Cynosure (CYNO) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

Form 10-Q

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

¨ 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 000-51623

Cynosure, Inc.

(Exact name of registrant as specified in its charter)

Delaware	04-3125110
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

5 Carlisle Road Westford, MA	01886
(Address of principal executive offices)	(Zip code)

(978) 256-4200

(Registrant’s telephone number, including area code)

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.    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  Yes    x  No

The number of shares outstanding of each of the registrant’s classes of common stock, as of November 1, 2007:

Class	Number of Shares
Class A Common Stock, $0.001 par value	8,447,006
Class B Common Stock, $0.001 par value	3,909,161

Cynosure, Inc.

Table of Contents

		Page No.
PART I Financial Information
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006	3
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006	4
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006	5
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
PART II Other Information
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 6.	Exhibits	29
SIGNATURES		30

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Cynosure, Inc.

Consolidated Balance Sheets

(Unaudited, in thousands)

	September 30, 2007			December 31, 2006
Assets
Current assets:
Cash and cash equivalents	$	27,561		$	13,690
Marketable securities		49,402			43,556
Accounts receivable, net		22,549			19,871
Amounts due from related party (Note 12)		16			335
Inventories		23,216			17,624
Prepaid expenses and other current assets		2,857			4,977
Deferred income taxes		2,714			2,604
Total current assets		128,315			102,657
Property and equipment, net		6,670			5,662
Other assets		1,272			1,247
Total assets	$	136,257		$	109,566
Liabilities and Stockholders’ Equity
Current liabilities:
Short-term loan	$	—		$	167
Accounts payable		4,177			5,986
Amounts due to related party (Note 12)		2,021			1,052
Accrued expenses		15,458			11,077
Deferred revenue		4,409			3,476
Capital lease obligation		465			439
Total current liabilities		26,530			22,197
Capital lease obligation, net of current portion		829			1,069
Deferred revenue, net of current portion		374			311
Other noncurrent liability		157			119
Commitments and contingencies (Note 10)
Stockholders’ equity:
Preferred stock, $0.001 par value
Authorized — 5,000 shares; Issued — none		—			—
Class A and Class B common stock, $0.001 par value
Authorized — 70,000 shares
Issued — 12,339 and 11,210 shares as of September 30, 2007 and December 31, 2006, respectively		12			11
Additional paid-in capital		94,100			81,026
Retained earnings		15,026			5,820
Accumulated other comprehensive loss		(484	)		(700	)
Treasury stock, 36 shares, at cost		(287	)		(287	)
Total stockholders’ equity		108,367			85,870
Total liabilities and stockholders’ equity	$	136,257		$	109,566

The accompanying notes are an integral part of these consolidated financial statements.

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Cynosure, Inc.

Consolidated Statements of Operations

(Unaudited, in thousands, except per share data)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2007		2006			2007		2006
Revenues	$	31,533	$	18,556		$	87,742	$	53,826
Cost of revenues		11,045		7,442			32,035		23,015
Gross profit		20,488		11,114			55,707		30,811
Operating expenses:
Sales and marketing		10,310		6,372			29,447		17,979
Research and development		1,468		1,207			4,958		3,455
General and administrative		3,143		2,041			8,371		6,218
Royalty settlement		—		10,000			—		10,000
Total operating expenses		14,921		19,620			42,776		37,652
Income (loss) from operations		5,567		(8,506	)		12,931		(6,841	)
Interest income, net		661		680			1,762		2,063
Other income, net		356		215			440		621
Income (loss) before provision for (benefit from) income taxes and minority interest		6,584		(7,611	)		15,133		(4,157	)
Provision for (benefit from) income taxes		2,207		(3,370	)		5,927		(2,019	)
Minority interest in net income of subsidiary		—		6			—		41
Net income (loss)	$	4,377	$	(4,247	)	$	9,206	$	(2,179	)
Basic net income (loss) per share	$	0.36	$	(0.38	)	$	0.78	$	(0.20	)
Diluted net income (loss) per share	$	0.34	$	(0.38	)	$	0.73	$	(0.20	)
Basic weighted-average common shares outstanding		12,281		11,107			11,863		11,061
Diluted weighted-average common shares outstanding		12,751		11,107			12,604		11,061

The accompanying notes are an integral part of these consolidated financial statements.

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Cynosure, Inc.

Consolidated Statements of Cash Flow

(Unaudited, in thousands)

	Nine Months Ended September 30,
	2007			2006
Operating activities:
Net income (loss)	$	9,206		$	(2,179	)
Reconciliation of net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		2,029			1,725
Stock-based compensation expense		4,283			1,611
Accretion of discounts on marketable securities		203			(601	)
Deferred income taxes		(137	)		(4,036	)
Minority interest in consolidated subsidiary		—			41
Gain on sale of investment		—			(118	)
Impairment of marketable security		190			—
Changes in operating assets and liabilities:
Accounts receivable		(2,118	)		(3,771	)
Due from related party		319			64
Inventories		(5,135	)		(3,542	)
Net book value of demonstration inventory sold		150			144
Prepaid expenses and other current assets		2,072			(2,415	)
Accounts payable		(1,874	)		1,233
Due to related party		967			(706	)
Accrued expenses		4,111			1,094
Accrued royalty settlement		—			10,000
Deferred revenue		906			(1,113	)
Other noncurrent liability		38			59
Net cash provided by (used in) operating activities		15,210			(2,510	)
Investing activities:
Purchases of property and equipment		(3,017	)		(1,758	)
Proceeds from the sales and maturities of marketable securities		51,204			119,025
Purchases of marketable securities		(57,362	)		(171,275	)
Decrease (increase) in other noncurrent assets		4			(13	)
Net cash used in investing activities		(9,171	)		(54,021	)
Financing activities:
Payment on short term loan		(168	)		—
Proceeds from exercise of stock options		5,211			340
Tax benefits related to stock options		3,582			291
Payments of initial public offering costs		—			(38	)
Payments on capital lease obligation		(319	)		(275	)
Net cash provided by financing activities		8,307			318
Effect of exchange rate changes on cash and cash equivalents		(475	)		(312	)
Net increase (decrease) in cash and cash equivalents		13,871			(56,525	)
Cash and cash equivalents, beginning of the period		13,690			64,646
Cash and cash equivalents, end of the period	$	27,561		$	8,121
Supplemental cash flow information
Cash paid for interest	$	116		$	90
Cash paid for taxes	$	31		$	2,780
Supplemental noncash investing and financing activities

5

	Nine Months Ended September 30,
	2007		2006
Assets acquired under capital lease	$	103	$	604

The accompanying notes are an integral part of these consolidated financial statements.

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Cynosure, Inc.

Notes to Consolidated Financial Statements

Note 1 — Interim Consolidated Financial Statements

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the consolidated financial statements and related notes that appear in the Annual Report of Cynosure, Inc. (Cynosure) as reported on Form 10-K for the year ended December 31, 2006. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations and cash flows as of the dates and for the periods presented have been included. The results of operations for the three months and nine months ended September 30, 2007 may not be indicative of the results that may be expected for the year ended December 31, 2007, or any other period.

Note 2 — Stock-Based Compensation

Cynosure follows the provisions of Financial Accounting Standards Board (FASB) Statement No. 123(R),Share-Based Payment, (SFAS 123(R)). SFAS 123(R) requires companies to utilize an estimated forfeiture rate when calculating the expense for the period. As a result, Cynosure has applied an estimated annual forfeiture rate of 1.0% in determining the expense recorded in the consolidated statements of income.

The stock-based compensation expense reduced both basic and diluted earnings per share by $0.08 for the three months ended September 30, 2007 and increased both basic and diluted net loss per share by $0.05 for the three months ended September 30, 2006. Stock-based compensation expense reduced basic and diluted earnings per share by $0.25 and $0.23, respectively, for the nine months ended September 30, 2007 and increased both basic and diluted loss per share by $0.11 for the nine months ended September 30, 2006. The accompanying financial statements reflect stock-based compensation expense of $1,436,000 and $820,000 and related tax benefits of $457,000 and $234,000 for the three months ended September 30, 2007 and 2006, respectively. The accompanying financial statements reflect stock-based compensation expense of $4,283,000 and $1,611,000 and related tax benefits of $1,337,000 and $404,000 for the nine months ended September 30, 2007 and 2006, respectively. Cynosure capitalized $61,000 and $14,000 of stock-based compensation expense as part of inventory as of September 30, 20007 and 2006, respectively. Cash received from option exercises was $5,211,000 and $340,000 during the nine months ended September 30, 2007 and 2006, respectively. Cynosure recognized $3,582,000 in actual tax benefits from these option exercises during the nine months ended September 30, 2007 and recognized $291,000 during the nine months ended September 30, 2006. Actual tax benefits are primarily the result of disqualifying dispositions of incentive stock options exercised which result in a reduction of income taxes payable.

Cynosure granted 549,800 and 424,150 stock options during the nine months ended September 30, 2007 and 2006, respectively. Cynosure uses the Black-Scholes model to determine the weighted-average fair value of options. The weighted-average fair value of the options granted during the nine months ended September 30, 2007 was $18.67 using the following assumptions:

	Nine Months Ended September 30, 2007
Risk-free interest rate	4.58% - 4.77	%
Expected dividend yield	—
Expected lives	5.8 years
Expected volatility	70	%

Option-pricing models require the input of various subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. Due to Cynosure’s initial public offering in December 2005, Cynosure believes there is not adequate information on the volatility of its own shares. As such, Cynosure’s estimated expected stock price volatility is based on a weighted-average of its own historical volatility and of the average volatilities of other guideline companies in the same industry. Cynosure believes this is more reflective and a better indicator of the expected future volatility than using an average of a comparable market index or of a single comparable company in the same industry. Cynosure’s expected term of options granted in the nine months ended September 30, 2007 was derived from the short-cut method described in SEC’s Staff Accounting Bulletin (SAB) No. 107. The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield of zero is based on the fact that Cynosure has never paid cash dividends and has no present intention to pay cash dividends.

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Note 3 — Royalty Settlement

In various communications that the Company received from Palomar Medical Technologies, Inc. (Palomar) prior to September 30, 2006, Palomar asserted that Cynosure needs a license under specified U.S. and foreign patents owned or licensed by Palomar with respect to Cynosure’s hair removal-only systems. In the third quarter of 2006, Cynosure entered into negotiations with Palomar with respect to such a license. On November 6, 2006, Cynosure entered into a non-exclusive patent license with Palomar. Under the cross-license agreement, Cynosure obtained a non-exclusive license to integrate into its products certain hair removal technology covered by specified U.S. and foreign patents held by Palomar and Palomar obtained a non-exclusive license under certain U.S. and foreign patents held by Cynosure. In November 2006, Cynosure made a payment to Palomar of $10 million for royalties related to sales prior to October 1, 2006 of hair removal-only systems including Cynosure’s Apogee family of products,PhotoLight,Acclaim 7000, andPhotoSilk Plus. Cynosure accrued this amount as of September 30, 2006 in the accompanying consolidated balance sheets and recorded this amount as a royalty settlement within Cynosure’s operating expenses for the three and nine months ended September 30, 2006.

In connection with this agreement, Cynosure also agreed to pay royalties to Palomar on Cynosure’s sales of certain hair removal products. The royalty rate for sales of hair removal products ranges from 3.75% to 7.5% of net sales, depending upon product configuration and the number of energy sources. Cynosure’s revenue from systems that do not include hair removal capabilities and revenue from service is not subject to any royalties under the Palomar agreement.

Note 4 — Inventories

Cynosure states all inventories at the lower of cost or market, determined on a first-in, first-out method. Inventory includes material, labor and overhead and consists of the following:

	September 30, 2007		December 31, 2006
	(in thousands)
Raw materials	$	1,477	$	1,848
Work in process		645		818
Finished goods		21,094		14,958
	$	23,216	$	17,624

Note 5 — Marketable Securities

Cynosure accounts for investments in marketable securities as available-for-sale securities in accordance with Statement of Financial Accounting Standards No. 115,Accounting for Certain Investments in Debt and Equity Securities(SFAS 115). Under SFAS 115, securities purchased to be held for indefinite periods of time and not intended at the time of purchase to be held until maturity are classified as available-for-sale securities with any unrealized gains and losses reported as a separate component of accumulated other comprehensive loss. Cynosure continually evaluates whether any marketable investments have been impaired and, if so, whether such impairment is temporary or other than temporary.

Cynosure’s available-for-sale securities at September 30, 2007 consist of approximately $49.3 million of investments in debt securities consisting of state and municipal bonds and corporate bonds and approximately $80,000 in equity securities. As of September 30, 2007, Cynosure’s equity security consisted of 133,511 shares of common stock of a public company with a fair market value of approximately $80,000. These shares were acquired in connection with the sale of Cynosure’s investment in a private company during 2006 and are considered available-for-sale securities in accordance with SFAS 115.

As of September 30, 2007, Cynosure’s marketable securities consisted of the following (in thousands):

	Market Value		Amortized Cost		Unrealized Gains		Unrealized Losses
Corporate bonds	$	823	$	823	$	—	$	—
State and municipal bonds		48,499		48,483		16		—
Equity security		80		270		—		—
	$	49,402	$	49,576	$	16	$	—

During the three months ended September 30, 2007, Cynosure concluded that its equity security investment in shares of common stock of another public company was other than temporarily impaired as of September 30, 2007 due to its consistent decline in value and public notification that the security is at risk of being delisted from the NASDAQ exchange. As such, Cynosure recorded an impairment charge of approximately $190,000 as an other expense in the accompanying consolidated statements of operations for the three months ended September 30, 2007.

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As of September 30, 2007, Cynosure’s debt securities mature as follows (in thousands):

	Maturities
	Total		Less Than One Year		One to Two Years
Corporate bonds	$	823	$	823	$	—
State and municipal bonds		48,499		48,499		—
	$	49,322	$	49,322	$	—

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Note 6 — Warranty Costs

Cynosure typically provides a one-year parts and labor warranty on end-user sales of laser systems. Distributor sales generally include a warranty on parts only. Estimated future costs for initial product warranties are provided at the time of revenue recognition.

The following table provides the detail of the change in Cynosure’s product warranty accrual during the nine months ended September 30, 2007, which is a component of accrued liabilities in the consolidated balance sheet at September 30, 2007:

	September 30, 2007
	(in thousands)
Warranty accrual, beginning of period	$	2,803
Charged to costs and expenses relating to new sales		2,801
Costs incurred		(2,658	)
Warranty accrual, end of period	$	2,946

Note 7 — Segment Information

In accordance with Statement of Financial Accounting Standard No. 131,Disclosures about Segments of an Enterprise and Related Information(SFAS 131), operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in determining how to allocate resources and assess performance. Cynosure’s chief decision-maker, as defined under SFAS 131, is a combination of the Chief Executive Officer and the Chief Financial Officer. Cynosure views its operations and manages its business as one segment, aesthetic treatment products and services.

The following table represents total revenue by geographic destination:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
	(in thousands)
United States	$	19,161	$	9,152	$	49,437	$	28,355
Europe		5,596		4,130		19,683		13,067
Asia / Pacific		2,818		3,068		9,032		6,943
Other		3,958		2,206		9,590		5,461
Total	$	31,533	$	18,556	$	87,742	$	53,826

Net assets by geographic area are as follows:

	September 30, 2007			December 31, 2006
	(in thousands)
United States	$	106,891		$	86,815
Europe		3,470			443
Asia / Pacific		357			374
Eliminations		(2,351	)		(1,762	)
Total	$	108,367		$	85,870

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Long-lived assets by geographic area are as follows:

	September 30, 2007		December 31, 2006
	(in thousands)
United States	$	7,267	$	6,435
Europe		523		316
Asia / Pacific		152		157
Total	$	7,942	$	6,909

No individual country within Europe or Asia/Pacific represented greater than 10% of total revenue, net assets or long-lived assets for any periods presented.

Note 8 — Net Income (Loss) Per Share

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

A reconciliation of basic and diluted shares is as follows:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2007	2006	2007	2006
	(in thousands)
Basic weighted-average number of shares outstanding	12,281	11,107	11,863	11,061
Potential common shares pursuant to stock options	470	—	741	—
Diluted weighted-average number of shares outstanding	12,751	11,107	12,604	11,061

During the three months ended September 30, 2007 and 2006, approximately, 196,000 and 1,333,000 shares, respectively, were excluded from the calculation of diluted weighted-average shares outstanding as the effect would have been anti-dilutive. During the nine months ended September 30, 2007 and 2006, approximately, 222,000 and 1,277,000 shares, respectively, were excluded from the calculation of diluted weighted-average shares outstanding as the effect would have been anti-dilutive.

Note 9 — Comprehensive Income (Loss)

Comprehensive income (loss) is the change in equity of a company during a period from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The components of total comprehensive income (loss) for the three and nine months ended September 30, 2007 and 2006 are as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2007		2006			2007			2006
	(in thousands)
Cumulative translation adjustment	$	117	$	92		$	162		$	226
Unrealized gain on marketable securities:
Unrealized holding gains (losses) on marketable securities		16		36			(34	)		5
Add-back: Reclassification adjustment for impairment of marketable security included in net income (loss)		87		—			87			—
Gross unrealized gain on marketable securities		103		36			53			5
Total other comprehensive income		220		128			215			231
Reported net income (loss)		4,377		(4,247	)		9,206			(2,179	)
Total comprehensive income (loss)	$	4,597	$	(4,119	)	$	9,421		$	(1,948	)

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Note 10 — Litigation

In May 2005, Dr. Ari Weitzner, individually and as putative representative of a purported class, filed a complaint against Cynosure under the federal Telephone Consumer Protection Act, or TCPA, in Massachusetts Superior Court in Middlesex County seeking monetary damages, injunctive relief, costs and attorneys fees. The complaint alleges that Cynosure violated the TCPA by sending unsolicited advertisements by facsimile to the plaintiff and other recipients without the prior express invitation or permission of the recipients. Under the TCPA, recipients of unsolicited facsimile advertisements are entitled to damages of up to $500 per facsimile for inadvertent violations and up to $1,500 per facsimile for knowing or willful violations. Although Cynosure is continuing to investigate the number of facsimiles transmitted during the period for which the plaintiff in the lawsuit seeks class certification and the number of these facsimiles that were “unsolicited” within the meaning of the TCPA, Cynosure expects the number of unsolicited facsimiles to be very large. Cynosure is vigorously defending the lawsuit and has filed initial briefs and motions with the court. Cynosure is not able to estimate the amount or range of loss that could result from an unfavorable outcome of the lawsuit as the matter is still in the early stages of the proceedings.

In December 2005, certain individuals commenced an arbitration against Cynosure along with Sona International Inc. (Sona MedSpa), Carousel Capital, Inc. and various individuals. The arbitration demand alleges fraud, violations of various state consumer protection laws and other causes of action in connection with the plaintiff’s acquisition of franchises from the Sona entities. Cynosure declined to participate in the arbitration because Cynosure had not agreed contractually to do so, and it has been dismissed from the arbitration by agreement of the parties.

In January 2006, Gentle Laser Solutions, Inc., Liberty Bell Med Spa, Inc. and Kevin T. Campbell filed suit against Cynosure and one of its former directors, along with Sona International Inc. Sona Lasers Centers, Inc. and various other individuals, in the Superior Court of New Jersey. The matter was later removed to the United States District Court in the District of New Jersey. The suit alleges fraud, breach of contract and other causes of action in connection with the plaintiffs’ acquisition of franchises from the Sona entities. Court-ordered conferences scheduled for December 1, 2006 and January 29, 2007 were postponed due to a pending motion to dismiss by Sona. Cynosure is not able to estimate the amount or range of loss that could result from an unfavorable outcome of the lawsuit as the matter is still in the early stages of the proceedings.

In June 2006, Baltimore Laser Solutions, Inc. and Kevin T. Campbell, filed suit against Cynosure and one of its former directors, along with Sona International Inc., Sona Lasers Centers, Inc. and various other individuals, in the United States District Court in the District of Maryland. The suit alleges fraud, breach of contract and other causes of action in connection with the plaintiffs’ acquisition of franchises from the Sona entities. Cynosure is not able to estimate the amount or range of loss that could result from an unfavorable outcome of the lawsuit as the matter is still in the early stages of the proceedings.

In addition to the matters discussed above, from time to time, Cynosure is subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against Cynosure incident to the operation of its business, principally product liability. Each of these other matters is subject to various uncertainties, and it is possible that some of these other matters may be resolved unfavorably to Cynosure. Cynosure establishes accruals for losses that management deems to be probable and subject to reasonable estimate. Cynosure believes that the ultimate outcome of these matters will not have a material adverse impact on its consolidated financial position, results of operations or cash flows.

Note 11 — Sona MedSpa

In October 2005, Cynosure entered into a preferred vendor agreement with Sona MedSpa, a spa franchisor that owns and operates hair removal clinics in the United States. Under the agreement, Cynosure sold certain laser systems to Sona MedSpa for approximately $1.3 million, which was recorded as deferred revenue as of December 31, 2005 because the fee was not fixed or determinable at the time of sale.

In March 2006, Sona MedSpa notified Cynosure that Sona MedSpa was uncertain that it had the financial resources to honor its commitments to Cynosure and Cynosure determined that the collectibility of the fee was not probable and, as a result, reversed the related deferred revenue. Cynosure expensed as cost of goods sold approximately $667,000 of inventory delivered under the agreement. Additionally, Cynosure provided an allowance for doubtful accounts of $463,000 for accounts receivable associated with services provided prior to the October 2005 preferred vendor agreement. On May 2, 2006, Cynosure sent Sona MedSpa a notice of default with respect to Sona MedSpa’s failure to pay Cynosure amounts payable under two agreements between the parties. On June 2, 2006, Cynosure terminated the agreement with Sona MedSpa as the defaults under the agreements were not cured. On June 16, 2006, Cynosure commenced an arbitration with Sona MedSpa.

On November 27, 2006, Cynosure settled the arbitration with Sona MedSpa and each party released its claims against the other in exchange for consideration of $250,000 in cash. The settlement payment received by Cynosure was in

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reimbursement for legal expenses and, as such, is reflected as a reduction in general and administrative expenses in the accompanying consolidated statements of income for the nine months ended September 30, 2007 as the period during which this payment was subject to certain avoidance action by a third-party had lapsed.

Note 12 — Related Party Transactions

As of September 30, 2007, El. En. S.p.A. (El.En.) owned 32% of Cynosure’s outstanding common stock. Purchases of inventory from El.En. during the three months ended September 30, 2007 and 2006 were approximately $1.4 million and $239,000, respectively. Purchases of inventory from El.En. during the nine months ended September 30, 2007 and 2006, were approximately $5.1 million and $2.4 million, respectively. As of September 30, 2007 and December 31, 2006, amounts due to related party for these purchases were approximately $2.0 million and $1.1 million, respectively. Amounts due from El.En. as of September 30, 2007 and December 31, 2006 were approximately $16,000 and $335,000, respectively, which represent services performed by Cynosure.

Note 13 — Income Taxes

Cynosure adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an Interpretation of FAS 109, Accounting for Income Taxes, (FIN 48) on January 1, 2007. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Cynosure generally reports tax positions in its financial statements as they are reported on tax returns as filed or to be filed. A tax benefit is reflected in the financial statements only if it is “more-likely-than-not” that Cynosure will be able to sustain the tax position, based on its technical merits. Tax benefits from uncertain tax positions that reduce current or future income tax liabilities are reported in the financial statements only to the extent each benefit is recognized and measured, in accordance with the provisions of FIN 48. As a result of adopting FIN 48, Cynosure determined that no material cumulative effect adjustment was necessary to the opening balance of retained earnings as of January 1, 2007. Cynosure further determined, based on its analysis, that there were no significant unrecognized tax benefits that, if recognized, would affect the effective tax rate for the three months and nine months ended September 30, 2007.

Under FIN 48, a tax return benefit that does not qualify for financial reporting recognition is generally treated as a government loan or incorrect application of a tax law and may result in interest and penalty charges. Cynosure classifies interest and penalties related to income taxes as interest expense and other expense, respectively, within the statement of income.

Cynosure files income tax returns in the U.S. federal jurisdiction, and in various state and foreign jurisdictions. With few exceptions, Cynosure is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003.

As part of an Internal Revenue Service audit, Cynosure discovered in May 2007 that it erroneously claimed an intercompany bad-debt deduction from its German subsidiary of approximately $1.7 million on its 2003 U.S. federal income tax return. The deduction increased the amount of the U.S. net operating loss (NOL) carryforward as of December 31, 2003. During 2004 and 2005, the Company utilized this NOL carryforward to reduce taxable income and also recognized the financial statement benefit through a reduction in its tax provision for those two years. In accordance with SAB No. 99 and SAB No. 108, Cynosure assessed the materiality of this error on Cynosure’s financial statements for the years ended December 31, 2004, 2005 and 2006 using both the roll-over method and iron-curtain method as defined in SAB No. 108. Cynosure concluded the effect of this error was not material to Cynosure’s financial statements for the years ended December 31, 2004, 2005 and 2006 and, as such, these financial statements are not materially misstated. Cynosure also concluded that providing for the correction of the error in 2007 would not have a material effect on Cynosure’s financial statements for the year ended December 31, 2007. As such, Cynosure recorded a provision for income taxes of $702,000 during the six months ended June 30, 2007 for the tax liability and related interest required to correct this error. As of September 30, 2007, Cynosure has accrued $728,000 for this tax liability and related interest within accrued expenses in the accompanying consolidated balance sheets.

Note 14 — Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157,Fair Value Measurements, or SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of this Statement are to be applied prospectively as of January 1, 2008, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. Cynosure does not expect that the adoption of SFAS 157 will have a material impact on its financial position or results of operations.

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In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115(SFAS 159), in order to permit entities to choose to measure many financial instruments and certain other eligible items at fair value at specified election dates and, thereby, mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. Unrealized gains and losses on items for which the fair value option has been elected shall be reported in earnings. The provisions of SFAS 159 are to be applied prospectively as of January 1, 2008; however, early adoption is permitted, subject to certain restrictions. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. Cynosure does not expect that the adoption of SFAS 159 will have a material impact on its financial position or results of operations.

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this Quarterly Report regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans, objectives of management and expected market growth are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements include, among other things, statements about:

• our ability to identify and penetrate new markets for our products and technology;

• our ability to innovate, develop and commercialize new products;

• our ability to obtain and maintain regulatory clearances;

• our sales and marketing capabilities and strategy in the United States and internationally;

• our intellectual property portfolio; and

• our estimates regarding expenses, future revenues, capital requirements and needs for additional financing.

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in our Annual Report on Form 10-K for the year ended December 31, 2006, particularly in Part I — Item 1A, and in our other public filings with the Securities and Exchange Commission that could cause actual results or events to differ materially from the forward-looking statements that we make.

You should read this Quarterly Report and the documents that we have filed as exhibits to the Quarterly Report completely and with the understanding that our actual future results may be materially different from what we expect. It is routine for internal projections and expectations to change as the year or each quarter in the year progresses, and therefore it should be clearly understood that the internal projections and beliefs upon which we base our expectations are made as of the date of this Quarterly Report on Form 10-Q and may change prior to the end of each quarter or the year. While we may elect to update forward-looking statements at some point in the future, we do not undertake any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with, and is qualified in its entirety by, the condensed consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and the condensed consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K filed with the SEC on March 12, 2007. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

Company Overview

We develop and market aesthetic treatment systems that are used by physicians and other practitioners to perform non-invasive procedures to remove hair, treat vascular lesions, rejuvenate skin through the treatment of shallow vascular lesions and pigmented lesions, temporarily reduce the appearance of cellulite, treat wrinkles, skin texture, skin discoloration and skin tightening, and to perform minimally invasive procedures for LaserBodySculpting and for the removal of unwanted fat. Our systems incorporate a broad range of laser and other light-based energy sources, including Alexandrite, pulse dye, Nd:Yag and diode lasers, as well as intense pulsed light. We believe that we are one of only a few companies that currently offer aesthetic treatment systems utilizing Alexandrite and pulse dye lasers, which are particularly well suited for some applications and skin types. We offer single energy source systems as well as workstations that incorporate two or more different types of lasers or pulsed light technologies. We offer multiple technologies and system alternatives at a variety of price points depending primarily on the number and type of energy sources included in the system. Our newer products are designed to be easily upgradeable to add additional energy sources and handpieces, which provides our customers with technological flexibility as they expand their practices. As the aesthetic treatment market evolves to include new customers, such as aesthetic spas and additional physician specialties, we believe that our broad technology base and tailored solutions will provide us with a competitive advantage.

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We sell over 15 different aesthetic treatment systems and have focused our development and marketing efforts on offering leading, or flagship, products for each of the major aesthetic procedure categories that we address. Our flagship products are:

• theApogee Elitesystem for hair removal;

• theCynergysystem for the treatment of vascular lesions;

• theTriActive LaserDermologysystem for the temporary reduction of the appearance of cellulite;

• theAffirmsystem for anti-aging, including treatments for wrinkles, skin texture, skin discoloration and skin tightening; and

• theSmartliposystem for LaserBodySculpting (SM) and the removal of unwanted fat.

In addition to their primary applications, theApogee EliteandCynergysystems can each be used by practitioners for a variety of other applications.

We recently expanded our anti-aging aesthetic solution to include the addition of a new 1320 nm wavelength Nd:YAG laser to theAffirmworkstation. TheAffirmproduct family now incorporates three energy sources. The new deep-heating component provided by the new 1320 nm wavelength Nd:YAG laser allows for tissue tightening as a result of tissue coagulation, which complements the system’s 1440 nm Nd:YAG laser for fractional micro-rejuvenation and Xenon Pulsed Light system for discoloration. We began shipping these new upgradeable systems in 2007.

We also recently expanded ourSmartlipo product family to include a 10-wattSmartlipo LaserBodySculpting workstation, which is intended for high-volume aesthetic laser practices, allowing a physician to complete a typical laser-assisted liposuction procedure in about half the time as the original 6-watt workstation. The 10-wattSmartlipo workstation is available as a standalone unit or as an upgrade to the 6-watt system.

We sell our products through a direct sales force in North America, four European countries, Japan and China and through international distributors in 44 other countries. As of December 31, 2006, we had sold more than 5,900 aesthetic treatment systems worldwide.

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Financial Operations Overview

Revenues

We generate revenues primarily from sales of our products and parts and accessories and, to a lesser extent, from services, including product warranty revenues. During the nine months ended September 30, 2007, we derived approximately 96% of our revenues from sales of our products and 4% of our revenues from service. For the comparable period in 2006, we derived approximately 95% of our revenues from sales of our products and 5% of our revenues from service. Generally, we recognize revenues from sales of our products upon delivery to our customers, revenues from service contracts and extended product warranties ratably over the coverage period and revenues from service in the period in which the service occurs.

We sell our products directly in North America, four European countries, Japan and China and use distributors to sell our products in other countries where we do not have a direct sales force. During the nine months ended September 30, 2007 and 2006, we derived 34% and 40%, respectively, of our product revenues from sales of our products outside North America. As of September 30, 2007, we had 67 sales employees in North America, 15 sales employees in four European countries, Japan and China and distributors in 44 countries. The following table provides revenue data by geographic region for the nine months ended September 30, 2007 and 2006:

	Percentage of Revenues
	Nine Months Ended September 30,
	2007		2006
Region
North America	64	%	57	%
Europe	22		24
Asia/Pacific	10		13
Other	4		6
Total	100	%	100	%

See Note 7 to our consolidated financial statements included in this Quarterly Report for revenues and asset data by geographic region.

Cost of Revenues

Our cost of revenues consists primarily of material, labor and manufacturing overhead expenses and includes the cost of components and subassemblies supplied by third party suppliers. Cost of revenues also includes royalties incurred on products sold, service and warranty expenses, as well as salaries and personnel-related expenses, including stock-based compensation, for our operations management team, purchasing and quality control.

Sales and Marketing Expenses

Our sales and marketing expenses consist primarily of salaries, commissions and other personnel-related expenses, including stock-based compensation, for employees engaged in sales, marketing and support of our products, trade show, promotional and public relations expenses and management and administration expenses in support of sales and marketing. We expect our sales and marketing expenses to increase in absolute dollars, though we do not expect them to increase significantly as a percentage of revenues, as we expand our sales, marketing and distribution capabilities.

Research and Development Expenses

Our research and development expenses consist of salaries and other personnel-related expenses, including stock-based compensation, for employees primarily engaged in research, development and engineering activities and materials used and other overhead expenses incurred in connection with the design and development of our products. We expense all of our research and development costs as incurred. We expect our research and development expenditures to increase in absolute dollars, though we do not expect them to increase significantly as a percentage of revenues, as we continue to devote resources to research and develop new products and technologies.

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General and Administrative Expenses

Our general and administrative expenses consist primarily of salaries and other personnel-related expenses, including stock-based compensation, for executive, accounting and administrative personnel, professional fees and other general corporate expenses. We expect our general and administrative expenses to increase in absolute dollars, though we do not expect them to increase significantly as a percentage of revenues.

Interest Income, net

Interest income consists primarily of interest earned on our marketable securities portfolio consisting mainly of state and municipal bonds and corporate bonds. Interest expense consists primarily of interest due on capitalized leases.

Other Income, net

Other income, net consists primarily of foreign currency remeasurement gains and losses.

Provision for Income Taxes

As of December 31, 2006, we had state tax credit carryforwards of approximately $209,000 to offset future tax liability, and state net operating loss (NOL) carryforwards of approximately $561,000 to offset future taxable income. If not utilized, these credit and operating loss carryforwards will expire at various dates through 2019, and the losses will expire through 2026. We also had foreign net operating loss carryforwards of approximately $2,067,000 available to reduce future foreign taxable income which will expire at various times through 2024. Foreign net operating loss carryforwards include $1,875,000 in Germany and France, which do not expire.

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Results of Operations

THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

The following table contains selected income statement information, which serves as the basis of the discussion of our results of operations for the three months ended September 30, 2007 and 2006, respectively (in thousands, except for percentages):

	Three Months Ended September 30,									$ Change			% Change
	2007				2006
	Amount		As a % of Total Revenues		Amount			As a % of Total Revenues
Revenues	$	31,533	100	%	$	18,556		100	%	$	12,977		70	%
Cost of revenues		11,045	35			7,442		40			3,603		48
Gross profit		20,488	65			11,114		60			9,374		84
Operating expenses
Sales and marketing		10,310	33			6,372		34			3,938		62
Research and development		1,468	5			1,207		7			261		22
General and administrative		3,143	10			2,041		11			1,102		54
Royalty settlement		—	—			10,000		54			(10,000	)	-100
Total operating expenses		14,921	47			19,620		106			(4,699	)	-24
Income (loss) from operations		5,567	18			(8,506	)	-46			14,073		165
Interest income, net		661	2			680		4			(19	)	-3
Other income, net		356	1			215		1			141		66
Income (loss) before provision for (benefit from) income taxes and minority interest		6,584	21			(7,611	)	-41			14,195		187
Provision for (benefit from) income taxes		2,207	7			(3,370	)	-18			5,577		166
Minority interest in net income of subsidiary		—	—			6		—			(6	)	-100
Net income (loss)	$	4,377	14	%	$	(4,247	)	-23	%	$	8,624		203	%

Revenues

Revenues in the three months ended September 30, 2007 exceeded revenues in the three months ended September 30, 2006 by $13.0 million or 70%. The increase in revenues was attributable to a number of factors (in thousands, except for percentages):

	Three Months Ended September 30,				$ Change			% Change
	2007		2006
Product sales in North America	$	20,475	$	9,430	$	11,045		117	%
Product sales outside North America		7,734		6,755		979		14
Original equipment manufacturer sales and revenue sharing		283		301		(18	)	(6	)
Parts, accessories and service sales		3,041		2,070		971		47
Total Revenues	$	31,533	$	18,556	$	12,977		70	%

• Revenues from the sale of products in North America increased due to an increase in the number of product units sold, a higher average selling price due to a favorable change in product mix and from the success of our recently introduced products, such as theSmartlipo andAffirmsystems. The increase in North American revenues resulted in part from the continued expansion of our North American sales organization, including the hiring of 36 additional direct sales employees between December 31, 2005 and September 30, 2007.

• Revenues from sales of products outside of North America increased mainly due to an increase in sales in Europe of $1.1 million, or 32%, over the 2006 period, and an increase in sales from distributors in the Middle East of $0.1 million, or 18%, over the 2006 period. These increases in sales were partially offset by $0.2 million, which relates to a decrease in the volume of sales from distributors in Asia Pacific.

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• Revenues from the sale of parts, accessories and services increased primarily as a result of the increase in our product sales over the past two years.

Cost of Revenues

	Three Months Ended September 30,						$ Change		% Change
	2007			2006
Cost of revenues (in thousands)	$	11,045		$	7,442		$	3,603	48	%
Cost of revenues (as a percentage of total revenues)		35	%		40	%

The increase in the cost of revenues was primarily attributable to an increase in direct labor, overhead and material costs associated with increased sales of our products. The improvement in gross margins is primarily the result of higher average selling prices of our products due to a favorable change in product mix as well as increased direct sales and the introduction of new products, offset by royalties incurred on products sold, which we began incurring in October 2006.

Sales and Marketing

	Three Months Ended September 30,						$ Change		% Change
	2007			2006
Sales and marketing (in thousands)	$	10,310		$	6,372		$	3,938	62	%
Sales and marketing (as a percentage of total revenues)		33	%		34	%

Sales and marketing expenses increased primarily due to an increase of $2.3 million in personnel costs and travel expenses associated with the expansion of our North American direct sales organization and $0.4 million in personnel costs and travel expenses associated with our international subsidiaries. Promotional costs increased $0.8 million, primarily due to an increased number of clinical workshops, trade shows and promotional efforts associated with our increase in direct sales employees. Sales and marketing expenses also increased due to an increase in stock-based compensation of approximately $0.4 million.

Research and Development

	Three Months Ended September 30,						$ Change		% Change
	2007			2006
Research and development (in thousands)	$	1,468		$	1,207		$	261	22	%
Research and development (as a percentage of total revenues)		5	%		7	%

Research and development expenses increased primarily due to an increase of $0.1 million in personnel costs and $0.2 million in costs incurred related to clinical studies, offset by a decrease in stock-based compensation of $0.1 million.

General and Administrative

	Three Months Ended September 30,						$ Change		% Change
	2007			2006
General and administrative (in thousands)	$	3,143		$	2,041		$	1,102	54	%
General and administrative (as a percentage of total revenues)		10	%		11	%

General and administrative expenses increased primarily due to an increase of $0.5 million in personnel costs, an increase in professional fees of $0.2 million, a $0.1 million increase in our international subsidiaries administrative expenses, and an increase in stock-based compensation of $0.3 million.

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Royalty Settlement

On November 6, 2006, we entered into a patent cross-license agreement with Palomar Medical Technologies, Inc. (Palomar). Under the cross-license agreement, we obtained a non-exclusive license to integrate into our products certain hair removal technology covered by specified U.S. and foreign patents held by Palomar and Palomar obtained a non-exclusive license under certain U.S. and foreign patents held by us. In November 2006, we made a payment to Palomar of $10.0 million for royalties related to sales prior to October 1, 2006 of hair removal-only systems including our Apogee family of products,PhotoLight,Acclaim 7000 and thePhotoSilk Plus. This was recorded as a royalty settlement within our operating expenses for the three months ended September 30, 2006.

Interest Income, net and Other Income, net

	Three Months Ended September 30,				$ Change			% Change
	2007		2006
Interest income, net (in thousands)	$	661	$	680	$	(19	)	(3	)%
Other income, net (in thousands)	$	356	$	215	$	141		66	%

The decrease in interest income, net resulted from the shift in our investment portfolio to tax-exempt securities, which generally generate lower yields, gross of tax, than taxable securities. The increase in other income, net is a result of larger foreign currency remeasurement gains in the third quarter of 2007 compared to the foreign currency remeasurement gains in the third quarter of 2006, offset by an impairment of marketable security of $0.1 million recorded during the three months ended September 30, 2007.

Provision for (Benefit from) Income Taxes

	Three Months Ended September 30,						$ Change		% Change
	2007			2006
Provision for (benefit from) income taxes (in thousands)	$	2,207		$	(3,370	)	$	5,577	166	%
Provision (benefit) as a % of income (loss) before provision for (benefit from) income taxes and minority interest		34	%		44	%

The increase in our provision for income taxes for the three months ended September 30, 2007 from a benefit position for the three months ended September 30, 2006, is primarily attributable to the $10.0 million royalty settlement with Palomar, which occurred during the three months ended September 30, 2006. The effective tax rates for the three months ended September 30, 2007 and 2006 were 34% and 44%, respectively. The higher effective tax rate for the three months ended September 30, 2006, was primarily due to the impact of the $10.0 million royalty settlement expense being accounted for in our benefit from income taxes as a discrete item at our statutory rate of 40%, which differs from our effective tax rate.

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NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

The following table contains selected income statement information, which serves as the basis of the discussion of our results of operations for the nine months ended September 30, 2007 and 2006, respectively (in thousands, except for percentages):

	Nine Months Ended September 30,									$ Change			% Change
	2007				2006
	Amount		As a % of Total Revenues		Amount			As a % of Total Revenues
Revenues	$	87,742	100	%	$	53,826		100	%	$	33,916		63	%
Cost of revenues		32,035	37			23,015		43			9,020		39
Gross profit		55,707	63			30,811		57			24,896		81
Operating expenses
Sales and marketing		29,447	34			17,979		33			11,468		64
Research and development		4,958	6			3,455		6			1,503		44
General and administrative		8,371	10			6,218		12			2,153		35
Royalty settlement		—	—			10,000		19			(10,000	)	-100
Total operating expenses		42,776	49			37,652		70			5,124		14
Income (loss) from operations		12,931	15			(6,841	)	-13			19,772		289
Interest income, net		1,762	2			2,063		4			(301	)	-15
Other income, net		440	1			621		1			(181	)	-29
Income (loss) before provision for (benefit from) income taxes and minority interest		15,133	17			(4,157	)	-8			19,290		464
Provision for (benefit from) income taxes		5,927	7			(2,019	)	-4			7,946		394
Minority interest in net income of subsidiary		—	—			41		—			(41	)	-100
Net income (loss)	$	9,206	10	%	$	(2,179	)	-4	%	$	11,385		522	%

Revenues

Revenues in the nine months ended September 30, 2007 exceeded revenues in the nine months ended September 30, 2006 by $33.9 million, or 63%. The increase in revenues was attributable to a number of factors (in thousands, except for percentages)

	Nine Months Ended September 30,				$ Change			% Change
	2007		2006
Product sales in North America	$	51,429	$	27,561	$	23,868		87	%
Product sales outside North America		26,355		18,683		7,672		41
Original equipment manufacturer sales and revenue sharing		834		875		(41	)	(5	)
Parts, accessories and service sales		9,124		6,707		2,417		36
Total Revenues	$	87,742	$	53,826	$	33,916		63	%

• Revenues from the sale of products in North America increased due to an increase in the number of product units sold, a higher average selling price due to a favorable change in product mix and from the introduction of new products, such as theSmartlipo andAffirmsystems. The increase in North American revenues resulted in part from the continued expansion of our North American sales organization, including the hiring of 36 additional direct sales employees between December 31, 2005 and September 30, 2007.

• Revenues from sales of products outside of North America increased mainly due to an increase in sales in Europe of $5.6 million, or 50%, and an increase in sales in Asia Pacific of $2.0 million, or 43%, over the 2006 period, resulting from a favorable change in product mix.

• Revenues from the sale of parts, accessories and services increased primarily as a result of the increase in our product sales over the past two years.

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Cost of Revenues

	Nine Months Ended September 30,						$ Change		% Change
	2007			2006
Cost of revenues (in thousands)	$	32,035		$	23,015		$	9,020	39	%
Cost of revenues (as a percentage of total revenues)		37	%		43	%

The increase in the cost of revenues was primarily attributable to an increase in direct labor, overhead and material costs associated with increased sales of our products. The increase in gross margin is due to higher average selling prices of our products due to a favorable change in product mix, as well as increased direct sales and lower product costs as a result of streamlining our manufacturing approach, offset by royalties incurred on products sold, which we began incurring in October 2006.

Sales and Marketing

	Nine Months Ended September 30,						$ Change		% Change
	2007			2006
Sales and marketing (in thousands)	$	29,447		$	17,979		$	11,468	64	%
Sales and marketing (as a percentage of total revenues)		34	%		33	%

Sales and marketing expenses increased primarily due to an increase of $5.3 million in personnel costs and travel expenses, as well as an increase in other costs for outside services and freight of approximately $0.4 million, associated with the expansion of our North American direct sales organization and $2.1 million in personnel costs and travel expenses associated with our international subsidiaries. Promotional costs increased $2.8 million, primarily due to our increased number of clinical workshops, trade shows and promotional efforts as well as costs associated with our rebranding initiative. Sales and marketing expenses also increased due to an increase in stock-based compensation of approximately $0.9 million.

Research and Development

	Nine Months Ended September 30,						$ Change		% Change
	2007			2006
Research and development (in thousands)	$	4,958		$	3,455		$	1,503	44	%
Research and development (as a percentage of total revenues)		6	%		6	%

The increase in research and development expenses is primarily due to an increase in stock-based compensation of $0.6 million, an increase of $0.2 million related to costs incurred for clinical studies and an increase of $0.7 million in personnel costs.

General and Administrative

	Nine Months Ended September 30,						$ Change		% Change
	2007			2006
General and administrative (in thousands)	$	8,371		$	6,218		$	2,153	35	%
General and administrative (as a percentage of total revenues)		10	%		12	%

General and administrative expenses increased primarily due to an increase in stock-based compensation of $0.8 million, an increase of $0.3 million in our international subsidiaries administrative expenses, and an increase of $0.7 million in personnel costs. General and administrative expenses also increased due to an increase of $0.3 million in professional services fees and an increase of $0.1 million in bank charges.

Royalty Settlement

On November 6, 2006, we entered into a patent cross-license agreement with Palomar. Under the cross-license agreement, we obtained a non-exclusive license to integrate into our products certain hair

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removal technology covered by specified U.S. and foreign patents held by Palomar and Palomar obtained a non-exclusive license under certain U.S. and foreign patents held by us. In November 2006, we made a payment to Palomar of $10.0 million for royalties related to sales prior to October 1, 2006 of hair removal-only systems including our Apogee family of products,PhotoLight,Acclaim 7000 and thePhotoSilk Plus. This was recorded as a royalty settlement within our operating expenses for the nine months ended September 30, 2006.

Interest Income, net and Other Income, net

	Nine Months Ended September 30,				$ Change			% Change
	2007		2006
Interest income, net (in thousands)	$	1,762	$	2,063	$	(301	)	(15	)%
Other income, net (in thousands)	$	440	$	621	$	(181	)	(29	)%

The decrease in interest income, net resulted from the shift in our investment portfolio to include investments in tax-exempt securities, which generally generate lower yields, gross of tax, than taxable securities. The decrease in other income, net is a result of smaller foreign currency remeasurement gains in 2007 compared to the foreign currency remeasurement gains in 2006, as well as a net realized loss from marketable securities of $0.1 million recorded during the three months ended September 30, 2007.

Provision for (Benefit from) Income Taxes

	Nine Months Ended September 30,						$ Change		% Change
	2007			2006
Provision for (benefit from) income taxes (in thousands)	$	5,927		$	(2,019	)	$	7,946	394	%
Provision (benefit) as a % of income (loss) before provision for (benefit from) income taxes and minority interest		39	%		49	%

The increase in our provision for income taxes for the nine months ended September 30, 2007 from a benefit position for the nine months ended September 30, 2006, is primarily attributable to the $10.0 million royalty settlement with Palomar, which occurred during the nine months ended September 30, 2006. The effective tax rates for the nine months ended September 30, 2007 and 2006 were 39% and 49%, respectively. The higher effective tax rate for the nine months ended September 30, 2006, was primarily due to the impact of the $10.0 million royalty settlement expense being accounted for in our benefit from income taxes as a discrete item at our statutory rate of 40%, which differs from our effective tax rate. The provision for income taxes for the six months ended June 30, 2007 includes a provision for income taxes of $702,000 recorded for an erroneously claimed intercompany bad-debt deduction from our German subsidiary of approximately $1.7 million in our 2003 U.S. federal income tax return which we discovered in May 2007 as part of an Internal Revenue Service audit. As of September 30, 2007, we have accrued $728,000 for this tax liability and related interest within accrued expenses in the accompanying consolidated balance sheets. The deduction increased the amount of the U.S. NOL carryforward as of December 31, 2003. During 2004 and 2005, we utilized this NOL carryforward to reduce taxable income and also recognized the financial statement benefit through a reduction in its tax provision for those two years. In accordance with SAB No. 99 and SAB No. 108, we assessed the materiality of this error on our financial statements for the years ended December 31, 2004, 2005 and 2006 using both the roll-over method and iron-curtain method as defined in SAB No. 108. We concluded the effect of this error was not material to our financial statements for the years ended December 31, 2004, 2005 and 2006 and, as such, these financial statements are not materially misstated. We also concluded that providing for the correction of the error in 2007 would not have a material effect on our financial statements for the year ended December 31, 2007.

Liquidity and Capital Resources

We require cash to pay our operating expenses, make capital expenditures and pay our long-term liabilities. Since our inception, we have funded our operations through private and public placements of equity securities, short-term borrowings and funds generated from our operations. In December 2005, we completed our initial public offering of 5,750,000 shares of our class A common stock at a price to the public of $15.00 per share. We sold 4,750,000 shares of our class A common stock, including an over-allotment option of 750,000 shares, and El.En. S.p.A., the selling stockholder in the offering, sold 1,000,000 of the shares. We received aggregate net proceeds of approximately $64.0 million from the sale of our shares, after deducting underwriting discounts and commission of approximately $5.0 million and expenses of the offering of approximately $2.3 million.

At September 30, 2007, our cash, cash equivalents and marketable securities were $77.0 million compared to $57.2 million as of December 31, 2006. Our cash and cash equivalents of $27.6 million are highly liquid investments with maturity

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of 90 days or less at date of purchase and consist of time deposits and investments in money market funds with commercial banks and financial institutions and United States government obligations. Our marketable securities of $49.4 million consist primarily of investments in various federal and state government obligations and corporate obligations, all of which mature by August 15, 2008.

We expect to continue to generate positive cash flows from operations in the future. Our future capital requirements depend on a number of factors, including the rate of market acceptance of our current and future products, the resources we devote to developing and supporting our products and continued progress of our research and development of new products. We expect our capital expenditures over the next 12 months generally to be consistent with our capital expenditures during the prior 12 months.

We believe that our current cash, cash equivalents and marketable securities, as well as cash generated from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the foreseeable future.

Cash Flows

Net cash provided by operating activities was $15.2 million for the nine months ended September 30, 2007. This resulted primarily from net income for the period of $9.2 million, increased by approximately $6.3 million in depreciation and stock-based compensation expense and increased by approximately $0.3 million in deferred income tax benefits, accretion of discounts on marketable securities and the realized loss on marketable investments. Net changes in working capital items decreased cash from operating activities by approximately $0.6 million principally related to an increase in accounts receivable and inventory of $2.1 million and $5.1 million, respectively, a decrease in accounts payable of $1.9 million, offset by a decrease in prepaid expenses and other assets and an increase in accrued expenses. Net cash used in investing activities was $9.2 million for the nine months ended September 30, 2007, which consisted primarily of the net purchase of $6.2 million of marketable securities and $3.0 million used for fixed asset purchases. Net cash provided by financing activities during the nine months ended September 30, 2007 was $8.3 million, principally relating to proceeds from option exercises and tax benefits related to stock options.

Net cash used in operating activities was $2.5 million for the nine months ended September 30, 2006. This resulted primarily from net loss for the period of $2.2 million, increased by approximately $3.3 million in depreciation and stock-based compensation expense and decreased by approximately $4.6 million in deferred income tax benefits and accretion of discounts on marketable securities. Net changes in working capital items decreased cash from operating activities by approximately $1.0 million principally related to an increase in accrued expenses, which primarily related to the $10.0 million accrual for the royalty settlement with Palomar, offset by an increase in accounts receivable due to the growth of our revenues from sales of products outside of North America, an increase in inventory manufactured for anticipated future sales and an increase in prepaid expenses and other current assets. Net cash used in investing activities was $54.0 million for the nine months ended September 30, 2006, which consisted primarily of the net purchase of $52.3 million of marketable securities and $1.8 million used for fixed asset purchases. Net cash provided in financing activities during the nine months ended September 30, 2006 was $0.3 million, principally relating to proceeds from exercises of stock options.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157,Fair Value Measurements, or SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of this Statement are to be applied prospectively as of January 1, 2008, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. We do not expect that the adoption of SFAS 157 will have a material impact on our financial position or results of operations.

In February 2007, the Financial Accounting Standards Board issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115(SFAS 159), in order to permit entities to choose to measure many financial instruments and certain other eligible items at fair value at specified election dates and, thereby, mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. Unrealized gains and losses on items for which the fair value option has been elected shall be reported in earnings. The provisions of SFAS 159 are to be applied prospectively as of January 1, 2008; however early adoption is permitted, subject to certain restrictions, as defined. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. We do not expect that the adoption of SFAS 159 will have a material impact on our financial position or results of operations.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments.

Interest Rate Sensitivity.We maintain an investment portfolio consisting mainly of state and municipal government obligations and corporate obligations. Each security matures by August 15, 2008. These available-for-sale securities are subject to interest rate risk and will decrease in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity (excluding acquisitions or mergers). Therefore, we do not expect our operating results or cash flows to be significantly affected by any sudden change in market interest rates on our securities portfolio. The following table provides information about our investment portfolio. For investment securities, the table presents principal cash flows (in thousands) and weighted-average interest rates by expected maturity dates.

	Fair Value at September 30, 2007
Investments (at fair value)	$	49,322
Weighted-average interest rate		4.66	%

Foreign Currency Exchange.A significant portion of our operations is conducted in countries other than the United States. Revenues from our international operations that were recorded in U.S. dollars represented approximately 46% of our total international revenues during the nine months ended September 30, 2007. Substantially all of the remaining 54% were sales in euros, British pounds, Japanese yen and Chinese yuan. Since we conduct our business in U.S. dollars, our main exposure, if any, results from changes in the exchange rate between these currencies and the U.S. dollar. Our functional currency is the U.S. dollar. Our policy is to reduce exposure to exchange rate fluctuations by having most of our assets and liabilities, as well as most of our revenues and expenditures, in U.S. dollars, or U.S. dollar linked. Therefore, we believe that the potential loss that would result from an increase or decrease in the exchange rate is immaterial to our business and net assets.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of September 30, 2007. Based on such evaluation, our principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable SEC rules and forms and were effective.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — Other Information

Item 1. Legal Proceedings

In May 2005, Dr. Ari Weitzner, individually and as putative representative of a purported class, filed a complaint against us under the federal Telephone Consumer Protection Act, or TCPA, in Massachusetts Superior Court in Middlesex County seeking monetary damages, injunctive relief, costs and attorneys fees. The complaint alleges that we violated the TCPA by sending unsolicited advertisements by facsimile to the plaintiff and other recipients without the prior express invitation or permission of the recipients. Under the TCPA, recipients of unsolicited facsimile advertisements are entitled to damages of up to $500 per facsimile for inadvertent violations and up to $1,500 per facsimile for knowing or willful violations. Although we are continuing to investigate the number of facsimiles transmitted during the period for which the plaintiff in the lawsuit seeks class certification and the number of these facsimiles that were “unsolicited” within the meaning of the TCPA, we expect the number of unsolicited facsimiles to be very large. We are vigorously defending the lawsuit and have filed initial briefs and motions with the court. We are not able to estimate the amount or range of loss that could result from an unfavorable outcome of the lawsuit as the matter is still in the early stages of the proceedings.

In December 2005, certain individuals commenced an arbitration against us along with Sona International Inc. (Sona MedSpa), Carousel Capital, Inc. and various individuals. The arbitration demand alleges fraud, violations of various state consumer protection laws and other causes of action in connection with the plaintiffs’ acquisition of franchises from the Sona entities. We declined to participate in the arbitration because we had not agreed contractually to do so, and we have been dismissed from the arbitration by agreement of the parties.

In January 2006, Gentle Laser Solutions, Inc., Liberty Bell Med Spa, Inc. and Kevin T. Campbell filed suit against us and one of our former directors, along with Sona International Inc., Sona Lasers Centers, Inc. and various other individuals, in the Superior Court of New Jersey. The matter was later removed to the U. S. District Court in the District of New Jersey. The suit alleges fraud, breach of contract and other causes of action in connection with the plaintiffs’ acquisition of franchises from the Sona entities. Court-ordered conferences scheduled for December 1, 2006 and January 29, 2007 were postponed due to a pending motion to dismiss by Sona. We are not able to estimate the amount or range of loss that could result from an unfavorable outcome of the lawsuit as the matter is still in the early stages of the proceedings.

In June 2006, Baltimore Laser Solutions, Inc. and Kevin T. Campbell, filed suit against us and one of our former directors, along with Sona International Inc., Sona Lasers Centers, Inc. and various other individuals, in the U. S. District Court in the District of Maryland. The suit alleges fraud, breach of contract and other causes of action in connection with the plaintiffs’ acquisition of franchises from the Sona entities. We are not able to estimate the amount or range of loss that could result from an unfavorable outcome of the lawsuit as the matter is still in the early stages of the proceedings.

In addition to the matters discussed above, from time to time, we are subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against us incident to the operation of its business, principally product liability. Each of these other matters is subject to various uncertainties, and it is possible that some of these other matters may be resolved unfavorably to us. We establish accruals for losses that management deems to be probable and subject to reasonable estimate. We believe that the ultimate outcome of these matters will not have a material adverse impact on our consolidated financial position, results of operations or cash flows.

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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, 2006 in addition to the other information included in this quarterly report. 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.

We have not made any material changes to the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On December 13, 2005, we completed an initial public offering of 5,750,000 shares of our class A common stock at a price to the public of $15.00 per share. We sold 4,750,000 shares of the class A common stock, including an over-allotment option of 750,000 shares, and El.En., the selling stockholder in the offering, sold 1,000,000 of the shares. The offer and sale of all of the shares in the initial public offering were registered under the Securities Act of 1933, as amended, pursuant to a registration statement on Form S-1 (File No. 333-127463), which was declared effective by the SEC on November 8, 2005. We received aggregate net proceeds of approximately $64.0 million, after deducting underwriting discounts and commission of approximately $5.0 and expenses of the offering of approximately $2.3 million. None of the underwriting discounts and commissions or offering expenses were incurred or paid to directors or officers of ours or their associates or to persons owning 10 percent or more of our common stock or to any affiliates of ours. From the effective date of the registration statement through September 30, 2007, we used approximately $5.5 million for general corporate purposes, with the remaining $58.5 million in proceeds invested in cash and cash equivalents.

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Item 6. Exhibits

Exhibit No.	Description
31.1	Certification of the Principal Executive Officer
31.2	Certification of the Principal Financial Officer
32.1	Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant certifies that it has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

		Cynosure, Inc.
		(Registrant)
Date: November 8, 2007	By:	/s/ Michael R. Davin
		Michael R. Davin
		Chairman, President, Chief Executive Officer
Date: November 8, 2007	By:	/s/ Timothy W. Baker
		Timothy W. Baker
		Executive Vice President, Chief Financial Officer and Treasurer

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EXHIBIT INDEX

Exhibit No.	Description
31.1	Certification of the Principal Executive Officer
31.2	Certification of the Principal Financial Officer
32.1	Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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