.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | Level 1  Inputs are
unadjusted, quoted prices in active markets for identical assets or liabilities at the
measurement date.
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------------

| |  | o |  | Level 2  Inputs (other than quoted prices included in Level 1)
are either directly or indirectly observable for the asset or
liability through correlation with market data at the measurement date and for the
duration of the instruments anticipated life.
| |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | Level 3  Inputs reflect managements best estimate of what market participants
would use in pricing the asset or liability at the measurement date. Consideration is
given to the risk inherent in the valuation technique and the risk inherent in the inputs
to the model.
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10


Fair Value on a Recurring
Basis


Assets
and liabilities measured at fair value on a recurring basis are categorized in the tables
below based upon the lowest level of significant input to the valuations. The following
table presents our assets measured at fair value on a recurring basis as of March 31, 2008
and 2007.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Assets                            | Fair Value as of March 31, 2008 |             |         |        
|--------------------------------- | ------------------------------- | ----------- | ------- | -------
|In thousands                      | Level 1                         | Level 2     | Level 3 | Total  
|                                  |                                 |             |         |        
|Auction-rate preferred securities | $        --                     | $        -- | $16,332 | $16,332
|                                  |                                 |             |         |        
|Auction-rate municipal securities | --                              | --          | 5,032   | 5,032  
|                                  |                                 |             |         |        
|Total                             | $        --                     | $        -- | $21,364 | $21,364
|                                  |                                 |             |         |        

|Assets                            | Fair Value as of March 31, 2007 |             |             |         
|--------------------------------- | ------------------------------- | ----------- | ----------- | --------
|In thousands                      | Level 1                         | Level 2     | Level 3     | Total   
|                                  |                                 |             |             |         
|Auction-rate preferred securities | $   24,550                      | $        -- | $        -- | $ 24,550
|                                  |                                 |             |             |         
|Auction-rate municipal securities | 57,348                          | --          | --          | 57,348  
|                                  |                                 |             |             |         
|Total                             | $    81,898                     | $        -- | $        -- | $ 81,898
|                                  |                                 |             |             |         

Level 3 Gains and Losses

|The
table presented below summarizes the change in balance sheet carrying values associated
with Level 3 financial instruments for the three months ended March 31, 2008.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|In thousands                      | Auction-rate
preferred securities | Auction-rate
municipal securities | Total
|--------------------------------- | --------------------------------- | --------------------------------- | -----
|
|Balance at December 31, 2007      |                                   |                                   | $    
|Net payments, purchases and sales |                                   |                                   |      
|Net transfers in/(out)            |                                   |                                   |      
|Gains/(losses)                    |                                   |                                  
|Realized                          |                                   |                                   |      
|Unrealized                        |                                   |                                   |      
|                                  |                                   |                                   |      
|Balance at March 31, 2008         |                                   |                                   | $    
|                                  |                                   |                                   |      

|At
March 31, 2008, we held $21.9 million in auction-rate securities (ARS). The ARS we
typically invest in are high quality, AAA-rated securities, none of which are
mortgage-backed, with interest rates often ranging from 3 to 14%. At December 31, 2007,
because of the short-term nature of our investment in these securities, they were
classified as available-for-sale and included in short-term investments on our
consolidated balance sheets. Subsequent to December 31, 2007 and through March 31, 2008,
our securities failed at auction due to a decline in liquidity in the ARS and other
capital markets. We will not be able to access our investments in ARS until future
auctions are successful, ARS are called for redemption by the issuers, or until sold in a
secondary market, which is not currently active. Until the auctions for our ARS are
successful, we have the potential to benefit from a penalty feature in our interest rates
which allows us to earn higher rates of interest on these securities. As our investments
in ARS currently lack short-term liquidity, we have reclassified these investments as
non-current as of March 31, 2008. We have also determined that the fair value of our ARS
was temporarily impaired as of March 31, 2008. For the three months ending March 31,
2008, we marked to market our ARS and recorded an unrealized loss of $341,000 in accumulated other comprehensive (loss)
income, net of taxes, in stockholder's equity to reflect the temporary impairment of our ARS.
The recovery of these investments is based upon market factors which are not within our control.


We
continue to monitor the market for auction-rate securities and consider its impact, if
any, on the fair value of our investments. If current market conditions deteriorate
further, we may be required to record additional unrealized losses in other comprehensive
(loss) income. If the credit rating of the security issuers deteriorates, or the
anticipated recovery in market values does not occur, we may be required to adjust the
carrying value of these investments through impairment charges in our Consolidated
Statement of Income.
11







Note 7  Geographic
information


North
America product revenue was $11.2 million and $19.8 million for the three months ended
March 31, 2008 and 2007, respectively. International product revenue outside North
America, consisting of revenue from our distributors and our sales shipped directly to
customers was $6.5 million and $7.6 million for the three months ended March 31, 2008 and
2007, respectively. The following table represents the percentage of product revenue by
geographic region for the three months ended March 31, 2008 and 2007:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                          | Three Months Ended
March 31, |       
|------------------------- | ---------------------------- | ------
|
|North America             | 63.5%                        | 72.2% 
|Europe                    | 17.2%                        | 10.7% 
|South and Central America | 6.3%                         | 2.4%  
|Japan                     | 4.3%                         | 3.0%  
|Middle East               | 4.0%                         | 3.1%  
|Asia/Pacific Rim          | 3.5%                         | 7.3%  
|Australia                 | 1.2%                         | 1.3%  
|                          |                              |       
|Total                     | 100.0%                       | 100.0%
|                          |                              |       
|                         

|Note 8  Net (loss)
income per common share


Basic
net (loss) income per share was determined by dividing net (loss) income by the weighted
average common shares outstanding during the period. Diluted net income per share was
determined by dividing net income by the diluted weighted average shares outstanding.
Diluted weighted average shares reflect the dilutive effect, if any, of stock options,
stock appreciation rights, and warrants based on the treasury stock method.


A
reconciliation of basic and diluted shares for the three months ended March 31, 2008 and
2007 is as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                      | Three Months Ended
March 31, |           
|----------------------------------------------------- | ---------------------------- | ----------
|
|Basic weighted average number of shares outstanding   | 18,313,701                   | 18,129,429
|Potential common shares pursuant to stock options,   
|stock appreciation rights, and warrants               | --                           | 1,291,968 
|                                                      |                              |           
|Diluted weighted average number of shares outstanding | 18,313,701                   | 19,421,397
|                                                      |                              |           
|                                                     

|At
March 31, 2008, approximately 3.4 million weighted average options to purchase shares of
our common stock were excluded from the computation of diluted earnings per share because
the effect of including the options would have been antidilutive.

12

Note 9  Development and
License Agreement with The Gillette Company and New License Agreement with The Procter
& Gamble Company (and its wholly owned subsidiary The Gillette Company)


Effective
as of February 14, 2003, we entered into a Development and License Agreement (the
Agreement) with Gillette to complete the development and commercialize a
home-use, light-based hair removal device for women. In October 2005, The Procter &
Gamble Company (P&G) (NYSE: PG) completed its acquisition of Gillette. Under the
Agreement, Procter & Gamble, as the acquiring party, assumed all of Gillettes
rights and obligations. The agreement provided for up to $7 million in support of research
and development to be paid by Gillette over approximately 30 months. Effective as of June
28, 2004, we completed the initial phase of the Agreement and both parties decided to move
onto the next phase. Accompanying this decision, we amended the Agreement, whereby,
Gillette provided $2.1 million in additional development funding to further technical
innovations over a 9-month extension of the development phase, which was completed on
August 31, 2006 (the Development Phase).


On
September 29, 2006, in response to a first decision point in the Agreement, Gillette
decided to continue with the project. On December 8, 2006, over-the-counter clearance was
obtained from the United States Food and Drug Administration for the device and, per the
Agreement, Gillette was obligated to make a development completion payment to us of $2.5
million, which was paid on December 26, 2006. The $2.5 million payment was recorded as
revenue over a 12 month period, as we were obligated to perform additional services to
Gillette during that period in consideration for this payment.


Gillette
was to conduct approximately 12 months of commercial assessment tests with respect to the
device. Based on the commercial assessment tests, Gillette was to decide by January 7,
2008 whether or not to continue with the project (the Launch Decision). On
February 21, 2007, we announced an amendment to our agreement with Gillette to include the
development and commercialization of an additional home-use, light-based hair removal
device for women, and we also announced that we had executed an amended and restated joint
development agreement to incorporate other amendments, including several new amendments to
allow for more open collaboration through commercialization. With regard to the additional
home-use, light-based hair removal device for women, we completed certain development
activities in consultation with Gillette during an eleven month program. Gillette provided
us with $1.2 million and an additional $300,000 upon the completion of certain
deliverables which was recognized over an eleven month period as costs were incurred and
services were provided.


On
December 21, 2007, we announced an agreement with Gillette to extend the Launch Decision
until no later than February 29, 2008. During this extension period, we negotiated with
Gillette and its parent company P&G for a new agreement to replace the existing one.
On February 29, 2008, we entered into a License Agreement with P&G under which we
granted a non-exclusive license to certain patents and technology to commercialize
home-use, light-based hair removal devices for women. This License Agreement terminated
and replaced the prior Development and License Agreement.


For
the three months ended March 31, 2008 and 2007, we recognized $198,000 and $844,000 of
funded product development revenues from P&G and Gillette, respectively, under the
Development and License Agreement. As of March 31, 2008 and 2007, $0 and $2.9 million,
respectively, of advance payments received from P&G and Gillette for which services were
not yet provided were included in deferred revenue, under the Development and License
Agreement.


Under
the new License Agreement, for the three months ended March 31, 2008, we recognized $1.25
million of other revenues from P&G. This $1.25 million is a quarterly technology
transfer payment (TTP Quarterly Payment as defined in the License Agreement).
TTP Quarterly Payments will be made by P&G during the term of the License Agreement
up to and including the quarter in which P&G launches the first Licensed Product (as
defined in the License Agreement). Thereafter TTP and royalty payments will be based on
product sales as set forth in the License Agreement. TTPs, including the TTP Quarterly
Payments, are non-creditable and non-refundable and there is no right of offset.
13






For
more information, please see the License Agreement filed as Exhibit 10.1 to our Current
Report on Form 8-K filed March 3, 2008, the Development and License Agreement and
subsequent amendments filed as Exhibit 10.1 to our Current Report on Form 8-K filed on
February 19, 2003, Exhibits 99.1, 99.2, and 99.3 to our Current Report on Form 8-K filed
on June 28, 2004, Exhibit 10.30 to our Annual Report on Form 10-K filed on March 6, 2006,
and Exhibits 10.1 and 10.2 to our Current Report on Form 8-K filed on February 21, 2007.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 10  Joint
Development and License Agreement with Johnson & Johnson Consumer Companies, Inc.
|-------------------------------------------------------------------------------------------------

|Effective
as of September 1, 2004, we entered into a Joint Development and License Agreement with
Johnson & Johnson Consumer Companies, Inc. to develop and commercialize home-use,
light-based devices in the fields of (i) reducing or reshaping body fat including
cellulite; (ii) reducing appearance of skin aging; and (iii) reducing or preventing acne.
Under the agreement, Johnson & Johnson funds our research and clinical studies during
an initial proof-of-principle phase. At the end of the proof-of-principle phase, Johnson
& Johnson will decide whether or not to continue with one or more of the devices in
one or more of the fields into a development phase. If Johnson & Johnson decides to
continue, Johnson & Johnson will be obligated to fund the development of the selected
devices.  If Johnson & Johnson decides not to continue, we may proceed in fields
not selected by Johnson & Johnson to develop and commercialize these and other devices
on our own or with a different party.


At
the end of the development phase, Johnson & Johnson will decide whether or not to
commercialize one or more of the devices in one or more fields. If Johnson & Johnson
decides to commercialize one or more of the devices, Johnson & Johnson will make
payments to us for each selected field. Upon commercial launch of the first device in each
selected field, Johnson & Johnson will make a payment to us, and for all devices sold
for use in each selected field, Johnson & Johnson shall pay us a percentage of sales
of such devices and certain topical compounds. If Johnson & Johnson decides not to
commercialize or fails to launch a device, we may proceed in fields not selected by
Johnson & Johnson to develop and commercialize these and other devices on our own or
with a different party.


On
August 22, 2007, we signed an amendment to our agreement with Johnson & Johnson to
provide for additional development funding for certain development activities. Johnson
& Johnson will provide us with quarterly payments of $448,000 for these development
activities. We will recognize this revenue as costs are incurred and services are
provided.


For
the three months ended March 31, 2008 and 2007, we recognized approximately $398,000 and
$375,000, respectively, of funded product development revenues from Johnson & Johnson.
As of March 31, 2008 and 2007, $576,000 and $63,000, respectively, of advance payments
received from Johnson & Johnson for which services were not yet provided were included
in deferred revenue.


For
more information, please see the Joint Development and License Agreement and amendments
filed as Exhibit 99.1 to our Current Report on Form 8-K filed on September 7, 2004,
Exhibit 10.45 to our Quarterly Report on Form 10-Q filed on May 8, 2007, and Exhibits
10.47 and 10.48 to our Quarterly Report on Form 10-Q filed on November 2, 2007.



Note 11  Research
Contract with the United States Department of the Army


In
the first quarter of 2004, we began providing services under a $2.5 million research
contract with the United States Department of the Army to develop a light-based
self-treatment device for Pseudofolliculitis Barbae or PFB. On October 25, 2005, we
announced that we had been awarded additional funding of $888,000 for a total of $3.4
million and a twelve month extension. On September 1, 2006, we were awarded additional
funding of $440,000 for a total of $3.8 million and an additional five month extension
until April 30, 2007. Since April 30, 2007, the contract has been extended on multiple
occasions, the last of which was through March 31, 2008. The contract was a cost plus fee
arrangement whereby we were reimbursed for the expenses incurred in connection with PFB
research plus an 8% fee. Our revenue from the contract is subject to government audit.


14



For
the three months ended March 31, 2008 and 2007, we recognized approximately $0 and
$216,000, respectively, of funded product development revenues under this agreement.



Note 12  Alma
Agreement


On
April 2, 2007, we announced the resolution of our patent infringement and trade dress
lawsuit against Alma Lasers, Inc. through the execution of a Settlement Agreement, a
Non-Exclusive Patent License Agreement and a Trade Dress Settlement Agreement. Under the
Patent License Agreement, we granted Alma a non-exclusive, royalty bearing license to U.S.
Patent Nos. 5,735,844 and 5,595,568 and all corresponding foreign patents and patent
applications in the professional field, excluding the consumer field. Alma admitted that
their products infringe these patents and that these patents are valid and enforceable. In
addition, Alma agreed not to challenge the infringement, validity and enforceability of
these patents in the future. Alma will pay for royalties and interest due on past sales of
their laser and lamp-based hair removal systems beginning with their initial sales in 2003
and a trade dress fee plus interest on past sales of their Harmony and Aria systems. The
amounts due to us were determined based on an audit by an independent accounting firm
which was completed in the first quarter of 2008. We have recognized royalty revenue as
amounts become determinable. Under our license agreement with the Massachusetts
General Hospital, we pay to the Massachusetts General Hospital 40% of all patent royalty
and interest thereof from Alma. Starting on March 30, 2007, Alma began paying us a royalty
on sales of its existing and any new light-based hair removal systems later developed.


For
the three months ended September 30, 2007, we recognized $3.1 million of back-owed royalty
revenues, $894,000 of other revenues for trade dress infringement, and $432,000 of
interest on back-owed royalties. As the result of the completion of the independent audit,
for the three months ended March 31, 2008, we recognized $682,000 of back-owed royalty
revenues, $248,000 of other revenues for trade dress infringement, and $87,000 of interest
on back-owed royalties. At March 31, 2008, we had deferred revenue of $576,000 related to
payments received from Alma.


For
more information, please see the Settlement Agreement, the Non-Exclusive Patent License
Agreement, the Trade Dress Settlement Agreement, the Consent Judgments and Stipulations of
Dismissal filed as Exhibits 10.1, 10.2, 10.3, 10.4 and 10.5 to our Current Report on Form
8-K filed on April 2, 2007.



Note 13  Income
Taxes


We
adopted the provisions of Financial Standards Accounting Board Interpretation No. 48
Accounting for Uncertainty in Income Taxes  an interpretation of FASB
Statement No. 109 (FIN 48) on January 1, 2007. As a result of the implementation of FIN
48, we recognized no material adjustment in the liability for unrecognized income tax
benefits. At March 31, 2008, we have $2.5 million of net unrecognized tax benefits, all of
which would affect our effective tax rate if recognized.




We
establish reserves based on managements assessment of exposure associated with
permanent tax differences and tax credits. The tax reserves are analyzed periodically and
adjustments are made, as events occur to warrant adjustment to the reserve.



15


We
recognize interest and penalties related to uncertain tax positions in income tax expense.
As of March 31, 2008, we had no accrued interest related to uncertain tax positions.


The
tax years 2004-2008 remain open to examination by the major taxing jurisdictions to which
we are subject. We file income tax returns in the U.S. federal jurisdiction, and
various state and foreign jurisdictions.



Note 14  Stock
Repurchase Program


On
August 13, 2007, our Board of Directors approved a stock repurchase program under which
our management is authorized to repurchase up to one million shares of our common stock.
The timing and actual number of shares purchased will depend on a variety of factors such
as price, corporate and regulatory requirements, alternative investment opportunities and
other market conditions. Stock repurchases under this program, if any, will be made using
our cash resources, and may be commenced or suspended at any time or from time to time at
managements discretion without prior notice.


The
following table shows our stock repurchase activity since December 31, 2007:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Period                                     | Total
number of
shares
purchased | Average
price paid
per share | Total number of shares purchased as part of publicly announced program | Maximum number of shares that may yet be purchased under program
|------------------------------------------ | -------------------------------- | ---------------------------- | ---------------------------------------------------------------------- | ----------------------------------------------------------------
|January 1, 2008 through January 31, 2008   | --                               | --                           | --                                                                     | 895,000                                                         
|February 1, 2008 through February 29, 2008 | --                               | --                           | --                                                                     | 895,000                                                         
|March 1, 2008 through March 31, 2008       | 100,000                          | 13.37                        | 100,000                                                                | 795,000                                                         
|                                           |                                  |                              |                                                                        |                                                                 
|Total                                      | 100,000                          | $13.37                       | 100,000                                                                | 795,000                                                         
|                                           |                                  |                              |                                                                        |                                                                 
|                                          

|16




Item
2.        Managements Discussion and
Analysis of Financial Condition and Results of Operations



Forward-looking
statements


The
condensed consolidated financial statements of Palomar Medical Technologies, Inc. in this
document present the Companys balance sheet, statement of income, and statement of
cash flows, and should be read in conjunction with the following discussion and analysis.
References to we, us, our, Company, and
Palomar mean Palomar Medical Technologies, Inc. and its subsidiaries. This
discussion includes forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. When used in filings with the SEC, in our press
releases, investor presentations, and in oral statements made by or with the approval of
one of our executive officers, the words or phrases like expects,
anticipates, intends, likely will result,
estimates, projects, or variations of such words and similar
expressions are intended to identify such forward-looking statements. These
forward-looking statements are not guarantees of future performance and are subject to
risks, uncertainties and assumptions, including, among other things, information set forth
in Item 1A. Risk Factors in our Form 10-K for the year ended December 31, 2007 that was
filed with the SEC on March 6, 2008 and in this Form 10-Q. In making these statements, we are not undertaking to
address or update these factors in future filings or communications regarding our business
or results. In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this document might not occur. There may also be other risks that we
are unable to predict at this time. Any of these risks and uncertainties may cause actual
results to differ materially from the results discussed in the forward-looking statements.


Critical accounting policies


The
discussion and analysis of our financial condition and results of operations are 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. On an on-going basis, we evaluate our estimates,
including those related to revenue recognition, bad debts, inventories, warranty
obligations, contingencies and income taxes. We base our estimates 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 under different assumptions or conditions. A
discussion of our critical accounting policies and the related judgments and estimates
affecting the preparation of our consolidated financial statements is included in the
Annual Report on our Form 10-K fiscal year 2007. There have been no material changes to
our critical accounting policies as of March 31, 2008.



Recent Accounting
Pronouncements


In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157).
 This Statement defines fair value, establishes a framework for measuring fair value
and expands disclosure of fair value measurements.  SFAS 157 applies under other
accounting pronouncements that require or permit fair value measurements and accordingly,
does not require any new fair value measurements.  SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007.  In
February 2008, the FASB issued FSP SFAS No. 157-2, Effective Date for FASB Statement No.
157. This FSP permits the delayed application of SFAS 157 for all non-recurring fair value
measurements of non-financial assets and non-financial liabilities until fiscal years
beginning after November 15, 2008. See Note 6 of our Notes to Condensed Consolidated
Financial Statements for the impact of adopting SFAS 157 for recurring fair value
measurements of financial assets.



Overview


We
are a specialty medical device company that discovers, develops, manufactures, markets and
sells innovative proprietary light-based systems for aesthetic treatments. Since our
inception, we have been able to develop a differentiated product mix of light-based
systems for aesthetic treatments through our own research and development as well as with
other companies and institutions around the world. We are continually
developing and testing new indications to further the advancement in aesthetic light-based
treatments.



17


We
generate our revenues through the sales of our medical products, royalties derived from
sales by our licensees, and funded product development programs from other companies.
 Our total revenues for the three month period ended March 31, 2008,
decreased by 27% as compared to the same period in 2007. This decrease was driven by a
decline in our product revenues and funded product development revenues, but was offset by
an increase in royalty revenues due to the recognition of back-owed royalties from one of
our licensees and an increase in other revenues due to a quarterly technology transfer
payment made by P&G under the License Agreement.


We
are continually working on initiatives for expanding our product base throughout the
world. Earlier this year, we executed an international distribution agreement with the
Swedish company, Q-MED AB. Once the transition is complete, Q-MED AB will be responsible
for the marketing, advertising, promotion, sale and distribution of our professional
products for aesthetic treatments outside of North America.


Our
balance sheet continues to be strong and includes $128.0 million in cash and non-current
marketable securities.



Results of operations


The
following table contains selected income statement information, which serves as the basis
of the discussion of our results of operations for the three months ended March 31, 2008
and 2007, respectively (in thousands, except for percentages):
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                          | Three Months Ended March 31, |  |   |        |   | 
|----------------------------------------- | ---------------------------- |  | - | ------ | - | 
|
|
|Revenues                                  |                              |  |   |        |   | 
|Product revenues                          |                              |  | $ | 17,689 |   | 
|Royalty revenues                          |                              |  |   | 3,247  |   | 
|Funded product development revenues       |                              |  |   | 596    |   | 
|Other revenues                            |                              |  |   | 1,498  |   | 
|                                          |                              |  |   |        |   | 
|Total revenues                            |                              |  |   | 23,030 |   | 
|                                          |                              |  |   |        |   | 
|Cost and expenses                         |                              | 
|Cost of product revenues                  |                              |  |   | 6,594  |   | 
|Cost of royalty revenues                  |                              |  |   | 1,299  |   | 
|Research and development                  |                              |  |   | 5,384  |   | 
|Selling and marketing                     |                              |  |   | 6,778  |   | 
|General and administrative                |                              |  |   | 6,237  |   | 
|                                          |                              |  |   |        |   | 
|Total cost and expenses                   |                              |  |   | 26,292 |   | 
|                                          |                              |  |   |        |   | 
|(Loss) income from operations             |                              |  |   | (3,262 | ) | 
|Interest income                           |                              |  |   | 1,423  |   | 
|Other income                              |                              |  |   | 11     |   | 
|                                          |                              |  |   |        |   | 
|(Loss) income before income taxes         |                              |  |   | (1,828 | ) | 
|(Benefit from) provision for income taxes |                              |  |   | (823   | ) | 
|                                          |                              |  |   |        |   | 
|Net (loss) income                         |                              |  | $ | (1,005 | ) | 
|                                          |                              |  |   |        |   | 

|18


Product
revenues. Sales of the StarLux Laser and Pulsed Light Systems, including a
base unit and multiple, optional handpieces were the leading contributor to our product
revenues for the three months ended March 31, 2008 and 2007. Product revenues for the
three months ended March 31, 2008 decreased by approximately $9.7 million as compared to
the same period in 2007 due to the turnover in our North America sales force over the past
year and the current economic conditions delaying the buying decisions of our customer
base. Offsetting this decrease was an increase of 57% in customer service revenue in
comparison to the same period in 2007.


Product
revenue for the three months ended March 31, 2008 consisted of 64% to North America
customers where we sell through a direct sales force and 36% outside of North America
where we sell through distributors. In comparison to the same three month period in 2007,
product revenue consisted of 72% to North America customers and 28% outside of North
America.


Royalty
revenues. Royalty revenues increased for the three months ended March 31,
2008 in comparison to the same period in 2007. This increase is attributed to two new
patent license agreements signed since the first quarter of 2007 and the recognition of
$682,000 in back-owed royalties from a patent settlement agreement executed in 2007 as
this amount was determinable based on the completion of an audit by an independent
accounting firm during the first quarter of 2008.


Funded
product development revenues. Funded product development revenues decreased
for the three months ended March 31, 2008, in comparison to the same period in 2007.
Funded product development revenues were generated from the development agreements with
Johnson & Johnson Consumer Companies, Inc. and Procter & Gamble (and its wholly
owned subsidiary The Gillette Company), and the United States Department of the Army.


For
the three months ended March 31, 2008 and 2007, we recognized $198,000 and $844,000,
respectively, of funded product development revenues from Procter & Gamble (and its
wholly owned subsidiary The Gillette Company). Funded product development revenue from
Procter & Gamble decreased over the same period in 2007 due to (i) a $2.5 million
payment received December 8, 2006, which was recognized over a twelve month period as we
were obligated to perform additional services and remain exclusive to Gillette, and (ii) a
February 21, 2007 amendment to our agreement with Gillette to include the development of a
second light-based hair removal device for home-use, which resulted in a payment which was
recognized over an eleven month period as costs were incurred and services were provided,
ending January 13, 2008. As of March 31, 2008 and 2007, $0 and $2.9 million, respectively,
of advance payments received from Procter & Gamble for which services were not yet
provided were included in deferred revenue.


For
the three months ended March 31, 2008 and 2007, we recognized $398,000 and $375,000,
respectively, of funded product development revenues from Johnson & Johnson. In August
2007, we signed an amendment with Johnson & Johnson to provide for additional
development funding for certain development activities. Johnson & Johnson will provide
us with quarterly payments of $448,000 for these development activities. These payments
will be recognized as revenue as costs are incurred and services are provided. As of March
31, 2008 and 2007, $576,000 and $63,000, respectively, of advance payments received from
Johnson & Johnson for which services were not yet provided were included in deferred
revenue.


We
provided services under a $3.8 million research contract with the United States Department
of the Army to develop a light-based self-treatment device for Pseudofolliculitis Barbae
or PFB. Since February 2004, the contract was extended on multiple occasions, the last of
which was through March 31, 2008. The contract was a cost plus fee arrangement whereby we
are reimbursed for the expenses incurred in connection with PFB research plus an 8% fee.
Revenue was recognized under the contract as the costs were incurred and the services were
rendered. For the three months ended March 31, 2008 and 2007, we recognized approximately
$0 and $216,000, respectively, of funded product development revenues from the United
States Department of the Army.

19






Other
revenues. For the three month period ended March 31, 2008, we recognized
$1.5 million of other revenues consisting of a payment relating to a new License Agreement
with The Procter & Gamble Company of $1.25 million (see Note 9) and the recognition of
the remaining portion of trade dress infringement fees associated with the Alma Lasers,
Ltd. settlement agreement of $250,000 (see Note 12).


Cost of product revenues. For the three month periods ended March 31, 2008
and 2007, the cost of product revenues as a percentage of total revenues was 29% and 27%,
respectively. The increase is due to lower product sales volume which resulted in lower
overhead absorption.


Cost
of royalty revenues. The cost of royalty revenues
increased for the three months ended March 31, 2008 in comparison to the same period in
2007. This increase is attributed to two new patent license agreements signed since the
first quarter of 2007 and the recognition of $682,000 in back-owed royalties from a patent
settlement agreement with Alma Lasers, Ltd. made in the second quarter of 2007 as this
amount was determinable based on the completion of an audit by an independent accounting
firm during the first quarter of 2008 (see Note 12). As a percentage of royalty revenues,
the cost of royalty revenues was consistent at 40% in accordance with our license
agreement with Massachusetts General Hospital in comparison to the same period in 2007.


Research
and development expense. Research and development expense is a direct
result of our spending related to our continued commitment of introducing new technology
as well as enhancing our current family of products.


Expenses
relating to the Johnson & Johnson Joint Development and License Agreement (see Note
10) increased during the three months ended March 31, 2008 by $584,000 as compared to the
same period in 2007. The increase was mainly due to increases of $406,000 for payroll and
payroll related expenses and $200,000 for material costs.


For
the three months ended March 31, 2008, expenses relating to our Research Agreement with
the United States Department of the Army (see Note 11) decreased by approximately $200,000
as compared to the same period in 2007. The decrease was due to the completion of the work
under the contract in the fourth quarter of 2007.


Expenses
for internal research and development projects relating to the introduction of new
products, enhancements made to the current family of products, and research and
development overhead increased by $761,000 for the three months ended March 31, 2008 as
compared to the same period in 2007.


For
the quarter ended March 31, 2008, research and development increased by $1.8 million from
payroll and payroll related expenses which was driven by a $1.5 million increase in SFAS
123R compensation expense.


Selling
and marketing expense. For the three months ended March 31, 2008, selling
and marketing expense increased by $502,000, or 8%, over the comparable period in 2007.
For the quarter ended March 31, 2008, selling and marketing increased by $569,000 from
payroll and payroll related expenses which was driven by a $620,000 increase in SFAS 123R
compensation expense, $104,000 from promotional related expenses, offset by a decrease of
$250,000 related to commission expense as compared to the same period in 2007. These
increases directly correlate with costs associated with our continued expansion efforts
and employee retention.


General
and administrative expense. For the three months
ended March 31, 2008, general and administrative expenses increased by $3.1 million over
the comparable period in 2007. For the quarter ended March 31, 2008, general and
administrative expense increased $2.2 million from legal expenses related to patent
litigation, $1.0 million from an investment banking fee related to our entry into an
international distribution agreement with Q-MED, $1.0 million from payroll and payroll
related expenses which was primarily due to an increase in SFAS 123R compensation expense,
offset by a decrease of $1.5 million from incentive compensation and a $267,000 increase
in bad debt recoveries as compared to the same period in 2007.



20


Interest
income.Interest income increased for the three months
ended March 31, 2008 over the comparable period in 2007 due to $52,000 of interest
received in 2008 on back-owed royalty revenues related to the new patent license agreement
with Alma Lasers, Ltd. (see Note 12) and an increase in cash balance, offset by lower
market interest rates.


Other
income. Other income for the three months ended March 31, 2008, includes
the foreign exchange gain as a result of transactions in currencies other than the U.S.
dollar.


     (Benefit from)
          provision for income taxes.  We file income tax returns
          in the U.S. federal jurisdiction, and various state and foreign
          jurisdictions. Effective January 1, 2007, the Company adopted FIN No. 48,
          Accounting for Uncertainty in Income Taxes. Our effective tax rate for
          the three months ended March 31, 2008 and 2007 was 45% and 38%, respectively.
          The increase in our effective tax rate in 2008  is due to the
          tax treatment of incentive stock options granted during the first quarter.



Liquidity and capital
resources


The
following table sets forth, for the periods indicated, a year over year comparison of key
components of our liquidity and capital resources (in thousands):
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                               | Three months ended
March 31, | Change |   |       
|---------------------------------------------- | ---------------------------- | ------ | - | ------
|
|Cash flows (used in) from operating activities |                              |        | $ | (2,594
|Cash flows from (used in) investing activities |                              |        |   | 19,757
|Cash flows (used in) from financing activities |                              |        |   | (955  
|                                               |                              |        |   |       
|Capital expenditures, net                      |                              |        | $ | 228   

|Additionally,
our cash, investments, accounts receivable, inventories and working capital are shown
below for the periods indicated (in thousands).
|---------------------------------------------------------------------------------------------------------------------------------------------------

|                                  | March 31, | December 31, | Change |        
|--------------------------------- | --------- | ------------ | ------ | -------
|
|Cash and cash equivalents         |           |              | $      | 106,668
|Available-for-sale investments    |           |              |        | --     
|Accounts receivable, net          |           |              |        | 11,746 
|Inventories, net                  |           |              |        | 15,138 
|Working capital                   |           |              |        | 125,480
|Non-current marketable securities |           |              |        | 21,364 

|At
March 31, 2008, we had $106.7 million in cash and cash equivalents and $21.4 million in non-current marketable securities. We believe that our
current cash balances and expected future cash flows will be sufficient to meet our
anticipated cash needs for working capital, capital expenditures and other activities for
at least the next twelve months. As of March 31, 2008, we had no borrowings or debt.


At
March 31, 2008, we held $21.9 million in auction-rate securities (ARS). The ARS we
typically invest in are high quality, AAA-rated securities, none of which are
mortgage-backed, with interest rates often ranging from 3 to 14%. At December 31, 2007,
because of the short-term nature of our investment in these securities, they were
classified as available-for-sale and included in short-term investments on our
consolidated balance sheets. Subsequent to December 31, 2007 and through March 31, 2008,
our securities failed at auction due to a decline in liquidity in the ARS and other
capital markets. We will not be able to access our investments in ARS until future
auctions are successful, ARS are called for redemption by the issuers, or until sold in a
secondary market, which is not currently active. Until the auctions for our ARS are
successful, we have the potential to benefit from a penalty feature in our interest rates
which allows us to earn higher rates of interest on these securities. As our investments
in ARS currently lack short-term liquidity, we have reclassified these investments as
non-current as of March 31, 2008. We have also determined that the fair value of our ARS
was temporarily impaired as of March 31, 2008. For the three months ending March 31,
2008, we marked to market our ARS and recorded an unrealized loss of $341,000 in accumulated other comprehensive (loss)
income, net of taxes, in stockholder's equity to reflect the temporary impairment of our ARS.
The recovery of these investments is based upon market factors which are not within our control.



21


Cash
flows from operating activities for the three months ended March 31, 2008, decreased
compared to the same period in 2007. This decrease in operating activity cash flows
reflects a decrease in profitability, an increase in working capital requirements, an
increase in bad debt recoveries, and an increase in tax benefit from stock option
exercises offset by an increase in stock compensation expense in the first quarter of
2008. Cash flows related to investing activities increased for the three months ended
March 31, 2008, compared to the same period in 2007. These amounts primarily reflect cash
used for purchases of property and equipment, purchases of available-for-sale investments
offset by proceeds from the sale of available-for-sale investments. Cash flows from
financing activities decreased for the three month period ended March 31, 2008, compared
to the same period in 2007. This decrease was primarily due to a decrease in proceeds
from stock option exercises and the repurchase of common stock, offset by an increase in
tax benefits related to stock option exercises.


We
anticipate that capital expenditures for the remainder of 2008 will total approximately
$750,000, consisting primarily of leasehold improvements, machinery, equipment, computers
and peripherals. We expect to finance these expenditures with cash on hand.


Effective
as of September 1, 2004, we entered into a Joint Development and License Agreement with
Johnson & Johnson Consumer Companies, Inc. to develop and commercialize home-use,
light-based devices in the fields of (i) reducing or reshaping body fat including
cellulite; (ii) reducing appearance of skin aging; and (iii) reducing or preventing acne.
(See Note 10.)


On
April 2, 2007, we announced the resolution of our patent infringement and trade dress
lawsuit against Alma Lasers, Inc. through the execution of a Settlement Agreement, a
Non-Exclusive Patent License Agreement and a Trade Dress Settlement Agreement. (See Note 12.)




On
February 29, 2008, we entered into a License Agreement including with P&G under which
we granted a non-exclusive license to certain patents and technology to commercialize
home-use, light-based hair removal devices for women. This License Agreement replaced the
prior Development and License Agreement. (See Note 9.)



Off-balance sheet
arrangements


We do
not participate in transactions that generate relationships with unconsolidated entities
or financial partnerships, such as entities often referred to as variable interest or
special purpose entities, which would have been established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or limited
purposes. As of March 31, 2008, we were not involved in any unconsolidated
transactions.



Contractual obligations


We
are a party to three exclusive patent license agreements executed March 16, 2008 with
Massachusetts General Hospital
whereby we are obligated to pay royalties to Massachusetts General Hospital for sales of
certain of our products as well as a percentage of royalties received from third party
sublicensees.  Royalty expense for the three months ended March 31, 2008
totaled approximately $1.5 million.



22


For
more information, please see the Amended and Restated License Agreement (MGH Case Nos.
783, 912, 2100), the License Agreement (MGH Case No. 2057) and the License Agreement (MGH
Case No. 1316) filed as Exhibits 10.1, 10.2, and 10.3 to our Current Report on Form 8-K
filed on March 20, 2008.


We
have obligations related to the adoption of FIN 48. Further information about changes in
these obligations can be found in Note 13.


We
are obligated to make future payments under various contracts, including non-cancelable
inventory purchase commitments and our operating lease relating to our Burlington,
Massachusetts manufacturing, research and development and administrative offices.


On
July 30, 2007, we signed an amendment to our lease to add an additional 13,600 square
feet. Rent expense, including this new lease, will total approximately $1.3 million per
year, expiring in August of 2009.


The
following table summarizes our estimated contractual cash obligations as of March 31,
2008, excluding royalty and employment obligations because they are variable and/or
subject to uncertain timing (in thousands):
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   | Payments due by period |        |      |           |         
|---------------------------------- | ---------------------- | ------ | ---- | --------- | --------
|
|Operating lease                    | $2,013                 | $1,465 | $548 | $      -- | $     --
|Purchase commitments               | 6,452                  | 6,452  | --   | --        | --      
|                                   |                        |        |      |           |         
|Total contractual cash obligations | $8,465                 | $7,917 | $548 | $     --  | $     --
|                                   |                        |        |      |           |         

|23





Cautionary statements


This
report contains forward-looking statements that involve risks and uncertainties, such as
statements of our objectives, expectations and intentions. The cautionary statements made
in this report should be read as applicable to all forward-looking statements wherever
they appear in this report. Our actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences include those
discussed below, as well as those discussed elsewhere in this report.


If we do not continue to develop
and commercialize new products and identify new markets for our products and technology,
we may not remain competitive, and our revenues and operating results could suffer.


The
aesthetic light-based (both lasers and lamps) treatment system industry is subject to
continuous technological development and product innovation. If we do not continue to be
innovative in the development of new products and applications, our competitive position
will likely deteriorate as other companies successfully design and commercialize new
products and applications. We compete in the development, manufacture, marketing, sales
and servicing of light-based devices with numerous other companies, some of which have
substantially greater direct worldwide sales capabilities. Our products also face
competition from medical products, prescription drugs and cosmetic procedures, such as
electrolysis and waxing.


Our products are subject to
numerous medical device regulations. Compliance is expensive and time-consuming. Without
necessary clearances, we may be unable to sell products and compete effectively.


All
of our current products are light-based devices, which are subject to FDA regulations for
clinical testing, manufacturing, labeling, sale, distribution and promotion. Before a new
product or a new use of or claim for an existing product can be marketed in the United
States, we must obtain clearance from the FDA. In the event that we do not obtain FDA
clearances, our ability to market products in the United States and revenue derived
therefrom may be adversely affected.  The types of medical devices that we seek to
market in the U.S. generally must receive either 510(k) clearance or PMA
approval in advance from the FDA pursuant to the Federal Food, Drug, and Cosmetic
Act. The FDAs 510(k) clearance process can be expensive and usually takes from three
to twelve months, but it can last longer. The process of obtaining PMA approval is much
more costly and uncertain and generally takes from one to three years or even longer from
the time the pre-market approval application is submitted to the FDA until an approval is
obtained.


In
order to obtain pre-market approval and, in some cases, a 510(k) clearance, a product
sponsor must conduct well controlled clinical trials designed to test the safety and
effectiveness of the product. Conducting clinical trials generally entails a long,
expensive and uncertain process that is subject to delays and failure at any stage. The
data obtained from clinical trials may be inadequate to support approval or clearance of a
submission. In addition, the occurrence of unexpected findings in connection with clinical
trials may prevent or delay obtaining approval or clearance. If we conduct clinical
trials, they may be delayed or halted, or be inadequate to support approval or clearance,
for numerous reasons, including:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | FDA, other regulatory authorities
or an institutional review board may place a clinical trial on hold;
| |  | - |  | ------------------------------------------------------------------------------------------------------

| |  | o |  | patients may not
enroll in clinical trials, or patient follow-up may not occur, at the rate we expect;
| |  | - |  | ------------------------------------------------------------------------------------------------------

| |  | o |  | patients may not comply with trial protocols;
| |  | - |  | ---------------------------------------------

| |  | o |  | institutional review boards and third
party clinical investigators may delay or reject our trial protocol;
| |  | - |  | ----------------------------------------------------------------------------------------------------------

| |  | o |  | third party
clinical investigators may decline to participate in a trial or may not perform a trial on
our anticipated schedule or consistent with the clinical trial protocol, good clinical practices, or other FDA
requirements;
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | third party organizations may not perform data collection and analysis in
a timely or accurate manner;
| |  | - |  | ------------------------------------------------------------------------------------------------------

|24
|--

| |  | o |  | regulatory inspections of our clinical trials or
manufacturing facilities may, among other things, require us to undertake corrective
action or suspend or terminate our clinical trials, or invalidate our clinical trials;
| |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | governmental regulations may change or administrative actions may occur that cause delays;
and
| |  | - |  | ----------------------------------------------------------------------------------------------

| |  | o |  | the interim or final results of the clinical trials may be inconclusive or
unfavorable as to safety or effectiveness.
| |  | - |  | ---------------------------------------------------------------------------------------------------------------------

|Medical devices may be marketed
only for the indications for which they are approved or cleared. The FDA may not approve
or clear indications that are necessary or desirable for successful commercialization.
Indeed, the FDA may refuse our requests for 510(k) clearance or pre-market approval of new
products, new intended uses or modifications to existing products. Our clearances can be
revoked if safety or effectiveness problems develop.


To
date, the FDA has deemed our products eligible for the 510(k) clearance process. We
believe that our products in development will receive similar treatment. However, we
cannot be sure that the FDA will not impose the more burdensome PMA approval process upon
one or more of our future products, nor can we be sure that 510(k) clearance or PMA
approval will ever be obtained for any product we propose to market, and our failure to do
so could adversely affect our ability to sell our products.


We
often seek FDA clearance for additional indications for use. Clinical trials in support of
such clearances for additional indications may be costly and time-consuming. In the event
that we do not obtain additional FDA clearances, our ability to market products in the
United States and revenue derived therefrom may be adversely affected. Medical devices may
be marketed only for the indications for which they are approved or cleared, and if we are
found to be marketing our products for off-label, or non-approved, uses we might be
subject to FDA enforcement action or have other resulting liability.


Our
products are subject to similar regulations in many international markets. Complying with
these regulations is necessary for our strategy of expanding the markets for sales of our
products into these countries. Compliance with the regulatory clearance process in any
country is expensive and time consuming.  Regulatory clearances may necessitate
clinical testing, limitations on the number of sales and limitations on the type of end
user, among other things.  In certain instances, these constraints can delay planned
shipment schedules as design and engineering modifications are made in response to
regulatory concerns and requests.  We may not be able to obtain clearances in each
country in a timely fashion or at all, and our failure to do so could adversely affect our
ability to sell our products in those countries.


After clearance or approval of our
products, we are subject to continuing regulation by the FDA, and if we fail to comply
with FDA regulations, our business could suffer.


Even
after clearance or approval of a product, we are subject to continuing regulation by the
FDA, including the requirements that our facility be registered and our devices listed
with the agency. We are subject to Medical Device Reporting regulations, which require us
to report to the FDA if our products may have caused or contributed to a death or serious
injury or malfunction in a way that would likely cause or contribute to a death or serious
injury if the malfunction were to recur. We must report corrections and removals to the
FDA where the correction or removal was initiated to reduce a risk to health posed by the
device or to remedy a violation of the Federal Food, Drug, and Cosmetic Act caused by the
device that may present a risk to health, and we must maintain records of other
corrections or removals. The FDA closely regulates promotion and advertising and our
promotional and advertising activities could come under scrutiny. If the FDA objects to
our promotional and advertising activities or finds that we failed to submit reports under
the Medical Device Reporting regulations, for example, the FDA may allege our activities
resulted in violations.



25


The
FDA and state authorities have broad enforcement powers. Our failure to comply with
applicable regulatory requirements could result in enforcement action by the FDA or state
agencies, which may include any of the following sanctions:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | letters, warning letters, fines,
injunctions, consent decrees and civil penalties;
| |  | - |  | ----------------------------------------------------------------------------------

| |  | o |  | repair, replacement, refunds, recall
or seizure of our products;
| |  | - |  | ----------------------------------------------------------------

| |  | o |  | operating restrictions or partial suspension or total
shutdown of production;
| |  | - |  | -----------------------------------------------------------------------------

| |  | o |  | refusing or delaying our requests for 510(k) clearance or
pre-market approval of new products or new intended uses; and
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------

| |  | o |  | criminal prosecution.
| |  | - |  | ---------------------

|If any of these events were to occur,
they could harm our business.


We have modified some of our
products and sold them under prior 510(k) clearances. The FDA could retroactively decide
the modifications required new 510(k) clearances and require us to cease marketing and/or
recall the modified products.


Any
modification to one of our 510(k) cleared devices that could significantly affect its
safety or effectiveness, or that would constitute a major change in its intended use,
requires a new 510(k) clearance. We may be required to submit pre-clinical and clinical
data depending on the nature of the changes. We may not be able to obtain additional
510(k) clearances or pre-market approvals for modifications to, or additional indications
for, our existing products in a timely fashion, or at all. Delays in obtaining future
clearances or approvals would adversely affect our ability to introduce new or enhanced
products into the market in a timely manner, which in turn would harm our revenue and
operating results. We have modified some of our marketed devices, but we believe that new
510(k) clearances are not required. We cannot be certain that the FDA would agree with any
of our decisions not to seek 510(k) clearance. If the FDA requires us to seek 510(k)
clearance for any modification, we also may be required to cease marketing and/or recall
the modified device until we obtain a new 510(k) clearance.


Federal regulatory reforms may
adversely affect our ability to sell our products profitably.


From
time to time, legislation is drafted and introduced in Congress that could significantly
change the statutory provisions governing the clearance or approval, manufacture and
marketing of a device. In addition, FDA regulations and guidance are often revised or
reinterpreted by the agency in ways that may significantly affect our business and our
products. It is impossible to predict whether legislative changes will be enacted or FDA
regulations, guidance or interpretations changed, and what the impact of such changes, if
any, may be.


We may also be subject to state
regulations.   State regulations, and changes to state regulations, may prevent
sales to particular end users or may restrict use of the products to particular end users
or under particular supervision which may decrease revenues or prevent growth of revenues.


Our
products may also be subject to state regulations.   Federal regulation allows
our products to be sold to and used by licensed practitioners as determined on a
state-by-state basis which complicates monitoring compliance. As a result, in some states
non-physicians may purchase and operate our products. In most states, it is within a
physicians discretion to determine whom they can supervise in the operation of our
products and the level of supervision. However, some states have specific regulations as
to appropriate supervision and who may be supervised. A state could disagree with our
decision to sell to a particular type of end user or change regulations to prevent sales
to particular types of end users or change regulations as to supervision requirements. In
several states, applicable regulations are in flux.  Thus, state regulations and
changes to state regulations may decrease revenues or prevent growth of revenues.

26

Outside of the United States, we
rely on third party distributors to market and sell a large portion of our products. Due
to our January 2008 international distribution agreement with Q-MED AB, we are in the
process of terminating or changing our relationship with our current distributors as we
transition to Q-MED as our exclusive distributor outside of North America. During this
transition period, current distributors may not commit the necessary resources to
effectively market and sell our products and we may not be able to collect receivables due
for past sales to these distributors and our business and operating results may be harmed.
Our relationship with Q-MED may not be successful and our business and operating results
may be harmed.


In
the United States, we sell our products through our internal sales organization. Outside
of this market, we sell our products through third party distributors. Our sales and
marketing success in these other markets depends on these distributors, in particular
their sales and service expertise and relationships with the customers in the marketplace.
On January 9, 2008, we announced our international distribution agreement with the Swedish
company Q-MED AB, the producer of Restylane, one of the most popular and widely
distributed dermal fillers in the world. Q-MED sells Restylane globally through a network
of fully owned sales companies, partners and distributors. The transition from our current
distributors to Q-MED shall be on a country-by-country basis as the companies agree on the
terms of each transition. We are working with Q-MED and current distributors to determine
how each distributor might successfully work with Q-MED during and after the time each
country is transitioned. The relationship with most, if not all, of our current
distributors will be terminated or changed. During this transition period, our
relationship with current distributors may be damaged such that they may not commit the
necessary resources to effectively market and sell our products and may leave us with a
greater collection risk on our outstanding receivables from these distributors. In
addition, the transition to, and our future relationship with, Q-MED may not be
successful. If the current distributors do not perform adequately or if our agreement with
Q-MED is unsuccessful, our revenue from international sales may be adversely affected and
our operating results could suffer.


Because we do not require training
for all users of our products, and sell our products to non-physicians, there exists an
increased potential for misuse of our products, which could harm our reputation and our
business.


Federal regulations allow us to sell our products to or on the order of practitioners
licensed by state law. The definition of licensed practitioners varies from
state to state. As a result, our products may be purchased or operated by physicians with
varying levels of training and, in many states, by non-physicians, including nurse
practitioners, chiropractors and technicians. Outside the United States, many
jurisdictions do not require specific qualifications or training for purchasers or
operators of our products. We do not supervise the procedures performed with our products,
nor do we require that direct medical supervision occur. Our products come with an
operators manual. We and our distributors offer product training sessions, but
neither we nor our distributors require purchasers or operators of our products to attend
training sessions. The lack of required training and the purchase and use of our products
by non-physicians may result in product misuse and adverse treatment outcomes, which could
harm our reputation and expose us to costly product liability litigation.


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


We
are subject to inspection and market surveillance by the FDA to determine compliance with
regulatory requirements. The FDAs regulatory scheme is complex, especially the
Quality System Regulation, which requires manufacturers to follow elaborate design,
testing, control, documentation, and other quality assurance procedures. Because some of
our products involve the use of lasers, those products also are covered by a performance
standard for lasers set forth in FDA regulations. The laser performance standard imposes
specific record keeping, reporting, product testing and product labeling requirements.
These requirements include affixing warning labels to laser products as well as
incorporating certain safety features in the design of laser products. The FDA enforces
the Quality System Regulation and laser performance standards through periodic unannounced
inspections. We have been, and anticipate in the future being, subject to such
inspections. The complexity of the Quality System Regulation makes complete compliance
difficult to achieve. Also, the determination as to whether a Quality System Regulation
violation has occurred is often subjective. If the FDA finds that we have failed to comply
with the Quality System Regulation or other applicable requirements or failed to take
satisfactory corrective action in response to an adverse Quality System Regulation
inspection or comply with applicable laser performance standards, the agency can institute
a wide variety of enforcement actions, including a public warning letter or other stronger
remedies, such as fines, injunctions, criminal and civil penalties, recall or seizure of
our products, operating  restrictions, partial suspension, or total shutdown of our
production, refusing to permit the import or export of our products, delaying or refusing
our requests for 510(k) clearance or PMA approval of new products, withdrawing product
approvals already granted or criminal prosecution, any of which could cause our business
and operating results to suffer.



27



Our effective income tax
rate may vary significantly.


Unanticipated
changes in our tax rates could affect our future results of operations. Our future
effective tax rates could be unfavorably affected by changing interpretations of existing
tax laws or regulations, changes in estimates of prior years items, changes in the
valuation of our deferred tax assets, future levels of research and development spending,
stock option grants, deductions for employee stock option exercises being different than
what we projected, and changes in overall levels of income before taxes.


Failure to manage our
relationships with third party researchers effectively may limit our access to new
technology, increase the cost of licensing new technology, and divert management attention
from our core business.


We
are dependent upon third-party researchers over whom we do not have absolute control to
satisfactorily conduct and complete research on our behalf.  We are also dependent
upon third-party researchers to grant us licensing terms, which may or may not be
favorable, for products and technology they may develop. We provide research funding,
light technology and optics know-how in return for licensing rights with respect to
specific dermatologic and cosmetic applications and patents. In return for certain
exclusive license rights, we are subject to due diligence obligations in order to maintain
such exclusivity.  Our success will be dependent upon the results of research with
our partners and meeting due diligence obligations. We cannot be sure that third-party
researchers will agree with our interpretation of the terms of our agreements, that we
will meet our due diligence obligations, or that such research agreements will provide us
with marketable products in the future or that any of the products developed under these
agreements will be profitable for us.


If our new products do not gain
market acceptance, our revenues and operating results could suffer.


The
commercial success of the products and technology we develop will depend upon the
acceptance of these products by providers of aesthetic procedures and their patients and
clients. It is difficult for us to predict how successful recently introduced products, or
products we are currently developing, will be over the long term. If the products we
develop do not gain market acceptance, our revenues and operating results could suffer.


We
expect that many of the products we develop will be based upon new technologies or new
applications of existing technologies. It may be difficult for us to achieve market
acceptance of some of our products, particularly the first products that we introduce to
the market based on new technologies or new applications of existing technologies.


If demand for our aesthetic
treatment systems by non-traditional physician customers and spas does not develop as we
expect, our revenues will suffer and our business will be harmed.


Our
revenues from non-traditional physician customers and spa purchasers of our products
continue to increase. We believe, and our growth expectations assume, that we and other
companies selling light-based (lasers and lamps) aesthetic treatment systems have only
begun to penetrate these markets and that our revenues from selling to these markets will
continue to increase. If our expectations as to the size of these markets and our ability
to sell our products to participants in these markets are not correct, our revenues will
suffer and our business will be harmed.



28


If there is not sufficient
consumer demand for the procedures performed with our products, practitioner demand for
our products could decline, which would adversely affect our operating results.


Most
procedures performed using our aesthetic treatment systems are elective procedures that
are not reimbursable through government or private health insurance. The cost of these
elective procedures must be borne by the client. As a result, the decision to undergo a procedure that utilizes
our products may be influenced by a number
of factors, including:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | consumer awareness of and demand for procedures and treatments;
| |  | - |  | ---------------------------------------------------------------

| |  | o |  | the cost, safety and effectiveness of the procedure and of alternative treatments;
| |  | - |  | ----------------------------------------------------------------------------------

| |  | o |  | the success of our and our
customers sales and marketing efforts to purchasers of these procedures; and
| |  | - |  | --------------------------------------------------------------------------------------------------------

| |  | o |  | consumer confidence, which may be affected by short-term or long-term economic and other
conditions.
| |  | - |  | ----------------------------------------------------------------------------------------------------

|If there
is not sufficient demand for the procedures performed with our products, a weakening in the economy,
or other factors, practitioner demand for our products may be reduced or buying decisions postponed,
which would adversely affect our operating results.


Our business and operations are
experiencing rapid growth. If we fail to effectively manage our growth, our business and
operating results could be harmed.


We
have experienced increased growth in the scope of our operations and the number of our
employees. This growth has placed significant demands on our management, as well as our
financial and operational resources. If we do not effectively manage our growth, the
efficiency of our operations and the quality of our products could suffer, which could
adversely affect our business and operating results. To effectively manage this growth, we
will need to continue to:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | implement appropriate operational,
financial and management controls, systems and procedures;
| |  | - |  | ---------------------------------------------------------------------------------------------

| |  | o |  | expand our manufacturing
capacity and scale of production;
| |  | - |  | ----------------------------------------------------------

| |  | o |  | expand our sales, marketing and distribution
infrastructure and capabilities; and
| |  | - |  | ---------------------------------------------------------------------------------

| |  | o |  | provide adequate training and supervision to
maintain high quality standards.
| |  | - |  | -----------------------------------------------------------------------------

|Failure to receive shipments of
critical components could reduce revenues and reduced reliability of critical components
could increase expenses.


We develop light-based systems that incorporate third-party components and we purchase
some of these components from small, specialized vendors that are not well capitalized. We
do not have long-term contracts with some of these third parties for the supply of parts.
A disruption in the delivery of these key components, or our inability to obtain
substitute components or subassemblies from alternate sources at acceptable prices in a
timely manner, or our inability to obtain assembly or testing services could prevent us
from manufacturing products and result in a decrease in revenue.  We depend on an
acceptable level of reliability for purchased components.  Reliability below
expectations for key components could have an adverse affect on inventory and inventory
reserves. Any extended interruption in our supplies of third-party components could
materially harm our business.

29

We forecast sales to determine
requirements for components and materials used in our products and if our forecasts are
incorrect, we may experience either delays in shipments or increased inventory costs.


To
manage our manufacturing operations with our suppliers, we forecast anticipated product
orders and material requirements to predict our inventory needs and enter into purchase
orders on the basis of these requirements. Our limited historical experience may not
provide us with enough data to accurately predict future demand. If our business expands,
our demand for components and materials would increase and our suppliers may be unable to
meet our demand. If we overestimate our component and material requirements, we will have
excess inventories, which would increase our expenses. If we underestimate our component
and material requirements, we may have inadequate inventories, which could interrupt,
delay, or prevent delivery of our products to our customers.


Our proprietary technology has
only limited protections which may not prevent competitors from copying our new
developments.  This may impair our ability to compete effectively.  We may
expend significant resources enforcing our intellectual property rights to prevent such
copying, and our intellectual property could be determined to be not infringed, invalid or
unenforceable.


Our
business could be materially and adversely affected if we are not able to adequately
protect our intellectual property rights. We rely on a combination of patent, copyright,
trademark and trade secret laws, licenses and confidentiality agreements to protect our
proprietary rights. We own and license a variety of patents and patent applications in the
United States and corresponding patents and patent applications in many foreign
jurisdictions. Our pending and future patent applications may not issue as patents or, if
issued, may not issue in a form that will be advantageous to us. Even if issued, patents
may be challenged, narrowed, invalidated or circumvented, which could limit our ability to
stop competitors from marketing similar products or limit the length of term of patent
protection we may have for our products. Changes in either patent laws or in
interpretations of patent laws in the United States and other countries may diminish the
value of our intellectual property or narrow the scope of our patent protection.


We
have granted certain patent licenses to several competitors, and in return for those
license grants, we receive a significant ongoing royalty revenue stream.  A few of
these competitors entered into license agreements only after we sued them for patent
infringement.  We are currently enforcing these patents against Candela Corporation
and intend to enforce against other competitors in the future.  We do not know how
successful we will be in asserting our patents against Candela or other suspected
infringers.  Whether or not we are successful in the pending lawsuit, litigation
consumes substantial amounts of our financial resources and diverts managements
attention away from our core business. Public announcements concerning this litigation
that are unfavorable to us may in the future result in significant declines in our stock
price. An adverse ruling or judgment in this matter could result in a loss of our
significant ongoing royalty revenue stream and could also have a material adverse effect
on license agreements with other companies both of which could have a material adverse
effect on our business and results of operation and cause our stock price to decline
significantly.  (For more information about our patent litigation, see Part II, Item
1 Legal Proceedings.)


In
addition to patented technology, we rely upon unpatented proprietary technology, processes
and know-how. We generally enter into agreements with our employees and third parties with
whom we work, including but not limited to consultants and vendors, to restrict access to,
and distribution of, our proprietary information and define our intellectual property
ownership rights. Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain and use our technology, proprietary
information and know-how and we may not have adequate remedies for any such breach.
Monitoring unauthorized use of our technology is difficult and we cannot be certain that
the steps we have taken will prevent unauthorized use of our technology, particularly in
foreign countries where the laws may not protect our proprietary rights as fully as in the
United States. If competitors are able to use our technology, our ability to compete
effectively could be harmed and the value of our technology and products could be
adversely affected.  Costly and time consuming lawsuits may be necessary to enforce
and defend patents issued or licensed exclusively to us, to protect our trade secrets
and/or know-how or to determine the enforceability, scope and validity of others
intellectual property rights. Such lawsuits may result in patents issued or licensed
exclusively to us to be found invalid and unenforceable.  In addition, our trade
secrets may otherwise become known or our competitors also may independently develop
technologies that are substantially equivalent or superior to our technology and which do
not infringe our patents.



30


Claims by others that our products
infringe their patents or other intellectual property rights could prevent us from
manufacturing and selling some of our products or require us to pay royalties or incur
substantial costs from litigation or development of non-infringing technology.


In recent years, there has been significant litigation in the United States involving
patents and other intellectual property rights.  The light-based cosmetic and
dermatology industry in particular is characterized by a large number of patents and
related litigation regarding patents and other intellectual property rights. Because our
resources are limited and patent applications are maintained in secrecy for a period of
time, we can conduct only limited searches to determine whether our technology infringes
any patents or patent applications. Any claims for patent infringement, regardless of
merit, could be time-consuming, result in costly litigation and diversion of technical and
management personnel, cause shipment delays, require us to develop non-infringing
technology or to enter into royalty or licensing agreements. Uncertainties resulting from
the initiation and continuation of patent litigation or other proceedings could have a
material adverse effect on our ability to compete in the marketplace. Although patent and
intellectual property disputes in the light-based industry have often been settled through
licensing or similar arrangements, costs associated with such arrangements may be
substantial and often require the payment of ongoing royalties, which could have a
negative impact on gross margins. There can be no assurance that necessary licenses would
be available to us on satisfactory terms, or that we could redesign our products or
processes to avoid infringement, if necessary. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain necessary licenses could
prevent us from manufacturing and selling some of our products. This could have a material
adverse effect on our business, results of operations and financial condition.


Candela
Corporation has filed two patent infringement lawsuits against us. (For more information
about our patent litigation, see Part II, Item 1 Legal Proceedings.) Litigation with
Candela is expected to be expensive and protracted, and our intellectual property position
may be weakened as a result of an adverse ruling or judgment. Whether or not we are
successful in the pending lawsuits, litigation consumes substantial amounts of our
financial resources and diverts managements attention away from our core business.
Public announcements concerning this litigation that are unfavorable to us may in the
future result in significant declines in our stock price. An adverse ruling or judgment in
this matter could cause our stock price to decline significantly.



We may not be able to
successfully collect licensing royalties.


Material portions of our revenues consist of royalties from sub-licensing patents licensed
to us on an exclusive basis by Massachusetts General Hospital. If we are unable to collect
our licensing royalties, our revenues will decline.


Quarterly revenue or operating
results could cause the price of our common stock to fall.


Our quarterly revenue and operating results are difficult to predict and may swing sharply
from quarter to quarter.  If our quarterly revenue or operating results fall
below the expectations of investors or public market analysts, the price of our common
stock could fall substantially. Our quarterly revenue is difficult to forecast for many
reasons, some of which are outside of our control.  For example, many factors are
related to market supply and demand, including potential increases in the level and
intensity of price competition between our competitors and us, potential decrease in
demand for our products and possible delays in market acceptance of our new
products.  Other factors are related to our customers and include changes in or
extensions of our customers budgeting and purchasing cycles and changes in the
timing of product sales in anticipation of new product introductions or enhancements by us
or our competitors.   Factors related to our operations may also cause quarterly
revenue or operating results to fall below expectations, including our effectiveness in
our manufacturing process, unsatisfactory performance of our distribution channels,
service providers, or customer support organizations, and timing of any acquisitions and
related costs.



31


Managing our relationships with
Johnson & Johnson Consumer Companies, Inc. and future development partners may divert
the attention of key technical personnel and management from the core
business.   If, pursuant to rights in their respective agreements with us, any
of these parties should end their relationship with us, our stock price could fall, and we
may be unable to bring home-use devices to the market.


We
believe that our relationship with Johnson & Johnson Consumer Companies, Inc.
represents a unique opportunity to bring light-based devices to the mass market.
Significant resources and the attention of key technical personnel and management have
been and may continue to be directed to the development and commercialization of such
devices even though such devices will not likely be commercialized for several years, if
ever.  In addition, we cannot be sure that these parties will agree with our
interpretation of the terms of the agreements, that the agreements will provide us with
marketable products in the future or that we will receive payments for any of the products
developed under the agreements.  During the term of the agreement, Johnson &
Johnson has the ability to choose not to continue and may terminate the agreement. 
If Johnson & Johnson should terminate their agreement with us, we will not receive
certain payments, and the price of our common stock could fall significantly. In that
event, we may proceed to develop and commercialize the devices on our own or with a
third party.  However, there can be no assurance that we will be able to successfully
implement such a strategy.  In addition, after commercialization of such devices,
Johnson & Johnson is to pay us a percentage of net sales of such devices. Certain of
these percentages of net sales are only owed if the devices are covered by valid
patents.  There can be no assurance that valid patents will cover the devices in any
or all countries, in which the devices will be manufactured, used or sold.  This
could have a material adverse effect on our business, results of operations and financial
condition.


The expense and potential
unavailability of liability insurance coverage for our customers could adversely affect
our ability to sell our products and our financial condition.


Some
of our customers and prospective customers have had difficulty in procuring or maintaining
liability insurance to cover their operation and use of our products. Medical malpractice
carriers are withdrawing coverage in some states or substantially increasing premiums. If
this trend continues or worsens, our customers may discontinue using our products, and
potential customers may elect not to purchase laser and other light-based products.


The reduced availability of
consumer financing could have a material adverse effect on our results of operations.


Prior
to selling to a new customer, we require proof of financing. Availability of financing is
dependent on the lending practices of financial institutions, financial markets,
governmental policies, and economic conditions, all of which are largely beyond our
control. The reduced availability of financing from third party lenders for our customers
could affect our sales volume and have a material adverse effect on our results of
operations.


We may be unable to attract and
retain key executives and research and development personnel that we need to succeed.


As a small company with approximately 250 employees, our success depends on the services
of key employees in executive and research and development positions. The loss of the
services of one or more of these employees could have a material adverse effect on our
business.  Our future success will depend in large part upon our ability to attract,
retain, and motivate highly skilled employees. We cannot be certain that we will be able
to do so.



32


Product liability suits could be
brought against us due to a defective design, material or workmanship or due to misuse of
our products. These lawsuits could be expensive and time consuming and result in
substantial damages to us and increases in our insurance rates.


If
our products are defectively designed, manufactured or labeled, contain defective
components or are misused, we may become subject to substantial and costly litigation by
our customers or their patients or clients. Furthermore, in the event that any of our
products prove to be defectively designed and manufactured, we may be required to recall
and redesign such products. Misusing our products or failing to adhere to operating
guidelines for our products can cause severe burns or other damage to the eyes, skin or
other tissue. We are routinely involved in claims related to the use of our products.
Product liability claims could divert managements attention from our core business,
be expensive to defend and result in sizable damage awards against us. Our current
insurance coverage may not be sufficient to cover these claims. Moreover, in the future,
we may not be able to obtain insurance in amount or scope sufficient to provide us with
adequate coverage against potential liabilities. Any product liability claims brought
against us, with or without merit, could increase our product liability insurance rates or
prevent us from securing continuing coverage, could harm our reputation in the industry
and reduce product sales. We would need to pay any product losses in excess of our
insurance coverage out of cash reserves, harming our financial condition and adversely
affecting our operating results.


We face risks associated with
product warranties.


We
could incur substantial costs as a result of product failures for which we are responsible
under warranty obligations.


Because we derive a significant
amount of our revenue from international sales, we are susceptible to currency
fluctuations, long payment cycles, credit risks and other risks associated with conducting
business overseas.


We sell a significant amount of our products and services outside the U.S. 
International product revenue, consisting of sales from our distributors in Japan, Europe,
Australia, Asia\Pacific Rim and South and Central America and sales shipped directly to
international locations from the United States, and we expect that international sales
will continue to be significant.  As a result, a major part of our revenues and
operating results could be adversely affected by risks associated with international
sales, including but not limited to political and economic instability and difficulties in
managing our foreign operations.  In particular, longer payment cycles common in
foreign markets, credit risk and delays in obtaining necessary import or foreign
certification or regulatory approvals for products may occur.  In addition,
significant fluctuations in the exchange rates between the U.S. dollar and foreign
currencies could cause us to lower our prices and thus reduce our profitability, or could
cause prospective customers to push out orders to later dates because of the increased
relative cost of our products in the aftermath of a currency devaluation or currency
fluctuation.


We may not be able to sustain or
increase profitability and we may seek additional financing to grow the business.


Although we have generated a profit in recent years, we incurred a loss this quarter and
have a history of losses. We may not be able to sustain or increase profitability on a
quarterly or annual basis due to many factors including lower demand for our products by practitioners, including practitioners postponing their buying decisions due to
the weakening economy or other factors. If our operating results fall below the
expectations of investors or public market analysts, the price of our common stock could
decline.


We
may determine, depending upon the opportunities available, to seek additional debt or
equity financing to fund the costs of expansion.  Additionally, if we incur
indebtedness to fund increased levels of accounts receivable, finance the acquisition of
capital equipment, or if we issue debt securities in connection with any acquisition we
will be subject to risks associated with incurring substantial additional indebtedness.

33


The liquidity and market value of our
investments may decrease.


As
of March 31, 2008, we held approximately $21.9 million of auction-rate securities.
Recently, there have been disruptions in the market for auction-rate securities related to
liquidity which has caused substantially all auctions to fail. All of our securities held
as of March 31, 2008 failed in its last auction. We will not be able to access our
investments in ARS until future auctions are successful, ARS are called for redemption by
the issuers, or until we sell the securities in a secondary market, which currently is not
active. In the event that we are unable to sell the underlying securities at or above our
carrying value, these securities may not provide us a liquid source of cash in the future.
At March 31, 2008, due to the uncertainty and illiquidity in this market, we have
classified our auction-rate securities as non-current assets and have recorded an
unrealized loss of $341,000 in accumulated other comprehensive (loss) income, net of
taxes in stockholder's equity. The recovery of these investments is based upon market factors which are not within our control.
We will continue to evaluate whether the impairment is temporary.


Our common stock could be further
diluted by the conversion of outstanding options and warrants.


In
the past, we have issued and still have outstanding convertible securities in the form of
options and warrants.  We may continue to issue options, warrants and other equity
rights as compensation for services and incentive compensation for our employees,
directors and consultants or others who provide services to us. We have a substantial
number of shares of common stock reserved for issuance upon the conversion and exercise of
these securities. Such a conversion would dilute our stockholders and could adversely
affect the market price of our common stock.


Our charter documents, Delaware
law and our shareholder rights plan may discourage potential takeover attempts.


Our Second Restated Certificate of Incorporation and our By-laws contain provisions that
could discourage takeover attempts or make more difficult the acquisition of a substantial
block of our common stock. Our By-laws require a stockholder to provide to our Secretary
advance notice of director nominations and business to be brought by such stockholder
before any annual or special meeting of stockholders, as well as certain information
regarding such nomination and/or business, the stockholder and others known to support
such proposal and any material interest they may have in the proposed business. They also
provide that a special meeting of stockholders may be called only by the affirmative vote
of a majority of the board of directors. These provisions could delay any stockholder
actions that are favored by the holders of a majority of our outstanding stock until the
next stockholders meeting. In addition, the board of directors is authorized to
issue shares of our common stock and preferred stock that, if issued, could dilute and
adversely affect various rights of the holders of common stock and, in addition, could be
used to discourage an unsolicited attempt to acquire control of us.


We
are also subject to the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law, which prohibits us from engaging in a business combination
with an interested stockholder for a period of three years after the date of
the transaction in which the person becomes an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203 may limit
the ability of stockholders to approve a transaction that they may deem to be in their
best interests. These provisions of our Second Restated Certificate of Incorporation,
By-laws and the Delaware General Corporation Law could deter certain takeovers or tender
offers or could delay or prevent certain changes in control or our management, including
transactions in which stockholders might otherwise receive a premium for their shares over
the then current market price.


In
April 1999, we adopted a shareholder rights plan or poison pill. This is
intended to protect shareholders from unfair or coercive takeover practices.


Any acquisitions that we make
could disrupt our business and harm our financial condition.


From
time to time, we evaluate potential strategic acquisitions of complementary businesses,
products or technologies, as well as consider joint ventures and other collaborative
projects. We may not be able to identify appropriate acquisition candidates or strategic
partners, or successfully negotiate, finance or integrate any businesses, products or
technologies that we acquire. Any acquisition we pursue could diminish our cash available
to us for other uses or be dilutive to our stockholders, and could divert
managements time and resources from our core operations.



34



Our stock price may be
volatile.


Our
common stock price may be volatile. The stock market in general has experienced extreme
volatility that has often been unrelated to the operating performance of particular
companies. The market price for our common stock may be influenced by many factors,
including:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | o |  | the success of competitive products or technologies;
| |  | - |  | ----------------------------------------------------

| |  | o |  | regulatory developments in the United States and foreign countries;
| |  | - |  | -------------------------------------------------------------------

| |  | o |  | developments or disputes concerning patents or other foreign countries;
| |  | - |  | -----------------------------------------------------------------------

| |  | o |  | the recruitment or departure of key personnel;
| |  | - |  | ----------------------------------------------

| |  | o |  | variations in our financial results
or those of companies that are perceived to be similar to us;
| |  | - |  | -------------------------------------------------------------------------------------------------

| |  | o |  | market conditions in our
industry and issuance of new or changed securities analysts reports or
recommendations; and
| |  | - |  | ---------------------------------------------------------------------------------------------------------------------

| |  | o |  | general economic, industry and market conditions.
| |  | - |  | -------------------------------------------------

|Item 3.  Quantitative and qualitative disclosures about market risk

Our
primary market risk exposures are in the areas of interest rate risk, liquidity risk, and
foreign currency exchange risk.


Our
investment portfolio of cash equivalents, corporate preferred securities, and municipal
debt securities is subject to interest rate fluctuations, but we believe this risk is
immaterial because of the historically short-term nature of these investments. At March
31, 2008, we held $21.9 million in auction-rate securities (ARS). The ARS we typically
invest in are high quality, AAA-rated securities, none of which are mortgage-backed, with
interest rates often ranging from 3 to 14%. At December 31, 2007, because of the
short-term nature of our investment in these securities, they were classified as
available-for-sale and included in short-term investments on our consolidated balance
sheets. Subsequent to December 31, 2007 and through March 31, 2008, our securities failed
at auction due to a decline in liquidity in the ARS and other capital markets. We will not
be able to access our investments in ARS until future auctions are successful, ARS are
called for redemption by the issuers, or until sold in a secondary market, which is not
currently active. Until the auctions for our ARS are successful, we have the potential to
benefit from a penalty feature in our interest rates which allows us to earn higher rates
of interest on these securities. As our investments in ARS currently lack short-term
liquidity, we have reclassified these investments as non-current as of March 31, 2008.
The recovery of these investments is based upon market factors which are not within our control.


Our
international subsidiary in The Netherlands conducts business in both local and foreign
currencies and therefore, we are exposed to foreign currency exchange risk resulting from
fluctuations in foreign currencies. This risk could adversely impact our results and
financial condition. We believe our current exposure to fluctuations in foreign currency
exchange rates is immaterial. We have not entered into any foreign currency exchange and
option contracts to reduce our exposure to foreign currency exchange risk and the
corresponding variability in operating results as a result of fluctuations in foreign
currency exchange rates.



Item 4. Controls and
procedures


Under the
direction of the principal executive officer and principal financial officer, the Company
has evaluated the effectiveness of its disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2008. Based on that
evaluation, the Company has concluded that its disclosure controls and procedures were
effective.



35


The
Companys management, including the CEO and CFO, does not expect that the
Companys disclosure controls or internal controls over financial reporting will
prevent all errors and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
systems objectives will be met. Further, the design of a control system must reflect
the fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These inherent
limitations include the realities that judgments in decision making can be faulty and that
individual acts of some persons, by collusion of two or more people, or by management
override of the controls. The design of any system of controls is based in part on certain
assumptions about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future conditions.
Over time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or procedures. Because of the
inherent limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.


There
were no significant changes in the Companys internal controls over financial
reporting or in other factors that could significantly affect these controls during the
quarter ended March 31, 2008, including any corrective actions with regard to significant
deficiencies and material weaknesses.



PART II  Other
information



Item
1.    Legal proceedings



Alma Lasers Litigation


On
July 7, 2006, we commenced an action for patent infringement against Alma Lasers, Inc. in
the United States District Court for the District of Massachusetts seeking both monetary
damages and injunctive relief. The complaint alleged Almas Harmony, Soprano and
Sonata Systems which use pulsed light and laser technology for hair removal willfully
infringe U.S. Patent Nos. 5,595,568 & 5,735,844, which are exclusively licensed to us
by the Massachusetts General Hospital. On July 27, 2006, we filed an amended complaint
including an additional claim against Alma for unfair competition due to infringement by
Almas Harmony System of the distinctive trade dress of our products, including the
unique, distinctive, and immediately recognizable design of our EsteLux, MediLux and
StarLux Systems.


On
April 2, 2007, we announced the resolution of our lawsuit against Alma Laser, Inc. through
the execution of a Non-Exclusive Patent License Agreement, a Trade Dress Settlement
Agreement, and a Settlement Agreement. Under the Patent License Agreement, we granted Alma
a non-exclusive, royalty bearing license to U.S. Patent Nos. 5,595,568 & 5,735,844
& corresponding foreign patents and applications in the professional field, excluding
the consumer field. Alma admitted that its products infringe these patents and that these
patents are valid and enforceable. In addition, Alma agreed not to challenge the
infringement, validity and enforceability of these patents in the future. Alma paid us an
estimated payment for royalties due on past sales of their laser and lamp-based hair
removal systems beginning with their initial sales in 2003 through the date of settlement,
plus interest and reimbursement of our legal costs. Alma also paid us an estimated payment
for trade dress fees on past sales of their Harmony and Aria Systems and interest, and
Alma agreed to change and has changed the trade dress of the Harmony and Aria systems. The
final amounts due to us were the subject of an audit by an independent accounting firm
completed in the first quarter of 2008. Starting on March 30, 2007, Alma began paying us a
royalty on sales of its existing and any new light-based hair removal systems later
developed.


For
more information, please see the Settlement Agreement, the Non-Exclusive Patent License
Agreement, the Trade Dress Settlement Agreement, the Consent Judgments and Stipulations of
Dismissal filed as exhibits to our Current Report on Form 8-K filed April 2, 2007.

36


Candela Corporation,
Massachusetts Litigation


On
August 9, 2006, we commenced an action for patent infringement against Candela Corporation
in the United States District Court for the District of Massachusetts seeking both
monetary damages and injunctive relief. The complaint alleges Candelas GentleYAG and
GentleLASE systems, which use laser technology for hair removal willfully, infringe U.S.
patent No. 5,735,844, which is exclusively licensed to us by the Massachusetts General
Hospital. Candela answered the complaint denying that its products infringe valid claims
of the asserted patents and filing a counterclaim seeking a declaratory judgment that the
asserted patent and U.S. patent No. 5,595,568 are invalid and not infringed. We filed a
reply denying the material allegations of the counterclaims. This lawsuit has been
transferred to the judge who presided over Palomar v Cutera, Inc.


We
filed an amended complaint on February 16, 2007 to add the Massachusetts General Hospital
as a plaintiff. In addition, we further alleged that Candelas GentleMAX system
willfully infringes U.S. Patent No. 5,735,844 and that Candelas Light Station system
willfully infringes both U.S. Patent Nos. 5,735,844 and 5,595,568. On February 16, 2007,
Candela filed an amended answer to our complaint adding allegations of inequitable
conduct, double patenting and violation of Massachusetts General Laws Chapter 93A. On
February 28, 2007, we filed a response to Candelas amended complaint pointing out
many weaknesses in Candelas allegations. A claim construction hearing, sometimes
called a Markman Hearing, was held August 2, 2007, and we received what we
consider to be a favorable Markman ruling on November 9, 2007. No trial date has yet been
set.


On
August 10, 2006, Candela Corporation commenced an action for patent infringement against
us in the United States District Court for the District of Massachusetts seeking both
monetary damages and injunctive relief. The complaint alleged that our StarLux System with
the LuxV handpiece willfully infringes U.S. Patent No. 6,743,222 which is directed to acne
treatment, that our QYAG5 System willfully infringes U.S. Patent No. 5,312,395 which is
directed to treatment of pigmented lesions, and that our StarLux System with the LuxG
handpiece willfully infringes U.S. Patent No. 6,659,999 which is directed to wrinkle
treatment. On October 25, 2006, Candela filed an amended complaint which did not include
U.S. Patent No. 6,659,999. Consequently, Candela no longer alleges in this lawsuit that
the StarLux System with LuxG handpiece infringes its patents. With regard to the two
remaining patents, Candela is seeking to enjoin us from selling these products in the
United States if we are found to infringe the patents, and to obtain compensatory and
treble damages, reasonable costs and attorneys fees, and other relief as the court
deems just and proper. On October 30, 2006 we answered the complaint denying that our
products infringe the asserted patents and filing counterclaims seeking declaratory
judgments that the asserted patents are invalid and not infringed. In addition, with
regard to U.S. Patent No. 5,312,395, we filed a counterclaim of inequitable conduct. In
February 2008, we filed a request for reexamination and then an amended request for
reexamination of Candelas 222 patent with the United States Patent and
Trademark Office (PTO). In our request, we argued that Candelas
222 patent is unpatentable over our own United States Patent No. 6,605,080 alone or
in combination with other prior art. About the same time, we filed a motion to stay all
proceedings in this action related to the 222 patent pending resolution of the
amended request for reexamination of the 222 patent. In March, the PTO granted our
request for reexamination of the 222 patent. However, before we could notify the
judge in this action, he denied our motion to stay. We then filed a motion for
reconsideration which was granted on April 10, 2008 and the judge set a hearing date of
June 16, 2008. A claim construction hearing, or a Markman Hearing, scheduled for April 15,
2008 was postponed. No trial date has yet been set. We are defending the action vigorously
and believe that we have meritorious defenses of non-infringement, invalidity and
inequitable conduct. However, litigation is unpredictable and we may not prevail in
successfully defending or asserting our position. If we do not prevail, we may be ordered
to pay substantial damages for past sales and an ongoing royalty for future sales of
products found to infringe in the United States. We could also be ordered to stop selling
any products in the United States that are found to infringe.



37



Candela Corporation,
Texas Litigation




On
December 19, 2006, Candela Corporation commenced an action for patent infringement against
us in the United States District Court for the Eastern District of Texas, seeking both
monetary damages and injunctive relief. The complaint alleges that our StarLux System with
the LuxY handpiece willfully infringes U.S. Patent No. 6,659,999 and that our StarLux
System with the Lux1540 handpiece willfully infringes related U.S. Patent Nos. 5,810,801
and 6,120,497. The three asserted patents are directed to wrinkle treatment. Candela is
seeking to enjoin us from selling these products in the United States if found to infringe
the patents, and to obtain compensatory and treble damages, reasonable costs and
attorneys fees, and other relief as the court deems just and proper. On January 10,
2007, we answered the complaint denying that our products infringe the asserted patents
and filing counterclaims seeking declaratory judgments that the asserted patents are
invalid and not infringed. On April 6, 2007, Candela filed their infringement contentions
which modified their complaint to accuse the Lux1540, Lux1540-Z, LuxIR, LuxDeepIR, LuxB,
LuxG and LuxY handpieces for use with the StarLux, StarLux 500, MediLux and EsteLux
Systems of infringing the three asserted patents. On July 13, 2007, we filed an amended
answer to Candelas first amended complaint including counterclaim of inequitable
conduct, and on March 21, 2008, we filed a second amended answer to Candelas second
amended complaint including a further counterclaim of inequitable conduct and a
counterclaim of bad faith filing and prosecution of this lawsuit. We are defending the
action vigorously and believe that we have meritorious defenses of non-infringement,
invalidity, and unenforceability. However, litigation is unpredictable and we may not
prevail in successfully defending or asserting our position. If we do not prevail, we may
be ordered to pay substantial damages for past sales and an ongoing royalty for future
sales of products found to infringe in the United States. We could also be ordered to stop
selling any products that are found to infringe in the United States. A Markman Hearing
was held on November 13, 2007 and we are waiting on a ruling from the Judge. The trial was
scheduled to begin July 14, 2008, however, on May 2, 2008, the Judge postponed the trial
start date to September 15, 2008.


Item 2.  Changes in securities, use of proceeds and issuer purchases of securities
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Period                                     | Total number of shares purchased | Average price paid per share | Total number of shares purchased as part of publicly announced program * | Maximum number of shares that may yet be purchased under program *
|------------------------------------------ | -------------------------------- | ---------------------------- | ------------------------------------------------------------------------ | ------------------------------------------------------------------
|January 1, 2008 through January 31, 2008   | --                               | --                           | --                                                                       | 895,000                                                           
|February 1, 2008 through February 29, 2008 | --                               | --                           | --                                                                       | 895,000                                                           
|March 1, 2008 through March 31, 2008       | 100,000                          | 13.37                        | 100,000                                                                  | 795,000                                                           
|                                           |                                  |                              |                                                                          |                                                                   
|                                           |                                  |                              |                                                                          |                                                                   
|Total                                      | 100,000                          | $     13.37                  | 100,000                                                                  | 795,000                                                           
|                                           |                                  |                              |                                                                          |                                                                   
|                                          

|*On August 13, 2007, our Board of Directors approved a stock repurchase program under
which our management is authorized to repurchase up to one million shares of our common
stock. The timing and actual number of shares purchased will depend on a variety of
factors such as price, corporate and regulatory requirements, alternative investment
opportunities and other market conditions. Stock repurchases under this program, if any,
will be made using our cash resources, and may be commenced or suspended at any time or
from time to time at managements discretion without prior notice.



Item 3. Defaults upon
senior securities

None.



Item 4.  Submission of matters to a vote of security holders
 
None.



Item 5. Other information

 
None.

38



Item 6. Exhibits
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.4 | Amended and Restated By-Laws (previously disclosed as exhibit 10.51 in our
                          Form 10-K dated March 6, 2008)
| | --- | -----------------------------------------------------------------------------------------------------------------------------------

| | 31.1 | Certification of Joseph P. Caruso, President and Chief Executive Officer of
                          the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                          2002.
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.2 | Certification of Paul S. Weiner, Vice President and Chief Financial Officer of the
Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 32 | Certification of Joseph P. Caruso, President and Chief Executive Officer of the
Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 32 | Certification of Paul S. Weiner, Vice President and Chief Financial Officer of the
Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|39




Signatures


Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Palomar Medical
Technologies, Inc.(Registrant)
| |  | ----------------------------------------------

|                   |                                                                                                     
|------------------ | ----------------------------------------------------------------------------------------------------
|Date:  May 8, 2008 | By:/s/ Joseph P. Caruso
      Joseph P. Caruso
      President, Chief Executive Officer and Director
|                   |                                                                                                     

|                   |                                                                                            
|------------------ | -------------------------------------------------------------------------------------------
|Date:  May 8, 2008 | By:/s/ Paul S. Weiner
      Paul S. Weiner
      Vice President and Chief Financial Officer
|                   |                                                                                            

|40
|--