UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




(Mark
One)




x           ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For the
fiscal year ended December 31, 2008




OR




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


For the
transition period from ______________ to _____________




Commission
file number: 0-11635




PHOTOMEDEX,
INC.


(Exact
name of registrant as specified in its charter)




Delaware
                
                59-2058100(State
      or other jurisdiction
                
                (I.R.S.  Employerof
      incorporation or organization)
                
                Identification
      No.)





147 Keystone Drive,
Montgomeryville, Pennsylvania 18936


(Address
of principal executive offices, including zip code)




(215)
619-3600


(Issuer’s
telephone number, including area code)




Securities
registered under Section 12(b) of the Exchange Act:





Name
      of each exchangeTitle of each class
                
                on which registeredNone
                
                None





Securities
registered under Section 12(g) of the Exchange Act:




Common Stock, $0.01 par
value per share


(Title of
Class)




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes  ̈ No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.


Yes  ̈  No x





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





Yes x No  ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.   ̈





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





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).





Yes  ̈ No x





The
number of shares outstanding of our common stock as of June 30, 2008, was
63,032,207 shares, which does not reflect the 1-for-7 reverse split effected on
January 26, 2009. The aggregate market value of the common stock held by
non-affiliates (54,071,462 shares), based on the closing market price ($0.72) of
the common stock as of June 30, 2008 was $38,931,453.





As of
March 19, 2009, the number of shares outstanding of our common stock was
9,005,175, reflecting the 1-for-7 reverse split of January 26, 2009, including
rounding up for fractional shares.







Table
of Contents




PagePart IItem 1.
                  
                  Business
                  1Item 1A.
                  
                  Risk
      Factors
                  18Item 1B.
                  
                  Unresolved
      Staff Comments
                  33Item 2.
                  
                  Properties
                  33Item 3.
                  
                  Legal
      Proceedings
                  33Item 4.
                  
                  Submission
      of Matters to a Vote of Security Holders
                  35Part IIItem 5.
                  
                  Market
      for the Registrant's Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                  35Item 6.
                  
                  Selected
      Financial Data
                  37Item 7.
                  
                  Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  38Item 7A.
                  
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  58Item 8.
                  
                  Financial
      Statements and Supplementary Data
                  58Item 9.
                  
                  Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                  59Item 9A.
                  
                  Controls
      and Procedures
                  59Item 9B.
                  
                  Other
      Information
                  60Part IIIItem 10.
                  
                  Directors,
      Executive Officers and Corporate Governance
                  60Item 11.
                  
                  Executive
      Compensation
                  65Item 12.
                  
                  Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                  75Item 13.
                  
                  Certain
      Relationships and Related Transactions and Director
      Independence
                  77Item 14.
                  
                  Principal
      Accountant Fees and Services
                  77Item IVItem 15.
                  
                  Exhibits
      and Financial Statement Schedules
                  78Signatures
                  82


i




Certain
statements in this Annual Report on Form 10-K, or this Report, are
"forward-looking statements." These forward-looking statements include, but are
not limited to, statements about the plans, objectives, expectations and
intentions of PhotoMedex, Inc., a Delaware corporation, (referred to in this
Report as “we,” “us,” “our”, “registrant” or “the Company”) and other statements
contained in this Report that are not historical facts. Forward-looking
statements in this Report or hereafter included in other publicly available
documents filed with the Securities and Exchange Commission, or the Commission,
reports to our stockholders and other publicly available statements issued or
released by us involve known and unknown risks, uncertainties and other factors
which could cause our actual results, performance (financial or operating) or
achievements to differ from the future results, performance (financial or
operating) or achievements expressed or implied by such forward-looking
statements. Such future results are based upon management's best estimates based
upon current conditions and the most recent results of operations. When used in
this Report, the words "expect," "anticipate," "intend," "plan," "believe,"
"seek," "estimate" and similar expressions are generally intended to identify
forward-looking statements, because these forward-looking statements involve
risks and uncertainties. There are important factors that could cause actual
results to differ materially from those expressed or implied by these
forward-looking statements, including our plans, objectives, expectations and
intentions and other factors discussed under "Risk Factors." We undertake no
obligation to update such forward-looking statements.




PART
I




Item
      1.
            Business




We are a
medical device and specialty pharmaceutical company focused on facilitating the
cost-effective use of technologies for doctors, hospitals and surgery centers to
enable their patients to achieve a higher quality of life. We were incorporated
in the State of Delaware in 1987 under our former name, Laser Photonics,
Inc.




Our
business operates in four distinct business units: three in Dermatology and one
in Surgical. Business units, or segments, are distinguished by our management
structure, products and services offered, markets served or types of customers.
In addition, on February 27, 2009 we acquired a fifth business segment – Photo
Therapeutics. This segment is part of our Dermatology business, and is discussed
below.




The
Domestic XTRAC® segment derives revenues principally from procedures performed
by dermatologists in the United States. Our XTRAC system is generally placed in
a dermatologist’s office without any initial capital cost and then we charge a
fee-per-use to treat skin disease. We also sell XTRAC lasers to customers, due
generally to customer circumstances and preferences. Our International
Dermatology Equipment segment, in contrast, generates revenues from the sale of
equipment and replacement parts to dermatologists outside the United States
through a network of distributors. The Skin Care segment generates revenues
primarily by selling physician-dispensed skincare products
worldwide.




The
Surgical Products segment generates revenues by selling laser products and
disposables to hospitals, surgery centers and doctors both domestically and
internationally. We sold the Surgical Services segment in August 2008 and
therefore have classified its operations as discontinued.




The XTRAC
laser system is designed and manufactured to phototherapeutically treat
psoriasis, vitiligo, atopic dermatitis and leukoderma. We have secured specific
510(k) clearances from the United States Food and Drug Administration to market
the XTRAC laser system for treatment of these conditions. The XTRAC is approved
by Underwriters’ Laboratories; it is also CE-marked, and accordingly a third
party regularly audits our quality system and manufacturing facility. Our
manufacturing facility for the XTRAC is located in Carlsbad,
California.




Our Skin
Care business markets products for skin health, hair care and wound care
generally distributed by dermatologists and plastic surgeons. Most of these
products incorporate proprietary copper and manganese peptide technologies. Our
primary facility for the skincare business is located in Redmond,
Washington.




The
Domestic XTRAC and Skin Care products and services are marketed to physicians by
a direct sales force and dedicated marketing department.




Our Surgical business is located in
Montgomeryville, Pennsylvania. In the surgical business, we also develop,
manufacture and market proprietary lasers and delivery systems for both contact
and non-contact surgery. The Montgomeryville facility also serves as our
corporate headquarters.




1




The Photo Therapeutics business markets
non-laser light aesthetic devices for the treatment of a range of clinical and
non-clinical dermatological conditions. There are three facilities for this
business, one in Carlsbad, CA and two in the United Kingdom.




Our
Business Strategy: The Dermatology Businesses




Our
short-term goal is to establish the XTRAC system as a preferred treatment
modality for psoriasis and other inflammatory skin disorders through persuasive
clinical evidence and widespread private healthcare reimbursement. Our
longer-term goal is to be a world-class provider of the highest-quality,
cost-effective, medical technologies. We may seek to acquire businesses or
technologies that complement our long-term goal. The following are the key
elements of our strategy:




Establish Our
XTRAC System as a Preferred Treatment Modality for Psoriasis and Other
Inflammatory Skin Disorders. Several opinion leaders in the
dermatological community have endorsed our XTRAC system as a preferred treatment
modality for the majority of psoriasis and vitiligo patients. We are using these
endorsements to attempt to accelerate the acceptance of our XTRAC system among
dermatologists. We have also developed a set of medical practice tools, such as
patient education videos, patient letters, sample press releases, point-of-sale
displays and other advertising literature, to assist dermatologists in marketing
our XTRAC system. As a result of improved health insurance reimbursement
covering the XTRAC procedure we have expanded our sales force, clinical
specialists and marketing initiatives.




Build Broad
Consumer Awareness Program to Attract Those Not Currently Seeking
Treatment.  Of the 7 million people in the United States who
have been diagnosed with psoriasis, only about 1.5 million seek regular care. We
believe that many do not seek care largely due to the frustration caused by the
limited effectiveness, inconvenience and negative side effects of treatment
alternatives other than treatment with the XTRAC system. We have expended funds
in print, radio and internet advertising to educate this segment of the
population about how our XTRAC system enables more convenient and effective
psoriasis treatment.




Increase
Installed Base of Our XTRAC Systems by Minimizing Economic Risk to the
Dermatologists.  In the United States, we generally place our
XTRAC system in dermatologists' offices on a fee-per-use basis to the physician.
This creates an opportunity for dermatologists to utilize our system without any
up-front capital costs, thereby eliminating the economic risk to them. Where
economic circumstances are favorable, we may sell the laser system directly to
dermatologists.




Sell the XTRAC
System in Foreign Countries to be Utilized to Treat Patients on a Wider
Basis.  We have entered into a number of distribution
relationships with respect to the sale of our XTRAC system internationally. We
have chosen this marketing approach over a direct marketing approach because of
the varying economic, regulatory, insurance reimbursement and selling channel
environments outside of the United States. We intend to enter into additional
relationships in the future. However, we cannot be certain that our
international distributors will be successful in marketing the XTRAC system
outside of the United States or that our distributors will purchase more than
the minimum contractual requirements or expected purchase levels under these
relationships. In addition, we have added a non-laser based product line to our
international offering, called the VTRACTM. This product line is a result of
licensed technologies from Stern Laser srl (“Stern”), our distributor in Italy.
The purpose of this product offering is to provide a best-in-class non-laser
purchase option to compete against lower-priced lamp-based international
competitors.




Background
on Psoriasis




Psoriasis
is believed to be a non-contagious, autoimmune medical disorder and a chronic
inflammatory skin disease diagnosed in more than 7 million Americans and between
1% and 3% of the world's population. There is no known cure for psoriasis.
Although clinical symptoms and severity vary greatly between individuals over
periods of time, psoriasis appears most commonly as inflamed swollen lesions
covered with silvery white scales. Psoriasis patients often suffer from
debilitating and painful swelling, itching, bleeding, cracking and burning,
resulting in decreased mobility, depression and low self-esteem. The National
Psoriasis Foundation, or NPF, estimates that, in the United States,
dermatologists treat over 1.5 million psoriasis patients each year.




2




While the
exact cause of the disease remains unknown, the emerging consensus among
scientists and physicians characterizes psoriasis as an autoimmune medical
disorder in which excessive "T" cell stimulation in skin cells activates an
inflammatory response and excessive skin cell production. The disease causes the
rate at which skin cells are produced and pushed to the outer skin layer to
increase seven-fold, from every 28 days to every two to four days. The body
cannot shed the skin cells fast enough and this process results in patches, or
"lesions," forming on the skin's surface. Psoriasis cases are classified as mild
(less than 2% of the body's surface area affected and usually localized on the
knees, elbows, scalp, hands and feet), moderate (between 2% and 10% of the
body's surface area affected and usually appearing on the arms, legs, torso and
head) and severe (greater than 10% of the body's surface area affected and
potentially involving all areas of the skin). Our initial target market is
patients with mild to moderate psoriasis that represent 80% of all psoriasis
cases. With the market introduction of the XTRAC VelocityTM model of the laser,
we can also treat certain cases of severe psoriasis; certain private insurance
carriers reimburse for treatment of patients who have up to 20% of the body
surface area afflicted with psoriasis.




Our
Solution for Psoriasis




The XTRAC
308-nanometer (nm) excimer laser is an effective treatment option for patients
with stable localized mild-to-moderate plaque psoriasis (about 80% of psoriasis
cases), especially for patients whose plaques are recalcitrant to topical
therapy. We continue to believe our XTRAC system will become a preferred
treatment modality for patients suffering from psoriasis. The XTRAC excimer
laser offers numerous benefits to the patient, the physician, and the
third-party insurance payer, including:




·
            At
      308 nanometers, the excimer laser utilizes an ultra-narrow wavelength in
      the narrowband UVB spectrum with a proven anti-psoriatic action. In
      addition, by focusing the energy exclusively to the psoriasis plaques, the
      laser avoids exposing normal skin to potentially detrimental UVB energy,
      all with fewer side effects than other treatment
  methods.




·
            Unlike
      most other lasers, our XTRAC system emits a pulsating beam of light that
      is neither hot nor cold to the touch, resulting in no pain or discomfort
      to virtually all patients. Clinical studies have demonstrated the XTRAC
      system to have equal or greater efficacy than the most effective treatment
      alternatives presently available for psoriasis with fewer treatment visits
      than conventional phototherapy.




·
            Our
      XTRAC system enables a physician to deliver concentrated doses of
      ultraviolet light to the psoriasis-affected skin at a higher intensity
      than is possible with traditional ultraviolet light therapy. As a result,
      physicians can use the XTRAC system to treat all degrees of psoriasis from
      mild to moderate cases and even some severe cases. The XTRAC system has
      also proven effective to treat hinged body areas (elbows and knees), which
      previously have been the most difficult areas of the body to effectively
      treat with topical treatments and other ultraviolet light
      therapy.




·
            Most
      patients (84%) will obtain significant improvement (>75%) with 6 to 10
      treatments (2 treatments per week for 3 to 5 weeks). These results have
      been demonstrated to be long-lasting as well, with mean remission rates
      reported from 3.5 to 6 months.




·
            The
      excimer laser also has an established cost-effectiveness profile. A
      clinical economic analysis has demonstrated that the addition of excimer
      laser treatment results in no expected cost increase to the payer. The
      annual cost of excimer laser treatment is comparable to or less than other
      standard “Step 2” psoriasis treatment modalities, such as phototherapy
      treatment alternatives or alternative topical therapies. In addition, the
      cost-effectiveness of the excimer laser is superior due to the increased
      number of expected clear days.




·
            The
      acceptance of this procedure has been established by the American Medical
      Association through the establishment of three specific Codes of
      Procedural Terminology (“CPT”) codes describing this procedure (96920,
      96921 and 96922), as well as the establishment of Relative Value Units
      adopted by Center for Medicare and Medicaid Services (“CMS”). Since 2003,
      rates set by CMS have generally trended
upward.




·
            Numerous
      private payers and CMS carriers have recognized the clinical and economic
      merits of excimer laser treatment and have adopted medical coverage
      policies endorsing its use. In addition, approximately 140,000 excimer
      laser psoriasis procedures have been performed in the United States in
      2008, approximately 113,000 in 2007, 89,000 in 2006, 60,000 in 2005 and
      53,000 in 2004. These statistics do not include procedures performed in
      the United States on XTRAC lasers we have sold. As of December 31, 2008,
      we had more than 500 XTRAC lasers in the fee-per-use program, and have
      sold more than 100 XTRAC lasers to
  physician-customers.




3




Our
Solution for Vitiligo




In March 2001, the FDA granted 501(k)
clearance to market our XTRAC system for the treatment of vitiligo. In 2006, we
secured exclusive rights to U.S. Patent No. 6,979,327 from the Mount Sinai
School of Medicine. The patent covers, among other things, treatment of vitiligo
by means of an excimer laser system. Vitiligo is a disease in which the skin
loses pigment due to destruction of the pigment cells, causing areas of the skin
to become lighter in color than adjacent healthy skin.. Between 1% and 2% of the
population suffers from the condition, and there is no known cure. The principal
conventional treatments for symptoms are PUVA radiation and, to a lesser extent,
topical steroids and combination therapies. According to the National Vitiligo
Foundation, or NVF, the cost of PUVA treatments, over a 12 to 18 month period,
can run $6,000 or more and involve 120 clinic visits. Moreover, according to the
NVF, current conventional treatment methods are unsatisfactory and many patients
tend to lose the pigment they were successful in gaining through PUVA
therapy.




Our XTRAC
system can effectively re-pigment a patient's skin, allowing treated areas to
become homogeneous in pigment to healthy surrounding skin and restore the
patient's skin to its original condition. As treatment levels of psoriasis
increase, we intend to promote use of the XTRAC for treatment of vitiligo. As
part of that promotion, we intend to explore whether CPT codes specific to
vitiligo can be established as well as whether CMS and/or private insurance
plans will establish reimbursement rates for the treatment of
vitiligo.




Our
Solution for Atopic Dermatitis




In August 2001, the FDA granted 510(k)
clearance to market our XTRAC system for the treatment of atopic dermatitis.
Atopic dermatitis is a common, potentially debilitating condition that can
compromise the quality of life for those it affects. The condition appears as
chronic inflammation of the skin that occurs in persons of all ages, but is
reported to be more common in children. Skin lesions observed in atopic
dermatitis vary greatly, depending on the severity of inflammation, different
stages of healing, chronic scratching and frequent secondary infections. It is
reported that atopic dermatitis affects some 10% of children in the United
States alone, and more than $364 million is spent annually in the treatment of
this disease. Treatment options include corticosteroids, which can have negative
side effects, and UVB phototherapy. The use of UVB phototherapy in the treatment
of atopic dermatitis has been shown effective in published studies. Because of
the controlled and targeted application provided by our XTRAC system, large
areas of healthy skin are not exposed to UVB light from the XTRAC system and the
corresponding potentially carcinogenic effect of other phototherapy treatments.
We believe that the XTRAC system could be an alternative protocol for treating
atopic dermatitis effectively. However, we do not intend to undertake clinical
research that would clarify such an alternative protocol until we have made
further progress in our main business initiatives.




Our
Solution for Leukoderma




In May 2002, the FDA granted 510(k)
clearance to market our XTRAC system for the treatment of leukoderma, commonly
known as white spots, and skin discoloration from surgical scars, stretch marks,
burns or injury from trauma. The XTRAC system utilizes UVB light to stimulate
melanocytes, or pigment cells, deep in the skin. As these cells move closer to
the outer layer of skin, re-pigmentation occurs. As with atopic dermatitis, we
do not intend to undertake further clinical research for leukoderma that would
clarify such an alternative protocol until we have made further progress in our
main business initiatives.




Our
XTRAC System




Our XTRAC
system combines the technology of an excimer laser, or "cold" laser system
(already in use for a variety of medical and cosmetic treatments), with the use
of ultraviolet light therapy. The XTRAC system applies a concentrated dose of
UVB radiation directly to diseased skin at a higher intensity than traditional
ultraviolet light therapy. Our XTRAC system utilizes a 308-nm light wavelength,
which studies have shown to be the optimal wavelength to treat psoriasis
effectively. Our XTRAC system consists of the laser, which is mobile, and a hand
piece attached to the laser by a liquid light guide or by a fiber optic cable,
which are designed to permit direct application of the ultraviolet light and an
aiming beam to psoriasis-affected skin. The XTRAC comes optionally with an
adjustable hand-piece that can decrease the spot size of the operating beam to
permit precise, operator-controlled irradiation of tissue. We also provide a
touch-control option on the handpiece. Our latest model of the XTRAC is the
XTRAC VelocityTM excimer laser (model AL 10000): it is faster, more powerful and
has better diagnostics than previous models and therefore is well-suited to
tackling patients with severe psoriasis. The XTRAC Velocity has made its market
debut at the annual meeting of the American Academy of Dermatology in March
2009.




4




Between
March 1998 and November 1999, we initiated five seminal clinical
trials of our XTRAC system at Massachusetts General Hospital. Our objective in
these clinical trials was to compare our XTRAC laser technology with standard
ultraviolet light therapy in the treatment of psoriasis. In January 2000, we
received a 510(k) clearance to market the XTRAC system from the FDA based on the
clinical results from these trials. The Massachusetts General Hospital clinical
trial, which involved 13 patients, concluded that our XTRAC laser made it
possible to treat psoriasis effectively in one session with moderately long
remission. The study also concluded that the number of treatments to remission
depended largely on the intensity of the ultraviolet light used, finding that
medium intensities seemed to provide the best results with a superior balance
between quick clearing and patient comfort.




To
support our commercialization strategy, we completed an additional clinical
trial in 2000. The trial was designed to validate the results obtained in
the Massachusetts General Hospital clinical study in mainstream dermatologists'
offices. We established five Beta sites throughout the United States using our
XTRAC system in a clinical trial of 124 persons. This study examined various
aspects of excimer laser therapy, including the number of treatments necessary
for clearing, the ultraviolet light intensity necessary for clearing and overall
patient satisfaction. Our Beta-Site Clinical Study indicated that:




·
            approximately
      72% of the subjects treated were 75% improved in slightly more than six
      sessions, with minimal and well-tolerated side
  effects;




·
            some
      subjects were cleared in as little as one session;
  and




·
            subjects
      were successfully treated for psoriasis in the hinged body areas (knees
      and elbows), which have proven the most difficult for other alternative
      therapies to demonstrate any significant remedial
  impact.




In the
following years, we received clearance to market our XTRAC system for the
treatment of vitiligo, atopic dermatitis leukoderma. Overall, more than 45
clinical publications have validated the clinical efficacy of our phototherapy
treatments for the cleared indications of use and have advanced our insurance
reimbursement process.




Domestic
Commercialization of Our XTRAC System




For the
past six years, we have sought to clear the path for the roll-out of the XTRAC
system in dermatology. In 2000, the technology, which was originally designed
for cardiology applications, was found to have significant therapeutic
advantages for psoriasis patients who were treated with the UVB light emitted
from the excimer-based laser system. For the first two years following such
discovery, we invested in establishing the clinical efficacy of the product and
mechanical reliability of the equipment. Starting in 2002, under the technical
leadership of Jeffrey Levatter, Ph.D., our chief technical officer, we made
numerous improvements and corrections to the design of the XTRAC laser system.
Over the last six years we have pursued - and in most regions, have
substantially achieved - widespread health insurance reimbursement.




We
believe, based on our analysis, that the XTRAC system may become a preferred
treatment modality for patients afflicted with psoriasis. Although existing
treatments provide some relief to psoriasis sufferers, they are inconvenient and
may involve negative side effects. We believe that our proprietary XTRAC system
will enable more effective and convenient treatment with minimal side
effects.




Treatment
of psoriasis commonly follows a step approach with topical therapy as a
first-step, phototherapy as second-step, and systemic medications reserved for
when all other treatments fail. The clinical body of evidence developed by us
and others supports the use of the 308-nm excimer laser as safe and effective
for localized plaque-type psoriasis recalcitrant to other first-step therapies,
such as topical creams and ointments. In addition, an economic analysis
completed in December 2003 has demonstrated that the addition of excimer laser
treatment results in no expected cost increase to the payer. Further, this
analysis demonstrates the cost-effectiveness of the excimer laser is superior
due to the increased number of expected disease-free days and remission
days.




5




In the
United States, we are commercializing our XTRAC system in a manner designed to
provide a recurring revenue stream not only to us, but also to the attending
dermatologists, who would otherwise refer the patient for alternative treatment
and thereby forego associated revenues for their practice. Although on occasion
we may sell the laser outright to a dermatologist, typically we place units in
the offices of dermatologists with high-volume psoriasis practices at no
up-front capital cost to the dermatologists. We own the equipment and charge the
dermatologist on a fee-per-treatment basis for the use of the XTRAC system.
Dermatologists generally take delivery of our XTRAC system under the terms of
our standard usage agreement. Our agreements generally provide the dermatologist
with a purchase option. Under the terms of the usage agreement, title to the
lasers remains in our name. There is generally no fixed amount that is to be
paid over pre-set intervals of time by a dermatologist. We reserve the right to
remove the laser unit from a dermatologist’s office if the parties’ economic
expectations from the onset of the placement are not borne out.




Our
agreements do not require the purchase of disposable products or similar items
from us. We make available various accessory products (e.g. canisters of xenon
chloride gas, subject to a special, proprietary formula tied to the
specifications of the XTRAC system), but do not require the purchase of set
amounts of such items. However, we require that only our qualified technicians
maintain the lasers and that the physicians observe the instructions for use for
the laser.




The
dermatologist has the right to purchase pre-paid treatments, which are generally
ordered telephonically and added to the laser’s computer by way of a random
access code obtained from us and input by the dermatologist. These purchased
treatments may be used for multiple treatments for the same or different
patients, for psoriasis, vitiligo, atopic dermatitis or leukoderma. A single
treatment is then deducted from the laser’s computer upon patient treatment.
Payment for access codes is usually set for 30 days. The agreement does not
provide for delay in payment based on third-party reimbursement. The
dermatologists retain any revenue received from patients or their medical
insurance providers.




Generally,
dermatologists who treat psoriasis patients refer their patients to independent
treatment centers for ultraviolet light or write prescriptions for topical
creams or systemic drugs. In such cases, the physician does not ordinarily share
in any of the revenue generated from providing treatments to the patient.
However, physicians using our XTRAC system will treat the patient in their own
office and, therefore, will retain revenue that would otherwise be lost to
outside providers. In addition, in most states, a trained technician, rather
than the physician, may apply the treatment under the physician’s supervision,
thus allowing the dermatologist to continue treating other patients, while at
the same time increasing revenue from treatments using our XTRAC system. We
believe that this will create an attractive incentive for dermatologists to use
our XTRAC system.




We
promote our XTRAC system through trade shows, advertising in scientific
journals, industry magazines, radio, TV and newsprint, as well as direct mail
programs. Our marketing campaign has been designed to accelerate market
acceptance of our XTRAC system by increasing physician and patient awareness for
our new technology, at times with direct-to-consumer advertising initiatives. We
also have initiated a best practices program, whereby we facilitate the exchange
of clinical and business information among our customer physicians.




International
Commercialization of Our Dermatology Equipment




Our
international dermatology equipment marketing plan is based on the sale of our
XTRAC system and the VTRAC® system through independent, exclusive distributors.
We have relationships with distributors and end users in more than 30 countries
in Europe, the Middle East, the Far East and Southeast Asia, and in Australia,
South Africa and parts of South America.




6




Skin
Care




General




Our Skin
Care division, ProCyte, generates revenues primarily from the sale of skin
health, hair care and wound care products. We also have revenues, though to a
markedly lesser degree than in the past, from the sale of copper peptide
compound in bulk and from royalties on licenses for the patented copper peptide
compound. ProCyte’s focus since 1996 had been to bring unique products to
selected markets, primarily based on patented technologies such as GHK and AHK
copper peptide. We currently sell products directly to the dermatology, plastic
and cosmetic surgery, and medical spa markets. We plan to expand the use of our
novel copper peptide technologies into the mass retail market for skin and hair
care through specifically targeted technology licensing and supply
agreements.




Products




Our
products address the growing demand for skin health and hair care products,
including products designed to mitigate the effects aging has on the skin and
hair and to enhance appearance. Our products are formulated, branded and
targeted for specific markets. Our initial products were developed to be
dispensed by physicians in the dermatology, plastic and cosmetic surgery markets
for use following various medical procedures. Anti-aging skin care products were
added to form a comprehensive approach for a patient’s skincare regimen. Certain
of these products incorporate our proprietary technologies, while others
complement the product line such as our advanced sunscreen products that reduce
the effects of sun damage and aging on the skin or our eyelash conditioning
product which promotes the appearance of thicker, longer eyelashes.




Our
products are well-suited for use in the medical specialties of dermatology,
plastic and cosmetic surgery. Several recent studies presented at the American
Academy of Dermatology and other medical symposia have confirmed the advantages
of products containing copper peptide formulations versus such other
formulations as tretinoin, vitamin C, and other popular anti-aging and skin
rejuvenation products. The actions of wound care gels and creams containing
copper peptide have been documented in the scientific literature for their
ability to stimulate collagen synthesis, new blood vessel growth and tissue
repair. This has led to the development of a variety of products designed to
treat the skin following certain cosmetic procedures such as microdermabrasion,
laser resurfacing and hair transplantation. We have a series of products
tailored to the needs of these types of procedures, including the GraftCyte® System
and the Complex Cu3®System,
and have developed a series of daily use products that contain our proprietary
copper peptide compounds to aid in maintaining the quality of the skin and hair
following these procedures.




Skin Care.  Our
GraftCyte System was created to address the special tissue repair needs of
patients following hair transplant surgery. This system continues to be the only
complete solution addressing post-procedure care in the hair restoration market.
We have continued to emphasize our Complex Cu3® Post
Laser Lotion, Intensive Repair Crème, Cleanser and Hydrating Gel products used
to treat patients following chemical peels, microdermabrasion and laser
treatments. The Complex Cu3 products
provide a comprehensive approach to post-procedure care and allow us to
differentiate our line of skincare products on the basis of our proprietary
copper and manganese peptide technologies. Studies have indicated that the skin
heals quicker with the use of copper peptide compounds.




We
launched the successful Neova® Therapy
line of anti-aging products in response to demand from physician customers for a
comprehensive approach to medically directed skincare. The Neova Therapy line of
GHK Copper Peptide Complex® products
showcase elegant moisturizers and serums complemented by supporting cleansers,
toners, and masks for an integrated approach to anti-aging skincare. We have
sought to add new products to the product line each year. In 2007, we expanded
our manganese peptide offerings with an anti-aging product that provides the
benefits of hydroquinone without the risks. Also added to our products were a
line of facial peel products and an eyelash conditioner. In 2007 and 2008, we
licensed marketing rights for MD Lash Factor® eyelash conditioner for marketing
to the physician market. Since January 2009, we have discontinued marketing MD
Lash Factor conditioner, a licensed product, and replaced it with our internally
developed, safe and efficacious Neova Advanced Essential LashTM eyelash
conditioner, which is peptide-based.




Our line
of advanced sun protection products, marketed under the brand names of
Ti-Silc® and
Z-Silc®, are
recommended by dermatologists and plastic surgeons to assist in the prevention
of sun exposure that can lead to a number of problems including age spots,
hyperpigmentation, premature aging and melanoma.




7




Hair Care.  Since
1998, we have marketed our Tricomin® line of
hair care products (Tricomin Shampoos, Conditioners and Follicle Therapy
Solution) as a program for the maintenance of thinning hair in men and women.
Hair follicles require high concentrations of biological copper and the Tricomin
products deliver copper along with amino acids for nourishing and stimulating
the hair and scalp for improved health, strength and appearance. We call this
the Triamino Nutritional Copper ComplexTM. These products provide physicians with
a non-drug alternative to the problem of thinning hair care for their patients.
We also sell Tricomin products directly via the internet. We are currently
working on the next generation of products to increase the effectiveness of the
Triamino Copper Nutritional ComplexTM delivery.




Markets
and Distribution




The
markets for skincare, hair care and wound care products are global. There are
numerous distinct markets where we have a presence through our own direct sales
efforts or through agreements with others. These include dermatology, plastic
and cosmetic surgery, catalog, and direct mail. In December 2007, we engaged a
distributor to handle our spa products.




We
emphasize high-quality products and services, technical knowledge, and
responsiveness to customer needs in our marketing activities. We educate our
distributors, customers and prospective customers about our products through a
series of detailed marketing brochures, technical bulletins and pamphlets,
presentations, news releases and direct mail pieces. We also conduct a series of
one-day educational symposia around the country to provide product updates and
marketing ideas to current and potential physician customers. These activities
are supplemented by advertising in industry publications, technical
presentations, and exhibitions at over 30 local, national and international
trade shows. We adopted an internet sales policy whereby our physician-customers
are to maintain the prestige of our brands to their own
patient-customers.




Technology
In-Licensing and Out-Licensing




We are
continuously seeking partners in the prestige, direct-to-consumer, specialty
retail and home shopping categories. Our skincare business strategy is to
identify skincare markets that would be best served by more established
companies and then target a significant partner in each market to license our
technology.




We have
operated under a worldwide license agreement with Neutrogena Corporation, a
Johnson & Johnson Company (“Neutrogena”), for worldwide use of our patented
copper peptidetechnology in products for
skin health in the mass retail market. Our current license agreement (the
“Neutrogena Agreement”) continues until April 2010. Neutrogena develops,
manufactures and markets skin and hair care products domestically and
internationally. Neutrogena launched its two initial products using our
technology under the brand name of Visibly FirmTM with Active CopperTM in April
2001. Since that time, it has continued to add new products using ProCyte’s
patented copper peptide technology. We receive royalty payments, based on
product sales by Neutrogena and revenue from the sale of the copper peptide
compound used in Neutrogena’s products.




In July
2007, we obtained a marketing license for MD Lash Factor® eyelash conditioner.
The license is for 5 years and gives us, among other things, exclusive rights to
market this cosmetic conditioner to physicians in the United States. Since
January 2009, we have discontinued marketing MD Lash Factor conditioner under
the terms of an agreement with Allergan, Inc. in settlement of certain patent
litigation. We replaced it with our internally developed, safe and efficacious
Neova Advanced Essential LashTM eyelash conditioner, which is
peptide-based.




Our
Business Strategy: Surgical Products




We engage
in the development, manufacture and sale of surgical products, including
proprietary free-beam and Contact LaserTM Systems for surgery. We introduced
Contact Laser surgery by combining proprietary Contact Laser Delivery Systems
with an Nd:YAG laser unit to create a multi-specialty surgical instrument that
can cut, coagulate or vaporize tissue. Our Contact Laser Delivery Systems can be
used effectively with any wavelength of laser between 532nm and 1064nm,
including the KTP laser (532nm), diode laser (various wavelengths) and Nd:YAG
laser (1064nm). We are currently marketing such products under the trade name
PhotoMedex Surgical Products.




8




Our
proprietary Contact Laser probe and scalpel surface treatments provide the
ability to alter selectively the temperature profile of tissue, replicating the
clinical effect of many different types of lasers. Through our Contact Laser
Delivery Systems, we are able to produce a wide range of temperature gradients,
which address a broad range of surgical procedures within multiple specialties.
Our multiple-specialty capability reduces a hospital’s need to purchase several
lasers to meet its specialists’ varied requirements. These factors, coupled with
the precision, hemostasis, tactile feedback and control that our Contact Laser
Delivery Systems provide, are our primary competitive strengths in surgical
products.




Our
LaserPro® Diode laser system has replaced the Nd:YAG laser as the preferred host
laser for our Contact Laser Delivery Systems. On the other hand, our LaserPro®
CTH holmium laser system and our LaserPro® CO2 laser system have generated few
sales and served primarily in our Surgical Services business, which we sold in
August 2008 to PRI Medical Technologies (“PRI Medical”). We have suspended
manufacturing the holmium and CO2 laser systems, pending whether PRI Medical
elects to order such lasers; however, we shall, at the request of PRI Medical,
service the LaserPro holmium and CO2 lasers that we sold and continue to
manufacture and provide delivery systems for the holmium lasers.




We
believe our surgical revenues will continue to be generated primarily
from:




·           the
sale of Contact Laser Delivery Systems and related accessories; and




·           the
sale of Diode laser units.




Our
Contact Laser Delivery Systems consist of proprietary fiberoptic delivery
systems which deliver the laser beam from our Diode (or Nd:YAG) laser unit via
an optical fiber to the tissue, either directly or through a proprietary Laser
Probe or Laser Scalpel. These delivery systems can also be used with the laser
systems of certain other manufacturers.




Surgical
Products




The
following is a summary of our major surgical products:




Fiberoptic
Delivery Systems.Wehave designed
disposable optical quartz fibersto channel the laser
beam from our laser unit to the fiber end, the Laser Probe or the Laser Scalpel
or to one of 24 interchangeable, application-specific handpieces that hold the
Laser Scalpel or Laser Probe. Many of these proprietary optical fibers and
handpieces are intended for single use, while others are designed to be
reusable.




Laser Probes and
Laser Scalpels.Our proprietary
Laser Probes and Laser Scalpels are made of either synthetic sapphire or fused
silica and have high mechanical strength, high melting temperature and
appropriate thermal conductivity. Most of these Laser Probes and Laser Scalpels
use our proprietary Wavelength Conversion Effect treatments. We offer more than
60 interchangeable Laser Probes and Laser Scalpels that provide different power
densities through various geometric configurations appropriate for cutting,
coagulation or vaporization. Our Laser Probes and Laser Scalpels are made with
varying distal tip diameters and surface treatments, each with a different
balance between cutting and coagulation, so that the instrument can be suited to
the particular tissue effect desired. Additionally, but at much lesser volumes,
we market side-firing and direct-firing free-beam laser probes. Instead of
changing laser units, surgeons may choose a different Laser Probe or Laser
Scalpel to perform a different procedure. The Laser Probes and Laser Scalpels
can be re-sterilized and reused. Within the family of probes and scalpels is the
patented Sinu-Clear® probe, which provides effective relief for disorders and
conditions of the sinus cavities.




Disposable Gas or
Fluid Cartridge Systems.Our proprietary
cartridge system provides gas or fluid to cool the junction between the optical
fiber and the Laser Scalpel or the Laser Probe. These cartridges are sterile and
used in one set of procedures.




Reusable Laser
Aspiration Handpieces. Our reusable
stainless-steel handpieces are all used with interchangeable laser aspiration
wands and flexible endoscopic fibers.These proprietary
handpieces are intended for intra-nasal/endoscopic sinus and oropharyngeal
procedures requiring smoke and/or fluid evacuation.




9




Laser
Units.Our LaserPro
Diode Laser System has replaced our CLMD line of Nd:YAG laser system. The CLMD
line has been largely phased out, although we continue to handle maintenance and
refurbishment of the existing base of Nd:YAG lasers. Like the Nd:YAG laser, the
Diode lasers are designed for use with our Contact Laser Delivery Systems. The
Diode laser unit can provide up to 25 watts of power to tissue. The laser has
three versions, depending on which wavelength the user desires to be installed
in the laser. The wavelengths are 810-nm, 940-nm and 980-nm. The laser unit is
small and portable, but also is designed to be rugged and dependable. Acting as
an original equipment manufacturer (OEM), we have provided the Diode laser to
third parties (e.g. AngioDynamics) to market in specialties lying outside our
area of focus. We expect to cultivate additional relationships in the
future.




We market
the LaserPro CTH holmium laser unit for use with fiber-optic laser delivery
systems. The laser unit delivers 20 watts to tissue, and includes a
variable-speed foot pedal for improved control of energy. It has a superior duty
cycle; its delivery systems are re-useable. The LaserPro CO2 laser unit can
provide up to 40 watts of power to tissue at a wavelength of 10,600-nm. The CO2
laser is readily transportable and has been designed for dependable use. This
laser was also designed to work seamlessly with a line of premiere CO2
accessories, including the Unimax® micromanipulator (“Unimax”), which we
acquired from Reliant Technologies. Our LaserPro® CTH holmium laser system and
our LaserPro® CO2 laser system have served primarily in our Surgical Services
business, which we sold in August 2008 to PRI Medical Technologies. We have
suspended manufacturing the holmium and CO2 laser systems, pending receipt of
orders from PRI Medical for such lasers; however, we shall, at the request of
PRI Medical, service the LaserPro holmium and CO2 lasers that we sold and
continue to manufacture and provide delivery systems for the holmium lasers. On
the other hand, we are not discontinuing the Unimax as we are seeing increasing
sales from the Unimax micromanipulator for use on CO2 laser systems manufactured
by other companies.




We
manufacture virtually all of our laser systems and laser delivery
systems  at our Montgomeryville, Pennsylvania facility. The raw
materials we use are generally available in adequate supply from multiple
suppliers. We obtain all of our partially finished Laser Probes and Laser
Scalpels from three suppliers in the United States. We perform materials
processing and final assembly on the Laser Probes and Laser Scalpels using
proprietary treatment processes. We also manufacture the fiberoptic delivery
systems, with and without handpieces. A domestic supplier manufactures our
sterile gas and fluid cartridge systems on an exclusive basis in accordance with
our specifications.




Irrigation and
Suction System.  We manufacture ClearESS®, which provides
convenient and effective irrigation and suction to remove blood and debris for
enhanced visualization during endoscopic sinus surgery.




Surgical
Services




Surgical
Services was a fee-based procedures business using mobile surgical laser
equipment operated by our technicians at hospitals and surgery centers in the
United States. After preliminary investigations and discussions, our Board of
Directors decided on June 13, 2008 to develop plans for implementing a disposal
of the assets and operations of the business. We accordingly classified this
former segment as held for sale in accordance with SFAS No. 144. On August 1,
2008, we entered into a definitive agreement to sell specific assets of the
business including accounts receivable, inventory and equipment, for $3,500,000,
subject to certain closing adjustments. See Note 2, Discontinued
Operations.




Photo
Therapeutics (acquired on February 27, 2009)




We
acquired Photo Therapeutics, Inc. and Photo Therapeutics Limited (collectively,
“PTL”) on February 27, 2009. The following is a summary of the business
conducted by our PTL segment.




General




Our PTL
light emitting diode (“LED”)
products compete in the professional aesthetics device market for LED aesthetic
medical procedures. In addition, we have recently developed a line of consumer
devices to address the home-use market opportunity. The FDA has issued OTC
clearances for our two hand-held consumer devices.




10




Our PTL
segment is a developer and provider of non-laser light aesthetic devices for the
treatment of a range of clinical and non-clinical dermatological conditions.
Since its founding in 1998, PTL has built a portfolio of independent,
experimental research that supports the efficacy and safety of its OmniluxTM
technology system. Based on a patented technology platform comprised of a unique
LED array, this technology delivers narrow-band, spectrally pure light of
specific intensity, wavelength and dose to achieve clinically proven results via
a process called photo bio-modulation. Importantly, since this technology
generates no heat, a patient feels no pain or discomfort which results in
improved regime compliance and likelihood of repeat procedures; this is in
direct contrast to the current laser light-based technologies serving the
aesthetics market today.




To date,
PTL has incorporated this technology offering into a range of products targeting
both the professional based sector and the larger home-use market. Therefore,
our PTL segment’s current
portfolio of products is divided into three types: professional products
comprising the Omnilux systems for the medical market; the LumiereTM systems to
address the non-medical professional market; and home-use products to address
the consumer market.




Products




Omnilux Product Offering. Our
proprietary technology platform is based on the principles of photo
bio-modulation and photo-dynamic therapy rather than photo-thermolysis employed
by laser and Intense pulsed light (“IPL”)
systems. Specifically, our Omnilux technology delivers a specific dose of pure
light that positively affects the skin's cellular and biochemical
characteristics, resulting in improved skin morphology. Conversely,
photo-thermolysis involves the delivery of high-intensity, non-specific heat and
light energy that arbitrarily destroys skin cells. In this instance, any
improvement in skin morphology is dependent upon a correct and complete wound
healing response.




In
addition to the perceived clinical benefits of employing photo-modulation rather
than photo-thermolysis techniques, our Omnilux systems further address the
disadvantages of lasers and IPL systems. Namely, Omnilux is a highly
efficient, non-laser continuous light source and therefore does not require
the large and cumbersome power supplies and the associated cooling systems, nor
are highly trained personnel required to operate the technology.




Our
Omnilux technology is comprised of a single base platform device, onto which one
of three heads can be attached and operated, namely Omnilux Blue, Omnilux Revive
or Omnilux Plus. Each of the three heads delivers a different wavelength of pure
band light, each clinically proven to promote photo bio-modulation with
differing clinical effects, either alone or in combination (including
photo-dynamic therapy) with additional Omnilux treatment regimes, or additional
aesthetic treatments such as Botox or peels.




While
each Omnilux head can be used as a sole photo-modulator or, in the case of
Omnilux Blue and Omnilux Revive, as a photo-dynamic therapy device, we believe
that when used in combination, a far greater clinical result can be obtained
across a wider range of dermatological indications. This has allowed us to
enhance our product acceptance by professionals, who now frequently purchase all
three heads at once with the base unit, rather than one or two heads for
isolated treatment regimes.




Non-Medical Product Offering.
Lumiere light therapy was approved by the FDA for sale to non-medical customers
in 2004, and was launched in November of that year to the US indoor tanning
market. This floor-standing version of the Omnilux Revive is designed for
self-use by a customer either at the salon or at home, typically in combination
with custom-made cosmetic products, to deliver "clearing", "firming" or
"repairing" regimes.




Home-Use Product Offering.
Omnilux is a highly efficient, non-laser, continuous light-source and
therefore does not require large and cumbersome power supplies and the
associated cooling systems. This has made PTL’s patent-protected LED system
ideally suited for miniaturization, and conversion into hand-held, home-use,
self-administering devices. PTL has completed the development of the Omnilux
New-UTM for wrinkle reduction and the Omnilux Clear-U for acne reduction. Each
device has received FDA OTC clearance. Having successfully completed clinical
trials and selected a US manufacturing partner, we have fully launched the
Omnilux New-UTM.




We have
commenced distribution of the New-UTM through N.V. Perricone M.D. (“Perricone”),
a leader in the prestige beauty market. Perricone has introduced the New-U in
conjunction with its cosmeceuticals under its LIGHT RenewalTM treatment regime.
Perricone skincare products are sold in many high-end skincare outlets such as
Sephora, Nordstrom and Bloomingdale’s. In addition, we have entered into an
agreement with CVS/pharmacy to distribute the New-U in the Healthy Skin Centers
found in nearly 600 of its stores.




11




Technology




Our PTL
technology was developed through 15 years of research into the photobiology of
the skin. We have a library of clinical data and a new generation of
phototherapeutic treatments for the treatment of skin diseases such as cancer
and acne. New technologies were developed to realize the full potential of these
new modalities, which previously had only been possible with costly light
sources such as lasers. Our PTL products incorporate solid-state matrix
integration, aerospace technologies and high-density turbulent cooling. This
enables the replacement of traditional products, with using liquid cooling, with
a much more cost-effective and simplified air-cooled design, to deliver a far
more effective range of patent-protected products.




Our PTL
products incorporate the use of proprietary "High Intensity Solid- State LED
Technology," or a custom-built matrix of narrow-band LEDs. This design offers
medical practitioners and home users a new and powerful tool, which is both
extremely flexible and versatile for a wide range of cosmetic and medical
procedures.




Sales
and Marketing




As of
March 19, 2009, our sales and marketing organization consists of 78 full-time
positions. Of the 78 sales personnel, they are directed to sales as
follows: 75 in Domestic XTRAC, Skin Care and Photo Therapeutics and 3 in
International Dermatology Equipment and Surgical Products.




Our sales
organization provides consultation and assistance to our customers on the
effective use of our products, whether in phototherapy or surgery. The
consultative sales effort varies depending on many factors, including the nature
of the specialty involved and complexity of the procedures. We believe that
maintaining this consultative effort allows us to develop a long-term
relationship with our customers.




The time
between identifying a U.S. customer for the XTRAC system and placing a unit with
the customer can be a long process. We have implemented a program to accelerate
this placement process. The length of the sales cycle for a laser unit, whether
an excimer unit sold internationally or one of our surgical lasers, varies from
one month to one year, with the average sale requiring approximately six
months.




Our sale
and post-sale support personnel includes regional managers and clinical support
specialists and marketing and technical personnel. We train our sales personnel
in the utilization of our products and services, which allows them to provide
clinical consultation regarding safety, efficacy and clinical protocols. Our
marketing and technology personnel provide our link to the customer to create
innovative solutions and identify new applications and product opportunities. In
some areas of the United States, we use independent distributors to provide this
support for surgical products.




We sell
our surgical products to hospitals and surgery centers as well as to individual
practitioners. We design our products to be cost-effective and, where
applicable, to be accessible and easy to use with various other technologies or
products. Our marketing efforts include activities designed to educate
physicians, nurses and other professional staff in the use of our
products.




We sell
our PTL products through a distributor network consisting of distributors
operating in more than 25 countries. We provide our distributors with sales and
marketing tools, technical and clinical training, and promote international
clinical trial activity. We work closely with its distributors on marketing and
branding efforts and approve all marketing material. Distributors are also
required to attend industry exhibitions and invest in service equipment. Minimum
sales commitments must be maintained in order to retain
exclusivity.




Manufacturing




We
manufacture our eximer products at our 8,000 sq. ft. facility in Carlsbad,
California; we have also leased another facility of approximately 6,000 sq. ft.
that is nearby. We manufacture our surgical products at our 42,000 sq. ft.
facility in Montgomeryville, Pennsylvania. Our California and Pennsylvania
facilities are ISO 13485 certified. We believe that our present manufacturing
capacity at these facilities is sufficient to meet foreseeable demand for our
products. We substantially outsource the manufacturing of our Skin Care products
to OEM contract manufactures. Our facility in Redmond, Washington is the final
assembly center and primary warehouse for our skincare products, and likewise is
operated in conformance with FDA Quality System.




12




We
manufacture most of our own components and utilize certain suppliers for the
manufacture of selected standard components and subassemblies, which are
manufactured to our specifications. Most major components and raw materials,
including optics and electro-optic devices, are available from a variety of
sources. We conduct all final testing and inspection of our products. We have
established a quality control program, including a set of standard manufacturing
and documentation procedures intended to ensure that, where required, our
instruments are manufactured in accordance with FDA Quality System Requirements
and the comparable requirements of the European Community and other countries,
including for example Japan and Canada.




We
currently out-source the manufacturing of our PTL products. The professional
product offerings are currently manufactured by an OEM manufacturer in the UK
with tooling provided and owned by us. We believe that the manufacturing
capacity of this supplier is more than adequate for anticipated demand. Quality
control is performed at the OEM manufacturer and at our PTL facilities in the UK
and the US. The hand-held devices and the consumable products are manufactured
by an OEM manufacturer in Carlsbad, CA. We are currently reliant on a single
supplier for LEDs. We have not had any difficulties in product supply to date
but we are actively seeking an alternate supplier.




Research
and Development




As of
March 19, 2009, our research and development team included five full-time
research employees and ten engineers. We conduct research and development
activities at four of our facilities. Our research and development expenditures
were approximately $1.1 million in 2008, $0.8 million in 2007 and $1.0 million
in 2006.




Our
research and development activities are focused on:




·
            the
      application of our XTRAC system to the treatment of inflammatory skin
      disorders;




·
            the
      development of complementary devices to further improve the phototherapy
      treatments performed with our XTRAC and other light-based
      systems;




·
            the
      development of new lines of phototherapy products for medical
      treatments;




·
            the
      development of new skin health and hair care
  products;




·
            the
      improvement of surgical products through tissue-effect technologies that
      include laser and non-laser based technologies focused on improving our
      product offerings;




·
            the
      development of new lines of delivery systems for medical treatments;
      and




·
            the
      development of additional products and applications, whether in
      phototherapy or surgery, by working closely with medical centers,
      universities and other companies
worldwide.




Patents
and Proprietary Technologies




We intend
to protect our proprietary rights from unauthorized use by third parties to the
extent that our proprietary rights are covered by valid and enforceable patents
or are effectively maintained as trade secrets.




Patents
and other proprietary rights are an element of our business. Our policy is to
file patent applications and to protect technology, inventions and improvements
to inventions that are commercially important to the development of our
business. As patents expire and expose our inventions to public use, we seek to
mitigate the impact of such expirations by improvements on the inventions
embodied in the expiring patents. The patents in our Skin Care segment relate to
use of our copper and manganese peptide-based technology for a variety of
healthcare applications, and to the composition of certain biologically active,
synthesized compounds. Our strategy has been to apply for patent protection for
certain compounds and their discovered uses that are believed to have potential
commercial value in countries that offer significant market potential. As of
March 19, 2009, we have more than 100 domestic and foreign issued patents,
which serve to help protect the technology of our businesses in phototherapy,
skin health and hair care, and surgical products and services. To the same
purpose, we have 30 patent applications pending in the United States and
abroad.




13




As a
minor part of our business, we have from time to time licensed certain of our
proprietary technology to third parties. Conversely, from time to time, we seek
licenses from third parties for technology that can broaden our product and
service offerings, as for example a license which we secured from the Mount
Sinai School of Medicine and which granted us exclusive rights to a patent
covering the use of excimer lasers in the treatment of vitiligo.




We also
rely on trade secrets, employee and third-party nondisclosure agreements and
other protective measures to protect our intellectual property rights pertaining
to our products and technology.




Many of
our products and services are offered under trademarks and service marks, both
registered and unregistered. We believe our trademarks encourage customer
loyalty and aid in the differentiation of our products from competitors’
products, especially in our skin care products. Accordingly, we have registered
more than 40 of our trademarks in the United States. We have 140 other
registrations for our skincare products in foreign jurisdictions.




Government
Regulation




Our
products and research and development activities are regulated by numerous
governmental authorities, principally the Federal Food and Drug Administration,
“FDA”, and corresponding state and foreign regulatory agencies. Any device
manufactured or distributed by us will be subject to pervasive and continuing
regulation by the FDA. The United States Food, Drug and Cosmetics Act, “FDA
Act”, and other federal and state laws and regulations govern the pre-clinical
and clinical testing, design, manufacture, use and promotion of medical devices
and drugs, including our XTRAC system, surgical lasers and other products
currently under development by us. Product development and approval within this
regulatory framework takes a number of years and involves the expenditure of
substantial resources.




In the
United States, medical devices are classified into three different classes,
Class I, II and III, on the basis of controls deemed reasonably necessary
to ensure the safety and effectiveness of the device. Class I devices are
subject to general controls, such as labeling, pre-market notification and
adherence to the FDA's good manufacturing practices, and quality system
regulations. Class II devices are subject to general as well as special
controls, such as performance standards, post-market surveillance, patient
registries and FDA guidelines. Class III devices are those which must
receive pre-market approval by the FDA to ensure their safety and effectiveness,
such as life-sustaining, life-supporting and implantable devices, or new devices
which have been found not to be substantially equivalent to existing legally
marketed devices.




Before a
new medical device can be marketed, marketing clearance must be obtained through
a pre-market notification under Section 510(k) of the Food and Drug
Modernization Act of 1997, or the FDA Act, or through a pre-market approval
application under Section 515 of such FDA Act. The FDA will typically grant
a 510(k) clearance if it can be established that the device is substantially
equivalent to a predicate device that is a legally marketed Class I or II
device or certain Class III devices. We have received FDA 510(k) clearance
to market our XTRAC system for the treatment of psoriasis, vitiligo, atopic
dermatitis and leukoderma. Additionally, the FDA has issued clearances to
commercially market our Contact Laser System, including the laser unit, Laser
Probes and Laser Scalpels and Fiberoptic Delivery Systems, in a variety of
surgical specialties and procedures in gynecology, gastroenterology, urology,
pulmonology, general and plastic surgery, cardio-thoracic surgery, ENT surgery,
ophthalmology, neurosurgery and head and neck surgery. The FDA granted these
clearances under Section 510(k) on the basis of substantial equivalence to other
laser or electrosurgical cutting devices that had received prior clearances or
were otherwise permitted to be used in such areas. The range of clearances for
our Diode laser system is similar to the range of clearances for the CLMD Nd:YAG
laser systems. We have also received FDA clearance under Section 510(k) to
market our CO2 laser system and our holmium laser system, including the laser
unit and fiberoptic delivery systems. In October 2008, we received 510(k)
clearance for laser lipolysis to be performed with our 980 nm diode
laser.




14




For any
devices that are cleared through the 510(k) process, modifications or
enhancements that could significantly affect the safety or effectiveness, or
that constitute a major change in the intended use of the device, will require
new 510(k) submissions. In August 2003, the FDA granted 510(k) clearance for
modifications that had been made to the XTRAC laser, which we have marketed as
the XTRAC XL Plus excimer laser system. In October 2004, the FDA granted
clearance for the UltraTM (AL 8000) excimer laser system. In March 2008, we
received 510(k) clearance for the XTRAC VelocityTM (AL 10000) excimer laser
system.




A
pre-market approval application may be required if a proposed device is not
substantially equivalent to a existing legally marketed Class I or II
device, or for certain Class III devices. A pre-market approval application
must be supported by valid scientific evidence to demonstrate the safety and
effectiveness of the device, typically including the results of clinical trials,
bench tests and laboratory and animal studies. In addition, the submission must
include the proposed labeling, advertising literature and any training
materials. The pre-market approval process can be expensive, uncertain and
lengthy, and a number of devices for which FDA approval has been sought by other
companies have never been approved for marketing.




We are
subject to routine inspection by the FDA and have to comply with a number of
regulatory requirements that usually apply to medical devices marketed in the
United States, including labeling regulation, good manufacturing process and
quality system requirements, medical device reporting regulation (which requires
a manufacturer to report to the FDA certain types of adverse events involving
its products), and the FDA's prohibitions against promoting products for
unapproved or off-label uses.




We are
also subject to the Radiation Control for Health and Safety Act with laser
radiation safety regulations administered by the Center for Devices and
Radiological Health, or CDRH, of the FDA. These regulations require laser
manufacturers to file new product reports and annual reports, to maintain
quality control, product testing and sales records, to incorporate certain
design and operating features in lasers sold to end users and to certify and
label each laser sold, except those sold to private-label customers, as
belonging to one of four classes, based on the level of radiation from the laser
that is accessible to users. Various warning labels must be affixed and certain
protective devices installed, depending on the class of product. The CDRH is
empowered to seek fines and other remedies for violations of the regulatory
requirements. To date, we have filed the documentation with the CDRH for our
laser products requiring such filing, and have not experienced any difficulties
or incurred significant costs in complying with such regulations.




We have
received ISO 13485/EN46001 certification for our XTRAC system and our Diode,
holmium, CO2 and Nd:YAG laser systems. This certification authorizes us to affix
a CE Mark to our products as evidence that they meet all European Community,
“EC”, quality assurance standards and compliance with applicable European
medical device directives for the production of medical devices. This will
enable us to market our approved products in all of the member countries of the
European Union, “EU” and in other countries that accept the “CE” mark. We also
will be required to comply with additional individual national requirements that
are outside the scope of those required by the EU. Our products have also met
the discrete requirements for marketing in various other countries. Failure to
comply with applicable regulatory requirements can result in fines, injunctions,
civil penalties, recalls or seizures of products, total or partial suspensions
of production, refusals by foreign governments to permit product sales and
criminal prosecution.




As to our
cosmetic products in the Skin Care business segment, the FDA Act, and the
regulations promulgated thereunder, and other federal and state statutes govern
the testing, manufacture, safety, labeling, storage, record-keeping, advertising
and promotion of cosmetic products as well. Our products and product candidates
in the Skin Care segment may be regulated by any of a number of divisions of the
FDA and in other countries by similar health and regulatory authorities. The
process of obtaining and maintaining regulatory approvals for the manufacturing
or marketing of our existing and potential skin care products is costly and
time-consuming and is subject to unanticipated delays. Regulatory requirements
ultimately imposed could also adversely affect our ability to clinically test,
manufacture or market products.




In the
United States, products that do not seek to make effectiveness claims based on
human clinical evaluation may be subject to review and regulation under the
FDA’s cosmetic, drug or 510(k) medical device guidelines. Similar guidelines
exist for such products in other countries. Such 510(k) products, which include
wound care dressings and certain ointments and gels, must show safety and
substantial equivalency with predicate products already cleared by the FDA to be
marketed. There can be no assurance that product applications submitted to the
FDA or similar agencies in other countries will receive clearance to be
marketed, or that the labeling claims sought will be approved, or that, if
cleared, such products will be commercially successful or free from third-party
claims relating to the effectiveness or safety of such products.




15




We are or
may become subject to various other federal, state, local and foreign laws,
regulations and policies relating to, among other things, safe working
conditions, good laboratory practices, and the use and disposal of hazardous or
potentially hazardous substances used in connection with research and
development. Failure to obtain regulatory approvals where appropriate for our
product candidates or to attain or maintain compliance with quality system
regulations or other manufacturing requirements would have a material adverse
effect on our business, financial condition and results of
operations.




Third-Party
Reimbursement




Our
ability to market our phototherapy products successfully depends in large part
on the extent to which various third parties are willing to reimburse patients
or providers for the cost of medical procedures utilizing our treatment
products. These third parties include government authorities, private health
insurers and other organizations, such as health maintenance organizations.
Third-party payers are systematically challenging the prices charged for medical
products and services. They may deny reimbursement if they determine that a
prescribed device is not used in accordance with cost-effective treatment
methods as determined by the payer, or is experimental, unnecessary or
inappropriate. Accordingly, if less costly drugs or other treatments are
available, third-party payers may not authorize or may limit reimbursement for
the use of our products, even if our products are safer or more effective than
the alternatives. Additionally, they may require changes to our pricing
structure and revenue model before authorizing reimbursement.




Reimbursement
systems in international markets vary significantly by country and by region
within some countries, and reimbursement approvals must be obtained on a
country-by-country basis. Many international markets have government-managed
healthcare systems that control reimbursement for new devices and procedures. In
most markets, there are private insurance systems, as well as government-managed
systems. Our XTRAC products remain substantially without approval for
reimbursement in any international markets under either government or private
reimbursement systems. Since the skincare products are primarily for cosmetic
applications, reimbursement is not a critical factor in growing revenues for
this product segment.




In 2008,
we continued our efforts to secure private, third-party reimbursement in our
domestic XTRAC business segment. We secured favorable reviews by BlueCross or
BlueShield affiliates in California, Arizona, Massachusetts and Tennessee, which
now essentially provides comprehensive coverage throughout the United States
Blue Cross/Blue Shield Plans. Many private plans key their reimbursement rates
to rates set by the Centers for Medicare and Medical Services under three
distinct CPT codes based on the total skin surface area being treated. The
national rates are presently:




· 96920 – designated for:
the total area less than 250 square centimeters. CMS assigned a 2008 national
payment of approximately $160.14 per treatment;




· 96921 – designated for:
the total area 250 to 500 square centimeters. CMS assigned a 2008 national
payment of approximately $156.89 per treatment; and




· 96922 – designated for:
the total area over 500 square centimeters. CMS assigned a 2008 national payment
of approximately $232.27 per treatment.




The
national rates are adjusted by overhead factors applicable to each
state.




16




In
addition to Medicare and Medicaid, consistent domestic private healthcare
reimbursement is critical for significant growth in XTRAC system procedures.
There were more than 140,000 XTRAC procedures in 2008, 113,000 XTRAC procedures
in 2007, 89,000 XTRAC procedures in 2006, 60,000 XTRAC procedures in 2005 and
more than 50,000 XTRAC procedures in 2004 with the majority being covered by
third-party reimbursement. Historically, it has been our belief that a rapid
increase in widespread adoption of private healthcare reimbursement was being
thwarted by a perception that the XTRAC therapy, although widely publicized as
clinically safe and efficacious, was not economically cost-effective compared to
other existing therapies. We sponsored the completion of an economic and
clinical study to review the clinical and economic effectiveness of the XTRAC
laser as a second-step therapy for the treatment of psoriasis. The conclusions
of the study were: there is no additional cost of adding XTRAC as second-line
therapy in a managed care plan; XTRAC is a cost-effective second-line treatment
for mild-to-moderate plaque psoriasis; XTRAC provides the greatest number of
treatment-free days in one year among all therapies, except for intralesional
corticosteroid injections (“ICI”); XTRAC has the lowest cost per
treatment-free-day, with the exception of ICI; XTRAC has the lowest cost per
remission day among all phototherapies; and XTRAC has the highest number of
remission days among all therapies. The results of this study were compiled in a
data compendium and distributed to all the major health insurers; the results
have also been published in a peer-review journal. From 2005 through 2008
substantive progress was made in connection with obtaining approvals for
covering medically necessary targeted UVB therapy for psoriasis.




Competition




The
market that our XTRAC system competes in is highly competitive. We compete with
other products and methodologies used to treat the symptoms of psoriasis,
vitiligo, atopic dermatitis and leukoderma, including topical treatments,
systemic medications and other phototherapies. We believe that our XTRAC system
will favorably compete with alternative treatments for these disorders primarily
on the basis of its effectiveness, as well as on the basis of the lower
out-of-pocket costs. Market acceptance of our XTRAC system treatment for these
diseases is dependent on our ability to establish, with the medical and patient
communities, the efficacy of our XTRAC system as a preferred treatment modality.
In addition, all or a portion of patient costs for many of the alternative
treatments are paid or are reimbursable by health insurance coverage or other
third-party payers, such as Medicaid and Medicare. Patient costs for treatments
utilizing our XTRAC system may not be initially eligible for health care
coverage or reimbursement by third-party payers until such payers approve
reimbursement. This may cause some patients or physicians to choose alternative
treatments offered by our competitors that are eligible for such coverage
reimbursement.




We also
face direct competition from other companies, including large pharmaceutical
companies, engaged in the research, development and commercialization of
treatments for psoriasis, atopic dermatitis, vitiligo and leukoderma. In some
cases, those companies have already received FDA approval or commenced clinical
trials for such treatments. Many of these companies have significantly greater
financial resources and expertise in research and development, manufacturing,
conducting pre-clinical studies and clinical trials, and marketing than we
do.




Various
other companies are now marketing laser-based phototherapy treatment products.
In addition to one company that has received FDA clearance to market an excimer
laser for the treatment of psoriasis in the United States, there have been at
least three foreign-based companies which market an excimer laser for the
treatment of skin disorders outside of the United States. Other devices include
pulse-dye lasers, lamp-based systems, intense pulsed systems and standard UVB
systems using fiber-optic delivery systems. We expect that other devices will
enter the market as well. All of these technologies will continue to evolve with
time. We cannot say how much these technologies will impact us, but we
anticipate that most competitors that enter the US market will not use a
fee-per-procedure model but will use an outright sales model, and will likely
sell not on claims of superior quality, but on claims of lower prices and
possibly better economic returns. In part, the economic returns of such
non-laser systems may be based on the incorrect application of laser
reimbursement codes to non-laser systems. Non-laser systems are typically
reimbursed at substantially lower rates.




Competition
in the wound care, skin health and hair care markets is intense. Our competitors
include well-established pharmaceutical, cosmetic and healthcare companies such
as Obagi, La Roche Posay, Pavonia, Declore, Murad and Allergan. These
competitors have substantially more financial and other resources, larger
research and development staffs, and more experience and capabilities in
researching, developing and testing products in clinical trials, in obtaining
FDA and other regulatory approvals, and in manufacturing, supply chain control,
marketing and distribution than we do. A number of smaller companies are also
developing or marketing competitive products. Our competitors may succeed in
developing and commercializing products or obtaining patent protection or other
regulatory approvals for products more rapidly than we can. In addition,
competitive products may be manufactured and marketed more successfully than our
potential products. Such developments could render our existing or potential
products less competitive or obsolete and could have a material adverse effect
on our business, financial condition and results of operations.




17




With
regard to surgical lasers, we face substantial competition from other
manufacturers of surgical laser systems, whose identity varies depending on the
medical application for which the surgical system is being used, and from
traditional surgical methods. Other companies are developing competitive
surgical systems and related technologies. Many of these companies are
substantially larger and have substantially greater resources than we
do.




Our PTL
LED products likewise face substantial competition. PTL competes on quality of
design, manufacture and clinical research. In addition PTL has a broad
intellectual property position which will deter companies with LED products from
entering the market.




Employees




As of
March 19, 2009, we had 171 full-time employees, which consisted of 3 executive
officers, 13 senior managers, 75 sales and marketing staff, 37 people engaged in
manufacturing of lasers, 11 customer-field service personnel, 4 people engaged
in research and development, 7 engineers and 21 finance and administration
staff. We intend to hire additional personnel as the development of our business
makes such action appropriate. The loss of the services of key employees could
have a material adverse effect on our business. Since there is intense
competition for qualified personnel knowledgeable in our industry, no assurances
can be given that we will be successful in retaining and recruiting needed
personnel.




Our
employees are not represented by a labor union nor covered by a collective
bargaining agreement. We believe that we have good relations with our
employees.




Item1A.
            Risk
      Factors




The
following discussion of risk factors contains forward-looking statements as
discussed on page 1. These risk factors may be important to understanding any
statements in this Report or elsewhere. Our business routinely encounters and
addresses risks, some of which may cause our future results to be different –
sometimes materially different – than we presently anticipate.




Risks
Related to Our Business




We
have a history of losses, entertain the possibility of future losses and cannot
assure you that we will become or remain profitable.




Historically,
we have incurred significant losses and have had negative cash flows from our
phototherapy operations. Our surgical products business also has generated
losses in recent years. To date, we have dedicated most of our financial
resources to research and development and selling, general and administrative
expenses. As of December 31, 2008, our accumulated deficit was approximately
$105.3 million.




Our
future revenues and success depend significantly upon acceptance of our excimer
laser systems for the treatment principally of psoriasis, but also of vitiligo,
atopic dermatitis and leukoderma. Our XTRAC system for the treatment of these
conditions generates revenues, but those revenues are presently insufficient to
generate consistent, positive cash flows from our operations in the two
XTRAC-related business segments. Our future revenues and success also depend on
the continued growth of the revenue from the skin health and hair care products
of our skincare business, revenue stability within our surgical products
business and growth from our PTL products in the consumer market. Our ability to
market our products and services successfully and the expected benefits to be
obtained from our products may be adversely affected by a number of factors,
such as unforeseen costs and expenses, technological changes, economic
downturns, competitive factors or other events beyond our control.




We intend
to scale our expenditures in 2009 to expected and realized revenues, but there
can be no assurance that we shall realize on expected revenues from our
established business segments or from the business of PTL, which must be
integrated into our business plan and developed. Neither can we assure that we
shall not incur operating losses. In the
event that such growth is less than forecasted in our 2009 operating plan,
management has developed contingency plans to reduce our operating
expenses.  However,
in any case, there can be no assurance that we will be able to maintain adequate
liquidity to allow us to continue to operate our business or prevent the
possible impairment of our assets.




18




We
may fail to meet the ongoing Nasdaq listing requirements.




If our
stock price falls below $1.00 for more than 30 consecutive trading days again,
or if we fail to satisfy any other Nasdaq listing requirements, our common stock
could be delisted from Nasdaq. We were on Nasdaq’s watch list twice in 2008.
After we had effected the 1-for-7 reverse stock split on January 26, 2009, the
stock price rose substantially and we were taken off the Nasdaq watch
list.




While
Nasdaq has suspended the minimum price requirement, we do not expect that such
suspension will be permanent. If we are put on Nasdaq’s watch list again and not
taken off, we may be de-listed from Nasdaq. If we are not able to find an
alternate listing, we would be in default under the Securities Purchase
Agreement (“SPA”) with Perseus
Partners VII, L.P., an investment fund managed by Perseus, L.L.C. (the “Investor”), and such a
default would result in cross-default under the CIT facility, which
would give our lendors the right to require all outstanding amounts to be
paid immediately.




We
may need additional financing to maintain and expand our business, and such
financing may not be available on favorable terms, if at all.




We have
historically financed our activities through working capital provided from
operations, the private placement of equity securities and from lines of credit.
We believe that our cash balance and other existing financial resources, and
revenues from sales, distribution, licensing and manufacturing relationships,
should be sufficient to meet our operating and capital requirements beyond the
second quarter of 2010. However, we may have to raise substantial additional
capital if:




·
            renewal
      of debt financing for capital expenditures cannot be
    obtained;




·
            operating
      losses continue, because anticipated demand for the dermatology products,
      including our PTL products, does not meet our current
      expectations;




·
            we
      fail to maintain existing, or develop new, customers or corporate partners
      for the marketing and distribution of our skincare
    products;




·
            we
      need to maintain or accelerate favorable, but costlier, growth of our
      revenues;




·
            changes
      in our research and development plans necessitate unexpected, large future
      expenditures;




·
            the
      Investor does not convert its note, thereby obliging us to have funds to
      pay the note off; or




·
            costs
      to defend existing and unknown future litigation exceed our current
      planned resources.




We must
secure the Investor’s consent to incur debt financing. To raise additional
equity financing, we must first offer our terms to our Investor, and if the
Investor declines, such terms, then we have 30 days in which to pursue
subscriptions and another 30 days in which to consummate the
subscriptions.




Uncertainty
in the global credit markets could adversely affect our ability to obtain
financing, and we cannot assure you that such financing will be available on
favorable terms or at all.




The
global credit markets have recently experienced significant dislocations and
liquidity disruptions, which, among other things, have caused the spreads on
prospective debt financings to widen considerably. These circumstances
materially impacted liquidity in the debt markets, making financing terms for
borrowers less attractive, and in certain cases resulted in the unavailability
of certain types of debt financing. Continued uncertainty in the credit markets
may negatively impact our ability to access additional debt financing or to
refinance our existing debt on favorable terms or at all, which could negatively
affect our ability to fund current operations, as well as future acquisitions
and development. A prolonged downturn in the credit markets may cause us to seek
alternative sources of potentially less attractive financing, and may require us
to adjust our business plan accordingly. The uncertainty in the credit markets
could also make it more challenging for us to carry out our financing
objectives, and federal legislation enacted to alleviate the current disruptions
in the financial markets could have an adverse affect on our ability to raise
other types of financing.




19




In
addition, if we raise additional financing via issuance of securities, such
future issuance of our securities may result in substantial dilution to existing
stockholders. If we need funds and cannot raise them on acceptable terms, we may
not be able to:




·
            execute
      our growth plan for the XTRAC system ; skincare products and our PTL
      products;




·
            expand
      our manufacturing facilities, if necessary, based on increased demand for
      the XTRAC system or other surgical products or new skincare products,
      which may be introduced;




·
            take
      advantage of future opportunities, including synergistic
      acquisitions;




·
            respond
      to customers, competitors or violators of our proprietary and contractual
      rights;




·
            meet
      our debt obligations; or




·
            remain
      in operation.




We must
secure the Investor’s consent to incur debt financing. To raise additional
equity financing, we must first offer our terms to our Investor, and if the
Investor declines, such terms, then we have 30 days in which to pursue
subscriptions and another 30 days in which to consummate the
subscriptions.




We
are susceptible to the current conditions of the global economy. If the
conditions do not improve, our business could be adversely
affected.




The
current financial crisis and uncertainty in global economic conditions have
resulted in a substantial slowdown in the global economy that could affect our
business and financial performance by reducing the prices that consumers, our
customers and third party insurers and other reimbursement organizations may be
willing or able to pay for our products. These conditions may also reduce demand
for our products, which could in turn negatively impact our sales and revenue
generation and result in a material adverse effect on our business, cash flow,
results of operations, financial position and prospects. In addition, we may
experience difficulties in scaling our operations to react to economic pressures
in the United States.




We
are affected by the market’s currency conditions.




Our PTL
business is exposed to currency fluctuations. The majority of sales invoicing is
done in either Euros or US dollars, while product costs and the overhead of the
UK offices is denominated in Pounds Sterling. Our US operations, with US dollar
operating costs, serve to reduce the exposure to fluctuations in the value of
the Pounds Sterling or the Euro.




Our
laser treatments of psoriasis, vitiligo, atopic dermatitis and leukoderma, our
skincare products and our surgical laser products and any of our future products
or services may fail to gain market acceptance, which could adversely affect our
competitive position.




No
independent studies with regard to the feasibility of our proposed business
plan, including integration of the PTL products into our corporate operations,
have been conducted by third parties with respect to our present and future
business prospects and capital requirements. We have generated limited
commercial distribution for our XTRAC system and our other products. Skincare
products sales are dependent on existing strategic partners for distributing and
marketing our products. It is still not established that the PTL devices
targeted for the consumer market will be widely accepted in that market. Though
we were successful in assigning our spa business to Universal Business Solutions
in December 2007, we may still be unsuccessful in continuing our existing, or
developing new, strategic partners in order to maintain or expand the markets
for the skincare business’ existing or future products. In addition, our
infrastructure to enable such expansion, though stronger than in the past, is
still limited.




Even if
adequate financing is available and our products are ready for market, we cannot
assure you that our products and services will find sufficient acceptance in the
marketplace to fulfill our long and short-term goals. Our efforts to help
physicians increase patient awareness and interest in the XTRAC system may fail,
as may also our efforts through our clinical specialists to improve and increase
physicians’ effective utilization of the XTRAC system.




20




We also
face a risk that other companies in the market for dermatological products and
services  may be able to provide dermatologists a higher overall yield
on investment and therefore compromise our ability to increase our base of users
and ensure they engage in optimal usage of our products. If, for example, such
other companies have products (such as Botox, or topical creams for disease
management) that require less time commitment from the dermatologist and yield
an attractive return on the dermatologist’s time and investment, we may find
that our efforts to increase our base of users is hindered, or even if we place
a laser or LED device with a dermatologist, we may find that insufficient time
is devoted to increasing patient awareness of laser treatment of
psoriasis.




While we
have engaged in clinical studies for our psoriasis treatment, and based on these
studies, we have gained FDA clearance, appropriate CPT reimbursement codes for
treatment and suitable reimbursement rates from CMS for those codes, we may face
other hurdles to market acceptance. If, for example, practitioners in
significant numbers wait to see longer-term studies or if it becomes necessary
to conduct studies corroborating the role of the XTRAC system as a second-line
therapy for treating psoriasis or if patients do not elect to undergo psoriasis
treatment using the XTRAC system. We have not had sufficient time to observe the
long-term effectiveness or potential side effects of our treatment system for
psoriasis, vitiligo, atopic dermatitis or leukoderma nor to gauge fully what
marketing and sales programs, if any, are effective in increasing patients’
demand for the treatment of psoriasis with the XTRAC system.




We have
designed the XTRAC system so that a properly in-serviced medical technician in a
physician’s office may, under the physician’s supervision, safely and
effectively administer treatments to a patient. In fact, the CMS reimbursement
rates at the lower labor rates are achieved through such delegation.
Nevertheless, whether a treatment may be delegated, and if so to whom and to
what extent, are matters that may vary state by state, as these matters are
within the province of the state medical boards. In states that may be more
restrictive in such delegation, a physician may decline to adopt the XTRAC
system into his or her practice, deeming it to be fraught with too many
constraints and finding other outlets for the physician’s time and staff time to
be more remunerative. There can be no assurance that we will be successful in
persuading such medical boards that a liberal standard for delegation is
appropriate for the XTRAC system, based on its design for ease and safety of
use. If we are not successful, we may find that even if a geographic region has
wide insurance reimbursement, the region’s physicians may decline to adopt the
XTRAC system into their practices.




We
therefore cannot assure you that the marketplace will be receptive to our
excimer laser technology or skincare products over competing products, services
and therapies or that a cure will not be found for the underlying diseases we
are focused on treating. Failure of our products to achieve market acceptance
could have a material adverse effect on our business, financial condition and
results of operations.




Our
success is dependent on intellectual property rights held by us, and our
business will be adversely affected by direct competition if we are unable to
protect these rights.




Our
success will depend, in part, on our ability to maintain and defend our patents.
However, we cannot guarantee that the technologies and processes covered by our
patents will not be found to be obvious or substantially similar to prior work,
which could render these patents unenforceable. Moreover, as our patents expire,
competitors may utilize the technology found in such patents to commercialize
their own laser systems. While we seek to offset the losses relating to expiring
patents by securing additional patents on critical, commercially desirable
improvements to the inventions of the expiring patents, there can be no
assurance that we will be successful in securing such additional patents, or
that such additional patents will adequately offset the effect of the expiring
patents.




Of
particular note is U.S. Patent No. 4,891,818, the so-called “818 Patent”, which
covers, among other things, the design of the gas chamber in the XTRAC laser.
The ‘818 Patent expired on August 31, 2007; it no longer serves as a barrier to
entry to the US market. The additional patent rights we seek may serve less to
bar competitors from entry and may serve more, when aggregated with other
clinical and competitive strengths, to differentiate and distinguish our product
(e.g. the UltraTM and the XTRAC VelocityTM), in both its utility and its range of
applications, from those of competitors. If we are unable through our
technological innovations to preserve our proprietary rights, our ability to
market the XTRAC system could be materially and adversely affected.




21




A U.S.
patent relating to a copper peptide compound manufactured and used in products
distributed by Neutrogena under the Neutrogena license agreement expired on
February 5, 2005. Upon expiration of this patent, the agreement specifies that
lower royalty percentages from sales of such products be used for the remaining
term, the impact of which is a reduction in the average effective royalty rate.
The actual amount of royalty income recognized in future periods is dependent
upon the royalty percentages in effect during the period and the actual
applicable sales reported by Neutrogena, which can vary from quarter to quarter.
The expiration of the patent allows competitors to apply the technology covered
by that patent in their products.




We had
licensed marketing rights to MD Lash Factor® eyelash conditioner. Allergan, Inc.
brought a patent infringement suit under two US patents against us and several
other companies which also market eyelash conditioners based on prostaglandins.
Since our licensor was also our supplier, our margins were lower than the
margins we have on products for which we control the supply, and our legal
defense costs in the infringement suit further depleted our profits. For this
reason, we settled with Allergan and exited the market for eyelash conditioners
based on prostaglandins in January 2009. In place of MD Lash Factor, we are
introducing our own, peptide-based eyelash conditioner.




We shall
rely on certain of our PTL patents to protect the home-use market for two of our
PTL hand-held devices. If the patents prove unenforceable or circumventable, we
may lose growth from these PTL products.




Trade
secrets and other proprietary information which are not protected by patents are
also critical to our business. We attempt to protect our trade secrets by
entering into confidentiality agreements with third parties, employees and
consultants. However, these agreements can be breached and, if they are and even
if we are able to prove the breach or that our technology has been
misappropriated under applicable state law, there may not be an adequate remedy
available to us. In addition, costly and time-consuming litigation may be
necessary to enforce and determine the scope of our proprietary rights; even
should we prevail in such litigation, the party we prevail over may have
insufficient resources available to satisfy a judgment.




Further,
our skincare business seeks to establish customer loyalty, in part, by means of
our use of trademarks. It can be difficult and costly to defend trademarks from
encroachment (especially on the internet, as for example on eBay) or
misappropriation overseas. Third parties may also challenge the validity of
certain of our trademarks. In either eventuality, our customers may become
confused and direct their purchases to competitors.




Third
parties may independently discover trade secrets and proprietary information
that allow them to develop technologies and products that are substantially
equivalent or superior to our own. Without the protection afforded by our
patent, trade secret and proprietary information rights, we may face direct
competition from others commercializing their products using our technology,
which may have a material adverse effect on our business and our
prospects.




Defending
against intellectual property infringement claims could be time-consuming and
expensive, and if we are not successful, could cause substantial expenses and
disrupt our business.




We cannot
be sure that the products, services, technologies and advertising we employ in
our business do not or will not infringe valid patents, trademarks, copyrights
or other intellectual property rights held by third parties. We may be subject
in the ordinary course of our business to legal proceedings and claims relating
to the intellectual property or derivative rights of others. Any legal action
against us claiming damages or seeking to enjoin commercial activities relating
to the affected products or our methods or processes could have a material
adverse effect on our business and prospects by:




·
            requiring
      us, or our collaborators, to obtain a license to continue to use,
      manufacture or market the affected products, methods or processes, and
      such a license may not be available on commercially reasonable terms, if
      at all;




·
            preventing
      us from making, using or selling the subject matter claimed in patents
      held by others and subject us to potential liability for
      damages;




·
            consuming
      a substantial portion of our managerial and financial resources;
      or


22


·
            resulting
      in litigation or administrative proceedings that may be costly or not
      covered by our insurance policies, whether we win or
  lose.




Our
success depends on third-party reimbursement of patients' costs for our XTRAC
system, which could result in potentially reduced prices or reduced
demand.




Our
ability to market the XTRAC system and other treatment products successfully
will depend in large part on the extent to which various third parties are
willing to reimburse patients or providers for the costs of medical procedures
utilizing such products. These third parties include government authorities,
private health insurers and other organizations, such as health maintenance
organizations. Third-party payers are systematically challenging the prices
charged for medical products and services. They may deny reimbursement if they
determine that a prescribed device is not used in accordance with cost-effective
treatment methods as determined by the payer, or is experimental, unnecessary or
inappropriate. Further, although third-parties may approve reimbursement, such
approvals may be under terms and conditions that discourage use of the XTRAC
system. Accordingly, if less costly drugs or other treatments are available,
third-party payers may not authorize or may limit reimbursement for the use of
our products, even if our products are safer or more effective than the
alternatives.




Although
we have received reimbursement approvals from an increasing number of private
healthcare plans, we cannot give assurance that private plans will continue to
adopt or maintain favorable reimbursement policies or to accept the XTRAC system
in its clinical role as a second-line therapy in the treatment of psoriasis.
Additionally, third-party payers may require further clinical studies or changes
to our pricing structure and revenue model before authorizing
reimbursement.




As of
March 19, 2009, we estimate, based on published coverage policies and on payment
practices of private and Medicare insurance plans, that more than 90% of the
insured population in the United States is covered by insurance coverage or
payment policies that reimburse physicians for using the XTRAC system for
treatment of psoriasis. Based on these reports and estimates, we are continuing
the implementation of a roll-out strategy for the XTRAC system in the United
States in selected areas of the country where reimbursement is widely available.
The success of the roll-out depends on increasing physician and patient demand
for the treatment. We can give no assurance that health insurers will not
adversely modify their reimbursement policies for the use of the XTRAC system in
the future.




We intend
to seek coverage and reimbursement for the use of the XTRAC system to treat
other inflammatory skin disorders, after additional clinical studies are
initiated. There can be no assurances that we will be in position to expand
coverage for vitiligo or to seek reimbursement for the use of the XTRAC system
to treat atopic dermatitis or leukoderma, or, if we do, that any health insurers
will agree to any reimbursement policy.




Cost
containment measures and any general healthcare reform could adversely affect
our ability to market our products.




Cost
containment measures instituted by healthcare providers and insurers and any
general healthcare reform could affect our ability to receive revenue from the
use of our XTRAC system or to market our skincare products, PTL light-based
products and surgical laser products, and may have a material adverse effect on
us. We cannot predict the effect of future legislation or regulation concerning
the healthcare industry and third-party coverage and reimbursement on our
business. In addition, fundamental reforms in the healthcare industry in the
United States and the European Union continue to be considered, although we
cannot predict whether or when any healthcare reform proposals will be adopted
and what impact such proposals might have on demand for our
products.




If
the effectiveness and safety of our products are not supported by long-term
data, our revenues could decline.




Our
products may not be accepted if we do not produce clinical data supported by the
independent efforts of clinicians. We received clearance from the FDA for the
use of the XTRAC system to treat psoriasis based upon our study of a limited
number of patients. Safety and efficacy data presented to the FDA for the XTRAC
system was based on studies on these patients. For the treatment of vitiligo,
atopic dermatitis and leukoderma, we have received clearance from the FDA for
the use of the XTRAC system based primarily on equivalence of predicate devices;
we may discover that physicians will expect clinical data on such treatments
with the XTRAC system. We may find that data from longer-term psoriasis patient
follow-up studies may be inconsistent with those indicated by our relatively
short-term data. If longer-term patient studies or clinical experience indicate
that treatment with the XTRAC system does not provide patients with sustained
benefits or that treatment with our product is less effective or less safe than
our current data suggests, our revenues could decline. We can give no assurance
that we may find that our data is not substantiated in studies involving more
patients; in such a case we may never achieve significant revenues or
profitability.




23




Certain
indications for use for the PTL light-based products are permitted in Europe and
elsewhere in the world, but are not approved for marketing in the U.S. Such
approvals could be costly and take significant time to obtain. It is uncertain
whether the products will be successful in the U.S. if we are not permitted, as
elsewhere in the world, to market the unapproved indications for
use.




Any
failure in our customer education efforts could significantly reduce product
marketing.




It is
important to the success of our marketing efforts to educate physicians and
technicians in the techniques of using the XTRAC system. We rely on physicians
to spend their time and money to attend our pre-sale educational sessions.
Positive results using the XTRAC system are highly dependent upon proper
physician and technician technique. If physicians and technicians use the XTRAC
system suboptimally or improperly, they may have unsatisfactory patient outcomes
or cause patient injury, which may give rise to negative publicity or lawsuits
against us, any of which could have a material adverse effect on our reputation
as a medical device company and our revenues and profitability.




Similarly,
it is important to our success that we educate and persuade hospitals, surgery
centers and practitioners of the clinical and economic benefits of our surgical
products and services. If we fail to educate and persuade our customers, we may
suffer adversely in our reputation and our revenues and our
profitability.




If
revenue from a significant customer declines, we may have difficulty replacing
the lost revenue, which would negatively affect our results and
operations.




Neutrogena,
one of the customers for the skin health and hair care products segment that we
acquired from ProCyte, has historically accounted for a significant portion of
that segment’s net revenue. ProCyte’s net revenues from Neutrogena for bulk sale
of copper peptide compound in 2004 were $2,768,072 (bulk compound $1,553,999 and
royalties $1,214,073), or approximately 20.8% of ProCyte’s gross revenues of
$13,320,200 (revenues which pre-date our acquisition and which are not reflected
in our financial statements). By contrast, the revenues from Neutrogena in 2008
were $262,977 (bulk compound $256,000 and royalties $6,977), or approximately
2.0% of ProCyte’s gross revenues of $12,829,816. The license agreement with
Neutrogena expires in April 2010. A U.S. patent related to the Neutrogena
license agreement expired February 5, 2005, the effect of which was a reduction
in the percentage paid as a royalty during the remaining royalty period under
the license agreement. To date, we have not found any one customer which
replaces the level of business which Neutrogena once represented to ProCyte.
Instead, we have sought to recoup the loss through other customers and
channels.




Excluding
niche marketing efforts, the Skin Care segment targets its sales in the U.S.
market to physicians, who then mark the products up for sale to their patients.
No single practice in itself is generally responsible for a significant
proportion of our sales. However, a number of practices, specializing in hair
transplants, are united under the management of a single group, and this group
accounts for a disproportionate share of our hair care products aimed at the
care of a scalp that has received a hair transplant. Revenues from this customer
were $990,455 in 2008 and $1,218,698 in 2007. We find as well that a few
physicians re-sell our products not just to their own patients, but also at
discounted prices on the internet. These practices undercut the sales of other
physicians and violate our internet sales policy, but it can be difficult to
enforce the sales policy.




In the
International Dermatology Equipment segment (as well as in the Surgical Products
segment), we depend on the international arena for a material portion of our
sales on several key distributors, as for example our master distributor in the
Pacific Rim. If we lose one of these distributors, our sales of phototherapy and
surgical lasers are likely to suffer in the short term.




24




Our
PTL products will likely be targeted to the consumer market significantly
through mass retailers. It may be unfeasible to obtain long-term purchase
commitments from such retailers. Loss of such a retailer could adversely impact
revenues from the consumer market.




We
may not be able to protect our intellectual property rights outside the United
States.




Intellectual
property law outside the United States is uncertain and in many countries is
currently undergoing review and revision. The laws of some countries do not
protect our intellectual property rights to the same extent as laws in the
United States. The intellectual property rights we enjoy in one country or
jurisdiction may be rejected in other countries or jurisdictions, or, if
recognized there, the rights may be significantly diluted. It may be necessary
or useful for us to participate in proceedings to determine the validity of our
foreign intellectual property rights, or those of our competitors, which could
result in substantial cost and divert our resources, efforts and attention from
other aspects of our business. If we are unable to defend our intellectual
property rights internationally, we may face increased competition outside the
United States, which could materially and adversely affect our future business,
prospects, operating results and financial results and financial
condition.




Our
failure to obtain or maintain necessary FDA clearances or approvals, or
equivalents thereof in relevant foreign markets, could hurt our ability to
distribute and market our products.




Our laser
products are considered medical devices and are subject to extensive regulation
in the United States and in foreign countries where we intend to do business. In
addition, certain of our skincare products and product candidates may be
regulated by a number of divisions of the FDA and in other countries by similar
health and regulatory authorities. We may also find that if a cosmetic product
of ours competes with a third-party’s drug product, competitive and regulatory
pressure may be applied against the cosmetic product. Unless an exemption
applies, each medical device that we wish to market in the United States and
certain skincare products that we may wish to market must first receive either
510(k) clearance or pre-market approval from the FDA. Either process can be
lengthy and expensive. The FDA's 510(k) clearance process may take from four to
twelve months, or longer. The pre-market application approval process is much
more costly, lengthy and uncertain. It may take one to three years or even
longer. Delays in obtaining regulatory clearance or approval could adversely
affect our revenues and profitability. Although we have obtained 510(k)
clearances for our XTRAC system for use in treating psoriasis, vitiligo, atopic
dermatitis and leukoderma, and extensive 510(k) clearances for our surgical
products, our clearances may be subject to revocation if post-marketing data
demonstrates safety issues or lack of effectiveness. Similar clearance processes
may apply in foreign countries. Further, more stringent regulatory requirements
or safety and quality standards may be issued in the future with an adverse
effect on our business.




Certain
indications for use for our PTL light-based products are permitted in Europe and
elsewhere in the world, but are not approved for marketing in the U.S. Such
approvals could be costly and take significant time to obtain. It is uncertain
whether the products will be successful in the U.S. if we are not permitted, as
elsewhere in the world, to market the unapproved indications for
use.




Although
we believe that we are in compliance with all material applicable regulations of
the FDA, current regulations depend heavily on administrative interpretation. We
are also subject to periodic inspections by the FDA and other third party
regulatory groups. Future interpretations made by the FDA or other regulatory
bodies, with possible retroactive effect, may vary from current interpretations
and may adversely affect our business and prospects.




Our
market acceptance in international markets requires regulatory approvals from
foreign governments and may depend on third party reimbursement of participants
cost.




We have
introduced our XTRAC system into markets in more than 30 countries in Europe,
the Middle East, the Far East and Southeast Asia, and in Australia, South Africa
and parts of Central and South America. We intend to expand the number of
countries in these markets where we distribute our products through the network
of distributors which PTL has built. We cannot be certain that our distributors
will be successful in marketing XTRAC systems in these or other countries or
that our distributors will purchase XTRAC systems beyond their current
contractual obligations or in accordance with our expectations.




25




Underlying
our approvals in a number of countries are our quality systems. We are regularly
audited on the compliance of our quality systems with applicable requirements,
which can be extensive and complex and subject to change due to evolving
interpretations and changing requirements. Adverse audit findings could
negatively affect our ability to market our products.




Even if
we obtain and maintain the necessary foreign regulatory registrations or
approvals, market acceptance of our products in international markets may be
dependent, in part, upon the availability of reimbursement within applicable
healthcare payment systems. Reimbursement and healthcare payment systems in
international markets vary significantly by country, and include both
government-sponsored healthcare and private insurance. We may seek international
reimbursement approvals for our products, but we cannot assure you that any such
approvals will be obtained in a timely manner, if at all. Failure to receive
international reimbursement approvals in any given market could have a material
adverse effect on the acceptance or growth of our products in that market or
others.




We
have limited marketing experience, and our failure to build and manage our
marketing force or to market and distribute our products effectively would hurt
our revenues and profits.




There are
significant risks involved in building and managing our sales and marketing
force and marketing our products, including our ability:




·
            to
      hire, as needed, a sufficient number of qualified sales and marketing
      people with the skills and understanding to market the XTRAC system, our
      skincare products and our surgical products
  effectively;




·
            to
      adequately train our sales and marketing force in the use and benefits of
      our products and services, making them more effective
      promoters;




·
            to
      set the prices and other terms and conditions for treatments using an
      XTRAC system in a complex legal environment so that they will be accepted
      as attractive and appropriate alternatives to conventional modalities and
      treatments; and




·
            to
      cope with employee turnover among the sales force in the skincare
      business, which is highly competitive for talented sales
      representatives.




To
increase acceptance and utilization of our XTRAC system, we may have to expand
our sales and marketing programs in the United States. While we may be able to
draw on currently available personnel within our organization to meet this need,
we also expect that we will have to increase the number of representatives
devoted to the sales and marketing programs and broaden, through such
representatives, the talents we have at our disposal. In some cases, we may look
outside our organization for assistance in marketing our products. We have
relatively limited marketing experience and cannot predict whether the
anticipated sales and marketing programs will be successful, either in design or
implementation.




In
similar fashion, we cannot predict how successful we may be in marketing our
skincare and surgical products in the United States, nor can we predict the
success of new skincare or surgical products that we may introduce. There are,
for example, skincare products and diode lasers already in the market against
which our comparable products must compete. No assurance can be given that we
will be successful in marketing and selling our skin health and hair care
products or our diode laser.




The
home-use consumer market is new to us. We may be unsuccessful in accessing this
market with our PTL products or with our skincare products. Distribution through
the consumer market will be principally through mass-retail chains. While the
volumes will be higher, the margins will be lower. The margins to our own
suppliers will be lower as well. It may also prove difficult obtaining long-term
commitments from the retailers. If we are unable to obtain favorable pricing or
such long-term commitments, our efforts in the home-use consumer market may be
unsuccessful.




We
may encounter difficulties manufacturing our products in commercial quantities,
which could adversely impact the rate at which we grow.




26




We may
encounter difficulties manufacturing our products because we have limited
experience manufacturing our products in significant commercial quantities and
because we will, in order to increase our manufacturing output significantly,
have to attract and retain qualified employees, who are in short supply, for
assembly and testing operations.




We shall
depend on contract manufacturers for PTL products. The consumer market products
are geared to be high-volume, lower-margined products. We face the risk that
there will be supply chain problems if the volumes do not match to the
margins.




Although
we believe that our current manufacturing facilities are adequate to support our
commercial manufacturing activities for the foreseeable future, we may be
required to expand or restructure our manufacturing facilities to increase
capacity substantially. If we are unable to provide customers with high-quality
products in a timely manner, we may not be able to achieve market acceptance for
our XTRAC system or achieve market acceptance and growth for our skincare
products. Our inability to manufacture or commercialize our devices successfully
could have a material adverse effect on our revenue.




We
may have difficulty managing our growth.




If
private carriers continue to approve favorable reimbursement policies for
psoriasis and our marketing programs are successful in increasing utilization of
the XTRAC system, we expect to experience growth in the number of our employees
and customers and the scope of our operations. We also intent to enter the
home-use market with our PTL products. Such growth may place a strain on our
management and operations. Our ability to manage this growth will depend upon
our ability to broaden our management team, attract, hire and retain skilled
employees and the ability of our officers and key employees to continue to
implement and improve our operational, financial and other systems, to manage
multiple, concurrent customer relationships and to respond to increasing
compliance requirements. Our future success is heavily dependent upon achieving
such growth and acceptance of our products. If we cannot scale our business
appropriately or otherwise adapt to anticipated growth and complexity and new
product introductions, a key part of our business strategy may not be
successful.




We
are reliant on a limited number of suppliers for production of key
products.




Production
of our XTRAC system requires specific component parts obtained from our
suppliers. Production of our surgical laser systems requires some component
parts that will become harder to procure, as the design of a system ages.
Similarly, our skincare products may require compounds that can be efficiently
produced only by a limited number of suppliers. Our PTL segment has one primary
supplier of LEDs and relies on contract manufacturers. While we believe that we
could find alternative suppliers, in the event that our suppliers fail to meet
our needs, a change in suppliers or any significant delay in our ability to have
access to such resources would have a material adverse effect on our delivery
schedules, business, operating results and financial condition.




Our
failure to respond to rapid changes in technology and its applications and
intense competition in the medical devices industry or the development of a cure
for skin conditions treated by our products could make our treatment system
obsolete.




The
medical devices industry is subject to rapid and substantial technological
development and product innovations. To be successful, we must respond to new
developments in technology, new applications of existing technology and new
treatment methods. We may also encounter in the consumer market greater pressure
for innovation in order to satisfy a demand for novelty. Our response may be
thwarted if we require, but cannot secure, rights to essential third-party
intellectual property. We compete against numerous companies offering
alternative treatment systems to ours, some of which have greater financial,
marketing and technical resources to utilize in pursuing technological
development and new treatment methods. Our financial condition and operating
results could be adversely affected if our medical devices fail to compete
favorably with these technological developments, or if we fail to be responsive
on a timely and effective basis to competitors’ new devices, applications,
treatments or price strategies. For example, the development of a cure for
psoriasis, vitiligo, atopic dermatitis or leukoderma would eliminate the need
for our XTRAC system for these diseases and would require us to focus on other
uses of our technology, which would have a material adverse effect on our
business or prospects.




27




In
addition, competition in the skin health and hair care markets is intense. Our
skincare competitors include well-established pharmaceutical, cosmetic and
healthcare companies such as Obagi, La Roche Posay, Pevonia, Declore, Murad and
Allergan, as we have seen with respect to MD Lash FactorTM. These competitors
have substantially more financial and other resources, larger research and
development staffs, and more experience and capabilities in researching,
developing and testing products in clinical trials, in obtaining FDA and other
regulatory approvals and in manufacturing, marketing and distribution than we
do. Further, a number of smaller companies are developing or marketing
competitive products. Our skincare competitors may succeed in developing and
commercializing products or obtaining patent protection or other regulatory
approvals for products more rapidly than we can. Competitive products may be
manufactured and marketed more successfully than our potential skincare
products. Such developments could render our existing or potential skincare
products less competitive or obsolete and could have a material adverse effect
on our business, financial condition and results of operations.




As we
develop new products or improve our existing products, we may accelerate the
economic obsolescence of the existing, unimproved products, and their
components. The obsolescent products and related components may have little to
no resale value, leading to an increase in the reserves we have against our
inventory. Likewise, there is a risk that the new products or improved existing
products may not achieve market acceptance and therefore also lead to an
increase in the reserves against our inventory.




Our
products may be found defective or physicians and technicians may misuse our
products and damages imposed on us may exceed our insurance coverage, or we may
be subject to claims that are not covered by insurance.




Product
returns and the potential need to remedy defects or provide replacement products
or parts for items shipped in volume could result in substantial costs and have
a material adverse effect on our business and results of operations. The
clinical testing, manufacturing, marketing and use of our products and
procedures may also expose us to product liability claims. Certain indications
for use for our PTL light-based devices though patented outside the U.S., are
not approved in the U.S. If a physician elects to apply an off-label use and the
use leads to injury, we may be involved in costly litigation. In addition, the
fact that we train technicians whom we do not supervise in the use of our XTRAC
system when patients are treated may expose us to third-party claims if those
doing the training are accused of providing inadequate training. We presently
maintain liability insurance with coverage limits of at least $5,000,000 per
occurrence. However, continuing insurance coverage may not be available at an
acceptable cost, if at all. We thus may not be able to obtain insurance coverage
that will be adequate to satisfy a liability that may arise. Regardless of merit
or eventual outcome, product liability claims may result in decreased demand for
a product, injury to its reputation, withdrawal of clinical trial volunteers and
loss of revenues. As a result, regardless of whether we are insured, a product
liability claim or product recall may result in losses that could have a
material adverse effect upon our business, financial condition and results of
operations.




Similarly,
we also may be subjected to third-party claims in the course of our business for
which we have no insurance coverage. If we should be found liable for any such
claim, we may suffer a material adverse effect on the business.




If
we use hazardous materials in a manner that causes injury or violates laws, our
business and operations may suffer.




Our XTRAC
system utilizes a xenon chloride gas mixture under high pressure, which is
extremely corrosive. While methods for proper disposal and handling of this gas
are well-known, we cannot completely eliminate the risk of accidental
contamination, which could cause:




·
            an
      interruption of our research and development
  efforts;




·
            injury
      to our employees, physicians, technicians or patients that results in the
      payment of damages; or




·
            liabilities
      under federal, state and local laws and regulations governing the use,
      storage, handling, transport and disposal of these materials and specified
      waste products.




28




From time
to time, customers return surgical products that appear not to have performed to
specification. Such products must be decontaminated before being returned to us.
If they are not, our employees may be exposed to dangerous
diseases.




We
depend on our executive officers and key personnel to implement our business
strategy and could be harmed by the loss of their services.




We
believe that our growth and future success will depend in large part upon the
skills of our management and technical team. In particular, our success depends
in part upon the continued service and performance of:




·
            Jeffrey
      F. O’Donnell, President and Chief Executive
  Officer;




·
            Dennis
      M. McGrath, Chief Financial Officer;
and




·
            Michael
      R. Stewart, Executive Vice President and Chief Operating
      Officer.




Although
we have employment agreements with Mr. O’Donnell, Mr. McGrath, and Mr.
Stewart, the loss of the services of one or more of these executive officers
could adversely affect our ability to develop and introduce our new
products.




The
competition for qualified personnel in the laser and skincare industries is
intense, and we cannot assure you that we will be able to retain our existing
key personnel or to attract additional qualified personnel. In addition, we do
not have key-person life insurance on any of our employees. The loss of our key
personnel or an inability to continue to attract, retain and motivate key
personnel could adversely affect our business.




We
may be unsuccessful in attaining our goals from the acquisition of
PTL.




We
acquired PTL with the following goals in mind:




·
            that
      PTL’s extensive international network of distributors would present a
      growth opportunity for PhotoMedex to market its existing
      products;




·
            that
      PTL will benefit from our significantly larger United States direct sales
      and marketing organization;




·
            that
      PTL’s presence in the tanning spa and medi-spa markets would present a
      growth opportunity for PhotoMedex to market its existing
      products;




·
            that
      the combined company may realize short-term cost savings and have the
      opportunity for additional longer-term cost efficiencies, thus providing
      additional cash flow for
operations;




·
            that
      PTL’s hand-held devices may open up to us a path to the consumer
      market.




We have
not begun to fully realize any of the goals. If we fail to attain some of the
goals, the benefits of the acquisition could be limited and our overall business
and financial health could be materially and adversely affected.




We
may be unsuccessful in integrating any other business we may acquire with our
other business segments.




As a part
of our strategy to grow our business, we seek to make strategic acquisitions of,
or significant investments in, complementary companies, products or
technologies. We may not be successful in the future in identifying companies
that meet our acquisition criteria. The failure to identify such companies may
limit the rate at which we are able to grow our business. Furthermore, any
future acquisitions that we do undertake could be accompanied by risks such
as:





·
            Difficulties
      in integrating the operations and personnel of acquired
      companies;




·
            Diversion
      of our management's attention from ongoing business
    concerns;




29




·
            Our
      potential inability to maximize our financial and strategic position
      through the successful incorporation of acquired technology and rights
      into our products and services;




·
            Additional
      expense associated with amortization of acquired
  assets;




·
            Maintenance
      of uniform standards, controls, procedures and policies;
    and




·
            Impairment
      of existing relationships with employees, suppliers and customers as a
      result of the integration of new management
  personnel.




We cannot
guarantee that we will be able to successfully integrate any business, products,
technologies or personnel that we might acquire in the future, and our failure
to do so could harm our business.




In
addition, we may acquire additional companies in the medical products and
services industry. Accordingly, in the ordinary course of our business, we
regularly consider, evaluate and enter into negotiations related to potential
acquisition opportunities. We may pay for these acquisitions in cash or
securities, including equity securities, or a combination of both. We cannot
assure you that attractive acquisition targets will be available at reasonable
prices, that we will have sufficient authorized but unissued securities
available to effect an acquisition, or that we will be successful in any such
transaction. Acquisitions involve a number of special risks,
including:




·
            diversion
      of our management’s attention;




·
            integration
      of the acquired business with our business;
and




·
            unanticipated
      legal liabilities and other circumstances or
  events.




Delaware
law and our charter documents, as well as the SPA, contain provisions that could
delay or prevent actual and potential changes in control, even if they would
benefit stockholders.




We are
subject to Section 203 of the Delaware General Corporation Law, which
prohibits a business combination between a corporation and an interested
stockholder within three years of the stockholder becoming an interested
stockholder, except in limited circumstances. In addition, our bylaws contain
certain provisions which require stockholders' actions to be taken at meetings
and not by written consent, and also require supermajority votes of stockholders
to notice special meetings of stockholders. Finally, pursuant to the SPA, the
Investor, must consent to any change of control transaction, subject to certain
exceptions. These provisions could delay or prevent actual and potential changes
in control, even if they would benefit our stockholders.




Potential
fluctuations in our operating results could lead to fluctuations in the market
price for our common stock.




Our
results of operations are expected to fluctuate significantly from
quarter-to-quarter, depending upon numerous factors, including:




·
            the
      present macroeconomic downturn in the global economy and financial
      industry, and governmental monetary and fiscal programs to stimulate
      better economic conditions;




·
            healthcare
      reform and reimbursement policies;




·
            demand
      for our products;




·
            changes
      in our pricing policies or those of our
  competitors;




·
            increases
      in our manufacturing costs;




·
            the
      number, timing and significance of product enhancements and new product
      announcements by ourselves and our
competitors;




·
            the
      termination or expiration of significant royalty-generating licensing
      contracts to which we are party;




·
            the
      expiration of certain of our key
patents;




30




·
            our
      ability to develop, introduce and market new and enhanced versions of our
      products on a timely basis considering, among other things, delays
      associated with the FDA and other regulatory approval processes and the
      timing and results of future clinical trials;
  and




·
            product
      quality problems, personnel changes, and changes in our business
      strategy.




Our
quarter-to-quarter operating results could also be affected by the timing and
usage of individual laser units in the treatment of patients, since our revenue
model for the XTRAC system is based on a payment-per-usage plan.




Variations
in the above operating factors could lead to significant fluctuations in the
market price of our stock.




Our
stock price has been and continues to be volatile.




The
market price for our common stock could fluctuate due to various factors. These
factors include:




·
            acquisition-related
      announcements;




·
            announcements
      by us or our competitors of new contracts, technological innovations or
      new products;




·
            changes
      in government regulations;




·
            fluctuations
      in our quarterly and annual operating results;
  and




·
            general
      market and economic conditions.




In
addition, the stock markets have, in recent years, experienced significant price
fluctuations. These fluctuations often have been unrelated to the operating
performance of the specific companies whose stock is traded. Market
fluctuations, as well as economic conditions, have adversely affected, and may
continue to adversely affect, the market price of our common stock.




On
January 27, 2009, we implemented a 1-for-7 reverse stock split to enable us to
comply with Nasdaq’s minimum bid requirement, to meet a condition of the
Securities Purchase Agreement dated August 4, 2008 with the Investor, and to be
more attractive to institutional investors. It remains uncertain if the reverse
split will have any impact in the volatility of our stock price.




Our
ability to pay dividends on our common stock may be limited.




We do not
expect to pay any cash dividends in the foreseeable future. We intend to retain
earnings, if any, to provide funds for the expansion of our
business.




Limitations
on director liability may discourage stockholders from bringing suit against a
director.




Our
certificate of incorporation provides, as permitted by governing Delaware law,
that a director shall not be personally liable to us or our stockholders for
monetary damages for breach of fiduciary duty as a director, with certain
exceptions. These provisions may discourage stockholders from bringing suit
against a director for breach of fiduciary duty and may reduce the likelihood of
derivative litigation brought by stockholders on our behalf against a director.
In addition, our certificate of incorporation and bylaws provide for mandatory
indemnification of directors and officers to the fullest extent permitted by
Delaware law. In addition, we have agreed to indemnify the past and present
directors, officers and employees of ProCyte for certain matters, to the same
extent such individuals are indemnified by ProCyte, for a period of six years
following the effective date of the acquisition.




31


Our
indebtedness and debt service obligations may adversely affect our cash
flows.




If we are
unable to generate sufficient cash to meet our interest and principal payment
obligations under our secured convertible promissory note and our other debt
obligations, we may have to restructure or limit our operations. Our
indebtedness could have significant additional negative consequences, including,
but not limited to:




·
            requiring
      the dedication of a substantial portion of our expected cash flow from
      operations to service the indebtedness, thereby reducing the amount of
      expected cash flow available for other purposes, including capital
      expenditures;




·
            increasing
      our vulnerability to general adverse economic and industry
      conditions;




·
            limiting
      our ability to obtain additional
financing;




·
            limiting
      our flexibility to plan for, or react to, changes in our business and the
      industry in which we compete; and




·
            placing
      us at a possible competitive disadvantage to competitors with less debt
      obligations and competitors that have better access to capital
      resources.




Shares
eligible for future sale by our current or future stockholders may cause our
stock price to decline.
  If our
stockholders or holders of our other securities sell substantial amounts of our
common stock in the public market, including shares issued in completed or
future acquisitions or upon the exercise of outstanding convertible promissory
notes, options and warrants, then the market price of our common stock could
fall. As of March 19, 2009, the Investor has the right to convert the
convertible promissory note into 3,487,344 shares of our common stock and holds
warrants to purchase 1,046,204 shares of our common stock.
  Our
convertible promissory note provides that upon the occurrence of various events
of default, the Investor would be entitled to require us to prepay the note for
cash, which could leave us with little or no working capital for operations or
capital expenditures.
  The terms
of our convertible promissory note issued to the Investor require us to prepay
the note upon the occurrence of various events of default, such as the failure
to pay any principal payments due and for the breach of any representations and
warranties under the note or the SPA. The note also contains
a cross-acceleration provision, which means that an acceleration of payment
under other instruments would give the Investor the right to accelerate
repayment under the note If we are unable to comply with the covenants under the
note, the Investor may declare us in default and may declare all amounts due
under the note, including any accrued interest and penalties. As of the date of
this filing, we were in compliance with the covenants under the note. We expect
to remain in compliance with the covenants of the note; however, no assurance is
made that we will remain in compliance with all of the covenants under the
note.
  In
addition, if an event of default or a change in control occurs, we may be unable
to prepay the entire amount due under the note in cash. Even if we were able to
prepay the entire amount in cash, any such prepayment could leave us with little
or no working capital for our business. We have not established a sinking fund
for payment of our obligations under the note, nor do we anticipate doing
so.
  Our
convertible promissory note is secured by a large portion of our
assets.
  Our
convertible promissory note issued to the Investor is secured by a security
interest in and a lien on a large portion of our assets, including on the
capital stock of certain of our subsidiaries. As a result of this security
interest and lien, if we fail to meet our payment or other obligations under the
note, the Investor would be entitled to foreclose on those assets. Under those
circumstances, we may not have sufficient funds to service our day-to-day
operational needs. Any foreclosure by the Investor of the note would have a
material adverse effect on our financial condition.
  Issuance
of shares of our common stock upon conversion or repayment of our convertible
promissory note and exercise of warrants, or payment of interest in kind, will
dilute the ownership interest of our existing stockholders and could adversely
affect the market price of our common stock.




32




We may
issue shares of our common stock (i) upon conversion of some or all of our
secured convertible promissory note issued to the Investor, and (ii) upon
exercise of warrants. In addition, we may issue
additional convertible promissory notes as payment of interest in kind.
Any of these issuances will dilute the ownership interests of our existing
stockholders. Any sales in the public market of this common stock could
adversely affect prevailing market prices of our common stock. In addition, the
existence of our note and our warrants may encourage short selling by market
participants.
  In addition the terms of our convertible promissory note
issued to the Investor provide that, if on any date that occurs 31 trading days
after the date of issuance, the market price for our common stock, as determined
in accordance with the terms and conditions of the SPA, exceeds 300% of the
then-effective conversion price of the note, then the entire principal amount
and all accrued but unpaid interest under the note will automatically convert
into shares of our common stock at the then-effective conversion price. Such a
mandatory conversion of the note will dilute the ownership interests of our
existing stockholders.
  The ownership interests of our existing stockholders may
be further diluted through adjustments to certain of our existing securities
under the terms of their anti-dilution provisions.
  If Photo
Therapeutics Group Limited earns all or any part of its $7 million earn-out and
we elect to finance such earn-out through the issuance of a convertible
promissory note to the Investor, we shall also have to issue a warrant to
purchase a number of shares of our common stock equal to 30% of the shares of
our common stock that the second note will covert into, and the conversion price
of the second note and the exercise price of the warrant will equal the lesser
of (i) 150% of the conversion price then in effect with respect to the first
convertible note, and (ii) the market price of our common stock measured in
accordance with the terms of the SPA. Thus, the second convertible promissory
note could lead to proportionately greater dilution than the first
note.
  Our
recent acquisition of Photo Therapeutics, Inc. and Photo Therapeutics Limited
may require us to pay additional amounts in the future.
  In
connection with our acquisition of PTL we may be required to pay up to an
additional $7 million to Photo Therapeutics Group Limited, subject to the
achievement of certain financial performance thresholds. Such a payment would
require us to issue an additional secured convertible promissory note and an
additional warrant to the Investor or an affiliate of the Investor, which could
implicate the dilution and other risks related to the issuance of the first
secured convertible promissory note and warrant issued to the
Investor as described above.
  Pursuant to the terms of the SPA, we are prohibited from
taking certain corporate actions without the prior consent of the
Investor.
  The SPA provides that, until such time as no secured
convertible promissory notes are outstanding and the Investor no longer holds at
least 66% of the aggregate number of shares of common stock issuable upon
conversion of the notes and the warrants, we may not take certain corporate
actions without the prior consent of the Investor. These actions include, among
others:
  ·
              consummating any transaction that would result in
      a change of control of us unless such transaction is for consideration
      that meets certain thresholds specified in the
  SPA;
  ·
              acquiring another business or corporation or a
      substantial portion of the assets of any such
    entity;
  ·
              selling any of our assets that are material,
      individually or in the aggregate, to our
  business;
  ·
              paying dividends to our stockholders;
      and
  ·
              amending or modifying any compensation arrangement
      with any of our executive officers or directors, including hiring or
      terminating the employment of our Chief Executive Officer or Chief
      Financial Officer.
  These restrictive covenants are in addition to the
Investor’s
right of first refusal with respect to future equity issuances and approval
right with respect to future debt financings. If our management and Board of
Directors desire to take any of such actions, there can be no assurance that the
Investor will provide its consent as required, despite the fact that such
actions may be in the best interests of us and our stockholders other than the
Investor. Any failure of the Investor to provide its consent could have a
material adverse effect on our business, financial condition and results of
operation.




Item
      1B.
            Unresolved
      Staff Comments




There are no unresolved comments from
the staff of the Securities and Exchange Commission.




Item
      2.
            Properties




We lease
an 8,000 sq. ft. facility consisting of office, manufacturing and warehousing
space in Carlsbad, California. The lease expires on June 15, 2012. We have a
right to cancellation after 5 years, provided that we pay off any remaining
obligation for tenant improvements. The outstanding obligation for the tenant
improvements was $106,215 as of December 31, 2008. The base rent is $7,256 per
month. Our Carlsbad facility houses the manufacturing and development operations
for our excimer laser business. We also lease a 6,643 sq. ft facility consisting
of office and warehousing space in Carlsbad, California for use by our PTL
segment. The lease expires on June 14, 2012. The base rent is $6,577 per
month.




We lease a 42,000 sq. ft. facility in
Montgomeryville, Pennsylvania that houses our executive offices and surgical
laser manufacturing operations. The term of the lease runs until July 2011. The
base rent is $20,475 per month.




We also
lease a 12,182 sq. ft facility consisting of office and warehousing space in
Redmond, Washington. The lease expires on June 30, 2010. The base rent is
$11,700 per month. Our Redmond facility houses the warehousing operations for
our skincare business.




Additionally,
our PTL segment leases two facilities in the United Kingdom. The first lease is
a 2,389 sq. ft. facility consisting of office space in Tamworth, UK. The lease
expires on April 1, 2011. The base rent is $3,896 per month. The second lease is
a 1,500 sq. ft. facility consisting of office space in Altrincham, UK. The lease
expires on April 2, 2011. The base rent is $2,856 per month.




Item
      3.
              Legal
      Proceedings




In the
matter brought by us on January 4, 2004, against Ra Medical Systems, Inc. and
Dean Irwin in the United States District Court for the Southern District of
California, we have appealed to the Ninth Circuit Court of Appeals from the
district judge’s grant of summary judgment to the defendants. No date has been
set for oral argument.




33




In the
matter which Ra Medical and Mr. Irwin brought against us on June 6, 2006 for
unfair competition and which we removed to the United States District Court for
the Southern District of California, the district judge has certified our
interlocutory appeal to the Ninth Circuit of Appeals from the judge’s dismissal,
among other things, of our counterclaim of misappropriation. We have filed our
opening brief on appeal and await appellees’ opposition brief.




On
October 29, 2008, Ra Medical and Dean Irwin brought a second malicious
prosecution action against us, and our outside counsel, in the California
Superior Court for San Diego County. We were not served until nearly the end of
the 60-day period in which service of process must be affected. The plaintiffs
allege that the action we brought in January 2004 against Ra Medical and Mr.
Irwin was initiated and maintained with malice. Indeed, on October 30, 2008, the
day of our quarterly investors’ conference call, Ra Medical issued a press
release accusing us of having acted with malice. On or about January 22, 2009,
we filed a demurrer to the complaint on the grounds that it was brought while
the underlying Federal action was still on appeal before the Ninth Circuit Court
of Appeals, and therefore before the plaintiffs had secured a final and
favorable judgment in the underlying Federal action – a necessary pre-condition
to bringing the action. Our demurrer was sustained, but the action was not
dismissed but was stayed with leave to amend the complaint.




On
December 1, 2008, we filed a complaint for declaratory judgment in the United
States District Court for the Southern District of California based on the
accusations made in Ra Medical’s press release of October 30, 2008
notwithstanding that the district judge in the underlying Federal action had
specifically ruled that we had not acted in the litigation vexatiously or in bad
faith. We are asking the court to rule on whether the accusations made in the
press release are true or false. The defendants have moved to dismiss our
complaint based on lack of jurisdiction in the Federal court. We await a ruling
on defendants’ motion, which has been fully briefed and submitted.




We
notified our general liability and umbrella liability insurer, St. Paul Fire and
Marine Insurance Company, of the suit that Ra Medical and Mr. Irwin stated in
their press release that they had brought for malicious prosecution. On or about
January 27, 2009, St. Paul sent us a letter via regular mail setting forth
reasons why it believed it had no duty to indemnify us against any liability we
might incur in the malicious prosecution action, and inviting our response to
its position. Meanwhile and before we received the January 27 letter, St. Paul
brought an action on January 29, 2009 in the California Superior Court for San
Diego County for a declaratory judgment that it has no duty to defend us or
indemnify us, asserting that it had been released from such duties in the
settlement of the first malicious prosecution action brought by Ra Medical and
also asserting that the policy should be governed by California law, not
Pennsylvania law. We have removed that action to the U.S. District Court for the
Southern District of California, but we have not yet been required to file a
response to the St. Paul complaint. Notwithstanding,
on March 20, 2009, St. Paul has informed us that it will pay for the cost of
defense subject to a full reservation of rights.
  The
insurance policy under which we seek coverage from St. Paul is the same policy
under which St. Paul defended and indemnified us in the first malicious
prosecution action brought by Ra Medical against us. In connection with the
first malicious prosecution action, we filed a declaratory judgment action in
the U.S. District Court for the Eastern District of Pennsylvania against St.
Paul seeking a ruling that it was obligated to pay all reasonable defense costs
incurred in the defense of that action and any judgment or settlement we might
incur. We obtained a summary judgment in that action holding that, under
governing Pennsylvania law, the policy covered malicious prosecution claims and
St. Paul was required to provide full coverage for the action brought by Ra
Medical. On March 3, 2009, we filed an action in the U.S. District Court for the
Eastern District of Pennsylvania seeking a ruling, consistent with the earlier
ruling of this court,  that the law of Pennsylvania governs the policy
and that the policy provides coverage for the latest malicious prosecution
action. Our complaint was served on St. Paul on March 4, 2009. The case has been
assigned to the same judge who granted our motion for summary judgment in the
earlier declaratory judgment action.




In the
patent infringement suit brought on November 7, 2007, by Allergan, Inc. in the
United States District Court for the Central District of California, we settled
this suit on November 11, 2008, and it was dismissed with prejudice. In return
for our promise to cease marketing MD Lash Factor eyelash conditioner or any
other prostaglandin-based conditioner on or before January 31, 2009, Allergan
released us and our affiliates, our licensor and supplier, and its
sub-suppliers, of MD Lash Factor, and our customers and their end-user customers
from any claims deriving from MD Lash Factor that we sold on or before January
31, 2009. In fact, we ceased marketing of MD Lash Factor by the appointed
date.




We are
involved in certain other legal actions and claims arising in the ordinary
course of business. We believe, based on discussions with legal counsel, that
these other litigation and claims will likely be resolved without a material
effect on our consolidated financial position, results of operations or
liquidity.




34




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




No
matters were submitted to a vote of security holders in the fourth quarter 2008.
The annual meeting of stockholders was held on January 26, 2009, at which
meeting, among other things, the 1-for-7 reverse split and the issuance of
shares of our common stock in connection with the Investor’s financing were
approved.





PART
II




Item
5. Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities




As of
March 19, 2009, we had 9,005,175
shares of common stock (post reverse split basis including the rounding up for
fractional shares) issued and outstanding, including 182,858 shares of issued
and outstanding restricted stock. This did not include (i) options to purchase
997,731shares of common stock, of which 555,612 were vested as of March 19,
2009, (ii) warrants to purchase up to 1,524,462 shares of common stock, all of
which warrants were vested, or (iii) 3,487,344 shares that may be issued upon a
presently vested right of conversion of a convertible promissory note held
by the Investor.




Our
common stock is listed on the Nasdaq National Market under the symbol "PHMD."
The following table sets forth, for the periods indicated, the high and low
closing sale prices of our common stock, as adjusted for the reverse stock split
of 1-for-7 effective January 26, 2009:




High
                  
                  
                  LowYear
      Ended December 31, 2008:Fourth
      Quarter
                  
                  $
                  3.01
                  
                  
                  $
                  1.26Third
      Quarter
                  
                  
                  5.53
                  
                  
                  
                  2.52Second
      Quarter
                  
                  
                  6.58
                  
                  
                  
                  4.06First
      Quarter
                  
                  
                  7.84
                  
                  
                  
                  5.60Year
      Ended December 31, 2007:Fourth
      Quarter
                  
                  $
                  7.70
                  
                  
                  $
                  5.53Third
      Quarter
                  
                  
                  9.10
                  
                  
                  
                  6.30Second
      Quarter
                  
                  
                  10.08
                  
                  
                  
                  8.05First
      Quarter
                  
                  
                  9.52
                  
                  
                  
                  7.42




On March
19, 2009, the closing market price for our common stock in The Nasdaq National
Market System (“Nasdaq”) was
$2.18 per
share. As of March 19, 2009, we had approximately 830 stockholders of record,
without giving effect to determining the number of stockholders who held shares
in “street name” or other nominee accounts.




Nasdaq
placed our common stock on a watch list on April 25, 2008, due to the fact that
the stock had traded under $1.00 per share for more than 30 consecutive trading
days. The 180-day deadline to regain compliance with the rule was extended
twice, due to deteriorating conditions in the stock market. On February 11,
2009, we received a letter from Nasdaq stating that we were now in compliance
with Nasdaq listing requirements.




Dividend
Policy




We have
not declared or paid any dividend since inception on our common stock. We do not
anticipate that any dividends will be declared or paid in the future on our
common stock.




The
following is a summary of all of our equity compensation plans, including plans
that were assumed through acquisitions and individual arrangements that provide
for the issuance of equity securities as compensation, as of December 31, 2008,
as adjusted to reflect the reverse stock split of 1-for-7 effective January 26,
2009. See Notes 1 and 11 to the consolidated financial statements for additional
discussion.




35





EQUITY COMPENSATION PLAN INFORMATIONNumber ofSecurities to beIssued UponExercise ofOutstandingOptions, Warrantsand Rights
                                
                                
                                Weighted-Average ExercisePrice ofOutstandingOptions,Warrants andRights
                                
                                
                                Number of SecuritiesRemaining Availablefor Future IssuanceUnder EquityCompensation Plans(excluding securitiesreflected in column (A))(A)
                                
                                
                                (B)
                                
                                
                                (C)Equity
      compensation plansapproved
      by security holders
                                
                                
                                1,346,123
                                
                                
                                $
                                11.69
                                
                                
                                
                                568,471Equity
      compensation plans not approved by security holders
                                
                                
                                3,000
                                
                                
                                $
                                12.95
                                
                                
                                
                                -Total
                                
                                
                                1,349,123
                                
                                
                                $
                                11.69
                                
                                
                                
                                568,471




Since
January 1, 2006, no options have been granted to employees or consultants out of
any plans except the 2005 Equity Compensation Plan. Options to our outside
directors will be made from the 2000 Non-Employee Director Stock Option Plan;
options under the 2005 Investment Plan may be made only to executive officers.
Most warrants issued by us have been to investors or placement agents, and no
warrants, including warrants issued to each of CIT Healthcare and Life Sciences
Capital, have been issued pursuant to equity compensation plans. Additionally,
all outstanding options were granted as compensation for benefits inuring to us
other than for benefits from capital-raising activities. With limited exceptions
under Nasdaq membership requirements, we intend in the future to issue options
pursuant to equity compensation plans which have already been approved by our
stockholders without necessity of further, special approval by our
stockholders.




36




Item
      6.
              Selected
      Financial Data




You
should read the following selected historical consolidated financial data in
conjunction with our consolidated financial statements included elsewhere in
this Annual Report and “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” beginning in Item 7 below. The selected
historical consolidated statements of operations data for the years ended
December 31, 2008, December 31, 2007 and December 31, 2006, and the selected
historical consolidated balance sheet data as of December 31, 2008 and December
31, 2007, are derived from our audited consolidated financial statements
included in this Report on Form 10-K. The selected historical consolidated
statements of operations data for the years ended December 31, 2005 and December
31, 2004 and the selected historical consolidated balance sheet data as of
December 31, 2006, December 31, 2005 and December 31, 2004 are derived from our
audited consolidated financial statements not included in this Report. The
historical results presented here are not necessarily indicative of future
results.




Year Ended December 31,(In thousands, except per- share data)2008
                                
                                
                                2007
                                
                                
                                2006
                                
                                
                                2005
                                
                                
                                2004Statement
      of Operations Data:Revenues
                                
                                $
                                34,770
                                
                                
                                $
                                31,046
                                
                                
                                $
                                26,246
                                
                                
                                $
                                20,665
                                
                                
                                $
                                9,919Costs
      of revenues
                                
                                
                                16,995
                                
                                
                                
                                13,486
                                
                                
                                
                                12,768
                                
                                
                                
                                10,000
                                
                                
                                
                                5,363Gross
      profit
                                
                                
                                17,775
                                
                                
                                
                                17,560
                                
                                
                                
                                13,478
                                
                                
                                
                                10,665
                                
                                
                                
                                4,556Selling,
      general and administrative
                                
                                
                                26,797
                                
                                
                                
                                22,375
                                
                                
                                
                                19,722
                                
                                
                                
                                15,284
                                
                                
                                
                                9,062Engineering
      and product development
                                
                                
                                1,073
                                
                                
                                
                                799
                                
                                
                                
                                1,007
                                
                                
                                
                                1,128
                                
                                
                                
                                1,802Loss
      from continuing operations before refinancing charge, interest and other
      income, net
                                
                                
                                (10,095
                                )
                                
                                
                                (5,614
                                )
                                
                                
                                (7,251
                                )
                                
                                
                                (5,747
                                )
                                
                                
                                (6,308
                                )Interest
      income
                                
                                
                                156
                                
                                
                                
                                384
                                
                                
                                
                                149
                                
                                
                                
                                61
                                
                                
                                
                                43Interest
      expense
                                
                                
                                (1,189
                                )
                                
                                
                                (913
                                )
                                
                                
                                (671
                                )
                                
                                
                                (403
                                )
                                
                                
                                (181
                                )Refinancing
      charge
                                
                                
                                -
                                
                                
                                
                                (442
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Other
      income, net
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,302
                                
                                
                                
                                -Loss
      from continuing operations
                                
                                
                                (11,128
                                )
                                
                                
                                (6,585
                                )
                                
                                
                                (7,773
                                )
                                
                                
                                (4,787
                                )
                                
                                
                                (6,446
                                )Discontinued
      operations:Income
      from discontinued operations
                                
                                
                                286
                                
                                
                                
                                231
                                
                                
                                
                                281
                                
                                
                                
                                851
                                
                                
                                
                                1,462Loss
      on sale of discontinued operations
                                
                                
                                (449
                                )
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Net
      loss
                                
                                $
                                (11,291
                                )
                                
                                $
                                (6,354
                                )
                                
                                $
                                (7,492
                                )
                                
                                $
                                (3,936
                                )
                                
                                $
                                (4,984
                                )Basic
      and diluted net loss per share(1):Continuing
      operations
                                
                                $
                                (1.23
                                )
                                
                                $
                                (0.73
                                )
                                
                                $
                                (1.00
                                )
                                
                                $
                                (0.68
                                )
                                
                                $
                                (1.16
                                )Discontinued
      operations
                                
                                
                                (0.02
                                )
                                
                                
                                0.03
                                
                                
                                
                                0.03
                                
                                
                                
                                0.12
                                
                                
                                
                                0.26Basic
      and diluted net loss per share
                                
                                $
                                (1.25
                                )
                                
                                $
                                (0.70
                                )
                                
                                $
                                (0.97
                                )
                                
                                $
                                (0.56
                                )
                                
                                $
                                (0.90
                                )Shares
      used in computing basic and diluted net loss per share (1)
                                
                                
                                9,004
                                
                                
                                
                                8,973
                                
                                
                                
                                7,741
                                
                                
                                
                                6,969
                                
                                
                                
                                5,548Balance
      Sheet Data (At Period End):Cash
      and cash equivalents
                                
                                $
                                3,737
                                
                                
                                $
                                9,954
                                
                                
                                $
                                12,886
                                
                                
                                $
                                5,610
                                
                                
                                $
                                3,997Working
      capital
                                
                                
                                3,408
                                
                                
                                
                                13,706
                                
                                
                                
                                16,070
                                
                                
                                
                                11,151
                                
                                
                                
                                6,119Total
      assets
                                
                                
                                46,714
                                
                                
                                
                                56,687
                                
                                
                                
                                57,482
                                
                                
                                
                                48,675
                                
                                
                                
                                22,962Long-term
      debt (net of current portion)
                                
                                
                                3,985
                                
                                
                                
                                5,709
                                
                                
                                
                                3,727
                                
                                
                                
                                2,437
                                
                                
                                
                                1,399Stockholders’
      equity
                                
                                $
                                29,682
                                
                                
                                $
                                39,533
                                
                                
                                $
                                44,103
                                
                                
                                $
                                38,417
                                
                                
                                $
                                14,580




(1)
            For
      all periods, all common stock equivalents and convertible issues are
      antidilutive and, therefore, are not included in the weighted shares
      outstanding during the years in which we incurred net losses. Share
      amounts and basic and diluted net loss per share amounts shown on the
      condensed statements of operations have been adjusted to reflect the
      reverse stock split of 1-for-7 effective January 26,
  2009.




37




Item
      7.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations




The
following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and related notes included elsewhere in this
Report.




Introduction,
Outlook and Overview of Business Operations




We view
our current business as comprised of the following four business
segments:




·
            Domestic
      XTRAC;




·
            International
      Dermatology Equipment;




·
            Skin
      Care (ProCyte); and




·
            Surgical
      Products.




Domestic
XTRAC




Our
Domestic XTRAC segment is a U.S. business with revenues primarily derived from
procedures performed by dermatologists. We are engaged in the development,
manufacturing and marketing of our proprietary XTRAC® excimer laser and delivery
systems and techniques used in the treatment of inflammatory skin
disorders,including psoriasis,
vitiligo, atopic dermatitis and leukoderma.




As part
of our commercialization strategy in the United States, we offer the XTRAC laser
system to targeted dermatologists at no initial capital cost. Under this
contractual arrangement, we maintain ownership of the laser and earn revenue
each time a physician treats a patient with the equipment. We believe this
arrangement will increase market penetration. At times, however, we sell the
laser directly to the customer for certain reasons, including the costs of
logistical support and customer preference as well as a means of addressing
under-performing accounts while still preserving a vendor-customer relationship.
We are finding that through sales of lasers we are able to reach, at reasonable
margins, a sector of the market that is better suited to a sale model than a
per-procedure model.




For the
last several years we have sought to obtain health insurance coverage for XTRAC
laser therapy to treat inflammatory skin disease, particularly psoriasis. With
the addition of new positive payment policies from Blue Cross Blue Shield plans
from certain states in 2008, we now benefit from the fact that, estimatedly,
more than 90% of the insured United States population has policies that provide
nearly full reimbursement for the treatment of psoriasis by means of an excimer
laser. We are now focusing our efforts on accelerating the adoption of the XTRAC
laser therapy for psoriasis and vitiligo by doctors and patients. Consequently,
we have increased the size of our sales force and clinical technician personnel
together with increased expenditures for marketing and advertising.




Our
36-person XTRAC sales organization includes 21 sales representatives, 11
clinical specialists and 4 marketing support personnel. Our 26-person skin care
sales organization includes 20 sales representatives, 4 customer service
representatives and 2 marketing support personnel. The sales representatives in
each segment provide follow-up sales support and share sales leads to enhance
opportunities for cross-selling. Our marketing department has been instrumental
in expanding the advertising campaign for the XTRAC laser system.




We have tried various
direct-to-consumer marketing programs that have positively influenced
utilization, but the increase in utilization is expected to be attained in
periods subsequent to the period in which we incurred the expense. We have also
increased the number of sales representatives and established a group of
clinical support specialists to optimize utilization levels and better secure
the willingness and interest of patients to seek follow-up courses of treatment
after the effect of the first battery of treatment sessions starts to wear off.
We have recently promoted a regional sales director in the Domestic XTRAC
segment to head up XTRAC marketing operations, with the aim of helping our less
successful customers emulate the business and clinical methods of our more
successful customers.




38




International
Dermatology Equipment




In the
international market, we derive revenues by selling our dermatology laser and
lamp systems and replacement parts to distributors and directly to physicians.
In this market, we have benefited from both our clinical studies and from the
improved reliability and functionality of the XTRAC laser system. Compared
to the domestic segment, the sales of laser and lamp systems in the
international segment are influenced to a greater degree by competition from
similar laser technologies as well as non-laser lamp alternatives. Over time,
this competition has reduced the prices we are able to charge to international
distributors for our XTRAC products. To compete with other non-laser UVB
products, we offer a lower-priced, lamp-based system called the VTRAC. We
expanded the international marketing of the VTRAC since its introduction in
2006. The VTRAC is used to treat psoriasis and vitiligo.




Skin
Care (ProCyte)




The Skin
Care segment generates revenues primarily from the sale of skin health, hair
care and wound care products. In prior periods, the sale of copper peptide
compound in bulk; and royalties on licenses for the patented copper peptide
compound were a significant factor in our revenues.




ProCyte’s
focus has been to provide unique products, primarily based upon patented
technologies for selected applications in the dermatology, plastic and cosmetic
surgery and medical spa markets. ProCyte has also expanded the use of its novel
copper peptide technologies into the mass retail market for skin and hair care
through targeted technology licensing and supply agreements.




ProCyte’s
products are aimed at the growing demand for skin health and hair care products,
including products to enhance appearance and address the effects of aging on
skin and hair. ProCyte’s products are formulated, branded and targeted at
specific markets. ProCyte’s initial products addressed the dermatology, plastic
and cosmetic surgery markets for use after various procedures. Anti-aging skin
care products were added to offer a comprehensive approach for a patient’s skin
care regimen.




Surgical
Products




The
Surgical Products segment generates revenues by selling laser products and
disposables to hospitals and surgery centers both inside and outside of the
United States. Also included are various non-laser surgical products (e.g. the
ClearEss® II suction-irrigation system). We believe that sales of surgical laser
systems and the related disposable base will tend to erode as hospitals continue
to seek outsourcing solutions instead of purchasing lasers and related
disposables for their operating rooms. We are working to offset such erosion by
increasing sales from the Diode surgical laser, including OEM arrangements.
Sales to AngioDynamics (as discussed below) helped increase surgical products
sales in 2008.




In
September 2007, we entered into a three-year OEM agreement with AngioDynamics
under which we manufacture for AngioDynamics, on a non-exclusive basis, a
private-label, 980-nanometer diode laser system. The OEM agreement provides that
we shall supply this laser on an exclusive basis to AngioDynamics, should
AngioDynamics meet certain purchase requirements. Through September 30, 2008
shipments to AngioDynamics exceeded the minimum purchase requirement for
delivery of lasers over the first contract year and therefore triggered
exclusivity for worldwide sale in the peripheral vascular treatment field.
Recently, however, AngioDynamics purchased the assets of a competitive diode
laser company, and if it elects to source its diodes through the assets so
purchased, our future sales of diode lasers to AngioDynamics under this
exclusive arrangement may be severely limited. There were no shipments to
AngioDynamics in the last six months ended December 31, 2008.




Sale
of Surgical Services Business




Surgical
Services was a fee-based procedures business using mobile surgical laser
equipment operated by our technicians at hospitals and surgery centers in the
United States. We decided to sell this division primarily because the growth
rates and operating margins of the division have decreased as the business had
changed to rely more heavily upon procedures performed using equipment from
third-party suppliers, thereby limiting the profit potential of these services.
After preliminary investigations and discussions, our Board of Directors
decided, with the aid of its investment banker, on June 13, 2008 to enter into
substantive, confidential discussions with potential third-party buyers and
began to develop plans for implementing a disposal of the assets and operations
of the business. On August 1, 2008, we entered into a definitive agreement to
sell specific assets of the business including accounts receivable, inventory
and equipment, for $3,500,000, subject to certain closing adjustments. The sale
closed on August 8, 2008 and such closing adjustments resulted in net proceeds
to us of approximately $3 million.




39




Acquisition
of the Subsidiaries of PTL




On
February 27, 2009, we completed the acquisition of PTL, Under the terms of the
acquisition agreement, the initial purchase price of $13 million paid at closing
(“PTL Closing”), and under an earn-out provision, up to an additional $7 million
of consideration may be paid to the sellers if certain gross profit milestones
are met by the acquired PTL business between July 1, 2008 and
June 30, 2009, subject to customary adjustments. The acquisition was funded
through a convertible debt investment of $18 million from the
Investor that closed simultaneously with the PTL Closing. The
convertible note transaction financed the $13 million purchase price of the
acquisition, and a further $5 million in working capital at the closing of the
acquisition. Under the terms of the investment, the Investor will make up to an
additional $7 million convertible debt investment in PhotoMedex in the event the
additional consideration is payable under the terms of the PTL acquisition.
After the payment of approximately $2 million of transaction expenses associated
with the acquisition and the debt investment, we will have approximately $3
million remaining for use as working capital.




At the
PTL Closing, in exchange for the Investor’s payment to us of a purchase price of
$18 million, we issued the Investor (i) a Note in the principal amount of $18
million and (ii) a Warrant to purchase 1,046,204 shares of our common
stock. At the PTL Closing, we also paid the Investor a transaction fee of
$210,000 in cash.




In
addition, at the PTL Closing we and the Investor entered into that certain
Pledge and Security Agreement (the “Security Agreement”). As security for our
obligations to the Investor under the SPA and the Notes, we granted the Investor
a first priority security interest in: (i) all of the stock of (A) ProCyte
Corporation, our wholly-owned subsidiary, and (B) Photo Therapeutics, Inc.,
which became our wholly-owned subsidiary at the PT Closing; (ii) 65% of the
stock of Photo Therapeutics Limited, which also became our wholly-owned
subsidiary of the Company at the PTL Closing; and (iii) certain other
assets of the Company.




Reverse
Stock Split




On
January 26, 2009, we completed the reverse split of its common stock in the
ratio of 1-for-7. Our common stock began trading at the market opening on
January 27, 2009 on a split-adjusted basis. The reverse split is intended to
enable us to increase our marketability to institutional investors and to
maintain our listing on the Nasdaq, among other benefits. As a result of the
stock split, we now has 9,005,175 shares of common
stock outstanding, taking into account the rounding up of fractional
shares.




Critical
Accounting Policies




The
discussion and analysis of our financial condition and results of operations in
this Report are based upon our Consolidated Financial Statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements requires management to
make estimates and judgments that affect the reported amounts of assets and
liabilities, revenues and expenses and disclosures at the date of the financial
statements. On an on-going basis, we evaluate our estimates, including, but not
limited to, those related to revenue recognition, accounts receivable,
inventories, impairment of property and equipment and of intangibles and
accruals for warranty claims. We use authoritative pronouncements, historical
experience and other assumptions as the basis for making estimates. Actual
results could differ from those estimates. Management believes that the
following critical accounting policies affect our more significant judgments and
estimates in the preparation of our Consolidated Financial Statements. These
critical accounting policies and the significant estimates made in accordance
with these policies have been discussed with our Audit Committee.




40




Revenue
Recognition




XTRAC-Related
Operations




We have two distribution channels for
our phototherapy treatment equipment. We either (i) sell the laser through a
distributor or directly to a physician or (ii) place the laser in a physician’s
offices (at no charge to the physician) and charge the physician a fee for an
agreed-upon number of treatments. In some cases, we and the customer stipulate
to a quarterly target of procedures to be performed. When we sell an XTRAC laser
to a distributor or directly to a foreign or domestic physician, revenue is
recognized when the following four criteria under Staff Accounting Bulletin No.
104 have been met: (i) the product has been shipped and we have no significant
remaining obligations; (ii) persuasive evidence of an arrangement exists; (iii)
the price to the buyer is fixed or determinable; and (iv) collection is probable
(the “SAB 104 Criteria”). At times, units are shipped, but revenue is not
recognized until all of the SAB 104 Criteria have been met, and until that time,
the unit is carried on our books as inventory.




We ship most of our products FOB
shipping point, although from time to time certain customers, for example
governmental customers, will insist upon FOB destination. Among the factors we
take into account in determining the proper time at which to recognize revenue
are when title to the goods transfers and when the risk of loss transfers.
Shipments to distributors or physicians that do not fully satisfy the collection
criteria are recognized when invoiced amounts are fully paid or
assured.




Under the terms of our distributor
agreements, distributors do not have a unilateral right to return any unit that
they have purchased. However, we do allow products to be returned, under
warranty, by our distributors for product defects or other claims.




When we place a laser in a physician’s
office, we recognize service revenue based on the number of patient treatments
performed by the physician. Treatments in the form of random laser-access codes
that are sold to physicians, but not yet used, are deferred and recognized as a
liability until the physician performs the treatment. Unused treatments remain
an obligation of ours because the treatments can only be performed on our
equipment. Once the treatments are delivered to a patient, this obligation has
been satisfied.




We exclude all sales of treatment codes
made within the last two weeks of the period in determining the number of
procedures performed by our physician-customers. Our management believes this
approach closely approximates the actual number of unused treatments that
existed at the end of a period. For the years ended December 31, 2008 and 2007,
we deferred $670,546 and $563,336, respectively, under this
approach.




Skin Care
Operations




We
generate revenues from our Skin Care business primarily through product sales
for skin health, hair care and wound care. Sales in bulk of the copper peptide
compound, and royalties related thereto, are no longer a significant factor in
our revenues. We recognize revenues on the products and copper peptide compound
when they are shipped, net of returns and allowances. We ship the products FOB
shipping point.




Surgical Products and
Service Operations




We generate revenues from our surgical
business primarily from product sales of laser systems, related maintenance
service agreements, recurring laser delivery systems and laser accessories. We
recognize revenues from surgical laser and other product sales, including sales
to distributors and other customers, when the SAB 104 Criteria have been
met.




Revenue
from maintenance service agreements is deferred and recognized on a
straight-line basis over the term of the agreements. Revenue from billable
services, including repair activity, is recognized when the service is
provided.




41




Inventory.  We account for
inventory at the lower of cost (first-in, first-out) or market. Cost is
determined to be purchased cost for raw materials and the production cost
(materials, labor and indirect manufacturing cost) for work-in-process and
finished goods. Throughout the laser manufacturing process, the related
production costs are recorded within inventory. Work-in-process is immaterial,
given the typically short manufacturing cycle, and therefore is disclosed in
conjunction with raw materials. We perform full physical inventory counts for
XTRAC and cycle counts on the other inventory to maintain controls and obtain
accurate data.




Our XTRAC laser is either (i) sold to
distributors or physicians directly or (ii) placed in a physician's office and
remains our property. The cost to build a laser, whether for sale or for
placement, is accumulated in inventory. When a laser is placed in a physician’s
office, the cost is transferred from inventory to “lasers in service” within
property and equipment. At times, units are shipped to distributors, but revenue
is not recognized until all of the SAB 104 Criteria have been met, and until
that time, the unit is carried on our books as inventory. Revenue is not
recognized from these distributors until payment is either assured or paid in
full.




Reserves for slow-moving and obsolete
inventories are provided based on historical experience and product demand.
Management evaluates the adequacy of these reserves periodically based on
forecasted sales and market trends.




Allowance for
Doubtful Accounts.  Accounts
receivable are reduced by an allowance for amounts that may become uncollectible
in the future. The majority of receivables related to phototherapy sales are due
from various distributors located outside of the United States and from
physicians located inside the United States. The majority of receivables related
to skincare products and surgical products are due from various customers and
distributors located inside the United States. From time to time, our customers
dispute the amounts due to us, and, in other cases, our customers experience
financial difficulties and cannot pay on a timely basis. In certain instances,
these factors ultimately result in uncollectible accounts. The determination of
the appropriate reserve needed for uncollectible accounts involves significant
judgment. Such factors include changes in the financial condition of our
customers as a result of industry, economic or customer-specific factors. A
change in the factors used to evaluate collectability could result in a
significant change in the reserve needed.




Property and
Equipment.  As of December 31, 2008 and 2007, we had net
property and equipment of $10,388,406 and $8,024,461, respectively. The most
significant component of these amounts relates to the XTRAC lasers placed by us
in physicians’ offices. We own the equipment and charge the physician on a
per-treatment basis for use of the equipment. The recoverability of the net
carrying value of the lasers is predicated on continuing revenues from the
physicians’ use of the lasers. If the physician does not generate sufficient
treatments, then we may remove the laser from the physician’s office and
redeploy elsewhere. As a result of their improved reliability, XTRAC lasers
placed in service after December 31, 2005 are depreciated on a straight-line
basis over the estimated useful life of five-years; other XTRAC
lasers-in-service were depreciated over the original useful life of three years.
For other property and equipment, including property and equipment acquired from
ProCyte, depreciation is calculated on a straight-line basis over the estimated
useful lives of the assets, primarily three to seven years for computer hardware
and software, furniture and fixtures, automobiles, and machinery and equipment.
Leasehold improvements are amortized over the lesser of the useful lives or
lease terms. Useful lives are determined based upon an estimate of either
physical or economic obsolescence, or both.




Intangibles.  Our balance sheet
includes goodwill and other intangible assets which affect the amount of future
period amortization expense and possible impairment expense that we will incur.
Management’s judgments regarding the existence of impairment indicators are
based on various factors, including market conditions and operational
performance of our business. As of December 31, 2008 and 2007, we had
$19,155,895 and $20,933,681, respectively, of goodwill and other intangibles,
accounting for 41% and 37% of our total assets at the respective dates. The
goodwill is not amortizable; the other intangibles are. The determination of the
value of such intangible assets requires management to make estimates and
assumptions that affect our consolidated financial statements. We test our
goodwill for impairment, at least annually. This test is usually conducted in
December of each year in connection with the annual budgeting and forecast
process. Also, on a quarterly basis, we evaluate whether events have occurred
that would negatively impact the realizable value of our intangibles or
goodwill.




There has
been no change in 2008 and 2007 to the carrying value of goodwill that is
allocated to the XTRAC domestic segment and the International Dermatology
Equipment segment .In connection with the acquisition of ProCyte on March 18,
2005, we acquired certain intangibles recorded at fair value as of the date of
acquisition and allocated them fully to the Skin Care (ProCyte) segment. As of
December 31, 2008, the Neutrogena Agreement was reduced to its fair value of
$0.




42


The
balances of these acquired intangibles, net of amortization, were:




December 31,2008
                  
                  
                  2007ProCyte
      Neutrogena Agreement
                  
                  $
                  -
                  
                  
                  $
                  1,062,000ProCyte
      Customer Relationships
                  
                  
                  412,265
                  
                  
                  
                  752,261ProCyte
      Tradename
                  
                  
                  683,360
                  
                  
                  
                  793,364ProCyte
      Developed Technologies
                  
                  
                  91,784
                  
                  
                  
                  120,356Goodwill
                  
                  
                  13,973,385
                  
                  
                  
                  13,973,385Total
                  
                  $
                  15,160,794
                  
                  
                  $
                  16,701,366




Deferred Income
Taxes.  We have a deferred tax asset that is fully reserved by
a valuation allowance. We have not recognized the deferred tax asset, given our
historical losses and the lack of certainty of future taxable income. However,
if and when we become profitable and can reasonably foresee continuing
profitability, then under SFAS No. 109 we may recognize some of the deferred tax
asset. Therecognized portion may
variously reduce acquired goodwill, increase stockholders’ equity directly
and/or benefit the statement of operations.




Warranty
Accruals.  We establish a
liability for warranty repairs based on estimated future claims for XTRAC
systems and based on historical analysis of the cost of the repairs for surgical
laser systems. However, future returns of defective laser systems and related
warranty liability could differ significantly from estimates, and historical
patterns, which would adversely affect our operating results.




Results
of Operations




Revenues


The
following table illustrates revenues from our four business segments for the
periods listed below:




For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Dermatology:XTRAC
      Domestic Services
                  
                  $
                  12,419,972
                  
                  
                  $
                  9,141,857
                  
                  
                  $
                  5,611,387International
      Dermatology Equipment Products
                  
                  
                  3,782,456
                  
                  
                  
                  3,256,505
                  
                  
                  
                  2,186,424Skin
      Care (ProCyte) Products
                  
                  
                  12,829,816
                  
                  
                  
                  13,471,973
                  
                  
                  
                  12,646,910Total
      Dermatology Revenues
                  
                  $
                  29,032,244
                  
                  
                  $
                  25,870,335
                  
                  
                  $
                  20,444,721Surgical:Surgical
      Products
                  
                  $
                  5,738,048
                  
                  
                  $
                  5,176,108
                  
                  
                  $
                  5,800,865Total
      Surgical Revenues
                  
                  $
                  5,738,048
                  
                  
                  $
                  5,176,108
                  
                  
                  $
                  5,800,865Total
      Revenues
                  
                  $
                  34,770,292
                  
                  
                  $
                  31,046,443
                  
                  
                  $
                  26,245,585




Revenues
from our Surgical Services segment, in the amount of $4,398,047 through August
4, 2008, the date of sale, have been accounted for in 2008 as a discontinued
operation. Revenues from our Surgical Services segment were $7,667,174 and
$6,994,291 for the years ended December 31, 2007 and 2006 were reclassified to
discontinued operations.




43




Domestic XTRAC
Segment




Recognized treatment revenue for the
years ended December 31, 2008, 2007, and 2006 was $8,500,452, $6,981,223 and
$5,142,022, respectively, reflecting billed procedures of 133,594, 109,139 and
83,272, respectively. In addition, 6,899, 4,157 and 5,168 procedures were
performed for the years ended December 31, 2008, 2007 and 2006, respectively,
without billing from us, in connection with clinical research and customer
evaluations of the XTRAC laser. The increase in procedures in the year ended
December 31, 2008 compared to the same periods in 2007 and 2006 was largely
related to our continuing progress in securing favorable reimbursement policies
from private insurance plans and to our increased marketing programs. Increases
in procedures are dependent upon building market acceptance through marketing
programs with our physician partners and their patients that the XTRAC
procedures will be of clinical benefit and be generally reimbursed.




We have a program to support certain
physicians who may be denied reimbursement by private insurance carriers for
XTRAC treatments. In accordance with the requirements of SAB No. 104, we
recognize service revenue during this program from the sale of XTRAC procedures
or equivalent treatments to physicians participating in this program only to the
extent the physician has been reimbursed for the treatments. For the year ended
December 31, 2008, we deferred revenues of $109,777 (1,682 procedures) net,
under this program, compared to deferred revenues of $103,851 (1,587 procedures)
net, under this program for the year ended December 31, 2007. For the year ended
December 31, 2006, we deferred revenues of $124,427, (1,897 procedures)
net, under this program. The change in deferred revenue under this program is
presented in the table below.




For the years ended December 31, 2008
and 2007, domestic XTRAC laser sales were $3,919,520 and $2,160,634,
respectively. There were 78 and 43 lasers sold, respectively. Included in the
year ended December 31, 2008 laser sales was a sale of one Omnilux® product from
PTL for which we have been acting as a distributor in the United States. There
were 11 XTRAC lasers sold for the year ended December 31, 2006 for a total of
$469,365. Laser sales have been made for various reasons, including costs of
logistical support and customer preferences. We are finding that through sales
of lasers we are able to reach, at reasonable margins, a sector of the market
that is better suited to a sale model than a per-procedure model.




The following table illustrates the
above analysis for the Domestic XTRAC segment for the periods reflected
below:




For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Total
      revenue
                  
                  $
                  12,419,972
                  
                  
                  $
                  9,141,857
                  
                  
                  $
                  5,611,387Less:
      laser sales revenue
                  
                  
                  (3,919,520
                  )
                  
                  
                  (2,160,634
                  )
                  
                  
                  (469,365
                  )Recognized
      treatment revenue
                  
                  
                  8,500,452
                  
                  
                  
                  6,981,223
                  
                  
                  
                  5,142,022Change
      in deferred program revenue
                  
                  
                  109,777
                  
                  
                  
                  103,851
                  
                  
                  
                  124,427Change
      in deferred unused treatments
                  
                  
                  107,210
                  
                  
                  
                  56,896
                  
                  
                  
                  194,869Net
      billed treatment revenue
                  
                  
                  8,717,439
                  
                  
                  
                  7,141,970
                  
                  
                  
                  5,461,318Procedure
      volume total
                  
                  
                  140,493
                  
                  
                  
                  113,296
                  
                  
                  
                  88,440Less:
      Non-billed procedures
                  
                  
                  6,899
                  
                  
                  
                  4,157
                  
                  
                  
                  5,168Net
      billed procedures
                  
                  
                  133,594
                  
                  
                  
                  109,139
                  
                  
                  
                  83,272Avg.
      price of treatments sold
                  
                  $
                  65.25
                  
                  
                  $
                  65.44
                  
                  
                  $
                  65.58Procedures
      with deferred program revenue, net
                  
                  
                  1,682
                  
                  
                  
                  1,587
                  
                  
                  
                  1,897Procedures
      with deferred unused treatments, net
                  
                  
                  1,643
                  
                  
                  
                  869
                  
                  
                  
                  2,971




The average price for a treatment may
be reduced in some instances based on the volume of treatments performed. The
average price for a treatment also varies based upon the mix of mild and
moderate psoriasis patients treated by our physician partners. We charge a
higher price per treatment for moderate psoriasis patients due to the increased
body surface area required to be treated, although there are fewer patients with
moderate psoriasis than there are with mild psoriasis.




44




International Dermatology
Equipment Segment




International
sales of our XTRAC and VTRAC systems and related parts were $3,782,456 for the
year ended December 31, 2008 compared to $3,256,505 and $2,186,424 for the
years ended December 31, 2007 and 2006, respectively. We sold 86 systems in
the year ended December 31, 2008 which compared to 65 and 46 systems in the
years ended December 31, 2007 and 2006, respectively. The average price of
dermatology equipment sold internationally varies due to the quantity mix of
refurbished domestic XTRAC systems and VTRACs sold. Both of these products have
lower average selling prices than new XTRAC laser systems. However, by adding
these to our product offerings along with expanding into new geographic
territories where the products are sold, we have been able to increase overall
international dermatology equipment revenues.




·
            We
      sell refurbished domestic XTRAC laser systems into the international
      market. The selling price for used equipment is substantially less than
      new equipment, some of which may be substantially depreciated in
      connection with its use in the domestic market. We sold 11 of these used
      lasers in the year ended December 31, 2008 at an average price of $33,000.
      We sold five and six of these used lasers, at an average price of $36,500
      and $28,000 for the years ended December 31, 2007 and 2006, respectively;
      and




·
            In
      addition to the XTRAC laser system (both new and used) we sell the VTRAC,
      a lamp-based, alternative UVB light source that has a wholesale sales
      price that is substantially below our competitors’ international
      dermatology equipment and below our XTRAC laser. In the years ended
      December 31, 2008, 2007 and 2006, we sold 34, 20 and 12 VTRAC systems,
      respectively.




The
following table illustrates the key changes in the International Dermatology
Equipment segment for the periods reflected below:




For the Year Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Revenues
                    
                    $
                    3,782,456
                    
                    
                    $
                    3,256,505
                    
                    
                    $
                    2,186,424Less:
      part sales
                    
                    
                    (664,456
                    )
                    
                    
                    (543,015
                    )
                    
                    
                    (322,964
                    )Laser/lamp
      revenues
                    
                    
                    3,118,000
                    
                    
                    
                    2,713,490
                    
                    
                    
                    1,863,460Laser/lamp
      systems sold
                    
                    
                    86
                    
                    
                    
                    65
                    
                    
                    
                    46Average
      revenue per laser/lamp
                    
                    $
                    36,256
                    
                    
                    $
                    41,746
                    
                    
                    $
                    40,510




Skin Care (ProCyte)
Segment




For the
year ended December 31, 2008, ProCyte revenues were $12,829,816 compared to
$13,471,973 for the year ended December 31, 2007 and $12,646,910 for the year
ended December 31, 2006. Skin Care revenues are generated primarily from the
sale of various skin and hair care products, and much less so now from the sale
of copper peptide compound and from royalties on licenses.




·
            The
      product sales decreased slightly for the year ended December 31, 2008 due
      to the macro economic conditions and to transitioning from the MD Lash
      product to our internally developed Neova Advanced Essential Lash eyelash
      conditioner. This segment is more susceptible to such economic conditions
      than our other segments because cosmetic products are more likely to be
      discretionary and not medically necessary. Product sales for the fourth
      quarter of 2008 were approximately $2.5 million down from approximately
      $3.9 million for the fourth quarter of
2007.




·
            Included
      in Product sales for the year ended December 31, 2008 were $2,687,241 of
      revenues from MD Lash Factor, an eyelash conditioning product, as part of
      an exclusive license to distribute in the United States. In 2007 there
      were $1,037,212 of revenues as the product was launched in August 2007. We
      have discontinued marketing MD Lash Factor as of January 31, 2009 under
      the terms of an agreement with Allergan, Inc. in settlement
      of certain patent litigation, and are replacing it with our own
      peptide-based conditioner.




45




·
            Bulk
      compound sales decreased by $208,000 for the year ended December 31, 2008
      compared to the year ended December 31, 2007. Minimum contractual
      royalties from Neutrogena expired in November 2007 and as such the
      royalties decreased $268,023 for the year ended December 31, 2008 from the
      year ended December 31, 2007. Royalties for the year ended December 31,
      2007 decreased $25,000 from the year ended December 31,
    2006.




The
following table illustrates the key changes in the Skin Care (ProCyte) segment
for the periods reflected below:




For the Year Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Product
      sales
                    
                    $
                    12,566,839
                    
                    
                    $
                    12,732,973
                    
                    
                    $
                    11,674,510Bulk
      compound sales
                    
                    
                    256,000
                    
                    
                    
                    464,000
                    
                    
                    
                    672,400Royalties
                    
                    
                    6,977
                    
                    
                    
                    275,000
                    
                    
                    
                    300,000Total
      Skin Care revenue
                    
                    $
                    12,829,816
                    
                    
                    $
                    13,471,973
                    
                    
                    $
                    12,646,910




Surgical Products
Segment




Surgical
Products revenues include revenues derived from the sales of surgical laser
systems together with sales of related laser fibers and laser disposables. Sales
of laser systems create recurring sales of laser fibers and laser disposables
that are more profitable than laser systems.




For the
year ended December 31, 2008, surgical products revenues were $5,738,048
compared to $5,176,108 in the year ended December 31, 2007. The increase was
mainly due to our OEM contract with AngioDynamics, which had initial shipments
in December 2007. In the second half of 2008, however, AngioDynamics purchased
the assets of Diomed, a competitive diode laser company. If it elects to source
its diodes through the business which it has purchased, our future sales of
diode lasers to AngioDynamics may be severely limited. Sales to Angio Dynamics
were $0 for the last six months of 2008. Sales to AngioDynamics were $1.4
million for the year ended December 31, 2008 compared to $480,000 for the year
ended December 31, 2007. There were no comparable sales in the year ended
December 31, 2006. We therefore do not expect the OEM business with Angio
Dynamics will recover in the foreseeable future.




Disposables
and fiber sales were consistent with the comparable year ended December 31,
2007. We expect that the disposables base may continue to erode over time as
hospitals continue to seek outsourcing solutions instead of purchasing lasers
and related disposables for their operating rooms.




For the
year ended December 31, 2007, surgical products revenues were $5,176,108
compared to $5,800,864 in the year ended December 31, 2006. The decrease was due
to $436,300 less disposable and fiber sales compared to the prior year period.
Also, there was a decline in the average price per laser sold for the year ended
December 31, 2007 compared to the prior year period.




The
change in average price per laser between the periods, as set forth in the table
below, was largely due to the mix of lasers sold and partly due to the trade
level at which the lasers were sold (i.e. wholesale versus retail). Our diode
laser has replaced our Nd:YAG laser, which had a substantially higher sales
price. Included in laser sales during the years ended December 31, 2008, 2007
and 2006 were sales of 141, 78 and 65 diode lasers, respectively. The diode
lasers have lower sales prices than our other types of lasers, and thus the
increase in the number of diodes sold reduced the average price per laser. We
expect that we will continue to sell more diode lasers than our other types of
lasers into the near future.




46


The
following table illustrates the key changes in the Surgical Products segment for
the periods reflected below:




For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Revenues
                  
                  $
                  5,738,048
                  
                  
                  $
                  5,176,108
                  
                  
                  $
                  5,800,864Percent
      increase/(decrease)
                  
                  
                  10.9
                  %
                  
                  
                  (10.8
                  )%Laser
      systems sold
                  
                  
                  145
                  
                  
                  
                  87
                  
                  
                  
                  80Laser
      system revenues
                  
                  $
                  2,236,000
                  
                  
                  $
                  1,684,000
                  
                  
                  $
                  1,802,000Average
      revenue per laser
                  
                  $
                  15,422
                  
                  
                  $
                  19,356
                  
                  
                  $
                  22,525




Cost
of Revenues




Our cost
of revenues are comprised of product cost of revenues and service cost of
revenues. Within product cost of revenues are the costs of products sold in the
International Dermatology Equipment segment, the Skin Care segment (with
royalties included in the services side of the segment), and the Surgical
Products segment (with laser maintenance fees included in the services side of
this segment). Product costs also include XTRAC domestic laser sales. Within
services cost of revenues are the costs associated with the Domestic XTRAC
segment, excluding the laser sales, as well as costs associated with the
above-referenced royalties and maintenance.




Product
cost of revenues during the year ended December 31, 2008 were $11,968,222,
compared to $9,582,715 for the year ended December 31, 2007. The increase of
$2,385,507 is due to product cost increases from the following business
segments: domestic XTRAC of $978,664; international dermatology equipment of
$170,368; surgical products of $1,013,217; and skin care of $223,258. The
increases are primarily a result of the increased number of laser sales which
have a higher cost percentage than non-laser products. The skin care increase is
the result of third party licensed products which have a higher cost. There were
also increases to the excess and obsolete inventory reserves mainly in the
surgical product, $374,000, and skin care segments, $162,000. Warranty expense,
which is included in cost of goods sold, amounted to $238,662 and $95,314 for
the year ended December 31, 2008 and 2007, respectively.




Product
cost of revenues during the year ended December 31, 2007 were $9,582,715,
compared to $8,571,133 for the year ended December 31, 2006. The increase of
$1,011,582 is due to product cost increases from the following business
segments: domestic XTRAC of $689,893; international dermatology equipment of
$499,115; and skincare of $349,343.The domestic XTRAC and international
dermatology equipment increases were primarily a result of increased number of
laser sales and the skin care increase was a direct result of the increased
sales. These increases were offset, in part, by a decrease of $526,769 for
surgical products.




Services
cost of revenues was $5,027,095 in the year ended December 31, 2008 compared to
$3,998,911 in the year ended December 31, 2007, representing an increase of
$1,028,184. The increase is directly related to the increase in Domestic XTRAC
segment costs of $1,029,175.




Services
cost of revenues was $3,998,911 in the year ended December 31, 2007 compared to
$4,115,822 in the year ended December 31, 2006, representing a decrease of
$116,911. The decrease is directly related to the decrease in Domestic XTRAC
segment costs of $125,692.




Certain
allocable XTRAC manufacturing overhead costs are charged against the XTRAC
service revenues. The manufacturing facility in Carlsbad, California is used
exclusively for the production of the XTRAC lasers, which are placed in
physicians’ offices domestically or sold. The unabsorbed costs, relating to
excess capacity, are allocated to the Domestic XTRAC and the International
Dermatology Equipment segments based on actual production of lasers for each
segment. Included in these allocated manufacturing costs are unabsorbed labor
and direct plant costs.




47




The following table illustrates the key
changes in cost of revenues for the periods reflected below:




For the Year Ended December 31,2008
                
                
                2007
                
                
                2006Product:XTRAC
      Domestic
                
                $
                1,797,397
                
                
                $
                818,733
                
                
                $
                128,840International
      Dermatology Equipment
                
                
                1,871,470
                
                
                
                1,701,102
                
                
                
                1,201,987Skin
      Care
                
                
                4,431,545
                
                
                
                4,208,287
                
                
                
                3,858,944Surgical
      products
                
                
                3,867,810
                
                
                
                2,854,593
                
                
                
                3,381,362Total
      Product costs
                
                $
                11,968,222
                
                
                $
                9,582,715
                
                
                $
                8,571,133Services:XTRAC
      Domestic
                
                $
                4,917,389
                
                
                $
                3,888,214
                
                
                $
                4,013,906Surgical
      products
                
                
                109,706
                
                
                
                110,697
                
                
                
                101,916Total
      Services costs
                
                $
                5,027,095
                
                
                $
                3,998,911
                
                
                $
                4,115,822Total
      Costs of Revenues
                
                $
                16,995,317
                
                
                $
                13,581,626
                
                
                $
                12,686,955




Gross
Profit Analysis




Gross
profit increased to $17,774,975 during the year ended December 31, 2008 from
$17,464,817 during the same period in 2007. As a percentage of revenues, the
gross margin decreased to 51.1% for the year ended December 31, 2008 from 56.3%
for the same period in 2007.




Gross
profit increased to $17,464,817 during the year ended December 31, 2007 from
$13,558,631 during the same period in 2006. As a percentage of revenues, the
gross margins increased to 56.3% for the year ended December 31, 2007 from 51.7%
for the same period in 2006.




The
following table analyzes changes in our gross margin for the periods reflected
below:




Company Profit Analysis
                  
                  For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Revenues
                  
                  $
                  34,770,292
                  
                  
                  $
                  31,046,443
                  
                  
                  $
                  26,245,586Percent
      increase
                  
                  
                  12.0
                  %
                  
                  
                  18.3
                  %Cost
      of revenues
                  
                  
                  16,995,317
                  
                  
                  
                  13,581,626
                  
                  
                  
                  12,686,955Percent
      increase
                  
                  
                  25.1
                  %
                  
                  
                  7.1
                  %Gross
      profit
                  
                  $
                  17,774,975
                  
                  
                  $
                  17,464,817
                  
                  
                  $
                  13,558,631Gross
      margin percentage
                  
                  
                  51.1
                  %
                  
                  
                  56.3
                  %
                  
                  
                  51.7
                  %




The
primary reasons for changes in gross profit for the year ended December 31,
2008, compared to the same period in 2007 were as follows:




·
            We
      sold approximately $1,759,000 worth of additional lasers domestically in
      the year ended December 31, 2008 at lower margins compared to the same
      period in 2007. Certain of these lasers were previously being depreciated.
      The margin on these capital equipment sales was 59% in the year ended
      December 31, 2008 compared to 62% in the comparable period in
      2007.




·
            There
      was an increase in depreciation of $429,000 included in the XTRAC Domestic
      cost of sales as a result of increasing the overall placements of new
      lasers since the year ended December 31,
2007.




·
            There
      was an increase in warranty expense of approximately $143,000 due to the
      increased number of laser sales for the year ended December 31, 2008
      compared to the same period in
2007.




48


·
            Additionally,
      we recorded additional excess and obsolete inventory reserves of
      approximately $579,000 mainly due to the decision to stop production of
      the CTH and CO2 laser systems and for slow-moving skincare
      products.




·
            Skincare
      product revenues included $2,687,241 and $1,037,212 for the year ended
      December 31, 2008 and 2007, respectively, of products which are
      manufactured by a third-party supplier in conjunction with a licensing
      agreement. The margin of these licensed products is lower than the margins
      of other internally developed brands which we
  distribute.




·
            Offsetting
      the above items that had a negative impact on gross profit, we sold a
      greater number of treatment procedures for the XTRAC laser systems in 2008
      than in 2007. Procedure volume increased 22% from 109,139 to 133,594
      billed procedures in the year ended December 31, 2008 compared to the same
      period in 2007. Since each incremental treatment procedure carries
      negligible variable cost, this significantly enhanced profit margins. The
      increase in procedure volume was a direct result of improving insurance
      reimbursement and increased marketing
efforts.




·
            We
      sold approximately $405,000 worth of additional international dermatology
      equipment for the year ended December 31, 2008 compared to the same period
      in 2007.




The
primary reasons for changes in gross profit for the year ended December 31,
2007, compared to the same period in 2006 were as follows:




·
            We
      sold a greater number of treatment procedures for the XTRAC laser systems
      in 2007 than in 2006. Procedure volume increased 31% from 83,272 to
      109,139 billed procedures in the year ended December 31, 2007 compared to
      the same period in 2006. Since each incremental treatment procedure
      carries negligible variable cost, this significantly enhanced profit
      margins. The increase in procedure volume was a direct result of improving
      insurance reimbursement and increased marketing
  efforts.




·
            We
      sold approximately $850,000 worth of additional international dermatology
      equipment for the year ended December 31, 2007 compared to the same period
      in 2006.




·
            We
      sold approximately $1,691,000 worth of additional lasers domestically in
      the year ended December 31, 2007 at lower margins compared to the same
      period in 2006. Certain of these lasers were previously being
      depreciated.




·
            There
      was an increase in warranty expense of approximately $176,000 due to the
      increased number of laser sales for the year ended December 31, 2007
      compared to the same period in
2006.




·
            There
      was an increase in depreciation of $417,000 included in the XTRAC Domestic
      cost of sales as a result of increasing the overall placements of new
      lasers since the year ended December 31,
2006.




The
following table analyzes the gross profit for our Domestic XTRAC segment for the
periods reflected below:




XTRAC Domestic Segment
                  
                  For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Revenues
                  
                  $
                  12,419,972
                  
                  
                  $
                  9,141,857
                  
                  
                  $
                  5,611,387Percent
      increase
                  
                  
                  35.9
                  %
                  
                  
                  62.9
                  %Cost
      of revenues
                  
                  
                  6,714,786
                  
                  
                  
                  4,706,947
                  
                  
                  
                  4,142,746Percent
      increase
                  
                  
                  42.7
                  %
                  
                  
                  11.7
                  %Gross
      profit
                  
                  $
                  5,705,186
                  
                  
                  $
                  4,434,910
                  
                  
                  $
                  1,468,641Gross
      margin percentage
                  
                  
                  45.9
                  %
                  
                  
                  48.5
                  %
                  
                  
                  26.2
                  %




Gross
profit increased for this segment for the year ended December 31, 2008 from the
comparable periods in 2007 by $1,270,276. The key factors were as
follows:




49




·
            XTRAC
      Domestic deferred revenues increased $151,612 between the year-end periods
      without any offset in the cost of
revenues.




·
            The
      cost of revenues increased by $2,007,839 for the year ended December 31,
      2008. This increase is due to an increase in depreciation on the
      lasers-in-service of $429,000, an increase in cost of revenues related to
      the laser sales of $978,700 and an increase in warranty expense of $88,700
      over the comparable prior period. The depreciation costs will continue to
      increase in subsequent periods as the business grows. In addition, there
      were unabsorbed costs, relating to excess capacity, allocated to the
      Domestic XTRAC including unabsorbed labor and direct plant
      costs.




·
            We
      sold approximately $1,759,000 worth of additional domestic XTRAC lasers in
      the year ended December 31, 2008 at lower margins compared to the same
      period in 2007. Certain of these lasers were previously being depreciated,
      since they were placements. The margin on these capital equipment sales
      was 59% in the year ended December 31, 2008 compared to 62% in the
      comparable period in 2007.




·
            Key
      drivers in increasing the fee-per-procedure revenue from this segment are
      insurance reimbursement and increased direct-to-consumer advertising in
      targeted territories. Improved insurance reimbursement, together with
      greater consumer awareness of the XTRAC therapy, increase treatment
      revenue accordingly. Our clinical support specialists focus their efforts
      on increasing physicians’ utilization of the XTRAC laser system.
      Consequently procedure volume increased 22% from 109,139 to 133,594 billed
      procedures in the year ended December 31, 2008 compared to the same period
      in 2007. Price per procedure did not change significantly between the
      periods. Each incremental treatment procedure carries negligible variable
      cost.




Gross
profit increased for this segment for the year ended December 31, 2007 from the
comparable period in 2006 by $2,966,269. The key factors were as
follows:




·
            XTRAC
      Domestic deferred revenues increased $49,011 between the year-end periods
      without any offset in the cost of revenues which is consistent with a
      procedures-based model.




·
            We
      sold approximately $1,691,000 worth of additional domestic XTRAC lasers in
      the year ended December 31, 2007 at lower margins compared to the same
      period in 2006. Certain of these lasers were previously being depreciated,
      since they were originally placements. The margin on these capital
      equipment sales was 62% in the year ended December 31, 2007 compared to
      73% in the comparable period in
2006.




·
            The
      cost of revenues increased by $564,201 for the year ended December 31,
      2007. This increase is due to an increase in depreciation on the
      lasers-in-service of $416,700, an increase in cost of revenues related to
      the laser sales of $690,000 and an increase in warranty expense of
      $176,000 over the comparable prior period. The depreciation costs will
      continue to increase in subsequent periods as the business
      grows.




·
            Key
      drivers in increasing the fee-per-procedure revenue from this segment are
      insurance reimbursement and increased direct-to-consumer advertising in
      targeted territories. Improved insurance reimbursement, together with
      greater consumer awareness of the XTRAC therapy, increase treatment
      revenue accordingly. Our clinical support specialists focus their efforts
      on increasing physicians’ utilization of the XTRAC laser system.
      Consequently procedure volume increased 31% from 83,272 to 109,139 billed
      procedures in the year ended December 31, 2007 compared to the same period
      in 2006. Price per procedure did not change significantly between the
      periods. Each incremental treatment procedure carries negligible variable
      cost.




50




The
following table analyzes the gross profit for our International Dermatology
Equipment segment for the periods reflected below:




International Dermatology Equipment
                    Segment
                  
                  For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Revenues
                  
                  $
                  3,782,456
                  
                  
                  $
                  3,256,505
                  
                  
                  $
                  2,186,424Percent
      increase
                  
                  
                  16.2
                  %
                  
                  
                  48.9
                  %Cost
      of revenues
                  
                  
                  1,871,470
                  
                  
                  
                  1,701,102
                  
                  
                  
                  1,201,987Percent
      increase
                  
                  
                  10.0
                  %
                  
                  
                  41.5
                  %Gross
      profit
                  
                  $
                  1,910,986
                  
                  
                  $
                  1,555,403
                  
                  
                  $
                  984,437Gross
      margin percentage
                  
                  
                  50.5
                  %
                  
                  
                  47.8
                  %
                  
                  
                  45.0
                  %




Gross
profit for the year ended December 31, 2008 increased by $355,583 from the
comparable prior year period. The key factors for the increase were as
follows:




·
            We
      sold 52 XTRAC laser systems and 34 VTRAC lamp-based excimer systems during
      the year ended December 31, 2008 and 45 XTRAC laser systems and 20 VTRAC
      systems in the comparable period in 2007. Consequently, gross profit
      increased as a result of an increase in the volume of units sold. The
      gross margin percentage for the VTRAC is higher than the
      XTRAC.




·
            International
      part sales, which have a higher margin percentage than system sales,
      increased for the year ended December 31, 2008 by approximately $121,400
      compared to the same period in
2007.




Gross
profit for the year ended December 31, 2007 increased by $570,966 from the
comparable prior year period. The key factors in this business segment were as
follows:




·
            We
      sold 45 XTRAC laser systems and 20 VTRAC lamp-based excimer systems during
      the year ended December 31, 2007 and 34 XTRAC laser systems and 12 VTRAC
      systems in the comparable period in
2006.




·
            Additionally,
      international part sales increased for the year ended December 31, 2007 by
      approximately $219,000 compared to the same period in
  2006.




51




The
following table analyzes our gross margin for our Skin Care (ProCyte) segment
for the periods presented below:




Skin Care (ProCyte) Segment
                  
                  For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Product
      revenues
                  
                  $
                  12,566,839
                  
                  
                  $
                  12,732,973
                  
                  
                  $
                  11,674,510Bulk
      compound revenues
                  
                  
                  256,000
                  
                  
                  
                  464,000
                  
                  
                  
                  672,400Royalties
                  
                  
                  6,977
                  
                  
                  
                  275,000
                  
                  
                  
                  300,000Total
      revenues
                  
                  
                  12,829,816
                  
                  
                  
                  13,471,973
                  
                  
                  
                  12,646,910Percent
      (decrease) increase
                  
                  
                  (4.8
                  )%
                  
                  
                  6.5
                  %Product
      cost of revenues
                  
                  
                  4,249,273
                  
                  
                  
                  3,885,229
                  
                  
                  
                  3,441,636Bulk
      compound cost of revenues
                  
                  
                  182,272
                  
                  
                  
                  323,058
                  
                  
                  
                  417,308Total
      cost of revenues
                  
                  
                  4,431,545
                  
                  
                  
                  4,208,287
                  
                  
                  
                  3,858,944Percent
      increase
                  
                  
                  5.3
                  %
                  
                  
                  9.1
                  %Gross
      profit
                  
                  $
                  8,398,271
                  
                  
                  $
                  9,263,686
                  
                  
                  $
                  8,787,966Gross
      margin percentage
                  
                  
                  65.5
                  %
                  
                  
                  68.8
                  %
                  
                  
                  69.5
                  %




Gross
profit for the year ended December 31, 2008 decreased by $865,415 over the
comparable period in 2007. The key factors in this business segment were as
follows:




·
            For
      the year ended December 31, 2008 and 2007 product revenues include
      $2,687,241 and $1,037,212, respectively, of products which are
      manufactured by a third-party supplier in conjunction with a licensing
      agreement. The margin of these licensed products is lower than the margins
      of other internally developed brands which we
  distribute.




·
              Copper
      peptide bulk compound is sold at a substantially lower gross margin than
      skincare products, while royalty revenues generated from licensees have no
      significant costs associated with this revenue
  stream.




·
                Additionally, we
      increased the excess and obsolete reserves by approximately $162,000 for
      slow moving products, which had a direct impact on the gross
      margin.




Gross
profit for the year ended December 31, 2007 increased by $475,720 over the
comparable period in 2006. The key factors in this business segment were as
follows:




·
            The
      gross margin for our skin care products is relatively consistent between
      the periods; 68.8% in 2007 and 69.5% in 2006. The increase in total cost
      of revenues of $349,343 in 2007 from 2006 is directly related to the
      increases in revenues.




·
            Copper
      peptide bulk compound is sold at a substantially lower gross margin than
      skincare products, while royalty revenues generated from licensees have no
      significant costs associated with this revenue
  stream.




52




The
following table analyzes our gross profit for our Surgical Products segment for
the periods reflected below:




Surgical Products Segment
                  
                  For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Revenues
                  
                  $
                  5,738,048
                  
                  
                  $
                  5,176,108
                  
                  
                  $
                  5,800,864Percent
      increase (decrease)
                  
                  
                  10.9
                  %
                  
                  
                  (10.8
                  )%Cost
      of revenues
                  
                  
                  3,977,516
                  
                  
                  
                  2,965,290
                  
                  
                  
                  3,483,278Percent
      increase (decrease)
                  
                  
                  34.1
                  %
                  
                  
                  (14.9
                  )%Gross
      profit
                  
                  $
                  1,760,532
                  
                  
                  $
                  2,210,818
                  
                  
                  $
                  2,317,586Gross
      margin percentage
                  
                  
                  30.1
                  %
                  
                  
                  42.7
                  %
                  
                  
                  40.0
                  %




Gross
profit for the year ended December 31, 2008 decreased by $450,286 from the
comparable prior year period. The key factors in this business segment were as
follows:




·
            This
      segment includes product sales of surgical laser systems and laser
      disposables. Disposables are more profitable than laser systems, but the
      sale of laser systems generates the subsequent recurring sale of laser
      disposables.




·
            Revenues
      for the year ended December 31, 2008 increased by $561,940 from the year
      ended December 31, 2007 while cost of revenues increased by $1,012,226
      between the same periods. There were 58 more laser systems sold in the
      year ended December 31, 2008 than in the comparable period of 2007.
      However, the lasers sold in the 2007 period were at higher prices than
      those sold in the comparable period in 2008. The decrease in average price
      per laser was largely due to the mix of lasers sold and volume discounts.
      Included in the laser sales for the year ended December 31, 2008 and 2007
      were sales of diode lasers of $2,026,000 (representing 141 systems) and
      $1,190,000 (representing 78 systems), respectively. Diode lasers have
      substantially lower list sales prices than the other types of surgical
      lasers. The sales of diode systems for the years ended December 31, 2008
      and 2007 included 100 diode lasers and 30 diode lasers, respectively, due
      to our OEM arrangement. Despite the lower average sales price of the laser
      systems sold compared to the prior year, the higher manufacturing levels
      in 2008 caused better absorption of fixed overheads thereby lowering
      average unit costs.




·
            Additionally,
      we increased the excess and obsolete inventory reserves by approximately
      $374,000 due to the decision to stop producing the CTH and CO2 laser
      systems, which should not impact future revenues as there was only one
      sale of these lasers in 2008. This had a direct impact on lowering the
      gross margin for the year ended December 31,
  2008.




Gross
profit for the year ended December 31, 2007 decreased by $106,768 from the
comparable prior year period. The key factors in this business segment were as
follows:




·
            This
      segment includes product sales of surgical laser systems and laser
      disposables. Disposables are more profitable than laser systems, but the
      sale of laser systems generates the subsequent recurring sale of laser
      disposables.




·
            Revenues
      for the year ended December 31, 2007 decreased by $624,756 from the year
      ended December 31, 2006 while cost of revenues decreased by $517,988
      between the same periods. There were 7 more laser systems sold in the year
      ended December 31, 2007 than in the comparable period of 2006. However,
      the lasers sold in the 2006 period were at higher prices than those sold
      in the comparable period in 2007. The decrease in average price per laser
      was largely due to the mix of lasers sold and volume discounts. Included
      in the laser sales for the year ended December 31, 2007 and 2006 were
      sales of $1,190,000, representing 78 systems, and $1,120,000, representing
      65 systems, of diode lasers, respectively, which have substantially lower
      list sales prices than the other types of surgical
  lasers.




53




·
            Additionally
      there was a decrease in sales of disposables between the periods. Fiber
      and other disposables sales decreased 15% between the comparable periods
      ended December 31, 2007 and 2006. This is due in part to having a one-time
      order of approximately $250,000 in the year ended December 31,
      2006.




Selling,
General and Administrative Expenses




For the
year ended December 31, 2008, selling, general and administrative expenses
increased to $26,797,107 from $22,279,534 for the year ended December 31,
2007for the
following reasons:




·
            The
      majority of the increase related to a $2,155,000 increase in salaries,
      benefits and travel expenses associated with an increase in the sales
      force, marketing programs and increased revenues which generate higher
      commission expenses, particularly in the Domestic XTRAC and Skin Care
      segments;




·
            We
      expensed $1,533,000 of costs under SFAS No. 141R incurred in connection
      with the acquisition of Photo
Therapeutics.




·
            We
      wrote off $353,000 for the investment in AzurTec and the related
      intangibles, net due to the dissolution of AzurTec and the impairment of
      the assets.




·
            Additionally,
      we wrote down the Neutrogena Agreement intangible due to impairment by
      $582,000 to its fair value.




For the
year ended December 31, 2007, selling, general and administrative expenses
increased to $22,279,534 from $19,803,179 for the year ended December 31,
2006.




·
            The majority of the increase
      related to a $2,062,000 increase in salaries, benefits and travel expenses
      associated with an increase in the sales force, marketing programs and
      increased revenues which generate higher commission expenses, particularly
      in the Domestic XTRAC and Skin Care segments;
  and




·
            An
      increase of $262,000 for legal
expenses.




Engineering
and Product
Development




Engineering
and product development expenses for the year ended December 31, 2008 increased
to $1,073,215 from $799,108 for the year ended December 31, 2007. The increase
for the year ended December 31, 2008 was due to meeting our financial
sponsorship obligations in March 2008 for the severe psoriasis study by John
Koo, MD, of the University of California at San Francisco, of
$189,000.




Engineering
and product development expenses for the year ended December 31, 2007 decreased
to $799,108 from $1,006,600 for the year ended December 31, 2006. The decrease
is primarily due to a decrease in salaries and related benefits of $154,000 due
to reduced headcount.




Refinancing
Charge




Refinancing charge for the year ended
December 31, 2007 was due to the termination of the lending arrangements with
both GE Capital Corporation and Leaf Financial. This included $108,876 for
prepayment penalties; $178,699 buyback of previously issued warrants to GE; and
$154,381 of unamortized costs for previous draws on the line of credit. These
costs were incurred in order to obtain a new credit facility with CIT on terms
more favorable to us.




Interest
Expense, Net




Net
interest expense for the year ended December 31, 2008 increased to $1,032,597,
as compared to $529,489 for the year ended December 31, 2007. The change in net
interest expense was the result of the interest earned on cash reserves in the
year ended December 31, 2007 due to the equity financing in November 2006, which
offset interest expense in those periods from the draws on the line of credit.
The draws, on average, were for larger amounts at higher rates in 2008 as
compared to 2007. The following table illustrates the change in interest
expense, net:




54




December 31, 2008
                    
                    
                    December 31, 2007
                    
                    
                    ChangeInterest
      expense
                    
                    $
                    1,188,783
                    
                    
                    $
                    913,821
                    
                    
                    $
                    274,962Interest
      income
                    
                    
                    (156,186
                    )
                    
                    
                    (384,332
                    )
                    
                    
                    228,146Net
      interest expense
                    
                    $
                    1,032,597
                    
                    
                    $
                    529,489
                    
                    
                    $
                    503,108




Net
interest expense for the year ended December 31, 2007 increased to $529,489, as
compared to $521,769 for the year ended December 31, 2006. The following table
illustrates the change in interest expense, net:




December 31, 2007
                    
                    
                    December 31, 2006
                    
                    
                    ChangeInterest
      expense
                    
                    $
                    913,821
                    
                    
                    $
                    670,839
                    
                    
                    $
                    242,982Interest
      income
                    
                    
                    (384,332
                    )
                    
                    
                    (149,070
                    )
                    
                    
                    (235,262
                    )Net
      interest expense
                    
                    $
                    529,489
                    
                    
                    $
                    521,769
                    
                    
                    $
                    7,720




Net
Loss




The
aforementioned factors resulted in a net loss of $11,290,907 during the year
ended December 31, 2008, as compared to a net loss of $6,354,246 for the year
ended December 31, 2007, an increase of 77.7%. The year ended December 31, 2008
included a loss on sale of discontinued operations of $448,675. The increase was
also due to expensing the Photo Therapeutics acquisition costs of $1,532,798
pursuant to SFAS No. 141(R), which is in effect for acquisitions closing after
December 31, 2008. Additionally, included in the net loss were impairments to
the fair values of certain intangibles and other long-lived asset of
$934,612.




The
following table illustrates the impact of these components between the
periods:




For the Year ended December 31,2008
                  
                  
                  2007
                  
                  
                  ChangeNet
      loss
                  
                  $
                  11,290,907
                  
                  
                  $
                  6,354,246
                  
                  
                  $
                  4,936,661Components
      included in net loss:Pending
      acquisition expenses
                  
                  
                  (1,532,798
                  )
                  
                  
                  -
                  
                  
                  
                  (1,532,798
                  )Loss
      on sale of discontinued operations
                  
                  
                  (448,675
                  )
                  
                  
                  -
                  
                  
                  
                  (448,675
                  )Impairment
      on intangibles and other long-lived asset
                  
                  
                  (934,612
                  )
                  
                  
                  -
                  
                  
                  
                  (934,612
                  )Refinancing
      charge
                  
                  
                  -
                  
                  
                  
                  (441,956
                  )
                  
                  
                  441,956Interest
      expense, net
                  
                  
                  (1,032,597
                  )
                  
                  
                  (529,489
                  )
                  
                  
                  (503,108
                  )Sales
      and marketing expenses
                  
                  
                  (15,583,293
                  )
                  
                  
                  (12,673,073
                  )
                  
                  
                  (2,910,220
                  )Legal
      expenses
                  
                  
                  (1,437,181
                  )
                  
                  
                  (1,558,387
                  )
                  
                  
                  121,206Depreciation
      and amortization expense
                  
                  
                  (4,542,038
                  )
                  
                  
                  (4,822,035
                  )
                  
                  
                  279,997Stock-based
      compensation expense
                  
                  
                  (1,395,538
                  )
                  
                  
                  (1,444,880
                  )
                  
                  
                  49,342$
                  (26,906,732
                  )
                  
                  $
                  (21,469,820
                  )
                  
                  $
                  (5,436,912
                  )




The
aforementioned factors resulted in a net loss of $6,354,246 during the year
ended December 31, 2007, as compared to a net loss of $7,492,397 for the year
ended December 31, 2006, a decrease of 15.2%. The decrease was primarily due to
an increase in revenues of 16.6% which was offset, in part by increases in
personnel for sales and marketing in the Domestic XTRAC segment of the business.
Also there was a charge to expense of $441,956 due to the costs involved in
refinancing of the GE and Leaf Financial Corporation (“Leaf”) credit
facilities.




55


The
following table illustrates the impact of these components between the
periods:




For the Year ended December 31,2007
                  
                  
                  2006
                  
                  
                  ChangeNet
      loss
                  
                  $
                  6,354,246
                  
                  
                  $
                  7,492,398
                  
                  
                  $
                  (1,138,152
                  )Components
      included in net loss:Refinancing
      charge
                  
                  
                  (441,956
                  )
                  
                  
                  -
                  
                  
                  
                  (441,956
                  )Interest
      expense, net
                  
                  
                  (529,489
                  )
                  
                  
                  (521,769
                  )
                  
                  
                  (7,720
                  )Sales
      and marketing expenses
                  
                  
                  (12,673,073
                  )
                  
                  
                  (10,550,202
                  )
                  
                  
                  (2,122,871
                  )Legal
      expenses
                  
                  
                  (1,558,387
                  )
                  
                  
                  (1,377,772
                  )
                  
                  
                  (180,615
                  )Depreciation
      and amortization expense
                  
                  
                  (4,822,035
                  )
                  
                  
                  (4,199,047
                  )
                  
                  
                  (622,988
                  )Stock-based
      compensation expense
                  
                  
                  (1,444,880
                  )
                  
                  
                  (1,437,170
                  )
                  
                  
                  (7,710
                  )$
                  (21,469,820
                  )
                  
                  $
                  (18,085,960
                  )
                  
                  $
                  (3,383,860
                  )




Income
taxes were immaterial, given our current period losses and operating loss
carryforwards.




Liquidity
and Capital Resources




We have
historically financed our operations with cash provided by equity financing and
from lines of credit.




At
December 31, 2008, our current ratio was 1.26 compared to 2.20 at December 31,
2007. As of December 31, 2008, we had $3,408,187 of working capital compared to
$13,705,775 as of December 31, 2007. Cash and cash equivalents were $3,736,607
as of December 31, 2008, as compared to $9,954,303 as of December 31, 2007. We
had $78,000 of cash that was classified as restricted as of December 31, 2008
compared to $117,000 as of December 31, 2007. The decrease was principally
because we incurred an operating loss in 2008 and because we had no further
availability for credit under our lending facility with CIT. In February 2009,
however, we received an additional $5 million of working capital under the
convertible note from the Investor, approximately $2 million of which will be
used for obligations incurred in connection with the PTL
acquisition.




We
believe that our existing cash balance together (including the working capital
received in the financing of the PTL acquisition), together with our other
existing potential financial resources and any revenues from sales and
distribution, will be sufficient to meet our operating and capital requirements
beyond the second quarter of 2010. The 2009 operating plan reflects increases in
per-treatment fee revenues for use of the XTRAC system based on increased
utilization of the XTRAC by physicians and on wider insurance coverage in the
United States. In addition, the 2009 operating plan calls for increased revenues
and profits from our Skin Care business and a contribution from the newly
acquired business of PTL.




On
December 31, 2007, we entered into a term-note credit facility from CIT
Healthcare and Life Sciences Capital (collectively “CIT”). The credit facility
had a commitment term of one year, which expired on December 31, 2008. We
accounted for each draw as funded indebtedness, with ownership in the lasers
remaining with us. CIT holds a security interest in the lasers and in their
revenue streams. Each draw against the credit facility has a repayment period of
three years, except for legacy components from GE and Leaf in the first draw. On
September 30, 3008, the facility was amended to permit us to make a fourth draw
of $1.9 million in the third quarter of 2008; Life Sciences Capital did not
participate in the fourth draw. We have used our entire availability under the
CIT credit facility and are considering, with CIT’s support, multiple written
proposals, including from CIT, for additional debt financing. However, no
assurance can be given that any such proposal will materialize on terms
favorable to us, if at all. On February 27, 2009, the Investor, LLC funded $5
million of working capital as part of the first tranche of the convertible debt
in connection with our acquisition of Photo Therapeutics. A summary of the terms
and activity under the CIT credit facility is presented in Note 9, “Long-term Debt”, of the
Financial Statements included in this Report.


56


Net cash
and cash equivalents used in operating activities – continuing operations was
$1,294,070 for the year ended December 31, 2008 compared to cash used of
$1,739,728 for the year ended December 31, 2007. The change in cash used between
the years was mostly due to the increases in accounts payable and other accrued
liabilities and decreases in accounts receivable and prepaid expenses and other
assets.




Net cash
and cash equivalents used in operating activities – continuing operations was
$1,739,728 for the year ended December 31, 2007, compared to cash used of
$580,411 for the year ended December 31, 2006. The increase was mostly due to
the increases in accounts receivable and inventory.




Net cash
and cash equivalents used in investing activities – continuing operations was
$2,766,153 for the year ended December 31, 2008 compared to $4,301,624 for the
year ended December 31, 2007. This was primarily for the placement of lasers
into service. The year ended December 31, 2008 was net of proceeds received from
the sale of discontinued operations of $3,149,736.




Net cash
and cash equivalents used in investing activities – continuing operations was
$4,301,624 for the year ended December 31, 2007 compared to $4,028,270 for the
year ended December 31, 2006. This was primarily for the placement of lasers
into service.




When we
retire a laser from service, we transfer the laser into inventory and then write
off the net book value of the laser, which is typically negligible. Over the
last three years, the retirements of lasers from service have been minor or
immaterial and, therefore, they are reported with placements on a net
basis.




Net cash
and cash equivalents used in financing activities was $2,634,849 for the year
ended December 31, 2008 compared to cash provided by financing activities of
$2,659,036 for the year ended December 31, 2007. In the year ended December 31,
2008 we repaid $1,655,123 on the lease and term-note lines of credit, net of
advances and $1,018,726 for the payment of certain notes payable and capital
lease obligations.




Net cash
provided by financing activities was $2,659,036 for the year ended December 31,
2007 compared to $12,292,533 for the year ended December 31, 2006. In the year
ended December 31, 2007 we received $3,314,426 from the advances under the lease
and term-note lines of credit, net of payments, $85,954 from the exercise of
common stock options and a decrease in restricted cash of $39,000. These cash
receipts were offset by $784,543 for the payment of certain notes payable and
capital lease obligations. The year ended December 31, 2006 included $10,547,002
of net cash received from the issuance of common stock.


57


Contractual
Obligations




Set forth
below is a summary of current obligations as of December 31, 2008 to make future
payments due by the period indicated below, excluding payables and accruals. We
expect to be able to meet our obligations in the ordinary course. The
obligations under the credit facility from CIT Healthcare LLC and Life
Sciences Capital are term notes. Operating lease and rental obligations are
respectively for personal and real property which we use in our business. The
table below does not include the $18 million convertible note which we
issued to the Investor in connection with acquisition of PTL on
February 27, 2009.




Payments due by periodContractual Obligations
                  
                  Total
                  
                  
                  Less than 1
                    year
                  
                  
                  1 – 3 years
                  
                  
                  4 – 5 yearsCredit
      facility obligations
                  
                  $
                  8,691,478
                  
                  
                  $
                  4,717,481
                  
                  
                  $
                  3,973,997
                  
                  
                  $
                  -Capital
      lease obligations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Operating
      lease obligations
                  
                  
                  1,410,420
                  
                  
                  
                  524,795
                  
                  
                  
                  885,625
                  
                  
                  
                  -Notes
      payable
                  
                  
                  106,214
                  
                  
                  
                  28,975
                  
                  
                  
                  77,239
                  
                  
                  
                  -Total
                  
                  $
                  10,208,112
                  
                  
                  $
                  5,271,251
                  
                  
                  $
                  4,936,861
                  
                  
                  $
                  -




Our
ability to expand our business operations is currently dependent in significant
part on financing from external sources. There can be no assurance that changes
in our manufacturing and marketing, research and development plans or other
changes affecting our operating expenses and business strategy will not require
financing from external sources before we will be able to develop profitable
operations. Under the terms of the SPA, we must secure the Investor’s approval
for the incurrence of debt or the issuance of equity securities. There can be no
assurance that additional capital will be available on terms favorable to us, if
at all. To the extent that additional capital is raised through the sale of
additional equity or convertible debt securities, the issuance of such
securities could result in additional dilution to our stockholders. Moreover,
our cash requirements may vary materially from those now planned because of
marketing results, product testing, changes in the focus and direction of our
marketing programs, competitive and technological advances, the level of working
capital required to sustain our planned growth, litigation, operating results,
including the extent and duration of operating losses, and other factors. In the
event that we experience the need for additional capital, and are not able to
generate capital from financing sources or from future operations, management
may be required to modify, suspend or discontinue our business
plan.




Off-Balance
Sheet Arrangements




At December 31, 2008, we had no
off-balance sheet arrangements.




Impact
of Inflation




We have
not operated in a highly inflationary period, and we do not believe that
inflation has had a material effect on our sales or expenses.




Item
7A.              Quantitative
and Qualitative Disclosure About Market Risk




As of
December 31, 2008, we were not exposed to market risks due to changes in
interest rates or foreign currency rates and, therefore, we do not use
derivative financial instruments to address risk management issues in connection
with changes in interest rates and foreign currency rates.




Item
      8.
            Financial
      Statements and Supplementary Data.




The
financial statements required by this Item 8 are included in this Report and
begin on page F-1.




58


Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure




None.




Item
9A.          Controls and
Procedures




Controls
and Procedures




As of
December 31, 2008, we carried out an evaluation, under the supervision and
with the participation of our chief executive officer and chief financial
officer, of the effectiveness of the design and operations of our disclosure
controls and procedures, as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended, (the “Exchange Act”).




Our chief
executive officer and chief financial officer concluded that as of the
evaluation date, such disclosure controls and procedures were effective to
ensure that information required to be disclosed by us in the reports we file or
submit under the Exchange Act are recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the Commission, and
is accumulated and communicated to our management, including our chief executive
officer and chief financial officer, as appropriate to allow timely decisions
regarding required disclosure. A control system cannot provide absolute
assurance, however, that the objectives of the controls system are met, and no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, with the Company have been
detected.




There
were no changes in our internal controls over financial reporting during the
year ended December 31, 2008 that materially affected, or were reasonably
likely to materially affect, our internal controls over financial
reporting.




Management’s
report on our internal controls over financial reporting can be found in the
following captioned discussion. The Independent Registered Public Accounting
Firm’s attestation report on management’s assessment of the effectiveness of our
internal control over financial reporting can be found with the attached
financial statements; and is incorporated by reference herein.




Management's Report on Internal
Control Over Financial Reporting





Our management is responsible for
establishing and maintaining an adequate system of internal control over
financial reporting. Our system of internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with accounting principles generally accepted in the United States of
America.




Our internal control over financial
reporting includes those policies and procedures that:




·
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect our transactions and dispositions of  our
      assets;




·
            provide
      reasonable assurance that our transactions are recorded as necessary to
      permit preparation of our financial statements in accordance with
      accounting principles generally accepted in the United States of America,
      and that our receipts and expenditures are being made only in accordance
      with authorizations of our management and our directors;
    and




·
            provide reasonable assurance
      regarding prevention or timely detection of unauthorized acquisition, use,
      or disposition of our assets that could have a material effect on the
      financial statements.




Because of its inherent limitations, a
system of internal control over financial reporting can provide only reasonable
assurance and may not prevent or detect misstatements. Further, because of
changes in conditions, effectiveness of internal controls over financial
reporting may vary over time. Our system contains self-monitoring mechanisms,
and actions are taken to correct deficiencies as they are
identified.




59


Our
management conducted an evaluation of the effectiveness of the system of
internal control over financial reporting based on the framework inInternal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation, our management concluded that our
system of internal control over financial reporting was effective as of December
31, 2008. Our management's assessment of the effectiveness of our internal
control over financial reporting has been audited by Amper, Politziner &
Mattia, LLP., an independent registered public accounting firm, as stated in
their report which is included herein.




Item
9B.           Other
Information




None.




PART
III




Item
10.               Directors,
Executive Officers and Corporate Governance




Our
directors currently have terms which will end at our next annual meeting of the
stockholders or until their successors are elected and qualify, subject to their
prior death, resignation or removal. Officers serve at the discretion of the
Board of Directors. There are no family relationships among any of our directors
and executive officers. Our Board members are encouraged to attend meetings of
the Board of Directors and the Annual Meeting of Stockholders. The Board of
Directors held twelve meetings and executed one unanimous written consent in
lieu of a meeting in 2008.




The
following sets forth certain biographical information concerning our directors
and our current executive officers.




Name
                        
                        Position
                        
                        AgeRichard
      J. DePiano
                        
                        Non-Executive
      Chairman of the Board of Directors
                        
                        67Jeffrey
      F. O'Donnell
                        
                        Director,
      President and Chief Executive Officer
                        
                        49Dennis
      M. McGrath
                        
                        Chief
      Financial Officer and Vice President – Finance and
      Administration
                        
                        52Michael
      R. Stewart
                        
                        Executive
      Vice President and Chief Operating Officer
                        
                        51Alan
      R. Novak
                        
                        Director
                        
                        74David
      W. Anderson
                        
                        Director
                        
                        56Wayne
      M. Withrow
                        
                        Director
                        
                        53Stephen
      P. Connelly
                        
                        Director
                        
                        57John
      M. Glazer
                        
                        Director
                        
                        44




Directors
and Executive Officers




Richard J.
DePiano was appointed to our Board of Directors in May 2000 and was
unanimously elected to serve as Non-Executive Chairman of the Board on January
31, 2003. Mr. DePiano has been a director of Escalon Medical Corp., a publicly
traded healthcare business specializing in the development and marketing of
ophthalmic devices and pharmaceutical and vascular access products, since
February 1996, and has served as its Chairman and Chief Executive Officer since
March 1997. Mr. DePiano has been the Chief Executive Officer of the Sandhurst
Company, L.P. and Managing Director of the Sandhurst Venture Fund since 1986.
Mr. DePiano was also the Chairman of the Board of Directors of SLT prior to our
acquisition of SLT.




Jeffrey F.
O’Donnell joined PhotoMedex in 1999 as President and CEO and has served
as a member of the Board of Directors since that date. Prior to PhotoMedex, he
joined Radiance Medical Systems in 1995 as Vice President of Sales and
Marketing, in 1997 served as its President and CEO, and then from 1999 to 2000
served as its Chairman. Previously, from 1994 to 1995, Mr. O’Donnell held the
position of President and CEO of Kensey Nash Corporation. In 2005, Mr. O’Donnell
was named Life Science CEO of the year by the Eastern Technology Council.
Additionally, he has held several senior sales and marketing management
positions at Boston Scientific, Guidant and Johnson & Johnson Orthopedic.
Mr. O’Donnell currently is on the Boards of Endologix, Inc. (ELGX), Replication
Medical, Inc. (RMI) and Embrella Cardiovascular, Inc. and sits on the Safeguard
Advisory Board (SFE). Mr. O’Donnell graduated from LaSalle University in 1982
with a B.S. in business administration.




60




Dennis M.
McGrath was appointed Chief Financial Officer and Vice President-Finance
and Administration in January 2000. Mr. McGrath has held several senior level
positions including from February 1999 to January 2000 serving as the Chief
Operating Officer of Internet Practice, the largest division for AnswerThink
Consulting Group, Inc., a public company specializing in business consulting and
technology integration. Concurrently, from August 1999 until January 2000, Mr.
McGrath assumed the role of Chief Financial Officer of Think New Ideas, Inc., a
public company specializing in interactive marketing services and business
solutions. In addition to the financial reporting responsibilities, Mr. McGrath
was responsible for the merger integration of Think New Ideas, Inc. and
AnswerThink Consulting Group, Inc. From September 1996 to February 1999, Mr.
McGrath was the Chief Financial Officer and Executive Vice-President–Operations
of TriSpan, Inc., an internet commerce solutions and technology consulting
company, which was acquired by AnswerThink in 1999. Mr. McGrath is currently an
outside Board member of RICOMM Systems, Inc., Noninvasive Medical Technologies,
Inc. and Embrella Cardiovascular, Inc. Mr. McGrath is a certified public
accountant and graduated with a B.S. in accounting from LaSalle University in
1979. Mr. McGrath holds a license from the states of Pennsylvania and New Jersey
as a certified public accountant.




Michael R.
Stewart was appointed as our Executive Vice President of Corporate
Operations on December 27, 2002, immediately following the acquisition of SLT
and on July 19, 2005, he was appointed our Chief Operating Officer. From July
1999 to the acquisition, Mr. Stewart was the President and Chief Executive
Officer of SLT, and from October 1990 to July 1999 he served as SLT’s Vice
President Finance and Chief Financial Officer. Mr. Stewart graduated from
LaSalle University with a B.S. in accounting and received an M.B.A. from LaSalle
University in 1986. Mr. Stewart passed the CPA examination in New York in
1986.




Alan R.
Novakwas
appointed to our Board of Directors in October 1997. Mr. Novak is Chairman of
Infra Group, L.L.C., an international project finance and development company.
He is also Chairman of Lano International, Inc., a real estate development
company. Mr. Novak is a graduate of Yale University, Yale Law School, and
Oxford University as a Marshall Scholar. Mr. Novak practiced law at Cravath,
Swaine & Moore and Swidler & Berlin, Chartered. His public service
includes three years as an officer in the United States Marine Corps, a U.S.
Supreme Court clerkship with Justice Potter Stewart, Senior Counsel to Senator
Edward M. Kennedy, Senior Executive Assistant to Undersecretary of State, Eugene
Rostow, and the Executive Director of President Johnson’s Telecommunications
Task Force. Mr. Novak was appointed by President Carter and served for five
years as Federal Fine Arts Commissioner.




David W.
Anderson was appointed to our Board of Directors on September 28, 2004.
Mr. Anderson has been the President and Chief Executive Officer of Gentis, Inc
since November 2004. He has over twenty years of entrepreneurial management
experience in the medical device, orthopedics and pharmaceutical field. He has
served as President and CEO of Sterilox Technologies, Inc., the world’s leader
in the development and marketing of non-toxic biocides; Bionx Implants, Inc., a
publicly traded orthopedic sports medicine and trauma company, and Kensey Nash
Corporation, a publicly traded cardiology and biomaterials company. In addition,
Mr. Anderson was previously Vice President of LFC Financial Corp., a venture
capital and leasing company, where he was responsible for LFC’s entry into the
healthcare market; and was a founder and Executive Vice President of Osteotech,
Inc., a high-technology orthopedic start-up.




Wayne M.
Withrow was appointed to our Board of Directors on August 16, 2006. Mr.
Withrow is currently Executive Vice President for SEI Investments Company, a
leading global provider of outsourced asset management, investment processing
and investment operation solutions. He is also the head of SEI’s Investment
Advisors Segment, and a member of its Executive Committee. Mr. Withrow’s broad
background was gained from over 15 years in various senior management positions
with SEI Investments. Formerly, he was with the law firm of Schnader, Harrison,
Segal & Lewis, where he was significantly involved in corporate securities
and acquisitions. His earlier experience also included a federal judicial
clerkship with the Honorable William J. Ditter as well as public accounting
experience with Deloitte & Touche.




61




Stephen P.
Connelly was appointed to our Board of Directors on May 3, 2007. Mr.
Connelly has served as President and Chief Operating Officer of Viasys
Healthcare, Inc. a medical technology and device company. In addition, Mr.
Connelly was Senior Vice President and General Manager of the Americas as well
as a member of the Executive Committee of Rhone Poulenc Rorer. Mr. Connelly’s
broad background includes over twenty-five years of experience in the planning,
development and management of rapid-growth marketing-driven businesses in the
medical device and pharmaceutical fields. In addition, Mr. Connelly has a
diverse and comprehensive business background, with expertise in such areas as
strategic and tactical business development, joint ventures, mergers,
acquisitions and corporate partnering, structuring and finance. Mr. Connelly is
well-versed in every aspect of marketing, sales, general management, research
and development of high-technology products and processes. Mr. Connelly
possesses extensive international experience, having lived in Asia and having
had operational P&L responsibility in many developed countries.




John M.
Glazer was appointed to our Board of Directors on February 27, 2009.Mr. Glazer was appointed
on behalf of Perseus Partners VII, L.P. pursuant to the Securities Purchase
Agreement dated August 4, 2008 between PhotoMedex, Inc. and Perseus Partners
VII, L.P.  Mr. Glazer is a Managing Director of Perseus, L.L.C, which he
joined in May 2006.  Perseus is a merchant bank and private equity fund
management company headquartered in Washington, D.C.  Since its inception
in 1995, Perseus has invested in numerous buyout and growth equity transactions
in the United States, Canada, and Western Europe.  The firm now manages
seven investment funds with capital commitments totaling approximately $2.0
billion.Before
joining Perseus, Mr. Glazer’s principal activity since 1997 was as an employee
and then as a long-term consultant for an affiliate of CSFB Private Equity,
where he executed and managed a portfolio of direct private equity and venture
capital investments, among them several in biotechnology and the life
sciences.  His prior experience included four years as a mergers and
acquisitions banker with Credit Suisse First Boston.




Compensation,
Nominations and Corporate Governance and Audit Committees




General.  The Board
maintains charters for select committees. In addition, the Board has adopted a
written set of corporate governance guidelines and a code of business conduct
and ethics and a code of conduct for our chief executive and senior financial
officers that generally formalize practices that we already had in place. We
have adopted a Code of Ethics on Interactions with Health Care Professionals and
have adopted a related Comprehensive Compliance Program and an Anti-Fraud
Program. To view the charters of the Audit, Compensation and Nominations and
Corporate Governance Committees, the Code of Ethics and Comprehensive Compliance
Program, the corporate governance guidelines and the codes of conduct and our
whistle blower policy, please visit our website at www.photomedex.com
(this website address is not intended to function as a hyperlink, and the
information contained on our website is not intended to be a part of this
Report). The Board determined in 2008 that all members of the Board are
independent under the revised listing standards of Nasdaq, except for Mr.
O'Donnell, who is also our Chief Executive Officer.




Compensation
Committee.  Our Compensation Committee discharges the Board’s
responsibilities relating to compensation of our Chief Executive Officer, other
executive officers, produces an annual report on executive compensation for
inclusion in our annual proxy statement and in this Report, and provides general
oversight of compensation structure. Other specific duties and responsibilities
of the Compensation Committee include:




·
            reviewing
      and approving objectives relevant to executive officer
      compensation;




·
            evaluating
      performance and determining the compensation of our Chief Executive
      Officer and other executive officers in accordance with those
      objectives;




·
            reviewing
      employment agreements for executive
officers;




·
            recommending
      to the Board the compensation for our
directors;




·
            administering
      our stock option plans (except the 2000 Non-Employee Director Stock Option
      Plan); and




62


·
              evaluating
      human resources and compensation strategies, as
  needed.
  Our Board
of Directors has adopted a written charter for the Compensation Committee. The
Compensation Committee is composed of Messrs. Novak, DePiano, Dimun, Withrow and
Connelly. Mr. Dimun serves as the Chairman of the Compensation Committee. The
Board determined in 2008 that each member of the Compensation Committee
satisfies the independence requirements of the Commission and Nasdaq. The
Compensation Committee held seven meetings during 2008. Mr. Dimun resigned from
the board effective as of March 17, 2009.
  The
Compensation Committee reviews executive compensation from time to time and
reports to the Board of Directors, which makes all decisions. The Compensation
Committee adheres to several guidelines in carrying out its responsibilities,
including performance by the employees, our performance, enhancement of
stockholder value, growth of new businesses and new markets and competitive
levels of fixed and variable compensation. The Compensation Committee reviews
and approves the annual salary and bonus for each executive officer (consistent
with the terms of any applicable employment agreement), provides oversight for
employee benefit plans (and changes thereto) and administers our stock option
plans and such other employee benefit plans as may be adopted by us from time to
time. The report of the Compensation Committee for 2008 is presented
below.
  Nominations and Corporate
Governance Committee.  Our
Board has established a Nominations and Corporate Governance Committee for the
purpose of reviewing all Board-recommended and stockholder-recommended nominees,
determining each nominee’s qualifications and making a recommendation to the
full Board as to which persons should be our Board’s nominees. Our Board has
adopted a written charter for the Nominations and Corporate Governance
Committee. The Nominations and Corporate Governance Committee is composed of
Messrs. Novak, DePiano, Anderson and Connelly. Mr. Anderson serves as the
Chairman of the Nominations and Corporate Governance Committee. The Board of
Directors determined in 2008 that each member of the Nominations and Corporate
Governance Committee satisfies the independence requirements of the Commission
and Nasdaq. The Nominations and Corporate Governance Committee held one formal
meeting during 2008.
  The
duties and responsibilities of the Nominations and Corporate Governance
Committee include:
  ·
              identifying
      and recommending to our Board individuals qualified to become members of
      our Board and to fill vacant Board
positions;
  ·
              overseeing
      the compensation of non-employee directors, including administering the
      2000 Non-Employee Director Stock Option
Plan;
  ·
              recommending
      to our Board the director nominees for the next annual meeting of
      stockholders;
  ·
              recommending
      to our Board director committee
assignments;
  ·
              reviewing
      and evaluating succession planning for our Chief Executive Officer and
      other executive officers;
  ·
              monitoring
      the independence of our board
members;
  ·
              developing
      and overseeing the corporate governance principles applicable to our Board
      members, officers and employees;
  ·
              monitoring
      the continuing education for our directors;
and
  ·
              evaluating
      annually the Nominations and Corporate Governance Committee
      charter.
  Our Board
of Directors believes that it is necessary that the majority of our Board of
Directors be comprised of independent directors and that it is desirable to have
at least one financial expert serving on the Audit Committee. The Nominations
and Corporate Governance Committee considers these requirements when
recommending Board nominees. Our Nominations and Corporate Governance Committee
utilizes a variety of methods for identifying and evaluating nominees for
director. Our Nominations and Corporate Governance Committee will regularly
assess the appropriate size of the Board, and whether any vacancies on the Board
are expected due to retirement or other circumstances. When considering
potential director candidates, the Nominations and Corporate Governance
Committee also considers the candidate’s character, judgment, diversity, age,
skills, including financial literacy, and experience in the context of the needs
of PhotoMedex and of the existing directors.
  63
  Audit
Committee.  Our Board of Directors has established an Audit
Committee to assist the Board in fulfilling its responsibilities for general
oversight of the integrity of our consolidated financial statements, compliance
with legal and regulatory requirements, the independent auditors’ qualifications
and independence, the performance of our independent auditors and an internal
audit function, and risk assessment and risk management. The duties of the Audit
Committee include:
  ·
              appointing,
      evaluating and determining the compensation of our independent
      auditors;
  ·
              reviewing
      and approving the scope of the annual audit, the audit fee and the
      financial statements;
  ·
              reviewing
      disclosure controls and procedures, internal control over financial
      reporting, any internal audit function and corporate policies with respect
      to financial information;
  ·
              reviewing
      other risks that may have a significant impact on our financial
      statements;
  ·
              preparing
      the Audit Committee report for inclusion in the annual proxy
      statement;
  ·
              establishing
      procedures for the receipt, retention and treatment of complaints
      regarding accounting and auditing matters;
and
  ·
              evaluating
      annually the Audit Committee
charter.
  The Audit
Committee works closely with management as well as our independent auditors. The
Audit Committee has the authority to obtain advice and assistance from, and
receive appropriate funding from us for, outside legal, accounting or other
advisors as the Audit Committee deems necessary to carry out its
duties.
  Our Board
of Directors has adopted a written charter for the Audit Committee, meeting
applicable standards of the Commission and Nasdaq. The members of the Audit
Committee in 2008 were Messrs. DePiano, Dimun, Anderson and Withrow. Mr. DePiano
serves as Chairman of the Audit Committee. The Audit Committee meets regularly
and held eight meetings during 2008. Mr. Dimun resigned from the board
effective as of March 17, 2009.
  The Board
of Directors determined in 2008 that each member of the Audit Committee
satisfies the independence and other composition requirements of the Commission
and Nasdaq. Our Board has determined that each member of the Audit Committee
qualifies as an “audit committee financial expert” under Item 401(h) of
Regulation S-K under the Exchange Act, and has the requisite accounting or
related financial expertise required by applicable Nasdaq rules.
  Compensation
Committee Interlocks and Insider Participation
  No
interlocking relationship exists between any member of our Board or Compensation
Committee and any member of the board of directors or compensation committee of
any other companies, nor has such interlocking relationship existed in the
past.
  Stockholder
Communications with the Board of Directors
  Our Board
of Directors has established a process for stockholders to communicate with the
Board of Directors or with individual directors. Stockholders who wish to
communicate with our Board of Directors or with individual directors should
direct written correspondence to Davis Woodward, Corporate Counsel at
dwoodward@photomedex.com or to the following address (our principal executive
offices): Board of Directors, c/o Corporate Secretary, 147 Keystone Drive,
Montgomeryville, Pennsylvania 18936. Any such communication must
contain:
  ·
              a
      representation that the stockholder is a holder of record of our capital
      stock;
  64
  ·
              the
      name and address, as they appear on our books, of the stockholder sending
      such communication; and
  ·
              the
      class and number of shares of our capital stock that are beneficially
      owned by such stockholder.
  Mr.
Woodward or the Corporate Secretary, as the case may be, will forward such
communications to our Board of Directors or the specified individual director to
whom the communication is directed unless such communication is unduly hostile,
threatening, illegal or similarly inappropriate, in which case Mr. Woodward or
the Corporate Secretary, as the case may be, has the authority to discard the
communication or to take appropriate legal action regarding such
communication.
  Compliance
with Section 16 of the Securities Exchange Act of 1934
  Section
16(a) of the Exchange Act requires our directors and executive officers and
beneficial holders of more than 10% of our common stock to file with the
Commission initial reports of ownership and reports of changes in ownership of
our equity securities. As of March 19, 2009, we believe, based solely on a
review of the copies of such reports furnished to us and representations of
these persons that no other reports were filed and that all reports needed to be
filed have been filed for the year ended December 31, 2008.
  Item
      11.
              Executive
      Compensation
  COMPENSATION
DISCUSSION AND ANALYSIS
  Introduction
  The
Compensation Committee is responsible for reviewing and approving the annual
compensation of our executive officers, of whom we presently have three. The
Nominations and Corporate Governance Committee is responsible for reviewing and
approving the compensation of our non-employee directors.
  The
Compensation Committee of the Board of Directors is composed solely of directors
who are not our current or former employees, and each is independent under the
revised listing standards of The Nasdaq Stock Market, Inc. The Board of
Directors has delegated to the Compensation Committee the responsibility to
review and approve our compensation and benefits plans, programs and policies,
including the compensation of the chief executive officer and our other
executive officers as well as middle-level management and other key employees.
The Compensation Committee administers all of our executive compensation
programs, incentive compensation plans and equity-based plans and provides
oversight for all of our other compensation and benefit programs.
  The key
components of the compensation program for executive officers are base salary
and bonus, and long-term incentives in the form of stock options and now, under
the 2005 Equity Compensation Plan, in the form of restricted shares of our
common stock. These components are administered with the goal of providing total
compensation that is competitive in the marketplace, recognizes meaningful
differences in individual performance and offers the opportunity to earn
superior rewards when merited by individual and corporate
performance.
  Objectives
of Compensation Program
  The
Compensation Committee intends to govern and administer compensation plans to
support the achievement of our long-term strategic objectives, to enhance
stockholder value, to attract, motivate and retain highly qualified employees by
paying them competitively and rewarding them for their own and our
success.
  We have
no retirement plans or deferred compensation programs in effect for our
non-employee directors and our executive officers, except for our 401(k) plan in
which the executive officers are eligible to participate. Compensation is
generally paid as earned. We do not have an exact formula for allocating between
cash and non-cash compensation, which has been in the form of stock options and
awards of stock. We do not have a Non-Equity Incentive Plan, as that term is
used in SFAS No. 123R, “Share-Based Payment.”
  65
  In order
to assess whether the compensation program we had been providing to our
executive officers was competitive and effective, the Compensation Committee
engaged in 2008 a third-party consulting firm specializing in executive
compensation. As an ongoing matter, the Committee does not engage a third-party
consultant to advise on our compensation policies. Nor does the Committee
delegate its responsibilities for reviewing and approving executive
compensation, except in the case of the 2005 Investment Plan, where the Plan has
pre-approved the grant of matching options to an executive who purchases shares
of our common stock in the open market in accordance with the provisions of the
Plan.
  To the
extent consistent with the foregoing objectives, the Compensation Committee also
intends to maximize the deductibility of compensation for tax purposes. The
Committee may, however, decide to exceed the tax deductible limits established
under Section 162(m) of the Internal Revenue Code of 1986, as amended (the
"Code") when such a decision appears to be warranted based upon competitive and
other factors.
  What
Our Compensation Program is Designed to Reward
  The key
components of the compensation program for our executive officers are base
salary and bonus, and long-term incentives in the form of stock options and
under the 2005 Equity Compensation Plan, restricted shares of our common stock.
These components are administered with the goal of providing total compensation
that is competitive in the marketplace, recognizes meaningful differences in
individual performance and offers the opportunity to earn superior rewards when
merited by individual and corporate performance.
  Stock
price performance has not been a factor in determining annual compensation
insofar as the price of our common stock is subject to a number of factors
outside of our control. We have endeavored through the grants of stock options
to the executive officers to incentivize individual and team performance,
providing a meaningful stake in us and linking them to a stake in our overall
success. Through the awards of restricted stock, we have striven to forge a
closer link by tying the vesting of the restricted stock to certain milestone
prices of our common stock.
  Elements
of Company’s Compensation Plan and How Each Element Relates to
Objectives
  There are
three primary elements in the compensation package of our executive officers:
base salary, bonus and long-term incentives. Compensation payable in the event
of an executive’s termination from the Company is a secondary, material element
in the package.
  Base
Salaries.Base salaries for our executive officers are
designed to provide a base pay opportunity that is appropriately competitive
within the marketplace. As an officer's level of responsibility increases, a
greater proportion of his or her total compensation will be dependent upon our
financial performance and stock price appreciation rather than base salary.
Adjustments to each individual’s base salary are made in connection with annual
performance reviews in addition to the assessment of market
competitiveness.
  Bonus.At
the outset of a fiscal year, the Compensation Committee establishes a bonus
program for executive officers and other managers and key employees eligible to
participate in the program. The program is based on a financial plan for the
fiscal year and other business factors. The amount of bonus, if any, hinges on
corporate performance and financial condition and on the performance of the
participant in the program. A program will typically allow some partial or
discretionary awards based on an evaluation of the relevant factors. Provision
for bonus expense is typically made over the course of a fiscal year. The
provision becomes fixed, based on the final review of the Committee, which is
usually made after the financial results of the fiscal year have been reviewed
by our independent accountants. For 2008, there were three factors of generally
equal weight: Company revenues, Company EBITDA and a discretionary
component.
  Long-Term
Incentives.Grants of stock options
under our stock option plans are designed to provide executive officers and
other managers and key employees with an opportunity to share, along with
stockholders, in our long-term performance. Stock option grants are generally
made annually to all executive officers, with additional grants being made
following a significant change in job responsibility, scope or title or a
significant achievement. The size of the option grant to each executive officer
is set by the Compensation Committee at a level that is intended to create a
meaningful opportunity for stock ownership based upon the individual's current
position with us, the individual's personal performance in recent periods and
his or her potential for future responsibility and promotion over the option
term. The Compensation Committee also takes into account the number of unvested
options held by the executive officer in order to maintain an appropriate level
of equity incentive for that individual. The relevant weight given to each of
these factors varies from individual to individual.
  66
  Prior to
2006, stock options granted under the various stock option plans generally had a
four-year vesting schedule depending upon the size of the grant, and generally
were set to expire five years from the date of grant. In 2006, the Committee
determined that such grants would be for ten years and vest over five years. The
exercise price of options granted under the stock option plans is at no less
than 100% of the fair market value of the underlying stock on the date of grant.
The number of stock options granted to each executive officer is determined by
the Compensation Committee based upon several factors, including the executive
officer’s salary grade, performance and the estimated value of the stock at the
time of grant, but the Compensation Committee has the flexibility to make
adjustments to those factors at its discretion. The options granted to
executives as a rule have provisions by which vesting and exercisability are
accelerated in the event of a change of control or a termination of employment
initiated by the Company other than for cause.
  Similar
criteria are applied in making awards of restricted shares of our common stock
under the 2005 Equity Compensation Plan, but in the case of restricted stock, we
have made direct linkage between the price performance of our stock with the
vesting schedule of the restricted stock.
  To
encourage our executive officers to have a greater stake in the equity of the
Company, the Committee recommended, and the Board of Directors and the Company
stockholders approved, the 2005 Investment Plan at the 2005 Annual Stockholders’
Meeting.
  Compensation on
Termination of Employment or Change of Control.We have employment
agreements with Messrs. O'Donnell, McGrath and Stewart. These agreements provide
for severance upon termination of employment, whether in context of a change of
control or not.
  In the
event of an involuntary termination not in connection with a change in control
of the Company, an executive will be vested in those options that were unvested
as of the termination but that would have vested in the 12 months following
termination. In the event of a change of control, all of an executive’s unvested
options will vest. As to unvested shares of restricted stock, they will vest
upon a change of control to the extent that the acquisition price exceeds a
milestone price or if the acquirer elects not to continue to employ the services
of the executive.
  We also
have arrangements with other key employees under which we would be obliged to
pay compensation upon their termination outside a context of change of control,
and, for a lesser number of key employees, by virtue of a change of control. If
all such executive officers and key employees were terminated other than for
cause and not because of a change of control, we would have had an aggregate
commitment of approximately $1,552,000 at December 31, 2008 for severance and
related compensation. However, the obligation for such compensation that would
arise in favor of the executive officers and certain key employees by virtue of
a change of control would have been approximately $2,102,000 at December 31,
2008.
  How
Amounts Were Selected for Each Element of an Executive’s
Compensation
  Each
executive’s current and prior compensation is considered in setting future
compensation. In addition, we review from time to time the compensation
practices of other companies, particularly peer companies. To some extent, our
compensation plan is based on the market and the companies we compete against
for executives. Base salary and the long-term incentives are not set with
reference to a formula.
  An
executive’s target bonus amount is set by an executive’s employment agreement,
which was negotiated at arm’s length. A target bonus, or portion thereof, is
earned, based on fulfillment of conditions, which are set by the Committee at
the outset of a fiscal year.
  As a
general rule, options and restricted stock awards are made in the first or
second quarter of a year and after the financial results for the prior year have
been audited and reported to the Board of Directors. Grants and awards are
valued, and exercise prices are set, as of the date the grant or award is made.
Exceptions to the general rule may arise for grants made to recognize a
promotion or to address the effect of expiring options. The Committee may elect
to defer a grant until after the Company has made public disclosure of its
financial results, typically in a conference call on earnings; in such a case,
the exercise price is set at the higher of the closing prices on the approval
date or the fixed grant date. In these deliberations, the Compensation Committee
does not delegate any related function, unless to the Board of Directors as a
whole, and the grants or awards made to executives are valued under the same
measurement standards as for grants made to other grantees.
  67
  Accounting
and Tax Considerations
  On
January 1, 2006, we adopted SFAS No. 123R. Under this accounting standard, we
are required to value stock options granted, and restricted stock awarded, in
2006 and beyond under the fair value method and expense those amounts in the
income statement over the vesting period of the stock option or restricted
stock. We were also required to value unvested stock options granted prior to
our adoption of SFAS 123R under the fair value method and amortize such expense
in the income statement over the stock option’s remaining vesting period. A
material portion of such amortizing expense relates to option grants made to our
executive officers, and future option grants and stock awards made in 2006 and
beyond to our executive officers will also have a material impact on such
expense.
  Our
compensation program has been structured to comply with Internal Revenue Code
Sections 409A and 162(m). If an executive is entitled to nonqualified deferred
compensation benefits that are subject to Section 409A, and such benefits do not
comply with Section 409A, then the benefits are taxable in the first year they
are not subject to a substantial risk of forfeiture. In such case, the executive
service-provider is subject to regular federal income tax, interest and an
additional federal income tax of 20% of the benefit includible in
income.
  Under
Section 162(m) of the Internal Revenue Code, a limitation was placed on tax
deductions of any publicly-held corporation for individual compensation to
certain executives of such corporation exceeding $1,000,000 in any taxable year,
unless the compensation is performance-based. The Compensation Committee has
been advised that based upon prior stockholder approval on January 26, 2009 of
the material terms of our Equity Compensation Plan, compensation under this plan
is excluded from this limitation, provided that the other requirements of
Section 162(m) are met. However, when warranted based upon competitive and other
factors, the Compensation Committee may decide to exceed the tax deductible
limits established under Section 162(m) Code. The base salary provided to each
executive in 2006, 2007 and 2008 did not exceed the limits under Section 162(m)
for tax deductibility; no executive exercised any options in 2006, 2007 or
2008.
  Overview
of Executive Employment Agreements and Option Awards
  Employment
Agreement with Jeffrey F. O'Donnell. In November 1999, we entered
into an employment agreement with Jeffrey F. O'Donnell to serve as our President
and Chief Executive Officer and amended and restated that agreement in August
2002 and October 2007. This agreement has been renewed through December 31, 2009
and will expire then if due notice is given by December 1, 2009. If due notice
is not given, then the agreement will renew for an additional year and
thereafter on an annual basis. Mr. O'Donnell's current base salary was $367,500
in 2008. If we terminate Mr. O'Donnell other than for "cause" (which definition
includes nonperformance of duties or competition of the employee with our
business), then he will receive severance pay equal to his base salary, payable
over 12 months. If a change of control occurs, Mr. O’Donnell becomes entitled to
severance pay by virtue of provisions related to the change of control, then he
may become entitled to severance equal to 200% of his then base salary in a lump
sum.
  On
February 1, 2008, Mr. O’Donnell was awarded from the 2005 Equity Compensation
Plan 195,900 options to purchase shares of our common stock, at $0.89 per share
(27,986 options at $6.23 per share as adjusted for the reverse stock split of
1-for-7 effective January 26, 2009). The options vest over 5 years and will
expire on February 1, 2018.
  68
  Employment
Agreement with Dennis M. McGrath. In November 1999, we entered into an
employment agreement with Dennis M. McGrath to serve as our Chief Financial
Officer and Vice President-Finance and Administration and amended and restated
that agreement in August 2002 and September 2007. This agreement has been
renewed through December 31, 2009 and will expire then if due notice is given by
December 1, 2009. If due notice is not given, then the agreement will renew for
an additional year and thereafter on an annual basis. Mr. McGrath's current base
salary was $299,250 in 2008. If we terminate Mr. McGrath other than for "cause"
(which definition includes nonperformance of duties or competition of the
employee with our business), then he will receive severance pay equal to his
base salary, payable over 12 months. If a change of control occurs, Mr. McGrath
becomes entitled to severance pay by virtue of provisions related to the change
of control, then he may become entitled to severance equal to 200% of his then
base salary in a lump sum.
  On
February 1, 2008, Mr. McGrath was awarded from the 2005 Equity Compensation Plan
163,200 options to purchase shares of our common stock, at $0.89 per share
(23,314 options at $6.23 per share as adjusted for the reverse stock split of
1-for-7 effective January 26, 2009). The options vest over 5 years and will
expire on February 1, 2018.
  Employment
Agreement with Michael R. Stewart.Effective December 27,
2002, Michael R. Stewart became the Company’s Executive Vice President of
Corporate Operations, pursuant to an employment agreement. The employment
agreement was amended and restated in September 2007. Mr. Stewart became our
Chief Operating Officer on July 19, 2005, at which time he was granted 40,000
options. Mr. Stewart’s current base salary was $262,500 in 2008. This agreement
has renewed through December 31, 2009 and will expire then if due notice is
given by December 1, 2009. If due notice is not given, then the agreement will
renew for an additional year and thereafter on an annual basis. If we terminate
Mr. Stewart other than for “cause” (which definition includes nonperformance of
duties or competition of the employee with our business), then he will receive
severance pay equal to his base pay, payable over 12 months. If a change of
control occurs, Mr. Stewart becomes entitled to severance pay by virtue of
provisions related to the change of control, then he may become entitled to
severance equal to 200% of his then base salary, payable over 12
months.
  On
February 1, 2008, Mr. Stewart was awarded from the 2005 Equity Compensation Plan
130,600 options to purchase shares of our common stock, at $0.89 per share
(18,657 options at $6.23 per share as adjusted for the reverse stock split of
1-for-7 effective January 26, 2009). The options vest over 5 years and will
expire on February 1, 2018.
  69
  SUMMARY
COMPENSATION TABLE
  The
following table includes information for the years ended December 31, 2008 and
2007 concerning compensation for our three named executive
officers.
  Name
      and Principal Position
                                    
                                    Year
                                    
                                    Salary
                                      ($)
                                    
                                    
                                    Bonus
                                      ($)
      (1)
                                    
                                    
                                    Stock
                                      Awards
                                      ($)
      (2)
                                    
                                    
                                    Option
                                      Awards
                                      ($)
      (2)
                                    
                                    
                                    Non-Equity
                                      Incentive
      Plan
                                      Compensation
                                      ($)
      (3)
                                    
                                    
                                    Change
      in
                                      Pension
      Value
                                      and
                                      Nonqualified
                                      Deferred
                                      Compensation
                                      Earnings
      ($)
                                    
                                    
                                    All
      Other
                                      Compensation
                                      ($)
      (4)
                                    
                                    
                                    Total
      ($)Jeffrey
      F. O’Donnell, President
                                    
                                    2008
                                    
                                    
                                    365,481
                                    
                                    
                                    151,594
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    139,677
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    20,388
                                    
                                    
                                    
                                    677,140and
      Chief Executive Officer
                                    
                                    2007
                                    
                                    
                                    350,000
                                    
                                    
                                    
                                    175,875
                                    
                                    
                                    
                                    127,050
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    19,475
                                    
                                    
                                    
                                    672,400Dennis
      M. McGrath, Chief
                                    
                                    2008
                                    
                                    
                                    297,606
                                    
                                    
                                    
                                    98,753
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    116,362
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    18,192
                                    
                                    
                                    
                                    530,913Financial
      Officer & Vice Pres.
                                    
                                    2007
                                    
                                    
                                    285,000
                                    
                                    
                                    
                                    114,570
                                    
                                    
                                    
                                    105,875
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    15,844
                                    
                                    
                                    
                                    521,289–
      Finance/AdministrativeMichael
      R. Stewart, Chief
                                    
                                    2008
                                    
                                    
                                    261,058
                                    
                                    
                                    
                                    72,198
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    93,158
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    19,261
                                    
                                    
                                    
                                    445,665Operating
      Officer and
                                    
                                    2007
                                    
                                    
                                    250,000
                                    
                                    
                                    
                                    83,750
                                    
                                    
                                    
                                    275,275
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    19,004
                                    
                                    
                                    
                                    628,029Executive
      Vice President
  (1)
“Bonus” in the foregoing table is the bonus earned in 2008 and 2007, even
though it will have been paid in a subsequent period.
  (2) The
amounts shown for option awards and restricted stock awards relate to shares
granted under our 2005 Equity Compensation Plan and 2005 Investment Plan. These
amounts are equal to the aggregate grant-date fair value with respect to the
awards made in 2008 and 2007, computed in accordance with SFAS 123(R), before
amortization and without giving effect to estimated forfeitures. The assumptions
used in determining the amounts in this column are set forth in Note 1 to our
consolidated financial statements. For information regarding the number of
shares subject to 2008 and 2007 awards, other features of those awards, and the
grant-date fair value of the awards, see the Grants of Plan-Based Awards Table
on p. 68.
  (3) The
Company does not have a Non-Equity Incentive Plan.
  (4) “All Other Compensation” includes
car allowance ($12,000), premiums for supplementary life insurance and matching
401(k) plan contributions for Messrs. O’Donnell, McGrath and
Stewart.
  Non-Qualified
Deferred Compensation
  The
Company has no plan or program of non-qualified deferred
compensation.
  Potential
Payments on Termination of Employment or Change of Control
  Potential
payments to our three named executive officers on termination of employment or
upon a change of control of the Company are governed by their respective
employment agreements and by the terms of their option agreements and restricted
stock agreements.
  If any of
the events set forth in the table had occurred by December 31, 2008, then we
estimate the value of the benefits that would have been triggered and thus
accrued to the three named executive officers as set forth below.
  70
  POTENTIAL
PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL TABLE
  Name
                                                
                                                Benefit
                                                
                                                Before
      Change
                                                  in
      Control
                                                  Termination
      w/o
                                                  Cause
      or for
                                                  Good
      Reason ($)
                                                
                                                
                                                After
      Change
                                                  in
      Control
                                                  Termination
                                                  w/o
      Cause or
                                                  for Good
                                                  Reason
      ($)
                                                
                                                
                                                Voluntary
                                                  Termination
                                                
                                                
                                                Death
                                                  (3)
                                                
                                                
                                                Disability
                                                  (3)
                                                
                                                
                                                Change in
                                                  ControlJeffrey
      F. O’Donnell (1)(2)(4)
                                                
                                                Severance
                                                
                                                
                                                367,500
                                                
                                                
                                                
                                                735,000
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AHealth
      continuation
                                                
                                                
                                                8,643
                                                
                                                
                                                
                                                17,286
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AAD&D
      insurance
                                                
                                                
                                                1,046
                                                
                                                
                                                
                                                2,092
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AExecutive
      life ins.
                                                
                                                
                                                7,259
                                                
                                                
                                                
                                                14,518
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AAccelerated
      vesting
                                                
                                                
                                                0
                                                
                                                
                                                
                                                170,100
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0TOTAL
                                                
                                                
                                                384,448
                                                
                                                
                                                
                                                938,996
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0Dennis
      McGrath (1)(2)(4)
                                                
                                                Severance
                                                
                                                
                                                300,000
                                                
                                                
                                                
                                                600,000
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AHealth
      continuation
                                                
                                                
                                                8,643
                                                
                                                
                                                
                                                17,286
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AAD&D
      insurance
                                                
                                                
                                                1,046
                                                
                                                
                                                
                                                2,092
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AExecutive
      life ins.
                                                
                                                
                                                3,682
                                                
                                                
                                                
                                                7,364
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AAccelerated
      vesting
                                                
                                                
                                                0
                                                
                                                
                                                
                                                114,075
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0TOTAL
                                                
                                                
                                                313,371
                                                
                                                
                                                
                                                740,817
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0Michael
      Stewart (1)(2)(4)
                                                
                                                Severance
                                                
                                                
                                                262,500
                                                
                                                
                                                
                                                525,000
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AHealth
      continuation
                                                
                                                
                                                8,643
                                                
                                                
                                                
                                                17,286
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AAD&D
      insurance
                                                
                                                
                                                1,046
                                                
                                                
                                                
                                                2,092
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AExecutive
      life ins.
                                                
                                                
                                                5,076
                                                
                                                
                                                
                                                10,152
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                N/AAccelerated
      vesting
                                                
                                                
                                                0
                                                
                                                
                                                
                                                61,425
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0TOTAL
                                                
                                                
                                                277,265
                                                
                                                
                                                
                                                615,955
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
                                                
                                                
                                                
                                                0
 
 (1)
                If
      upon a change of control, the acquirer does not desire the services of the
      executive, then any unvested restricted stock will vest. The closing price
      of our stock on December 31, 2008 (the last trading day of the year) was
      $0.28. All shares were unvested at that date and were purchased for the
      par value of the stock, i.e. $0.01, assuming a change of control as of
      December 31, 2008, each share would return a gain of
  $0.27.
  (2)
                All
      unvested options become exercisable by reason of a change of control.
      However, none of the executives’ unvested options as of December 31, 2008
      were in the money, and therefore there would have been no benefit as of
      December 31, 2008. Similarly, in the event of an involuntary termination
      without cause, the executive optionee becomes vested in those options that
      would otherwise have vested in twelve months following the date of
      termination. As in the hypothetical change of control, so in this case of
      hypothetical involuntary termination, there would have been no benefit to
      the optionee inasmuch as no option was in the money at December 31,
      2008.
  (3)
                An
      executive’s salary and benefits are paid through the end of the month of
      termination due to death or disability, except that we will pay the
      disability premiums during the period of
  disability.
  (4)
                Severance
      based on 2008 salary levels.
  71
  STOCK
OPTIONS
  The 2005
Equity Compensation Plan is currently the primary vehicle by which restricted
stock awards and option grants are made to the executives and other
service-providers. At the January 26, 2009 meeting of the stockholders, the
number of shares reserved for issuance under the Plan was increased to 8,160,000
shares of our common stock (1,165,714 shares of our common stock as adjusted for
the 1-for-7 reverse stock split effective January 26, 2009). Participation in
the 2005 Investment Plan is limited to the executives; this Plan has been
authorized by the stockholders for 400,000 shares of our common stock (57,143
shares of our common stock as adjusted for the 1-for-7 reverse stock split
effective January 26, 2009).
  Grants
of Plan-Based Awards Table
  The
following table sets forth certain information with respect to the options
granted and restricted stock awarded during or for the year ended December 31,
2008 to each of our executive officers listed in the Summary Compensation Table
as shown under the caption “Executive Compensation.” Stock awards and option
grants made in 2008 were from the 2005 Equity Compensation Plan.
 
 GRANTS
OF PLAN-BASED AWARDS TABLE
  Estimated
      Future Payouts Under
                        Equity
      Incentive Plan Awards (1)
                      
                      
                      All
      Other
                        Option
                        Awards:
                        Number
      of
                        Securities
                        Underlying
                        Options
      (#)
                        (2)
                      
                      
                      Exercise
                        or
      Base
                        Price
      of
                        Option
                        Awards
                        ($/Sh)
      (2)
                      
                      
                      Closing
                        Price
      on
                        Grant
                        Date
                        ($/Sh)
                      
                      
                      Grant
      Date
                        Fair
      Value
                        of
      Stock and
                        Option
                        Awards
      ($)
                        (3)Name
                      
                      Grant
                        Date
                      
                      Approval
                        Date
                      
                      Threshold
                        (#)
                      
                      
                      Target
                        (#)
                      
                      
                      Maximum
                        (#)Jeffrey
      O’Donnell
                      
                      2/1/08
                      
                      2/1/08
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      27,986
                      
                      
                      
                      6.23
                      
                      
                      
                      N/A
                      
                      
                      
                      139,677Dennis
      McGrath
                      
                      2/1/08
                      
                      2/1/08
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      23,314
                      
                      
                      
                      6.23
                      
                      
                      
                      N/A
                      
                      
                      
                      145,248Michael
      Stewart
                      
                      2/1/08
                      
                      2/1/08
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      18,657
                      
                      
                      
                      6.23
                      
                      
                      
                      N/A
                      
                      
                      
                      116,234
 
 (1)
              The
      Company does not have a Non-Equity Incentive Plan. The Equity Incentive
      Plan is comprised of the restricted shares of common stock issued toMessrs.
      O’Donnell, McGrath and Stewart under the 2005 Equity Compensation
      Plan.
  (2)
              The
      grants have been adjusted to reflect the reverse stock split of 1-for-7
      effective January 26, 2009.
  (3)
              Computed
      in accordance with SFAS 123 (R).
  Outstanding
Equity Awards Value at Fiscal Year-End Table
  The
following table includes certain information with respect to the value of all
unexercised options previously awarded to the executive officers named above at
the fiscal year end, December 31, 2008.
  72
   OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END TABLE, AS ADJUSTED TO REFLECT THE REVERSE STOCK
SPLIT OF 1-FOR-7 EFFECTIVE JANUARY 26, 2009
 Option
      Awards
                                                  
                                                  
                                                  Stock
      AwardsName
                                                  
                                                  Number
      of
                                                    Securities
                                                    Underlying
                                                    Unexercised
                                                    Options
      (#)
                                                    Exercisable
                                                  
                                                  
                                                  Number
      of
                                                    Securities
                                                    Underlying
                                                    Unexercised
                                                    Options
      (#)
                                                    Unexercisable
                                                  
                                                  
                                                  Equity
                                                    Incentive
      Plan
                                                    Awards:
                                                    Number
      of
                                                    Securities
                                                    Underlying
                                                    Unexercised
                                                    Unearned
                                                    Options
      (#)
                                                  
                                                  
                                                  Option
                                                    Exercise
                                                    Price
      ($)
                                                  
                                                  
                                                  Option
                                                    Expiration
                                                    Date
                                                  
                                                  
                                                  Number
      of
                                                    Shares
      or
                                                    Units
      of
                                                    Stock
      That
                                                    Have
      Not
                                                    Vested
      (#)
                                                  
                                                  
                                                  Market
                                                    Value
      of
                                                    Shares
      or
                                                    Units
      of
                                                    Stock
      That
                                                    Have
      Not
                                                    Vested
      ($)(1)
                                                  
                                                  
                                                  Equity
      Incentive
                                                    Plan
      Awards:
                                                    Number
      of
                                                    Unearned
      Shares,
                                                    Units
      or Other
                                                    Rights
      That Have
                                                    Not
      Vested (#)
                                                  
                                                  
                                                  Equity
                                                    Incentive
                                                    Plan
      Awards:
                                                    Market
      or
                                                    Payout
      Value
                                                    of
      Unearned
                                                    Shares,
      Units
                                                    or
      Other
                                                    Rights
      That
                                                    Have
      Not
                                                    Vested
      ($) (1)Jeffrey
      O’Donnell
                                                  
                                                  
                                                  21,429
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  14.98
                                                  
                                                  
                                                  1/22/09
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A16,071
                                                  
                                                  
                                                  
                                                  5,357
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  17.15
                                                  
                                                  
                                                  3/1/10
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A11,428
                                                  
                                                  
                                                  
                                                  17,143
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  17.50
                                                  
                                                  
                                                  1/15/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  75,000
                                                  
                                                  
                                                  
                                                  147,0000
                                                  
                                                  
                                                  
                                                  286
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  11.13
                                                  
                                                  
                                                  5/24/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A7,143
                                                  
                                                  
                                                  
                                                  10,714
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  7.77
                                                  
                                                  
                                                  11/20/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  286
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  7.91
                                                  
                                                  
                                                  3/6/17
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  143
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  8.05
                                                  
                                                  
                                                  3/7/17
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  15,000
                                                  
                                                  
                                                  
                                                  29,4000
                                                  
                                                  
                                                  
                                                  27,986
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  6.23
                                                  
                                                  
                                                  2/1/18
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/ADennis
      McGrath
                                                  
                                                  
                                                  17,857
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  14.98
                                                  
                                                  
                                                  1/22/09
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A15,000
                                                  
                                                  
                                                  
                                                  5,000
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  17.15
                                                  
                                                  
                                                  3/1/10
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  47,857
                                                  
                                                  
                                                  
                                                  93,8008,000
                                                  
                                                  
                                                  
                                                  12,000
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  15.61
                                                  
                                                  
                                                  3/10/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  714
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  11.06
                                                  
                                                  
                                                  5/24/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  286
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  11.41
                                                  
                                                  
                                                  5/25/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A6,286
                                                  
                                                  
                                                  
                                                  9,429
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  7.77
                                                  
                                                  
                                                  11/20/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  12,500
                                                  
                                                  
                                                  
                                                  24,5000
                                                  
                                                  
                                                  
                                                  23,314
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  6.23
                                                  
                                                  
                                                  2/1/18
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/AMichael
      Stewart
                                                  
                                                  
                                                  10,714
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  14.98
                                                  
                                                  
                                                  1/22/09
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A10,714
                                                  
                                                  
                                                  
                                                  3,572
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  17.15
                                                  
                                                  
                                                  3/1/10
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A5,714
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  18.41
                                                  
                                                  
                                                  7/19/10
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A5,714
                                                  
                                                  
                                                  
                                                  8,572
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  15.61
                                                  
                                                  
                                                  3/10/16
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  10,000
                                                  
                                                  
                                                  
                                                  19,6000
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  22,500
                                                  
                                                  
                                                  
                                                  44,1000
                                                  
                                                  
                                                  
                                                  18,657
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  6.23
                                                  
                                                  
                                                  2/1/18
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  N/A
  (1) The
market value of unvested shares of restricted stock is based on $1.96 per share,
which was the closing price of our stock on December 31, 2008, the last trading
day of 2008 as adjusted to reflect the reverse stock split of 1-for-7 effective
January 26, 2009.
  Option
Exercises and Stock Vested Table
  None.
  Compensation
Committee Report on Executive Compensation
  We have
reviewed and discussed with management certain Compensation Discussion and
Analysis provisions to be included in the Company’s 2008 Form 10-K. Based on the
reviews and discussions referred to above, we recommend to the Board of
Directors that the Compensation Discussion and Analysis referred to above be
included in the Company’s Annual Report on Form 10-K.
  Mr.
Dimun who resigned from the Board effective March 17, 2009 was a member of the
Compensation Committee during 2008 and took part in the above-referenced reviews
and discussions.
  Compensation
Committee
 
 Richard
J. DePiano Wayne M. Withrow Stephen P.
Connelly Alan R.
Novak
  73
  Director
Compensation
  Directors who are also our employees
receive no separate compensation for serving as directors or as members of Board
committees. Directors who are not our employees are compensated under the 2000
Non-Employee Director Plan. Each director receives non-qualified options to
purchase up to 5,000 shares of common stock, (giving effect to the reverse stock
split on January 27, 2009) on an annual basis; the options vest quarterly in the
year of grant vesting on the last day of service within a quarter. Each outside
director receives an annual cash retainer of $20,000 and is also paid $1,000 for
personal attendance at each meeting of the Board and each committee meeting held
not in conjunction with meetings of the Board itself, and $500 for telephonic
attendance at each Board or committee meeting, excluding meetings of limited
scope and duration. The chairmen of the Committees will receive additional
annual compensation, i.e. audit, $10,000; compensation, $5,000; Nominations and
Corporate Governance, $5,000. We pro-rate the retainer for a director serving
less than a full year. The table below sets forth non-employee directors’
compensation in 2008.
  DIRECTOR
COMPENSATION TABLE
  Name
                  
                  Fees
      Earned or
                    Paid
      in Cash ($)
                  
                  
                  Option
      Awards
                    ($)
      (1)(2)
                  
                  
                  Total
      ($)Richard
      J. DePiano
                  
                  
                  47,000
                  
                  
                  
                  26,810
                  
                  
                  
                  73,810Alan
      R. Novak
                  
                  
                  31,500
                  
                  
                  
                  26,810
                  
                  
                  
                  58,310Anthony
      J. Dimun (3)
                  
                  
                  40,000
                  
                  
                  
                  26,810
                  
                  
                  
                  66,810David
      W. Anderson
                  
                  
                  40,000
                  
                  
                  
                  26,810
                  
                  
                  
                  66,810Wayne
      M. Withrow
                  
                  
                  37,000
                  
                  
                  
                  26,810
                  
                  
                  
                  63,810Stephen
      P. Connelly
                  
                  
                  32,500
                  
                  
                  
                  26,810
                  
                  
                  
                  59,310
  (1) The
amounts shown for option awards relate to shares granted under our 2000
Non-Employee Director Plan. These amounts are equal to the dollar amounts
recognized in 2008 with respect to the option awards for financial statement
purposes, computed in accordance with SFAS 123(R), but without giving effect to
estimated forfeitures. The assumptions used in determining the amounts in this
column are set forth in note 1 to our consolidated financial
statements.
  (2) The
grant date fair value computed in accordance with SFAS 123(R) was
$0.77.
  (3)
Mr. Dimun resigned from the Board effective March 17, 2009.
  Limitation
on Directors' Liabilities; Indemnification of Officers and
Directors
  Our
certificate of incorporation and bylaws designate the relative duties and
responsibilities of our officers, establish procedures for actions by directors
and stockholders and other items. Our certificate of incorporation and bylaws
also contain extensive indemnification provisions, which will permit us to
indemnify our officers and directors to the maximum extent provided by Delaware
law. Pursuant to our certificate of incorporation and under Delaware law, our
directors are not liable to us or our stockholders for monetary damages for
breach of fiduciary duty, except for liability in connection with a breach of
duty of loyalty, for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, for dividend payments or
stock repurchases illegal under Delaware law or any transaction in which a
director has derived an improper personal benefit. We have also instituted a new
form of indemnification agreement between the directors and the Company, whereby
directors may be indemnified by us against claims brought against them out of
their services to us. As of the dated hereof, only Mr. Glazer has entered
into such an indemnification agreement.
  Directors'
and Officers' Liability Insurance
  We have
obtained directors' and officers' liability insurance which expires on April 15,
2009. We are required to maintain such insurance as a covenant under the form of
indemnification agreement for members of the Board of Directors.
  74
  Item
      12.
              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
  The
following table reflects, as of March 19, 2009, the beneficial common stock
ownership of: (a) each of our directors, (b) each executive officer, (c) each
person known by us to be a beneficial holder of five percent (5%) or more of our
common stock, and (d) all of our executive officers and directors as a
group:
  Name
      and Address Of Beneficial Owner (1)
                  
                  Number
      of Shares
                      Beneficially
                      Owned;
      Post Split
                  
                  
                  Percentage
      of
                      Shares
                      Beneficially
                      Owned
      (1)Richard
      J. DePiano(2)
                  
                  
                  44,900
                  
                  
                  
                  *Jeffrey
      F. O’Donnell (3)
                  
                  
                  163,740
                  
                  
                  
                  1.80
                  %Dennis
      M. McGrath (4)
                  
                  
                  122,734
                  
                  
                  
                  1.35
                  %Michael
      R. Stewart (5)
                  
                  
                  75,723
                  
                  
                  
                  *Alan
      R. Novak (6)
                  
                  
                  42,300
                  
                  
                  
                  *David
      W. Anderson (7)
                  
                  
                  25,000
                  
                  
                  
                  *Stephen
      P. Connelly (8)
                  
                  
                  13,393
                  
                  
                  
                  *Wayne
      M. Withrow (9)
                  
                  
                  19,286
                  
                  
                  
                  *John
      M. Glazer.(10)
                  
                  
                  1,250
                  
                  
                  
                  *Perseus
      Partners VII, L.P.(11)
                  
                  
                  4,553,548
                  
                  
                  
                  33.50
                  %LB
      I Group, Inc.(12)
                  
                  
                  880,161
                  
                  
                  
                  9.77
                  %James
      W. Sight (13)
                  
                  
                  505,000
                  
                  
                  
                  5.61
                  %Goldman
      Capital Management, Inc. (14)
                  
                  
                  1,098,415
                  
                  
                  
                  12.20
                  %All
      directors and officers as a group (9 persons)(15)
                  
                  
                  508,226
                  
                  
                  
                  5.47
                  %
  *
              Less
      than 1%.
  (1)
              Beneficial
      ownership is determined in accordance with the rules of the SEC. Shares of
      common stock subject to options or warrants currently exercisable or
      exercisable within 60 days of March 19, 2009, are deemed outstanding for
      computing the percentage ownership of the stockholder holding the options
      or warrants, but are not deemed outstanding for computing the percentage
      ownership of any other stockholder. Unless otherwise indicated in the
      footnotes to this table, we believe stockholders named in the table have
      sole voting and sole investment power with respect to the shares set forth
      opposite such stockholder's name. Unless otherwise indicated, the
      officers, directors and stockholders can be reached at our principal
      offices. Percentage of ownership is based on 9,005,175 shares of common
      stock outstanding as of March 19, 2009, reflecting the 1-for-7 split
      (including rounding up for fractional shares) effective January 26,
      2009.
  (2)
              Includes
      4,543 shares and options to purchase up to 40,357 shares of common stock.
      Does not include options to purchase up to 2,500 shares of common stock,
      which may vest more than 60 days after March 19, 2009. Mr. DePiano's
      address is 147 Keystone Drive, Montgomeryville,
      PA  18936.
  (3)
              Includes
      1,000 shares, 90,000 additional shares subject to restriction agreements
      with us and options to purchase up to 70,740 shares of common stock. Does
      not include options to purchase up to 45,246 shares of common stock, which
      may vest more than 60 days after March 19, 2009. Mr. O’Donnell's address
      is 147 Keystone Drive, Montgomeryville,
    PA  18936.
  (4)
              Includes
      1,571 shares, 60,357 additional shares subject to restriction agreements
      with us and options to purchase up to 60,806 shares of common stock. Does
      not include options to purchase up to 20,640 shares of common stock, which
      may vest more than 60 days after March 19, 2009. Mr. McGrath's address is
      147 Keystone Drive, Montgomeryville,
  PA  18936.
  (5)
              Includes
      206 shares, 32,500 additional shares subject to restriction agreements
      with us and options to purchase 43,017 shares of common stock. Does not
      include options to purchase up to 24,211 shares of common stock, which may
      vest more than 60 days after March 19, 2009. Mr. Stewart's address is 147
      Keystone Drive, Montgomeryville,
  PA  18936.
  75
  (6)
              Includes
      4,086 shares of common stock and options to purchase
      up to 38,214 shares of common stock. Does not include options to purchase
      up to 2,500 shares of common stock, which may vest more than 60 days after
      March 19, 2009. Mr. Novak's address is 147 Keystone Drive,
      Montgomeryville,
PA  18936.
  (7)
              Includes
      options to purchase up to 25,000 shares of common stock. Does not include
      options to purchase up to 2500 shares of common stock, which may vest more
      than 60 days after March 19, 2009. Mr. Anderson's address is 147 Keystone
      Drive, Montgomeryville,
PA  18936.
  (8)
              Includes
      2,143 shares of common stock and options to purchase up to 11,250 shares
      of common stock. Does not include options to purchase up to 2,500 shares
      of common stock, which may vest more than 60 days after March 19, 2009.
      Mr. Connelly's address is 147 Keystone Drive, Montgomeryville,
      PA  18936.
  (9)
              Includes
      4,286 shares of common stock owned by Mr. Withrow and his wife and options
      to purchase up to 15,000 shares of common stock. Does not include options
      to purchase up to 2,500 shares of common stock, which may vest more than
      60 days after March 19, 2009. Mr. Withrow’s address is 147 Keystone Drive,
      Montgomeryville,
PA  18936.
  (10)
              Includes
      options to purchase 1,250 shares of common stock. Does not include options
      to purchase up to 3,750 shares of common stock which may vest more than 60
      days after March 19, 2009. The foregoing information has been derived from
      a Schedule 13D filed on March 9, 2009, by Perseus, L.L.C. In
      a Form 4 filed on March 3, 2009, Mr. Glazer indicated that he holds any
      options, shares of stock or other securities issued to him as a nominee of
      Perseus, L.L.C. and disclaims beneficial ownership thereof, except to the
      extent he has any pecuniary interest therein.Mr. Glazer’s address
      is c/o Perseus, L.L.C., 2009 Pennsylvania Avenue, NW, Suite 900,
      Washington, DC 20006.
  (11)
              Perseus
      Partners VII, L.P. is a Delaware limited partnership. Its general partner
      is Perseus Partners VII GP, L.P. a Delaware limited partnership. Perseus
      Partners VII GP, L.L.C. is a Delaware limited liability company and is the
      general partner of Perseus Partners VII GP, L.P. The sole member of
      Perseus Partners VII GP, L.L.C. is Perseus, L.L.C., a Delaware limited
      liability company. Perseuspur, L.L.C., a Delaware limited liability
      company is the managing member of Perseus, L.L.C. Frank H. Pearl owns
      72.9% of Perseuspur, L.L.C. Mr. Pearl also is the sole director and sole
      shareholder of Rappahannock Investment Company, a Delaware corporation,
      which in turn owns the remaining 27.1% of Perseuspur, L.L.C.In
      a Form 4 filed on March 4, 2009, Mr. Pearl indicated that by virtue of
      such control, he and the other entities listed in this Note 11 other
      than the Investor may be deemed to have indirect beneficial
      ownership of the securities issued to the Investor.The holdings
      include 3,487,344 shares that may be issued pursuant to the conversion of
      a convertible note and 1,046,204 shares that may be issued pursuant to the
      exercise of warrants. Does not include 1,674,777 shares that may be issued
      for the conversion of additional convertible notes that may be issued in
      lieu of cash to pay interest, nor does it include options that were
      granted to Mr. Glazer and that may vest within 60 days after March 19,
      2009. The foregoing information has been derived from a Schedule 13D filed
      on March 9, 2009. The address of the Investor is c/o Perseus,
      L.L.C., 2099 Pennsylvania Avenue, NW, Ninth Floor, Washington, D.C.
      20006.
  (12)
              LB
      I Group Inc. is a wholly-owned subsidiary of Lehman Brothers Inc, which is
      a wholly-owned subsidiary of Lehman Brothers Holdings Inc. LB I Group Inc.
      owns 880,161 shares of common stock and warrants which became exercisable
      on May 15, 2007 to purchase up to 127,748 shares of common stock but which
      cannot be exercised if LBI owns more than 4.999% of our stock. The
      foregoing information has been derived from a Schedule 13G/A filed on
      behalf of LBI Group, Inc. on February 13, 2008. The address of LB I Group
      is 745 Seventh Avenue, New York, New York,
  10019.
  (13)
              James
      W. Sight owns 505,000 shares of common stock. The foregoing information
      has been derived from Schedule 13D, filed on December 31, 2008. Mr.
      Sight’s address is 8500 College Boulevard, Overland Park, Kansas
      66210.
  (14)
              Goldman
      Capital Management Inc. owns 1,098,415 shares of common stock. The
      foregoing information has been derived from Form 13F-HR filed by Goldman
      Capital Management on July 21, 2008. The address of Goldman Capital
      Management is 320 Park Avenue, New York, New York
  10022.
  76
  (15)
              Includes
      17,835 unrestricted shares, 182,857 restricted shares and options to
      purchase 307,634 shares of common stock. Does not include options to
      purchase up to 179,216 shares of common stock, which may vest more than 60
      days after March 19, 2009.
  Item
      13.
              Certain
      Relationships and Related Transactions, Director
    Independence
  As of
March 19, 2009, Messrs. Michael R. Matthias and Jeffrey P. Berg, shareholders in
Baker & Hostetler LLP, outside counsel to us in certain litigation, held in
the aggregate 6,224 shares of our common stock. Messrs. Matthias and Berg
acquired such shares through the exercise of stock options that they accepted
from us in exchange for legal services performed from July 1998 to May
2000.
  See
disclosure regarding the convertible note financing with an investment fund
managed by Perseus, L.L.C. contained in the Management’s Discussion and Analysis
of Financial Condition and Results of Operations sections of this Annual Report.
Perseus, L.L.C. is a parent of PhotoMedex as required to be disclosed pursuant
to Item 404(d) of Registration 8-K. Perseus, L.L.C. is the manager of an
investment fund that beneficially owns approximately 33.5% of our voting
securities. In addition, such investment fund has the right to appoint a
Director to our Board and has certain approval and negative control
rights.
  We
believe that all transactions with our affiliates have been entered into on
terms no less favorable to us than could have been obtained from independent
third parties. We intend that any transactions with officers, directors and 5%
or greater stockholders will be on terms no less favorable to us than could be
obtained from independent third parties and will be approved by a majority of
our independent, disinterested directors and will comply with the Sarbanes Oxley
Act and other securities laws and regulations.
  Our Board
determined in 2008 that all members of our Board are independent under the
applicable Nasdaq listing standards, except for Mr. O'Donnell, who is also our
Chief Executive Officer.
  Item
      14.
              Principal
      Accountant Fees and Services
  Our Audit
Committee has appointed Amper, Politziner & Mattia, LLP as our independent
auditors for the fiscal years ending December 31, 2008 and 2007.
  The
following table shows the fees paid or accrued by us for the audit and other
services provided by Amper, Politziner & Mattia, LLP for 2008 and
2007:
  2008
                    
                    
                    2007Audit
      Fees
                    
                    $
                    307,000
                    
                    
                    $
                    298,000Audit-Related
      Fees
                    
                    
                    59,500
                    
                    
                    
                    20,000Tax
      Fees
                    
                    
                    -
                    
                    
                    
                    -All
      Other Fees
                    
                    
                    20,000
                    
                    
                    
                    20,000Total
                    
                    $
                    386,500
                    
                    
                    $
                    338,000
  As defined by the Commission, (i)
“audit fees” are fees for professional services rendered by our principal
accountant for the audit of our annual financial statements and review of
financial statements included in our Form 10-Q, or for services that are
normally provided by the accountant in connection with statutory and regulatory
filings or engagements for those fiscal years; (ii) “audit-related fees” are
fees for assurance and related services by our principal accountant that are
reasonably related to the performance of the audit or review of our financial
statements and are not reported under “audit fees”; (iii) “tax fees” are fees
for professional services rendered by our principal accountant for tax
compliance, tax advice, and tax planning; and (iv) “all other fees” are fees for
products and services provided by our principal accountant, other than the
services reported under audit fees,” “audit-related fees,” and “tax
fees.”
  Audit
Fees.The
aggregate fees billed to us in 2008 and 2007 by the independent auditors, Amper,
Politziner & Mattia, LLP, for professional services rendered in connection
with our Quarterly Reports on Form 10-Q and for the audits of our financial
statements and internal controls included in this Annual Report on Form 10-K for
2008 and 2007, totaled approximately $307,000 and $298,000,
respectively.
  77
  Audit-Related
Fees.The
aggregate fees billed to us by Amper, Politziner & Mattia, LLP for assurance
and related services that are reasonably related to the performance of the audit
and review of our financial statements that are not already reported in the
paragraph immediately above totaled approximately $59,500 for 2008 and $20,000
for 2007, principally for the SIS carve out audit and for the audit of the
401(K) plan.
  All Other
Fees.The
aggregate fees billed to us by Amper, Politziner & Mattia, LLP. for products
and services rendered for tax consulting and other services were for $20,000 for
2008 and $20,000 for 2007.
  Engagement of the
Independent Auditor. The Audit Committee is
responsible for approving every engagement of Amper, Politziner & Mattia,
LLP to perform audit or non-audit services for us before Amper, Politziner &
Mattia, LLP is engaged to provide those services. Under applicable Commission
rules, the Audit Committee is required to pre-approve the audit and non-audit
services performed by the independent auditors in order to ensure that they do
not impair the auditors’ independence. The Commission’s rules specify the types
of non-audit services that an independent auditor may not provide to its audit
client and establish the Audit Committee’s responsibility for administration of
the engagement of the independent auditors.
  Consistent
with the Commission’s rules, the Audit Committee Charter requires that the Audit
Committee review and pre-approve all audit services and permitted non-audit
services provided by the independent auditors to us or any of our subsidiaries.
The Audit Committee may delegate pre-approval authority to a member of the Audit
Committee and if it does, the decisions of that member must be presented to the
full Audit Committee at its next scheduled meeting.
  The Audit
Committee’s pre-approval policy provides as follows:
  ·      First,
once a year when the base audit engagement is reviewed and approved, management
will identify all other services (including fee ranges) for which management
knows it will engage Amper, Politziner & Mattia, LLP for the next 12 months.
Those services typically include quarterly reviews, specified tax matters,
certifications to the lenders as required by financing documents, consultation
on new accounting and disclosure standards and, in future years, reporting on
management’s internal controls assessment.
  ·      Second,
if any new “unlisted” proposed engagement arises during the year, the engagement
will require approval of the Audit Committee.
  Auditor Selection
for Fiscal 2009 Amper, Politziner & Mattia, LLP has been selected to
serve as our independent auditors for the year ending December 31,
2009.
  PART
IV
  Item
      15
              Exhibits
  (a)(1)
              Financial
      Statements
  Consolidated balance sheet of
PhotoMedex, Inc. and subsidiaries as of December 31, 2008 and 2007, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the 3-year period ended December 31,
2008.
  (a)(2)
              Financial Statement
      Schedules
  All schedules have been omitted because
they are not required, not applicable, or the information is otherwise set forth
in the consolidated financial statements or notes thereto.
  78
  (b)           Exhibits
  2.1
                    
                    Agreement
      and Plan of Merger, dated September 25, 2002, between PhotoMedex, Inc., J
      Merger Corp., Inc. and Surgical Laser Technologies, Inc.
    (1)2.2
                    
                    Agreement
      and Plan of Merger, dated December 1, 2004, between PhotoMedex, Inc., Gold
      Acquisition Merger Corp. and ProCyte Corporation (2)2.3
                    
                    Securities
      Purchase Agreement, dated October 31, 2006, by and between PhotoMedex,
      Inc. and each purchaser a party thereto (3)2.4
                    
                    Purchase
      Agreement, dated August 4, 2008, by and among PhotoMedex, Inc., Photo
      Therapeutics Group Limited and Neil Crabb. (21)2.5
                    
                    Asset
      Purchase Agreement, dated August 1, 2008, by and between PhotoMedex, Inc.
      and PRI Medical Technologies, Inc. (21)3.1
                    
                    Restated
      Certificate of Incorporation, filed on August 8, 2000
  (4)3.2
                    
                    Amendment
      to Restated Certificate of Incorporation, filed on January 6, 2004
      (22)3.3
                    
                    Amendment
      to Restated Certificate of Incorporation, filed on January 26, 2009.
      (26)3.4
                    
                    Amended
      and Restated Bylaws (5)3.5
                    
                    Amended
      Section 6.01 of the By-Laws, October 30, 2007 (19)4.1
                    
                    Securities
      Purchase Agreement, dated August 4, 2008, by and between PhotoMedex, Inc.
      and Perseus Partners VII, LP, including Form of Convertible Note, Form of
      Warrant and Registration Rights Agreement (21)4.2
                    
                    Amendment
      No. 1 to Securities Purchase Agreement, dated February 27, 2009.
      (24)4.3
                    
                    First
      Tranche Convertible Promissory Note, dated February 27, 2009.
      (24)4.4
                    
                    Pledge
      and Security Agreement, dated February 27, 2009. (24)4.5
                    
                    First
      Tranche Warrant, dated February 27, 2009. (24)4.6
                    
                    Registration
      Rights Agreement, dated February 27, 2009 (26)10.1
                    
                    Lease
      Agreement dated May 29, 1996, between Surgical Laser Technologies, Inc.
      and Nappen & Associates (Montgomeryville, Pennsylvania)
      (5)10.2
                    
                    Lease
      Renewal Agreement, dated January 18, 2001, between Surgical Laser
      Technologies, Inc. and Nappen & Associates (5)10.3
                    
                    Lease
      Agreement, dated July 10, 2006, PhotoMedex, Inc. and Nappen &
      Associates (6)10.4
                    
                    Standard
      Industrial/Commercial Multi-Tenant Lease - Net, dated July 30, 2008
      (additional facility at Carlsbad, California)(26)10.5
                    
                    Standard
      Industrial/Commercial Multi-Tenant Lease  Net, dated March 17,
      2005 (Carlsbad, California)(8)10.6
                    
                    Industrial
      Real Estate Lease, dated May 3, 2007, and delivered December 14, 2007
      (26)10.7
                    
                    License
      and Development Agreement, dated May 22, 2002, between Surgical Laser
      Technologies, Inc. and Reliant Technologies, Inc. (5)10.8
                    
                    Settlement
      Agreement and Release, dated November 11, 2008, by and among Allergan,
      Inc., Murray A. Johnstone, MD, PhotoMedex, Inc. and ProCyte Corporation.
      (26)10.9
                    
                    Master
      Purchase Agreement, dated September 7, 2004, between PhotoMedex, Inc. and
      Stern Laser, srl (9)10.10
                    
                    Master
      Lease Agreement, dated June 25, 2004, between PhotoMedex, Inc. and GE
      Capital Corporation. (10)10.11
                    
                    Investment
      Agreement, dated March 30, 2006, between AzurTec, Inc. and PhotoMedex,
      Inc. (11)10.12
                    
                    License
      Agreement, dated March 30, 3006, between AzurTec, Inc. and PhotoMedex,
      Inc. (11)10.13
                    
                    License
      Agreement, dated March 31, 2006, and effective April 1, 1006, between the
      Mount Sinai School of Medicine and PhotoMedex, Inc.
(12)10.14
                    
                    2005
      Equity Compensation Plan, approved December 28, 2005
  (13)10.15
                    
                    2005
      Investment Plan, approved December 28, 2005 (13)10.16
                    
                    Amended
      and Restated 2000 Non-Employee Director Stock Option Plan
    (1)10.17
                    
                    Amended
      and Restated 2000 Stock Option Plan (1)10.18
                    
                    2004
      Stock Option Plan, assumed from ProCyte (14)10.19
                    
                    1996
      Stock Option Plan, assumed from ProCyte
(14)
  79
  10.20
              
              1991
      Restated Stock Option Plan for Non-Employee Directors, assumed from
      ProCyte (14)10.21
              
              1989
      Restated Stock Option Plan, assumed from ProCyte (14)10.22
              
              Amended
      and Restated Employment Agreement with Jeffrey F. O'Donnell, dated October
      30, 2007 (19)10.23
              
              Amended
      and Restated Employment Agreement with Dennis M. McGrath, dated September
      1, 2007 (19)10.24
              
              Amended
      and Restated Employment Agreement of Michael R. Stewart, dated September
      1, 2007 (19)10.25
              
              Employment
      Agreement of John F. Clifford, dated March 18, 2005 (2)10.26
              
              Employment
      Agreement of Robin L. Carmichael, dated March 18, 2005
  (2)10.27
              
              Separation
      Agreement, effective June 30, 2006, between PhotoMedex, Inc. and John F.
      Clifford. (15)10.28
              
              Restricted
      Stock Purchase Agreement of Jeffrey F. O’Donnell, dated January 15, 2006
      (8)10.29
              
              Restricted
      Stock Purchase Agreement of Dennis M. McGrath, dated January 15, 2006
      (8)10.30
              
              Consulting
      Agreement dated January 21, 1998 between the Company and R. Rox
      Anderson, M.D. (7)10.31
              
              Restricted
      Stock Purchase Agreement of Jeffrey F. O’Donnell, dated May 1, 2007
      (17)10.32
              
              Restricted
      Stock Purchase Agreement of Dennis M. McGrath, dated May 1, 2007
      (17)10.33
              
              Restricted
      Stock Purchase Agreement of Michael R. Stewart, dated May 1, 2007
      (17)10.34
              
              Restricted
      Stock Purchase Agreement of Michael R. Stewart, dated August 13, 2007
      (18)10.35
              
              Amended
      and Restated 2000 Non-Employee Director Stock Option Plan, dated as of
      June 26, 2007 (17)10.36
              
              Amended
      and Restated 2005 Equity Compensation Plan, dated as of June 26, 2007, as
      amended on October 28, 2008 (25)10.37
              
              Master
      Term Loan and Security Agreement, dated December 31, 2007 among
      PhotoMedex, Inc., CIT Healthcare LLC, as Agent and Lender, and Life
      Sciences Capital LLC, as Lender (20)10.38
              
              Omnibus
      Amendment dated September 30, 2008 by and among CIT Healthcare LLC, Life
      Sciences Capital LLC and PhotoMedex, Inc. (23)10.39
              
              Amendment
      No. 1 to Omnibus Amendment, dated February 27, 2009
(24)10.40
              
              Form
      of Indemnification Agreement for directors and executive officers of
      PhotoMedex, Inc. (24)22.1
              
              List
      of subsidiaries of the Company23.1
              
              Consent
      of Amper, Politziner & Mattia LLP31.1
              
              Rule
      13a-14(a) Certificate of Chief Executive Officer31.2
              
              Rule
      13a-14(a) Certificate of Chief Financial Officer32.1
              
              Certificate
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  200232.2
              
              Certificate
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002
 
  (1)
              Filed
      as part of our Registration Statement on Form S-4, as filed with the
      Commission on October 18, 2002, and as
amended.
  (2)
              Filed
      as part of our Registration Statement on Form S-4/A filed with the
      Commission on January 21, 2005, and as
amended.
  (3)
              Filed
      as part of our Current Report on Form 8-K, dated November 6,
      2006.
  (4)
              Filed
      as part of our Quarterly Report on Form 10-Q for the quarter ended June
      30, 2000.
  (5)
              Filed
      as part of our Annual Report on Form 10-K for the year ended December 31,
      2002.
  (6)
                Filed
      as part of our Annual Report on Form 10-K for the year ended December 31,
      2006.
  (7)
                Filed
      as part of our Registration Statement on Form S-1, as filed with the
      Commission on January 28, 1998, as
amended.
  (8)
                Filed
      as part of our Annual Report on Form 10-K for the year ended December 31,
      2005.
  (9)
                Filed
      as part of our Current Report on Form 8-K, dated September 10,
      2004.
  (10)
                Filed
      as part of our Quarterly Report on Form 10-Q for the quarter ended June
      30, 2004.
  (11)
                Filed
      as part of our Current Report on Form 8-K, filed on April 6,
      2006.
  80
  (12)
                Filed
      as part of our Current Report on Form 8-K, filed on April 10,
      2006.
  (13)
                Filed
      as part of our Definitive Proxy Statement on Schedule 14A, as filed with
      the Commission on November 15,
2005.
  (14)
                Filed
      as part of our Registration Statement on Form S-8, as filed with the
      Commission on April 13, 2005.
  (15)
                Filed
      as part of our Quarterly Report on Form 10-Q for the quarter ended March
      31, 2006.
  (16)
                Filed
      as part of our Quarterly Report on Form 10-Q for the quarter ended
      September 30, 2003.
  (17)
                Filed
      as part of our Quarterly Report on Form 10-Q for the quarter ended June
      30, 2007.
  (18)
                Filed
      as part of our Quarterly Report on Form 10-Q for the quarter ended
      September 30, 2007.
  (19)
              Filed
      as part of our Annual Report on Form 10-K for the year ended December 31,
      2007.
  (20)
                Filed
      as part of our amended Annual Report on Form 10-K/A for the year ended
      December 31, 2007.
  (21)
                Filed
      as part of our Current Report on Form 8-K filed on August 4,
      2008.
  (22)
                Fled
      as part of our Annual Report on Form 10-K for the year ended December 31,
      2003.
  (23)
                Filed
      as part of our Current Report on Form 8-K on February 27,
      2009.
  (24)
                Filed
      as part of our Current Report on Form 8-K on March 5,
  2009.
  (25)
                Filed
      as part of our Definitive Proxy Statement on Schedule 14A on December 18,
      2008.
  (26)
                Filed
      with this Form 10-K.
  AVAILABLE
INFORMATION
  We are a
reporting company and file annual, quarterly and special reports, proxy
statements and other information with the Commission. You may inspect and copy
these materials at the Public Reference Room maintained by the Commission at
Room 100 F Street, N.W., Washington, D.C. 20549. Please call the Commission
at 1-800-SEC-0330 for more information on the Public Reference Room. You can
also find our Commission filings at the Commission's website at www.sec.gov. You
may also inspect reports and other information concerning us at the offices of
the Nasdaq Stock Market at 1735 K Street, N.W., Washington, D.C. 20006. We
intend to furnish our stockholders with annual reports containing audited
financial statements and such other periodic reports as we may determine to be
appropriate or as may be required by law.
  Our
primary Internet address is www.photomedex.com.
Corporate information can be located by clicking on the “Investor Relations”
link in the top-middle of the page, and then clicking on “SEC Filing” in the
menu. We make our periodic Commission Reports (Forms 10-Q and Forms 10-K) and
current reports (Form 8-K) available free of charge through our Web site as soon
as reasonably practicable after they are filed electronically with the
Commission. We may from time to time provide important disclosures to investors
by posting them in the Investor Relations section of our Web site, as allowed by
Commission’s rules. The information on the website listed above is not and
should not be considered part of this Annual Report on Form 10-K and is intended
to be an inactive textual reference only.
  81
  SIGNATURES
  Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
  PHOTOMEDEX,
      INC.Date:  March
      20, 2009
                  By:
                  /s/ Jeffrey F. O’DonnellJeffrey
      F. O’DonnellPresident,
      Chief Executive Officer and
Director
  Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
  Signature
                                          
                                          Capacity in Which Signed
                                          
                                          Date/s/
      Richard J. DePiano
                                          
                                          Chairman
      of the Board of Directors
                                          
                                          March
      20, 2009Richard
      J. DePiano/s/
      Jeffrey F. O’Donnell
                                          
                                          President,
      Chief Executive Officer and
                                            Director
      (Principal Executive Officer)
                                          
                                          March
      20, 2009Jeffrey
      F. O'Donnell/s/
      Dennis M. McGrath
                                          
                                          Chief
      Financial Officer (Principal
                                            Financial
      and Accounting Officer)
                                          
                                          March
      20, 2009Dennis
      M. McGrath/s/
      Alan R. Novak
                                          
                                          Director
                                          
                                          March
      20, 2009Alan
      R. Novak/s/
      David W. Anderson
                                          
                                          Director
                                          
                                          March
      20, 2009David
      W. Anderson/s/
      Stephen P. Connelly
                                          
                                          Director
                                          
                                          March
      20, 2009Stephen
      P. Connelly/s/
      Wayne M. Withrow
                                          
                                          Director
                                          
                                          March
      20, 2009Wayne
      M. WithrowDirectorJohn
      M. Glazer
  82





PHOTOMEDEX,
INC. AND SUBSIDIARIES




Index to
Consolidated Financial Statements




PageReport
      of Independent Registered Public Accounting Firm
                
                F-2Consolidated
      Balance Sheets, December 31, 2008 and 2007
                
                F-3Consolidated
      Statements of Operations, Years ended December 31, 2008, 2007 and
      2006
                
                F-4Consolidated
      Statements of Stockholders’ Equity, Years ended December 31,
      2008,2007
      and 2006
                
                F-5Consolidated
      Statements of Cash Flows, Years ended December 31, 2008, 2007 and
      2006
                
                F-6Notes
      to Consolidated Financial Statements
                
                F-7





REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





Board of
Directors and shareholders


PhotoMedex,
Inc. and Subsidiaries




We have
audited the accompanying consolidated balance sheets of PhotoMedex, Inc. and
Subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
each of the three years in the period ended December 31, 2008. We also have
audited PhotoMedex, Inc.’s internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control-Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). PhotoMedex, Inc.’s management is responsible for
these financial statements, for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
controls over financial reporting, included in the accompanying consolidated
financial statements. Our responsibility is to express an opinion on these
financial statements and an opinion on the Company’s internal control over
financial reporting based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinions.




A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of PhotoMedex, Inc. and Subsidiaries
as of December 31, 2008 and 2007, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2008 in
conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, PhotoMedex, Inc. and Subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control-Internal
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).




/s/ Amper
Politziner & Mattia, LLP





March 20,
2009


Edison,
New Jersey


F-2


PHOTOMEDEX,
INC. AND SUBSIDIARIES




CONSOLIDATED
BALANCE SHEETS




December 31,2008
                    
                    
                    2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                    
                    $
                    3,658,607
                    
                    
                    $
                    9,837,303Restricted
      cash
                    
                    
                    78,000
                    
                    
                    
                    117,000Accounts
      receivable, net of allowance for doubtful accounts of $486,000 and
      $526,000, respectively
                    
                    
                    5,421,688
                    
                    
                    
                    5,797,620Inventories
                    
                    
                    6,974,194
                    
                    
                    
                    6,980,180Prepaid
      expenses and other current assets
                    
                    
                    322,549
                    
                    
                    
                    508,384Current
      assets of discontinued operation
                    
                    
                    -
                    
                    
                    
                    1,910,802Total
      current assets
                    
                    
                    16,455,038
                    
                    
                    
                    25,151,289Property
      and equipment, net
                    
                    
                    10,388,406
                    
                    
                    
                    8,024,461Patents
      and licensed technologies, net
                    
                    
                    1,142,462
                    
                    
                    
                    1,408,248Goodwill,
      net
                    
                    
                    16,917,808
                    
                    
                    
                    16,917,808Other
      intangible assets, net
                    
                    
                    1,095,625
                    
                    
                    
                    2,607,625Other
      assets
                    
                    
                    714,930
                    
                    
                    
                    448,046Assets
      of discontinued operation
                    
                    
                    -
                    
                    
                    
                    2,129,226Total
      assets
                    
                    $
                    46,714,269
                    
                    
                    $
                    56,686,703LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      liabilities:Current
      portion of notes payable
                    
                    $
                    28,975
                    
                    
                    $
                    129,305Current
      portion of long-term debt
                    
                    
                    4,663,281
                    
                    
                    
                    4,757,133Accounts
      payable
                    
                    
                    5,204,334
                    
                    
                    
                    3,634,519Accrued
      compensation and related expenses
                    
                    
                    1,487,153
                    
                    
                    
                    1,581,042Other
      accrued liabilities
                    
                    
                    864,433
                    
                    
                    
                    674,374Deferred
      revenues
                    
                    
                    798,675
                    
                    
                    
                    668,032Total
      current liabilities
                    
                    
                    13,046,851
                    
                    
                    
                    11,444,405Notes
      payable, net of current maturities
                    
                    
                    77,239
                    
                    
                    
                    106,215Long-term
      debt, net of current maturities
                    
                    
                    3,907,752
                    
                    
                    
                    5,602,653Total
      liabilities
                    
                    
                    17,031,842
                    
                    
                    
                    17,153,273Commitment
      and contingenciesStockholders'
      Equity:Common
      Stock, $.01 par value, 100,000,000 shares authorized; 63,032,207 shares
      issued and outstanding (9,004,601 shares deemed
      issued and outstanding after adjustments to reflect the reverse stock
      split of 1-for-7 effective January 26, 2009)
                    
                    
                    90,046
                    
                    
                    
                    90,046Additional
      paid-in capital
                    
                    
                    134,912,537
                    
                    
                    
                    133,472,633Accumulated
      deficit
                    
                    
                    (105,320,156
                    )
                    
                    
                    (94,029,249
                    )Total
      stockholders' equity
                    
                    
                    29,682,427
                    
                    
                    
                    39,533,430Total
      liabilities and stockholders’ equity
                    
                    $
                    46,714,269
                    
                    
                    $
                    56,686,703




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


F-3


PHOTOMEDEX,
INC. AND SUBSIDIARIES




CONSOLIDATED
STATEMENTS OF OPERATIONS





For the Year Ended December 31,2008
                
                
                2007
                
                
                2006Revenues:Product
      sales
                
                $
                26,144,084
                
                
                $
                23,626,660
                
                
                $
                20,659,506Services
                
                
                8,626,208
                
                
                
                7,419,783
                
                
                
                5,586,08034,770,292
                
                
                
                31,046,443
                
                
                
                26,245,586Cost
      of revenues:Product
      cost of revenues
                
                
                11,968,222
                
                
                
                9,582,715
                
                
                
                8,571,133Services
      cost of revenues
                
                
                5,027,095
                
                
                
                3,998,911
                
                
                
                4,115,82216,995,317
                
                
                
                13,581,626
                
                
                
                12,686,955Gross
      margin
                
                
                17,774,975
                
                
                
                17,464,817
                
                
                
                13,558,631Operating
      expenses:Selling,
      general and administrative
                
                
                26,797,107
                
                
                
                22,279,534
                
                
                
                19,803,179Engineering
      and product development
                
                
                1,073,215
                
                
                
                799,108
                
                
                
                1,006,60027,870,322
                
                
                
                23,078,642
                
                
                
                20,809,779Loss
      from continuing operations before refinancing charge and interest expense,
      net
                
                
                (10,095,347
                )
                
                
                (5,613,825
                )
                
                
                (7,251,148
                )Refinancing
      charge
                
                
                -
                
                
                
                (441,956
                )
                
                
                -Interest
      expense, net
                
                
                (1,032,597
                )
                
                
                (529,489
                )
                
                
                (521,769
                )Loss
      from continuing operations
                
                
                (11,127,944
                )
                
                
                (6,585,270
                )
                
                
                (7,772,917
                )Discontinued
      operations:Income
      from discontinued operations, net of tax
                
                
                285,712
                
                
                
                231,024
                
                
                
                280,520Loss
      on sale of discontinued operations
                
                
                (448,675
                )
                
                
                -
                
                
                
                -Net
      loss
                
                $
                (11,290,907
                )
                
                $
                ( 6,354,246
                )
                
                $
                ( 7,492,397
                )Basic
      and diluted net loss per share (Note 1):Continuing
      operations
                
                $
                (1.23
                )
                
                $
                (0.73
                )
                
                $
                (1.00
                )Discontinued
      operations
                
                
                (0.02
                )
                
                
                0.03
                
                
                
                0.03Basic
      and diluted net loss per share
                
                $
                (1.25
                )
                
                $
                (0.70
                )
                
                $
                (0.97
                )Shares
      used in computing basic and diluted net loss per share (Note
      1)
                
                
                9,004,601
                
                
                
                8,972,905
                
                
                
                7,741,273




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


F-4


PHOTOMEDEX,
INC. AND SUBSIDIARIES




CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY





Common Stock
                              
                              
                              AdditionalPaid-In
                              
                              
                              Accumulated
                              
                              
                              DeferredShares (1)
                              
                              
                              Amount (1)
                              
                              
                              Capital (1)
                              
                              
                              Deficit
                              
                              
                              Compensation
                              
                              
                              TotalBALANCE,
      DECEMBER 31, 2005
                              
                              
                              7,344,899
                              
                              
                              $
                              73,449
                              
                              
                              $
                              118,581,532
                              
                              
                              $
                              (80,182,606
                              )
                              
                              $
                              (55,347
                              )
                              
                              $
                              38,417,028Reversal
      of deferred compensation upon adoption of SFAS 123R
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (55,347
                              )
                              
                              
                              -
                              
                              
                              
                              55,347
                              
                              
                              
                              -Exercise
      of warrants
                              
                              
                              20,000
                              
                              
                              
                              200
                              
                              
                              
                              167,800
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              168,000Exercise
      of stock options
                              
                              
                              8,679
                              
                              
                              
                              87
                              
                              
                              
                              87,184
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              87,271Sale
      of stock, net of expenses
                              
                              
                              1,394,286
                              
                              
                              
                              13,943
                              
                              
                              
                              10,533,059
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              10,547,002Amortization
      of deferred compensation
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              55,347
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              55,347Stock
      options issued to consultants for services
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              132,624
                              
                              
                              
                              
                              
                              
                              
                              -
                              
                              
                              
                              132,624Stock-based
      compensation expense related to employee options
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              990,372
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              990,372Issuance
      of restricted stock
                              
                              
                              122,857
                              
                              
                              
                              1,228
                              
                              
                              
                              321,546
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              322,774Issuance
      of stock for AzurTec agreement
                              
                              
                              28,571
                              
                              
                              
                              286
                              
                              
                              
                              382,987
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              383,273Issuance
      of stock for Stern laser assets acquisition, net of
    expenses
                              
                              
                              14,430
                              
                              
                              
                              144
                              
                              
                              
                              191,591
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              191,735Stock-based
      compensation expense related to severance agreement
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              195,497
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              195,497Issuance
      of warrants for draws under line of credit
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              104,388
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              104,388Net
      loss
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (7,492,397
                              )
                              
                              
                              -
                              
                              
                              
                              (7,492,397
                              )BALANCE,
      DECEMBER 31, 2006
                              
                              
                              8,933,722
                              
                              
                              
                              89,337
                              
                              
                              
                              131,688,580
                              
                              
                              
                              (87,675,003
                              )
                              
                              
                              -
                              
                              
                              
                              44,102,914Exercise
      of stock options
                              
                              
                              10,879
                              
                              
                              
                              109
                              
                              
                              
                              85,845
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              85,954Stock
      options issued to consultants for services
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              109,107
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              109,107Stock-based
      compensation expense related to employee options
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              955,767
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              955,767Issuance
      of restricted stock
                              
                              
                              60,000
                              
                              
                              
                              600
                              
                              
                              
                              383,607
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              384,207Issuance
      of warrants for draws under line of credit
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              249,727
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              249,727Net
      loss
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (6,354,246
                              )
                              
                              
                              -
                              
                              
                              
                              (6,354,246
                              )BALANCE,
      DECEMBER 31, 2007
                              
                              
                              9,004,601
                              
                              
                              
                              90,046
                              
                              
                              
                              132,472,633
                              
                              
                              
                              (94,029,249
                              )
                              
                              
                              -
                              
                              
                              
                              39,533,430Stock
      options issued to consultants for services
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              92,501
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              92,501Stock-based
      compensation expense related to employee options
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              888,546
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              888,546Amortization
      of restricted stock
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              414,491
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              414,491Issuance
      of warrants for draws under line of credit
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              44,366
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              44,366Net
      loss
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (11,290,907
                              )
                              
                              
                              -
                              
                              
                              
                              (11,290,907
                              )BALANCE,
      DECEMBER 31, 2008
                              
                              
                              9,004,601
                              
                              
                              $
                              90,046
                              
                              
                              $
                              134,912,537
                              
                              
                              $
                              (105,320,156
                              )
                              
                              
                              -
                              
                              
                              $
                              29,682,427




(1)  Adjusted
to reflect the reverse stock split of 1-for-7 effective January 26,
2009.





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


F-5


PHOTOMEDEX,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS




For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Cash
      Flows From Operating Activities:Net
      loss
                  
                  $
                  (11,290,907
                  )
                  
                  $
                  (6,354,246
                  )
                  
                  $
                  (7,492,397
                  )Adjustments
      to reconcile net loss to net cash used in operating activities-continuing
      operations:Depreciation
      and amortization
                  
                  
                  4,172,436
                  
                  
                  
                  3,834,870
                  
                  
                  
                  3,407,889Loss
      on sale of discontinued operations
                  
                  
                  448,675
                  
                  
                  
                  -
                  
                  
                  
                  -Refinancing
      charge
                  
                  
                  -
                  
                  
                  
                  441,956
                  
                  
                  
                  -Impairment
      on intangibles and other long-lived assets
                  
                  
                  934,611
                  
                  
                  
                  -
                  
                  
                  
                  -Loss
      on disposal of property and equipment
                  
                  
                  4,658
                  
                  
                  
                  -
                  
                  
                  
                  -Provision
      for doubtful accounts
                  
                  
                  137,766
                  
                  
                  
                  92,892
                  
                  
                  
                  66,211Stock
      options issued to consultants for services
                  
                  
                  92,501
                  
                  
                  
                  109,107
                  
                  
                  
                  132,624Stock-based
      compensation
                  
                  
                  1,303,037
                  
                  
                  
                  1,335,773
                  
                  
                  
                  1,1,359,893Changes
      in operating assets and liabilities, net of effects from discontinued
      operations:Accounts
      receivable
                  
                  
                  238,166
                  
                  
                  
                  (1,836,091
                  )
                  
                  
                  (437,145
                  )Inventories
                  
                  
                  (63,946
                  )
                  
                  
                  (460,564
                  )
                  
                  
                  1,010,738Prepaid
      expenses and other assets
                  
                  
                  932,306
                  
                  
                  
                  818,555
                  
                  
                  
                  1,123,772Accounts
      payable
                  
                  
                  1,569,815
                  
                  
                  
                  172,794
                  
                  
                  
                  45,648Accrued
      compensation and related expenses
                  
                  
                  (93,889
                  )
                  
                  
                  51,180
                  
                  
                  
                  315,508Other
      accrued liabilities
                  
                  
                  190,058
                  
                  
                  
                  18,189
                  
                  
                  
                  (279,295
                  )Deferred
      revenues
                  
                  
                  130,643
                  
                  
                  
                  35,857
                  
                  
                  
                  166,143Net
      cash used in operating activities-continuing operations
                  
                  
                  (1,294,070
                  )
                  
                  
                  (1,739,728
                  )
                  
                  
                  (580,411
                  )Net
      cash provided by operating activities-discontinued
    operations
                  
                  
                  584,838
                  
                  
                  
                  761,741
                  
                  
                  
                  641,395Net
      cash (used in) provided by operating activities
                  
                  
                  (709,232
                  )
                  
                  
                  (977,987
                  )
                  
                  
                  60,984Cash
      Flows From Investing Activities:Purchases
      of property and equipment
                  
                  
                  (261,822
                  )
                  
                  
                  (131,654
                  )
                  
                  
                  (94,976
                  )Lasers
      placed into service
                  
                  
                  (5,089,137
                  )
                  
                  
                  (4,169,970
                  )
                  
                  
                  (3,933,294
                  )Proceeds
      from disposition of discontinued operations
                  
                  
                  3,149,736
                  
                  
                  
                  -
                  
                  
                  
                  -Deferred
      costs on proposed debt financing
                  
                  
                  (564,930
                  )
                  
                  
                  -
                  
                  
                  
                  -Net
      cash used in investing activities-continuing operations
                  
                  
                  (2,766,153
                  )
                  
                  
                  (4,301,624
                  )
                  
                  
                  (4,028,270
                  )Net
      cash used in investing activities-discontinued operations
                  
                  
                  (68,462
                  )
                  
                  
                  (271,864
                  )
                  
                  
                  (998,541
                  )Net
      cash used in investing activities
                  
                  
                  (2,834,615
                  )
                  
                  
                  (4,573,488
                  )
                  
                  
                  (5,026,811
                  )Cash
      Flows From Financing Activities:Proceeds
      from issuance of common stock, net
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  10,547,002Proceeds
      from issuance of restricted common stock
                  
                  
                  -
                  
                  
                  
                  4,200
                  
                  
                  
                  8,600Proceeds
      from exercise of options
                  
                  
                  -
                  
                  
                  
                  85,954
                  
                  
                  
                  87,271Proceeds
      from exercise of warrants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  168,000Payments
      on long-term debt
                  
                  
                  (107,376
                  )
                  
                  
                  (96,504
                  )
                  
                  
                  (179,993
                  )Payments
      on notes payable
                  
                  
                  (911,350
                  )
                  
                  
                  (688,040
                  )
                  
                  
                  (900,715
                  )Advances
      on line of credit
                  
                  
                  3,580,933
                  
                  
                  
                  6,824,778
                  
                  
                  
                  4,712,325Repayments
      on line of credit
                  
                  
                  (5,236,056
                  )
                  
                  
                  (3,510,351
                  )
                  
                  
                  (2,200,888
                  )Decrease
      in restricted cash and cash equivalents
                  
                  
                  39,000
                  
                  
                  
                  39,000
                  
                  
                  
                  50,931Net
      cash (used in) provided by financing activities-continuing
      operations
                  
                  
                  (2,634,849
                  )
                  
                  
                  2,659,036
                  
                  
                  
                  12,292,533Net
      cash provided by financing activities-discontinued
    operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      cash (used in) provided by financing activities
                  
                  
                  (2,634,849
                  )
                  
                  
                  2,659,036
                  
                  
                  
                  12,292,533Net
      (decrease) increase in cash and cash equivalents
                  
                  
                  (6,178,696
                  )
                  
                  
                  (2,892,439
                  )
                  
                  
                  7,326,706Cash
      and cash equivalents, beginning of year
                  
                  
                  9,837,303
                  
                  
                  
                  12,729,742
                  
                  
                  
                  5,403,036Cash
      and cash equivalents, end of year
                  
                  $
                  3,658,607
                  
                  
                  $
                  9,837,303
                  
                  
                  $
                  12,729,742




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


F-6


PHOTOMEDEX,
INC. AND SUBSIDIARIES




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





Note
1


The
Company and Summary of Significant Accounting Policies:




The
Company:




PhotoMedex,
Inc. (and its subsidiaries) (the “Company”) is a medical device and specialty
pharmaceutical company focused on facilitating the cost-effective use of
technologies for doctors, hospitals and surgery centers to enable their patients
to achieve a higher quality of life. The Company currently operates in four
distinct business units, or segments (as described in Note 10): three in
Dermatology, - Domestic XTRAC®, International Dermatology Equipment, and Skin
Care (ProCyte®); and one in Surgical, - Surgical Products (SLT®). The segments
are distinguished by our management structure, products and services offered,
markets served or types of customers. A fifth segment of business, the Surgical
Services segment was sold on August 8, 2008 and is reported as a discontinued
operation, with its related assets as assets of discontinued operations, in
these financial statements.




The
Domestic XTRAC segment generally derives revenues from procedures performed by
dermatologists in the United States. Under these circumstances, the Company’s
XTRAC laser system is placed in a dermatologist’s office without any initial
capital cost to the dermatologist, and the Company charges a fee-per-use to
treat skin disease. At times, however, the Company sells XTRAC lasers to
customers, due generally to customer circumstances and preferences. In
comparison to the Domestic XTRAC segment, the International Dermatology
Equipment segment generates revenues solely from the sale of equipment to
dermatologists outside the United States through a network of distributors. The
Skin Care segment generates revenues by selling physician-dispensed skincare
products worldwide and, now to a markedly lesser degree, by earning royalties on
licenses for our patented copper peptide compound.




The
Company designed and manufactured the XTRAC laser system to treat psoriasis,
vitiligo, atopic dermatitis and leukoderma phototherapeutically. The Company has
received clearances from the U.S. Food and Drug Administration (“FDA”) to market
the XTRAC laser system for each of these indications. The XTRAC is approved by
Underwriters’ Laboratories; it is also CE-marked, and accordingly a third party
regularly audits the Company’s quality system and manufacturing facility. The
manufacturing facility for the XTRAC is located in Carlsbad,
California.




For the
last several years the Company has sought to obtain health insurance coverage
for its XTRAC laser therapy to treat inflammatory skin disease, particularly
psoriasis. With the addition of new positive payment policies from Blue Cross
Blue Shield plans from certain states during the first nine months of 2008, the
Company now benefits from the fact that more than 90% of the insured United
States population has policies that provide nearly full reimbursement for the
treatment of psoriasis by means of an excimer laser (XTRAC). The Company is now
focusing its efforts on accelerating the adoption of the XTRAC laser therapy for
psoriasis and vitiligo by doctors and patients. Consequently, the Company has
increased the size of its sales force and clinical technician personnel together
with increased expenditures for marketing and advertising.




The
Surgical Products segment generates revenues by selling laser products and
disposables to hospitals and surgery centers both domestically and
internationally. The Surgical Products segment also sells other non-laser
products (e.g., the ClearESS® II suction-irrigation system).




Surgical
Services was a fee-based procedures business using mobile surgical laser
equipment operated by Company technicians at hospitals and surgery centers in
the United States. After preliminary investigations and discussions, the Board
of Directors of the Company decided on June 13, 2008 to develop plans for
implementing a disposal of the assets and operations of the business. The
Company accordingly classified this former segment as held for sale in
accordance with SFAS No. 144. On August 1, 2008, the Company entered into a
definitive agreement to sell specific assets of the business including accounts
receivable, inventory and equipment, for $3,500,000, subject to certain closing
adjustments. See Note 2, Discontinued
Operations.




The
Company's board of directors approved a 1-for-7 reverse stock split of the
Company's common stock, which became effective on January 26, 2009. As a result
of the reverse stock split, each seven shares of common stock were combined and
reclassified into one share of common stock and the total number of shares
outstanding was reduced from approximately 63 million shares to
approximately 9 million shares.


F-7


Liquidity
and Going Concern


The
Company has incurred significant losses and negative cash flows from operations.
As of December 31, 2008, the Company had an accumulated deficit of $105,320,156.
The Company has historically financed its activities from operations, the
private placement of equity securities and borrowings under lines of credit. To
date, the Company has dedicated most of its financial resources to research and
development, marketing and general and administrative expenses.




Cash and
cash equivalents as of December 31, 2008 were $3,736,607, including restricted
cash of $78,000. The Company has historically financed its operations with cash
provided by equity financing and from lines of credit. The Company is exploring
expressions of interest from third party lenders, including one of its existing
lenders, to offer further debt financing for the domestic XTRAC program, though
there can be no assurance that any such expressions of interest will materialize
on terms favorable to the Company. In addition, the Company completed its
purchase of Photo Therapeutics, Inc. and the related acquisition financing on
February 27, 2009. The acquisition financing included $5 million of incremental
working capital to the Company of which approximately $2 million will be applied
to expenses incurred in the acquisition of the subsidiaries of Photo
Therapeutics Group Limited. Management believes that the existing cash balance
together with its other existing financial resources and any revenues from
sales, distribution, licensing and manufacturing relationships, will be
sufficient to meet the Company’s operating and capital requirements beyond the
end of the second quarter of 2010. The 2009 operating plan reflects anticipated
growth from both increased fee revenues for use of the XTRAC laser system based
on increased utilization and wider insurance coverage in the United States and
anticipated growth in revenues of the Company’s skincare products. Should
such planned growth be less than expectations, management has established
contingency plans to reduce its operation expense, though there can be no
assurance that any such contingency plans will maintain adequate liquidity and
prevent the possible impairment of assets.




The
Company’s historical operating results cannot be relied on to be an indicator of
future performance, and management cannot predict whether the Company will
obtain or sustain positive operating cash flow or generate net income in the
future.




Summary
of Significant Accounting Policies:




Principles
of Consolidation


The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.




Use
of Estimates


The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates and be based on events different from those assumptions. Future
events and their effects cannot be perceived with certainty; estimating,
therefore, requires the exercise of judgment. Thus, accounting estimates change
as new events occur, as more experience is acquired, or as additional
information is obtained.




Cash
and Cash Equivalents and Restricted Cash


The Company invests its excess cash in
highly liquid short-term investments. The Company considers short-term
investments that are purchased with an original maturity of three months or less
to be cash equivalents. Cash and cash equivalents consisted of cash and money
market accounts at December 31, 2008 and 2007. Cash that is pledged to secure
obligations is disclosed separately as restricted cash. The Company maintains
its cash and cash equivalents in accounts in one bank, the balances which at
times may exceed federally insured limits.Deposits attheinstitution are insured by the Federal
Deposit Insurance Corporation up to $250,000 through December 31, 2009. As of
December 31, 2008, the Company had uninsured cash balances of approximately
$1,680,000on deposit withthe bank.The bankis participating in the FDIC’s
Transaction Account Guarantee Program, whereby all non-interest bearing checking
accounts (including accounts with interest rates less than 0.50%) are fully
guaranteed by the FDIC for the entire amount through December 31,
2009.




Accounts
Receivable


The
majority of the Company’s accounts receivables are due from distributors
(domestic and international), hospitals, universities and physicians and other
entities in the medical field. Credit is extended based on evaluation of a
customer’s financial condition and, generally, collateral is not required.
Accounts receivable are most often due within 30 to 90 days and are stated at
amounts due from customers net of an allowance for doubtful accounts. Accounts
outstanding longer than the contractual payment terms are considered past due.
The Company determines its allowance by considering a number of factors,
including the length of time trade accounts receivable are past due, the
Company’s previous loss history, the customer’s current ability to pay its
obligation to the Company, and the condition of the general economy and the
industry as a whole. The Company writes-off accounts receivable when they become
uncollectible, and payments subsequently received on such receivables are
credited to the allowance for doubtful accounts. The Company does not accrue
interest on accounts receivable past due.


F-8


Inventories


Inventories
are stated at the lower of cost (first-in, first-out basis) or market. Cost is
determined to be purchased cost for raw materials and the production cost
(materials, labor and indirect manufacturing cost) for work-in-process and
finished goods. Throughout the laser manufacturing process, the related
production costs are recorded within inventory. Work-in-process is immaterial,
given the typically short manufacturing cycle, and therefore is disclosed in
conjunction with raw materials.




The
Company's skin disorder treatment equipment will either (i) be placed in a
physician's office and remain the property of the Company or (ii) be sold to
distributors or physicians directly. The cost to build a laser, whether for sale
or for placement, is accumulated in inventory. When a laser is placed in a
physician’s office, the cost is transferred from inventory to “lasers in
service” within property and equipment. At times, units are shipped to
distributors, but revenue is not recognized until all of the criteria of Staff
Accounting Bulletin No. 104 have been met, and until that time, the unit is
carried on the books of the Company as inventory. Revenue is not recognized from
these distributors until payment is either assured or paid in full. Until this
time, the cost of these shipments continues to be recorded as finished goods
inventory.




Reserves
for slow moving and obsolete inventories are provided based on historical
experience and product demand. Management evaluates the adequacy of these
reserves periodically based on forecasted sales and market trend.




Property,
Equipment and Depreciation


Property
and equipment are recorded at cost. Excimer lasers-in-service were depreciated
on a straight-line basis over the estimated useful life of three years. In
reflection of their improved reliability, XTRAC lasers placed in service after
December 31, 2005 are depreciated on a straight-line basis over the estimated
useful life of five years; other XTRAC lasers-in-service continue to be
depreciated over the original useful life of three years. For other property and
equipment, depreciation is calculated on a straight-line basis over the
estimated useful lives of the assets, primarily three to seven years for
computer hardware and software, furniture and fixtures, automobiles, and
machinery and equipment. Leasehold improvements are amortized over the lesser of
the useful lives or lease terms. Expenditures for major renewals and betterments
to property and equipment are capitalized, while expenditures for maintenance
and repairs are charged to operations as incurred. Upon retirement or
disposition, the applicable property amounts are deducted from the accounts and
any gain or loss is recorded in the consolidated statements of operations.
Useful lives are determined based upon an estimate of either physical or
economic obsolescence or both.




Laser
units and laser accessories located at medical facilities for sales evaluation
and demonstration purposes or those units/accessories used for development and
medical training are included in property and equipment under the caption
“machinery and equipment”. These units and accessories are being depreciated
over a period of up to five years.




Management
evaluates the realizability of property and equipment based on estimates of
undiscounted future cash flows over the remaining useful life of the asset. If
the amount of such estimated undiscounted future cash flows is less than the net
book value of the asset, the asset is written down to the net realizable value.
As of December 31, 2008, no such write-down was required (see Impairment of
Long-Lived Assets below).




Patent
Costs and Licensed Technologies


Costs
incurred to obtain or defend patents and licensed technologies are capitalized
and amortized over the shorter of the remaining estimated useful lives or eight
to 12 years. Developed technology was recorded in connection with the purchase
in August 2000 of the minority interest of Acculase, a former subsidiary of the
Company, and was amortized on a straight-line basis over seven years. Developed
technology was also recorded in connection with the acquisition of ProCyte in
March 2005 and is being amortized on a straight-line basis over seven years.
Other licenses, for example, the Stern and Mount Sinai licenses, are capitalized
and amortized over the estimated useful lives of 10 years.


F-9


Management
evaluates the realizability of intangible assets based on estimates of
undiscounted future cash flows over the remaining useful life of the asset. If
the amount of such estimated undiscounted future cash flows is less than net
book value of the asset, the asset is written down to fair value. As of December
31, 2008, no such write-down was required except that the carrying value of the
license from, and the investment in, AzurTec was reduced from $84,320 to its
fair value of $0 due to the dissolution of AzurTec in December 2008. (see Impairment of
Long-Lived Assets below).




Other
Intangible Assets


Other
intangible assets were recorded in connection with the acquisition of ProCyte in
March 2005. The assets are being amortized on a straight-line basis over 5 to 10
years.




Management
evaluates the recoverability of such other intangible assets based on estimates
of undiscounted future cash flows over the remaining useful life of the asset.
If the amount of such estimated undiscounted future cash flows is less than the
net book value of the asset, the asset is written down to fair value. As of
December 31, 2008, the Neutrogena Agreement intangible was reduced from
$582,000 to its fair value of $0. No other write-down was required.




Goodwill


Goodwill
was recorded in connection with the acquisition of ProCyte in March 2005 and the
acquisition of Acculase in August 2000.




Management
evaluates the recoverability of such goodwill based on estimates of the fair
value over the remaining useful life of the asset. If the amount of such
estimated fair value is less than the net book value of the asset, the asset is
written down to fair value. As of December 31, 2008, no such write-down was
required (see Impairment of
Long-Lived Assets below).




Accrued
Warranty Costs


The
Company offers a warranty on product sales generally for a one to three-year
period. The Company provides for the estimated future warranty claims on the
date the product is sold. The activity in the warranty accrual during the years
ended December 31, 2008 and 2007 is summarized as follows:




December 31,2008
                  
                  
                  2007Accrual
      at beginning of year
                  
                  $
                  218,587
                  
                  
                  $
                  123,738Additions
      charged to warranty expense
                  
                  
                  359,200
                  
                  
                  
                  270,000Expiring
      warranties
                  
                  
                  (49,784
                  )
                  
                  
                  (81,899
                  )Claims
      satisfied
                  
                  
                  (85,476
                  )
                  
                  
                  (93,252
                  )Accrual
      at end of year
                  
                  $
                  442,527
                  
                  
                  $
                  218,587




Revenue
Recognition


The
Company has two distribution channels for its phototherapy treatment equipment.
The Company either (i) sells the laser through a distributor or directly to a
physician or (ii) places the laser in a physician’s office (at no charge to the
physician) and charges the physician a fee for an agreed upon number of
treatments. In some cases, the Company and the customer stipulate to a quarterly
target of procedures to be performed. When the Company sells an XTRAC laser to a
distributor or directly to a foreign or domestic physician, revenue is
recognized when the following four criteria under Staff Accounting Bulletin No.
104 have been met: (i) the product has been shipped and the Company has no
significant remaining obligations; (ii) persuasive evidence of an arrangement
exists; (iii) the price to the buyer is fixed or determinable; and (iv)
collection is probable (the “SAB 104 Criteria”). At times, units are shipped,
but revenue is not recognized until all of the SAB 104 criteria have been met,
and until that time, the unit is carried on the books of the Company as
inventory.




The
Company ships most of its products FOB shipping point, although from time to
time certain customers, for example governmental customers, will insist upon FOB
destination. Among the factors the Company takes into account in determining the
proper time at which to recognize revenue are when title to the goods transfers
and when the risk of loss transfers. Shipments to distributors or physicians
that do not fully satisfy the collection criterion are recognized when invoiced
amounts are fully paid or assured full payment.




Under the
terms of the Company’s distributor agreements, distributors do not have a
unilateral right to return any unit that they have purchased. However, the
Company does allow products to be returned, under warranty, by its distributors
for product defects or other claims.


F-10


When the
Company places a laser in a physician’s office, it recognizes service revenue
based on the number of patient treatments performed by the physician. Treatments
in the form of random laser-access codes that are sold to physicians, but not
yet used, are deferred and recognized as a liability until the physician
performs the treatment. Unused treatments are deemed to remain an obligation of
the Company because the treatments can only be performed on Company-owned
equipment. Once the treatments are delivered to a patient, this obligation has
been satisfied.




The
Company excludes all sales of treatment codes made within the last two weeks of
the period in determining the amount of procedures performed by its
physician-customers and therefore the amount of revenue to be recognized.
Management believes this approach closely approximates the actual amount of
unused treatments that existed at the end of a period. For the year ended
December 31, 2008 and 2007, the Company deferred $670,546 and $563,336,
respectively, under this approach.




The
Company generates revenues from its Skin Care business primarily through product
sales for skin health, hair care and wound care. Lesser revenues are through
sales of the copper peptide compound and through royalties generated by our
licenses. The Company recognizes revenues on the products and copper peptide
compound when they are shipped, net of returns and allowances. The Company ships
the products FOB shipping point. Royalty revenues are based upon sales generated
by our licensees. The Company recognizes royalty revenue at the applicable
royalty rate applied to shipments reported by our licensee.




The
Company generates revenues from its Surgical business primarily from product
sales of laser systems, related maintenance service agreements, recurring laser
delivery systems and laser accessories. Domestic sales generally are direct to
the end-user, though the Company has some sales to or through a small number of
domestic distributors; foreign sales are to distributors. The Company recognizes
revenues from surgical laser and other product sales, including sales to
distributors and other customers, when the SAB 104 Criteria have been
met.




Revenue
from maintenance service agreements is deferred and recognized on a
straight-line basis over the term of the agreements. Revenue from billable
services, including repair activity, is recognized when the service is
provided.




Product
Development Costs


Costs of
research, new product development and product redesign are charged to expense as
incurred.




Income
Taxes


The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes.” Under SFAS No. 109, the liability method is used for income
taxes. Under this method, deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax basis of assets and
liabilities and are measured using enacted tax rates and laws that are expected
to be in effect when the differences reverse. Any resulting net deferred tax
assets are evaluated for recoverability and, accordingly, a valuation allowance
is provided when it is more likely than not that all of some portion of the
deferred tax asset will not be realized.




Net
Loss Per Share


The
Company computes net loss per share in accordance with SFAS No. 128, "Earnings
Per Share." In accordance with SFAS No. 128, basic net loss per share is
calculated by dividing net loss available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted net loss per
share reflects the potential dilution from the conversion or exercise of
securities into common stock, such as stock options and warrants.




In these
consolidated financial statements, diluted net loss per share is the same as
basic net loss per share. No additional shares for the potential dilution from
the conversion or exercise of securities into common stock are included in the
denominator since the result would be anti-dilutive. Common stock options and
warrants of 1,349,123, 1,468,465 and 1,548,626 as of December 31, 2008, 2007 and
2006, respectively, were thus excluded from the calculation of fully diluted
earnings per share. Share amounts shown on the consolidated balance sheets and
share amounts and basic and diluted net loss per share amounts shown on the
consolidated statements of operations have been adjusted to reflect the reverse
stock split of 1-for-7 effective January 26, 2009, excluding the rounding up of
fractional shares.


F-11


Fair
Value of Financial Instruments


The
estimated fair values for financial instruments under SFAS No. 107, “Disclosures
about Fair Value of Financial Instruments,” are determined at discrete points in
time based on relevant market information. These estimates involve uncertainties
and cannot be determined with precision. The fair value of cash and cash
equivalents is based on its demand value, which is equal to its carrying value.
The fair values of notes payable and long-term debt are based on borrowing rates
that are available to the Company for loans with similar terms, collateral and
maturity. The estimated fair values of notes payable and long-term debt
approximate the carrying values. Additionally, the carrying value of all other
monetary assets and liabilities is estimated to be equal to their fair value due
to the short-term nature of these instruments.




Impairment
of Long-Lived Assets


In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” long-lived assets, such as property and equipment, and
purchased intangibles subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the fair value of
the asset. If the carrying amount of an asset exceeds the fair value, an
impairment charge is recognized in the amount by which the carrying amount of
the asset exceeds the fair value of the asset. Assets to be disposed of would be
separately presented in the balance sheet and reported at the lower of the
carrying amount or fair value less costs to sell, and would no longer be
depreciated. The assets and liabilities of a disposed group classified as
discontinued operations would be presented separately in the appropriate asset
and liability sections of the balance sheet. As of December 31, 2008, no such
impairment exists, except for the Company’s investment in, AzurTec, which was
reduced from its carrying value of $352,611 to its fair value of $0 and the
Neutrogena intangible which was reduced from its carrying value $582,000 to its
fair value of $0.




Share-Based
Compensation


The
Company accounts for stock-based compensation in accordance with SFAS No.
123(R), share based payment. Under the fair value recognition provision, of this
statement, share-based compensations cost is measured at the grant date based on
the fair value of the award and is recognized as expense over the applicable
vesting period of the stock award using the straight line method.




Reclassifications


Certain
prior period amounts have been reclassified to conform to the current year
presentation.





The
Company revised its consolidated statement of operations for the year ended
December 31, 2007 and 2006 to reflect a reclass from sales, general and
administrative costs to costs of revenues, which resulted in a decrease in gross
profit. The reclassification was to move warranty expense to cost of revenues
that had previously been shown as a selling expense. The correction had no
effect on the Company’s previously reported net loss, consolidated balance
sheet, or net cash flows, and is not considered material to any previously
reported consolidated financial statements.




Supplemental
Cash Flow Information


During
the year ended December 31, 2008, the Company financed certain insurance
policies through notes payable for $635,243 and issued warrants to a term-note
credit facility which are valued at $44,366, and which offset the carrying value
of debt.




During
the year ended December 31, 2007, the Company financed certain credit facility
costs for $149,480, financed insurance policies through notes payable for
$594,815 and issued warrants to a leasing credit facility which were valued at
$249,727, and which offset the carrying value of debt. In addition, the Company
financed vehicle purchases of $71,941 and laser purchases of $156,000 under
capital leases.




During
the year ended December 31, 2006, the Company financed insurance policies
through notes payable for $763,982, financed certain credit facility costs for
$160,279, financed a license agreement with a note payable of $77,876 and issued
warrants to credit facilities which were valued at $104,388, and which offset
the carrying value of debt. In March 2006, the Company issued 101,010 shares of
its restricted common stock to Stern Laser srl (“Stern”) due upon achievement of
a milestone under the Master Purchase Agreement with Stern. The cost associated
with this issuance is included in the license from Stern, which is found in
patents and licensed technologies. In March 2006, the Company also issued
200,000 shares of its restricted common stock to AzurTec, Inc. (“AzurTec”) as
part of an investment in the capital stock of AzurTec as well as for a license
agreement on AzurTec technology, both existing and to be developed in the
future.




For the
years ended December 31, 2008, 2007 and 2006, the Company paid interest of
$1,188,783, $913,821and $670,839, respectively. Income taxes paid in the years
ended December 31, 2008, 2007 and 2006 were immaterial.


F-12


Recent
Accounting Pronouncements




In
October 2008, the FASB issued FSP No. 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”). FSP
157-3 clarifies the application of SFAS 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active. FSP 157-3 was effective for the Company on September 30, 2008 for all
financial assets and liabilities recognized or disclosed at fair value in our
Consolidated Financial Statements on a recurring basis (at least
annually).




In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. The statement is intended to improve financial reporting
by identifying a consistent hierarchy for selecting accounting principles to be
used in preparing financial statements that are presented in conformity with
GAAP. Prior to the issuance of SFAS No. 162, GAAP hierarchy was defined in the
American Institute of Certified Public Accountants (“AICPA”) Statement on
Auditing Standards (SAS) No. 69, “The Meaning of Present Fairly in Conformity
With Generally Accepted Accounting Principles.” Unlike SAS No. 69, SFAS No. 162
is directed to the entity rather than the auditor. Statement No. 162 is
effective 60 days following the SEC’s approval of the Public Company Accounting
Oversight Board Auditing amendments to AU Section 411, The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles. SFAS No. 162
is not expected to have any material impact on the Company’s results of
operations, financial condition or liquidity.




Effective
January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements". In
February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157", which
provides a one year deferral of the effective date of SFAS No. 157 for
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. Therefore, the Company has adopted the provisions of SFAS No. 157 with
respect to its financial assets and liabilities only. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value under generally accepted
accounting principles and enhances disclosures about fair value measurements.
Fair value is defined under SFAS No. 157 as the exchange price that would be
received for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date. Valuation
techniques used to measure fair value under SFAS No. 157 must maximize the use
of observable inputs and minimize the use of unobservable inputs. The standard
describes a fair value hierarchy based on three levels of inputs, of which the
first two are considered observable and the last unobservable, that may be used
to measure fair value.


The
adoption of this Statement did not have a material impact on the Company's
consolidated results of operations and financial condition.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations”, or SFAS No. 141R. SFAS No. 141R replaces SFAS No. 141. This
Statement establishes principles and requirements for how an acquirer recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, any non-controlling interest in the acquiree and the
goodwill acquired. This Statement also establishes disclosure requirements which
will enable users to evaluate the nature and financial effects of the business
combination. This Statement is effective for business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. This Statement will have an
impact on future acquisitions. The acquisition of the subsidiaries of Photo
Therapeutics Group Ltd. was completed after December 31, 2008, so the Company
expensed its costs incurred in the acquisition of $1,532,798 as of December 31,
2008. As part of the purchase accounting, the Company will also have to record
an estimate of the earn-out payment the Company expects to pay to the sellers to
Photo Therapeutics.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—an Amendment of Accounting Research Bulletin
No. 51.” SFAS No. 160 establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. This Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the noncontrolling owners. This
Statement is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008. The Company does not expect the
adoption of this Statement to have a material impact, if any, on the Company's
consolidated financial statements.


F-13


Note
2


Discontinued
Operations:




Surgical
Services is a fee-based procedures business using mobile surgical laser
equipment operated by Company technicians at hospitals and surgery centers in
the United States. The Company decided to sell this division primarily because
the growth rates and operating margins of the division had decreased as the
business had begun to rely more heavily upon procedures performed using
equipment from third-party suppliers, thereby limiting the profit potential of
these services. After preliminary investigations and discussions, the Board of
Directors of the Company, with the aid of its investment banker, decided on June
13, 2008 to enter into, substantive, confidential discussions with potential
third-party buyers and began to develop plans for implementing a disposal of the
assets and operations of the business. The Company accordingly classified this
former segment as held for sale in accordance with SFAS No. 144. On August 1,
2008, the Company entered into a definitive agreement to sell specific assets of
the business including accounts receivable, inventory and equipment, for
$3,500,000, subject to certain closing adjustments. Such closing adjustments
resulted in net proceeds to the Company of $3,149,737. The transaction closed on
August 8, 2008. No income tax benefit was recognized by the Company from the
loss on the sale of discontinued operations.




The
accompanying consolidated financial statements reflect the operating results and
balance sheet items of the discontinued operations separately from continuing
operations. Prior year financial statements for 2007 have been restated in
conformity with generally accepted accounting principles to present the
operations of Surgical Services as a discontinued operation. The Company
recognized a loss of $448,675 on the sale of the discontinued operations in the
year ended December 31, 2008, representing the difference between the adjusted
net purchase price and the carrying value of the assets being sold.




Revenues
from Surgical Services, reported as discontinued operations, for the years ended
December 31, 2008, 2007 and 2006 were $4,398,047, $7,667,174 and $6,944,291,
respectively. Income from surgical services, reported as discontinued
operations, for the years ended December 31, 2008, 2007 and 2006 were $285,712,
$231,024 and $280,520, respectively. No income tax provision was recognized by
the Company against income from Surgical Services over the three comparable
years.




The
following is a summary of the net assets sold as initially determined as of
December 31, 2007:




December 31, 2007Current
      assets of discontinued operationsAccounts
      receivable
                    
                    $
                    961,440Inventories
                    
                    
                    949,362Total
      current assets of discontinued operations
                    
                    
                    1,910,802Long
      term assets of discontinued operations:Property,
      plant and equipment, net
                    
                    
                    2,119,347Deposits
                    
                    
                    9,879Total
      long term assets of discontinued operations
                    
                    
                    2,129,226Total
      net assets of discontinued operations
                    
                    $
                    4,040,028




AzurTec
Transaction


On March
30, 2006, the Company closed the transaction provided for in the Investment
Agreement with AzurTec. The Company issued 200,000 shares of its restricted
common stock in exchange for 6,855,141 shares of AzurTec common stock and
181,512 shares of AzurTec Class A preferred stock, which represents a 14%
interest in AzurTec, on a fully diluted basis. In accordance with APB No. 18,
and related interpretations, the Company accounted for its investment in AzurTec
on the cost basis.




The
Company also received a license from AzurTec with respect to its existing and
future technology for the MetaSpex Laboratory System. The license gives the
Company rights to manufacture and market the ex vivo versions of the MetaSpex
product in exchange for certain royalty obligations. The license also provides
the Company certain rights on a potential in situ version of the MetaSpex
product. AzurTec remains responsible for the development and clinical trial
costs of the MetaSpex products, for which AzurTec is committed to raise
additional equity capital. AzurTec has contracted with the Company to resume
development work of the ex
vivo versions of the MetaSpex product. The Company would resume, and be
paid for, such work once AzurTec has raised additional equity capital and has
settled its prior indebtedness owed to the Company for development
work.


F-14


AzurTec
did not raise additional equity capital. AzurTec elected to dissolve in December
2008. AzurTec assigned its intellectual property to the Company, and the Company
reduced the carrying value of $352,611 to its fair value of $0 for its license
from, and investment in, AzurTec.




Note
3


Inventories:




Set forth
below is a detailed listing of inventories.




December 31,2008
                    
                    
                    2007Raw
      materials and work-in-process
                    
                    $
                    5,157,455
                    
                    
                    $
                    4,527,708Finished
      goods
                    
                    
                    1,816,739
                    
                    
                    
                    2,452,472Total
      inventories
                    
                    $
                    6,974,194
                    
                    
                    $
                    6,980,180




Work-in-process
is immaterial given the typically short manufacturing cycle, and therefore is
disclosed in conjunction with raw materials. There are no finished goods as of
December 31, 2008 and 2007 for laser systems shipped to distributors, but not
recognized as revenue until all the criteria of Staff Accounting Bulletin No.
104 have been met. At times, units are shipped but revenue is not recognized
until all of the criteria are met, and until that time, the unit is carried on
the books of the Company as inventory. The Company ships most of its products
FOB shipping point, although from time to time certain customers, for example
governmental customers, will insist on FOB destination. Among the factors the
Company takes into account in determining the proper time at which to recognize
revenue are when title to the goods transfers and when the risk of loss
transfers. Shipments to the distributors that do not fully satisfy the
collection criteria are recognized when invoiced amounts are fully paid. As of
December 31, 2008 and 2007, the Company carried reserves against its inventories
of $1,836,441 and $1,124,345, respectively.




Note
4


Property
and Equipment:




Set forth
below is a detailed listing of property and equipment.




December 31,2008
                  
                  
                  2007Lasers
      in service
                  
                  $
                  17,288,400
                  
                  
                  $
                  15,055,730Computer
      hardware and software
                  
                  
                  341,407
                  
                  
                  
                  341,407Furniture
      and fixtures
                  
                  
                  562,418
                  
                  
                  
                  361,174Machinery
      and equipment
                  
                  
                  830,778
                  
                  
                  
                  870,986Leasehold
      improvements
                  
                  
                  259,595
                  
                  
                  
                  247,36819,282,597
                  
                  
                  
                  16,876,665Accumulated
      depreciation and amortization
                  
                  
                  (8,894,192
                  )
                  
                  
                  (8,852,204
                  )Property
      and equipment, net
                  
                  $
                  10,388,406
                  
                  
                  $
                  8,024,461




Depreciation
expense was $2,977,506 in 2008, $2,608,106 in 2007 and $2,148,751 in 2006. At
December 31, 2008 and 2007, net property and equipment included $0 and $471,385,
respectively, of assets recorded under capitalized lease arrangements, of which
$0 and $254,178, respectively, of the capital lease obligation was included in
long-term debt at December 31, 2008 and 2007 (see Note 9).


F-15


Note
5


Patents
and Licensed Technologies:




Set forth
below is a detailed listing of patents and licensed technologies.




December 31,2008
                  
                  
                  2007Patents,
      owned and licensed, at gross costs of $583,623 and $501,657 net of
      accumulated amortization of $359,195 and $268,540,
      respectively
                  
                  $
                  224,428
                  
                  
                  $
                  242,402Other
      licensed and developed technologies, at gross costs of $2,328,059 and
      $2,432,258, net of accumulated amortization of $1,410,025 and
      $1,266,412  respectively
                  
                  
                  918,034
                  
                  
                  
                  1,165,846Total
      patents and licensed technologies, net
                  
                  $
                  1,142,462
                  
                  
                  $
                  1,408,248




Related
amortization expense was $264,930, $296,764 and $329,138 for the years ended
December 31, 2008, 2007 and 2006, respectively. Included in other licensed
and developed technologies is $200,000 for cost of developed technologies
acquired from ProCyte and $114,982 of cost for the license with AzurTec, for the
year ended December 31, 2007 only.




On March
31, 2006, the Mount Sinai School of Medicine of New York University granted the
Company an exclusive license, effective April 1, 2006, to use Mount Sinai's
patented methodology for utilization of ultraviolet laser light for the
treatment of vitiligo. The licensed patent is US Patent No. 6,979,327, Treatment
of Vitiligo. It was issued December 27, 2005, and the inventor is James M.
Spencer, MD, a member of the Company’s Scientific Advisory Board. The license is
carried on the Company’s books at $66,494 and $64,248, net at December 31, 2008
and 2007, respectively. Amortization of this intangible is on a straight-line
basis over 10 years, which began in April 2006. The Company is also obligated to
pay Mount Sinai a royalty on a combined base of domestic sales of XTRAC
treatment codes used for psoriasis as well as for vitiligo. In the first four
years of the license, however, Mount Sinai may elect to be paid royalties on an
alternate base, comprised simply of treatments for vitiligo, but at a higher
royalty rate than the rate applicable to the combined base. This technology is
for the laser treatment of vitiligo and is included in other licensed and
developed technologies.




Estimated
amortization expense for amortizable intangible assets for the next five years
is $214,000 in 2009, $213,000 in 2010, $175,000 in 2011, $151,000 in 2012,
$141,000 in 2013 and $248,000 thereafter.




Note
6


Other
Intangible Assets:




Set forth
below is a detailed listing of other intangible assets, all of which were
acquired from ProCyte and which were initially recorded at their appraised fair
values:




December 31,2008
                  
                  
                  2007Neutrogena
      Agreement, at gross cost of $0 and $2,400,000 net of accumulated
      amortization of 0 and $1,338,000, respectively.
                  
                  $
                  -
                  
                  
                  $
                  1,062,000Customer
      Relationships, at gross cost of $1,700,000 net of accumulated amortization
      of $1,287,735 and $947,739, respectively.
                  
                  
                  412,265
                  
                  
                  
                  752,261Tradename,
      at gross cost of $1,100,000 net of accumulated amortization of $416,640
      and $306,636, respectively.
                  
                  
                  683,360
                  
                  
                  
                  793,364$
                  1,095,625
                  
                  
                  $
                  2,607,625




Related
amortization expense was $930,000 for 2008, 2007 and 2006. Estimated
amortization expense for amortizable intangible assets for the next five years
is $450,000 in 2009, $182,250 in 2010, $110,000 in 2011, $110,000 in 2012,
$110,000 in 2013 and $133,375 thereafter. Under the Neutrogena Agreement, the
Company has licensed to Neutrogena rights to its copper peptide technology and
for which the Company receives royalties. As of December 31, 2008, the Company
reduced the carrying value of $582,000 to its fair value of $0 for the
Neutrogena Agreement. Customer Relationships represent the value to the Company
of relationships that ProCyte had formed with its customers. Tradename includes
the name of “ProCyte” and various other trademarks associated with ProCyte’s
products.


F-16


Note
7


Other
Accrued Liabilities:




Set forth
below is a detailed listing of other accrued liabilities.




December 31,2008
                        
                        
                        2007Accrued
      professional and consulting fees
                        
                        $
                        186,162
                        
                        
                        $
                        225,820Accrued
      warranty
                        
                        
                        442,527
                        
                        
                        
                        218,587Accrued
      sales taxes and other expenses
                        
                        
                        235,744
                        
                        
                        
                        229,967Total
      other accrued liabilities
                        
                        $
                        864,433
                        
                        
                        $
                        674,374




Note
8


Notes
Payable:




Set forth
below is a detailed listing of notes payable. The stated interest rate
approximates the effective cost of funds from the notes.




December 31,2008
                            
                            
                            2007Note
      payable – unsecured creditor, interest at 5.44%, payable in monthly
      principal and interest installments of $51,354 through February
      2008.
                            
                            $
                            -
                            
                            
                            $
                            102,013Note
      payable – unsecured creditor, interest at 6%, payable in monthly principal
      and interest installments of $2,880 through June 2012.
                            
                            
                            106,214
                            
                            
                            
                            133,507106,214
                            
                            
                            
                            235,520Less:
      current maturities
                            
                            
                            (28,975
                            )
                            
                            
                            (129,305
                            )Notes
      payable, net of current maturities
                            
                            $
                            77,239
                            
                            
                            $
                            106,215




Aggregate
maturities of the notes payable as of December 31, 2008 are $28,975 in 2009,
$30,762 in 2010, $32,660 in 2011 and $13,817 in 2012.




Note
9


Long-term
Debt:




In the
following table is a summary of the Company’s long-term debt.




December 31,2008
                      
                      
                      2007Total
      borrowings on credit facilities
                      
                      $
                      8,571,033
                      
                      
                      $
                      10,105,608Capital
      lease obligations (see Note 4)
                      
                      
                      -
                      
                      
                      
                      254,178Less:
      current portion
                      
                      
                      (4,663,281
                      )
                      
                      
                      (4,757,133
                      )Total
      long-term debt
                      
                      $
                      3,907,752
                      
                      
                      $
                      5,602,653




Term-Note
Credit Facility


The
Company entered into a leasing credit facility with GE Capital Corporation
(“GE”) on June 25, 2004. Eleven draws were made against the facility, the last
of which was in March 2007. In June 2007, the Company entered a term-note
facility with Leaf Financial Corporation (“Leaf”) and made its single draw
against that facility. In December 2007, the Company extinguished its
outstanding indebtedness under the GE and Leaf facilities, recognizing as costs
(including acceleration of the amortization of debt issuance costs and the debt
discount and termination costs) of such extinguishment as a refinancing charge
of $441,956, including $178,699 related to the premium paid for the buyback of
the warrants, under APB No. 26.


F-17


Upon the
pay-off of the GE and Leaf facilities, the Company entered a term-note facility
with CIT Healthcare LLC and Life Sciences Capital LLC, as equal participants
(collectively, “CIT”), for which CIT Healthcare acts as the agent. The facility
was for $12 million and was for one year. The stated interest rate for any draw
was set as 675 basis points above the three-year Treasury rate. CIT levied no
points on a draw. Each draw was secured by specific XTRAC laser systems
consigned under usage agreements with physician-customers.




The first
draw had three discrete components: carryover debt attributable to the former GE
borrowings, as increased by extinguishment costs (including redemption of the GE
warrants) which CIT financed; carryover debt attributable to Leaf, as increased
by extinguishment costs which CIT financed; and debt newly incurred to CIT on
XTRAC units not pledged to GE or Leaf. The carryover components maintained the
monthly debt service payments from GE and Leaf with increases to principal and
changes in the stated interest rates causing minor changes in the number of
months set to pay off the discrete draws. The third component was
self-amortizing over three years.




The
beginning principal of each component was $4,724,699, $1,612,626, and
$3,990,000, respectively. The effective interest rate for the first draw was
12.50%. The pay-off of each component is 27, 30, and 36 months, respectively. On
March 31, 2008, the Company made an additional draw under the credit facility
for $840,000. This additional draw is amortized over 36 months at an effective
interest rate of 8.55%. On June 30, 2008, the Company made a draw under the
credit facility for $832,675 based on the limitations on gross borrowings under
the facility. This draw is amortized over 36 months at an effective interest
rate of 9.86%.




On
September 30, 2008, CIT amended the credit facility to increase the amount the
Company could draw on the credit facility by $1,927,534. The interest rate for
draws against this amount was set at 850 basis points above the LIBOR rate two
days prior to the draw. Each draw was to be secured by certain XTRAC laser
systems consigned under usage agreements with physician-customers and the stream
of payments generated from such lasers. Each draw would have a repayment period
of three years. On September 30, 2008, the Company made a draw under the credit
facility for the maximum amount allowable under the credit facility. This draw
is amortized over 36 months at an effective interest rate of 12.90%. The Company
has used its entire availability under the CIT credit facility. The Company is
considering multiple written proposals for additional debt financing but there
can be no assurance whether any such proposals will materialize on terms
favorable to the Company. CIT also raised certain defaults, which the Company
took steps to cure and which CIT waived as of February 27, 2009.




In
connection with the CIT facility, the Company issued 235,525 warrants to each of
CIT Healthcare and Life Sciences Capital in December 2007 (33,646 warrants as
adjusted to reflect the reverse stock split of 1-for-7 effective January 26,
2009). In connection with the amendment to the CIT facility, the Company issued
192,753 warrants to CIT Healthcare in September 2008 (27,536 warrants as
adjusted to reflect the reverse stock split of 1-for-7 effective January 26,
2009). The warrants are treated as a discount to the debt and are amortized
under the effective interest method over the repayment term of 36 months. The
Company has accounted for these warrants as equity instruments in accordance
with EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" since there is no option for
cash or net-cash settlement when the warrants are exercised. The Company
computed the value of the warrants using the Black-Scholes method. The key
assumptions used to value the warrants are, as adjusted to reflect the reserve
stock split of 1-for-7 effective January 27, 2009, as follows:




CIT
                    
                    December
                      2007
                    
                    
                    September
                      2008Number
      of warrants
                    
                    
                    67,293
                    
                    
                    
                    27,536Exercise
      price
                    
                    $
                    7.84
                    
                    
                    $
                    3.08Fair
      value of warrants
                    
                    $
                    221,716
                    
                    
                    $
                    44,366Volatility
                    
                    
                    59.44
                    %
                    
                    
                    60.92
                    %Risk-free
      interest rate
                    
                    
                    3.45
                    %
                    
                    
                    2.98
                    %Expected
      dividend yield
                    
                    
                    0
                    %
                    
                    
                    0
                    %Expected
      warrant life
                    
                    5
      years
                    
                    
                    5
      years


F-18





GE
                  
                  March
                    2006
                  
                  
                  June
                    2006
                  
                  
                  September
                    2006
                  
                  
                  December
                    2006
                  
                  
                  March
                    2007Number
      of warrants
                  
                  
                  2,935
                  
                  
                  
                  3,530
                  
                  
                  
                  3,577
                  
                  
                  
                  4,580
                  
                  
                  
                  4,757Exercise
      price
                  
                  $
                  14.42
                  
                  
                  $
                  11.83
                  
                  
                  $
                  11.76
                  
                  
                  $
                  8.40
                  
                  
                  $
                  8.96Fair
      value of warrants
                  
                  $
                  27,853
                  
                  
                  $
                  26,548
                  
                  
                  $
                  28,103
                  
                  
                  $
                  21,884
                  
                  
                  $
                  28,011Volatility
                  
                  
                  87.16
                  %
                  
                  
                  84.17
                  %
                  
                  
                  84.52
                  %
                  
                  
                  72.53
                  %
                  
                  
                  68.37
                  %Risk-free
      interest rate
                  
                  
                  4.79
                  %
                  
                  
                  5.18
                  %
                  
                  
                  4.59
                  %
                  
                  
                  4.69
                  %
                  
                  
                  4.54
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Expected
      warrant life
                  
                  5 years
                  
                  
                  5 years
                  
                  
                  5 years
                  
                  
                  5 years
                  
                  
                  5 years




The
following table summarizes the future minimum payments that the Company expects
to make for the draws made under the credit facility:




Year
      Ended December 31,2009
                  
                  $
                  5,375,7882010
                  
                  
                  3,444,7822011
                  
                  
                  811,059Total
      minimum payments
                  
                  
                  9,631,629Less:
      interest
                  
                  
                  (940,152
                  )Less:
      unamortized warrant discount
                  
                  
                  (120,444
                  )Present
      value of total minimum obligations
                  
                  $
                  8,571,033




Note
10


Commitments
and Contingencies:




Leases


The
Company has entered into various non-cancelable lease agreements for real
property, and one minor operating lease for personal property. These
arrangements expire at various dates through 2012. Rent expense was $601,947,
$583,372 and $601,062 for the years ended December 31, 2008, 2007 and 2006,
respectively. The future annual minimum payments under these leases are as
follows:




Year
      Ending December 31,2009
                            
                            $
                            524,7952010
                            
                            
                            488,1952011
                            
                            
                            307,567Thereafter
                            
                            
                            89,863Total
                            
                            $
                            1,410,420




Litigation


In the
matter brought by the Company on January 4, 2004, against Ra Medical Systems,
Inc. and Dean Irwin in the United States District Court for the Southern
District of California, the Company has appealed to the Ninth Circuit Court of
Appeals from the district judge’s grant of summary judgment to the defendants.
No date has been set for oral argument.




In the
matter which Ra Medical and Mr. Irwin brought against the Company on June 6,
2006 for unfair competition and which the Company removed to the United States
District Court for the Southern District of California, the district judge has
certified the Company’s an interlocutory appeal to the Ninth Circuit of Appeals
from the judge’s dismissal, among other things, of the Company’s counterclaim of
misappropriation. The Company has filed its opening brief on appeal and await
appellees’ opposition brief.


F-19


On
October 29, 2008, Ra Medical and Dean Irwin brought a second malicious
prosecution action against the Company, and outside counsel, in the California
Superior Court for San Diego County. The Company was not served until nearly the
end of the 60-day period in which service of process must be affected. The
plaintiffs allege that the action which the Company brought in January 2004
against Ra Medical and Mr. Irwin was initiated and maintained with malice. On
October 30, 2008, the day of the Company’s quarterly investors’ conference call,
Ra Medical issued a press release accusing the Company of having acted with
malice. On or about January 22, 2009, the Company filed a demurrer to the
complaint on the grounds that it was brought while the underlying Federal action
was still on appeal before the Ninth Circuit Court of Appeals, and therefore
before the plaintiffs had secured a final and favorable judgment in the
underlying Federal action – a necessary pre-condition to bringing the action.
The Courst sustained the Company's demurer but did not dismiss the complaint but
rather stayed the action with leave to amend the complaint.




On
December 1, 2008, the Company filed a complaint for declaratory judgment in the
United States District Court for the Southern District of California based on
the accusations made in Ra Medical’s press release of October 30,
notwithstanding that the district judge in the underlying Federal action had
specifically ruled that the Company had not acted in the litigation vexatiously
or in bad faith. The Company is asking the court to rule on whether the
accusations made in the press release are true or false. The defendants have
moved to dismiss the complaint based on lack of jurisdiction in the Federal
court. The Company awaits a ruling on the defendants’ motion, which has been
fully briefed and submitted.




The
Company notified its general liability and umbrella liability insurer, St. Paul
Fire and Marine Insurance Company, of the suit that Ra Medical and Mr. Irwin
stated in their press release that they had brought for malicious prosecution.
On or about January 27, 2009, St. Paul sent the Company a letter via regular
mail setting forth reasons why it believed it had no duty to indemnify the
Company against any liability which the Company might incur in the malicious
prosecution action, and inviting the Company’s response to its position.
Meanwhile and before the Company had received the January 27 letter, St. Paul
brought an action on January 29, 2009 in the California Superior Court for San
Diego County for a declaratory judgment that it has no duty to defend us or
indemnify the Company, asserting that it had been released from such duties in
the settlement of the first malicious prosecution action brought by Ra Medical
and also asserting that the policy should be governed by California law, not
Pennsylvania law. The Company has removed that action to the U.S. District Court
for the Southern District of California, but the Company has not yet been
required to file a response to the St. Paul complaint. Notwithstanding,
on March 20, 2009, St. Paul has informed the Company that it will pay for the
cost of defense subject to a full reservation of rights.
  The
insurance policy under which the Company seeks coverage from St.
Paul  is the same policy under which St. Paul defended and indemnified
the Company in the first malicious prosecution action brought by Ra Medical
against the Company. In connection with the first malicious prosecution action,
the Company filed a declaratory judgment action in the U.S. District Court for
the Eastern District of Pennsylvania against St. Paul seeking a ruling that it
was obligated to pay all reasonable defense costs incurred in the defense of
that action and any judgment or settlement which the Company might incur. The
Company obtained a summary judgment in that action holding that, under governing
Pennsylvania law, the policy covered malicious prosecution claims and St. Paul
was required to provide full coverage for the action brought by Ra Medical. On
March 3, 2009, the Company filed an action in the U.S. District Court for the
Eastern District of Pennsylvania seeking a ruling, consistent with the earlier
ruling of this court, that the law of Pennsylvania governs the policy and that
the policy provides coverage for the latest malicious prosecution action. The
Company’s complaint was served on St. Paul on March 4, 2009. The case has been
assigned to the same judge who granted the Company’s motion for summary judgment
in the earlier declaratory judgment action.




In the
patent infringement suit brought on November 7, 2007, by Allergan, Inc. in the
United States District Court for the Central District of California, the Company
settled this suit on November 11, 2008, and it was dismissed with prejudice. In
return for the Company’s promise to cease marketing MD Lash Factor eyelash
conditioner or any other prostaglandin-based conditioner on or before January
31, 2009, Allergan released PhotoMedex and its affiliates, its licensor and
supplier, and the sub-suppliers, of MD Lash Factor, and the Company’s customers
and their end-user customers from any claims deriving from MD Lash Factor that
the Company sold on or before January 31, 2009. In fact, the Company ceased
marketing of MD Lash Factor by the appointed date.




The
Company is involved in certain other legal actions and claims arising in the
ordinary course of business. The Company believes, based on discussions with
legal counsel, that these other litigation and claims will likely be resolved
without a material effect on the Company’s consolidated financial position,
results of operations or liquidity.




Employment
Agreements


The
Company has severance agreements with certain key executives and employees that
create certain liabilities in the event of their termination of employment
without cause, or following a change in control of the Company. The aggregate
commitment under these executive severance agreements, should all covered
executives and employees be terminated other than for cause, was approximately
$1,552,197 as of December 31, 2008, based on 2008 salary levels. Should all
covered executives be terminated following a change in control of the Company,
the aggregate commitment under these executive severance agreements at December
31, 2008 was approximately $2,102,269, based on 2008 salary levels.




Restricted
Securities and Warrants


If an
investor participating in the November 2006 private placement exercises a
warrant received in the placement, then Cowen & Company is entitled to a
6.5% commission on the gross proceeds to the Company from such exercise. If all
such warrants are exercised, then the Company will receive $3,904,000 and will
owe Cowen & Company $253,760 in commissions. To date, no such exercises of
these warrants have occurred.


F-20


Note
11


Stockholders’
Equity:




Common
Stock, adjusted to reflect the reverse stock split of 1-for-7 effective January
26, 2009


The
Company's board of directors approved a 1-for-7 reverse stock split of the
Company's common stock, which became effective on January 26, 2009. As a result
of the reverse stock split, each seven shares of common stock were combined and
reclassified into one share of common stock and the total number of shares
outstanding was reduced from approximately 63 million shares to
approximately 9 million shares.




On
January 26, 2009, the stockholders voted to increase the number of authorized
shares of common stock from 14,285,714 to 21,428,571 shares.




As of
December 31, 2008, the Company had issued 84,266 shares of its restricted common
stock in connection with the Asset Purchase agreement with Stern Laser Srl, or
Stern.




On June
26, 2007, the stockholders voted to increase the number of authorized shares of
common stock from 10,714,286 to 14,285,714 shares.




On
November 3, 2006, the Company closed on a private placement for 1,394,286 shares
of common stock at $8.19 per share resulting in gross proceeds of $11,419,200.
The closing price of the Company’s common stock on November 1, 2006 was $8.89
per share. In connection with this private placement, the Company paid
commissions and other expenses of $864,308, resulting in net proceeds of
$10,554,892. In addition, the investors received warrants to purchase 348,571
shares of common stock at an exercise price of $11.20 per share, and Cowen &
Company, the placement agent, received warrants to purchase 34,857 shares of
common stock, under the same terms and conditions as the warrants issued to the
investors. As such the warrants have a five-year term and will become
exercisable on May 1, 2007 (see Common Stock
Warrants below). Cowen & Company is entitled to a6.5% commission on any
proceeds to the Company from future exercises by the investors of their
warrants. The warrants issued to Cowen & Company were in consideration of
its services as the placement agent and have a value under the Black Scholes
method of approximately $200,000. The Company has used the proceeds of this
financing to pay for working capital and other general corporate purposes. The
shares sold in the private placement, including the shares underlying the
warrants, have been registered with the Securities and Exchange
Commission.




Common
Stock Options, adjusted to reflect the reverse stock split of 1-for-7 effective
January 26, 2009


In
January 1996, the Company adopted the 1995 Non-Qualified Option Plan (the “1995
Plan”) for key employees, officers, directors, and consultants, and initially
provided for up to 71,429 options to be issued thereunder.




On April
10, 1998, the Company created a stock option plan for outside/non-employee
members of the Board of Directors. Pursuant to the stock plan, each
outside/non-employee director was to receive an annual grant of options, in
addition to any other consideration he or she may receive, to purchase up to
2,857 shares of common stock as compensation, at an exercise price equal to the
market price of the common stock on the last trading day of the preceding year.
The options granted pursuant to this plan vested at the rate of 714.25 options
per quarter during each quarter in which such person had served as a member of
the Board of Directors. Since the date of adoption of the Non-Employee Director
Stock Option Plan (discussed below), the Company no longer grants options to
members of the Board of Directors under this plan. At December 31, 2008, the
plan had 2,143 options outstanding.




In May
2000, the Company adopted the 2000 Stock Option Plan (the “2000 Plan”). The 2000
Plan initially reserved for issuance up to 142,857 shares of the Company’s
common stock, which was increased to 285,714 shares pursuant to the affirmative
vote of the stockholders on June 10, 2002 and to 478,571 shares on December 16,
2003. The reserved shares are to be used for granting of incentive stock options
(“ISOs”) to employees of the Company and for granting of non-qualified stock
options (“NSOs”) and other stock-based awards to employees and consultants. The
option exercise price for ISOs shall not be less than the fair market value of
the Company’s stock on the date of grant. All ISOs granted to less than
ten-percent stockholders may have a term of up to 10 years, while ISOs granted
to greater than ten-percent stockholders shall have a term of up to five years.
The option exercise price for NSOs shall not be less than 85% of the fair market
value of the Company’s stock on the date of grant. No NSOs shall be exercisable
for more than 10 years after the date of the respective grant. The plan became
inactive on December 28, 2005, and had 194,857 options outstanding at December
31, 2008.


F-21


In May
2000, the Company also adopted the Non-Employee Director Stock Option Plan (the
“Non-Employee Director Plan”). The Non-Employee Director Plan reserved for
issuance up to 35,714 shares of the Company’s common stock for the granting of
non-qualified options to members of the Company’s Board of Directors. In
consideration for services rendered, each director received on each of January
1, 2001 and 2002 an option to purchase 2,857 shares of the Company’s common
stock. The Company’s stockholders voted on June 10, 2002 to increase the number
of reserved shares to 92,857 and also to increase the annual grant to each
director from 2,857 to 5,000. On December 16, 2003, the stockholders voted to
increase the number of reserved shares to 142,857, on December 28, 2005, they
voted to increase the number of reserved shares to 200,000 and on June 26, 2007,
they voted to increase the number of reserved shares to 300,000. The plan is
active and had 192,857 options outstanding at December 31, 2008.




In March
2005, the Company assumed four option plans from ProCyte: the 2004 Stock Option
Plan, the 1996 Stock Option Plan, the 1991 Restated Stock Option Plan for
Non-Employee Directors and the 1989 Restated Stock Option Plan. The plans became
inactive on December 28, 2005, and had 6,214, 54,789, 1,514 and 3,784 options
outstanding at December 31, 2008, respectively.




On
December 28, 2005, the stockholders approved the 2005 Equity Compensation Plan,
authorizing 451,429 shares thereto. The Company’s stockholders voted on June 26,
2007, to increase in the number of shares reserved to 880,000. The Company’s
stockholders voted on January 26, 2009, to increase in the number of shares
reserved to 1,165,714. The plan is active and had 592,850 options outstanding at
December 31, 2008.




On
December 28, 2005, the stockholders approved the 2005 Investment Plan,
authorizing 57,143 shares thereto. The plan is active and had 1,714 options
outstanding at December 31, 2008.




In
January 2008, the Company issued 30,000 options to purchase common stock to
non-employee directors, in accordance with the terms of the Non-Employee
Director Plan.




Also,
during the course of 2008, the Company granted an aggregate of 151,457 options
to purchase common stock to a number of employees and consultants with a strike
price equal to the quoted market value of our stock at the date of grant. The
options vest over five years and expire ten years from the date of
grant.




In
January 2007 and May 2007, the Company issued 30,000 and 3,750 options,
respectively, to purchase common stock to non-employee directors, in accordance
with the terms of the Non-Employee Director Plan.




On May 1,
2007, the Company awarded 37,500 restricted shares of our common stock to three
of the Company’s executive officers, and on August 13, 2007, 22,500 restricted
shares of our common stock to one of the Company’s executive
officers.




Also,
during the course of 2007, the Company granted an aggregate of 81,179 options to
purchase common stock to a number of employees and consultants with a strike
price equal to the quoted market value of our stock at the date of grant. The
options vest over five years and expire ten years from the date of
grant.




In
January 2006 and August 2006, the Company issued 25,000 and 2,500 options,
respectively, to purchase common stock to non-employee directors, in accordance
with the terms of the Non-Employee Director Plan.




On
January 15, 2006, the Company awarded 122,857 restricted shares of our common
stock to two of the Company’s executive officers, and 28,571 stock options to
one of the two executive officers.




Also,
during the course of 2006, the Company granted an aggregate of 176,929 options
to purchase common stock to a number of employees and consultants at the market
value at the date of grant. The options vest over five years and expire ten
years from the date of grant.




In
January 2006, the Company granted 6,000 options to purchase common stock to the
various members of the Company’s Scientific Advisory Board for services rendered
with a strike price equal to the quoted market value of our stock at the date of
grant. The options have an exercise price of $12.04 per share. The options vest
upon issuance and will expire ten years from the date of the
grant.


F-22


In May
2006, the Company granted 1,286 options to purchase common stock to executives
in accordance with the terms of the 2005 Investment Plan.




A summary
of option transactions for all of the Company’s options during the years ended
December 31, 2008, 2007 and 2006,asadjusted to reflect the
reverse stock split of 1-for-7 effective January 26, 2009, is as
follows:




Number
      of Shares
                
                
                Weighted
                    Average
                    Exercise
      PriceOutstanding
      at December 31, 2005
                
                
                725,378
                
                
                $
                14.77Granted
                
                
                240,286
                
                
                
                13.44Exercised
                
                
                (8,679
                )
                
                
                10.08Expired/cancelled
                
                
                (86,453
                )
                
                
                13.44Outstanding
      at December 31, 2006
                
                
                870,532
                
                
                
                14.63Granted
                
                
                114,929
                
                
                
                7.84Exercised
                
                
                (10,879
                )
                
                
                7.91Expired/cancelled
                
                
                (98,915
                )
                
                
                13.3Outstanding
      at December 31, 2007
                
                
                875,667
                
                
                
                14.00Granted
                
                
                181,457
                
                
                
                5.95Exercised
                
                
                -
                
                
                
                -Expired/cancelled
                
                
                (186,259
                )
                
                
                13.16Outstanding
      at December 31, 2008
                
                
                870,865
                
                
                $
                12.46Exercisable
      at December 31, 2008
                
                
                552,385
                
                
                $
                14.07




As of
December 31, 2008, 552,385 options to purchase common stock were vested and
exercisable at prices ranging from $5.53 to $66.50 per share. As of December 31,
2007, 581,148 options to purchase common stock were vested and exercisable at
prices ranging from $5.18 to $66.50 per share. Options are issued with exercise
prices equal to the market price on the date of issue, so the weighted-average
exercise price equals the weighted-average fair value price.




The
aggregate intrinsic value for options outstanding and exercisable at December
31, 2008 was immaterial.




The
weighted average grant date fair value of options was $4.83 and $6.44 for
options granted during the years ended December 31, 2008 and 2007, respectively.
The total intrinsic value of options exercised during the years ended December
31, 2008 and 2007 was $0 and $13,035, respectively.




The
Company uses the Black-Scholes option-pricing model to estimate fair value of
grants of stock options with the following weighted average
assumptions:




Year
      Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Risk-free
      interest rate
                    
                    
                    3.75
                    %
                    
                    
                    4.74
                    %
                    
                    
                    4.62
                    %Volatility
                    
                    
                    84.06
                    %
                    
                    
                    85.94
                    %
                    
                    
                    92.48
                    %Expected
      dividend yield
                    
                    
                    0
                    %
                    
                    
                    0
                    %
                    
                    
                    0
                    %Expected
      life
                    
                    8.1
      years
                    
                    
                    8.1
      years
                    
                    
                    7.50
      yearsEstimated
      forfeiture rate
                    
                    
                    10
                    %
                    
                    
                    16
                    %
                    
                    
                    16
                    %




The
Company calculates expected volatility for a share-based grant based on historic
daily stock price observations of its common stock during the period immediately
preceding the grant that is equal in length to the expected term of the grant.
For estimating the expected term of share-based grants made in the years ended
December 31, 2008 and 2007, the Company has adopted the simplified method
authorized in Staff Accounting Bulletin No. 107. SFAS No. 123R also requires
that estimated forfeitures be included as a part of the estimate of expense as
of the grant date. The Company has used historical data to estimate expected
employee behaviors related to option exercises and forfeitures.


F-23


With
respect to both grants of options and awards of restricted stock, the risk-free
rate of interest is based on the U.S. Treasury rates appropriate for the
expected term of the grant or award.




With
respect to awards of restricted stock, the Company uses the Monte-Carlo pricing
model to estimate fair value of restricted stock awards. There were no
restricted stock awards for the year ended December 31, 2008. The awards made in
the first and second quarters 2007 and the first quarter 2006 were estimated
with the following weighted average assumptions:





Assumptions for Stock
Awards
                    
                    Year
      Ended
                      December
      31, 2007
                    
                    
                    Year
      Ended
                      December
      31, 2006Risk-free
      interest rate
                    
                    
                    4.52
                    %
                    
                    
                    4.32
                    %Volatility
                    
                    
                    74.64
                    %
                    
                    
                    70
                    %Expected
      dividend yield
                    
                    
                    0
                    %
                    
                    
                    0
                    %Expected
      Life
                    
                    5.07
      years
                    
                    
                    4.92
      years




The
Company calculated expected volatility for restricted stock based on a mirror
approach, where the daily stock price of our common stock during the seven-year
period immediately after the grant would be the mirror of the historic daily
stock price of our common stock during the seven-year period immediately
preceding the grant.




Options
that were assumed from ProCyte and that were unvested as of March 18, 2005 were
re-measured as of March 18, 2005 under intrinsic-value-based accounting.
Unearned or deferred compensation of $132,084 was recorded and was amortized
over the remaining vesting period, which is an average of two years. The Company
recognized $55,347 of such expense in the year ended December 31, 2006 and the
remaining $76,737 in 2005.




Compensation
expense for the year ended December 31, 2008 included $888,546 from stock
options grants and $414,491 from restricted stock awards. Compensation expense
for the year ended December 31, 2007 included $955,767 from stock options grants
and $380,007 from restricted stock awards. Compensation expense for the year
ended December 31, 2006 included $990,372 from stock options grants and $314,174
from restricted stock awards.




Compensation
expense is presented as part of the operating results in selling, general and
administrative expenses. For stock options granted to consultants an additional
selling, general, and administrative expense in the amount of $92,501, $109,107
and $132,624 was recognized during the years ended December 31, 2008, 2007 and
2006, respectively.




At
December 31, 2008, there was $2,613,357 of total unrecognized compensation cost
related to non-vested option grants and stock awards that is expected to be
recognized over a weighted-average period of 2.18 years.




The
outstanding options, including options exercisable at December 31, 2008, have a
range of exercise prices and associated weighted remaining contractual life and
weighted average exercise price, as adjusted to reflect the reverse stock
split of 1-for-7 effective January 26, 2009, as follows:




Options
      Range
                      of
      Exercise
                      Prices
                    
                    Outstanding
                      Number
      of
                      Shares
                    
                    
                    Weighted
      Average
                      Remaining
                      Contractual
      Life
                      (years)
                    
                    
                    Weighted
                      Average
                      Exercise
      Price
                    
                    
                    Exercisable
                      Number
      of
                      Shares
                    
                    
                    Exercisable
                      Weighted
      Avg.
                      Exercise
      Price$0 
            - $17.50
                    
                    
                    831,143
                    
                    
                    
                    5.77
                    
                    
                    $
                    11.76
                    
                    
                    
                    514,717
                    
                    
                    $
                    13.09$17.51
      - $35.00
                    
                    
                    26,150
                    
                    
                    
                    1.33
                    
                    
                    $
                    18.90
                    
                    
                    
                    24,096
                    
                    
                    $
                    18.76$35.01
      - $52.50
                    
                    
                    11,429
                    
                    
                    
                    2.00
                    
                    
                    $
                    39.41
                    
                    
                    
                    11,429
                    
                    
                    $
                    39.41$52.51
      - up
                    
                    
                    2,143
                    
                    
                    
                    1.34
                    
                    
                    $
                    66.50
                    
                    
                    
                    2,143
                    
                    
                    $
                    66.50Total
                    
                    
                    870,865
                    
                    
                    
                    5.56
                    
                    
                    $
                    12.46
                    
                    
                    
                    552,385
                    
                    
                    $
                    14.14




F-24


The
outstanding options will expire, as adjusted to reflect the reverse stock
split of 1-for-7 effective January 26, 2009, as follows:




Year Ending
                          
                          Number
      of Shares
                          
                          
                          Weighted
                              Average
                              Exercise
      Price
                          
                          
                          Exercise
      Price2009
                          
                          
                          106,481
                          
                          
                          $
                          14.77
                          
                          
                          $
                          6.93
      - $18.902010
                          
                          
                          112,815
                          
                          
                          
                          17.85
                          
                          
                          $
                          7.49
      - $66.502011
                          
                          
                          30,940
                          
                          
                          
                          22.40
                          
                          
                          $
                          10.43
      - $39.412012
                          
                          
                          18,859
                          
                          
                          
                          14.00
                          
                          
                          $
                          12.95
      - $19.322013
      and later
                          
                          
                          601,770
                          
                          
                          
                          10.50
                          
                          
                          $
                          1.82
      - $17.15870,865
                          
                          
                          $
                          12.46
                          
                          
                          $
                          1.82
      - $66.50




Common
Stock Warrants, adjusted to reflect the reverse stock split of 1-for-7 effective
January 26, 2009


In
September 2008, the Company issued 27,536 warrants to purchase common stock to
CIT Healthcare related to the term-note credit facility amendment of September,
2008. The warrants have an exercise price of $3.08 per share and have a
five-year term, expiring in September 2013.




In
December 2007, the Company issued 33,646 warrants to purchase common stock to
each of CIT Healthcare and Life Sciences Capital related to the term-note credit
facility of December 31, 2007. The warrants have an exercise price of $7.84 per
share and have a five-year term, expiring in December 2012. Also in December
2007, the Company redeemed and cancelled all of the warrants that were
previously issued to GE Capital Corporation.




In March
2007, the Company issued 4,757 warrants to purchase common stock to GE Capital
Corporation related to the leasing credit facility. The warrants had an exercise
price of $8.96 per share and had a five-year term.




In
November 2006, in addition to receiving common stock in the Company’s private
placement, the investors and placement agent received warrants to purchase
383,429 shares of common stock at an exercise price of $11.20 per share. The
warrants have a five-year term, expiring in November 2011.




In 2006,
the Company issued warrants to purchase common stock to GE Capital Corporation
related to the leasing credit facility in the following manner: on March 29,
2006, 2,935 shares at an exercise price of $14.42; on June 30, 2006, 3,530
shares at an exercise price of $11.83 per share; on September 29, 2006, 3,577
shares at an exercise price of $10.71 per share; and on December 28, 2006, 4,580
at an exercise price of $8.40 per share. The warrants had a five-year
term.




A summary
of warrant transactions for the years ended December 31, 2008, 2007 and
2006, adjusted to reflect the reverse stock split of 1-for-7 effective
January 26, 2009, is as follows:




Number
      of Warrants
                  
                  
                  Weighted
                    Average
                    Exercise
      PriceOutstanding
      at December 31, 2005
                  
                  
                  300,044
                  
                  
                  $
                  13.86Issued
                  
                  
                  398,050
                  
                  
                  
                  11.20Exercised
                  
                  
                  (20,000
                  )
                  
                  
                  14.00Expired/cancelled
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2006
                  
                  
                  678,094
                  
                  
                  
                  12.25Issued
                  
                  
                  72,050
                  
                  
                  
                  7.91Exercised
                  
                  
                  -
                  
                  
                  
                  -Expired/cancelled
                  
                  
                  (157,346
                  )
                  
                  
                  13.23Outstanding
      at December 31, 2007
                  
                  
                  592,798
                  
                  
                  
                  11.48Issued
                  
                  
                  27,536
                  
                  
                  
                  3.08Exercised
                  
                  
                  -
                  
                  
                  
                  -Expired/cancelled
                  
                  
                  (142,076
                  )
                  
                  
                  14.00Outstanding
      at December 31, 2008
                  
                  
                  478,258
                  
                  
                  $
                  10.29




F-25




At
December 31, 2008, all outstanding warrants were exercisable at prices ranging
from $3.08 to $11.20 per share.




If not
previously exercised, the outstanding warrants will expire, as adjusted to
reflect the reverse stock split of 1-for-7 effective January 27, 2009, as
follows:




Year
      Ending December 31,
                
                Number
      of Warrants
                
                
                Weighted
                    Average
                    Exercise
      Price2009
                
                
                -
                
                
                $
                -2010
                
                
                -
                
                
                
                -2011
                
                
                383,429
                
                
                
                11.202012
                
                
                67,293
                
                
                
                7.842013
                
                
                27,536
                
                
                
                3.08478,258
                
                
                $
                10.29




Note
12


Income
Taxes:




The
Company accounts for income taxes pursuant to SFAS No. 109, "Accounting for
Income Taxes". SFAS No. 109 is an asset-and-liability approach that requires the
recognition of deferred tax assets and liabilities for the expected tax
consequences of events that have been recognized in the Company's financial
statements or tax returns.




The
Company recorded no provisions in 2008, 2007 and 2006 due to losses incurred.
Any other provisions, including accrual adjustments for prior periods, were
completely offset by changes in the deferred tax valuation
allowance.




Because
the Company acquired ProCyte Corporation on March 18, 2005, the effect of
ProCyte’s deferred tax asset is included for 2007, 2006 and only a part of 2005.
Income tax expense (benefit) consists of the following:




Year
      Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006Federal,
      including AMT tax:Current
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -Deferred
                      
                      
                      (2,494,000
                      )
                      
                      
                      (2,371,000
                      )
                      
                      
                      (1,805,000
                      )State:Current
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Deferred
                      
                      
                      (228,000
                      )
                      
                      
                      (630,000
                      )
                      
                      
                      (2,131,000
                      )(2,722,000
                      )
                      
                      
                      (3,001,000
                      )
                      
                      
                      (3,936,000
                      )Change
      in valuation allowance
                      
                      
                      2,722,000
                      
                      
                      
                      3,001,000
                      
                      
                      
                      3,936,000Income
      tax expense
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -




F-26


A
reconciliation of the effective tax rate with the Federal statutory tax rate of
34% follows:




Year
      Ended December 31,2008
                
                
                2007
                
                
                2006Expected
      Federal tax benefit at statutory rate
                
                $
                3,839,000
                
                
                $
                2,160,000
                
                
                $
                2,547,000Gross
      change in valuation allowance
                
                
                (2,722,000
                )
                
                
                (3,001,000
                )
                
                
                3,936,000Adjustments
      of temporary differences and net operating loss expirations and
      limitations
                
                
                (1,313,000
                )
                
                
                130,000
                
                
                
                (4,460,000
                )State
      income taxes
                
                
                228,000
                
                
                
                630,000
                
                
                
                278,000Other,
      including adjustment due to State loss carryforwards
                
                
                (32,000
                )
                
                
                81,000
                
                
                
                (2,301,000
                )Income
      tax expense
                
                $
                -
                
                
                $
                -
                
                
                $
                -




In 2006,
the gross deferred tax asset from net operating loss carryforwards was reduced
to take into account expirations of state and federal net operating loss
carryforwards and cumulative limitations as to the utilization of such loss
carryforwards. In 2007, the gross deferred tax asset from net operating loss
carryforwards was further adjusted to account for a change of ownership, as
defined under the Internal Revenue Code Section 382, deemed to have occurred as
of July 31, 2005.




As of
December 31, 2008, the Company had approximately $135,000,000 of federal net
operating loss carryforwards. Included in the aggregate net operating loss
carryforward are approximately $9,812,000 of losses sustained by SLT prior to
the tax-free acquisition on December 27, 2002 and approximately $36,877,000 of
losses sustained by ProCyte prior to the tax-free acquisition on March 18, 2005.
As of December 31, 2008, the Company has estimated that only $5,025,000 of the
net operating loss from SLT and $16,636,000 of the loss from ProCyte can be
realized upon, based on Federal limitations on the useabililty of such expiring
losses. There have been no other changes of ownership identified by management
in 2008 that materially constrain the Company’s utilization of loss
carryforwards. If the Company undergoes a change or ownership in the future, the
utilization of the Company’s loss carryforwards may be materially
constrained.




In
addition, the Company had approximately $1,588,000 of Federal tax credit
carryforwards and alternative minimum tax credits of $112,000 as of December 31,
2008. The credit carryforwards have begun, and continue, to expire over the
ensuing 20 years. Primarily due to Federal rules applicable to the acquisition
of SLT and ProCyte, approximately $901,000 are subject to severe utilization
constraints and accordingly have been ascribed minimal value in the deferred tax
asset.




Net
deductible, or favorable, temporary differences were approximately $29,602,000
at December 31, 2008.


F-27


The
changes in the deferred tax asset are as follows.




December
      31,2008
                      
                      
                      2007Beginning
      balance, gross
                      
                      $
                      49,116,000
                      
                      
                      $
                      46,115,000Net
      changes due to:Operating loss
      carryforwards
                      
                      
                      (203,000
                      )
                      
                      
                      1,955,000Other, including adjustment due
      to state loss carryforwards and net operating loss limitations and
      expirations
                      
                      
                      2,925,000
                      
                      
                      
                      1,046,000Ending
      balance, gross
                      
                      
                      51,838,000
                      
                      
                      
                      49,116,000Less:
      valuation allowance
                      
                      
                      (51,838,000
                      )
                      
                      
                      (49,116,000
                      )Ending
      balance, net
                      
                      $
                      -
                      
                      
                      $
                      -




The
ending balances of the deferred tax asset have been fully reserved, reflecting
the uncertainties as to realizability evidenced by the Company’s historical
results and restrictions on the usage of the net operating loss
carryforwards.




Deferred
tax assets (liabilities) are comprised of the following.




December
      31,2008
                      
                      
                      2007Loss
      carryforwards
                      
                      $
                      39,208,000
                      
                      
                      $
                      39,411,000Carryforward
      and AMT credits
                      
                      
                      799,000
                      
                      
                      
                      831,000Accrued
      employment expenses
                      
                      
                      1,249,000
                      
                      
                      
                      830,000Amortization
      and write-offs
                      
                      
                      2,783,000
                      
                      
                      
                      1,418,000Bad
      debts
                      
                      
                      185,000
                      
                      
                      
                      206,000Deferred
      R&D costs
                      
                      
                      3,594,000
                      
                      
                      
                      3,291,000Deferred
      revenues
                      
                      
                      304,000
                      
                      
                      
                      254,000Depreciation
                      
                      
                      2,757,000
                      
                      
                      
                      1,970,000Inventoriable
      costs
                      
                      
                      66,000
                      
                      
                      
                      86,000Inventory
      reserves
                      
                      
                      698,000
                      
                      
                      
                      460,000Other
      accruals and reserves
                      
                      
                      195,000
                      
                      
                      
                      359,000Gross
      deferred tax asset
                      
                      
                      51,838,000
                      
                      
                      
                      49,116,000Less:
      valuation allowance
                      
                      
                      (51,838,000
                      )
                      
                      
                      (49,116,000
                      )Net
      deferred tax asset
                      
                      $
                      -
                      
                      
                      $
                      -




Benefits
that may be realized from components in the deferred tax asset that were
contributed by Acculase from periods prior to the buy-out of the minority
interest in August 2000 and that approximate $4,087,000 in benefit, or that were
contributed by ProCyte from periods prior to the acquisition in March 2005 and
that approximate $7,070,000 in benefit will first be taken to reduce the
carrying value of goodwill and other intangibles that were recorded in the
respective transactions. Only after such values have been fully reduced will any
remaining benefit be reflected in the Company’s Statement of Operations. It is
expected that benefits of $2,968,000 and $1,309,000 will be reflected in the
Statement of Operations from Acculase and ProCyte, respectively. Within the net
operating loss carryforward as of December 31, 2008 are approximately $6,651,000
of benefit from tax deductions from the exercise of Company stock options. The
preponderance of these options were to employees and therefore no book expense
was recognized on their grant under APB No. 25.




F-28




Effective
January 1, 2007, the Company adopted FASB Interpretation No. 48 “Accounting for
Uncertainty in Income Taxes” (“FIN No. 48”), which clarifies the accounting for
uncertainty in income taxes recognized in the financial statement in accordance
with FASB Statement No. 109 Accounting for Income Taxes. This interpretation
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken, or expected to be
taken, in a tax return. There were no significant matters determined to be
unrecognized tax benefits taken or expected to be taken in a tax return that
have been recorded on the Company's consolidated financial statements for the
year ended December 31, 2008.




Additionally,
FIN No. 48 provides guidance on the recognition of interest and penalties
related to income taxes. There were no interest or penalties related to income
taxes that have been accrued or recognized as of and for the years ended
December 31, 2008, 2007 and 2006.




The
Company files corporate income tax returns in the United States, both in the
Federal jurisdiction and in various state jurisdictions. The Company is subject
to Federal income tax examination for calendar tax years 2005 through 2008 and
is also generally subject to various state income tax examinations for calendar
years 2002 through 2008.




Note
13


Significant
Alliances/Agreements:




On March
31, 2005, the Company entered into a Sales and Marketing Agreement with
GlobalMed (Asia) Technologies Co., Inc. (“GlobalMed”). Under this agreement,
GlobalMed acts as master distributor in the Pacific Rim for the Company’s XTRAC
excimer laser and for the Company’s LaserPro® diode surgical laser system. The
Company’s diode laser will be marketed for, among other things, use in a
gynecological procedure pioneered by David Matlock, MD. The Company has engaged
Dr. Matlock as a consultant to explore further business opportunities for the
Company. In connection with this engagement, Dr. Matlock received options to
purchase up to 25,000 shares of the Company’s common stock at an exercise price
which was the market value of the Company’s common stock on the date of the
grant. In July 2006, the Company broadened the territory covered by the Sales
and Marketing Agreement to include the United States and added Innogyn, Inc., a
related party of GlobalMed, as co-distributor under the agreement. For the years
ended December 31, 2008, 2007 and 2006, sales to GlobalMed were $2,995,000,
$2,137,200 and $1,354,300, respectively.




On March
31, 2006, the Mount Sinai School of Medicine of New York University granted the
Company an exclusive license, effective April 1, 2006, to use Mount Sinai's
patented methodology for utilization of ultraviolet laser light for the
treatment of vitiligo. The licensed patent is US Patent No. 6,979,327, Treatment
of Vitiligo. It was issued December 27, 2005, and the inventor is James M.
Spencer, MD, a member of the Company’s Scientific Advisory Board. The Company is
obligated to pay royalties, quarterly, over the life of the
agreement.




Pursuant
to the license agreement, the Company reimbursed $77,876 to Mount Sinai, over
the first 18 months of the license term and at no interest, for patent
prosecution costs incurred. The Company is also obligated to pay Mount Sinai a
royalty on a combined base of domestic sales of XTRAC treatment codes used for
psoriasis as well as for vitiligo. In the first four years of the license,
however, Mount Sinai may elect to be paid royalties on a alternate base,
comprised simply of treatments for vitiligo, but a higher royalty rate and
developed technologies. (See Note 5 Patents and Licensed Technologies). The
Company has paid Mount Sinai royalties of $156,179, $119,560 and $90,174 for the
years ended December 31, 2008, 2007 and 2006, respectively.




On April
14, 2006, the Company entered into a Clinical Trial Agreement protocol with the
University of California at San Francisco. The agreement covers a protocol for a
phase 4, randomized, double-blinded study to evaluate the safety and efficacy of
the XTRAC laser system in the treatment of moderate to severe psoriasis. John
Koo, MD, a member of our Scientific Advisory Board, is guiding the study using
our high-powered UltraTM excimer laser. Dr. Koo presented the favorable findings
of the study at the Hawaii Dermatology Seminar in March 2008. Dr. Koo concluded
that the XTRAC Excimer Laser may be appropriate for the majority of moderate to
severe psoriasis sufferers. It also allows dermatologists to treat those
patients with a high level of safety, as opposed to the use of many systemic
products. Other phototherapy treatments such as broadband or narrow band UVB can
also be used; however, undesirable aspects of these treatments include exposure
of healthy skin to UVB light, and the inconvenience of extended treatment
periods, which are often necessary for moderate to severe patients. We expensed
$189,000 in the year ended December 31, 2008 in payment for this
study.




F-29




In
September 2007, the Company entered with AngioDynamics into a three-year OEM
agreement under which the Company manufactures for AngioDynamics, on a
non-exclusive basis, a private-label, 980-nanometer diode laser system. The
system is designed for use with AngioDynamics’ NeverTouchTM VenaCure® patented
endovenous therapy for treatment of varicose veins. The OEM agreement provides
that the Company shall supply this laser on an exclusive basis to AngioDynamics,
should AngioDynamics meet certain purchase requirements. Having received from
AngioDynamics a purchase order that exceeded the minimum purchase requirement
for delivery of lasers over the first contract year, the Company will now
provide this laser exclusively to AngioDynamics for worldwide sale in the
peripheral vascular treatment field. Notwithstanding, AngioDynamics settled
Diomed’s patent infringement claims against itself, AngioDynamics, and purchased
the assets of Diomed out of bankruptcy. Having received no purchase orders from
AngioDynamics in the last six months of 2008, it appears that AngioDynamics will
source its diode lasers from the assets purchased from Diomed. The Company has
no carrying value for the OEM arrangement on its balance sheet, as no up-front
investment was required and no other costs have otherwise been
capitalized.




In
December 2007, the Company engaged Universal Business Solutions, Inc. (“UBS”) to
distribute in the United States the line of spa products of the skin care
segment. UBS will be a stocking distributor. The agreement is for 3
years.




Note
14


Significant
Customer Concentration:




No one
customer represented 10% or more of total revenues for the year ended December
31, 2008, 2007 and 2006





Note
15


Business
Segment and Geographic Data:




Segments
are distinguished by the Company’s management structure, products and services
offered, markets served and types of customers. The Domestic XTRAC business
derives its primary revenues from procedures performed by dermatologists in the
United States. The International Dermatology Equipment segment, in comparison,
generates revenues from the sale of equipment to dermatologists outside the
United States through a network of distributors. The Skin Care (ProCyte) segment
generates revenues by selling skincare products and by earning royalties on
licenses for the Company’s patented copper peptide compound. The Surgical
Products segment generates revenues by selling laser products and disposables to
hospitals and surgery centers on both a domestic and international basis. For
the years ended December 31, 2008, 2007 and 2006, the Company did not have
material revenues from any individual customer.




Unallocated
operating expenses include costs incurred for administrative and accounting
staff, general liability and other insurance, professional fees and other
similar corporate expenses. Unallocated assets include cash, prepaid expenses
and deposits. Goodwill that was carried at $2,944,423 at December 31, 2008
and 2007 has been allocated to the domestic and international XTRAC segments
(i.e. International Dermatology Equipment) based upon its fair value as of the
date of the Acculase buy-out in the amounts of $2,061,096 and $883,327,
respectively. Goodwill of $13,973,385 at December 31, 2008 from the ProCyte
acquisition has been entirely allocated to the Skin Care segment. The following
tables reflect results of operations from our business segments for the periods
indicated below:


F-30





Year
      Ended December 31, 2008DOMESTIC
                      XTRAC
                    
                    
                    INTERN’L
                      DERM.
                      EQUIPMENT
                    
                    
                    SKIN
                      CARE
                    
                    
                    SURGICAL
                      PRODUCTS
                      AND
      OTHER
                    
                    
                    TOTALRevenues
                    
                    $
                    12,419,972
                    
                    
                    $
                    3,782,456
                    
                    
                    $
                    12,829,816
                    
                    
                    $
                    5,738,048
                    
                    
                    $
                    34,770,292Costs
      of revenues
                    
                    
                    6,714,786
                    
                    
                    
                    1,871,470
                    
                    
                    
                    4,431,545
                    
                    
                    
                    3,977,516
                    
                    
                    
                    16,995,317Gross
      profit
                    
                    
                    5,705,186
                    
                    
                    
                    1,910,986
                    
                    
                    
                    8,398,271
                    
                    
                    
                    1,760,532
                    
                    
                    
                    17,774,975Allocated
      operating expenses:Selling,
      general and administrative
                    
                    
                    8,141,717
                    
                    
                    
                    248,262
                    
                    
                    
                    6,883,466
                    
                    
                    
                    377,489
                    
                    
                    
                    15,650,934Engineering
      and product development
                    
                    
                    168,214
                    
                    
                    
                    20,790
                    
                    
                    
                    461,702
                    
                    
                    
                    422,509
                    
                    
                    
                    1,073,215Unallocated
      operating expenses
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    11,146,1738,309,931
                    
                    
                    
                    269,052
                    
                    
                    
                    7,345,168
                    
                    
                    
                    799,998
                    
                    
                    
                    27,870,322Loss
      from operations
                    
                    
                    (2,604,745
                    )
                    
                    
                    1,641,934
                    
                    
                    
                    1,053,103
                    
                    
                    
                    960,534
                    
                    
                    
                    (10,095,347
                    )Interest
      expense, net
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,032,597
                    )(Loss)
      income from continuing operations
                    
                    
                    (2,604,745
                    )
                    
                    
                    1,641,934
                    
                    
                    
                    1,053,103
                    
                    
                    
                    960,534
                    
                    
                    
                    (11,127,944
                    )Discontinued
      operations:Income
      from discontinued operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    285,712Sale
      of discontinued operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (448,675
                    )Net
      (loss) income
                    
                    $
                    (2,604,745
                    )
                    
                    $
                    1,641,934
                    
                    
                    $
                    1,053,103
                    
                    
                    $
                    960,534
                    
                    
                    $
                    (11,290,907
                    )Segment
      assets
                    
                    $
                    17,369,541
                    
                    
                    $
                    2,542,375
                    
                    
                    $
                    18,398,212
                    
                    
                    $
                    3,765,114
                    
                    
                    $
                    42,075,242Capital
      expenditures
                    
                    $
                    2,405,082
                    
                    
                    $
                    25,363
                    
                    
                    $
                    -
                    
                    
                    $
                    31,241
                    
                    
                    $
                    2,461,686




Year
      Ended December 31, 2007DOMESTIC
                    XTRAC
                  
                  
                  INTERN’L
                    DERM.
                    EQUIPMENT
                  
                  
                  SKIN
                    CARE
                  
                  
                  SURGICAL
                    PRODUCTS
                    AND
      OTHER
                  
                  
                  TOTALRevenues
                  
                  $
                  9,141,857
                  
                  
                  
                  3,256,505
                  
                  
                  $
                  13,471,973
                  
                  
                  $
                  5,176,108
                  
                  
                  $
                  31,046,443Costs
      of revenues
                  
                  
                  4,706,947
                  
                  
                  
                  1,701,102
                  
                  
                  
                  4,208,287
                  
                  
                  
                  2,965,290
                  
                  
                  
                  13,581,626Gross
      profit
                  
                  
                  4,434,910
                  
                  
                  
                  1,555,403
                  
                  
                  
                  9,263,686
                  
                  
                  
                  2,210,818
                  
                  
                  
                  17,464,817Allocated
      operating expenses:Selling,
      general and administrative
                  
                  
                  6,189,047
                  
                  
                  
                  251,318
                  
                  
                  
                  5,812,185
                  
                  
                  
                  395,211
                  
                  
                  
                  12,647,761Engineering
      and product development
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  391,928
                  
                  
                  
                  407,180
                  
                  
                  
                  799,108Unallocated
      operating expenses
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,631,7736,189,047
                  
                  
                  
                  251,318
                  
                  
                  
                  6,204,113
                  
                  
                  
                  802,391
                  
                  
                  
                  23,078,642Loss
      from operations
                  
                  
                  (1,754,137
                  )
                  
                  
                  1,304,085
                  
                  
                  
                  3,059,573
                  
                  
                  
                  1,408,427
                  
                  
                  
                  (5,613,825
                  )Refinancing
      charge
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (441,956
                  )Interest
      expense, net
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (529,489
                  )(Loss)
      income from continuing operations
                  
                  
                  (1,754,137
                  )
                  
                  
                  1,304,085
                  
                  
                  
                  3,059,573
                  
                  
                  
                  1,408,427
                  
                  
                  
                  (6,585,270
                  )Discontinued
      operations:Income
      from discontinued operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  231,024Net
      loss,
                  
                  $
                  (1,754,137
                  )
                  
                  $
                  1,304,085
                  
                  
                  $
                  3,059,573
                  
                  
                  $
                  1,408,427
                  
                  
                  $
                  (6,354,246
                  )Segment
      assets
                  
                  $
                  13,823,060
                  
                  
                  $
                  2,194,876
                  
                  
                  $
                  21,269,256
                  
                  
                  $
                  4,946,011
                  
                  
                  $
                  42,233,203Capital
      expenditures
                  
                  $
                  3,324,411
                  
                  
                  $
                  15,679
                  
                  
                  $
                  6,917
                  
                  
                  $
                  72,474
                  
                  
                  $
                  3,419,481




F-31





Year
      Ended December 31, 2006DOMESTIC
                    XTRAC
                  
                  
                  INTERN’L
                    DERM.
                    EQUIPMENT
                  
                  
                  SKIN
                    CARE
                  
                  
                  SURGICAL
                    PRODUCTS
                    AND
      OTHER
                  
                  
                  TOTALRevenues
                  
                  $
                  5,611,387
                  
                  
                  $
                  2,186,424
                  
                  
                  $
                  12,646,910
                  
                  
                  $
                  5,800,865
                  
                  
                  $
                  26,245,586Costs
      of revenues
                  
                  
                  4,142,746
                  
                  
                  
                  1,201,987
                  
                  
                  
                  3,858,944
                  
                  
                  
                  3,483,278
                  
                  
                  
                  12,686,955Gross
      profit
                  
                  
                  1,468,641
                  
                  
                  
                  984,437
                  
                  
                  
                  8,787,966
                  
                  
                  
                  2,317,587
                  
                  
                  
                  13,558,631Allocated
      operating expenses:Selling,
      general and administrative
                  
                  
                  4,408,753
                  
                  
                  
                  193,947
                  
                  
                  
                  5,580,985
                  
                  
                  
                  517,487
                  
                  
                  
                  10,701,172Engineering
      and product development
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  498,602
                  
                  
                  
                  507,998
                  
                  
                  
                  1,006,600Unallocated
      operating expenses
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,102,0074,408,753
                  
                  
                  
                  193,947
                  
                  
                  
                  6,079,587
                  
                  
                  
                  1,025,485
                  
                  
                  
                  20,728,808Loss
      from operations
                  
                  
                  (2,940,112
                  )
                  
                  
                  790,490
                  
                  
                  
                  2,708,379
                  
                  
                  
                  1,292,102
                  
                  
                  
                  (7,251,148
                  )Interest
      expense, net
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (521,769
                  )(Loss)
      income from continuing operations
                  
                  
                  (2,940,112
                  )
                  
                  
                  790,490
                  
                  
                  
                  2,708,379
                  
                  
                  
                  1,292,102
                  
                  
                  
                  (7,772,917
                  )Discontinued
      operations:Income
      from discontinued operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  280,520Sale
      of discontinued operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      (loss) income
                  
                  $
                  (2,940,112
                  )
                  
                  $
                  790,490
                  
                  
                  $
                  2,708,379
                  
                  
                  $
                  1,292,102
                  
                  
                  $
                  (7,492,397
                  )Segment
      assets
                  
                  $
                  11,143,750
                  
                  
                  $
                  1,838,558
                  
                  
                  $
                  21,750,716
                  
                  
                  $
                  4,772,302
                  
                  
                  $
                  39,505,326Capital
      expenditures
                  
                  $
                  2,933,680
                  
                  
                  $
                  885
                  
                  
                  $
                  -
                  
                  
                  $
                  70,215
                  
                  
                  $
                  3,004,780




December
      31,Assets:
                  
                  2008
                  
                  
                  2007Total
      assets for reportable segments
                  
                  $
                  42,075,242
                  
                  
                  $
                  42,233,203Total
      assets held for sale
                  
                  
                  -
                  
                  
                  
                  4,040,028Other
      unallocated assets
                  
                  
                  4,639,027
                  
                  
                  
                  10,413,472Consolidated
      total
                  
                  $
                  46,714,269
                  
                  
                  $
                  56,686,703




For the
years ended December 31, 2008, 2007 and 2006, there were no material net
revenues attributed to an individual foreign country. Net revenues by geographic
area were as follows:




Year
      Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Domestic
                    
                    $
                    27,398,356
                    
                    
                    $
                    24,359,462
                    
                    
                    $
                    20,746,866Foreign
                    
                    
                    7,371,936
                    
                    
                    
                    6,686,981
                    
                    
                    
                    5,498,720$
                    34,770,292
                    
                    
                    $
                    31,046,443
                    
                    
                    $
                    26,245,586


F-32


Note
16


Quarterly
Financial Data (Unaudited):


For
      the Quarter Ended2008
                                                      
                                                      Mar.
      31
                                                      
                                                      
                                                      Jun.
      30
                                                      
                                                      
                                                      Sep.
      30
                                                      
                                                      
                                                      Dec.
      31Revenues
                                                      
                                                      $
                                                      8,330,000
                                                      
                                                      
                                                      $
                                                      9,390,000
                                                      
                                                      
                                                      $
                                                      8,797,000
                                                      
                                                      
                                                      $
                                                      8,253,000Gross
      profit
                                                      
                                                      
                                                      4,213,000
                                                      
                                                      
                                                      
                                                      5,355,000
                                                      
                                                      
                                                      
                                                      4,727,000
                                                      
                                                      
                                                      
                                                      3,480,000Net
      loss
                                                      
                                                      
                                                      (2,542,000
                                                      )
                                                      
                                                      
                                                      (1,607,000
                                                      )
                                                      
                                                      
                                                      (1,787,000
                                                      )
                                                      
                                                      
                                                      (5,354,000
                                                      )Basic
      and diluted net loss per share(1)
                                                      
                                                      $
                                                      (0.28
                                                      )
                                                      
                                                      $
                                                      (0.18
                                                      )
                                                      
                                                      $
                                                      (0.20
                                                      )
                                                      
                                                      $
                                                      (0.59
                                                      )Shares
      used in computing basic and diluted net loss per share(1)
                                                      
                                                      
                                                      9,004,601
                                                      
                                                      
                                                      
                                                      9,004,601
                                                      
                                                      
                                                      
                                                      9,004,601
                                                      
                                                      
                                                      
                                                      9,004,6012007
                                                      
                                                      Mar.
      31
                                                      
                                                      
                                                      Jun.
      30
                                                      
                                                      
                                                      Sep.
      30
                                                      
                                                      
                                                      Dec.
      31Revenues
                                                      
                                                      $
                                                      7,207,000
                                                      
                                                      
                                                      $
                                                      7,311,000
                                                      
                                                      
                                                      $
                                                      7,023,000
                                                      
                                                      
                                                      $
                                                      9,505,000Gross
      profit
                                                      
                                                      
                                                      3,967,000
                                                      
                                                      
                                                      
                                                      4,007,000
                                                      
                                                      
                                                      
                                                      3,885,000
                                                      
                                                      
                                                      
                                                      5,606,000Net
      loss
                                                      
                                                      
                                                      (1,883,000
                                                      )
                                                      
                                                      
                                                      (1,836,000
                                                      )
                                                      
                                                      
                                                      (1,653,000
                                                      )
                                                      
                                                      
                                                      (982,000
                                                      )Basic
      and diluted net loss per share(1)
                                                      
                                                      $
                                                      (0.21
                                                      )
                                                      
                                                      $
                                                      (0.20
                                                      )
                                                      
                                                      $
                                                      (0.18
                                                      )
                                                      
                                                      $
                                                      (0.11
                                                      )Shares
      used in computing basic and diluted net loss per share(1)
                                                      
                                                      
                                                      8,933,722
                                                      
                                                      
                                                      
                                                      8,958,450
                                                      
                                                      
                                                      
                                                      8,993,840
                                                      
                                                      
                                                      
                                                      9,004,6012006
                                                      
                                                      Mar.
      31
                                                      
                                                      
                                                      Jun.
      30
                                                      
                                                      
                                                      Sep.
      30
                                                      
                                                      
                                                      Dec.
      31Revenues
                                                      
                                                      $
                                                      6,465,000
                                                      
                                                      
                                                      $
                                                      6,474,000
                                                      
                                                      
                                                      $
                                                      6,498,000
                                                      
                                                      
                                                      $
                                                      6,808,000Gross
      profit
                                                      
                                                      
                                                      3,172,000
                                                      
                                                      
                                                      
                                                      3,614,000
                                                      
                                                      
                                                      
                                                      3,249,000
                                                      
                                                      
                                                      
                                                      3,526,000Net
      loss
                                                      
                                                      
                                                      (2,350,000
                                                      )
                                                      
                                                      
                                                      (1,340,000
                                                      )
                                                      
                                                      
                                                      (1,693,000
                                                      )
                                                      
                                                      
                                                      (2,109,000
                                                      )Basic
      and diluted net loss per share(1)
                                                      
                                                      $
                                                      (0.32
                                                      )
                                                      
                                                      $
                                                      (0.18
                                                      )
                                                      
                                                      $
                                                      (0.22
                                                      )
                                                      
                                                      $
                                                      (0.25
                                                      )Shares
      used in computing basic and diluted net loss per share(1)
                                                      
                                                      
                                                      7,453,374
                                                      
                                                      
                                                      
                                                      7,517,456
                                                      
                                                      
                                                      
                                                      7,522,733
                                                      
                                                      
                                                      
                                                      8,462,840




(1)  Adjusted
to reflect the reverse stock split of 1-for-7 effective January 26,
2009.




Note
17


Valuation
and Qualifying Accounts:





Additions Charged toDescription
                                      
                                      Balance
      at
                                        Beginning
                                        of
      Period
                                      
                                      
                                      Cost
      and
                                        Expenses
                                      
                                      
                                      Other
                                        Accounts
                                      
                                      
                                      Deductions
      (1)
                                      
                                      
                                      Balance
      at End
                                        of
      PeriodFor
      The Year Ended December 31, 2008:Reserve
      for Doubtful Accounts
                                      
                                      $
                                      520,913
                                      
                                      
                                      $
                                      144,750
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      179,501
                                      
                                      
                                      $
                                      486,162Reserve
      for Excess and Obsolete Inventories
                                      
                                      $
                                      1,124,345
                                      
                                      
                                      $
                                      769,323
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      57,227
                                      
                                      
                                      $
                                      1,836,441For
      The Year Ended December 31, 2007:Reserve
      for Doubtful Accounts
                                      
                                      $
                                      496,540
                                      
                                      
                                      $
                                      95,624
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      71,251
                                      
                                      
                                      $
                                      520,913Reserve
      for Excess and Obsolete Inventories
                                      
                                      $
                                      1,354,443
                                      
                                      
                                      $
                                      134,541
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      364,639
                                      
                                      
                                      $
                                      1,124,345For
      The Year Ended December 31, 2006:Reserve
      for Doubtful Accounts
                                      
                                      $
                                      734,450
                                      
                                      
                                      $
                                      66,211
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      304,121
                                      
                                      
                                      $
                                      496,540Reserve
      for Excess and Obsolete Inventories
                                      
                                      $
                                      931,719
                                      
                                      
                                      $
                                      435,679
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      12,955
                                      
                                      
                                      $
                                      1,354,443





(1)
            Represents
      write-offs of specific accounts receivable and
  inventories.


F-33


Note
18


Subsequent
Events:




On
January 26, 2009, the Company completed the reverse split of its common stock in
the ratio of 1-for-7. The Company’s common stock began trading at the market
opening on January 27, 2009 on a split-adjusted basis. The reverse split is
intended to enable the Company to increase its marketability to institutional
investors and to maintain its listing on the Nasdaq Global Market, among other
benefits. As a result of the stock split, the Company now has 9,005,175
shares of common stock outstanding, taking into account any fractional
shares issued.




On
February 27, 2009, the Company completed the acquisition of PTL. Under the terms
of the acquisition agreement, the initial purchase price of $13 million
was paid at closing (“PTL Closing”), and under an earn-out provision, up to
an additional $7 million of consideration to be paid to the sellers if certain
gross profit milestones are met by the acquired PTL business between
July 1, 2008 and June 30, 2009, subject to customary adjustments. The
acquisition was funded through a convertible debt investment of $18 million
from the Investor that closed simultaneously with the PTL
Closing. The convertible note transaction financed the $13 million purchase
price of the acquisition, and a further $5 million in working capital at the
closing of the acquisition. Under the terms of the investment, the Investor will
make up to an additional $7 million convertible debt investment in PhotoMedex in
the event the additional consideration is payable under the terms of
the PTL acquisition. After the payment of approximately $2 million of
transaction expenses associated with the acquisition and the debt investment,
the Company will have approximately $3 million remaining for use as working
capital.




At the
PTL Closing, in exchange for the Investor’s payment to the Company of a purchase
price of $18 million, the Company issued the Investor (i) a Note in the
principal amount of $18 million and (ii) a Warrant to purchase 1,046,204 shares
of our common stock. At the PTL Closing, the Company also paid the
Investor a transaction fee of $210,000 in cash.




In
connection with the Amendment No. 1 to the Securities Purchase Agreement, at the
PTL Closing the Company and the Investor entered into that certain Pledge and
Security Agreement (the “Security Agreement”). As security for the Company’s
obligations to the Investor under the SPA and the Notes, the Company granted the
Investor a first priority security interest in: (i) all of the stock of (A)
ProCyte Corporation, the Company’s wholly-owned subsidiary, and (B) Photo
Therapeutics, Inc., which became a wholly-owned subsidiary of the Company at the
PT Closing; (ii) 65% of the stock of Photo Therapeutics Limited, which also
became a wholly-owned subsidiary of the Company at the PTL Closing; and
(iii) certain other assets of the Company.


F-34