PALOMAR MEDICAL TECHNOLOGIES INC - FORM 10-Q

Attached files

file	filename
EX-31.1 - PALOMAR MEDICAL TECHNOLOGIES INC	ex31.htm
EX-32 - PALOMAR MEDICAL TECHNOLOGIES INC	ex32.htm
EX-31.2 - PALOMAR MEDICAL TECHNOLOGIES INC	ex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarter Ended September 30, 2010

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

15 Network Drive, 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

Preferred Stock Purchase Rights

Name of each exchange on which registered

NASDAQ – Global Select Market

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. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ¨ No ¨

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 ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

(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 ¨ No x

The number of shares outstanding of the registrant’s common stock as of the close of business on November 3, 2010 was 18,573,445.

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 September 30, 2010 and December 31, 2009	3
	Unaudited Condensed Consolidated Statements of Operations for the periods ended September 30, 2010 and September 30, 2009	4
	Unaudited Condensed Consolidated Statements of Cash Flows for the periods ended September 30, 2010 and September 30, 2009	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and the Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	21
PART II – Other Information
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	24
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Securities	26
Item 3.	Defaults Upon Senior Securities	26
Item 4.	(Removed and Reserved)	26
Item 5.	Other Information	26
Item 6.	Exhibits	26
SIGNATURES		27

Palomar Medical Technologies, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

	September 30,			December 31,
	2010			2009

Assets
Current assets
Cash and cash equivalents	$	76,623,685		$	81,948,482
Short-term investments		1,999,675			25,000,000
Total cash, cash equivalents and short-term investments		78,623,360			106,948,482
Accounts receivable, net		5,035,232			4,436,219
Inventories		12,218,475			11,126,352
Other current assets		1,783,674			2,179,233
Total current assets		97,660,741			124,690,286

Marketable securities, at estimated fair value		24,129,348			4,024,313

Property and equipment, net		37,271,766			34,629,410

Other assets		218,716			126,087

Total assets	$	159,280,571		$	163,470,096

Liabilities and Stockholders' Equity

Current liabilities
Accounts payable	$	3,326,847		$	2,696,217
Accrued liabilities		9,245,816			8,959,679
Deferred revenue		3,793,124			5,221,924
Total current liabilities		16,365,787			16,877,820

Accrued income taxes		2,788,802			2,965,077

Total liabilities	$	19,154,589		$	19,842,897

Commitments and contingencies (Note 9)

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 - 18,573,262 and 18,521,045 shares, respectively		185,733			185,211
Additional paid-in capital		209,629,876			206,740,492
Accumulated other comprehensive loss		(460,540	)		(292,297	)
Accumulated deficit		(69,229,087	)		(63,006,207	)
Total stockholders' equity	$	140,125,982		$	143,627,199

Total liabilities and stockholders’ equity	$	159,280,571		$	163,470,096

See accompanying notes to condensed consolidated financial statements.

Palomar Medical Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2010			2009			2010			2009
Revenues
Product revenues	$	9,273,158		$	7,528,645		$	27,655,391		$	23,939,493
Service revenues		3,749,164			3,700,511			11,512,299			10,884,073
Royalty revenues		1,499,182			1,264,022			4,444,327			4,032,039
Funded product development revenues		-			806,482			-			1,636,082
Other revenues		1,250,000			1,250,000			3,750,000			3,750,000
Total revenues		15,771,504			14,549,660			47,362,017			44,241,687

Costs and expenses
Cost of product revenues		3,781,473			2,873,956			10,583,241			9,849,383
Cost of service revenues		1,367,316			1,901,303			4,320,439			5,417,280
Cost of royalty revenues		599,673			505,609			1,777,731			1,612,816
Research and development		3,545,622			3,305,311			11,320,691			10,125,279
Selling and marketing		4,663,632			4,062,930			14,408,442			13,464,732
General and administrative		4,267,535			2,451,496			11,579,566			7,566,053
Total costs and expenses		18,225,251			15,100,605			53,990,110			48,035,543

Loss from operations		(2,453,747	)		(550,945	)		(6,628,093	)		(3,793,856	)

Interest income		108,630			218,169			309,747			551,817
Other income		390,784			156,941			212,922			506,761

Loss before income taxes		(1,954,333	)		(175,835	)		(6,105,424	)		(2,735,278	)

Provision for (benefit from) income taxes		69,454			120,752			117,456			(780,319	)

Net loss	$	(2,023,787	)	$	(296,587	)	$	(6,222,880	)	$	(1,954,959	)

Net loss per share
Basic	$	(0.11	)	$	(0.02	)	$	(0.34	)	$	(0.11	)
Diluted	$	(0.11	)	$	(0.02	)	$	(0.34	)	$	(0.11	)

Weighted average number of shares outstanding
Basic		18,561,877			18,065,655			18,539,847			18,058,246
Diluted		18,561,877			18,065,655			18,539,847			18,058,246

Comprehensive loss:
Net loss	$	(2,023,787	)	$	(296,587	)	$	(6,222,880	)	$	(1,954,959	)
Unrealized gain (loss) on marketable securities, net of taxes		5,256			(24,138	)		(56,657	)		142,645
Foreign currency translation adjustment		(122,434	)		(24,690	)		(111,586	)		(115,680	)
Comprehensive loss	$	(2,140,965	)	$	(345,415	)	$	(6,391,123	)	$	(1,927,994	)

See accompanying notes to condensed consolidated financial statements.

Palomar Medical Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

					Nine Months Ended
					September 30,
					2010		2009
Operating activities
	Net loss				$ (6,222,880	)	$ (1,954,959	)

	Adjustments to reconcile net loss to net cash (used in) from operating activities:
		Depreciation and amortization			956,602		469,167
		Stock-based compensation expense			2,794,761		2,573,483
		Provision for bad debt			70,694		139,810
		Inventory write-off			207,443		151,274
		Change in deferred tax asset			5,176		(1,179,411	)
		Tax benefit from the exercise of stock options			(46,437	)	(264,100	)
		Other non-cash items			(44,781	)	178,000
		Changes in assets and liabilities:
			Accounts receivable		(660,480	)	738,195
			Inventories		(1,163,575	)	3,690,047
			Other current assets		402,125		894,688
			Other assets		(54,797	)	2,538
			Accounts payable		351,590		2,947,087
			Accrued liabilities		476,106		1,428,661
			Accrued income taxes		(176,275	)	15,122
			Deferred revenue		(1,612,595	)	(2,047,346	)
				Net cash (used in) from operating activities	(4,717,323	)	7,782,256

Investing activities
	Purchases of property and equipment				(3,592,144	)	(15,775,678	)
	Purchases of marketable securities				(22,055,963	)	-
	Purchases of short-term investments				(1,999,675	)	-
	Proceeds from sale of short-term investments				25,000,000		-
	Proceeds from sale of marketable securities				1,850,000		625,000
				Net cash used in investing activities	(797,782	)	(15,150,678	)

Financing activities
	Proceeds from the exercise of stock options and warrants				48,708		117,415
	Tax benefit from the exercise of stock options				46,437		264,100
	Costs incurred related to purchase of stock for treasury				-		(258,491	)
	Proceeds from borrowings on credit facility				-		14,000,000
	Payments on borrowings on credit facility				-		(20,000,000	)
				Net cash from (used in) financing activities	95,145		(5,876,976	)

Effect of exchange rate changes on cash and cash equivalents					95,163		4,236

Net decrease in cash and cash equivalents					(5,324,797	)	(13,241,162	)
Cash and cash equivalents, beginning of the period					81,948,482		122,601,139
Cash and cash equivalents, end of the period					$ 76,623,685		$ 109,359,977

Supplemental disclosure of cash flow information

	Cash paid for income taxes				$ 52,000		$ 36,493

Supplemental noncash investing activities
	Unrealized (loss) gain on marketable securities, net of taxes				$ (56,657	)	$ 142,645

See accompanying notes to condensed consolidated financial statements.

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, 2009 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, 2009.

In 2010, we reclassified certain balances within revenues and costs and expenses. To be consistent with the 2010 presentation, we reclassified certain 2009 balances within revenues and costs and expenses in the accompanying Condensed Consolidated Statements of Operations. The reclassifications had no impact on previously reported results of operations or cash flow related to operating activities.

There have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2010, as compared to the recent accounting pronouncements described in the Company’s Form 10-K, that are of significance, or potential significance to the Company.

Note 2 – Stock-based compensation

Stock-based compensation expense recorded was $0.9 million and $1.0 million for the three months ended September 30, 2010 and 2009, respectively and $2.8 million and $2.6 million for the nine months ended September 30, 2010 and 2009, respectively. As of September 30, 2010, there was $4.1 million of unrecognized compensation expense related to non-vested share awards. The expense is expected to be recognized over a weighted-average period of 1.6 years.

During the three months ended September 30, 2010, no equity awards, including options, warrants, stock-settled stock appreciation rights, or restricted stock were granted. During the nine months ended September 30, 2010, 8,000 stock-settled stock appreciation rights were granted.

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 September 30, 2010 and December 31, 2009, inventories consisted of the following:

		September 30,	December 31,
		2010	2009
Raw materials		$ 4,984,923	$ 4,365,150
Work in process		1,397,387	361,931
Finished goods		5,836,165	6,399,271
	Total	$ 12,218,475	$ 11,126,352

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. Land and construction in progress assets are not depreciated. At September 30, 2010 and December 31, 2009, property and equipment consisted of the following:

	September 30,			December 31,			Estimated
	2010			2009			useful life

Land	$	10,680,000		$	10,680,000
Building		24,307,148			-		39 years
Machinery and equipment		2,698,464			2,100,331		3-7 years
Furniture and fixtures		5,405,189			3,364,989		7 years
Leasehold improvements		39,589			537,648		Shorter of estimated useful life or term of lease
Construction in progress		-			23,385,614
		43,130,390			40,068,582
Accumulated depreciation		(5,858,624	)		(5,439,172	)
Total	$	37,271,766		$	34,629,410

Note 5 – Warranty costs

We typically offer a one year warranty on our base systems. Warranty coverage provided is for labor and parts necessary to repair the systems during the warranty period. We account for the estimated warranty cost of the standard warranty coverage as a charge to cost of revenue when revenue is recognized. The estimated warranty cost is based on units sold, historical product performance and the cost per repair. We assess the adequacy of the warranty provision and we may adjust this provision if necessary.

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 as of September 30, 2010 and December 31, 2009:

	September 30,			December 31,
	2010			2009
Warranty accrual, beginning of period	$	596,210		$	856,158
Charges to cost and expenses relating to new sales		1,097,107			1,280,301
Costs of product warranty claims/change of estimate		(1,173,832	)		(1,540,249	)
Warranty accrual, end of period	$	519,485		$	596,210

Note 6 – Fair Value of Financial Instruments

In September 2006, the Financial Accounting Standards Board (FASB) issued new guidance on fair value measurements. This guidance defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. The guidance applies under other accounting pronouncements that require or permit fair value measurements and accordingly, does not require any new fair value measurements. This guidance was effective for financial statements issued for fiscal years beginning after November 15, 2007, and we adopted this guidance on January 1, 2008. In February 2008, the FASB issued an update to the fair value measurement guidance. This guidance permitted the delayed application of the fair value measurement guidance for all non-recurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. The adoption of this guidance had no impact on the Company’s consolidated financial statements.

We performed an analysis of our investments held at September 30, 2010 and December 31, 2009 to determine the significance and character of all inputs to their fair value determination. 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.

The FASB’s fair value measurement guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three broad categories.

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

·	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.

·	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.

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 September 30, 2010 and December 31, 2009.

Assets	Fair Value as of September 30, 2010
(In thousands)	Level 1		Level 2		Level 3			Total
Short-term investments	$	2,000	$	-	$	-	24	$	2,000
Marketable securities		22,042		-		-			22,042
Auction-rate preferred securities		-		-		1,006			1,006
Auction-rate municipal securities		-		-		1,081			1,081
Total	$	24,042	$	-	$	2,087		$	26,129

Assets	Fair Value as of December 31, 2009
(In thousands)	Level 1		Level 2		Level 3			Total
Short-term investments	$	25,000	$	-	$	-	24	$	25,000
Auction-rate preferred securities		-		-		2,622			2,622
Auction-rate municipal securities		-		-		1,402			1,402
Total	$	25,000	$	-	$	4,024		$	29,024

At September 30, 2010, the amortized cost basis of the auction-rate preferred securities and auction-rate municipal securities were $1.1 million and $1.4 million, respectively. At December 31, 2009, the amortized cost basis of the auction-rate preferred securities and auction-rate municipal securities were $2.9 million and $1.5 million, respectively. As described in more detail below, all of our auction-rate securities (ARS) have unrealized losses which have been recorded in accumulated other comprehensive loss.

There is no maturity date of the auction-rate preferred securities while the maturity date for our auction-rate municipal securities is in December 2045.

At September 30, 2010, we had $22.0 million of marketable securities classified as held-to-maturity securities which included commercial paper, U.S Treasuries, and corporate bonds. The maturity dates range from 91 days to 2 years.

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 nine months ended September 30, 2010.

	Auction-rate		Auction-rate
(In thousands)	preferred securities		municipal securities		Total
Balance at December 31, 2009	$2,622		$1,402		$4,024
Net payments, purchases and sales	(1,750	)	(100	)	(1,850	)
Net transfers in/(out)	-		-		-
Gains/(losses)
Realized	-		-		-
Unrealized	134		(221	)	(87	)
Balance at September 30, 2010	$1,006		$1,081		$2,087

All of the above ARS have been in a continuous unrealized loss position for 12 months or longer. We continue to receive regular dividends from each of our ARS at current market rates.

Historically, the ARS market was an active and liquid market where we could purchase and sell our ARS on a regular basis through auctions. As such, we classified our ARS as Level 1 investments in accordance with the FASB’s guidance at December 31, 2007. Subsequent to December 31, 2007, several of our ARS 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. As all of our investments in ARS currently lack short-term liquidity, we have classified these investments as non-current investments as of September 30, 2010 and December 31, 2009.

The estimated fair value of our holdings of ARS at September 30, 2010 was $2.1 million. To value our ARS, we determined the present value of the ARS at the balance sheet date by discounting the estimated future cash flows based on a fair value rate of interest and an expected time horizon to liquidity. We also evaluated the credit rating of the issuer and found them all to be investment grade securities. There was no change in our valuation method during the three and nine month periods ended September 30, 2010 as compared to prior reporting periods. Our valuation analysis showed that our ARS have nominal credit risk. The impairment is due to liquidity risk. Additionally, as of September 30, 2010, we do not intend to sell the ARS, it is not more likely than not that we will be required to sell the ARS before recovery of their amortized cost bases, which may be at maturity, and we expect to recover the full amortized cost basis of these securities. As a result of our valuation analysis, our investment strategy, recurring dividend stream from these investments, and our strong cash and cash equivalents position, we have determined that the fair value of our ARS was temporarily impaired as of September 30, 2010.

We continue to monitor the market for ARS 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 accumulated other comprehensive (loss) income. If the credit rating of the security issuers deteriorates, the anticipated recovery in market values does not occur, or we stop receiving dividends, we may be required to adjust the carrying value of these investments through impairment charges in our Consolidated Statements of Operations.

Note 7 – Net loss per common share

Basic net loss per share was determined by dividing net loss by the weighted average common shares outstanding during the period. Diluted net loss per share was determined by dividing net loss 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 and nine months ended September 30, 2010 and 2009 is as follows:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2010		2009		2010		2009
Basic weighted average number of shares outstanding		18,561,877		18,065,655		18,539,847		18,058,246
Potential common shares pursuant to stock options, stock appreciation rights and warrants		-		-		-		-
Diluted weighted average number of shares outstanding		18,561,877		18,065,655		18,539,847		18,058,246

For the three months ended September 30, 2010 and 2009, approximately a net of 2.5 million and 2.3 million, respectively, weighted average options, stock-settled SARs, and warrants to purchase shares of our common stock were excluded from the computation of diluted earnings per share because the effect of including the options, stock-settled SARs, and warrants would have been antidilutive.

Note 8 – Income Taxes

We provide for income taxes under the liability method in accordance with the FASB’s guidance on accounting for income taxes. Under this guidance, we can only recognize a deferred tax asset for future benefit of our tax loss, temporary differences and tax credit carry forwards to the extent that it is more likely than not that these assets will be realized. We consider available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance.

In evaluating our ability to recover our US and foreign deferred tax assets, we considered all available positive and negative evidence, giving greater weight to the recent current losses, the absence of taxable income in the carry back periods and the uncertainty regarding our ability to project financial results in future periods. We believe that it is more likely than not that the associated deferred tax assets will not be utilized and have established a full valuation allowance.

We establish reserves for uncertain tax positions based on management’s assessment of exposure associated with tax deductions, 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. At September 30, 2010, we have $2.8 million of net unrecognized tax benefits, all of which would affect our effective tax rate, if recognized.

We recognize interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2010, we had approximately $113,000 of accrued interest and penalties related to uncertain tax positions.

The tax years 2007-2009 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 9 – Contingencies

Candela Corporation, Massachusetts Litigation

On August 9, 2006, we commenced an action for patent infringement against Candela Corporation (now Syneron, Inc.) 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 (the “’844 patent”), which is exclusively licensed to us by MGH. Candela answered the complaint denying that its products infringe valid claims of the asserted patent and filing a counterclaim seeking a declaratory judgment that the asserted patent and U.S. Patent No. 5,595,568 (the “’568 patent”) are invalid and not infringed. We filed a reply denying the material allegations of the counterclaims.

We filed an amended complaint on February 16, 2007 to add MGH as a plaintiff. In addition, we further alleged that Candela’s GentleMAX system willfully infringes the ‘844 patent and that Candela’s Light Station system willfully infringes both the ‘844 and ‘568 patents. 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.

On November 17, 2008, the Judge stayed the lawsuit pending the outcome of reexamination procedures requested by a third party on both the ‘844 and ‘568 patents in the United States Patent and Trademark Office (the “Patent Office”). On December 9, 2008, Candela also filed requests for reexamination of both patents. Generally, a reexamination proceeding is one which re-opens patent prosecution to ensure that the claims in an issued patent are valid over prior art references. On January 16, 2009, we filed a preliminary amendment to the ‘844 patent adding new claims 33-59 which depend from claim 32 and a preliminary amendment to the ‘568 patent adding new claims 23 and 24 which depend from claim 1. On June 9, 2009, the Patent Office issued an office action confirming the validity of all claims of the ‘844 patent except claims 12-14. Rejecting Candela's and the other company's arguments to the contrary, the Patent Office confirmed that claims 1-3, 6-8, 11, 17-20, 27, 28, 30, 32 of the '844 patent are valid and patentable. The Patent Office also confirmed new claims 33-59 as valid and patentable. The Patent Office rejected only independent claim 12 and related dependent claims 13-14 of the ‘844 patent as unpatentable. We cancelled claims 12-14 from the '844 patent in order to expedite the reexamination proceeding. Claims 4, 5, 9, 10, 15, 16, 21-26, 29 and 31 were not under reexamination. Consequently, all currently pending claims were found valid by the Patent Office. On November 18, 2009, the Patent Office issued a Reexamination Certificate for the ‘844 patent that closed the reexamination proceeding on the ‘844 patent.

On June 19, 2009, we filed a motion to lift the stay and reopen the lawsuit. Because Candela has discontinued products which infringe the ‘568 patent, we dropped our claims of infringement of the ‘568 patent from the lawsuit and we agreed to a covenant not to sue Candela for past infringement under the ‘568 patent. On July 13, 2009, Candela filed their opposition to our motion to lift the stay, and on July 17, 2009, we filed our response to their opposition. On January 5, 2010 the Judge lifted the stay. Expert discovery is complete. A hearing was held on September 14, 2010 on Candela's motion for summary judgment regarding both invalidity and non-infringement of certain claims of the '844 patent. A trial date will not be set until the Judge rules on Candela's motion.

On August 10, 2006, Candela Corporation (now Syneron, Inc.) 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 (the “’222 patent”) 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 Patent Office. 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 2008, the Patent Office granted our request for reexamination of the ‘222 patent. On June 11, 2008, the Court ordered the parties to report back to the Court after the Patent Office made its decision in the reexamination of the ‘222 patent, after which a claim construction hearing (i.e., a Markman Hearing) would be scheduled for both the ‘222 and ‘395 patents. On June 12, 2008, the parties informed the Court that the total time the reexamination will remain pending is not known. On January 19, 2010, the Patent Office issued a Notice of Intent to Issue Ex Parte Reexamination Certificate for the ‘222 patent which will close the reexamination proceeding on the ‘222 patent. If this lawsuit is re-started, we will continue to defend 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.

Alma Lasers, Inc., Delaware Litigation

On September 11, 2008, Alma Lasers, Inc. filed a complaint requesting a declaratory judgment that our fractional patent, U.S. Patent No. 6,997,923, is not infringed by Alma's products and is invalid over prior art. Alma served this lawsuit on us on November 6, 2008, and on November 21, 2008, we filed an answer which denied Alma's allegations that the patent is invalid and not infringed. We also filed a counterclaim accusing Alma's Pixel C02 Omnifit Fractional C02 Handpiece and Pixel C02 Fractional C02 Skin Resurfacing System of infringing the patent. On December 16, 2008, upon the request of both parties, a mediation conference was scheduled for June 30, 2009 before Magistrate Judge Mary Pat Thynge. On December 18, 2008, upon the request of both parties, the Judge presiding over the lawsuit, stayed the lawsuit and later closed the lawsuit pending the outcome of the mediation. Due to unforeseen circumstances, the mediation scheduled for June 30, 2009 was postponed until October 13, 2009. Following our request, Magistrate Judge Mary Pat Thynge cancelled the mediation on October 6, 2009. By letter dated October 13, 2009, we asked presiding Judge Farnan to re-open the case. On December 28, 2009, Alma filed a First Amended Complaint to add a claim that U.S. Patent No. 6,997,923 is unenforceable due to inequitable conduct. On January 11, 2010, we filed our Amended Answer and Counterclaim to Alma’s First Amended Complaint denying Alma’s allegation of inequitable conduct. On March 4, 2010 the parties filed a joint stipulated order of dismissal requesting that the court dismiss this action, including all claims and counterclaims, in its entirety without prejudice, with the parties agreeing that any future litigation between them over U.S. Patent No. 6,997,923, any patent claiming priority (either directly or indirectly) thereto, and/or any patents relating to fractional technology, shall be commenced in this Court.

Syneron, Inc., Massachusetts Litigation

On November 14, 2008, we commenced an action for patent infringement against Syneron, Inc. in the United States District Court for the District of Massachusetts seeking both monetary damages and injunctive relief. The complaint alleges Syneron's eLight, eMax, eLaser, Aurora DS, Polaris DS, Comet and Galaxy Systems, which use light-based technology for hair removal, willfully infringe the ‘568 patent and the ‘844 patent, which are exclusively licensed to us by MGH. In March 2009, we served Syneron with this suit. On April 30, 2009, the parties filed a stipulation to stay the lawsuit pending the outcome of the reexaminations of the ‘568 patent and the ‘844 patent.

On June 9, 2009, the Patent Office issued an office action confirming the validity of all claims of the ‘844 patent except claims 12-14. The Patent Office confirmed that claims 1-3, 6-8, 11, 17-20, 27, 28, 30, 32 of the '844 patent are valid and patentable. The Patent Office also confirmed new claims 33-59 as valid and patentable. The Patent Office rejected only independent claim 12 and related dependent claims 13-14 of the ‘844 patent as unpatentable. We cancelled claims 12-14 from the '844 patent in order to expedite the reexamination proceeding. Claims 4, 5, 9, 10, 15, 16, 21-26, 29 and 31 were not under reexamination. Consequently, all currently pending claims were found valid by the Patent Office. On November 18, 2009, the Patent Office issued a Reexamination Certificate for the ‘844 patent which closed the reexamination proceeding on the ‘844 patent.

On October 28, 2009, the Patent Office issued a Reexamination Certificate for the ‘568 patent which closed the reexamination proceeding on the ‘568 patent. The Patent Office confirmed the validity and patentability of all the claims of the ‘568 patent including new claims 23 and 24.

On September 23, 2009, we filed a motion to lift the stay and reopen the lawsuit. On October 6, 2009, Syneron filed their opposition to our motion to lift the stay, and on October 9, 2009, we filed our response to their opposition. On November 13, 2009, the Judge re-opened the case and a scheduling hearing took place on January 6, 2010. The parties are in discovery. A claim construction hearing (also known as a Markman hearing) is scheduled for November 17, 2010. No trial date has yet been set.

Tria Beauty, Inc., Massachusetts Litigation

On June 24, 2009, we commenced an action for patent infringement against Tria Beauty, Inc. (previously named Spectragenics, Inc.), in the United States District Court for the District of Massachusetts seeking both monetary damages and injunctive relief. The complaint alleged that the Tria System, which uses light-based technology for hair removal, willfully infringes the ‘844 patent, which is exclusively licensed to us by MGH. Tria answered the complaint denying that its products infringe valid claims of the asserted patent and filing a counterclaim seeking a declaratory judgment that the asserted patent is not infringed, is invalid and not enforceable. We filed a reply denying the material allegations of the counterclaims. On September 21, 2009, following successful re-examination of the ‘568 patent, we filed a motion to amend our complaint to add a claim for willful infringement of the ‘568 patent, which is also exclusively licensed to us by MGH. Our motion also included adding MGH as a plaintiff in the lawsuit. Tria did not oppose the motion and the Judge granted the motion on October 8, 2009. A claim construction hearing (also known as a Markman hearing) was held on August 10, 2010, and we received what we consider to be a favorable ruling on October 13, 2010. The parties are in discovery. No trial date has yet been set.

Asclepion Laser Technologies GmbH, German Litigation

On October 13, 2010, we commenced an action for patent infringement against Asclepion Laser Technologies GmbH in the District Court of Düsseldorf, Germany seeking both monetary damages and injunctive relief. The complaint alleged that Asclepion's MedioStar and RubyStar products infringe European Patent Number EP 0 806 913, which is the first issued European patent corresponding to U.S. Patent Numbers 5,595,568 and 5,735,844.

Asclepion Laser Technologies GmbH, Italian Litigation

On October 22, 2010, we were served with an International Summons for a lawsuit filed September 20, 2010 by Asclepion Laser Technologies GmbH in the Court of Rome in Italy. In this suit, Asclepion asks the Italian court to declare that Asclepion's MedioStar and RubyStar products do not infringe either the Italian or German portions of EP 0 806 913 B1 or EP 1 230 900 B1, which are the first two issued European patents corresponding to U.S. Patent numbers 5,595,568 and 5,735,844.

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

The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth previously under the caption “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 5, 2010 and those included in Item 1A below. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report.

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, investments, 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 2009. There have been no material changes to our critical accounting policies as of September 30, 2010.

Recently issued accounting standards

Overview

We are a global medical device company engaged in research, development, manufacturing and distribution of proprietary light-based systems for medical and cosmetic treatments. Since our inception, we have been able to develop a differentiated product mix of light-based systems for various treatments through our research and development as well as with our partnerships throughout the world. We are continually developing and testing new indications to further the advancement in light-based treatments.

Our corporate headquarters and United States operations are located in Burlington, Massachusetts, where we conduct our manufacturing, warehousing, research and development, regulatory, sales, customer service, marketing and administrative activities. In the United States, Australia, Canada, and Japan, we market, sell and service our products primarily through our direct sales force and customer service employees. In the rest of the world, sales are generally made through our worldwide distribution network in over 50 countries.

Recent Events

On September 21, 2010, we announced that we would move the launch of our patented, home-use laser for the treatment of periorbital wrinkles by a few months. This is the only laser with over-the-counter (OTC) clearance from the United States Food and Drug Administration (FDA) for the treatment of periorbital wrinkles.

Results of operations

Revenues for the quarter ended September 30, 2010 increased to $15.8 million, as compared to $14.5 million reported in the third quarter of 2009. Product and service revenues increased to $13.0 million, a 16 percent increase over the $11.2 million reported in the third quarter of 2009. Third quarter gross margin from product and service revenues was 60 percent, an increase over the 57 percent reported in the third quarter of 2009. Loss before income taxes for the third quarter ended September 30, 2010 was $2.0 million, which included a $1.5 million patent litigation expense and a $0.9 million non-cash stock-based compensation expense.

The following table contains selected income statement information, which serves as the basis of the discussion of our results of operations for the three and nine months ended September 30, 2010 and 2009, respectively (in thousands, except for percentages):

	Three Months Ended September 30,
	2010						2009
				As a % of						As a % of
				Total						Total			Change
	Amount			Revenue			Amount			Revenue			$			%
Revenues
Product revenues	$	9,273			59	%	$	7,529			52	%	$	1,744		23	%
Service revenues		3,749			24	%		3,700			25	%		49		1	%
Royalty revenues		1,499			10	%		1,264			9	%		235		19	%
Funded product development revenues		-			-	%		806			6	%		(806	)	(100	%)
Other revenues		1,250			8	%		1,250			9	%		-		-	%
Total revenues		15,771			100	%		14,549			100	%		1,222		8	%

Costs and expenses
Cost of product revenues		3,781			24	%		2,874			20	%		907		32	%
Cost of service revenues		1,367			9	%		1,901			13	%		(534	)	(28	%)
Cost of royalty revenues		600			4	%		506			3	%		94		19	%
Research and development		3,546			22	%		3,305			23	%		241		7	%
Selling and marketing		4,664			30	%		4,063			28	%		601		15	%
General and administrative		4,267			27	%		2,451			17	%		1,816		74	%
Total costs and expenses		18,225			116	%		15,100			104	%		3,125		21	%

Loss from operations		(2,454	)		(16	%)		(551	)		(4	%)		1,903		345	%

Interest income		109			1	%		218			1	%		(109	)	(50	%)
Other income		391			2	%		157			1	%		234		149	%

Loss before income taxes		(1,954	)		(12	%)		(176	)		(1	%)		1,778		1010	%

Provision for income taxes		69			-	%		121			1	%		(52	)	(43	%)

Net loss	$	(2,023	)		(13	%)	$	(297	)		(2	%)	$	1,726		581	%

	Nine Months Ended September 30,
	2010						2009
				As a % of						As a % of
				Total						Total			Change
	Amount			Revenue			Amount			Revenue			$			%
Revenues
Product revenues	$	27,656			58	%	$	23,940			54	%	$	3,716		16	%
Service revenues		11,512			24	%		10,884			25	%		628		6	%
Royalty revenues		4,444			9	%		4,032			9	%		412		10	%
Funded product development revenues		-			-	%		1,636			4	%		(1,636	)	(100	%)
Other revenues		3,750			8	%		3,750			8	%		-		-	%
Total revenues		47,362			100	%		44,242			100	%		3,120		7	%

Costs and expenses
Cost of product revenues		10,584			22	%		9,850			22	%		734		7	%
Cost of service revenues		4,320			9	%		5,417			12	%		(1,097	)	(20	%)
Cost of royalty revenues		1,778			4	%		1,613			4	%		165		10	%
Research and development		11,321			24	%		10,125			23	%		1,196		12	%
Selling and marketing		14,408			30	%		13,465			30	%		943		7	%
General and administrative		11,579			24	%		7,566			17	%		4,013		53	%
Total costs and expenses		53,990			114	%		48,036			109	%		5,954		12	%

Loss from operations		(6,628	)		(14	%)		(3,794	)		(9	%)		2,834		75	%

Interest income		310			1	%		552			1	%		(242	)	(44	%)
Other income		212			-	%		507			1	%		(295	)	(58	%)

Loss before income taxes		(6,106	)		(13	%)		(2,735	)		(6	%)		(3,371	)	123	%

Provision for (benefit from) income taxes		117			-	%		(780	)		(2	%)		897		115	%

Net loss	$	(6,223	)		(13	%)	$	(1,955	)		(4	%)	$	4,268		218	%

Product revenues. During the three and nine months ended September 30, 2010, our product revenues increased 23% and 16%, respectively, as compared to the corresponding periods in the prior year, primarily due to increases in revenues from sales of our StarLux Laser and Pulsed Light Systems, including a base unit and multiple, optional handpieces.

Service revenues. Service revenues are primarily comprised of revenue generated from our service organization to provide ongoing service, sales of replacement handpieces, sales of consumables and accessories and repair of our products. During the three and nine months ended September 30, 2010, service revenues increased 1% and 6%, respectively, as compared to the corresponding periods in the prior year, primarily in sales from replacement handpieces and sales of consumables and accessories.

The following table sets forth, for the periods indicated, information about our total product and service revenues, by geographic region:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2010			2009			2010			2009
North America		52	%		63	%		58	%		60	%
Europe		22	%		17	%		20	%		18	%
South and Central America		7	%		10	%		7	%		8	%
Australia		6	%		4	%		6	%		5	%
Asia/Pacific Rim		10	%		3	%		6	%		5	%
Other		3	%		3	%		3	%		4	%
Total Product and Service Revenues		100	%		100	%		100	%		100	%

Royalty revenues. Royalty revenues increased for the three and nine months ended September 30, 2010 by 19% and 10%, respectively, as compared to the corresponding periods in the prior year. The increase is attributed to an increase in on-going royalty payments from our licensees.

Funded product development revenues. Funded product development revenues decreased during the three and nine months ended September 30, 2010 as compared to the same periods in 2009. This decrease in funded product development revenues is directly related to the termination of our Joint Development and License Agreement with Johnson & Johnson Consumer Companies, Inc. in the fourth quarter of 2009.

Other revenues. For the three months ended September 30, 2010 and 2009, we recognized $1.25 million of other revenues, consisting of quarterly payments relating to a License Agreement with The Procter & Gamble Company. For the nine months ended September 30, 2010 and 2009, we recognized $3.75 million of other revenues relating to the License Agreement.

Cost of product revenues. For the three months ended September 30, 2010, our cost of product revenues as a percentage of total revenues was 24% as compared to 20% in the corresponding period in 2009. The increase as a percentage of total revenues is due to a shift in product revenues away from North American sales where we sell our product through a direct sales force instead of through distributors at fixed transfer prices, offset by higher product sales volume which resulted in higher overhead absorption. For both the nine months ended September 30, 2010 and 2009, our cost of product revenues as a percentage of total revenues was 22%.

Cost of service revenues. For the three months ended September 30, 2010, our cost of service revenues as a percentage of total revenues was 9% as compared to 13% in the corresponding period in 2009. For the nine months ended September 30, 2010 and 2009, our cost of service revenues as a percentage of total revenues was 9% and 12%, respectively. The decrease is due in part to the improved absorption of fixed service costs and the continued growth of service contract revenue. We have been able to convert a high percentage of our domestic installed base to service contracts upon the expiration of the warranty periods. In addition, the failure rates in certain of our products have decreased.

Cost of royalty revenues. The cost of royalty revenues increased for the three and nine months ended September 30, 2010 in comparison to the same periods in 2009. This increase is attributed to higher on-going royalty payments from our licensees. 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 periods in 2009.

Research and development expense. For the three and nine months ended September 30, 2010, research and development expenses increased 7% and 12%, respectively, as compared to the corresponding periods in the prior year. Research and development expenses relating to our professional business decreased by 26% and 12%, respectively, for the three and nine months ended September 30, 2010, as compared to the same periods in the prior year. Research expenses relating to our professional business include internal research and development projects relating to the introduction of new professional products, enhancements to our current line of professional products as well as research and development overhead. Research and development expense relating to our consumer business increased by 106% and 76%, respectively, for the three and nine months ended September 30, 2010 as compared to the same periods in 2009. This increase in research and development expense related to our consumer business includes increases in payroll and payroll related expense, materials, consultants, and other overhead expenses related directly to our consumer products as compared to the same periods in 2009.

Selling and marketing expense. For the three and nine months ended September 30, 2010, selling and marketing expenses increased 15% and 7%, respectively, as compared to the corresponding periods in the prior year. Selling and marketing expenses relating to our professional business for the three and nine months ended September 30, 2010 remained consistent with the same periods in 2009. Contributing to our overall increase in selling and marketing expenses in 2010 were our expenses related to our consumer business. We did not incur any sales and marketing expenses related to our consumer business in the first nine months of 2009.

General and administrative expense. For the three and nine months ended September 30, 2010, general and administrative expenses increased 74% and 53%, respectively, as compared to the corresponding periods in the prior year primarily due to increases in legal expenses, incentive compensation, and general overhead expenses. The nine months ended September 30, 2010 includes the remaining lease obligation at our old facility in addition to depreciation and other expenses related to our new facility.

Interest income. Interest income decreased for the three and nine months ended September 30, 2010 as compared to the corresponding periods in the prior year primarily from lower cash and cash equivalents, short-term investments, and marketable securities balances and lower interest rates. The decline in our cash and cash equivalents, short-term investments, and marketable securities balance is primarily from costs associated with the construction of our new operational facility in 2009.

Other income. Other income for the three and nine months ended September 30, 2010 and 2009 includes the foreign exchange gain resulting from transactions in currencies other than the U.S. dollar.

Provision for (benefit from) income taxes. Our effective tax rate was 2% and (29%) for the nine months ended September 30, 2010 and 2009, respectively. In 2010, our effective tax rate was less than the combined federal and state statutory rates primarily due to an increase in the valuation allowance.

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):


	Nine months ended
	September 30,						Change
	2010			2009			$	%

Cash flows (used in) from operating activities	$	(4,717	)	$	7,782		(12,499	)	(161	%)
Cash flows used in investing activities		(798	)		(15,151	)	14,353		95	%
Cash flows from (used in) financing activities		95			(5,877	)	5,972		102	%

Capital expenditures	$	3,592		$	15,776		(12,184	)	(77	%)

Additionally, our cash and cash equivalents, short-term investments, accounts receivable, inventories, working capital and marketable securities, at estimated fair value are shown below for the periods indicated (in thousands).

		September 30,		December 31,		Change
		2010		2009		$		%

Cash and cash equivalents	$	76,624	$	81,948	$	(5,324	)	(6	%)
Short-term investments		2,000		25,000		(23,000	)	(92	%)
Accounts receivable, net		5,035		4,436		599		14	%
Inventories, net		12,218		11,126		1,092		10	%
Working capital		81,295		107,812		(26,517	)	(25	%)
Marketable securities, at estimated fair value		24,129		4,024		20,105		500	%

We believe that our current cash, cash equivalents, short-term investments, and marketable securities 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.

Cash flows (used in) from operating activities for the nine months ended September 30, 2010, decreased compared to the same period in 2009. This decrease in operating activity cash flows reflects an increase in working capital requirements, an increase in net loss, offset by an increase in depreciation and amortization and an increase in stock-based compensation expense in the first nine months of 2010, compared to the same period in 2009. Cash flows used in investing activities decreased for the nine months ended September 30, 2010, compared to the same period in 2009. The decrease reflects lower purchases of property and equipment and higher purchases of short-term investments and marketable securities over the same period in 2009, offset by sales of marketable securities and short-term investments. Cash flows from (used in) financing activities increased for the nine month period ended September 30, 2010, compared to the same period in 2009. This increase was primarily due to a decrease in borrowings.

We anticipate that capital expenditures relating to machinery and equipment, furniture and fixtures, and building improvements for the remainder of 2010 will total approximately $300,000. We expect to finance these expenditures with cash on hand.

At September 30, 2010, we held $2.1 million in auction-rate securities (ARS). The ARS we invest in are high quality securities, none of which are mortgage-backed. 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, 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. As our investments in ARS currently lack short-term liquidity, we have reclassified these investments as non-current as of September 30, 2010. In the nine months ended September 30, 2010, we sold $1.9 million of the ARS held at December 31, 2009.

We have determined that the fair value of our ARS was temporarily impaired as of September 30, 2010. For the three and nine months ended September 30, 2010, we marked to market our ARS and recorded an unrealized gain of $5,000, and an unrealized loss of $57,000, respectively, net of taxes in accumulated other comprehensive (loss) income 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. As of September 30, 2010, we do not intend to sell the ARS and it is not more likely than not that we will be required to sell the ARS before recovery of their amortized cost bases, which may be at maturity.

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.

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 September 30, 2010, we were not involved in any unconsolidated transactions.

Contractual obligations

We are a party to three patent license agreements with Massachusetts General Hospital whereby we are obligated to pay royalties to Massachusetts General Hospital for sales of certain products as well as a percentage of royalties received from third parties. Royalty expense for the three and nine months ended September 30, 2010 totaled approximately $0.7 million and $2.2 million, respectively.

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 ASC Topic 740, “Accounting for Income Taxes” (ASC 740). Further information about changes in these obligations can be found in Note 8.

We are obligated to make future payments under various contracts, including non-cancelable inventory purchase commitments.

On November 19, 2008, we purchased land for $10.7 million on which we built our new operational facility. Construction of the building was completed and the building was placed in service during the first quarter of 2010. We financed the project by using cash on hand. We vacated our old facility during the first quarter of 2010 and incurred a charge of $1.2 million relating to the write-off of our remaining lease obligation.

The following table summarizes our estimated contractual cash obligations as of September 30, 2010, excluding royalty and employment obligations because they are variable and/or subject to uncertain timing (in thousands):

	Payments due by period
		Total	Less than 1 year		1 - 3 Years		4 - 5 Years			After 5 Years
Operating leases	$	265	$	167	$	98	$	-	$		-
Purchase commitments		7,928		7,928		-		-			-
Total contractual cash obligations	$	8,193	$	8,095	$	98	$	-	$		-

Item 3. Quantitative and qualitative disclosures about market risk

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and a decline in the stock market. The current turbulence in the U.S. and global financial markets has caused a decline in stock values across all industries. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

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 September 30, 2010, we held $2.1 million in auction-rate securities (“ARS”). The ARS we invest in are high quality securities, none of which are mortgage-backed. 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, 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. As our investments in ARS currently lack short-term liquidity, we have reclassified these investments as non-current as of September 30, 2010. In the nine months ended September 30, 2010, we sold $1.9 million of the ARS held at December 31, 2009. The recovery of the remaining $2.1 million ARS held is based upon market factors which are not within our control.

Our international subsidiaries in The Netherlands, Australia and Japan conduct 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 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, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2010. Based on that evaluation, we have concluded that our disclosure controls and procedures were effective.

The Company’s management, including the CEO and CFO, does not expect that our 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 our internal controls over financial reporting or in other factors that could significantly affect these controls during the quarter ended September 30, 2010, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II – Other information

Item 1. Legal proceedings

Candela Corporation, Massachusetts Litigation

Alma Lasers, Inc., Delaware Litigation

Syneron, Inc., Massachusetts Litigation

Tria Beauty, Inc., Massachusetts Litigation

Asclepion Laser Technologies GmbH, German Litigation

Asclepion Laser Technologies GmbH, Italian Litigation

Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described in our Annual Report on Form 10-K for the year ended December 31, 2009 in addition to the other information included in this quarterly report, including the additional risk factors below. If any of the risks actually occur, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall.

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, or 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 certain of our patents against Candela Corporation, Syneron, Inc., Tria Beauty, Inc. and Asclepion Laser Technologies GmbH 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, Syneron, Tria, Asclepion or other suspected infringers. 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 these lawsuits that are unfavorable to us may in the future result in significant declines in our stock price. An adverse ruling or judgment in these lawsuits 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 proprietary 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 proprietary 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.

To successfully grow our international presence, we must address many issues with which we have little or no experience. We may not be able to properly manage our foreign subsidiaries which may have an adverse effect on our business and operating results.

We have three international subsidiaries which are located in The Netherlands, Australia, and Japan. In managing foreign operations, we must address many issues with which we have little or no experience which exposes our business to additional risk. Our foreign operations redirect management's time from other operating issues. We may not be successful in operating our foreign subsidiaries. If we are unsuccessful in managing our foreign subsidiaries, the foreign subsidiaries could be unprofitable and negatively impact our resources and financial position.

The liquidity and market value of our investments may decrease.

As of September 30, 2010, we held approximately $2.1 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 September 30, 2010 failed in their 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. In the event that we are unable to sell the underlying securities at or above par, these securities may not provide us a liquid source of cash in the future. At September 30, 2010, due to the uncertainty and illiquidity in this market, we have classified our auction-rate securities as non-current assets and have recorded a cumulative unrealized loss of $0.4 million, net of taxes in accumulated other comprehensive (loss) income. The recovery of these investments is based upon market factors which are not within our control. As of September 30, 2010, we do not intend to sell the ARS and it is not more likely than not that we will be required to sell the ARS before recovery of their amortized cost bases, which may be at maturity.

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 *
July 1, 2010 through July 31, 2010	-	-	-	324,500
August 1, 2010 through August 31, 2010	-	-	-	324,500
September 1, 2010 through September 30, 2010	-	-	-	324,500
Total	-	-	-	324,500

* 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. (Removed and Reserved)

None.

Item 5. Other information

None.

Item 6. Exhibits

	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.

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: November 5, 2010	/s/ Joseph P. Caruso Joseph P. Caruso President, Chief Executive Officer and Director

Date: November 5, 2010	/s/ Paul S. Weiner Paul S. Weiner Vice President and Chief Financial Officer

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