Caution Regarding Forward-Looking Statements

The following discussion should be read in conjunction with the attached financial statements and notes thereto, and with our audited financial statements and notes thereto for the fiscal year ended December 31, 2008 as contained in our annual report on Form 10-K filed with the SEC on March 16, 2009. This quarterly report, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Throughout this report, and particularly in this Item 2, the forward-looking statements are based upon our current expectations, estimates and projections and reflect our beliefs and assumptions based upon information available to us at the date of this report. In some cases, you can identify these statements by words such as "may," "might," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue," and other similar terms. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions that are difficult to predict. Our actual results, performance or achievements could differ materially from those expressed or implied by the forward-looking statements. These forward-looking statements include, but are not limited to, statements relating to our future financial performance, the ability to grow our business, increase our revenue, manage expenses, generate additional cash, achieve and maintain profitability, develop and commercialize existing and new products and applications, and improve the performance of our worldwide sales and distribution network, and the outlook regarding long term prospects. These forward-looking statements involve risks and uncertainties. The cautionary statements set forth below and those contained in Part II, Item 1A - "Risk Factors" commencing on page 27, identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution you to not place undue reliance on these forward-looking statements, which reflect management's analysis and expectations only as of the date of this report. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-Q.

Introduction

The Management's Discussion and Analysis, or MD&A, is organized as follows:

· Executive Summary. This section provides a general description and history of our business, a brief discussion of our product lines and the opportunities, trends, challenges and risks we focus on in the operation of our business.

· Critical Accounting Policies and Estimates. This section describes the key accounting policies that are affected by critical accounting estimates.

· Recent Accounting Pronouncements. This section describes the issuance and effect of new accounting pronouncements that may be applicable to us.

· Results of Operations. This section provides our analysis and outlook for the significant line items on our Consolidated Statements of Operations.

· Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows, as well as a discussion of our commitments that existed as of June 30, 2009.

Executive Summary

Company Description. We are a global medical device company engaged in the design, development, manufacture, marketing and servicing of laser and other light-based aesthetics systems for practitioners worldwide. We offer products on three platforms-CoolGlide, Xeo and Solera- for use by physicians and other qualified practitioners to allow our customers to offer safe and effective aesthetic treatments to their customers.

Our corporate headquarters and U.S. operations are located in Brisbane, California, from where we conduct our manufacturing, warehousing, research, regulatory, sales, service, marketing and administrative activities. In the United States, we market, sell and service our products primarily through direct sales and service employees and through a distribution relationship with PSS World Medical Shared Services, Inc., a wholly owned subsidiary of PSS World Medical, or PSS, which has over 700 sales representatives serving physician offices throughout the United States. In addition, we also sell certain items, like Titan hand piece refills and marketing brochures, through the internet.

International sales are generally made through direct sales employees and through a worldwide distributor network in over 30 countries. Outside the United States, we have a direct sales presence in Australia, Canada, France, Japan, Spain, Switzerland and the United Kingdom.

Products. Our revenue is derived from the sale of Products, Upgrades, Service and Titan hand piece refills. Product revenue represents the sale of a system, which consists of one or more hand pieces and a console that incorporates a universal graphic user interface, a laser and/or other light-based module, control system software and high voltage electronics. However, depending on the application, the laser or other light-based module is sometimes contained in the hand piece, such as with our Pearl and Pearl Fractional applications, instead of in the console. We offer our customers the ability to select the system that best fits their practice at the time of purchase and then to cost-effectively add applications to their system as their practice grows. This enables customers to upgrade their systems whenever they want and provides us with a source of recurring revenue, which we classify as Upgrade revenue. Service revenue relates to amortization of pre-paid service contract revenue and receipts for services on out-of-warranty products. Titan hand piece refill revenue is associated with our Titan hand piece which requires replacement of the optical source after a set number of pulses has been used.

Significant Business Trends. We believe that our ability to grow revenue has been, and will continue to be, primarily dependent on the following:

· Investments made in our global sales and marketing infrastructure.

· Introduction and developing clinical results for new aesthetic products and applications.

· Customer demand for our products and consumer demand for the applications they offer.

· Marketing to physicians in the core dermatology and plastic surgeon specialties, as well as outside those specialties.

· Generating Service, Upgrade and Titan hand piece refill revenue from our growing installed base of customers.

During the three and six months ended June 30, 2009, our U.S. revenue decreased 63% and 56%, respectively, and our international revenue decreased 42% and 30%, respectively, compared to the same periods in 2008. For the three and six months ended June 30, 2009, international revenue accounted for 61% and 58% of our total revenue, respectively, compared with 50% and 47% in the same periods in 2008, respectively. We believe that the decline in U.S. and international revenue was primarily attributable to the global recession that has caused our prospective customers to be reluctant on spending significant amounts of money on capital equipment during these unstable economic times. Historically a significant portion of our U.S. revenue was sourced from the non-core market of practitioners such as primary care physicians, gynecologists and physicians offering aesthetic treatments in spa environments. We believe our U.S. revenue declined greater than our international revenue, because the recession impacted our U.S. revenue ? and particularly the non-core market ? more severely than our international revenue. Further, we also believe that those prospects who do not have established medical offices, are finding it more difficult to obtain credit financing, which also contributed to the reduced U.S. revenue.

Service revenue increased 26% to $3.4 million and 23% to $6.7 million for the three and six months ended June 30, 2009, respectively, compared to the same periods in 2008. Service contract amortization is the primary component of our total service revenue. Due to an increasing installed base of customers, our revenue from contract amortization has consistently increased. However, our deferred service revenue balance declined by $2.0 million, or 17%, to $9.6 million as of June 30, 2009, compared to December 31, 2008. This decline was primarily attributable to: (i) a decrease in unit sales volume in the U.S. that historically included an element of deferred revenue for service contracts beyond our standard warranty terms; (ii) a reducing of our service contract pricing, but including prorate charges for hand piece usage, which resulted in a reduction of our deferred service revenue balance as of June 30, 2009; and
(iii) a shift by customers towards purchasing more quarterly, rather than annual, service contracts. With the reconfiguring of our service contracts to include prorate charges for hand piece usage during the service coverage period, we expect that in the long term, there will be an increase in revenue derived from hand piece sales which would offset the service contract amortization decline resulting from lower priced contracts being sold.

For the three and six months ended June 30, 2009, our gross margin decreased to 56% and 58%, compared to 63% and 62% for the same periods in 2008, respectively. This decrease in gross margin was due primarily to: (i) lower overall revenue, due to lower volume, which resulted in reduced leverage of our manufacturing and service department expenses; (ii) higher Service and Titan refill revenue as a percentage of our total revenue, which has a lower gross margin than our total revenue; (iii) higher international distributor revenue as a percentage of total revenue, which has a lower gross margin than our direct business; partially offset by (iv) reduced expenses resulting from improved product reliability.

Our sales and marketing expenses for the three and six months ended June 30, 2009, as a percentage of net revenue, increased to 52% and 50%, respectively, compared to 42% and 45% in the same periods of 2008, respectively, due to a significant decline in our revenue. In absolute dollars, sales and marketing expenses decreased by $4.3 million to $6.1 million in the second quarter of 2009, compared to same period in 2008. This decrease in total dollars in the second quarter of 2009, compared to the same period in 2008, was primarily attributable to reduced personnel expenses in the United States due to lower headcount, and reduced sales commission expenses resulting from lower revenue.

For the three and six months ended June 30, 2009, our research and development (R&D) expenses as a percentage of net revenue increased to 13% and 12%, respectively, compared to 8% for both the three and six months ended June 30, 2008. The increase in expenses as a percentage of net revenue was due primarily to lower revenue in the three and six months ended June 30, 2009, compared to the same periods in 2008. In absolute dollars, in the second quarter of 2009, compared to the same period in 2008, R&D expenses decreased by $509,000 due primarily to lower material spending resulting from our current R&D project timing. During the initial phases of the development of a product, material expenditure is significantly higher due to the design and development of a prototype, however, in the later stages of the product development efforts are mostly labor intensive.

General and administrative (G&A) expenses as a percentage of net revenue for the three and six months ended June 30, 2009 increased to 31% and 24%, compared to 12% and 13% during the same periods in 2008, respectively, due primarily to lower revenue combined with an increase in expenses. In absolute dollars, G&A expenses increased in the three and six months ended Jun 30, 2009, compared to the same period in 2008, by $593,000 and $172,000, respectively. This increase was primarily associated with higher expenses in our second quarter ended June 30, 2009 associated with $499,000 of higher bad debt expense resulting primarily from one leasing company that has defaulted on its payment; $300,000 of stock-based compensation for fully vested stock granted to our independent board members; and $135,000 for restructuring charges related to our headcount reduction in April 2009. Given these expenses are not expected to recur, we expect our quarterly G&A expenses to decline in the second half of 2009, compared to the second quarter of 2009.

We are a defendant in a Telephone Consumer Protection Act class action lawsuit. See Part II, Item I - Legal Proceedings below. We have included $850,000 in our Condensed Consolidated Statement of Operations for the six months ended June 30, 2009 for the estimated cost of the tentative settlement, net of administrative expenses and amounts that may be recoverable from our insurance carrier.

In response to the current economic environment, we reduced our company-wide workforce by approximately 12% in April 2009 and implemented other cost-reduction measures in the first half of 2009. The headcount reductions impacted all departments and functions and resulted in restructuring charges of approximately $646,000 in our second quarter ended June 30, 2009. As of June 30, 2009, there were no service requirements outstanding from the employees who were affected. We expect our quarterly operating expenses in the second half of 2009 to decline, compared to our second quarter 2009 expenses, as we expect to experience the full impact of our cost cutting measures implemented in the first half of 2009.

At June 30, 2009, we had recognized deferred tax assets of $10.8 million. Deferred tax assets are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. A valuation allowance reduces deferred tax assets to estimated realizable value, which assumes that it is more likely than not that the Company will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the net carrying value. Determining whether a valuation allowance for deferred tax assets is necessary requires an analysis of both positive and negative evidence regarding realization of the deferred tax assets. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified and judgment must be used in considering the relative impact of positive and negative evidence. As of June 30, 2009, the Company considered positive and negative evidence, including cumulative results in recent years, and did not record a valuation allowance against its deferred tax assets. Future changes in the positive and negative evidence, including the Company's recent cumulative and expected results, could have a significant impact on the realization of the deferred tax assets and result in a full or partial valuation allowance against the deferred tax assets. This would result in an immediate material income tax charge in the Company's Consolidated Statement of Operations.

Factors that May Impact Future Performance.

Our industry is impacted by numerous competitive, regulatory and other significant factors. Our industry is highly competitive and our future performance depends on our ability to compete successfully. Additionally, our future performance is dependent upon our ability to continue to develop new products and innovative technologies, obtain regulatory clearances for our products, protect the proprietary technology of our products and our manufacturing processes, manufacture our products cost effectively, and successfully market and distribute our products in a profitable manner. If we fail to execute on the aforementioned initiatives, our business would be adversely affected. A detailed discussion of these and other factors that could impact our future performance are provided in Part II, Item 1A "Risk Factors" section below.

Critical Accounting Policies and Estimates.

The preparation of our Condensed Consolidated Financial Statements and related disclosures in conformity with generally accepted accounting principles in the United States, or GAAP, requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates, judgments and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. We periodically review our estimates and make adjustments when facts and circumstances dictate. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected.

Recently Adopted and Recently Issued Accounting Standards

For a full description of recent accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition see Note 1 "Summary of Significant Accounting Policies - Recent Accounting Pronouncement" in the Notes to Condensed Consolidated Financial Statements in Part I, Item I of this Form 10-Q".

Critical Accounting Policies and Estimates

Critical accounting estimates, as defined by the SEC, are those that are most important to the portrayal of our financial condition and results of operations and require our management's most difficult and subjective judgments and estimates of matters that are inherently uncertain. The accounting policies that we consider to be critical, subjective, and requiring judgment in their application are summarized in "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with SEC on March 16, 2009. There have been no significant changes to ,those accounting policies and estimates disclosed in our Form 10-K, except for the following policies that were adopted in 2009 and discussed below.

Fair Value Measurement of our Long Term Auction Rate Securities Investments

We hold a variety of interest bearing auction rate securities (ARS) that represent investments in pools of student loan assets. At the time of acquisition, these ARS investments were intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined calendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. Since February 2008, uncertainties in the credit markets affected our ARS investments and auctions for some of ARS have continued to fail to settle on their respective settlement dates while some have been redeemed in full at their respective par values. The current portfolio of investments shown as "Long term investments" in our Consolidated Financial Statements represents those investments that are not currently liquid and we will not be able to access these funds until a future auction of these investments is successful, a buyer is found outside of the auction process or the issuer refinances their debt. Maturity dates for these ARS investments range from to 2028 to 2043.

At June 30, 2009, total financial assets measured and recognized at fair value were $101.8 million and of these assets, $7.6 million, or 8%, were ARS that were measured and recognized using significant unobservable inputs (Level 3). During the six months ended June 30, 2009, as a result of the redemption of $3.9 million par value ($2.0 million of fair value), we transferred $2.0 million of Level 3 assets into cash and cash equivalents. This redemption resulted in a gain of $1.9 million being recorded to accumulated comprehensive income (loss) for the six months ended June 30, 2009.

As of June 30, 2009, we had $9.3 million par value ($7.6 million fair value) of long-term ARS investments that remained outstanding. The aggregate loss in value is included as an unrealized loss in accumulated other comprehensive income
(loss). Given observable market information was not available to determine the fair values of our ARS portfolio, we valued these investments based on a discounted cash flow model. While our ARS valuation model was based on both Level 2 (credit quality and interest rates) and Level 3 inputs, we determined that the Level 3 inputs were the most significant to the overall fair value measurement, particularly the estimates of risk adjusted discount rates. The expected future cash flows of the ARS were discounted using a risk adjusted discount rate that compensated for the illiquidity. Projected future cash flows over the economic life of the ARS were modeled based on the contractual penalty rates for the security added to a tax adjusted LIBOR interest rate curve. The discount rates that were applied to the cash flows were based on a premium over the projected yield curve and included an adjustment for credit, illiquidity, and other risk factors. See Note 2 "Balance Sheet Details- Fair Value of Financial Instruments" in the Notes to Condensed Consolidated Financial Statement in Part I, Item 1 of this Form 10-Q for more information.

The valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact the valuation include duration of time that the ARS remain illiquid, changes to credit ratings of the securities, rates of default of the underlying assets, changes in the underlying collateral value, market discount rates for similar illiquid investments, and ongoing strength and quality of credit markets. If the auctions for our ARS investments continue to fail, and there is a further decline in their valuation, then we would have to: (i) record additional reductions to the fair value of our ARS investments; (ii) record unrealized losses in our accumulated comprehensive income (loss) for the losses in value that are associated with market risk; and
(iii) record an other-than-temporary-impairment charge in our Consolidated Statement of Operations for the loss in value associated with the worsening of the credit worthiness (credit losses) of the issuer, which would reduce future earnings and harm our business.

We had no non-financial assets or liabilities measured at fair value as of June 30, 2009.

Recognition and Presentation of Other-Than-Temporary-Impairments

We review our impairments on a quarterly basis in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and FSP FAS 115-2/ 124-2 in order to determine the classification of the impairment as "temporary" or "other-than-temporary." The recognition provision within FSP FAS 115-2 applies only to fixed maturity investments that are subject to the other-than-temporary impairments. If an entity intends to sell or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its cost basis, the security is other-than-temporarily impaired and the full amount of the impairment is required to be recognized as a loss through earnings. Otherwise, losses on securities which are other-than-temporarily impaired are separated into:

(iii) the portion of loss which represents the credit loss; and

(iv) the portion which is due to other factors.

The credit loss portion is recognized as a loss through earnings while the loss due to other factors is recognized in other comprehensive loss, net of taxes and related amortization.

In accordance with the guidance provided in FSP FAS 115-2, with respect to the ARS that we held as of April 1, 2009, we determined that the cumulative effect adjustment required to reclassify the non-credit portion of previously recognized other-than-temporarily impaired adjustments was $3.5 million. Therefore, we increased our accumulated earnings and decreased our accumulated other comprehensive income (loss) by the $3.5 million cumulative effect adjustment. With respect to the $9.3 million of par value ARS investments held as of June 30, 2009, the unrealized losses included in accumulated comprehensive income (loss) was $1.6 million.

Results of Operations

The following table sets forth selected consolidated financial data for the
periods indicated, expressed as a percentage of net total revenue.



                                         Three Months Ended           Six Months Ended
                                               June 30,                   June 30,

                                          2009           2008        2009          2008
Operating Ratio:
Net revenue                                  100%         100%          100%       100%
Cost of revenue                               44%          37%           42%        38%
Gross profit                                  56%          63%           58%        62%

Operating expenses:
Sales and marketing                           52%          42%           50%        45%
Research and development                      13%           8%           12%         8%
General and administrative                    31%          12%           24%        13%
Litigation settlement                          -%           -%            3%         -%
Total operating expenses                      96%          62%           89%        66%

Income (loss) from operations               (40)%           1%         (31)%       (4)%
Interest and other income, net                 5%           3%            4%         4%
Income (loss) before income taxes           (35)%           4%         (27)%         0%
Provision (benefit) for income taxes        (15)%           1%         (11)%         0%
Net income (loss)                           (20)%           3%         (16)%         0%