UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended June 30, 2006

Or

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

Commission File No. 000-25705

GSI Group Inc.

(Exact name of registrant as specified in its charter)

New Brunswick, Canada	98-0110412
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
39 Manning Road Billerica, MA	01821
(Address of principal executive offices)	(Zip Code)

(978) 439-5511

(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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  þ    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  þ                Non-accelerated filer  ¨

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

As of August 2, 2006 there were approximately 41,815,442 of the Registrant’s common shares, no par value, issued and outstanding.

GSI GROUP INC.

TABLE OF CONTENTS

Item No.		Page No.
PART I — FINANCIAL INFORMATION		1
ITEM 1.	FINANCIAL STATEMENTS
	CONSOLIDATED BALANCE SHEETS (unaudited)	1
	CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)	2
	CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)	3
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)	4
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	17
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	26
ITEM 4.	CONTROLS AND PROCEDURES	26
PART II — OTHER INFORMATION		26
ITEM 1.	LEGAL PROCEEDINGS	26
ITEM 1A.	RISK FACTORS	26
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	27
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	27
ITEM 6.	EXHIBITS	28
SIGNATURES		29

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

GSI GROUP INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(U.S. GAAP and in thousands of U.S. dollars, except share amounts)

	June 30, 2006			December 31, 2005
ASSETS
Current
Cash and cash equivalents (note 8)	$	115,339		$	69,286
Short-term investments (note 4 and 8)		—			26,757
Accounts receivable, less allowance of $1,116 (December 31, 2005 — $1,592) (note 7, 10)		64,308			55,348
Income taxes receivable (note 11)		2,903			2,517
Inventories (note 2)		71,113			63,475
Deferred tax assets (note 11)		12,421			10,630
Other current assets (note 2)		12,868			20,357
Total current assets		278,952			248,370
Property, plant and equipment, net of accumulated depreciation of $24,220 (December 31, 2005 — $20,608)		34,045			32,220
Deferred tax assets (note 11)		24,943			20,124
Other assets (note 2)		784			699
Long-term investments (note 8)		644			613
Intangible assets, net of amortization of $5,138 (December 31, 2005 — $4,035) (note 2)		16,091			16,834
Patents and acquired technology, net of amortization of $32,812 (December 31, 2005 — $30,359) (note 2)		26,155			28,163
Goodwill (note 2)		26,421			26,421
	$	408,035		$	373,444
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current
Accounts payable	$	20,742		$	14,998
Income taxes payable (note 11)		10,610			2,475
Accrued compensation and benefits		10,391			9,212
Other accrued expenses (note 2)		17,662			14,625
Total current liabilities		59,405			41,310
Deferred compensation		2,629			2,576
Deferred tax liabilities (note 11)		12,338			13,252
Accrued minimum pension liability (note 12)		10,243			9,750
Total liabilities		84,615			66,888
Commitments and contingencies (note 10)
Stockholders’ equity (note 5, 6)
Common shares, no par value; Authorized shares: unlimited; Issued and outstanding: 41,815,442 (December 31, 2005 — 41,628,171)		310,022			309,545
Additional paid-in capital		4,401			3,339
Retained earnings		18,975			7,688
Accumulated other comprehensive loss		(9,978	)		(14,016	)
Total stockholders’ equity		323,420			306,556
	$	408,035		$	373,444

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

1

GSI GROUP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(U.S. GAAP and in thousands of U.S. dollars, except share amounts)

	Three Months Ended						Six Months Ended
	June 30, 2006			July 1, 2005			June 30, 2006			July 1, 2005
Sales	$	76,401		$	66,850		$	152,524		$	131,691
Cost of goods sold		44,009			39,168			88,583			81,061
Gross profit		32,392			27,682			63,941			50,630
Operating expenses:
Research and development and engineering		7,400			6,368			14,841			12,827
Selling, general and administrative		15,753			15,098			30,575			30,479
Amortization of purchased intangibles		1,513			1,648			3,341			3,400
Restructuring and other (note 9)		(129	)		4			(135	)		201
Total operating expenses		24,537			23,118			48,622			46,907
Income from operations		7,855			4,564			15,319			3,723
Other income (expense)		(6	)		8			24			8
Interest income		1,876			387			2,763			779
Interest expense		(1,323	)		(68	)		(1,467	)		(63	)
Foreign exchange transaction gains (losses)		140			325			(569	)		943
Income before income taxes		8,542			5,216			16,070			5,390
Income tax provision (note 11)		2,358			2,091			4,783			2,155
Net income	$	6,184		$	3,125		$	11,287		$	3,235
Net income per common share:
Basic	$	0.15		$	0.08		$	0.27		$	0.08
Diluted	$	0.15		$	0.07		$	0.27		$	0.08
Weighted average common shares outstanding (000’s)		42,100			41,522			42,008			41,493
Weighted average common shares outstanding for diluted net income per common share (000’s)		42,304			41,728			42,400			41,755

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

2

GSI GROUP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(U.S. GAAP and in thousands of U.S. dollars, except share amounts)

	Three Months Ended						Six Months Ended
	June 30, 2006			July 1, 2005			June 30, 2006			July 1, 2005
Cash flows from operating activities:
Net income	$	6,184		$	3,125		$	11,287		$	3,235
Adjustments to reconcile net income to net cash provided by operating activities:
(Gain) loss on disposal of assets		(187	)		4			(193	)		201
Depreciation and amortization		3,388			3,522			6,937			7,100
Unrealized gain on derivatives		(119	)		(93	)		(119	)		(37	)
Stock-based compensation		61			(28	)		61			(90	)
Deferred income taxes		(4,424	)		(720	)		(6,748	)		(1,118	)
Changes in current assets and liabilities:
Accounts receivable		1,588			(8,652	)		(8,287	)		(2,388	)
Inventories		(7,295	)		(2,181	)		(6,551	)		(5,244	)
Other current assets		1,990			(468	)		1,707			1,559
Accounts payable, accruals and taxes (receivable) payable		10,072			(2,637	)		16,424			(12,533	)
Cash provided by (used in) operating activities		11,258			(8,128	)		14,518			(9,315	)
Cash flows from investing activities:
Acquisition of business		—			(71	)		—			(71	)
Sale of assets		341			1,550			6,454			1,550
Other additions to property, plant and equipment		(2,560	)		(1,132	)		(4,368	)		(2,030	)
Proceeds from the sale and maturities of short-term and long-term investments		22,471			8,000			49,271			11,000
Purchases of short-term and long-term investments		—			(9,243	)		(22,514	)		(17,219	)
(Increase) decrease in other assets		(81	)		(16	)		(229	)		86
Cash provided by (used in) investing activities		20,171			(912	)		28,614			(6,684	)
Cash flows used in financing activities:
Purchase of treasury shares		(3,773	)		—			(3,773	)		—
Tax benefit of stock options		—			—			1,001			—
Issue of common shares from the exercise of stock options		6			273			4,250			464
Cash (used in) provided by financing activities		(3,767	)		273			1,478			464
Effect of exchange rates on cash and cash equivalents		1,292			(1,579	)		1,443			(2,785	)
Increase (decrease) in cash and cash equivalents		28,954			(10,346	)		46,053			(18,320	)
Cash and cash equivalents, beginning of period		86,385			74,360			69,286			82,334
Cash and cash equivalents, end of period	$	115,339		$	64,014		$	115,339		$	64,014

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

3

GSI GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

As of June 30, 2006

(U.S. GAAP and tabular amounts in thousands of U.S. dollars, except share amounts)

1. Basis of Presentation

These unaudited interim consolidated financial statements have been prepared by GSI Group Inc. in United States (U.S.) dollars and in accordance with generally accepted accounting principles in the U.S. for interim financial statements and the rules and regulations promulgated by the U.S. Securities and Exchange Commission, including the instructions to Form 10-Q and the provisions of Regulation S-X pertaining to interim financial statements. Accordingly, these interim consolidated financial statements do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. The consolidated financial statements reflect all adjustments and accruals, consisting only of adjustments and accruals of a normal recurring nature, which management considers necessary for a fair presentation of financial position and results of operations for the periods presented. The consolidated financial statements include the accounts of GSI Group Inc. and its wholly-owned subsidiaries (the “Company”). Intercompany transactions and balances have been eliminated. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The results for interim periods are not necessarily indicative of results to be expected for the year or for any future periods. The amounts are stated in thousands of U.S. dollars, unless otherwise indicated.

Comparative Amounts

Certain prior year amounts have been reclassified to conform to the current year presentation in the financial statements and notes as of and for the three and six months ended June 30, 2006. These reclassifications had no effect on the previously reported results of operations or financial condition.

2. Supplementary Balance Sheet Information

The following tables provide details of selected balance sheet accounts.

Inventories

	June 30, 2006		December 31, 2005
Raw materials	$	31,250	$	27,155
Work-in-process		12,120		10,299
Finished goods		21,183		19,323
Demo inventory		6,560		6,698
Total inventories	$	71,113	$	63,475

Other Assets

	June 30, 2006		December 31, 2005
Other current assets:
Prepaid VAT and VAT receivable	$	5,461	$	6,648
Other prepaid expenses		3,549		4,119
Other current assets		3,858		9,590
Total	$	12,868	$	20,357
Other assets:
Deposits and other	$	784	$	699
Total	$	784	$	699

4

Intangible Assets

	June 30, 2006						December 31, 2005
	Cost			Accumulated Amortization			Cost			Accumulated Amortization
Patents and acquired technology	$	58,967		$	(32,812	)	$	58,522		$	(30,359	)
Accumulated amortization		(32,812	)					(30,359	)
Net Patents and acquired technology	$	26,155					$	28,163

	June 30, 2006						December 31, 2005
	Cost			Accumulated Amortization			Cost			Accumulated Amortization
Customer relationships	$	14,791		$	(3,686	)	$	14,528		$	(2,791	)
Trademarks, trade names, and other		6,438			(1,452	)		6,341			(1,244	)
Total cost		21,229		$	(5,138	)		20,869		$	(4,035	)
Accumulated amortization		(5,138	)					(4,035	)
Net intangible assets	$	16,091					$	16,834

Goodwill

The Company accounts for goodwill pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. During the second quarter of 2006, the Company completed its annual testing of goodwill. There were no indications of impairment; therefore, no write-down of goodwill was necessary.

Other Accrued Expenses

	June 30, 2006		December 31, 2005
Accrued warranty	$	4,619	$	4,445
Deferred revenue		5,895		2,963
Accrued audit		862		1,100
VAT payable		93		498
Accrued restructuring (note 9)		1,381		1,392
Accrual for recourse receivables		1,194		730
Other		3,618		3,497
Total	$	17,662	$	14,625

Accrued Warranty

	For the Three Months Ended June 30, 2006			For the Three Months Ended July 1, 2005			For the Six Months Ended June 30, 2006			For the Six Months Ended July 1, 2005
Balance at the beginning of the period	$	4,578		$	5,532		$	4,445		$	5,880
Charged to costs of goods sold		1,389			1,428			2,752			3,148
Use of provision		(1,383	)		(1,978	)		(2,622	)		(3,999	)
Foreign currency exchange rate changes		35			(80	)		44			(127	)
Balance at the end of the period	$	4,619		$	4,902		$	4,619		$	4,902

5

3. New Accounting Pronouncements

Income Taxes

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 establishes standards for measurement and recognition in financial statements of positions taken by an entity in its income tax returns. In addition, FIN 48 requires new disclosures about positions taken by an entity in its tax returns that are not recognized in its financial statements, information about potential significant changes in estimates related to tax positions and descriptions of open tax years by major jurisdiction. The provisions of FIN 48 will become effective for us beginning January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to retained earnings. We are currently evaluating the impact that FIN 48 will have on our results of operations and financial condition.

Inventory Costs

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”) to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). It requires that abnormal expenditures be recognized as expenses in the current period. SFAS 151 also requires that the amount of fixed production overhead allocated to inventory be based on the normal capacity of the production facilities. The standard is effective for fiscal years beginning after June 15, 2005, and is required to be adopted by the Company effective January 1, 2006. The Company’s adoption of SFAS 151 on January 1, 2006 did not have a material impact on the consolidated results of operations and financial condition.

Share-Based Payment

The Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) on January 1, 2006. SFAS 123R replaced SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) which superseded APB 25. SFAS 123R requires the determination of the fair value of all share-based payments to employees, including grants of employee stock options, and the recognition of the related expense over the period in which the service is received. The Company has elected to apply the modified prospective method of adoption of SFAS 123R. Under the modified prospective method, awards that are granted, modified, or settled after the date of adoption should be measured and accounted for in accordance with SFAS 123R. Additionally, SFAS 123R requires that tax benefits received in excess of compensation cost be reclassified from operating cash flows to financing cash flows in the Consolidated Statement of Cash Flows. See note 6, stock based compensation, for a description of the impact to the Company’s financial position, results of operations and liquidity due to the adoption of SFAS 123(R).

Accounting for Conditional Asset Retirement Obligations

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 clarifies that a conditional asset retirement obligation, as used in SFAS 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of the settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. FIN 47 is effective January 1, 2006, with early adoption allowed. The Company adopted FIN 47 on January 1, 2006. The adoption of FIN 47 did not have a material impact on the Company’s consolidated results of operations or financial condition.

4. Bank Indebtedness

At December 31, 2005, pursuant to a security agreement between the Company and Bank of America, marketable securities included in short-term investments totaling $5.0 million were pledged as collateral for the Bank of America pledge agreement. This pledge was no longer required at June 30, 2006.

5. Stockholders’ Equity

Capital Stock

The authorized capital of the Company consists of an unlimited number of common shares without nominal or par value. During the six months ended June 30, 2006, 565,877 common shares were issued pursuant to exercised stock options for proceeds of approximately $4.3 million. During the six months ended July 1, 2005, 132,177 common shares were issued pursuant to exercised stock options for proceeds of approximately $0.6 million. During the six months ended June 30, 2006 warrants were exercised to purchase 2,694 of the Company’s common shares for an aggregate of $26 thousand.

6

Stock option and warrant activity for the six months ended June 30, 2006 is presented below:

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Outstanding at December 31, 2005	3,565		$	8.21
Granted	—			—
Exercised	(569	)		7.52
Forfeited and expired	(121	)		17.33
Outstanding at June 30, 2006	2,875		$	11.03	2.29	$	825
Exercisable at June 30, 2006	2,875		$	11.03	2.29	$	825

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying options and warrants and the quoted price of our common shares for the 464,000 options and warrants that were in the money at June 30, 2006. The intrinsic value of exercised options and warrants for the six months ended June 30, 2006 was $3.0 million. For the six months ended July 1, 2005, the aggregate intrinsic value of exercised options was $0.5 million.

The Company has a number of share based programs for its directors, officers and employees. Options to purchase the Company’s common shares are granted with exercise prices equal to the market value at the date of grant. Options granted have a ten year life and typically vest 25% each year for four years. Compensation expense is recognized on a straight line basis over the vesting period. The Company has granted both incentive stock options and non-qualified stock options. The Company, in accordance with New Brunswick law, is not permitted to hold its own stock, (i.e. treasury stock). As a result, all option and warrant exercises will result in the issuance of new common shares.

In the second quarter of 2006, the Company purchased 381,300 shares of its common shares on the open market in accordance with its stock repurchase plan and is shown as a reduction to common shares on the balance sheet. These were purchased at an aggregate cost of $3.8 million plus broker commissions at the then prevailing market prices. Subsequent to quarter end on July 28, 2006, all 381,300 common shares were cancelled.

Accumulated Other Comprehensive Loss

The following table provides the details of accumulated other comprehensive loss at:

	June 30, 2006			December 31, 2005
Unrealized gain on investments, net of tax of nil	$	—		$	9
Accumulated foreign currency translations		265			(4,275	)
Accrued minimum pension liability, net of tax of nil		(10,243	)		(9,750	)
Total accumulated other comprehensive loss	$	(9,978	)	$	(14,016	)

The components of comprehensive income (loss) are as follows:

	Three Months Ended						Six Months Ended
	June 30, 2006			July 1, 2005			June 30, 2006			July 1, 2005
Net income	$	6,184		$	3,125		$	11,287		$	3,235
Change in unrealized loss (gain) on investments, net of tax of nil		(2	)		(2	)		(9	)		—
Change in accrued minimum pension liability, net of tax of nil		(456	)		389			(493	)		411
Foreign currency translation adjustments		4,177			(4,180	)		4,540			(6,817	)
Comprehensive income (loss)	$	9,903		$	(668	)	$	15,325		$	(3,171	)

7

Net income per common share

Basic net income per common share was computed by dividing net income by the weighted-average number of common shares outstanding during the period. For diluted net income per common share, the denominator also includes dilutive outstanding stock options and warrants determined using the treasury stock method.

Common and common share equivalent disclosures are:

	Three Months Ended		Six Months Ended
	June 30, 2006	July 1, 2005	June 30, 2006	July 1, 2005
	(In thousands)		(In thousands)
Weighted average common shares outstanding	42,100	41,522	42,008	41,493
Dilutive potential common shares	204	206	392	262
Diluted common shares	42,304	41,728	42,400	41,755
Excluded from calculation - stock options and warrants that would have been anti-dilutive	1,603	2,984	761	2,589

At June 30, 2006, the Company had options and warrants outstanding entitling holders to acquire up to 2,831,861 and 43,104 common shares, respectively. At July 1, 2005, the Company had options and warrants outstanding entitling holders to acquire up to 3,404,362 and 51,186 common shares, respectively. At June 30, 2006 and July 1, 2005, the Company had both incentive stock options and non-qualified stock options outstanding.

Shareholders Rights Plan

At the May 26, 2005 Annual and Special Meeting of Shareholders, the shareholders of the Company approved a resolution to implement a Shareholder Rights Plan (the “Plan”) for a term of three years. This Plan was substantially similar to the Shareholder Rights Plan that was approved by the shareholders on May 9, 2002 and expired on April 12, 2005.

Under the Plan, one Right was issued in respect of each common share outstanding as of May 26, 2005 and one Right has been or will be issued in respect of each common share issued thereafter. Under the Plan, each Right, when exercisable, entitles the holder to purchase from the Company one common share at the exercise price of Cdn$200, subject to adjustment and certain anti-dilution provisions (the “Exercise Price”).

The Rights cannot be transferred separately from the common shares until the eighth business day (subject to extension by the Board of Directors) after the earlier of (a) the first date of public announcement that a person or group of affiliated or associated persons (excluding certain persons and groups) has acquired beneficial ownership of 20% or more of the outstanding common shares of the Company, or (b) the date of commencement of, or first public announcement of the intent of any person or group of affiliated or associated persons to commence, a take-over bid. At such time as any person or group of affiliated or associated persons becomes an “Acquiring Person”, meaning they hold 20% or more of the outstanding common shares of the Company (a “Flip-In Event”), each Right shall constitute the right to purchase from the Company that number of common shares having an aggregate market price on the date of the Flip-In Event equal to twice the Exercise Price, for the Exercise Price (such Right being subject to anti-dilution adjustments).

So long as the Rights are not transferable separately from the common shares, the Company will issue one Right with each new common share issued.

6. Stock Based Compensation

Stock Based Compensation

On January 1, 2006, the Company adopted FAS123R on a modified prospective basis. Prior to this, the Company used the intrinsic value method as proscribed in APB 25. On December 16, 2005, prior to the adoption of FAS 123R, the Company accelerated all outstanding unvested stock options. The decision to accelerate the vesting of these options was made primarily to reduce future compensation expense under SFAS 123R. As a result of the acceleration, options to purchase 558,446 of GSI Group Inc.’s common shares, which would otherwise have vested over the four following years, became fully vested. No options were issued during the

8

three and six months ended June 30, 2006. As discussed below in 2006 Equity Incentive Plan, 213,000 restricted stock awards were granted during the quarter ended June 30, 2006.

Pro Forma Stock Based Compensation

Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value method as proscribed under APB 25. Had compensation cost for the Company’s stock option plans been determined consistent with SFAS No. 123 prior to 2006, the Company’s net income and net income per share would have been decreased to the pro forma amounts below.

	Three months ended July 1, 2005			Six months ended July 1, 2005
Net income:
As reported	$	3,125		$	3,235
Stock based compensation included in results of operations, net of related tax effects		(28	)		(90	)
Stock based compensation if fair value based method was applied, net of related tax effects		(491	)		(1,143	)
Pro forma income (loss)	$	2,606		$	2,002
Basic net income (loss) per share:
As reported	$	0.08		$	0.08
Pro forma	$	0.06		$	0.05
Diluted income (loss) per share:
As reported	$	0.07		$	0.08
Pro forma	$	0.06		$	0.05

The fair value of options was estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions:

	July 1, 2005
Risk-free interest rate		3.88	%
Expected dividend yield		—
Expected life from date of grant		5.0 years
Expected volatility		60	%
Weighted average fair value per share	$	5.28

2006 Equity Incentive Plan

On May 15, 2006, shareholders of the Company approved the adoption of the 2006 Equity Incentive Plan, replacing the 1995 Equity Incentive Plan. The 2006 Equity Incentive Plan corrects structural deficiencies in the Second Restatement of the 1995 Equity Incentive Plan. The 2006 Equity Incentive Plan generally provides for the sale or grant of various awards of, or the value of, the Company’s common shares including stock options, restricted stock, stock appreciation rights, restricted stock and performance shares and units, performance-based awards, and stock grants, to officers, directors, employees and certain consultants to the Company and its affiliates. The 2006 Equity Incentive Plan and a detailed summary description of its terms was included in the Company’s 2006 Proxy Statement.

The maximum number of the Company’s common shares which may be issued pursuant to the 2006 Equity Incentive Plan is 6,906,000 common shares, subject to adjustment in the event of certain corporate events and reduced by the number of common shares already issued pursuant to awards under the Company’s 1992 and 1995 Equity Incentive Plans. As of June 30, 2006, there remain 1,806,446 common shares available to issue to eligible participants going forward pursuant to the 2006 Equity Incentive Plan. That number is subject to increase by the number of outstanding options that expire without exercise. The Company reserves the right to seek approval to issue additional common shares to fund equity incentive awards in the event that it determines a future need. The Compensation Committee will administer the 2006 Equity Incentive Plan, determine the terms of all awards and otherwise decide all questions arising under the 2006 Equity Incentive Plan. Under the 2006 Equity Incentive Plan, outstanding options, stock appreciation rights, and restricted stock and restricted stock units not based on performance goals will continue to vest after a change of control, and will accelerate in full upon any termination of the participant’s employment within one year following the change of control. Restricted stock and restricted stock units based on performance goals will be deemed to have been satisfied upon a change of control pro rata from the date of grant to the change of control event. The 2006 Equity Incentive Plan has a ten-year term.

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On May 18, 2006, the Compensation Committee approved 213,000 restricted stock awards. Of the restricted stock awards approved, 63,900 were granted and are time-based shares which vest annually over 3 years on May 18, 2006, March 10, 2007 and March 10, 2008. 149,100 of the approved restricted stock awards are performance-based shares which will be granted at the end of the program year based on achievement criteria. Failure to meet the performance criteria will result in a portion or all of the shares being forfeited and cancelled. 49,700 of those performance-based shares will vest immediately on the grant date and of the remaining 99,400 shares half will vest on March 10, 2008 and the remainder will vest on March 10, 2009. The Company recognizes expense on the restricted stock awards over the requisite service period, which is generally from the approval of the awards through the end of the vesting period. The Company recognizes expense on the performance-based shares using an estimate of the shares expected to be earned, based on the probability of meeting the performance criteria, multiplied by the trading price of the shares on the reporting date. The Company has applied an estimated forfeiture rate of zero to these awards. The Company reevaluates the estimated forfeiture rate periodically and adjusts for actual experience as necessary. Until granted, no expense will be recognized on the performance-based shares.

On June 3, 2006, GSI granted 194,717 time-based shares of restricted stock to the incoming CEO, pursuant to his employment agreement. At the same time, also pursuant to the employment agreement, GSI authorized the issuance of 254,341 performance-based shares of restricted stock for the incoming CEO. The performance criteria will be determined within the first 100 days of his employment. The performance-based shares will be granted once the Company and CEO have obtained a mutual understanding of the terms of the awards. The Company will begin expensing these shares over the vesting period when the CEO’s employment commences.

The Company recorded compensation expense related to its restricted stock awards totaling $61 thousand during the three and six months ended June 30, 2006. No compensation expense was recorded for restricted stock awards during the three and six months ended July 1, 2005. Total income tax benefit recognized in the income statement for stock based compensation arrangements was nil for the three and six months ended June 30, 2006. The cost of the performance-based shares will be revalued quarterly.

Nonvested Restricted Shares	Shares	Weighted- Average Grant Date Fair Value
Nonvested shares at December 31, 2005	0		—
Granted (except for CEO awards above)	63,900	$	9.78
Vested	0		—
Forfeited	0		—
Nonvested shares at June 30, 2006	63,900	$	9.78

As of June 30, 2006, there was $0.6 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average remaining period of 2.75 years. No shares vested during the six months ended June 30, 2006.

2005 Incentive Awards

On October 25, 2005, the Company established a 2005 Incentive Award program (the “Program”) with a four-year term with awards triggered by achieving defined annual operating income goals. If the Company meets the goals, the Company will make cash payments to participants based on the trading price of Company common stock as of the date that the Board approves the audited financial statements for the applicable year times the number of imputed shares awarded to each participant as of October 25, 2005. No awards were earned for 2005 based on audited operating profit. On May 15, 2006, the shareholders approved the adoption of the 2006 Equity Incentive Plan, and on July 24, 2006 the Compensation Committee of the Board of Directors replaced the cash payment feature for reaching the profit target in 2006, 2007, and 2008, with restricted stock. The terms of the Program otherwise did not change. As the Compensation Committee did not modify the profit targets it is currently not probable that any awards will be earned in 2006, 2007 or 2008. As a result, no compensation expense has been accrued in the financial statements. The Company will continue to monitor the circumstances and make appropriate updates to the accounting as required.

7. Related Party Transactions

Richard B. Black, a director of the Company, is also the President and Chief Executive Officer of ECRM, Inc. ECRM, Inc. purchased $0.1 million in equipment from the Westwind business unit of GSI Group Corporation in the three months ended July 1, 2005 at amounts and terms equivalent to third-party transactions. There were no purchases made in the period ended June 30, 2006. In the six months ended June 30, 2006 and July 1, 2005, sales revenue from ECRM, Inc. of $95 thousand and $0.2 million, respectively were recorded. Receivables from ECRM, Inc. of $103 thousand and $51 thousand as at June 30, 2006 and December 31, 2005, respectively, are included in accounts receivable on the balance sheet.

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The Company recorded sales revenue from Sumitomo Heavy Industries Ltd., a significant shareholder of the Company, of $1.6 million in the three months ended June 30, 2006 and $1.7 million in the three months ended July 1, 2005 at amounts and terms approximately equivalent to third-party transactions. In the six months ended June 30, 2006 and July 1, 2005, these revenues were $2.6 million and $3.2 million, respectively. Receivables from Sumitomo Heavy Industries Ltd. of $1.4 million and $0.4 million as at June 30, 2006 and December 31, 2005, respectively, are included in accounts receivable on the balance sheet. The Company purchases raw materials from Sumitomo at amounts and terms approximately equivalent to third-party transactions. The Company purchased $0.1 million from Sumitomo in both the three months ended June 30, 2006 and July 1, 2005. In both the six months ended June 30, 2006 and July 1, 2005, these purchases were $0.1 million. Payables due to Sumitomo Heavy Industries Ltd. of $18 thousand and $9 thousand at June 30, 2006 and December 31, 2005 are included in accounts payable on the balance sheet.

The Company has an agreement with V2Air LLC relating to the use of V2Air LLC’s aircraft for Company purposes. The Company’s former President and Chief Executive Officer, Charles D. Winston owns V2Air LLC. Pursuant to the terms of the agreement, the Company is required to reimburse V2Air LLC for certain expenses associated with the use of the aircraft for Company business travel. During the three months ended June 30, 2006 and July 1, 2005, the Company reimbursed V2Air LLC $56 thousand and $22 thousand, respectively, under the terms of the agreement. During the six months ended June 30, 2006, the Company reimbursed V2Air LLC $111 thousand under the terms of the agreement compared to $35 thousand for the six months ended July 1, 2005.

8. Financial Instruments

Cash Equivalents, Short-term and Long-term Investments

At June 30, 2006, the Company had $95.8 million invested in cash equivalents. At December 31, 2005, the Company had $43.7 million invested in cash equivalents. At both June 30, 2006 and December 31, 2005, cost approximates fair value.

At June 30, 2006, the Company had no short-term investments. At December 31, 2005, the Company had $26.8 million in short-term investments with maturity dates between January 3, 2006 and February 16, 2006. These are recorded at fair value based upon market quotes. At December 31, 2005, the unrealized gain (loss) on the short-term and long-term investments was not material. As discussed in Note 4 to the financial statements at December 31, 2005, $5.0 million of short-term investments was pledged as collateral for the Bank of America pledge agreement which is no longer outstanding at June 30, 2006. Long-term investments at June 30, 2006 and December 31, 2005 represents a 20% equity investment in a private United Kingdom company, Laser Quantum, valued at GBP 0.4 million (approximately $0.6 million at both June 30, 2006 and December 31, 2005). This is recorded at cost. The Company does not have the ability to exercise significant control over this investment. It is not practicable to determine the fair value of this investment and there has been no indication of impairment.

Derivative Financial Instruments

The Company uses derivatives to manage exposures to changes in foreign currency exchange rates associated with forecasted sales transactions. Currency forwards and swaps are used to fix the cash flow variable of local currency costs or selling prices denominated in currencies other than the functional currency. For hedged forecasted transactions, hedge accounting is discontinued if the forecasted transaction is no longer intended or expected to occur and any previously unrealized hedging gains or losses recorded in other comprehensive income are immediately recorded to earnings. Earnings impacts for all designated hedges are recorded in the consolidated statement of operations generally on the same line item as the gain or loss on the item being hedged. The Company records all derivatives at fair value as assets or liabilities in the consolidated balance sheet, with classification as current or long-term depending on the duration of the instrument. Although the Company marks-to-market short-term hedge contracts to the statement of operations, the Company does not intend to enter into hedging contracts for speculative purposes.

9. Restructuring and Other

Restructuring Charges

Several significant markets for our products had been in severe decline from 2000 through early 2003. In response to the business environment, the Company restructured operations in an effort to bring costs in line with our expectations for sales of systems for the semiconductor and telecommunications markets. Our emphasis was predominantly on consolidating operations at various locations and reducing overhead. The Company incurred restructuring charges in each of the years from 2000 to 2003 as it continued to reduce and consolidate operations around the world. Each year, the Company evaluates accruals that it has made as part of prior restructuring actions. In 2004 and 2005, it was determined that additional charges of $0.6 million and $0.5 million, respectively, were needed for the excess space in the Munich facility due to continued softness in the Munich commercial market. At June 30, 2006, the Company reviewed its Munich facility excess space accrual and an additional $59 thousand restructuring charge was recorded.

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The following table summarizes changes in the restructuring reserve included in other accrued expenses on the balance sheet.

	Total
	(In millions)
Reserve at December 31, 2005	$	1.4
Charges during the three months ended March 31, 2006		—
Cash payments during the three months ended March 31, 2006		(0.1	)
Reserve at March 31, 2006		1.3
Charges during the three months ended June 30, 2006		0.1
Cash payments during the three months ended June 30, 2006		—
Reserve at June 30, 2006	$	1.4

Other

On June 30, 2006, the Company sold a small parcel of land in Nepean, Ontario, Canada for Cdn $380 thousand (approximately US$338 thousand) and recorded a gain of $0.2 million on the transaction.

10. Commitments and Contingencies

Operating leases

The Company leases certain equipment and facilities under operating lease agreements. Most of these lease agreements expire between 2006 and 2013. In the United Kingdom where longer leases are more common, the Company has land leases that extend through 2078. The facility leases require the Company to pay real estate taxes and other operating costs. The rent on certain leases is subject to escalation clauses in future years.

Legal Proceedings and Disputes

The Company’s French subsidiary is subject to a claim by a customer that a Laserdyne 890 system, which was delivered in 1999, had unresolved technical problems that resulted in the customer’s loss of revenue and profit, plus the costs to repair the machine. In May 2001, the Le Creusot commercial court determined that the Company had breached its obligations to the customer and that it should be liable for damages. An expert appointed by the Le Creusot commercial court had filed an initial report, which estimated the cost to repair the machine at approximately French Franc 0.8 million (or approximately US$0.2 million). In the third quarter of 2003, the Company was notified that the customer is seeking cost of repairs, damages and lost profits of Euro 1.9 million (approximately US$2.6 million). In July 2004, a court appointed expert estimated the actual damages at Euro 0.9 million (or approximately $1.2 million). The customer has not paid Euro 0.3 million (or approximately $0.4 million) of the purchase price for the system, which the Company believes it may offset against any damages. The Company has fully reserved this receivable.

During the second quarter of 2005, the Company’s French subsidiary filed for bankruptcy protection, which was granted by the French courts on July 7, 2005. On January 25, 2006, the commercial court of Le Creusot held a hearing on the amount the customer could properly claim under French bankruptcy law. The customer proposed Euro 1,572,531 (approximately US$1.87 million), and the Company argued that the amount should be Euro 598,079 (approximately US$712,203).

On April 18, 2006, the commercial court in Le Creusot rendered its final decision and ruled that the customer’s claim was Euro 598,079 (approximately US$712,203), plus court costs and expert fees for a total claim of Euro 684,024 (approximately US$862,358). As a result of the bankruptcy petition, any claim in excess of available assets in the bankruptcy estate would have to be brought against the French subsidiary’s parent in its home jurisdiction, which is the United Kingdom. At this time, the Company does not believe it will be required to make a payment regarding this action as the costs to pursue a foreign action in the United Kingdom would be substantial relative to the amount in dispute. Accordingly, nothing has been accrued in the financial statements.

The Company has made claims for indemnification and breaches of warranty under the asset purchase agreement against Lumenis Ltd. and Spectron Cosmetics Ltd. (formerly known as Spectron Laser Systems Limited) (collectively “Spectron”). The Company filed its claim in the English courts on July 29, 2005 as a result of defects in the line of laser products purchased under the asset agreement, and related claims. The Company has also put Spectron on notice of the Company’s intent to file a second action against Spectron for fraud in connection with representations made to the Company by Spectron pre-sale concerning the viability of Spectron’s DPSS product line. As part of the asset purchase agreement, US$1.3 million was deposited into escrow, which amount remains in the hands

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of the escrow agent. The Company filed a claim for the entire escrow balance, as well as additional amounts in excess of the escrow account. The Company has recorded in other current assets a receivable of £0.4 million (approximately US$0.7 million) for certain indemnification claims, and for a purchase price adjustment as part of the Company’s initial purchase accounting. One customer, Hapa, thereafter raised a warranty claim associated with lasers sold by Spectron prior to the acquisition. Hapa has made the same demand to Spectron, and the Company has sent a formal demand to Spectron for indemnification from the Hapa claim. To date, no Spectron customer claims are the subject of any legal proceeding against the Company.

It is not possible to determine the amount of recovery, if any, which the Company may ultimately receive from the Spectron litigation, but the Company anticipates that at least the amount recorded as a receivable will be recovered. Additionally, it is not possible to determine any amounts that we may have to pay to satisfy Spectron customer warranty claims, although it is expected that any such amounts would be included in any future settlement with, or award from Spectron.

The Company is also subject to various legal proceedings and claims that arise in the ordinary course of business. The Company does not believe that the outcome of these claims will have a material adverse effect upon the Company’s financial conditions or results of operations but there can be no assurance that any such claims, or any similar claims, would not have a material adverse effect upon the Company’s financial condition or results of operations.

Guarantees

In the normal course of our operations, we execute agreements that provide for indemnification and guarantees to counterparties in transactions such as business dispositions, the sale of assets, sale of products and operating leases. Additionally, the by-laws of the Company require it to indemnify certain current or former directors, officers, and employees of the Company against expenses incurred by them in connection with each proceeding in which he or she is involved as a result of serving or having served in certain capacities. Indemnification is not available with respect to a proceeding as to which it has been adjudicated that the person did not act in good faith in the reasonable belief that the action was in the best interests of the Company. These indemnities and guarantees are routine and customary in the industry.

These indemnification undertakings and guarantees may require us to compensate the counterparties for costs and losses incurred as a result of various events including breaches of representations and warranties, intellectual property right infringement, loss of or damages to property, environmental liabilities, changes in the interpretation of laws and regulations (including tax legislation) or as a result of litigation that may be suffered by the counterparties. Also, in the context of the sale of all or a part of a business, this includes the resolution of contingent liabilities of the disposed businesses or the reassessment of prior tax filings of the corporations carrying on the business.

Certain indemnification undertakings can extend for an unlimited period and generally do not provide for any limit on the maximum potential amount. The nature of substantially all of the indemnification undertakings prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay counterparties as some agreements do not specify a maximum amount, although our standard terms and conditions limits exposure to the sales price of our products. Additionally, the amounts are dependent upon the outcome of future contingent events, the nature and likelihood of which cannot be determined at this time.

Historically, we have not made any significant payments under such indemnifications. At June 30, 2006 and December 31, 2005, nothing has been accrued in the consolidated balance sheet with respect to these indemnification undertakings.

Risks and uncertainties

The Company uses financial instruments that potentially subject it to concentrations of credit risk. Such instruments include cash equivalents, securities available-for-sale, trade receivables and financial instruments used in hedging activities. The Company does not believe it is exposed to any significant credit risk on these instruments.

Due to the short term nature of the Company’s investments, the Company does not believe it is exposed to any significant interest rate risk.

Certain of the components and materials included in the Company’s laser systems and optical products are currently obtained from single source suppliers. There can be no assurance that a disruption of this outside supply would not create substantial manufacturing delays and additional cost to the Company.

There is no concentration of credit risk related to the Company’s position in trade accounts receivable. Credit risk, with respect to trade receivables, is minimized because of the diversification of the Company’s operations, as well as its large customer base and its geographical dispersion.

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The Company’s operations involve a number of other risks and uncertainties including, but not limited to, the cyclicality of the semiconductor and electronics markets, the effects of general economic conditions, rapidly changing technology, and international operations.

11. Income Taxes

At the end of each interim reporting period, the Company determines its estimated annual effective tax rate, which is revised, as required, at the end of each successive interim period based on facts known at that time. The estimated annual effective tax rate is applied to the year-to-date pre-tax income at the end of each interim period. The tax effect of significant unusual items is reflected in the period in which they occur. The Company’s reported effective tax rate of 30% for the six months ended June 30, 2006, differed from the expected Canadian federal statutory rate, primarily due to the partial release of valuation allowances in certain jurisdictions and discrete items that occurred in the six months ending June 30, 2006.

As part of the process of preparing the consolidated financial statements, the Company is required to estimate its income tax provision (benefit) in each of the jurisdictions in which it operates. This process involves estimating the current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the Company’s consolidated balance sheets.

The Company records a valuation allowance to reduce its deferred tax assets for the amount that is not more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of the net recorded amount, an adjustment to the allowance for the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the allowance for the deferred tax asset would be charged to income in the period such determination was made.

Income taxes have not been provided for unremitted earnings of foreign subsidiaries because such earnings are intended to be permanently reinvested by the Company.

12. Defined Benefit Pension Plan

The Company’s subsidiary in the United Kingdom maintains a pension plan, known as the GSI Lumonics Ltd. United Kingdom Pension Scheme Retirement Savings Plan. The plan has two components: the Final Salary Plan, which is a defined benefit plan, and the Retirement Savings Plan, which is a defined contribution plan. Effective April 1997, membership to the Final Salary Plan was closed. Benefits under this plan were based on the employees’ years of service and compensation. In December 2002, the Company notified plan participants that it no longer wanted to sponsor the Final Salary Plan. After a consultation period, the curtailment of the plan was effective June 1, 2003, after which no additional benefits accrue to the participants.

The Company continues to follow its policy to fund pensions and other benefits based on widely used actuarial methods as permitted by regulatory authorities. The funded amounts reflect actuarial assumptions regarding compensation, interest and other projections. The assets of this plan consist primarily of equity and fixed income securities of U.K. and foreign issuers.

Pension and other benefit costs reflected in the consolidated statements of operations are based on the projected benefit method of valuation. Within the consolidated balance sheet, pension plan benefit liabilities are included in accrued compensation and benefits.

The table below sets forth the estimated net periodic cost of the Final Salary Plan of GSI Lumonics Ltd. United Kingdom Pension Scheme Retirement Savings Plan.

	Three Months Ended						Six Months Ended
	June 30, 2006			July 1, 2005			June 30, 2006			July 1, 2005
Components of the net periodic pension cost:
Interest cost	$	352		$	414		$	703		$	828
Expected return on plan assets		(263	)		(265	)		(526	)		(529	)
Amortization of unrecognized gain (loss)		106			98			212			197
Net periodic pension cost	$	195		$	247		$	389		$	496

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The Company’s subsidiary in Japan maintains a tax qualified pension plan. The plan, a quasi-defined benefit pension plan, covers substantially all regular employees, under which the company deposits funds under various fiduciary-type arrangements and/or purchases annuities under group contracts. Benefits are based on years of service and the employee’s compensation at retirement. For employees with less than twenty years of service to the Company, the benefit is paid out in a lump sum based on years of service and the employee’s compensation at retirement. For employees with twenty or more years of service to the Company, the benefit is guaranteed for a certain number of years and is based on years of service and the employee’s compensation at retirement. Participants may under certain circumstances, receive a benefit upon termination of employment.

The assumptions that are used to value the costs and obligations of the plan reflect the Japanese economic environment. The Company continues to fund the plan sufficiently to meet current benefits as well as to fund a certain portion of future benefits as permitted in accordance with regulatory authorities.

The table below sets forth the estimated net periodic cost of the tax qualified pension plan.

	Three Months Ended						Six Months Ended
	June 30, 2006			July 1, 2005			June 30, 2006			July 1, 2005
Components of the net periodic pension cost:
Service cost	$	47		$	51		$	95		$	104
Interest cost		7			8			14			15
Expected return on plan assets		(1	)		(1	)		(2	)		(2	)
Amortization of unrecognized gain (loss)		16			17			32			35
Net periodic pension cost	$	69		$	75		$	139		$	152

13. Segment Information

General Description

There have been no significant changes to the Company’s reportable operating segments since December 31, 2005. The Company’s operating segments are the same as those described in the Annual Report on Form 10-K. The Laser Systems Group has been renamed the Semiconductor Systems Group. This name change more accurately reflects its business and markets served. The name change had no change on the operations or the results of the segment.

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Segments

Information on reportable segments is as follows:

	Three Months Ended						Six Months Ended
	June 30, 2006			July 1, 2005			June 30, 2006			July 1, 2005
Sales:
Precision Motion Group	$	41,171		$	34,151		$	79,743		$	68,136
Laser Group		9,268			11,426			17,674			21,686
Semiconductor Systems Group		29,012			23,711			60,341			45,714
Intersegment sales elimination		(3,050	)		(2,438	)		(5,234	)		(3,845	)
Total	$	76,401		$	66,850		$	152,524		$	131,691
Segment income from operations:
Precision Motion Group	$	7,256		$	4,872		$	13,007		$	8,169
Laser Group		210			803			24			92
Semiconductor Systems Group		4,756			3,146			10,492			4,769
Total by segment		12,222			8,821			23,523			13,030
Unallocated amounts:
Corporate expenses		4,496			4,227			8,313			9,053
Amortization of purchased intangibles not allocated to a segment		—			26			26			53
Restructuring and other		(129	)		4			(135	)		201
Income from operations	$	7,855		$	4,564		$	15,319		$	3,723
Amortization of purchased intangibles by segment included in the above segment income from operations:
Precision Motion Group	$	1,408		$	1,515		$	3,109		$	3,133
Laser Group	$	105		$	106		$	205		$	215

The Company’s chief operating decision maker does not review asset information on a segmented basis and the Company does not maintain assets on a segmented basis, therefore a breakdown of assets by segments is not included.

Geographic Segment Information

The Company attributes revenues to geographic areas on the basis of the bill-to customer location. Not infrequently, equipment is sold to large international companies, which may be headquartered in Asia-Pacific for example, but the sales of our systems are billed and shipped to locations in the United States. In this example, these sales are reflected in North America totals in the table below. Long-lived assets, which include property, plant and equipment, intangibles and goodwill, but exclude other assets, long-term investments and deferred tax assets, are attributed to geographic areas in which the Company assets reside.

	Three months ended
	June 30, 2006				July 1, 2005
	Sales		% of Total		Sales		% of Total
	(In millions)				(In millions)
Revenues from external customers:
North America	$	22.1	29	%	$	28.9	43	%
Latin and South America		0.5	1			0.4	1
Europe (EMEA)		14.3	18			11.2	17
Japan		8.8	12			9.0	13
Asia-Pacific, other		30.7	40			17.4	26
Total	$	76.4	100	%	$	66.9	100	%

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	Six months ended
	June 30, 2006				July 1, 2005
	Sales		% of Total		Sales		% of Total
	(In millions)				(In millions)
Revenues from external customers:
North America	$	43.2	28	%	$	53.9		41	%
Latin and South America		0.8	1			0.8		1
Europe (EMEA)		26.3	17			22.3		17
Japan		19.5	13			22.7		17
Asia-Pacific, other		62.7	41			32.0		24
Total	$	152.5	100	%	$	131.7		100	%
					June 30, 2006		December 31, 2005
Long-lived assets and goodwill:
USA					$	65,613	$	67,055
Europe						33,687		33,434
Japan						1,029		946
Asia-Pacific, other						2,383		2,203
Total					$	102,712	$	103,638

14. Subsequent Event

As detailed in footnote 6 above, on July 24, 2006, the Compensation Committee of the Board of Directors issued a total of 355,000 restricted shares to the Company’s Executives and General Managers in connection with a modification of the 2005 Incentive Award Program. The amount of shares issued to each individual and the profit targets are detailed in the Company’s 8-K filed on July 28, 2006. In connection with a severance agreement entered into between the Company and Charles D. Winston, Mr. Winston’s 100,000 share award opportunity under the Program was cancelled.

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

(In United States dollars, and in accordance with U.S. GAAP)

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Consolidated Financial Statements and Notes included in Item 1 of this Report. MD&A contains certain forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, Section 27A of the United States Securities Act of 1933, as amended, and Section 21E of the United States Securities Exchange Act of 1934, as amended. These forward-looking statements relate to anticipated financial performance; drivers of revenue growth; management’s plans and objectives for future operations and expenditures; business prospects; industry trends; market conditions; changes in accounting principles and changes in actual or assumed tax liabilities; our expectations regarding tax exposure; our anticipated capital requirements and working capital needs; our anticipated reinvestment of future earnings; our anticipated expenditures in regard to our benefit plans; and our anticipated use of currency hedges. These forward-looking statements are neither promises nor guarantees, but involve risks and uncertainties that may cause actual results to differ materially from those in the forward-looking statements. Factors that may cause such differences include, but are not limited to, our ability to maintain or accurately forecast revenue growth or to anticipate and accurately forecast a decline in revenue from any of our products or services; our ability to compete in an intensely competitive market; our ability to develop and introduce new products or enhancements on schedule and that respond to customer requirements and rapid technological change; new product introductions and enhancements by competitors; our ability to select and implement appropriate business models; plans and strategies and to execute on them; our ability to identify, hire, train, motivate, and retain highly qualified management/other key personnel and our ability to manage changes and transitions in management/other key personnel, including the transition to a new Chief Executive Officer, the impact of global economic conditions on our business; unauthorized use or misappropriation of our intellectual property; as well as the risk factors discussed previously and in other periodic reports filed with the SEC. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date they are made. We disclaim any obligation to publicly update or revise any such statement to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those contained in the forward-looking statements.

17

Overview

The Company develops and delivers the enabling technology to customers’ advanced manufacturing and product applications. Our leading brands include precision motion products, semiconductor systems and lasers, and are used to boost efficiency and productivity in the global semiconductor, electronics, industrial and medical markets.

Our Precision Motion Group contains diversified product lines ranging from ultra high speed drills to highly precise measuring devices. Applications include formatting hard drives and drilling holes in printed circuit boards.

Our Laser products produces high quality repeatable cuts, welds, holes and specialist marks on customer’s products. These include hermetically sealing (by laser) heart defibrillators and rechargeable batteries.

Our Semiconductor Systems Group supplies leading edge equipment to the semiconductor industry. These include systems to scribe and test silicon wafers and repair semiconductor memory wafers.

Highlights for the Three Months Ended June 30, 2006

• Sales for the quarter increased to $76.4 million from $66.9 million in the second quarter of 2005.

• Net income for the quarter was $6.2 million, or $0.15 per diluted share, compared to a net income of $3.1 million, or $0.07 per diluted share, in the second quarter of 2005.

• Bookings of orders were $99.1 million in the second quarter of 2006 compared to $69.6 million in the second quarter of 2005. Ending backlog was $92.7 million as compared with $61.6 million at the end of the second quarter of last year.

• Cash and cash equivalents were $115.3 million at June 30, 2006.

Results of Operations Three Months Ended June 30, 2006 Compared to Three Months Ended July 1, 2005

The following table sets forth items in the unaudited consolidated quarterly statement of operations as a percentage of sales for the periods indicated:

	Three Months Ended
	June 30, 2006		July 1, 2005
Sales	100.0	%	100.0	%
Cost of goods sold	57.6		58.6
Gross profit	42.4		41.4
Operating expenses:
Research and development and engineering	9.7		9.5
Selling, general and administrative	20.7		22.6
Amortization of purchased intangibles	2.0		2.5
Restructuring and other	(0.2	)	—
Total operating expenses	32.2		34.6
Income from operations	10.2		6.8
Other income	—		—
Interest income	2.5		0.6
Interest expense	(1.7	)	(0.1	)
Foreign exchange transaction gains	0.2		0.5
Income before income taxes	11.2		7.8
Income tax provision	3.1		3.1
Net income	8.1	%	4.7	%

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Sales by Segment. The following table sets forth sales in thousands of dollars by our business segments for the second quarter of 2006 and 2005.

	Three Months Ended
	June 30, 2006			July 1, 2005			Increase (Decrease)
Sales:
Precision Motion Group	$	41,171		$	34,151		$	7,020
Laser Group		9,268			11,426			(2,158	)
Semiconductor Systems Group		29,012			23,711			5,301
Intersegment sales elimination		(3,050	)		(2,438	)		(612	)
Total	$	76,401		$	66,850		$	9,551

Sales. Sales for the three months ended June 30, 2006 increased by $9.5 million or 14.3%, compared to the quarter ended July 1, 2005.

Sales in the Precision Motion Group segment increased by $7.0 million, or 20.6%, from $34.2 million for the second quarter of 2005 to $41.2 million in the same period in 2006. The increase is attributed to growth in nearly all of our OEM product lines as compared to the same period last year.

Sales in the Laser Group segment decreased in the second quarter of 2006 to $9.3 million from $11.4 million in the second quarter of 2005, an 18.9% decrease. This decrease was primarily due to softness in served markets.

In the second quarter of 2006, sales in the Semiconductor Systems Group segment increased by $5.3 million, or 22.4% over sales in the same period in 2005 as a result of stronger semiconductor markets and increased market share.

Sales in our Corporate segment represent elimination of sales between our segments and are shown in the table above as intersegment sales elimination.

Sales by Region. We distribute our systems and services via our global sales and service network and through third-party distributors and agents. Our sales territories are divided into the following regions: North America consisting of the United States and Canada; Latin and South America; Europe, consisting of Europe, the Middle East and Africa; Japan; and Asia-Pacific, consisting of ASEAN countries, the People’s Republic of China (“PRC”) and other Asia-Pacific countries. Sales are attributed to these geographic areas on the basis of the bill-to customer location. Not infrequently, equipment is sold to large international companies, which may be headquartered in Asia-Pacific for example, but the sales of our systems are billed and shipped to locations in the United States, although the equipment may eventually be installed in Asia-Pacific, for instance. In this example, these sales are therefore reflected in North America totals in the table below. The following table shows sales in millions of dollars to each geographic region for the second quarter of 2006 and 2005, respectively.

	Three Months Ended
	June 30, 2006				July 1, 2005
	Sales		% of Total		Sales		% of Total
	(In millions)				(In millions)
North America	$	22.1	29	%	$	28.9	43	%
Latin and South America		0.5	1			0.4	1
Europe (EMEA)		14.3	18			11.2	17
Japan		8.8	12			9.0	13
Asia-Pacific, other		30.7	40			17.4	26
Total	$	76.4	100	%	$	66.9	100	%

Asia-Pacific continues to be an area of growth for all of the Company’s segments.

Backlog. We define backlog as unconditional purchase orders or other contractual agreements for products for which customers have requested delivery within the next twelve months. Order backlog as of June 30, 2006 was $92.7 million compared to $61.6 million as of July 1, 2005.

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Gross Profit by Segment. The following table sets forth gross profit in thousands of dollars by our business segments for the second quarter of 2006 and 2005.

	Three Months Ended
	June 30, 2006			July 1, 2005
Gross profit:
Precision Motion Group	$	17,299		$	14,295
Laser Group		3,262			4,120
Semiconductor Systems Group		11,952			9,257
Intersegment sales elimination and other		(122	)		10
Total	$	32,391		$	27,682
Gross profit %:
Precision Motion Group		42.0	%		41.9	%
Laser Group		35.2			36.1
Semiconductor Systems Group		41.2			39.0
Intersegment sales elimination and other		(4.0	)		(0.4	)
Total		42.4	%		41.4	%

Gross profit was 42.4% in the three months ended June 30, 2006 compared to 41.4% in the three months ended July 1, 2005. The Company’s total gross profit is a result of the changes in gross profit at each segment level. Those changes are described below.

The gross profit for the Precision Motion Group remained constant at 42.0% for the three months ended June 30, 2006, compared to 41.9% in the same period last year.

The gross profit in our Laser Group was 35.2% in the second quarter of 2006 compared to 36.1% in the second quarter of 2005 largely due to changes in product mix.

The gross profit for Semiconductor Systems Group was 41.2% for the second quarter of 2006 compared to 39.0% in the same period last year. In the second quarter of 2006, the Semiconductor Systems group experienced improved product sales mix which favorably contributed to the gross margin improvement.

Research and Development Expenses. Research and development expenses for the three months ended June 30, 2006 were 9.7% of sales, or $7.4 million, compared to 9.5% of sales, or $6.4 million in the three months ended July 1, 2005. The Company has announced a number of new product development projects in the Precision Motion and Semiconductor Systems Groups.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $15.8 million in the three months ended June 30, 2006, compared with $15.1 million, in the three months ended July 1, 2005 mainly the result of increased personnel and related costs stemming from an increase in sales.

Amortization of Purchased Intangibles. Amortization of purchased intangibles was $1.5 million for the quarter ended June 1, 2006 primarily as a result of amortizing intangible assets from acquisitions. This compares to $1.6 million for the same period in 2005.

Restructuring and Other. For the three months ended June 30, 2006, the Company reported $0.1 million in other income from operations compared to $4 thousand in other operating expenses for the three months ended July 1, 2005. In the three months ended June 30, 2006, the Company recorded a $0.1 million charge on the Munich facility which is an update to previous restructuring charges. The charge represents the difference between estimated sublet income and the Company’s lease payments over the remainder of the lease. On June 30, 2006 the Company sold a small parcel of land in Nepean, Ontario, Canada and recorded a gain of $0.2 million on the transaction. This land was the last Canadian property that the Company owned. In the three months ended July 1, 2005, the Company recorded a loss of $4 thousand for the loss on the sale of another Nepean, Ontario facility. The sale was completed in the second quarter of 2005.

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Income from Operations. The following table sets forth income from operations in thousands of dollars by our business segments for the second quarter of 2006 and 2005.

	Three Months Ended
	June 30, 2006			July 1, 2005
Segment income from operations:
Precision Motion Group	$	7,256		$	4,872
Laser Group		210			803
Semiconductor Systems Group		4,756			3,146
Total by segment		12,222			8,821
Unallocated amounts:
Corporate expenses		4,496			4,227
Amortization of purchased intangibles not allocated to a segment		—			26
Restructuring and Other		(129	)		4
Income from operations	$	7,855		$	4,564

Interest Income. Interest income was $1.9 million in the second quarter of 2006 compared to $0.4 million in the second quarter of 2005. The $1.5 million increase is attributable to higher total cash and short term investment balances along with higher interest rate yields for the quarter ended June 30, 2006 compared to the quarter ended July 1, 2005.

Interest Expense. Interest expense was $1.3 million in the three months ended June 30, 2006 compared to $0.1 million, in the three months ended July 1, 2005. During 2006 and 2005, the Company had no bank debt. Interest expense is primarily from discounting receivables with recourse at a bank and for interest on deferred compensation. The Company recorded a one time charge of $0.5 million in the three months ended June 30, 2006 for interest associated with the settlement of value added tax payment to a foreign jurisdiction.

Foreign Exchange Transaction Gain (Loss). Foreign exchange transaction gains were approximately $0.1 million in the three months ended June 30, 2006 compared to a $0.3 million gain for the three months ended July 1, 2005. These amounts arise primarily from transactions denominated in currencies other than functional currency and unrealized gains (losses) on derivative contracts.

Income Taxes. The effective tax rate for three months ended June 30, 2006 was 27.6% compared with 40.1% for the same period in 2005. The tax rate for three months ended June 30, 2006 reflects the Company’s estimated annual effective tax rate and is driven by the jurisdictions where income is earned.

Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes” (“SFAS No. 109”) requires a valuation allowance be established when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. When making this determination, a review of all available positive and negative evidence needs to be considered, including a company’s performance, the market environment in which the company operates, length of carry-back and carry-forward periods, existing sales backlog, future taxable income projections and tax planning strategies. We have previously provided valuation allowances against losses in the parent company and subsidiaries with an inconsistent history of taxable income and loss due to the uncertainty of their realization. In addition, the Company has provided a valuation allowance on tax credits and net operating losses, due to the uncertainty of generating earned income to claim the tax credits or use the net operating losses.

In the event that actual results differ from our estimates of future taxable income, or we adjust these estimates in future periods, we may need to establish an additional valuation allowance, which could have a material impact on our financial position and results of operations.

Net Income. As a result of the foregoing factors, net income for the second quarter of 2006 was $6.2 million, compared to $3.1 million in the same period in 2005.

21

Results of Operations for the Six Months Ended June 30, 2006 Compared to the Six Months Ended July 1, 2005

The following table sets forth items in the unaudited consolidated year-to-date statement of operations as a percentage of sales for the periods indicated:

	Six Months Ended
	June 30, 2006		July 1, 2005
Sales	100.0	%	100.0	%
Cost of goods sold	58.1		61.6
Gross profit	41.9		38.4
Operating expenses:
Research and development and engineering	9.7		9.7
Selling, general and administrative	20.2		23.1
Amortization of purchased intangibles	2.2		2.6
Restructuring and other	(0.2	)	0.2
Total operating expenses	31.9		35.6
Income from operations	10.0		2.8
Other income (expense)	—		—
Interest income	1.9		0.6
Interest expense	(1.0	)	—
Foreign exchange transaction (losses) gains	(0.4	)	0.7
Income before income taxes	10.5		4.1
Income tax provision	3.1		1.6
Net income	7.4	%	2.5	%

Sales by Segment. The following table sets forth sales in thousands of dollars by our business segments for the six months ended June 30, 2006 and July 1, 2005.

	Six Months Ended
	June 30, 2006			July 1, 2005			Increase (Decrease)
Sales:
Precision Motion Group	$	79,743		$	68,136		$	11,607
Laser Group		17,674			21,686			(4,012	)
Semiconductor Systems Group		60,341			45,714			14,627
Intersegment sales elimination		(5,234	)		(3,845	)		(1,389	)
Total	$	152,524		$	131,691		$	20,833

Sales. Sales for the six months ended June 30, 2006 increased $20.8 million or 15.8% compared to the six months ended July 1, 2005.

Sales for our Precision Motion Group segment increase by $11.6 million, or 17.0%, for the first half of 2006 as compared to the same period in 2005. The increase is attributed to growth in nearly all of our product lines as compared to the same period last year.

Sales in our Laser Group segment in the six months ended June 1, 2006 decreased by $4.0 million, or 18.5%, over the same period last year largely the result of softer served markets.

In the first half of 2006, sales in our Semiconductor Systems Group segment increased by approximately $14.6 million, or 32%, as compared to the same period last year largely due to a recovery in served markets and increased market share.

Sales in our Corporate segment represent the elimination of sales between segments. There was a $1.4 million increase in sales between segments for the six months ended June 30, 2006 as compared to the same period last year.

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Sales by Region. We distribute our systems and services via our global sales and service network and through third-party distributors and agents. Our sales territories are divided into the following regions: North America consisting of the United States and Canada; Latin and South America; Europe, consisting of Europe, the Middle East and Africa; Japan; and Asia-Pacific, consisting of ASEAN countries, the PRC and other Asia-Pacific countries. Sales are attributed to these geographic areas on the basis of the bill-to customer location. Not infrequently, equipment is sold to large international companies, which may be headquartered in Asia-Pacific for example, but the sales of our systems are billed and shipped to locations in the United States, although the equipment may eventually be installed in Asia-Pacific, for instance. In this example, these sales are therefore reflected in North America totals in the table below. The following table shows sales in millions of dollars to each geographic region for the six months ended June 30, 2006 and July 1, 2005.

	Six Months Ended
	June 30, 2006				July 1, 2005
	Sales		% of Total		Sales		% of Total
	(In millions)
North America	$	43.2	28	%	$	53.9	41	%
Latin and South America		0.8	1			0.8	1
Europe (EMEA)		26.3	17			22.3	17
Japan		19.5	13			22.7	17
Asia-Pacific, other		62.7	41			32.0	24
Total	$	152.5	100	%	$	131.7	100	%

Asia-Pacific continues to be an area of focus for growth for all of the Company’s segments.

Gross Profit by Segment. The following table sets forth gross profit in thousands of dollars by our business segments for the six months ended June 30, 2006 and July 1, 2005.

	Six Months Ended
	June 30, 2006			July 1, 2005
Gross profit:
Precision Motion Group	$	32,994		$	26,843
Laser Group		6,050			6,722
Semiconductor Systems Group		24,922			17,043
Intersegment sales elimination and other		(25	)		22
Total	$	63,941		$	50,630
Gross profit %:
Precision Motion Group		41.4	%		39.4	%
Laser Group		34.2			31.0
Semiconductor Systems Group		41.3			37.3
Intersegment sales elimination and other		(0.5	)		(0.6	)
Total		41.9	%		38.4	%

Gross profit was 41.9% in the six months ended June 30, 2006 compared to 38.4% in the six months ended July 1, 2005. Gross profit percentage primarily increased due to increased sales volume, improved productivity and changes in mix of product sales. The Company’s total gross profit is a result of the changes in gross profit at a segment level. Those changes are described below.

The gross profit for the Precision Motion Group was 41.4% for the first six months of 2006 versus 39.4% in the same period last year primarily due to a favorable mix of products.

For our Laser Group the gross profit percentage was 34.2% in the first half of 2006 compared to 31.0% in the first half of 2005 largely due to changes in product mix.

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The gross profit for Semiconductor Systems Group is 41.3% for the six months ended June 30, 2006 compared to 37.3% for the first half of 2005 primarily the result of product mix and sales volume.

Research and Development Expenses. Research and development expenses for the six months ended June 30, 2006 were 9.7% of sales, or $14.8 million, compared with 9.7% of sales, or $12.8 million, for the six months ended July 1, 2005. Research and development expenses generally approximate 10% of sales.

Selling, General and Administrative Expenses. Selling, general and administrative expenses remained consistent at $30.6 million in the six months ended June 30, 2006, compared with $30.5 million in the six months ended July 1, 2005.

Amortization of Purchased Intangibles. Amortization of purchased intangibles was consistent at $3.4 million for the six months ended June 30, 2006 and 2005.

Restructuring and Other. In the six months ended June 30, 2006, the Company recorded a $0.1 million charge on the Munich facility. On June 30, 2006 the Company sold a small parcel of land in Nepean, Ontario and recorded a gain of $0.2 million on the transaction. This land was the last Canadian property that the Company owned. In the six months ended July 1, 2005, the Company recorded a write-down of $0.2 million for the loss on the sale of another Nepean, Ontario facility. The sale was completed in the second quarter of 2005.

Income from Operations. The following table sets forth income from operations in millions of dollars by our business segments for the six months ended June 30, 2006 and July 1, 2005.

	Six Months Ended
	June 30, 2006			July 1, 2005
Segment income from operations:
Precision Motion Group	$	13,007		$	8,169
Laser Group		24			92
Semiconductor Systems Group		10,492			4,769
Total by segment		23,523			13,030
Unallocated amounts:
Corporate expenses		8,313			9,053
Amortization of purchased intangibles not allocated to a segment		26			53
Restructuring and other		(135	)		201
Income from operations	$	15,319		$	3,723

Interest Income. Interest income was $2.8 million in the six months ended June 1, 2006, compared to $0.8 million in the six months ended July 1, 2005. The $2.0 million increase is attributable to an increase in overall cash and short-term investment balances along with higher interest rate yields for the six months ended June 30, 2006 compared to the six months ended July 1, 2005.

Interest Expense. Interest expense was $1.5 million in the six months ended June 30, 2006, compared to $0.1 million in the six months ended July 1, 2005. During 2006 and 2005, the Company had no bank debt. Interest expense is primarily from discounting receivables with recourse at a bank and for interest on deferred compensation. The Company recorded a one time charge of $0.5 million in the six months ended June 30, 2006 for interest associated with the settlement of value added tax payment to a foreign jurisdiction.

Foreign Exchange Transaction Gains (Losses). Foreign exchange transaction losses were $0.6 million for the six months ended June 30, 2006, compared to a gain of $0.9 million in the six months ended July 1, 2005. These amounts arise primarily from transactions denominated in currencies other than functional currency and unrealized gains (losses) on derivative contracts.

Income Taxes. The effective tax rate at June 30, 2006, was 30% of income before taxes, compared to an effective tax rate of 40% for the same period in 2005. Our effective tax rate in 2006 reflects an annualized statutory tax rate as the company operates in multiple tax jurisdictions.

Net Income. As a result of the foregoing factors, net income for the six months ended June 30, 2006 was $11.3 million, compared to $3.2 million in the same period in 2005.

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Critical Accounting Policies and Estimates

Our consolidated financial statements are based on the selection and application of significant accounting policies, which require management to make significant estimates and assumptions. There is no change in our critical accounting policies included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of the Company’s Form 10-K, as amended, for the year ended December 31, 2005.

Liquidity and Capital Resources

Cash and cash equivalents totaled $115.3 million at June 30, 2006 compared to $69.3 million at December 31, 2005. In addition, the Company had no marketable short-term investments and no marketable long-term investments at June 30, 2006, compared to $26.8 million in marketable short-term investments at December 31, 2005. Long-term investments, at both June 30, 2006 and December 31, 2005 consist of a minority equity investment in a private United Kingdom company valued at $0.6 million.

Cash Flows for Three Months Ended June 30, 2006 and July 1, 2005

Cash flows provided by operating activities for the three months ended June 30, 2006 were $11.3 million compared to cash used of $8.1 million during the same period in 2005. Net income after adjusting for gain on disposal of long-lived assets, depreciation and amortization, unrealized gain on derivatives, stock-based compensation and deferred income taxes provided cash of $4.9 million in the second quarter of 2006. Decreases in accounts receivable, other current assets and increases in current liabilities provided $13.7 million, which was offset by a decrease in inventories of $7.3 million. Net income, after adjusting for loss on disposal of long lived asset, depreciation and amortization, unrealized gain on derivatives, stock-based compensation and deferred income taxes provided cash of $5.8 million in the second quarter of 2005. Increases in accounts receivable, inventories, other current assets, and decreases in current liabilities used $13.9 million in cash.

Cash flows provided by investing activities were $20.2 million during the three months ended June 30, 2006, primarily from the net maturities of short-term investments of $22.5 million, offset by purchases of property plant and equipment which used $2.6 million in cash. In the same period in 2005, cash flows from investing activities were $0.9 million primarily from the net purchases of short-term and long-term investments of $1.2 million. The sale of the Nepean building provided $1.5 million in cash, which was offset by purchases of property plant and equipment of $1.1 million during the six months ended July 1, 2005.

Cash flows used in financing activities during the three months ended June 30, 2006 were $3.8 million primarily from the purchase of our common stock in accordance with the Company’s stock buyback program. This compares with $0.3 million in cash provided by financing activities in the quarter ended July 1, 2005 from the issue of share capital.

Cash Flows for Six Months Ended June 30, 2006 and July 1, 2005

Cash flows provided by operating activities for the six months ended June 30, 2006 were $14.5 million, compared to $9.3 million in cash used during the same period in 2005. Net income, after adjusting for gain on disposal of long lived asset, depreciation and amortization, unrealized gain on derivatives, stock-based compensation and deferred income taxes, provided cash of $11.2 million in the first six months of 2006. Increases in accounts receivable and inventory used $14.8 million, which was offset by decreases in other current assets and increases in current liabilities providing $18.1 million in cash. The increase in receivables was mainly a result of timing of sales at the end of the quarter, as well as some longer terms extended to customers. Net income, after adjusting for loss on disposal of long lived asset, depreciation and amortization, unrealized gain on derivatives, stock-based compensation and deferred income taxes, provided cash of $9.3 million in the first six months of 2005. Increases in accounts receivable, inventory, and decreases in other current liabilities used $20.2 million, which was offset by a decrease in other current assets providing $1.6 million in cash.

Cash flows provided by investing activities were $28.6 million during the six months ended June 30, 2006, primarily from the net maturities of short-term investments of $26.8 million. The sale of the Maple Grove building and Nepean land provided $6.5 million which was offset by purchases of property, plant and equipment which used $4.4 million in cash. Cash flows used in investing activities were $6.7 million during the six months ended July 1, 2005, primarily from the net purchases of short-term and long-term investments of $6.2 million. The sale of the Nepean building provided $1.5 million in cash, which was offset by a use of cash of $2.0 million for the addition of property plant and equipment during the six months ended July 1, 2005.

Cash flows provided by financing activities during the six months ended June 30, 2006 were $1.5 million from the issue of share capital and tax benefit associated with stock options of $5.3 million offset by purchases of our common stock which used $3.8 million in cash. This compares to $0.5 million in cash provided from the issue of share capital for the same period in 2005.

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Other Liquidity Matters

There have been no significant changes in the Company’s lines of credit, pensions, contractual obligations, acquisitions or off-balance sheet arrangements since December 31, 2005.

Our future liquidity and cash requirements will depend on numerous factors, including, but not limited to, the level of sales we will be able to achieve in the future, the amount of expenses incurred, the introduction of new products and potential acquisitions of related businesses or technology. We believe that existing cash and investment balances, together with cash generated from operations, will be sufficient to satisfy anticipated cash needs to fund working capital and investments.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk. Our exposure to market risk associated with changes in interest rates relates primarily to our cash equivalents, short-term investments, long-term investments and debt obligations. As described in note 8 to the consolidated financial statements, at June 30, 2006, the Company had $115.3 million invested in cash equivalents. At December 31, 2005, the Company had $43.7 million invested in cash equivalents and $26.8 million in short-term marketable investments. Due to the average maturities and the nature of the cash portfolio at June 30, 2006, a one percent change in interest rates could have approximately a $1.2 million impact on our interest income on an annual basis. We do not use derivative financial instruments in our investment portfolio. We do not actively trade derivative financial instruments but may use them to manage interest rate positions associated with our debt instruments. We currently do not hold interest rate derivative contracts.

Foreign Currency Risk. We have substantial sales and expenses and working capital in currencies other than U.S. dollars. As a result, we have exposure to foreign exchange fluctuations, which may be material. To reduce the Company’s exposure to exchange gains and losses, we generally transact sales and costs and related assets and liabilities in the functional currencies of the operations. Additionally, we may utilize currency forwards, currency swaps and currency options to hedge exposure to foreign currencies. These financial instruments are used to fix the cash flow variable of local currency costs or selling prices denominated in currencies other than the functional currency. We do not currently use currency forwards or currency options for trading purposes. The Company does not designate short-term contracts as hedges. Accordingly, such contracts are recorded at fair value with changes in fair value recognized in income, instead of included in accumulated other comprehensive income. Although the Company now marks-to-market short-term hedge contracts to the statement of operations, the Company does not intend to enter into hedging contracts for speculative purposes.

Item 4. Controls and Procedures

The Company’s management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of effectiveness of disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the United States Securities Exchange Act of 1934, as amended. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures of the Company are effective as of the end of the period covered by this report. There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

See the description of legal proceedings in note 10 to the Consolidated Financial Statements.

Item 1A. Risk Factors

Except as noted below, there is no change in the risks included in Item 1A, Risk Factors, of the Company’s Form 10-K, for the year ended December 31, 2005. We face a number of risks. The risks presented below and those included in our Form 10-K, may not be all of the risks that we face. Other sections of this report include additional factors that could have an effect on our business and financial performance. The markets in which we compete are very competitive and change rapidly. Sometimes new risks emerge and management may not be able to predict all of them, or be able to predict how they may cause actual results to be different from those contained in any forward-looking statements. You should not rely upon forward-looking statements as a prediction of future results.

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Our operations could be negatively affected if we lose key executives or employees or are unable to attract and retain skilled executives and employees as needed. Our business and future operating results depend in part upon our ability to attract, groom and retain qualified management, technical, sales and support personnel for our operations on a worldwide basis. The loss of key personnel could negatively impact our operations. Competition for qualified personnel is intense and we cannot guarantee that we will be able to continue to attract, train and retain qualified personnel. In addition, subsequent to quarter end, the Company transitioned to a new CEO in July, 2006. There is no assurance that the transition will not have an adverse impact in the Company’s operations or financial performance.

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

The following table provides information about purchases by the Company during the quarter ended June 30, 2006 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

GSI Group Inc. Purchases of Equity Securities

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan or Programs	Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under Plans or Programs
April 26 – April 28, 2006	62,000	$	9.995	62,000	$	14,378,911
May 1 – May 26, 2006	319,300	$	9.876	319,300	$	11,217,419
Totals	381,300	$	9.895	381,300	$	11,217,419

All of the purchases above were made on the open market at prevailing prices using the Company’s available cash. The Stock Repurchase Program was announced on December 21, 2005 and provides for the repurchase of up to $15 million of the Company’s common shares. The plan will expire on December 22, 2006 unless extended by the Company.

Item 4. Submission of Matters to a Vote of Security Holders

On May 15, 2006, the Company held its annual and special meeting of shareholders. For more information on the following proposals, see the Company’s definitive management proxy circular filed with the Securities and Exchange Commission on April 17, 2006.

			Votes for	Votes withheld
1.	Election of Directors:
	Richard B. Black		31,538,037	673,086
	Garrett A. Garrettson		31,637,131	573,992
	Phillip A. Griffiths, Ph.D.		31,965,212	245,911
	Marina Hatsopoulos		31,960,549	250,574
	Byron O. Pond		31,952,224	258,899
	Benjamin J. Virgilio		31,960,095	251,028
	Charles D. Winston		31,836,409	374,714
2.	Ratification of selection of Ernst & Young LLP as the Company’s independent registered public accounting firm		32,181,685	29,438
		Votes for	Votes against	Votes abstain
3.	Approval of the adoption of the 2006 Equity Incentive Plan	19,422,790	8,602,954	0

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Item 6. Exhibits

a) List of Exhibits

Exhibit Number	Description
10.1	Interim Incentive Program, FINAL Dated 5/18/06
31.1	Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Chief Executive Officer Certification pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Chief Financial Officer Certification pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

GSI Group Inc. (Registrant)

Name	Title	Date
/s/    SERGIO EDELSTEIN         Sergio Edelstein	President and Chief Executive Officer (Principal Executive Officer)	August 8, 2006
/s/    ROBERT L. BOWEN         Robert L. Bowen	Vice President and Chief Financial Officer (Principal Financial Officer)	August 8, 2006

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EXHIBIT INDEX

Exhibit Number	Description
10.1	Interim Incentive Program, FINAL, Dated 5/18/06
31.1	Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Chief Executive Officer Certification pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Chief Financial Officer Certification pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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