*Table
          of Contents*





**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
                  1934For
                  the fiscal year ended December 31, 2007ORo
              TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                  OF 1934For
                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 jurisdictionof
                  incorporation or organization)
              
              (I.R.S.
                  EmployerIdentification
                  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:


Title
                  of each class
              
              Name
                  of each exchangeon
                  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 o 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 o 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 o





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. o





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  o Accelerated
      filer  o


Non-accelerated
      filer  oSmaller
      reporting company x





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





Yes o No x





The
      number of shares outstanding of our common stock as of March 14, 2008, was
      63,032,207 shares. The aggregate market value of the common stock held by
      non-affiliates (61,482,362 shares), based on the closing market price ($0.99)
      of
      the common stock as of March 14, 2008 was $60,867,538.







*Table
        of Contents*






**Table
      of Contents**




**Page****Part I**Item 1.
            
            Business
            
            1Item 1A.
            
            Risk
                Factors
            
            17Item 1B.
            
            Unresolved
                Staff Comments
            
            30Item 2.
            
            Properties
            
            30Item 3.
            
            Legal
                Proceedings
            
            30Item 4.
            
            Submission
                of Matters to a Vote of Security
                Holders
            
            32**Part II**Item 5.
            
            Market
                for the Registrant's Common Equity, Related
                Stockholder Matters and Issuer Purchases of Equity
                Securities
            
            32Item 6.
            
            Selected
                Financial Data
            
            35Item 7.
            
            Management's
                Discussion and Analysis of Financial Condition
                and Results of Operations
            
            36Item 7A.
            
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            
            57Item 8.
            
            Financial
                Statements and Supplementary
                Data
            
            57Item 9.
            
            Changes
                in and Disagreements with Accountants on Accounting
                and Financial Disclosure
            
            57Item 9A.
            
            Controls
                and Procedures
            
            58Item 9B.
            
            Other
                Information
            
            58**Part III**Item 10.
            
            Directors,
                Executive Officers and Corporate
                Governance
            
            59Item 11.
            
            Executive
                Compensation
            
            64Item 12.
            
            Security
                Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters
            
            75Item 13.
            
            Certain
                Relationships and Related Transactions and Director
                Independence
            
            76Item 14.
            
            Principal
                Accountant Fees and Services
            
            77**Item IV**Item 15.
            
            Exhibits
                and Financial Statement Schedules
            
            78Signatures
            
            82




i
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***Certain
      statements in this Annual Report on Form 10-K, or the 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” or “registrant”) 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.




Our
      business operates in five distinct business units: three in Dermatology and
      two
      in Surgical. Business units, or segments, are distinguished by our management
      structure, products and services offered, markets served or types of customers.




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. On occasion, however, we 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 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 Services segment generates revenues by providing fee-based procedures
      typically using our mobile surgical laser equipment delivered and operated
      by a
      technician at hospitals and surgery centers in the United States. The Surgical
      Products segment generates revenues by selling laser products and disposables
      to
      hospitals, surgery centers and doctors both domestically and internationally.




The
      XTRAC
      laser system is designed and manufactured by us 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.
      The
      Skin Care business has a dedicated national sales force and marketing
      department. Our primary facility for the skincare business is located in
      Redmond, Washington.




Our
      Surgical businesses are located in Montgomeryville, Pennsylvania. In the
      surgical businesses, we also develop, manufacture and market proprietary lasers
      and delivery systems for both contact and non-contact surgery and provide
      surgical services utilizing these and other manufacturers’ products. The
      Montgomeryville facility also serves as our corporate headquarters.




1
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**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. 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.




***Achieve
      Widespread Private Healthcare Reimbursement.*** The
      Centers for Medicare and Medicaid Services (CMS) published national Medicare
      rates, effective March 1, 2003, for the newly established laser reimbursement
      codes for inflammatory skin disorders such as psoriasis. For most of the last
      five years, we have sought to obtain widespread private reimbursement for the
      XTRAC procedure. Presently more than 90% of the U.S. population covered by
      private-health insurance has plans that reimburse for the excimer treatment
      of
      psoriasis.




***Build
      Broad Consumer Awareness Program to Attract Those Not Currently Seeking
      Treatmen*** t.
      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 frustrated 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. Occasionally, favorable economic
      circumstances influence our decision to 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. To date, no units have been placed in
      international markets that provide a usage-based revenue stream. 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.




**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 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:




2
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·
            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 CPT codes
                describing this procedure (96920, 96921 and 96922), as well as the
                establishment of Relative Value Units adopted by CMS. Since 2003,
                rates
                set by CMS have 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 113,000 excimer
                laser psoriasis procedures have been performed in the United States
                in
                2007, approximately 89,000 in 2006, 60,000 in 2005 and 53,000 in
                2004.




**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. This condition can be distressing to patients. 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.




3
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**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.




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. We supported the clinical trials
      with research grants of approximately $954,000, between 1998 –
1999.




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:




4
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·
            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 who had 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.




**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.




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.




**Domestic
      Commercialization of Our XTRAC System**




For
      the
      past six years, we have sought to clear the path of obstacles and barriers
      to a
      smooth and orderly 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 four 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 should 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
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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
      dermatologist, 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.




A
      dermatologist generally takes 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.




**International
      Commercialization of Our Dermatology Equipment**




Our
      international dermatology equipment marketing plan is based on the sale of
      our
      XTRAC system and the newly developed 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 Central and South America.




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**Skin
      Care**




**General**




Our
      Skin
      Care division, ProCyte, generates revenues primarily from the sale of skin
      health, hair care and wound care products; 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 spa markets. We have also expanded 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 Cu 3 ® 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 Cu 3 ® Post
      Laser Lotion, Intensive Repair Crème, Cleanser and Hydrating Gel products used
      to treat patients following chemical peels, microdermabrasion and laser
      treatments. The Complex Cu 3 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
      MD
      Lash FactorTM eyelash conditioner and a line of facial peel products.




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.




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*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 website, www.tricomin.com.
      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 also generate minor revenues from
      technology licensing.




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 peptide  technology
      in products for skin health in the mass retail market. Our current license
      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 and other
      countries. A US patent is pending on the key ingredient in the product, which
      is
      a unique prostaglandin analogue.




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**Our
      Business Strategy: Surgical Products and Services**




We
      market
      lasers used in surgery in hospitals, surgi-centers and doctors offices under
      the
      trademark of SLT and, to a lesser degree, the trade name of Surgical Innovations
      & Services. We market many of our surgical laser products using a similar
      business model to the marketing of our excimer laser products by charging a
      per-procedure fee, thereby limiting the initial outlay to the customer for
      capital expenditure, while promoting continued revenue flow to us. We offer
      a
      wide range of laser services in various specialties, including urology,
      gynecology, orthopedics and general surgery. We are currently marketing such
      services under the trade name PhotoMedex Surgical Services. We also provide
      products that we manufacture for use in our surgical services business.




We
      also
      engage in the development, manufacture and sale of surgical products, including
      proprietary free-beam and Contact LaserTM Systems for surgery and in the
      provision of surgical services on a turnkey procedural basis. 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.




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 patented 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® CTH holmium laser is a versatile and compact holmium laser for
      lithotripsy, or fragmentation of calculi of the genito-urinary tract, as well
      as
      a broad range of other surgical applications. We also introduced a line of
      fiber-optic laser delivery systems to be used with the holmium laser. This
      laser
      has been used in the provision of surgical services and has also been offered
      for sale. The sales have become a very minor component of revenue, approximately
      $55,000 in 2007. Our LaserPro® Diode laser system has replaced the Nd:YAG laser.
      Our LaserPro® CO2 laser system is used with PhotoMedex surgical services and is
      sold through our surgical products business.




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




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




·
            the
                sale of Diode laser units;




·
            the
                sale of CTH holmium and CO2 units, and related service;
                and


·
                providing
                    surgical services.


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. Our holmium laser delivery systems
      consist of fiber-optic delivery systems, which deliver the laser beam from
      our
      CTH holmium laser unit to the surgical site. The CO2 laser system does not
      use a
      fiberoptic and therefore will have less of a recurrent revenue steam. Our
      CO2-related Unimax® accessories enjoy wide acceptance and can be used on other
      CO2 laser systems than our own.




**Surgical
      Services**




We
      provide our customers with the ability to utilize our laser systems, as well
      as
      those of other companies, on a per-procedure basis. We provide these services
      through field technicians, called clinical support specialists, for a variety
      of
      surgical procedures utilizing various laser technologies. The per-procedure
      prices we charge for surgical services vary based on the surgical procedure
      performed.




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Our
      primary competitive strengths in surgical services are in the training we
      provide to our clinical service specialists, our adherence to quality standards
      and our ability to integrate products that we manufacture into the range of
      services we provide. These strengths allow us to provide multiple-specialty
      capability on a cost-effective basis, which in turn reduces or eliminates a
      hospital’s need to purchase laser systems, associated delivery systems and
      clinical support to meet its professionals’ requirements. To the extent,
      however, that we must satisfy customer demand through products not manufactured
      by us, we realize reduced margins.




Most
      of
      our operations in surgical services are in the southeastern states of the United
      States. We also have operations in the Milwaukee, Wisconsin,
      Baltimore-Washington DC and Philadelphia, Pennsylvania areas.




**Surgical
      Products**




The
      following is a summary of our major surgical products:




***Fiberoptic
      Delivery Systems*** *.* We ** have
      designed disposable optical quartz fibers **** to
      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.




***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.




***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. The delivery systems are re-useable.




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The
      LaserPro CO2 laser unit can provide up to 40 watts of power to tissue at a
      wavelength of 10,600-nm. Like the Diode, 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, which we acquired from Reliant Technologies. As in the case
      of
      the Diode laser, we have in the case of the CO2 laser undertaken discussions
      to
      supply the laser on an OEM basis to third parties.




We
      manufacture virtually all of our laser systems and laser delivery systems (other
      than those manufactured by other companies that are utilized in the provision
      of
      surgical services) 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. We previously used to supply this product to Linvatec
      Corporation, but have now brought the line back for us to market.




**Our
      Operating Strategies:**




**Sales
      and Marketing**




As
      of
      March 14, 2008, our sales and marketing organization consists of 74 full-time
      positions. Of the 74 direct sales personnel, they are directed to sales in
      the
      Dermatology and Surgical divisions by business segment as follows: Dermatology:
      33 in Domestic XTRAC; 32 in Skin Care; 3 in International Dermatology Equipment
      and Surgical Products and 6 in Surgical Services.




Our
      sales
      organization provides consultation and assistance to 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 the regional
      managers and clinical support specialists 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 and services 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 and services.




**Manufacturing**




We
      manufacture our phototherapy products at our 8,000 sq. ft. facility in Carlsbad,
      California and 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 a quality system.




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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.




**Research
      and Development**




As
      of
      March 14, 2008, our research and development team included four full-time
      research employees and ten engineers. We conduct research and development
      activities at all three of our facilities. Our research and development
      expenditures were approximately $0.8 million in 2007, $1.0 million in 2006
      and
      $1.1 million in 2005.




Our
      research and development activities are focused on:




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




·
            the
                development of additional devices to further improve the phototherapy
                treatments performed with our XTRAC system;




·
            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 and service offerings;




·
            the
                development of new lines of surgical lasers and related 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 14, 2008, we have more than 85 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 24 patent applications pending in the United States and
      abroad.




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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. In July 2007,
      we secured a license to market MD Lash Factor® eyelash conditioner.




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 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 United States 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 Federal Food, Drug and Cosmetics 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 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 holmium laser system, including the laser unit and fiberoptic
      delivery systems, in a variety of surgical specialties and procedures in
      urology, otorhinolaryngology, discectomy and percutaneous laser disc
      decompression.




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. We also received in
      2004 510(k) marketing clearance for our Diode and CO2 surgical laser
      systems.




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A
      pre-market approval application may be required if a proposed device is not
      substantially equivalent to a 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
      products in the Skin Care business segment, the Federal Food, Drug and Cosmetic
      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.




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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. Reimbursement for the products and services provided
      by
      our Surgical Services and Surgical Products segments has been generally
      well-established and is not viewed as an obstacle to growth in those segments.
      Since the skincare products are primarily for cosmetic applications,
      reimbursement is not a critical factor in growing revenues for this product
      segment.




In
      2007,
      we continued our efforts to secure private, third-party reimbursement in our
      domestic XTRAC business segment. 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 $155.78 per
                  treatment;




·
            96921
                – designated for: the total area 250 to 500 square centimeters. CMS
                assigned a 2008 national payment of approximately $153.49 per treatment;
                and




·
            96922
                – designated for: the total area over 500 square centimeters. CMS assigned
                a 2008 national payment of approximately $226.62 per
                treatment.




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




In
      addition to Medicare and Medicaid, consistent domestic private healthcare
      reimbursement is critical for significant growth in XTRAC system procedures.
      There were more than 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. In 2005 substantive progress
      was made in connection with obtaining approvals for covering medically necessary
      targeted UVB therapy for psoriasis. As a result of certain national insurers
      approving the XTRAC excimer laser therapy in the latter part of 2005, we
      initiated – and have continued in 2007 - a direct-to-consumer advertising
      campaign in certain geographic regions.




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In
      addition to the level of insurance reimbursement that currently exists, we
      were
      advised in February 2007 that the technology assessment branch of the Blue
      Cross
      Blue Shield Association had determined that among other things, phototherapy
      with the excimer laser is not an experimental use and may be used in the
      treatment of up to 20% the skin surface area for psoriasis. We believe that
      this
      determination will positively influence some remaining subscribing private
      plans
      to cover treatment of psoriasis with the XTRAC laser and increase our estimated
      level of reimbursement beyond the current level. In fact, Blue Shield of
      California approved a favorable policy in January 2008. In addition, in 2007
      a
      bill was introduced in Congress, at the urging of NPF, to increase the patient’s
      awareness of available treatments of psoriasis. We believe that this too should
      positively influence patients suffering from psoriasis to seek
      treatment.




**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, as compared to costs associated with alternative
      treatments. 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.




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 competitors that enter the US market will predominantly 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 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.




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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.




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.




In
      addition, we face competition from other surgical services companies and from
      product manufacturers who may offer their products through a similar
      per-procedure method. Additionally, we face substantial competition from
      well-established manufacturers of non-laser products. These well-established
      companies have substantially greater resources than we do and could exert
      considerable competitive pressure on us.




**Employees**




As
      of
      March 14, 2008, we had 205 full-time employees, which consisted of 3 executive
      officers, 11 other senior officers or managers, 69 sales and marketing staff,
      84
      people engaged in manufacturing of lasers and laser-related products, 8
      customer-field service personnel, 4 people engaged in research and development,
      8 engineers and 18 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.




**Item
      1A.****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 Annual Report on Form 10-K 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 and services 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, 2007, our accumulated deficit was
      approximately $94.0 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 and from our surgical services business and revenue
      stability within our surgical products business. Our ability to market our
      products and services successfully and the expected benefits to be obtained
      from
      our products and services 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.




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We
      expect
      to incur losses as we move into fiscal 2008 because we plan to continue to
      spend
      substantial amounts on expanding, in controlled fashion, our sales and marketing
      operations in phototherapy, and particularly in increasing our customers’
effective utilization of the XTRAC system. We cannot assure you that we will
      market any products successfully, operate profitably in the future, or that
      we
      will not require significant additional financing in order to accomplish our
      business plan.




**We
      may fail to meet the ongoing Nasdaq listing requirements.**




Nasdaq placed
      our common stock on a watch list on November 19, 2007, due to the fact that
      the
      stock had traded for under $1.00 for more than 30 consecutive trading days.
      On
      March 10, 2008, we received a letter from Nasdaq stating that we were now in
      compliance with 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.




Our
      ability to raise funds through issuance of our common stock may be compromised
      by the fact that our stock has been put on the Nasdaq watch list because it
      has
      been trading for under $1.00. We cannot guarantee that market demand for our
      common stock by itself or in response to our business strategy will suffice
      to
      take us off the watch list in timely fashion.




**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, together with access to debt financing for
      capital expenditures 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 2009. However, we may have to raise substantial additional capital
      if:




·
            operating
                losses continue, because anticipated demand for the XTRAC system
                for the
                treatment of psoriasis or surgical laser systems does not meet our
                current
                expectations;




·
            our current line of credit, with a remaining balance
              of
              $1,672,675 at December 31, 2007, is not adequate to fund expansion
              of
              future domestic XTRAC placements;




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




·
            the
                geographic expansion of our surgical services is stymied by competition
                and revenue increases do not materialize;




·
            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; or




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




**If
      we need additional financing, we cannot assure you that such financing will
      be
      available on favorable terms, if at all. 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, surgical services and skincare
                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; or




·
            remain
                in operation.




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**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
      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. Though we were successful in assigning our spa business
      to Universal Business Solutions in December 2007, we may still be unsuccessful
      in continuing existing, or developing new, strategic partners in order to
      maintain or expand the markets for the skincare business’ existing or future
      products. Our surgical services may fail to gain market acceptance in new
      territories into which we expand. 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.




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 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 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, skincare products, or our surgical services 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
      and
      surgical services to achieve market acceptance could have a material adverse
      effect on our business, financial condition and results of
      operations.




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**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 US 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 relatively reimbursement-rich 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 Ultra), in both its utility and its range
      of applications, from those of competitors. If we unable through our
      technological innovations to preserve our proprietary rights, our ability to
      market the XTRAC system could be materially and adversely affected.




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 would also allow others, including Neutrogena,
      to
      apply the technology covered by that patent in their products.




We
      have
      licensed marketing rights to MD Lash FactorTM eyelash conditioner. Allergan, Inc.
      has brought a patent infringement suit under U.S Patent No. 6,262,105 (the
“’105
      Patent”) against us and several other companies which also market eyelash
      conditioners. While we believe that Allergan is wrong in its interpretation
      of
      the ‘105 Patent, we cannot guarantee that a court will agree with our
      assessment. It has been reported to us that Allergan intends to introduce its
      own eyelash conditioner, possibly in connection with efforts with Clinique
      to
      tap the market of physicians, and has another patent pending for its own eyelash
      conditioner. Allergan has greater resources than we do to maintain a
      lengthy infringement suit.




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 scant
      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 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.**




20
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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




·
            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
      laser 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 14, 2008, 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.




21
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**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, 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.




**The
      XTRAC system will continue to be the most promising product that is currently
      marketed by us. If physicians do not adopt the XTRAC system, we will not achieve
      anticipated revenue growth.**




We
      commercially introduced the XTRAC system in August 2000, but decelerated that
      introduction while we sought appropriate CPT codes and suitable rates of
      reimbursement from CMS. After we obtained CPT codes and reimbursement rates
      from
      CMS for the CPT codes, we began a roll-out strategy for the XTRAC system in
      the
      United States. To achieve increasing revenue, this product must also gain
      recognition and adoption by physicians who treat psoriasis and other skin
      disorders. The XTRAC system represents a significant departure from conventional
      psoriasis treatment methods. We believe that the recognition and adoption of
      the
      XTRAC system would be expedited if there were long-term clinical data
      demonstrating that the XTRAC system provides an effective and attractive
      alternative to conventional means of treatment for psoriasis. Currently,
      however, there are still only limited peer-reviewed clinical reports and
      short-term clinical follow-up data on the XTRAC system. Physicians are
      traditionally cautious in adopting new products and treatment practices,
      partially due to the anticipation of liability risks and partially due to
      uncertainty of third-party reimbursement. If physicians do not adopt the XTRAC
      system, we may never achieve significant revenues or profitability.




**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.




**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.




22
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**If
        revenue from a significant customer continues to decline, we may have difficulty
        replacing the lost revenue.**
  Neutrogena,
        one of the customers for the skin health and hair care products segment that
        we
        acquired from ProCyte, used to account for a significant portion of our net
        revenue in that business segment. ProCyte’s net revenues from Neutrogena in 2004
        were $2,768,072, 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). For the year ended December 31, 2005, Skin
        Care’s
        (ProCyte) net revenues from Neutrogena were $1,421,946, or approximately
        10.9%
        of Skin Care’s (ProCyte) gross revenues of $13,011,694 (revenues which are
        reflected in our financial statements to the extent that they were earned
        since
        March 19, 2005). For the year ended December 31, 2006, Skin Care’s net revenues
        from Neutrogena were $972,400, approximately 7.7% of Skin Care’s gross revenues
        of $12,646,910. For the year ended December 31, 2007, Skin Care’s net revenues
        from Neutrogena were $598,058, approximately 4.4% of Skin Care’s gross revenues
        of $13,471,973. We receive royalty revenues on sales of products by Neutrogena
        under the terms of a license agreement with
        Neutrogena. The royalties from Neutrogena for 2004 and for our fiscal years
        ended December 31, 2005, December 31, 2006 and December 31, 2007, were
        $1,214,073, $609,946, $300,000 and $275,000, respectively. The license agreement
        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. We also receive revenues from sales of copper peptide compound
        to
        Neutrogena pursuant to a related supply agreement. ProCyte’s sales to Neutrogena
        under the supply agreement for 2004 and for our fiscal years ended December
        31,
        2005, December 31, 2006 and December 31, 2007, were $1,553,999, $812,000,
        $672,400 and $323,058, respectively. To date, we have not found any one customer
        which replaces the level of business which Neutrogena once represented to
        ProCyte.





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 $1,218,698 in 2007 and $1,170,892 in 2006. 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.




In
      the
      Surgical Services segment, we find that our model works best if we have several
      accounts in a territory that have sufficient volume to allow us to be efficient
      in the delivery of our services. If we lose one of these anchor accounts, then
      we may become less efficient and therefore less competitive.




In
      order
      to pursue a strategic partnership, we have acted as contract developer of a
      system designed to detect cancerous cells in human tissue and act as an OEM
      manufacturer of surgical lasers and delivery systems and diode laser systems
      for
      AngioDynamics. This work exposes us to heightened financial risk and
      technological uncertainties, and also exposes us to the business risks faced
      by
      our OEM customers. In addition, OEM work is usually limited to a contracted
      period of time, at the end of which there may be no extension or renewal. If
      we
      fail to obtain a renewal or extension, or if we incur losses associated with
      the
      development projects we may have a substantive impact on our financial
      statements.




The
      loss
      or reduction of business from any of our significant customers or strategic
      partners in that business segment, Neutrogena in particular, or the failure
      to
      develop new significant customers or strategic partners could have a material
      adverse effect on the results of operations and our overall financial
      condition.




**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.




23
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            of Contents*





**Our
      failure to obtain or maintain necessary FDA clearances or approvals, or
      equivalents there of 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 any of a number of divisions of the FDA and in other countries
      by
      similar health and regulatory authorities. 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.




The
      FDA
      is currently conducting a limited review of our MD Lash FactorTM eyelash
      conditioner to determine if it contains bimatoprost as an active ingredient.
      Products that contain bimatoprost require a separate regulatory process for
      application. To date, we believe we have established to the satisfaction of
      the
      FDA that the prostaglandin analogue in MD Lash FactorTM is not bimatoprost, which
      is the active ingredient in Allergan’s FDA-approved drug Lumigan, used for
      treatment of certain types of glaucoma. In November 2007, the FDA had seized
      a
      competitor’s eyelash conditioner that contained bimatoprost. This illustrates
      the fact that we and every other company subject to FDA regulation faces a
      risk
      that product believed to conform to regulatory requirements may be challenged
      by
      the FDA and possibly found not to meet such requirements.




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 require 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. 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.




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.




24
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**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 services
                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 and our surgical services in a complex legal environment
                so
                that they will be accepted as attractive and appropriate alternatives
                to
                conventional service 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 products or surgical services 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 and CO2 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 and CO2 lasers.




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




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.




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, maintain the benefits of vertical integration in the delivery
      of our surgical services 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.




25
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**We
      may have difficulty managing our growth.**




If
      additional private carriers approve favorable reimbursement policies for
      psoriasis (as for example Blue Shield did in California in January 2008) 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. This 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. 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. Our response may be thwarted if we require, but cannot
      secure, rights to essential third-party intellectual property. In the surgical
      services segment, we have faced declining margins partly because we are
      obligated to purchase equipment demanded by the customers, but manufactured
      by
      third parties who hold intellectual property in such equipment. 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. 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.




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.




26
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**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. In addition, the
      fact
      that we train technicians whom we do not supervise in the use of our XTRAC
      system when patients are treated and that we train and provide our technicians
      as part of our surgical services business may expose us to third-party claims
      if
      those doing the training are accused of providing inadequate training or if
      a
      technician is accused of negligently applying such 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 and disposal of these materials and specified waste
                products.




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.




27
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            of Contents*





**We
      may be unsuccessful in integrating any 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;


·
            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 have anti-takeover 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 amend our bylaws and to notice special meetings of stockholders. These
      anti-takeover 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:




·
            healthcare
                reform and reimbursement policies;




·
            demand
                for our products;




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




28
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·
            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;




·
            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 and for our surgical services 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:




·
            announcements
                related to our efforts to secure favorable reimbursement policies
                from
                private carriers concerning the treatment of psoriasis with the XTRAC
                system or to our efforts to increase utilization of the XTRAC
                system;




·
            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 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.




**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 merger.




29
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            of Contents*







**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 $133,507 as of December 31, 2007. The base rent is $6,640
      per
      month. Our Carlsbad facility houses the manufacturing and development operations
      for our excimer laser business.




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. In addition
      to
      this facility, we also lease several offices throughout the southeastern United
      States and other locations elsewhere. Our marketing and sales representatives
      use these offices to perform their sales and training responsibilities. These
      offices consist of small one-room facilities and are leased for various terms
      and amounts.




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.




**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 from the new judge’s grant of summary judgment to
      the defendants. We expect to file our brief in March 2008.




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, we have filed a petition to lodge an
      interlocutory appeal from the new judge’s dismissal, among other things, of our
      counterclaim of misappropriation. The plaintiffs have opposed the petition.
      No
      decision has yet been rendered on the petition.




In
      the
      action we brought on January 3, 2007, against our insurance carrier in the
      United States District Court for the Eastern District of Pennsylvania, we
      invoked the carrier to defend us and to indemnify us in the malicious
      prosecution action brought by Ra Medical Systems and its principal. In May
      2007,
      the malicious prosecution case settled. In February 2008, the Court granted
      our
      motion for partial summary judgment and denied the motion of the carrier for
      summary judgment. The Court ruled that the extent to which our defense costs,
      amounting to more than $900,000, would also be reimbursable by the carrier
      under
      the policy would be governed by the law of Pennsylvania based on their
      reasonableness, and not by the law of California, which would statutorily impose
      a cap on the such fees at a level the carrier would pay in similar cases. A
      scheduling order has been issued under which the parties will begin discovery
      on
      the reasonableness of the fees. We are also evaluating other claims that we
      may
      have against the carrier, due, among other things, to its dilatory handling
      of
      our claim for reimbursement under provisional application the carrier’s own,
      purportedly self-validated hourly rates for defense counsel and its other
      billing guidelines. Our claim under such provisional application was for
      approximately $328,000, which we recorded as an offset to our expensed defense
      costs; approximately $100,000 remains unreimbursed. The Company has not
      recognized any possible reimbursements other than the $328,000.




30
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On
      November 7, 2007, Allergan, Inc. brought a patent infringement suit against
      PhotoMedex, Inc., as well as against a number of other co-defendants. Suit
      was
      brought in the United States District Court for the Central District of
      California. Allergan alleges that the various eyelash conditioners of the
      defendants, including MD Lash Factor, were marketed in violation of the claims
      of US Patent No. 6,262,105. We have moved to have the case dismissed on the
      grounds that Allergan had failed to join the owner-inventor of the patent in
      the
      suit and that there had been no common transaction or occurrence among the
      various defendants to justify that they should be tried en masse. In January
      2008, ProCyte Corporation filed a declaratory judgment action against Allergan
      and the owner-inventor of the ‘105 patent in the United States District Court
      for the Western District of Washington. ProCyte has petitioned the court to
      decide whether its marketing activities of MD Lash Factor infringed the ‘105
      patent. Allergan has opposed the actions of PhotoMedex and of ProCyte. The
      Central District Court has ruled that it will not dismiss the action and will
      allow Allergan to amend its complaint; nevertheless, that Court has also ruled
      that the petition in the Western District Court will be recognized by the
      Central District Court as the first action to be filed in respect of ProCyte.
      The Western District Court is expected to rule later in March 2008.




We
      have
      lodged a protest with the Food and Drug Administration under the Freedom of
      Information Act. In a limited review of ProCyte Corporation for its marketing
      of
      MD Lash Factor, the FDA employed a third party’s testing protocol, which the
      third party modified to accommodate FDA’s testing equipment, to determine, among
      other things, whether MD Lash Factor contained the prostaglandin analogue
      bimatoprost. Bimatoprost is the active ingredient of the ophthalmic drug
      Lumigan. As best we can discern, that testing protocol has established that
      MD
      Lash Factor does not contain bimatoprost, and our own collateral, independent
      testing has demonstrated the same. The FDA, however, has declined to disclose
      to
      us the details of the testing protocol that it employed, on the basis that
      the
      protocol is proprietary to the developer of the drug Lumigan. We are awaiting
      a
      response to our protest.




On
      February 19, 2008, Cardiofocus, Inc. brought a patent infringement suit against
      PhotoMedex, Inc., as well as against a number of other co-defendants. Suit
      was
      brought in the United States District Court for Massachusetts. Cardiofocus
      alleges that the various holmium laser systems of the defendants, including
      our
      LaserPro® CTH holmium laser system, were marketed in violation of the claims of
      US Patent No. 5,843,073. We are presently evaluating our course of
      action.




On
      February 25, 2008, Bella Bella brought a patent infringement suit against a
      number of companies in the United States District Court for the Central District
      of California. Among the defendants are Johnson & Johnson, L’Oreal, Avon,
      Sharper Image and PhotoMedex. Bella Bella alleges that the defendants have
      infringed its U.S. patents dealing with microdermabrasion. We are presently
      evaluating our course of action. We believe their claim is without
      merit.




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.




31
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**Item
      4.****Submission
      of Matters to a Vote of Security Holders**




None.




**PART
      II**




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




As
      of
      March 14, 2008, we had 63,032,207 shares of common stock issued and
      outstanding, including 1,280,000 shares of issued and outstanding
      restricted stock. This does not include options to purchase 7,111,252
      shares of common stock, of which 4,614,626 were vested as of March 14, 2008,
      and
      warrants to purchase up to 4,149,583 shares of common stock, all of which
      warrants were vested.




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,




**High**
            
            **Low**Year
                Ended December 31, 2007:Fourth
                Quarter
            
            $
            1.10
            
            $
            0.79Third
                Quarter
            
            
            1.30
            
            
            0.90Second
                Quarter
            
            
            1.44
            
            
            1.15First
                Quarter
            
            
            1.36
            
            
            1.06Year
                Ended December 31, 2006:Fourth
                Quarter
            
            $
            1.85
            
            $
            1.04Third
                Quarter
            
            
            1.65
            
            
            0.99Second
                Quarter
            
            
            1.99
            
            
            1.46First
                Quarter
            
            
            2.34
            
            
            1.70




On
      March
      14, 2008, the closing market price for our common stock in The Nasdaq National
      Market System was $0.99 per share. As of March 14, 2008, we had approximately
      890 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 November 17, 2007, due to the fact that
      the
      stock had traded under $1.00 per share for more than 30 consecutive trading
      days. On March 10, 2008, 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.




32
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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, 2007.
      See Notes 1 and 12 to the consolidated financial statements for additional
      discussion.




**(A)**
              
              **Number of**
              **Securities to be**
              **Issued Upon**
              **Exercise of**
              **Outstanding**
              **Options, Warrants**
              **and Rights**
            
            **(B)**
              
              **Weighted-**
              **Average Exercise**
              **Price of**
              **Outstanding**
              **Options,**
              **Warrants and**
              **Rights**
            
            **(C)**
              
              **Number of Securities**
              **Remaining Available**
              **for Future Issuance**
              **Under Equity**
              **Compensation Plans**
              **(excluding securities**
              **reflected in column (A))****Equity
                compensation plans approved by security holders**
            
            
            10,228,254
            
            $
            1.85
            
            
            5,591,550**Equity
                compensation plans not approved by security
                holders**
            
            
            51,000
            
            $
            1.66
            
            
            -**Total**
            
            
            10,279,254
            
            $
            1.85
            
            
            5,591,550




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.




**Recent
      Issuances of Unregistered Securities**




On
      November 3, 2006, we completed a private placement for 9,760,000 shares of
      common stock at $1.17 per share resulting in gross proceeds of $11,419,200.
      The
      closing price of our common stock on November 1, 2006 was $1.27 per share,
      the
      date we agreed to the private placement. In connection with this private
      placement, we paid commissions and other expenses of $864,308, resulting in
      net
      proceeds of $10,554,892. In addition, the investors received warrants to
      purchase 2,440,000 shares of common stock at an exercise price of $1.60 per
      share, and Cowen & Company, the placement agent, received warrants to
      purchase 244,000 shares of common stock, under the same terms and conditions
      as
      the warrants issued to the investors. All such warrants have a five-year term
      and became first exercisable on May 1, 2007. Cowen & Company is entitled to
      a **** 6.5%
      commission on any proceeds to us from future exercises by the investors of
      their
      warrants. To date, there have been no exercises of these 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. We have 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.




On
      March
      31, 2006, we issued to Stern 101,010 of our restricted common stock, pursuant
      to
      a Master Asset Purchase Agreement (the “Master Agreement”) dated September 7,
      2004 with Stern. As of December 31, 2007, we have issued to Stern an aggregate
      589,864 shares of our restricted common stock in connection with the Master
      Agreement. We do not expect to issue any further shares of stock to Stern,
      as
      the time for completing remaining milestones has expired.




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




In
      December 2007, we issued 235,525 warrants to each of CIT Healthcare and Life
      Sciences Capital to purchase our common stock in connection with the term loan
      commenced in December 2007.




In
      March
      2007, we issued to GE Capital Corporation (“GE”) 33,297 warrants to purchase our
      common stock. In 2006, we issued to GE 20,545, 24,708, 25,038 and 32,057
      warrants to purchase our common stock issued on March 29, 2006, June 30, 2006,
      September 29, 2006 and December 28, 2006, respectively, in connection with
      draws
      we made against a Master Lease Agreement. We redeemed all such warrants from
      GE
      in December 2007 for $178,699 as part of the termination of the lending
      arrangement, which we recognized as part of the refinancing charge. (See ***Note
      9*** )




We
      believe that all of the foregoing issuances of securities were made solely
      to
      accredited investors in transactions exempt from registration under Section
      4(2)
      of the Securities Act.




**ISSUER
                PURCHASES OF EQUITY
                SECURITIES**


**Period**
              ****
              **Total Number of**
                **Shares (or Units)**
                **Purchased**
              ****
              **Average Price Paid**
                **per Share (or Units)**
              ****
              **Total Number of**
                **Shares (or Units)**
                **Purchased as part of**
                **Publicly Announced**
                **Plans or Programs**
              ****
              **Maximum Number**
                **(or Approximate**
                **Dollar Value) of**
                **Shares (or Units)**
                **that May Yet Be**
                **Purchased Under the**
                **Plans or Programs**December
                  2007
              
              
              213,071
              
              $
              0.84
              
              
              0
              
              
              0
  The
        securities were warrants held by GE Capital Corporation.


34
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          of Contents*




**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 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,
      2007, December 31, 2006 and December 31, 2005, and the selected historical
      consolidated balance sheet data as of December 31, 2007 and December 31, 2006,
      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, 2004 and December 31, 2003
      and
      the selected historical consolidated balance sheet data as of December 31,
      2005,
      December 31, 2004 and December 31, 2003 are derived from our audited
      consolidated financial statements not included in this Annual Report on Form
      10-K. The historical results presented here are not necessarily indicative
      of
      future results.




Year Ended December 31,(In thousands, except per- share
                data)**2007**
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003****Statement
                of Operations Data:**Revenues
            
            $
            38,714
            
            $
            33,190
            
            $
            28,384
            
            $
            17,745
            
            $
            14,319Costs
                of revenues
            
            
            20,068
            
            
            18,472
            
            
            15,675
            
            
            10,363
            
            
            10,488Gross
                profit (loss)
            
            
            18,646
            
            
            14,718
            
            
            12,709
            
            
            7,382
            
            
            3,831Selling,
                general and administrative
            
            
            23,229
            
            
            20,682
            
            
            16,477
            
            
            10,426
            
            
            9,451Engineering
                and product development
            
            
            799
            
            
            1,006
            
            
            1,128
            
            
            1,802
            
            
            1,777Loss
                from operations before interest and other income, net
            
            
            (5,382
            )
            
            (6,970
            )
            
            (4,896
            )
            
            (4,846
            )
            
            (7,397
            )Interest
                income
            
            
            384
            
            
            149
            
            
            61
            
            
            43
            
            
            50Interest
                expense
            
            
            (914
            )
            
            (671
            )
            
            (403
            )
            
            (181
            )
            
            (96
            )Refinancing
                charge
            
            
            (442
            )
            
            -
            
            
            -
            
            
            -
            
            
            -Other
                income, net
            
            
            -
            
            
            -
            
            
            1,302
            
            
            -
            
            
            -Net
                loss
            
            $
            (6,354
            )
            $
            (7,492
            )
            $
            (3,936
            )
            $
            (4,984
            )
            $
            (7,443
            )Basic
                and diluted net loss per share
            
            $
            (0.10
            )
            $
            (0.14
            )
            $
            (0.08
            )
            $
            (0.13
            )
            $
            (0.21
            )Shares
                used in computing basic and diluted net loss per share (1)
            
            
            62,810
            
            
            54,189
            
            
            48,786
            
            
            38,835
            
            
            35,134**Balance
                Sheet Data (At Period End):**Cash
                and cash equivalents
            
            $
            9,954
            
            $
            12,886
            
            $
            5,610
            
            $
            3,997
            
            $
            6,633Working
                capital
            
            
            13,706
            
            
            16,070
            
            
            11,151
            
            
            6,119
            
            
            8,678Total
                assets
            
            
            56,687
            
            
            57,482
            
            
            48,675
            
            
            22,962
            
            
            22,753Long-term
                debt (net of current portion)
            
            
            5,701
            
            
            3,727
            
            
            2,437
            
            
            1,399
            
            
            457Stockholders’
                equity
            
            $
            39,533
            
            $
            44,103
            
            $
            38,417
            
            $
            14,580
            
            $
            15,978




(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.




35
 *Table
          of Contents*





**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.***




**Overview**




We
      view
      our business as comprised of the following five business segments:




·
            Domestic
                XTRAC,




·
            International
                Dermatology Equipment,




·
            Skin
                Care (ProCyte),




·
            Surgical
                Services, 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, and 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. We are finding that through sales
      of
      lasers we are able to reach, at respectable margins, a sector of the market
      that
      is better suited to a sale model than a per-procedure model.




For
      the
      past six years, we have sought to clear the path of obstacles and barriers
      to a
      roll-out of the XTRAC laser system in dermatology. Our efforts culminated in
      March 2007, when the Blue Cross Blue Shield Association (BCBSA) published a
      National Reference Policy that now recommends positive reimbursement coverage
      for psoriasis, including the XTRAC, as first-step therapy for moderate to severe
      psoriasis comprising less than 20% body area. Subsequent to publication of
      this
      reference policy many states adopted the XTRAC as a reimbursable procedure
      including the Blue Cross Blue Shield Insurance plans in Illinois, New Mexico,
      Oklahoma, Texas and California. Only a few remaining states do not have a
      positive payment policy. We estimate that 90% of the insured population in
      the
      United States has plan coverage for the treatment of psoriasis by the excimer
      laser.




Our
      26-person XTRAC sales organization includes 13 sales representatives, 11
      clinical specialists and 2 marketing support personnel. Our 28-person skin
      care
      sales organization includes 20 sales representatives, 6 customer service
      representatives and 2 marketing support personnel. The sales representatives
      of
      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.




While
      our
      sales and marketing expenses have grown faster than the revenues on which the
      expenses are targeted to have positive impact, we expect to increase our overall
      revenue and productivity as a result of these expenditures in the long term.
      For
      example, we have tried various direct-to-consumer marketing programs that have
      positively influenced utilization, but the payback 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.




36
 *Table
          of Contents*




**International
      Dermatology Equipment**




In
      the
      international market, we derive revenues by selling our dermatology laser
      systems 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 systems in the international segment
      is 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. In 2005, as a result of the acquisition of worldwide rights to certain
      proprietary light-based technology from Stern, we also explored new product
      offerings in the treatment of dermatological conditions. We expanded the
      international marketing of this product, called the VTRACTM, in 2006. The VTRAC
      is a lamp-based UVB targeted therapy, positioned at a price point lower than
      the
      XTRAC laser system so that it will effectively compete with other
      non-laser-based therapies for psoriasis and vitiligo.




**Skin
      Care (ProCyte)**




On
      March
      18, 2005, we completed the acquisition of ProCyte Corporation. ProCyte generates
      revenues from the sale of skin health, hair care and wound care products; the
      sale of copper peptide compound in bulk; and royalties on licenses for the
      patented copper peptide compound. The operating results of ProCyte for the
      year
      ended December 31, 2005 are included from March 19, 2005 through December 31,
      2005. Under purchase accounting rules, the operating results of ProCyte for
      prior periods are not included in our Statement of Operations. A description
      of
      transaction and pro-forma operating results are disclosed as part of Note 2,
      “ *Acquisitions”,* to the
      financial statements.




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 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
      skincare regimen.




**Surgical
      Services**




The
      Surgical Services segment typically generates revenues by providing fee-based
      procedures using our mobile surgical laser equipment delivered and operated
      by a
      technician at hospitals and surgery centers in the United States. We have
      pursued a cautious growth strategy for this business segment in order to
      conserve our cash resources for the XTRAC business segments.




We
      have
      limited marketing experience in expanding our surgical services business. The
      majority of this business is in the southeastern part of the United States.
      New
      procedures and geographical expansion, together with new customers and different
      business habits and networks, will likely continue to pose different challenges
      compared to those that we have encountered in the past.




**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). Surgical product revenues decreased in
      2007 compared to 2006, reflecting we believe that sales of surgical laser
      systems and the related disposable base have eroded as hospitals continue to
      seek outsourcing solutions instead of purchasing lasers and related disposables
      for their operating rooms. We are working to offset this erosion by increasing
      sales from the Diode surgical laser introduced in 2004, including OEM
      arrangements.




37
 *Table
          of Contents*




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 system is designed for
      use
      with AngioDynamics’ NeverTouchTM VenaCure® patented endovenous therapy for
      treatment of varicose veins. The OEM agreement provides that we 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, we will now provide this laser exclusively to
      AngioDynamics for worldwide sale in the peripheral vascular treatment field.




**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.




***Revenue
      Recognition***




*XTRAC-Related
      Operations*




We
      have
      two distribution channels for our phototherapy treatment equipment. We either
      (i) 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 or (ii) to a lesser extent, sell the laser through a distributor
      or
      directly to a physician. 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 assured
      or fully paid. 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 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.




38
 *Table
          of Contents*




We
      exclude all sales of treatment codes made within the last two weeks of the
      period in determining the amount of procedures performed by our
      physician-customers. Our management believes this approach closely approximates
      the actual amount of unused treatments that existed at the end of a period.
      For
      the years ended December 31, 2007 and 2006, we deferred $563,336 and $506,440,
      respectively, under this approach.




We
      have a
      program to support certain physicians in addressing treatments with the XTRAC
      laser system that may be denied reimbursement by private insurance carriers.
      We
      recognize service revenue from the sale of treatment codes to physicians
      participating in this program only if and to the extent the physician has been
      reimbursed for the treatments. We estimate a contingent liability for potential
      refunds under this program by reviewing the history of denied insurance claims
      and appeals processed. At December 31, 2007 and 2006, we had net deferred
      revenues of $72,812 and $80,697, respectively, under this program.




*Skin
      Care Operations*




We
      generate revenues from our Skin Care business primarily through three channels.
      The primarily channel is through product sales for skin health, hair care and
      wound care; the second is through sales of the copper peptide compound,
      primarily to Neutrogena Corporation, a Johnson & Johnson company; and the
      third is through royalties generated by our licenses, principally to Neutrogena.
      The second and third channels have become minor. 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. Royalty revenues are based
      upon sales generated by our licensees. We recognize royalty revenue at the
      applicable royalty rate applied to shipments reported by our
      licensee.




*Surgical
      Products and Service Operations*




We
      generate revenues from our surgical businesses primarily from two channels.
      The
      first is through product sales of laser systems, related maintenance service
      agreements, recurring laser delivery systems and laser accessories, and the
      second is through per-procedure surgical services. 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.




For
      per-procedure surgical services, we recognize revenue upon the completion of
      the
      procedure. 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.




***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.




39
 *Table
          of Contents*




***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, surgical services 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
      collectibility could result in a significant change in the reserve needed.




***Property
      and Equipment.*** As of
      December 31, 2007 and 2006, we had net property and equipment of $10,143,808
      and
      $9,054,098, 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 remove the laser
      from
      the physician’s office and redeploy elsewhere. 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. Surgical lasers-in-service are depreciated
      on a straight-line basis over an estimated useful life of seven years if new,
      five years or less if used equipment. The straight-line depreciation basis
      for
      lasers-in-service is reflective of the pattern of use. 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, 2007 and 2006,
      we
      had $20,933,681 and $22, 151,160, respectively, of goodwill and other
      intangibles, accounting for 37% and 39% 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 2007 and 2006 to the carrying value of goodwill that is
      allocated to the XTRAC domestic segment and the XTRAC international segment
      in
      the amounts of $2,061,096 and $883,327, respectively. The allocation of goodwill
      to each segment was based upon the relative fair values of the two segments
      as
      of August 2000, when we bought out the minority interest in Acculase, Inc.
      and
      thus recognized the goodwill. 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 fully to the Skin Care (ProCyte) segment.
      In
      2006, we adjusted the carrying value of the goodwill from the ProCyte
      acquisition reflecting management’s best estimate of pre-acquisition
      contingencies based upon plans entered into prior to March 18, 2005. The
      balances of these acquired intangibles, net of amortization, were :




December 31,2007
              
              2006ProCyte
                  Neutrogena Agreement
              
              $
              1,062,000
              
              $
              1,542,000ProCyte
                  Customer Relationships
              
              
              752,261
              
              
              1,092,257ProCyte
                  Tradename
              
              
              793,364
              
              
              903,368ProCyte
                  Developed Technologies
              
              
              120,356
              
              
              148,928Goodwill
              
              
              13,973,385
              
              
              13,973,385Total
              
              $
              16,701,366
              
              $
              17,659,938




40
 *Table
          of Contents*




***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. The **** recognized
      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 five business segments for the
      periods listed below:




For the Year Ended December 31,2007
            
            2006
            
            2005**Dermatology:**XTRAC
                Domestic Services
            
            $
            9,141,857
            
            $
            5,611,387
            
            $
            3,498,235International
                Dermatology Equipment Revenues
            
            
            3,256,505
            
            
            2,186,424
            
            
            1,404,096Skin
                Care (ProCyte) Revenues
            
            
            13,471,973
            
            
            12,646,910
            
            
            10,042,132Total
                Dermatology Revenues
            
            $
            25,870,335
            
            $
            20,444,721
            
            $
            14,944,463**Surgical:**Surgical
                Services
            
            $
            7,667,174
            
            $
            6,944,292
            
            $
            7,719,529Surgical
                Products
            
            
            5,176,108
            
            
            5,800,864
            
            
            5,720,514Total
                Surgical Revenues
            
            $
            12,843,282
            
            $
            12,745,156
            
            $
            13,440,043Total
                Revenues
            
            $
            38,713,617
            
            $
            33,189,877
            
            $
            28,384,506




***Domestic
      XTRAC Segment***




Recognized
      treatment revenue for the years ended December 31, 2007, 2006, and 2005 was
      $6,981,223, $5,142,022 and $3,498,235, respectively, reflecting billed
      procedures of 109,139, 83,272 and 54,255, respectively. In addition, 4,157,
      5,168 and 6,371 procedures were performed for the years ended December 31,
      2007,
      2006 and 2005, 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, 2007 compared to the comparable
      periods in 2006 and 2005 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 the program only to the extent
      the physician has been reimbursed for the treatments. For the year ended
      December 31, 2007, we deferred revenues of $103,851 (1,587 procedures) net,
      under this program, compared to deferred revenues of $124,427 (1,897 procedures)
      net, under this program for the year ended December 31, 2006. For the year
      ended
      December 31, 2005, we deferred revenues of $57,302, (873 procedures) net,
      under this program. The change in deferred revenue under this program is
      presented in the table below.




41
 *Table
          of Contents*





For
      the
      years ended December 31, 2007 and 2006, domestic XTRAC laser sales were
      $2,160,634 and $469,365, respectively. There were 43 and 11 lasers sold,
      respectively. There were no lasers sold for the year ended December 31, 2005.
      Overall, 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 31,2007
              
              2006
              
              2005Total
                  revenue
              
              $
              9,141,857
              
              $
              5,611,387
              
              $
              3,498,235Less:
                  laser sales revenue
              
              
              (2,160,634
              )
              
              (469,365
              )
              
              -Recognized
                  treatment revenue
              
              
              6,981,223
              
              
              5,142,022
              
              
              3,498,235Change
                  in deferred program revenue
              
              
              103,851
              
              
              124,427
              
              
              57,302Change
                  in deferred unused treatments
              
              
              56,896
              
              
              194,869
              
              
              5,371Net
                  billed treatment revenue
              
              
              7,141,970
              
              
              5,461,318
              
              $
              3,560,908Procedure
                  volume total
              
              
              113,296
              
              
              88,440
              
              
              60,626Less:
                  Non-billed procedures
              
              
              4,157
              
              
              5,168
              
              
              6,371Net
                  billed procedures
              
              
              109,139
              
              
              83,272
              
              
              54,255Avg.
                  price of treatments sold
              
              $
              65.44
              
              $
              65.58
              
              $
              65.63Procedures
                  with deferred program revenue, net
              
              
              1,587
              
              
              1,897
              
              
              873Procedures
                  with deferred unused treatments, net
              
              
              869
              
              
              2,971
              
              
              82




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. Due to the length of treatment time required, it has
      not generally been practical to use our therapy to treat severe psoriasis
      patients, but this may change as our new product, the XTRAC Ultra, has shorter
      treatment times. A study undertaken with the guidance of John Koo, MD, of the
      University of California at San Francisco, is evaluating the effectiveness
      of
      the Ultra in treating patients suffering from severe psoriasis. In March 2007,
      the BCBSA published a National Reference Policy that now recommends positive
      reimbursement coverage for treatment of psoriasis by laser, including the XTRAC
      as first step therapy for moderate to severe psoriasis comprising less than
      20%
      body area.




***International
      Dermatology Equipment Segment***




International
      sales of our XTRAC and VTRAC systems and related parts were $3,256,505 for
      the
      year ended December 31, 2007 compared to $2,186,424 and $1,404,096 for the
      years ended December 31, 2006 and 2005, respectively. We sold 65 systems in
      the year ended December 31, 2007 compared to 46 and 26 systems in the years
      ended December 31, 2006 and 2005, respectively. Compared to the domestic
      business, the international dermatology equipment operations are more influenced
      by competition from similar laser technology from other manufacturers and from
      non-laser lamps. Such competition has caused us at times to reduce the prices
      we
      charge to international distributors. The average price of dermatology equipment
      sold internationally also varies due to the quantities of refurbished domestic
      XTRAC systems sold and the amount of 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.




42
 *Table
          of Contents*




·
              We
                  began selling refurbished domestic XTRAC laser systems into the
                  international market during 2005. The selling price for used equipment
                  is
                  substantially less than new equipment. We sold five of these used
                  lasers
                  in the year ended December 31, 2007 at an average price of $36,500.
                  We
                  sold six of these used lasers, in each year, at an average price
                  of
                  $28,000 and $27,000 for the years ended December 31, 2006 and 2005,
                  respectively; and
  ●
              We
                  began selling the new 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
                  during 2006. In the years ended December 31, 2007 and 2006, we
                  sold 20 and
                  12 VTRAC systems, respectively.


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


For the Year Ended December 31,2007
              
              2006
              
              2005Revenues
              
              $
              3,256,505
              
              $
              2,186,424
              
              $
              1,404,096Laser
                  and lamp systems sold
              
              
              65
              
              
              46
              
              
              26Average
                  revenue per system
              
              $
              50,100
              
              $
              47,531
              
              $
              54,004




***Skin
      Care (ProCyte) Segment***




For
      the
      year ended December 31, 2007, ProCyte revenues were $13,471,973 compared to
      $12,646,910 for the year ended December 31, 2006 and $10,042,132 for the year
      ended December 31, 2005. Inasmuch as ProCyte was acquired on March 18, 2005,
      the
      operating results of ProCyte for the year ended December 31, 2005 include
      activity from ProCyte from March 19, 2005 through December 31, 2005. Skin Care
      revenues are generated from the sale of various skin and hair care products,
      from the sale of copper peptide compound and from royalties on licenses, mainly
      from Neutrogena. For the full year 2005, unaudited Skin Care revenues were
      approximately $13 million.




●
            Physician
                dispensed product revenues, our most strategic and most profitable
                revenues, increased approximately 16% in 2007 over 2006, or about
                $985,000.




●
            Bulk
                product and royalty revenues decreased approximately 24% in 2007
                over
                2006, or about $233,000.




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




For the Year Ended December 31,2007
            
            2006
            
            2005Product
                sales
            
            $
            12,732,973
            
            $
            11,674,510
            
            $
            8,902,615Bulk
                compound sales
            
            
            464,000
            
            
            672,400
            
            
            679,550Royalties
            
            
            275,000
            
            
            300,000
            
            
            459,967Total
                Skin Care revenue
            
            $
            13,471,973
            
            $
            12,646,910
            
            $
            10,042,132




***Surgical
      Services Segment***




In
      the
      years ended December 31, 2007, 2006 and 2005, surgical service revenues
      were $7,667,174, $6,944,292and $7,719,529, respectively, representing a 10%
      increase and a 1% decrease from the comparable prior year periods. The increases
      were primarily due to an increase in revenue from urological procedures
      delivered using a laser system purchased from a third party manufacturer. Such
      procedures included a charge to the customer for the use of the laser and the
      technician to operate it, as well as a charge to the customer for the third
      party’s proprietary fiber delivery system. The decrease from the year ended
      December 31, 2006 compared to the year ended December 31, 2005, was primarily
      due to the six territories that we closed since January 1, 2005, the largest
      of
      which was in the fourth quarter of 2005, and business interruption in New
      Orleans and Alabama from the hurricanes in August and September 2005. Operations
      in two of our territories on the western side of Florida were closed due to
      the
      termination of a customer contract. We closed operations in the other four
      territories for insufficient profitability.




43
 *Table
          of Contents*




***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, 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 $434,133 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.




Disposables
      and fiber sales decreased approximately 15% from the comparable year ended
      December 31, 2006. This is due to the fact that in the year ended December
      31,
      2006, we had a one-time customer order for approximately $250,000 in
      disposables. 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. We have sought to offset
      this
      erosion through expansion of our surgical services. We expect that our OEM
      contract with AngioDynamics with initial shipments in December 2007 will help
      grow this segment of the business.




For
      the
      year ended December 31, 2006, surgical products revenues were $5,800,864
      compared to $5,720,514 in the year ended December 31, 2005. The increase was
      almost entirely due to $207,000 in additional laser system revenues derived
      from
      an increase in the number of systems sold (80 vs. 47), as partially offset
      by a
      decline in the average price per laser sold. The $207,000 in additional laser
      system revenues was offset, in part, by a decrease in disposable and fiber
      sales
      of approximately 5%.




As
      set
      forth in the table below, the decrease in average price per laser between the
      periods 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 higher sales price. Included
      in
      laser sales during the years ended December 31, 2007, 2006 and 2005 were sales
      of 78, 65 and 28 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.




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




For the Year Ended December 31,2007
            
            2006
            
            2005Revenues
            
            $
            5,176,108
            
            $
            5,800,864
            
            $
            5,720,514Percent
                (decrease)/increase
            
            
            (10.8
            )%
            
            1.4
            %
            
            13.6
            %Laser
                systems sold
            
            
            87
            
            
            80
            
            
            47Laser
                system revenues
            
            $
            1,684,000
            
            $
            1,801,000
            
            $
            1,594,000Average
                revenue per laser
            
            $
            19,356
            
            $
            22,513
            
            $
            33,915




44
 *Table
          of Contents*




***Cost
      of Revenues***




Cost
      of
      revenues divides into 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 as part of services), and the Surgical Products segment
      (with
      laser maintenance included as part of services). Within services cost of
      revenues are the costs associated with the Domestic XTRAC segment and the
      Surgical Services segment, as well as costs associated with the royalties and
      maintenance.




Product
      cost of revenues during the year ended December 31, 2007 were $9,539,787,
      compared to $8,628,651 for the year ended December 31, 2006. The $911,136
      increase is due to the increases in product cost of sales for domestic XTRAC
      laser sales in the amount of $689,893 and international dermatology equipment
      sales in the amount of $378,199, due to increased number of laser sales. There
      was also an increase in skincare cost of revenues of $349,343 due to increased
      revenues. These increases were offset, in part, by a decrease of $506,299 for
      surgical products.




Product
      cost of revenues during the year ended December 31, 2006 were $8,628,651,
      compared to $7,219,504 for the year ended December 31, 2005. The $1,409,147
      increase reflected the cost of sales for the domestic XTRAC laser sales of
      $128,840, an increase of $726,412 in costs for the ProCyte business acquired
      on
      March 18, 2005, and therefore the operating results of ProCyte for the year
      ended December 31, 2005 include activity from ProCyte from March 19, 2005
      through December 31, 2005. Additionally there was an increase of $216,389 for
      surgical products, due to increased laser system sales and a $337,506 increase
      in costs associated with sales of XTRAC laser equipment sold outside the United
      States.




Services
      cost of revenues was $10,528,247 and $9,843,199 in the years ended December
      31,
      2007 and 2006, respectively. Contributing to the $685,048 increase was a
      $886,578 increase in the Surgical Services business associated with the increase
      in urological procedures performed with laser systems and fibers purchased
      from
      a third-party manufacturer, which carry a higher cost of sale rather than
      equipment and fibers we manufacture. This increase was offset, in part, by
      a
      decrease in the cost of revenues in the Domestic XTRAC business segment of
      $201,531.




Services
      cost of revenues was $9,843,199 and $8,456,001 in the years ended December
      31,
      2006 and 2005, respectively. Contributing to the $1,387,198 increase was a
      $1,345,853 increase in the Domestic XTRAC business segment due to increased
      depreciation on the lasers of $629,000, an increase in excess and obsolete
      inventory reserve and abnormal gas consumption, which has been corrected by
      software modifications. Additionally there was an increase of $41,345 in the
      cost of revenues for the Surgical Services business.




45
 *Table
          of Contents*


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.




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




For
                the Year Ended December 31,2007
            
            2006
            
            2005Product:XTRAC
                Domestic
            
            $
            818,733
            
            $
            128,840
            
            $
            -International
                Dermatology Equipment
            
            
            1,646,279
            
            
            1,268,080
            
            
            930,574Skin
                Care
            
            
            4,208,287
            
            
            3,858,944
            
            
            3,132,532Surgical
                products
            
            
            2,866,488
            
            
            3,372,787
            
            
            3,156,398Total
                Product costs
            
            $
            9,539,787
            
            $
            8,628,651
            
            $
            7,219,504Services:XTRAC
                Domestic
            
            $
            3,835,828
            
            $
            4,037,359
            
            $
            2,691,506Surgical
                Services
            
            
            6,692,419
            
            
            5,805,840
            
            
            5,764,495Total
                Services costs
            
            $
            10,528,247
            
            $
            9,843,199
            
            $
            8,456,001Total
                Costs of Revenues
            
            $
            20,068,034
            
            $
            18,471,850
            
            $
            15,675,505




***Gross
      Margin Analysis***




Gross
      margin increased to $18,645,583 during the year ended December 31, 2007
      from $14,718,027 during the same period in 2006. As a percentage of revenues,
      the gross margins for the year ended December 31, 2007 increased to 48.2%
      compared to 44.3% for the same period in 2006.




Gross
      margin increased to $14,718,027 during the year ended December 31, 2006
      from $12,709,001 during the same period in 2005. As a percentage of revenues,
      the gross margins for the year ended December 31, 2006, decreased to 44.3%
      compared to 44.8% for the same period in 2005.




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




**Company Margin Analysis**
            
            For the Year Ended December 31,2007
            
            2006
            
            2005Revenues
            
            $
            38,713,617
            
            $
            33,189,877
            
            $
            28,384,506Percent
                increase
            
            
            16.6
            %
            
            16.9
            %Cost
                of revenues
            
            
            20,068,034
            
            
            18,471,850
            
            
            15,675,505Percent
                increase
            
            
            8.6
            %
            
            17.8
            %Gross
                profit
            
            $
            18,645,583
            
            $
            14,718,027
            
            $
            12,709,001Gross
                margin percentage
            
            
            48.2
            %
            
            44.3
            %
            
            44.8
            %




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. 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.




46
 *Table
          of Contents*




·
            We
                sold approximately $1.7 million worth of additional lasers domestically
                in
                the year ended December 31, 2007 at high margins compared to the
                same
                period in 2006. Certain of these lasers were previously being
                depreciated.




·
            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.




·
            Offsetting
                the above 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
      primary reasons for changes in gross profit for the year ended December 31,
      2006, compared to the same period in 2005 were as follows:




·
            Our
                Skin Care business has the highest gross profit percentage of any
                of our
                business segments. However, we acquired ProCyte on March 18, 2005,
                and, as
                such, the operating results of ProCyte for the year ended December
                31,
                2005 only included activity from March 19, 2005 through December
                31, 2005.




·
            We
                sold a greater number of treatment procedures for the XTRAC laser
                systems
                in 2006 than in 2005. Each incremental treatment procedure carries
                negligible variable cost. The increase in procedure volume was a
                direct
                result of improving insurance reimbursement and increased marketing
                efforts.




·
            We
                sold a greater number of surgical laser systems due to the increased
                marketing of the Diode laser. These units were primarily sold to
                our
                master distributor at a gross margin of approximately
                36%.




·
            We
                sold XTRAC laser systems domestically during the year ended December
                31, 2006. The gross margin on these sales is higher, approximately
                73%,
                since certain of the lasers were previously being
                depreciated.




·
            Offsetting
                the above was an increase in depreciation of $629,000 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,
                2005.




·
            In
                the Surgical Products segment, unabsorbed labor and overhead plant
                costs,
                due to lower production levels, accounted for $387,000 of the increase
                in
                cost of goods sold for the year ended December 31,
                2006.




·
            Surgical
                services revenues decreased due to lost contracts, while costs related
                to
                laser repairs increased during the period. Some revenues were lost
                due to
                hurricanes. While we believe a portion of the loss will be covered
                by
                insurance, we will not record any expected recovery until we have
                greater
                assurance of such recovery.




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 31,2007
            
            2006
            
            2005Revenues
            
            $
            9,141,857
            
            $
            5,611,387
            
            $
            3,498,235Percent
                increase
            
            
            62.9
            %
            
            60.4
            %Cost
                of revenues
            
            
            4,654,561
            
            
            4,166,199
            
            
            2,691,506Percent
                increase
            
            
            11.7
            %
            
            54.8
            %Gross
                profit
            
            $
            4,487,296
            
            $
            1,445,188
            
            $
            806,729Gross
                margin percentage
            
            
            49.1
            %
            
            25.8
            %
            
            23.1
            %




47
 *Table
          of Contents*




The
      gross
      profit increased for this segment for the year ended December 31, 2007 from
      the
      comparable periods in 2006 by $3,042,108. The key factors were as
      follows:




·
            Key
                drivers in increased revenue in 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, increased treatment revenue accordingly. Our
                clinical support specialists have also begun to show favorable impact
                on
                increasing physicians’ utilization of the XTRAC laser
                system.




·
            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.




·
            We
                sold approximately $1.7 million worth of additional domestic XTRAC
                lasers
                in the year ended December 31, 2007 at high margins compared to the
                same
                period in 2006. Certain of these lasers were previously being depreciated.
                The margin on these capital equipment sales was 62% in 2007 compared
                to
                73% in 2006.




·
            The
                cost of revenues increased by $221,932 for the year ended December
                31,
                2007. This increase is due to additional cost of sales for the lasers
                sold
                domestically of approximately $227,000 in 2007 compared to the same
                period
                in 2006.




The
      gross
      profit increased for this segment for the year ended December 31, 2006 from
      the
      comparable periods in 2005 by $638,459. The key factors were as
      follows:




·
            We
                sold XTRAC lasers domestically during the year ended December 31,
                2006.
                The gross margin on these sales was approximately 72%, which is higher
                than overall gross margin of 25.8% in this segment and which is largely
                due to the fact that certain of the lasers were previously being
                depreciated.




·
            A
                key driver in increased revenue in this segment is insurance reimbursement
                and increased direct-to-consumer advertising in targeted territories.
                In
                2005, several private health insurance plans adopted a favorable
                policy to
                cover the medically necessary treatment of psoriasis using our XTRAC
                laser
                system (e.g. United Healthcare, Highmark, Independence Blue Cross,
                Empire
                BCBS, Cigna, Premera, Blue Cross of Michigan). These insurers added
                to the
                group of companies that had already adopted a favorable policy in
                2004. In
                2006, we increased our level of direct-to-consumer advertising to
                recruit
                patients to dermatologists’ offices to seek treatment with the XTRAC laser
                system. While the advertising helped increase revenues, the advertising
                is
                also costly. We continue to analyze and adjust the advertising campaigns
                for cost-effectiveness.




·
            Procedure
                volume increased 46% from 60,626 to 88,440 procedures in the year
                ended
                December 31, 2006 compared to the same period in 2005. Price per
                procedure
                did not change significantly between the
                periods.




·
            Price
                per procedure was not a meaningful component of the revenue change
                between
                the periods.




·
            The
                cost of revenues increased by $1,474,693 for the year ended December
                31,
                2006. This increase is due to the cost of sales for the lasers of
                $128,840
                and to an increase in depreciation on the lasers-in-service of $629,000
                over the comparable prior year period, an increase in excess and
                obsolete
                inventory reserve and abnormal gas consumption, which has been corrected
                by software modification. The depreciation costs will continue to
                increase
                in subsequent periods as the business grows. In addition, there was
                an
                increase in certain allocable XTRAC manufacturing overhead costs
                that are
                charged against the XTRAC service
                revenues.




48
 *Table
          of Contents*




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 31,2007
            
            2006
            
            2005Revenues
            
            $
            3,256,505
            
            $
            2,186,424
            
            $
            1,404,096Percent
                increase
            
            
            48.9
            %
            
            55.7
            %Cost
                of revenues
            
            
            1,646,279
            
            
            1,268,080
            
            
            930,574Percent
                increase
            
            
            29.8
            %
            
            36.3
            %Gross
                profit
            
            $
            1,610,226
            
            $
            918,344
            
            $
            473,522Gross
                margin percentage
            
            
            49.4
            %
            
            42.0
            %
            
            33.7
            %




The
      gross
      profit for the year ended December 31, 2007 increased by $691,882 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.




·
            The
                International Dermatology Equipment operations are influenced by
                competition from similar laser technology from other manufacturers
                and
                from non-laser lamp alternatives for treating inflammatory skin disorders,
                which has served generally to reduce the prices we charge international
                distributors for our excimer products.




·
            There
                were more new XTRAC lasers sold in the year ended December 31, 2007
                compared to the year ended December 31, 2006. The average selling
                price in
                2007 was approximately 6% higher in 2007 compared to the average
                selling
                price 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.




The
      gross
      profit for the year ended December 31, 2006 increased by $444,822 from the
      comparable prior year period. The key factors in this business segment were
      as
      follows:




·
            We
                sold 34 XTRAC laser systems and 12 VTRAC lamp-based excimer systems
                during
                the year ended December 31, 2006 and 26 XTRAC laser systems in the
                comparable period in 2005. The VTRAC systems have a higher gross
                margin
                than the XTRAC laser systems.  ·
            The
              International dermatology equipment operations are influenced by
              competition from similar laser technology from other manufacturers
              and
              from non-laser lamp alternatives for treating inflammatory skin disorders,
              which has served generally to reduce the prices we charge international
              distributors for our excimer products.  ·
            There
              were more new XTRAC lasers sold in the year ended December 31, 2006
              compared to the year ended December 31, 2005 and the average selling
              price
              was approximately the same.




·
            Additionally,
                international part sales increased for the year ended December 31,
                2006 by
                approximately $106,000 compared to the same period in
                2005.




49
 *Table
          of Contents*




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 31,2007
            
            2006
            
            2005Product
                revenues
            
            $
            12,732,973
            
            $
            11,674,510
            
            $
            8,902,615Bulk
                compound revenues
            
            
            464,000
            
            
            672,400
            
            
            679,550Royalties
            
            
            275,000
            
            
            300,000
            
            
            459,967Total
                revenues
            
            
            13,471,973
            
            
            12,646,910
            
            
            10,042,132Percent
                increase
            
            
            6.5
            %
            
            25.9
            %Product
                cost of revenues
            
            
            3,885,229
            
            
            3,441,636
            
            
            2,664,959Bulk
                compound cost of revenues
            
            
            323,058
            
            
            417,308
            
            
            467,573Total
                cost of revenues
            
            
            4,208,287
            
            
            3,858,944
            
            
            3,132,532Percent
                increase
            
            
            9.1
            %
            
            23.2
            %Gross
                profit
            
            $
            9,263,686
            
            $
            8,787,966
            
            $
            6,909,600Gross
                margin percentage
            
            
            68.8
            %
            
            69.5
            %
            
            68.8
            %




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
                from year
                to year; 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 between the
                periods.




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




Gross
      profit for the year ended December 31, 2006 increased by $1,878,366 over the
      comparable period in 2005. The key factors impacting gross profit were as
      follows:




·
            Skin
                Care (ProCyte) business was acquired on March 18, 2005 and, as such,
                the
                operating results of ProCyte for the year ended December 31, 2005
                only
                included activity from March 19, 2005 through December 31,
                2005.




·
            The
                gross margin for our skin care products is relatively consistent
                from year
                to year 69.5% in 2006 and 68.8% in 2005. The increase in total cost
                of
                revenues of $726,412 in 2006 from 2005 is directly related to the
                increases in revenues between the
                periods.




50
 *Table
          of Contents*




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




**Surgical Services Segment**
            
            For the Year Ended December 31,2007
            
            2006
            
            2005Revenues
            
            $
            7,667,174
            
            $
            6,944,292
            
            $
            7,719,529Percent
                increase (decrease)
            
            
            10.4
            %
            
            (10.0
            )%Cost
                of revenues
            
            
            6,581,722
            
            
            5,703,925
            
            
            5,675,787Percent
                increase
            
            
            15.4
            %
            
            0.5
            %Gross
                profit
            
            $
            1,085,452
            
            $
            1,240,367
            
            $
            2,043,742Gross
                margin percentage
            
            
            14.2
            %
            
            17.9
            %
            
            26.5
            %




Gross
      profit in the Surgical Services segment for year ended December 31, 2007
      decreased by $154,915, from the comparable period in 2006. The key factors
      impacting gross margin for the Surgical Services business were as
      follows:




·
            For
                the year ended December 31, 2007 compared to the year ended December
                31,
                2006, we incurred incremental costs in technicians of $165,000 and
                outside
                contractors of $140,000 and incremental depreciation of $197,000.
                These
                increases were offset, in part, by a decrease in repairs of
                $81,000.




·
            Although
                our revenues have increased by 10%, our product cost of revenue has
                increased 30%. This is due to a continuing change in the mix of procedures
                performed. A certain urological procedure performed on a laser purchased
                from an unrelated party has increased as a percentage of revenue
                from
                2006. This procedure has a lower gross margin than margins obtained
                from
                procedures performed on lasers manufactured by
                us.




Gross
      profit in the Surgical Services segment for year ended December 31, 2006
      decreased by $803,375, from the comparable period in 2005. The key factors
      impacting gross margin for the Surgical Services business were as
      follows:




·
            We
                have closed business operations in six territories due to unacceptable
                operating profit and in one additional territory due to competition.
                Although closing these unprofitable territories will save costs and
                improve profitability over time, the overall costs saved for the
                year
                ended December 31, 2006 have not kept pace with the revenues lost.
                Nevertheless, in the case of the territory lost to competition, we
                have
                opened a new, contiguous territory in which we have secured a long-term
                contract from which we anticipate significant procedure volume. For
                that
                reason, we have relocated our personnel and material from the lost
                territory to the new one.




·
            Our
                product cost percentage has increased due to a change in the mix
                of
                procedures performed. A certain urological procedure performed on
                a laser
                purchased from an unrelated party has increased as a percentage of
                revenue
                from 2005. This procedure has a lower gross margin than margins obtained
                from procedures performed on lasers manufactured by
                us.




51
 *Table
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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 31,2007
            
            2006
            
            2005Revenues
            
            $
            5,176,108
            
            $
            5,800,864
            
            $
            5,720,514Percent
                (decrease) increase
            
            
            (10.8
            )%
            
            1.4
            %Cost
                of revenues
            
            
            2,977,185
            
            
            3,474,702
            
            
            3,245,103Percent
                (decrease) increase
            
            
            (14.3
            )%
            
            7.1
            %Gross
                profit
            
            $
            2,198,923
            
            $
            2,326,162
            
            $
            2,475,411Gross
                margin percentage
            
            
            42.5
            %
            
            40.1
            %
            
            43.3
            %




The
      gross
      profit for the year ended December 31, 2007 decreased by $127,239 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 $497,517
                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.




·
            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.




The
      gross
      profit for the year ended December 31, 2006 decreased by $149,249 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, 2006 increased by $80,350 from the
                year
                ended December 31, 2005 while cost of revenues increased by $229,599
                between the same periods. There were 33 more laser systems sold in
                the
                year ended December 31, 2006 than in the comparable period of 2005.
                However, the lasers sold in the 2005 period were at higher prices
                than in
                the comparable period in 2006. The decrease in average price per
                laser was
                largely due to the mix of lasers sold. Included in the laser sales
                for the
                year ended December 31, 2006 and 2005 were sales of $1,120,000 and
                $605,000 of diode lasers, respectively, which have substantially
                lower
                list sales prices than the other types of surgical
                lasers.




·
            Unabsorbed
                labor and overhead plant costs, due to lower production levels, accounted
                for $387,000 of the increase in cost of goods sold for the year ended
                December 31, 2006.




52
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·
            This
                revenue increase was partly offset by a decrease in AzurTec project
                revenues of $156,000 and a decrease in sales of disposables between
                the
                periods. The AzurTec revenues recognized in 2005 had substantially
                no
                associated direct costs. Disposables, which have a higher gross margin
                as
                a percent of revenues than lasers, represented a higher percentage
                of
                revenue in the year ended December 31, 2006 compared to the same
                period in
                2005.




***Selling,
      General and Administrative Expenses***




For
      the
      year ended December 31, 2007, selling, general and administrative expenses
      increased to $23,229,276 from $20,682,056 for the year ended December 31, 2006.




·
            We have increased our investment in
              sales and
              marketing to respond to the improved reimbursement environment related
              to
              our domestic XTRAC business. We expect this investment to increase
              future
              revenues;




·
            The
                majority of the increase related to a $1,770,000 increase in salaries,
                benefits and travel expenses associated with an increase in the sales
                force and increased revenues, particularly in the Domestic XTRAC
                segment;




·
            Anincrease
                of $292,000 in salaries, benefits and travel expenses associated
                with an
                increase in the marketing team, particularly in the Domestic XTRAC
                segment;




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




·
            An
                increase of $174,000 in outside services and consulting
                expenses;




·
            An
                increase of $176,000 in additional warranty expense due to the increase
                in
                lasers sold; and




·
            These
                increases were offset, in part, by a decrease in commercial, workers’
                compensation and directors and officers liability insurance of
                $171,000.




For the
        year
        ended December 31, 2006, selling, general and administrative expenses increased
        to $20,682,056 from $16,477,322 for the year ended December 31, 2005.




·
            Selling,
                general and administrative expenses related to the ProCyte business
                accounted for $1,360,000 of the increase. This is due to the acquisition
                which occurred on March 18, 2005, so only expenses from March 19,
                2005
                through December 31, 2005 were
                included.




·
            The
                remaining increase related to a $387,000 increase in salaries, benefits
                and travel expenses associated with an increase in the sales force,
                particularly in the Domestic XTRAC
                segment;




·
            An
                increase in direct-to-consumer advertising of
                $676,000;




·
            An
                increase in royalties to Mount Sinai of
                $112,000;




·
            An
                increase in bonus accrual of
                $255,000;




·
            An
                increase of $210,000 for legal
                expenses;




·
            An
                increase of $1,304,546 for stock-based compensation expense following
                adoption of SFAS No. 123R (see Note 1, “*Stock-Based
                Compensation*”)
                and $132,624 for stock options issued to consultants;
                and




·
            These
                increases were partially offset by a reduction in bad debt expense
                of
                $213,000.




***Engineering***  ***and
      Product Development***




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. During the 2007 and 2006 periods, the engineers at the
      Carlsbad plant were primarily focused on manufacturing efforts, and therefore,
      their costs have been reflected in cost of goods sold.




Engineering
      and product development expenses for the year ended December 31, 2006 decreased
      to $1,006,600 from $1,127,961 for the year ended December 31, 2005. The decrease
      was primarily due to a decrease of $117,000 in salaries associated with reduced
      headcount. During the 2006 and 2005 periods, the engineers at the Carlsbad
      plant
      were primarily focused on manufacturing efforts, and therefore, their costs
      have
      been reflected in cost of goods sold.




53
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***Other
      Income***




Other
      income for the year ended December 31, 2005 was $1,302,537 reflecting the
      following components: a litigation settlement, net of expenses, of $968,882,
      a
      non-monetary exchange of assets during June 2005 of two depreciable engineering
      development prototypes in exchange for four product units to be held for sale
      for $88,667 and the expiration, and therefore reversal, of the liability for
      SLT
      subordinated notes of $244,988. There was no other income in the comparable
      periods in 2007 and 2006.




***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 warrants
      previously issued 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 in terms more favorable to us.




**Interest
      Expense, Net**




Net
      interest expense for the year ended December 31, 2007 increased to $529,489,
      as
      compared to $521,768 for the year ended December 31, 2006. The increase in
      net
      interest expense was the result of the draws on the lease line of credit during
      the year ended December 31, 2006 and the first and second quarters of 2007.
      This
      was offset by the increase in interest income earned on the funds from the
      private placement in November 2006.




Net
      interest expense for the year ended December 31, 2006 increased to $521,768,
      as
      compared to $342,299 for the year ended December 31, 2005. The increase in
      net
      interest expense was the result of the draws on the lease line of credit during
      the year ended December 31, 2005 and the first, second and third quarters of
      2006.




***Net
      Loss***




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:




·
            The
                increase in revenues of 16.6% which resulted in an increase in gross
                margin of $3,927,556 or 26.7%.




·
            This
                increase was offset, in part by increases in personnel for sales
                and
                marketing in the Domestic XTRAC segment of the business;




·
                A
                    charge to expense of $441,956 due to the costs involved in refinancing
                    of
                    the GE and Leaf Financial Corporation (“Leaf”) credit facilities;
                    and




·
            An
                increase of $622,988 of depreciation, substantially all of which
                is
                included in costs of goods sold, and amortization over the comparable
                period of the prior year.




54
 *Table
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The
      following table illustrates the impact of the three 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
            )Depreciation
                and amortization expense
            
            
            (4,822,035
            )
            
            (4,199,047
            )
            
            (622,988
            )Stock-based
                compensation expense
            
            
            (1,444,880
            )
            
            (1,437,170
            )
            
            (7,710
            )$
            (6,768,871
            )
            $
            (5,636,217
            )
            $
            (1,072,654
            )




The
      aforementioned factors resulted in a net loss of $7,492,397 during the year
      ended December 31, 2006, as compared to a net loss of $3,936,044 for the year
      ended December 31, 2005, an increase of 90.4%. The increase was primarily due
      to:




·
            The
                result of the other income for the year ended December 31, 2005 of
                $1,302,537;




·
            The
                increase in cost of sales and resulting decrease in gross margin,
                due to
                stock option expense of $1,437,170 following the adoption of SFAS
                No.
                123R; and




·
            An
                increase of $982,110 of depreciation and amortization over the comparable
                period of the prior year.




For the Year ended December 31,2006
            
            2005
            
            ChangeNet loss
            
            $
            7,492,398
            
            $
            3,936,044
            
            $
            3,556,354Components
                included in net loss:Other
                income
            
            
            -
            
            
            1,302,537
            
            
            (1,302,537
            )Depreciation
                and amortization expense
            
            
            (4,199,047
            )
            
            (3,216,937
            )
            
            (982,110
            )Stock-based
                compensation expense
            
            
            (1,437,170
            )
            
            -
            
            
            (1,437,170
            )$
            (5,636,217
            )
            $
            (1,914,400
            )
            $
            (3,721,817
            )




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 and, more recently, from positive cash flow generated
      from
      operations.




At
      December 31, 2007, our current ratio was 2.20 compared to 2.66 at December
      31,
      2006. As of December 31, 2007, we had $13,705,775 of working capital compared
      to
      $16,069,615 as of December 31, 2006. Cash and cash equivalents were $9,954,303
      as of December 31, 2007, as compared to $12,885,742 as of December 31, 2006.
      We
      had $117,000 of cash that was classified as restricted as of December 31, 2007
      compared to $156,000 as of December 31, 2006.




55
 *Table
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We
      believe that our existing cash balance together with our other existing
      financial resources, including access to debt financing for capital
      expenditures, and revenues from sales, distribution, licensing and manufacturing
      relationships, will be sufficient to meet our operating and capital requirements
      beyond the second quarter of 2009. The 2008 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 2008 operating plan calls for increased revenues
      and profits from our Skin Care business.




On
      December 31, 2007, we entered into a term-note credit facility from CIT
      Healthcare and Life Sciences Capital (collectively “CIT”). The credit facility
      has a commitment term of one year, expiring on December 31, 2008. We account
      for
      each draw as funded indebtedness, with ownership in the lasers remaining with
      us. CIT holds a security interest in the lasers. Each draw against the credit
      facility has a repayment period of three years. A summary of the activity under
      the CIT credit facility is presented in Note 9, “ *Long-term
      Debt* ”
Of
      the
      Financial Statements included in this Report.




Net
      cash
      used in operating activities was $992,858 for the year ended December 31, 2007,
      compared to net cash provided by operating activities was $60,984 for the year
      ended December 31, 2006. The decrease was mostly due to the increases in
      accounts receivable and inventory.




Net
      cash
      provided by operating activities was $60,984 for the year ended December 31,
      2006, compared to cash used of $1,729,842 for the same period in 2005. The
      change was primarily due to a decrease in inventory. In the prior year,
      significant inventory purchases were made of copper peptide in the skincare
      products segment and in launching the diode program in the surgical products
      segment. Increases in sales in these segments in 2006, reduced the inventory
      levels.




Net
      cash
      used in investing activities was $4,558,617 for the year ended December 31,
      2007
      compared to $5,026,811 for the year ended December 31, 2006. This was primarily
      for the placement of lasers into service.




Net
      cash
      used in investing activities was $5,026,811 for the year ended December 31,
      2006
      compared to cash provided by investing activities of $1,993,412 for the year
      ended December 31, 2005. This change was mostly the result of receiving cash
      of
      $5,578,416, net of costs, in the acquisition of ProCyte in 2005. Of this
      increase in cash from the acquisition, we used $3,461,803 for production of
      our
      lasers-in-service compared to $4,931,835 in 2006.




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
      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.




Net
      cash
      provided by financing activities was $12,292,533 for the year ended December
      31,
      2006 compared to $1,254,649 for the year ended December 31, 2005. In the year
      ended December 31, 2006 we received $10,449,402, net from the issuance of common
      stock, $2,511,437 from the advances under the lease line of credit, net of
      payments, $361,469 from the exercise of common stock options and warrants and
      a
      decrease in restricted cash of $50,931. These cash receipts were offset by
      $1,080,706 for the payment of certain notes payable and capital lease
      obligations.




**Contractual
      Obligations**




Set
      forth
      below is a summary of current obligations as of December 31, 2007 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 and Life Sciences
      Capital are term notes. The capital lease obligations are from transactions
      entered into for the surgical services division. Operating lease and rental
      obligations are respectively for personal and real property which we use in
      our
      business.




56
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Payments due by periodContractual Obligations
            
            Total
            
            Less than 1
              year
            
            1 – 3 years
            
            4 – 5 yearsCredit
                facility obligations
            
            $
            10,105,609
            
            $
            4,671,811
            
            $
            5,433,798
            
            $
            -Capital
                lease obligations
            
            
            254,179
            
            
            74,735
            
            
            131,089
            
            
            48,355Operating
                lease obligations
            
            
            46,578
            
            
            27,971
            
            
            18,607
            
            
            -Rental
                obligations
            
            
            1,727,473
            
            
            528,979
            
            
            1,115,497
            
            
            82,997Notes
                payable
            
            
            235,220
            
            
            129,305
            
            
            92,097
            
            
            13,818Total
            
            $
            12,369,059
            
            $
            5,432,801
            
            $
            6,791,088
            
            $
            145,170




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. 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, 2007, 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 sales or expenses.




**Item
      7A.****Quantitative
      and Qualitative Disclosure About Market Risk**




We
      are
      not currently exposed to market risks due to changes in interest rates and
      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.




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




None.




57
 *Table
          of Contents*




**Item
      9A.****Controls
      and Procedures**




**Controls
      and Procedures**




As
      of
      December 31, 2007, 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.




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 Securities
      and
      Exchange 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.




There
      were no changes in our internal controls over financial reporting during the
      year ended December 31, 2007 that materially affected, or were reasonably
      likely to materially affect, our internal controls over financial reporting.
      As
      a prophylactic measure and support for our compliance with the Sarbanes Oxley
      Act, we adopted an Anti-Fraud Program in October 2007.




Management’s
      report on our internal controls over financial reporting can be found with
      the
      attached financial statements. The Independent Registered Public Accounting
      Firm’s attestation report on management’s assessment of the effectiveness of our
      internal control over financial reporting can also be found with the attached
      financial statements.




**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.




Our
      management conducted an evaluation of the effectiveness of the system of
      internal control over financial reporting based on the framework in *Internal 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, 2007. Our management's
      assessment of the effectiveness of our internal control over financial reporting
      has been audited by Amper, Politziner & Mattia, P.C., an independent
      registered public accounting firm, as stated in their report which is included
      herein.




**Item
      9B.****Other
      Information**




On
      October 30, 2007, we amended Section 6.01 of our By-Laws to provide that each
      share of our common stock shall be eligible for record of ownership, and
      transfer of ownership for book-entry under a Direct Registration System that
      complies under Nasdaq rules, and that a stockholder while entitled to a physical
      certificate, shall not be required to have a certificate. This was done in
      conformance with Nasdaq requirements to facilitate the trading in listed
      companies’ shares.




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**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 seven meetings and executed one unanimous written consent in
      lieu
      of a meeting in 2007.




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




**Name**
            
            **Position**
            
            **Age**Richard
                J. DePiano
            
            Non-Executive
                Chairman of the Board of Directors
            
            66Jeffrey
                F. O'Donnell
            
            Director,
                President and Chief Executive Officer
            
            48Dennis
                M. McGrath
            
            Chief
                Financial Officer and Vice President – Finance and
                Administration
            
            51Michael
                R. Stewart
            
            Executive
                Vice President and Chief Operating Officer
            
            50Alan
                R. Novak
            
            Director
            
            73Anthony
                J. Dimun
            
            Director
            
            64David
                W. Anderson
            
            Director
            
            55Wayne
                M. Withrow
            
            Director
            
            52Stephen
                P. Connelly
            
            Director
            
            56




**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 (originally Cardiovascular Dynamics) as Vice President of Sales and
      Marketing from 1995 to 1997; from 1997 to 1999 he served as its President and
      CEO and subsequently assumed a role as non-executive chairman of the board.
      Previously, from 1994 to 1995 Mr. O’Donnell held the position of President and
      CEO of Kensey Nash Corporation. Additionally, he has held several senior sales
      and marketing management positions at Boston Scientific, Guidant and Johnson
      & Johnson Orthopedic. In addition to sitting on the Board of Directors for
      PhotoMedex, Mr. O’Donnell is currently an outside Board Member of Endologix,
      Inc., Cardiac Sciences Inc. and Replication Medical, Inc. and had served until
      December 28, 2004 on the Board of Escalon Medical Corp. He had served as an
      outside Board member of AzurTec, Inc. but resigned from that board in 2003.
      Mr.
      O’Donnell graduated from LaSalle University in 1982 with a B.S. in business
      administration.




***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. and Noninvasive Medical Technologies, 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.




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***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. Novak*** **** was
      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.




***Anthony
      J. Dimun*** was
      appointed to our Board of Directors on October 3, 2003. Mr. Dimun has served
      since May 2001 as Chairman of Nascent Enterprises, L.L.C., a medical device
      venture advisory firm. He also has served since 1987 as the Managing Director
      and Chief Executive Officer of Strategic Concepts, Inc., a financial advisory
      company with specific focus on venture capital and acquisition transactions.
      From March 1991 to May 2001, Mr. Dimun served as Executive Vice President and
      Chief Financial Officer of Vital Signs, Inc., a publicly held anesthesia and
      respiratory medical device company. Mr. Dimun also serves as a member of the
      Board of Trustees of the New Jersey Center for Biomaterials, a non-profit
      collaboration of the three leading New Jersey universities. Prior to 1991,
      Mr.
      Dimun held positions as a Certified Public Accountant with several national
      accounting firms and served as Senior Vice President for an international
      merchant-banking firm.




***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.




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***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 publicly
      traded medical technology and device company. In addition, Mr. Connelly was
      Senior Vice President and General Manager of the America’s 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.




**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 2007 that all members of the Board are independent under the
      revised listing standards of The Nasdaq Stock Market, Inc. (“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




·
            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; Mr.
      Connelly joined the Committee in May 2007. The Board determined in 2007 that
      each member of the Compensation Committee satisfies the independence
      requirements of the Commission and Nasdaq. The Compensation Committee held
      eleven meetings during 2007.




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 2007 is presented
      below.




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**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 and Anderson. Mr. Anderson serves as the Chairman of
      the
      Nominations and Corporate Governance Committee. The Board of Directors
      determined in 2007 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 three meetings during
      2007.




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 audit committee 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 our
      needs, the needs of PhotoMedex and of the existing directors. The Committee
      recommended to the Board that Mr. Stephen P. Connelly be invited to join the
      Board. The Board accepted the recommendation, and Mr. Connelly accepted the
      invitation in May 2007.




**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;




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·
            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 2007 were Messrs. DePiano, Dimun, Anderson and Withrow. Mr. DePiano
      serves as Chairman of the Audit Committee. The Audit Committee meets regularly
      and held nine meetings during 2007.




The
      Board
      of Directors determined in 2007 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;




·
                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 Securities Exchange Act of 1934, as amended, (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 14, 2008, 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, 2007.




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**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.”




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 2005 a third-party consulting firm specializing in executive
      compensation. The consulting firm advised that our program was within the range
      of compensation programs that appeared to be offered by a group of our peer
      companies. The consulting firm also counseled the Compensation Committee on
      modifications to the compensation program which were under consideration. The
      primary consideration was the use of performance-based restricted stock. 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 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.




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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 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 2007, there were three factors of generally
      equal weight: Company revenues, the Company’s 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.




Prior
      to
      2006, stock options granted under the various stock option plans generally
      have
      had a four-year vesting schedule depending upon the size of the grant, and
      generally have been 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.




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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 a 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 within a change of control, we would have had an aggregate
      commitment of approximately $1,735,000 at December 31, 2007 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 $2,148,000 at December 31,
      2007.




**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.




**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.




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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 of the material terms
      of
      our stock option plans, compensation under these plans 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 2005, 2006 and 2007 did not exceed the limits under Section 162(m)
      for tax deductibility; no executive exercised any options in 2005, 2006 or
      2007.




**Overview
      of Executive Employment Agreements and 2007 Equity-Based
      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, 2008 and will expire then if due notice is given by
      December 1, 2008. 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 has been $350,000 per year and will be $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
      May 1,
      2007, Mr. O’Donnell was awarded from the 2005 Equity Compensation Plan 105,000
      restricted shares of our common stock, setting their purchase price at $0.01
      per
      share. Shares that are purchased will be held in escrow by us for as long as
      they are subject to our right of repurchase. Our right of repurchase will
      continue for such shares for so long as the shares remain subject to performance
      restrictions and time restrictions.




As
      to the
      performance restrictions, our repurchase right will lapse if the trading price
      of our common stock attains certain targets above the 2007 Average Price, which
      by contract was set at $1.23, being higher than the average fair market value
      (generally the closing price of our common stock) for each of the trading days
      in the 90-day period ending on May 1, 2007. For the years 2008 through 2012,
      the
      Average Price will mean the average fair market value of our common stock for
      each of the trading days in the period February 1 to April 30 of the applicable
      calendar year. Our right of repurchase shall lapse with respect to 20% of the
      purchased shares if the 2008 Average Price equals or exceeds the 2008 Target
      Price, where the term “2008 Target Price” will equal 125% of the 2007 Average
      Price, or $1.54, and where the lapsing shall be effective as of May 1, 2008.




Likewise,
      our right of repurchase will lapse with respect to 20% of the purchased shares
      if the 2009 Average Price equals or exceeds the 2009 Target Price, where the
      term “2009 Target Price” will equal 125% of the 2009 Target Price, or $1.92, and
      so on. For 2012, if the 2012 Average Price equals or exceeds the 2012 Target
      Price of $3.75, then our right of repurchase will lapse with respect to all
      of
      the purchased shares for which our repurchase right has not previously lapsed,
      and such lapsing will be effective as of May 1, 2012. As to time restrictions,
      to the extent that any of the purchased shares remain subject to our right
      of
      repurchase and therefore are unvested, they will vest ratably (i.e. one-third)
      on the fifth, sixth and seventh anniversaries of the award of the restricted
      shares.




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However,
      in the event of a transaction that constitutes a change in control of the
      Company, our right of repurchase will lapse with respect to the performance
      restrictions on the restricted shares that are unvested immediately prior to
      the
      consummation of such transaction as follows. Where the per-share purchase price
      paid or deemed paid in connection with such change in control is equal to or
      greater than a Target Price described above, then it shall be deemed that the
      Target Price has been attained as of the change in control, and our repurchase
      rights applicable to such Target Price will lapse. Shares that have not vested
      on a change of control will remain subject to such repurchase restriction.
      Such
      shares still subject to repurchase shall vest ratably and monthly over the
      period of time (but not greater than 36 months) that the acquirer in the change
      in control event contracts for Mr. O’Donnell’s services. If the acquirer opts
      not to contract for such services, then the unvested balance of shares will
      vest
      as of the change in control event.




On
      March
      6 and March 7, 2007, Mr. O’Donnell was granted 2,000 and 1,000 stock options,
      respectively, under the 2005 Investment Plan to match his purchase on the same
      date of an equal number of shares of our common stock on the open market.




***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, 2008 and
      will expire then if due notice is given by December 1, 2008. 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 has been $285,000 per
      year
      and will be $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
      May 1,
      2007, Mr. McGrath was awarded from the 2005 Equity Compensation Plan 87,500
      restricted shares of our common stock, having a purchase price at $0.01 per
      share. The terms and conditions applicable to Mr. McGrath’s award of restricted
      stock are the same as the terms and conditions applicable to the award to Mr.
      O’Donnell, which are discussed above.




***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 has been $250,000 per
      year and will be $262,500 in 2008. This agreement has renewed through December
      31, 2008  and
      will
      expire then if due notice is given by December 1, 2008. 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
      May 1,
      2007 and August 13, 2007, Mr. Stewart was awarded from the 2005 Equity
      Compensation Plan 70,000 and 105,000 restricted shares of our common stock,
      respectively, having a purchase price at $0.01 per share. The terms and
      conditions applicable to Mr. Stewart’s award of restricted stock in May 2007are
      the same as the terms and conditions applicable to the award to Mr. O’Donnell,
      which are discussed above. The mechanics of the August agreement are the same
      as
      the mechanics of the May agreement, the notable differences being: (i) that
      the
      2007 Average Price in the August agreement was set at $1.21; (ii) the Average
      Price for the subsequent 5 years is set within the period May 14 to August
      12 of
      the applicable year, and (iii) our rights lapse as of August 13 of the
      applicable year.






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The
        following
  **SUMMARY
        COMPENSATION TABLE**
  The
        following table includes information for the years ended December 31, 2007
        and
        2006 concerning compensation for our three incumbent executive officers.
        All of
        our other officers are not executive officers, within
        the meaning ascribed by the Securities and Exchange Act of 1934.
  **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,
                
                
                2007
                
                
                350,000
                
                
                175,875
                
                
                127,050
                
                
                0
                
                
                0
                
                
                0
                
                
                19,475
                
                
                672,400President
                    and Chief Executive
                    Officer
                
                
                2006
                
                
                350,000
                
                
                157,500
                
                
                943,005
                
                
                420,213
                
                
                0
                
                
                0
                
                
                17,395
                
                
                1,888,113Dennis
                    M. McGrath,
                
                
                2007
                
                
                285,000
                
                
                114,570
                
                
                105,875
                
                
                0
                
                
                0
                
                
                0
                
                
                15,844
                
                
                521,289Chief
                    Financial Officer
                  &
Vice
                    Pres. -Finance/
                  Administrative
                
                
                2006
                
                
                285,000
                
                
                102,600
                
                
                601,727
                
                
                377,054
                
                
                0
                
                
                0
                
                
                15,105
                
                
                1,381,486Michael
                    R. Stewart,
                
                
                2007
                
                
                250,000
                
                
                83,750
                
                
                275,275
                
                
                0
                
                
                0
                
                
                0
                
                
                19,004
                
                
                628,029Chief
                    Operating Officer
                  and
                    Executive Vice President
                
                
                2006
                
                
                250,000
                
                
                75,000
                
                
                0
                
                
                190,200
                
                
                0
                
                
                0
                
                
                18,366
                
                
                533,566
  (1)
        “ Bonus”
in
        the foregoing table is the bonus earned in 2007 and 2006, 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 2007 and 2006, 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 2007 and 2006 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. 71. In 2006, 125,000 and 110,000 options granted to Messrs. O’Donnell and
        McGrath, respectively, expired; in 2007, 150,000 options granted to Mr. Stewart
        expired.
  (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 incumbent executives 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, 2007, then we
      estimate the value of the benefits that would have been triggered and thus
      accrued to the three incumbent executives as set forth below.




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**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**
                **Control**Jeffrey
                  F. O’Donnell (1)(2)(4)
              Severance
              350,000
              700,000
              0
              0
              0
              N/AHealth
                  continuation
              15,554
              31,108
              0
              0
              0
              N/AAD&D
                  insurance
              780
              1,560
              0
              0
              0
              N/AExecutive
                  life ins.
              5,355
              10,711
              0
              0
              0
              N/AAccelerated
                  vesting
              0
              592,200
              0
              0
              0
              0TOTAL
              371,689
              1,335,579
              0
              0
              0
              0Dennis
                  McGrath (1)(2(4))
              Severance
              285,000
              570,000
              0
              0
              0
              N/AHealth
                  continuation
              15,554
              31,108
              0
              0
              0
              N/AAD&D
                  insurance
              780
              1,560
              0
              0
              0
              N/AExecutive
                  life ins.
              1,680
              3,360
              0
              0
              0
              N/AAccelerated
                  vesting
              0
              397,150
              0
              0
              0
              0TOTAL
              303,014
              1,003,178
              0
              0
              0
              0Michael
                  Stewart (1)(2)(4)
              Severance
              250,000
              500,000
              0
              0
              0
              N/AHealth
                  continuation
              15,554
              31,108
              0
              0
              0
              N/AAD&D
                  insurance
              780
              1,560
              0
              0
              0
              N/AExecutive
                  life ins.
              5,076
              10,152
              0
              0
              0
              N/AAccelerated
                  vesting
              0
              213,850
              0
              0
              0
              0TOTAL
              271,410
              756,670
              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, 2007 (the last trading day of the year) was $0.95. 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, 2007, each share would
        return a gain of $0.94.
  (2)
        All
        unvested options become exercisable by reason of a change of control. However,
        none of the executives’ unvested options as of December 31, 2007 were in the
        money, and therefore there would have been no benefit as of December 31,
        2007.
        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, 2007.
  (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 2007 salary levels.




**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. The Plan has been authorized by the stockholders for
      6,160,000 shares of our common stock. 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.




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**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, 2007 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 2007 were primarily from the 2005 Equity Compensation Plan. Matching options
      grants were made out of the 2005 Investment Plan to Mr. O ’ Donnell
      for 3,000 options.





**GRANTS
      OF PLAN-BASED AWARDS TABLE**


**Estimated Future Payouts Under**
                **Equity Incentive Plan Awards(2)**
              
              **All Other**
                **Option Awards:**
                **Number of**
                **Securities**
                **Underlying**
              
              **Exercise or**
                **Base Price**
                **of Option**
              
              **Closing**
                **Price on**
                **Grant**
              
              **Grant Date**
                **Fair**
                **Value of Stock****Name**
              
              **Grant**
                **Date**
              
              **Approval**
                **Date (1)**
              
              **Threshold**
                **(#)**
              
              **Target**
                **(#)**
              
              **Maximum**
                **(#)**
              
              **Options**
                **(#)**
              
              **Awards**
                **($ / Sh)(3)**
              
              **Date**
                ****($ / Sh)(4)****
              
              **and Option**
                **Awards ($)(5)**Jeffrey
                  O’Donnell
              
              
              3/6/07
              
              
              3/6/07
              
              
              
              
              
              
              
              
              
              
              
              2,000
              
              
              1.13
              
              
              N/A
              
              
              1,8543/7/07
              
              
              3/7/07
              
              
              
              
              
              
              
              
              
              
              
              1,000
              
              
              1.15
              
              
              N/A
              
              
              9245/1/07
              
              
              5/1/07
              
              
              -
              
              
              105,000
              
              
              -
              
              
              N/A
              
              
              N/A
              
              
              1.22
              
              
              127,050Dennis
                  McGrath
              
              
              5/1/07
              
              
              5/1/07
              
              
              -
              
              
              87,500
              
              
              -
              
              
              N/A
              
              
              N/A
              
              
              1.22
              
              
              105,875Michael
                  Stewart
              
              
              5/1/07
              
              
              5/1/07
              
              
              -
              
              
              70,000
              
              
              -
              
              
              N/A
              
              
              N/A
              
              
              1.22
              
              
              84,7008/13/07
              
              
              7/31/07
              
              
              -
              
              
              157,500
              
              
              -
              
              
              N/A
              
              
              N/A
              
              
              1.14
              
              
              190,575





(1)
            The
                award of restricted stock to Mr. Stewart on August 13, 2007 was approved
                on July 31, 2007. The award was delayed due to a pending earnings
                call and
                publication of our quarterly report. The 2007 average price was to
                be set
                at the higher of the average closing price in the 90 days from the
                second
                day following the filing of our 10-Q, and the closing price of the
                award
                date.




(2)
            The
                Company does not have a Non-Equity Incentive Plan. The Equity Incentive
                Plan is comprised of the restricted shares of common stock issued
                to
                Messrs. O’Donnell, McGrath and Stewart under the 2005 Equity Compensation
                Plan.




(3)
            The
                exercise prices of options granted under the 2005 Investment Plan
                were set
                equal to the optionee’s purchase price of shares of common stock on the
                date of the grant.




(4)
            The
                exercise price of options granted on 3/6/07 and 3/7/07 were set equal
                to
                the optionee’s purchase price of shares of common stock on the date of the
                grant.




(5)
            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, 2007.




71
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          of Contents*




**OUTSTANDING
      EQUITY AWARDS AT FISCAL YEAR-END TABLE**


**Option
                  Awards**
              
              **Stock
                  Awards****Name**
              
              **Number o****f**
                **Securities**
                **Underlying**
                **Unexercised**
                **Options**
                **(#)**
                **Exercisable**
              
              **Number o****f**
                **Securities**
                **Underlying**
                **Unexercised**
                **Options**
                **(#)**
                **Unexercisable**
              
              **Equit****y**
                **Incentive**
                **Plan Awards:**
                **Number of**
                **Securities**
                **Underlying**
                **Unexercised**
                **Unearned**
                **Options**
                **(#)**
              
              **Optio****n**
                **Exercise**
                **Price**
                **($)**
              
              **Optio****n**
                **Expiration**
                **Date**
              
              **Number o****f**
                **Shares or**
                **Units of**
                **Stock That**
                **Have Not**
                **Vested**
                **(#)**
              
              **Marke****t**
                **Value of**
                **Shares or**
                **Units of**
                **Stock That**
                **Have Not**
                **Vested**
                **($) (1)**
              
              **Equity Incentiv****e**
                **Plan Awards:**
                **Number of**
                **Unearned**
                **Shares, Units**
                **or Other**
                **Rights That**
                **Have Not**
                **Vested**
                **(#)**
              
              **Equit****y**
                **Incentive**
                **Plan Awards:**
                **Market or**
                **Payout Value**
                **of Unearned**
                **Shares, Units**
                **or Other**
                **Rights That**
                **Have Not**
                **Vested**
                **($) (1)**Jeffrey
                  O’Donnell
              
              
              125,000
              
              
              0
              
              
              0
              
              
              1.66
              
              
              4/29/08
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A112,500
              
              
              37,500
              
              
              0
              
              
              2.14
              
              
              1/22/09
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A75,000
              
              
              75,000
              
              
              0
              
              
              2.45
              
              
              3/1/10
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A40,000
              
              
              160,000
              
              
              0
              
              
              2.50
              
              
              1/15/16
              
              
              0
              
              
              0
              
              
              525,000
              
              
              498,7500
              
              
              2,000
              
              
              0
              
              
              1.59
              
              
              5/24/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A25,000
              
              
              100,000
              
              
              0
              
              
              1.11
              
              
              11/20/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              2,000
              
              
              0
              
              
              1.13
              
              
              3/6/17
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              1,000
              
              
              0
              
              
              1.15
              
              
              3/7/17
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              N/A
              
              
              0
              
              
              N/A
              
              
              N/A
              
              
              0
              
              
              0
              
              
              105,000
              
              
              99,750Dennis
                  McGrath
              
              
              110,000
              
              
              0
              
              
              0
              
              
              1.66
              
              
              4/29/08
              
              
              
              
              
              
              
              
              N/A
              
              
              N/A93,750
              
              
              31,250
              
              
              0
              
              
              2.14
              
              
              1/22/09
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A70,000
              
              
              70,000
              
              
              0
              
              
              2.45
              
              
              3/1/10
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              N/A
              
              
              0
              
              
              N/A
              
              
              N/A
              
              
              0
              
              
              0
              
              
              335,000
              
              
              318,25028,000
              
              
              112,000
              
              
              0
              
              
              2.23
              
              
              3/10/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              5,000
              
              
              0
              
              
              1.58
              
              
              5/24/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              2,000
              
              
              0
              
              
              1.63
              
              
              5/25/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A22,000
              
              
              88,000
              
              
              0
              
              
              1.11
              
              
              11/20/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              N/A
              
              
              0
              
              
              N/A
              
              
              N/A
              
              
              0
              
              
              0
              
              
              87,500
              
              
              83,125Michael
                  Stewart
              
              
              75,000
              
              
              0
              
              
              0
              
              
              1.83
              
              
              1/2/08
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A56,250
              
              
              18,750
              
              
              0
              
              
              2.14
              
              
              1/22/09
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A50,000
              
              
              50,000
              
              
              0
              
              
              2.45
              
              
              3/1/10
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A30,000
              
              
              10,000
              
              
              0
              
              
              2.63
              
              
              7/19/10
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A20,000
              
              
              80,000
              
              
              0
              
              
              2.23
              
              
              3/10/16
              
              
              0
              
              
              0
              
              
              N/A
              
              
              N/A0
              
              
              N/A
              
              
              0
              
              
              N/A
              
              
              N/A
              
              
              0
              
              
              0
              
              
              70,000
              
              
              66,5000
              
              
              N/A
              
              
              0
              
              
              N/A
              
              
              N/A
              
              
              0
              
              
              0
              
              
              157,500
              
              
              149,625




(1)
      The
      market value of unvested shares of restricted stock is based on $0.95 per share,
      which was the closing price of our stock on December 31, 2007, the last trading
      day of 2007.




**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 2007 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 Form 10-K.




72
 *Table
          of Contents*




**Compensation
      Committee**





Anthony
      J. Dimun  Richard
      J. DePiano  Wayne
      M.
      Withrow  Stephen
      P. Connelly  Alan
      R.
      Novak




**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 35,000 shares of common stock
      on an annual basis. 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. We pro-rate the
      retainer for a director serving less than a full year. The table below sets
      forth non-employee directors’ compensation in 2007.




**DIRECTOR
      COMPENSATION TABLE**




**Name**
            
            **Fees Earned or**
              **Paid in Cash ($)**
            
            **Option Awards**
              **($) (1)**
            
            **Total ($)**Richard
                J. DePiano
            
            
            32,500
            
            
            32,060
            (2)
            
            64,560Warwick
                Alex Charlton
            
            
            9,167
            
            
            32,060
            (2)
            
            41,227Alan
                R. Novak
            
            
            30,000
            
            
            32,060
            (2)
            
            62,060Anthony
                J. Dimun
            
            
            32,000
            
            
            32,060
            (2)
            
            64,060David
                W. Anderson
            
            
            28,500
            
            
            32,060
            (2)
            
            60,560Wayne
                M. Withrow
            
            
            32,000
            
            
            32,060
            (2)
            
            64,060Stephen
                P. Connelly
            
            
            13,500
            
            
            26,171
            (3)
            
            39,671




(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 2007 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
      $1.11.




(3)
      The
      grant date fair value computed in accordance with SFAS 123(R) was
      $1.22.




In
      2008,
      the following charges to outside director compensation will be made: (i) each
      member of a committee attending a committee meeting on the day of a meeting
      of
      the Board shall receive $1,000 for such committee attendance; (ii) the chairmen
      of the Committees will receive additional annual compensation, i.e. audit,
      $10,000; compensation, $5,000; Nominations and Corporate Governance, $5,000.




**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
      adopted a form of indemnification agreement, which provides the indemnitee
      with
      the maximum indemnification allowed under applicable law. Since the Delaware
      statutes are non-exclusive, it is possible that certain claims beyond the scope
      of the statute may be indemnifiable. The indemnification agreement provides
      a
      scheme of indemnification, which may be broader than that specifically provided
      by Delaware law. It has not yet been determined, however, to what extent the
      indemnification expressly permitted by Delaware law may be expanded, and
      therefore the scope of indemnification provided by the indemnification agreement
      may be subject to future judicial interpretation.




73
 *Table
          of Contents*




The
      indemnification agreement provides that we are to indemnify an indemnitee,
      who
      is or was a party or becomes a party or is threatened to be made a party to
      any
      threatened, pending or completed action or proceeding whether civil, criminal,
      administrative or investigative by reason of the fact that the indemnitee is
      or
      was one of our directors, officers, key employees or agents. We are to advance
      all expenses, judgments, fines, penalties and amounts paid in settlement
      (including taxes imposed on indemnitee on account of receipt of such payouts)
      incurred by the indemnitee in connection with the investigation, defense,
      settlement or appeal of any civil or criminal action or proceeding as described
      above. The indemnitee is to repay such amounts advanced only if it shall be
      ultimately determined that he or she is not entitled to be indemnified by us.
      The advances paid to the indemnitee by us are to be delivered within 20 days
      following a written request by the indemnitee. Any award of indemnification
      to
      an indemnitee, if not covered by insurance, would come directly from our assets,
      thereby affecting a stockholder's investment.




**Directors'
      and Officers' Liability Insurance**




We
      have
      obtained directors' and officers' liability insurance which expires on February
      24, 2009.




74
 *Table
          of Contents*


**Item
          12.****Security
          Ownership of Certain Beneficial Owners and Management and Related Stockholder
          Matters**




The
      following table reflects, as of March 14, 2008, the beneficial common stock
      ownership of: (a) each of our directors, (b) each executive officer (See Item
      11, "Executive Compensation"), (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**
            
            **Percentage of**
              **Shares**
              **Beneficially**
              **Owned****(1)**Richard
                J. DePiano(2)
            
            
            279,300
            
            
            *Jeffrey
                F. O’Donnell(3)
            
            
            1,129,500
            
            
            1.78Dennis
                M. McGrath(4)
            
            
            851,500
            
            
            1.34Michael
                R. Stewart(5)
            
            
            448,940
            
            
            *Alan
                R. Novak(6)
            
            
            261,101
            
            
            *David
                W. Anderson(7)
            
            
            140,000
            
            
            *Stephen
                P. Connelly(8)
            
            
            58,750
            
            
            *Anthony
                J. Dimun(9)
            
            
            311,250
            
            
            *Wayne
                M. Withrow(10)
            
            
            100,004
            
            
            *LB
                I Group, Inc.(11)
            
            
            6,161,124
            
            
            9.77All
                directors and officers as a group (9 persons)(12)
            
            
            3,580,345
            
            
            5.50




*
            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 14, 2008, 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 63,032,207shares of
                common
                stock outstanding as of March 14, 2008.




(2)
            Includes
                31,800 shares and options to purchase up to 247,500 shares of common
                stock. Does not include options to purchase up to 17,500 shares of
                common
                stock, which may vest more than 60 days after March 14, 2008. Mr.
                DePiano's address is 351 East Conestoga Road, Wayne, Pennsylvania
                19087.




(3)
            Includes
                7,000 shares, 630,000 additional shares subject to restriction agreements
                with us and options to purchase up to 492,500 shares of common stock.
                Does
                not include options to purchase up to 458,400 shares of common stock,
                which may vest more than 60 days after March 14, 2008. Mr. O’Donnell's
                address is 147 Keystone Drive, Montgomeryville, PA
                18936.




(4)
            Includes
                11,000 shares, 422,500 additional shares subject to restriction agreements
                with us and options to purchase up to 418,000 shares of common stock.
                Does
                not include options to purchase up to 377,200 shares of common stock,
                which may vest more than 60 days after March 14, 2008. Mr. McGrath's
                address is 147 Keystone Drive, Montgomeryville, PA
                18936.




(5)
            Includes
                1,440 shares, and options to purchase 220,000 shares of common stock.
                Does
                not include options to purchase up to 225,600 shares of common stock,
                which may vest more than 60 days after March 14, 2008. Mr. Stewart's
                address is 147 Keystone Drive, Montgomeryville, PA
                18936.




(6)
            Includes
                28,601 shares of common stock and options to purchase up to 232,500
                shares
                of common stock. Does not include options to purchase up to 17,500
                shares
                of common stock, which may vest more than 60 days after March 14,
                2008.
                Mr. Novak's address is 3050 K Street, NW, Suite 105, Washington, D.C.
                20007.




75
 *Table
          of Contents*




(7)
            Includes
                options to purchase up to 140,000 shares of common stock. Does not
                include
                options to purchase up to 17,500 shares of common stock, which may
                vest
                more than 60 days after March 14, 2008. Mr. Anderson's address is
                147
                Keystone Drive, Montgomeryville, PA
                18936.




(8)
            Includes
                15,000 shares of common stock and options to purchase up to 43,750
                shares
                of common stock. Does not include options to purchase up to 17,500
                shares
                of common stock, which may vest more than 60 days after March 14,
                2008.
                Mr. Connelly's address is 147 Keystone Drive, Montgomeryville, PA
                18936.




(9)
            Includes
                145,000 shares of common stock owned by Mr. Dimun and his wife and
                options
                to purchase up to 166,250 shares of common stock. Does not include
                options
                to purchase up to 17,500 shares of common stock, which may vest more
                than
                60 days after March 14, 2008. Mr. Dimun’s address is 46 Parsonage Hill
                Road, Short Hills, New Jersey
                07078.




(10)
            Includes
                30,004 shares of common stock owned by Mr. Withrow and his wife and
                options to purchase up to 70,000 shares of common stock. Does not
                include
                options to purchase up to 17,500 shares of common stock, which may
                vest
                more than 60 days after March 14, 2008. Mr. Withrow’s address is 23 Craig
                Lane, Malvern, PA 19355.




(11)
            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 6,161,124 shares of common stock and warrants which became
                exercisable on May 15, 2007 to purchase up to 894,231 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.




(12)
            Includes
                249,845 unrestricted shares, 1,2800,000 restricted shares and options
                to
                purchase 2,030,500 shares of common stock. Does not include options
                to
                purchase up to 1,166,200 shares of common stock, which may vest more
                than
                60 days after March 14, 2008.




**Item
      13.****Certain
      Relationships and Related Transactions, Director
      Independence**




As
      of
      March 14, 2008, Messrs. Michael R. Matthias and Jeffrey P. Berg, shareholders
      in
      Baker & Hostetler LLP, outside counsel to us in certain litigation, held in
      the aggregate 43,563 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.




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 2007 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.




76
 *Table
          of Contents*


**Item
      14.****Principal
      Accountant Fees and Services**




Our
      Audit
      Committee has appointed Amper, Politziner & Mattia, P.C. as our independent
      auditors for the fiscal years ending December 31, 2007 and 2006.




The
      following table shows the fees paid or accrued by us for the audit and other
      services provided by Amper, Politziner & Mattia for 2007 and
      2006:




2007
            
            2006Audit
                Fees
            
            $
            298,000
            
            $
            343,000Audit-Related
                Fees
            
            
            20,000
            
            
            20,000Tax
                Fees
            
            
            -
            
            
            -All
                Other Fees
            
            
            20,000
            
            
            38,140Total
            
            $
            338,000
            
            $
            401,140




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 2007 and 2006 by the independent auditors, Amper,
      Politziner & Mattia, P.C., 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
      2007 and 2006, totaled approximately $298,000 and $343,000, respectively.




***Audit-Related
      Fees.*** ** The
      aggregate fees billed to us by Amper, Politziner & Mattia, P.C. 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 $21,000 for 2007 and
      $35,000 for 2006, principally for the audit of the 401(K) plan.




***All
      Other Fees.*** ** The
      aggregate fees billed to us by Amper, Politziner & Mattia, P.C. for products
      and services rendered for tax consulting and other services were for $17,365
      for
      2007 and $1,250 for 2006.




***Engagement
      of the Independent Auditor*** *.* The
      Audit Committee is responsible for approving every engagement of Amper,
      Politziner & Mattia, P.C. to perform audit or non-audit services for us
      before Amper, Politziner & Mattia, P.C. 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:




77
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          of Contents*




·  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 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 2008*** Amper,
      Politziner & Mattia, P.C. **** has
      been
      selected to serve as our independent auditors for the year ending December
      31,
      2008, subject to conclusion of an engagement letter and ratification by our
      stockholders at the next Annual Meeting.




**PART
      IV**




**Item
      15.****Exhibits**




(a)(1)
            Financial
                Statements




Consolidated
      balance sheet of PhotoMedex, Inc. and subsidiaries as of December 31, 2007
      and
      2006, 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, 2007.




(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
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          of Contents*


(b)  Exhibits




Following
      the footnote reference is the number of the exhibit in the original filing
      (e.g.
“Exh 10.3”) in which it was submitted to the SEC.




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)3.1(a)
            
            Restated
                Certificate of Incorporation, filed on August 8, 2000 (4) (Exh
                3.1)3.1(b)
            
            Amendment
                to Restated Certificate of Incorporation, filed on January 6, 2004
                (5)
                (Exh 3.2)3.2
            
            Amended
                and Restated Bylaws , (5) (Exh 3.1E)3.2(a)
            
            Amended
                Section 6.01 of the By-laws, October 30, 200710.1
            
            Lease
                Agreement dated May 29, 1996, between Surgical Laser Technologies,
                Inc.
                and Nappen & Associates (Montgomeryville, Pennsylvania) (5)(Exh
                10.31)10.2
            
            Lease
                Renewal Agreement, dated January 18, 2001, between Surgical Laser
                Technologies, Inc. and Nappen & Associates (5)(Exh
                10.32)10.3
            
            Lease
                Agreement, dated July 10, 2006, PhotoMedex, Inc. and Nappen &
                Associates (6)(Exh 10.3)10.4
            
            Lease
                Agreement (Carlsbad, California) dated August 4, 1998
                (7)10.5
            
            Standard
                Industrial/Commercial Multi-Tenant Lease - Net, dated March 17, 2005
                (Carlsbad, California)(8)(Exh 10.52)10.6
            
            Industrial
                Real Estate Lease, dated May 3, 2007, and delivered December 14,
                200710.7
            
            License
                and Development Agreement, dated May 22, 2002, between Surgical Laser
                Technologies, Inc. and Reliant Technologies, Inc. (5)(Exh
                10.7)10.8
            
            Secured
                Promissory Note, dated May 22, 2002, between Surgical Laser Technologies,
                Inc. and Reliant Technologies, Inc. (5)(Exh 10.8)10.9
            
            Security
                Agreement, dated May 22, 2002, between Surgical Laser Technologies,
                Inc.
                and Reliant Technologies, Inc. (5)(Exh 10.9)10.10
            
            Agreement
                as to Collateral, dated May 22, 2002, among Surgical Laser Technologies,
                Inc., Reliant Technologies, Inc. and AmSouth Bank (5)(Exh
                10.10)10.11
            
            Master
                Purchase Agreement, dated September 7, 2004, between PhotoMedex,
                Inc. and
                Stern Laser, srl (9)10.12
            
            Master
                Lease Agreement, dated June 25, 2004, between PhotoMedex, Inc. and
                GE
                Capital Corporation. (10)10.13
            
            Investment
                Agreement, dated March 30, 2006, between AzurTec, Inc. and PhotoMedex,
                Inc. (11)(Exh 10.56)10.14
            
            License
                Agreement, dated March 30, 3006, between AzurTec, Inc. and PhotoMedex,
                Inc. (11)(Exh 10.57)10.15
            
            License
                Agreement, dated March 31, 2006, and effective April 1, 1006, between
                Mount Sinai School of Medicine and PhotoMedex, Inc.
                (12)10.16
            
            2005
                Equity Compensation Plan, approved December 28, 2005
                (13)10.17
            
            2005
                Investment Plan, approved December 28, 2005 (13)10.18
            
            Amended
                and Restated 2000 Non-Employee Director Stock Option Plan
                (1)10.19
            
            Amended
                and Restated 2000 Stock Option Plan (1)10.20
            
            2004
                Stock Option Plan, assumed from ProCyte (14)10.21
            
            1996
                Stock Option Plan, assumed from ProCyte (14)10.22
            
            1991
                Restated Stock Option Plan for Non-Employee Directors, assumed from
                ProCyte (14)10.23
            
            1989
                Restated Stock Option Plan, assumed from ProCyte (14)10.24
            
            Amended
                and Restated Employment Agreement with Jeffrey F. O'Donnell, dated
                October
                30, 200710.25
            
            Amended
                and Restated Employment Agreement with Dennis M. McGrath, dated September
                1, 200710.26
            
            Amended
                and Restated Employment Agreement of Michael R. Stewart, dated September
                1, 200710.27
            
            Employment
                Agreement of John F. Clifford, dated March 18, 2005 (2)10.28
            
            Employment
                Agreement of Robin L. Carmichael, dated March 18, 2005
                (2)10.29
            
            Separation
                Agreement, effective June 30, 2006, between PhotoMedex, Inc. and
                John F.
                Clifford. (15)10.30
            
            Restricted
                Stock Purchase Agreement of Jeffrey F. O’Donnell, dated January 15, 2006
                (8)(Exh 10.44)10.31
            
            Restricted
                Stock Purchase Agreement of Dennis M. McGrath, dated January 15,
                2006
                (8)(Exh 10.45)10.32
            
            Consulting
                Agreement dated January 21, 1998 between the Company and R. Rox
                Anderson, M.D. (7)(Exh 10.4)




79
 *Table
          of Contents*




10.33
            
            Restricted
                Stock Purchase Agreement of Jeffrey F. O’Donnell, dated May 1, 2007
                (17)10.34
            
            Restricted
                Stock Purchase Agreement of Dennis M. McGrath, dated May 1, 2007
                (17)10.35
            
            Restricted
                Stock Purchase Agreement of Michael R. Stewart, dated May 1, 2007
                (17)10.36
            
            Restricted
                Stock Purchase Agreement of Michael R. Stewart, dated August 13,
                2007
                (18)10.37
            
            Amended
              and Restated 2000 Non-Employee Director Stock Option Plan, dated as
              of
              June 26, 2007 (17)10.38
            
            Amended
              and Restated 2005 Employee Compensation Plan, dated as of June 26,
              2007
              (17)


22.1
            
            List
                of subsidiaries of the Company23.1
            
            Consent
                of Amper, Politziner & Mattia P.C.31.1
            
            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 quater ended
                June 30, 2004.




(11)
            Filed
                as part of our Current Report on Form 8-K, filed on April 6,
                2006.




(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.





**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 1024, 450 Fifth 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.




80
 *Table
          of Contents*




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
 *Table
          of Contents*


**SIGNATURES**




Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Act of
      1934, the registrant has duly caused this Report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.




PHOTOMEDEX,
                INC.Date:
                March 17, 2008
            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
                17, 2008Richard
                J. DePiano/s/
                Jeffrey F. O’Donnell
            
            President,
                Chief Executive Officer and Director
            
            March
                17, 2008Jeffrey
                F. O'Donnell/s/
                Dennis M. McGrath
            
            Chief
                Financial Officer
            
            March
                17, 2008Dennis
                M. McGrath/s/
                Alan R. Novak
            
            Director
            
            March
                17, 2008Alan
                R. Novak/s/
                David W. Anderson
            
            Director
            
            March
                17, 2008David
                W. Anderson/s/
                Stephen P. Connelly
            
            Director
            
            March
                17, 2008Stephen
                P. Connelly/s/
                Anthony J. Dimun
            
            Director
            
            March
                17, 2008Anthony
                J. Dimun/s/
                Wayne M. Withrow
            
            Director
            
            March
                17, 2008Wayne
                M. Withrow





82
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          of Contents*




PHOTOMEDEX,
      INC. AND SUBSIDIARIES




Index
      to
      Consolidated Financial Statements




PageReport
                of Independent Registered Public Accounting
                Firm
            
            F-2Consolidated
                Balance Sheets, December 31, 2007 and
                2006
            
            F-3Consolidated
                Statements of Operations, Years ended December
                31, 2007, 2006 and 2005
            
            F-4Consolidated
                Statements of Stockholders’ Equity, Years ended
                December 31, 2007, 2006 and 2005
            
            F-5Consolidated
                Statements of Cash Flows, Years ended December 31,
                2007, 2006 and 2005
            
            F-6Notes
                to Consolidated Financial
                Statements
            
            F-7




*Table
          of Contents*




REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
      FIRM





Board
      of
      Directors and shareholders


PhotoMedex,
      Inc. and Subsidiaries




We
      have
      audited the accompany consolidated balance sheets of PhotoMedex, Inc. and
      Subsidiaries as of December 31, 2007 and 2006, and the related consolidated
      statements of operations, stockholders’ equity and cash flows for each of the
      years in the three-year period ended December 31, 2007. We also have audited
      PhotoMedex, Inc.’s internal control over financial reporting as of December 31,
      2007, based on criteria established in *Internal
      Control-Integrated Framework* issued
      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. 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 my 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, 2007 and 2006, and the results of its operations and its
      cash
      flows for each of the years in the three-year period ended December 31, 2007
      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, 2007, based on criteria established in *Internal
      Control-Internal Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission
      (COSO).




As
      discussed in Note 1 to the consolidated financial statements, the Company
      changed the manner in which it accounts for stock-based compensation in 2006.
      As
      discussed in Note 13 to the consolidated financial statements, the Company
      changed the manner in which it accounts for uncertainty in income taxes in
      2007.




/s/
      Amper
      Politziner & Mattia P.C.





March
      11,
      2008


Edison,
      New Jersey




F-2
 *Table
          of Contents*




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      BALANCE SHEETS




December
                31,2007
            
            2006ASSETSCurrent
                assets:Cash
                and cash equivalents
            
            $
            9,837,303
            
            $
            12,729,742Restricted
                cash
            
            
            117,000
            
            
            156,000Accounts
                receivable, net of allowance for doubtful accounts of $542,983 and
                $508,438, respectively
            
            
            6,759,060
            
            
            4,999,224Inventories
            
            
            7,929,542
            
            
            7,301,695Prepaid
                expenses and other current assets
            
            
            508,384
            
            
            534,135Total
                current assets
            
            
            25,151,289
            
            
            25,720,796Property
                and equipment, net
            
            
            10,143,808
            
            
            9,054,098Patents
                and licensed technologies, net
            
            
            1,408,248
            
            
            1,695,727Goodwill,
                net
            
            
            16,917,808
            
            
            16,917,808Other
                intangible assets, net
            
            
            2,607,625
            
            
            3,537,625Other
                assets
            
            
            457,925
            
            
            555,467Total
                assets
            
            $
            56,686,703
            
            $
            57,481,521LIABILITIES
                AND STOCKHOLDERS' EQUITYCurrent
                liabilities:Current
                portion of notes payable
            
            $
            129,305
            
            $
            195,250Current
                portion of long-term debt
            
            
            4,757,133
            
            
            3,018,874Accounts
                payable
            
            
            3,634,519
            
            
            3,617,726Accrued
                compensation and related expenses
            
            
            1,581,042
            
            
            1,529,862Other
                accrued liabilities
            
            
            674,374
            
            
            657,293Deferred
                revenues
            
            
            668,032
            
            
            632,175Total
                current liabilities
            
            
            11,444,405
            
            
            9,651,180Notes
                payable, net of current maturities
            
            
            106,215
            
            
            133,507Long-term
                debt, net of current maturities
            
            
            5,602,653
            
            
            3,593,920Total
                liabilities
            
            
            17,153,273
            
            
            13,378,607Commitment
                and contingenciesStockholders'
                Equity:Common
                Stock, $.01 par value, 100,000,000 shares authorized; 63,032,207
                and
                62,536,054 shares issued and outstanding, respectively
            
            
            630,322
            
            
            625,360Additional
                paid-in capital
            
            
            132,932,357
            
            
            131,152,557Accumulated
                deficit
            
            
            (94,029,249
            )
            
            (87,675,003
            )Total
                stockholders' equity
            
            
            39,533,430
            
            
            44,102,914Total
                liabilities and stockholders’ equity
            
            $
            56,686,703
            
            $
            57,481,521




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




F-3
 *Table
          of Contents*




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS





For
                the Year Ended December 31,2007
            
            2006
            
            2005Revenues:Product
                sales
            
            $
            23,626,660
            
            $
            20,352,905
            
            $
            16,544,894Services
            
            
            15,086,957
            
            
            12,836,972
            
            
            11,839,61238,713,617
            
            
            33,189,877
            
            
            28,384,506Cost
                of revenues:Product
                cost of revenues
            
            
            9,539,787
            
            
            8,628,651
            
            
            7,219,504Services
                cost of revenues
            
            
            10,528,247
            
            
            9,843,199
            
            
            8,456,00120,068,034
            
            
            18,471,850
            
            
            15,675,505Gross
                profit
            
            
            18,645,583
            
            
            14,718,027
            
            
            12,709,001Operating
                expenses:Selling,
                general and administrative
            
            
            23,229,276
            
            
            20,682,056
            
            
            16,477,322Engineering
                and product development
            
            
            799,108
            
            
            1,006,600
            
            
            1,127,96124,028,384
            
            
            21,688,656
            
            
            17,605,283Loss
                from operations
            
            
            (5,382,801
            )
            
            (6,970,629
            )
            
            (4,896,282
            )Refinancing
                charge
            
            
            (441,956
            )
            
            -
            
            
            -Interest
                expense, net
            
            
            (529,489
            )
            
            (521,768
            )
            
            (342,299
            )Other
                income, net
            
            
            -
            
            
            -
            
            
            1,302,537Net
                loss
            
            $
            (6,354,246
            )
            $
            (7,492,397
            )
            $
            (3,936,044
            )Basic
                and diluted net loss per share
            
            $
            (0.10
            )
            $
            (0.14
            )
            $
            (0.08
            )Shares
                used in computing basic and diluted net loss per share
            
            
            62,810,338
            
            
            54,188,914
            
            
            48,786,109




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




F-4
 *Table
          of Contents*




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY





AdditionalCommon
                Stock
            
            Paid-In
            
            Accumulated
            
            DeferredShares
            
            Amount
            
            Capital
            
            Deficit
            
            Compensation
            
            TotalBALANCE,
                DECEMBER 31, 2004
            
            
            40,075,019
            
            $
            400,750
            
            $
            90,427,632
            
            $
            (76,246,562
            )
            $
            (1,537
            )
            $
            14,580,283Exercise
                of warrants
            
            
            73,530
            
            
            735
            
            
            146,325
            
            
            -
            
            
            -
            
            
            147,060Exercise
                of stock options
            
            
            350,189
            
            
            3,502
            
            
            624,329
            
            
            -
            
            
            -
            
            
            627,831Issuance
                of stock for ProCyte merger, net of expense
            
            
            10,540,579
            
            
            105,406
            
            
            26,197,732
            
            
            -
            
            
            (132,081
            )
            
            26,171,057Stock
                options issued to consultants for services
            
            
            -
            
            
            -
            
            
            123,257
            
            
            -
            
            
            -
            
            
            123,257Reversal
                of unamortized portion of deferred compensation for terminated
                employee
            
            
            -
            
            
            -
            
            
            (1,534
            )
            
            -
            
            
            1,534
            
            
            -Amortization
                of deferred compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            76,737
            
            
            76,737Issuance
                of stock for Stern laser assets acquisition, net of
                expenses
            
            
            374,977
            
            
            3,750
            
            
            723,300
            
            
            -
            
            
            -
            
            
            727,050Registration
                expense
            
            
            -
            
            
            -
            
            
            (161,739
            )
            
            -
            
            
            -
            
            
            (161,739
            )Issuance
                of warrants for draws under line of credit
            
            
            -
            
            
            -
            
            
            61,536
            
            
            -
            
            
            -
            
            
            61,536Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (3,936,044
            )
            
            -
            
            
            (3,936,044
            )BALANCE,
                DECEMBER 31, 2005
            
            
            51,414,294
            
            
            514,143
            
            
            118,140,838
            
            
            (80,182,606
            )
            
            (55,347
            )
            
            38,417,028Reversal
                of deferred compensation upon adoption of SFAS 123R
            
            
            -
            
            
            -
            
            
            (55,347
            )
            
            -
            
            
            55,347
            
            
            -Exercise
                of warrants
            
            
            140,000
            
            
            1,400
            
            
            166,600
            
            
            -
            
            
            -
            
            
            168,000Exercise
                of stock options
            
            
            60,750
            
            
            607
            
            
            86,664
            
            
            -
            
            
            -
            
            
            87,271Sale
                of stock, net of expenses
            
            
            9,760,000
            
            
            97,600
            
            
            10,449,402
            
            
            -
            
            
            -
            
            
            10,547,002Amortization
                of deferred compensation
            
            
            -
            
            
            -
            
            
            55,347
            
            
            -
            
            
            -
            
            
            55,347Stock
                options issued to consultants for service
            
            
            -
            
            
            -
            
            
            132,624
            
            
            
            
            
            -
            
            
            132,624Stock-based
                compensation expense related to employee options
            
            
            -
            
            
            -
            
            
            990,372
            
            
            -
            
            
            -
            
            
            990,372Issuance
                of restricted stock
            
            
            860,000
            
            
            8,600
            
            
            314,174
            
            
            -
            
            
            -
            
            
            322,774Issuance
                of stock for Azurtec agreement
            
            
            200,000
            
            
            2,000
            
            
            381,273
            
            
            -
            
            
            -
            
            
            383,273Issuance
                of stock for Stern laser assets acquisition, net of
                expenses
            
            
            101,010
            
            
            1,010
            
            
            190,725
            
            
            -
            
            
            -
            
            
            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
            
            
            62,536,054
            
            
            625,360
            
            
            131,152,557
            
            
            (87,675,003
            )
            
            -
            
            
            44,102,914Exercise
                of stock options
            
            
            76,153
            
            
            762
            
            
            85,192
            
            
            -
            
            
            -
            
            
            85,954Stock
                options issued to consultants for service
            
            
            -
            
            
            -
            
            
            109,107
            
            
            -
            
            
            -
            
            
            109,107Stock-based
                compensation expense related to employee options
            
            
            -
            
            
            -
            
            
            955,767
            
            
            -
            
            
            -
            
            
            955,767Issuance
                of restricted stock
            
            
            420,000
            
            
            4,200
            
            
            380,007
            
            
            -
            
            
            -
            
            
            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
            
            
            63,032,207
            
            $
            630,322
            
            $
            132,932,357
            
            $
            (94,029,249
            )
            
            -
            
            $
            39,533,430




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




F-5
 *Table
          of Contents*




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF CASH FLOWS




For the Year Ended December 31,2007
            
            2006
            
            2005**Cash
                Flows From Operating Activities:**Net
                loss
            
            $
            (6,354,246
            )
            $
            (7,492,397
            )
            $
            (3,936,044
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            4,822,035
            
            
            4,199,047
            
            
            3,217,200Refinancing
                charge
            
            
            441,956
            
            
            -
            
            
            -Loss
                on disposal of property and equipment
            
            
            1,922
            
            
            7,500
            
            
            101,009Provision
                for doubtful accounts
            
            
            103,064
            
            
            66,211
            
            
            373,964Stock
                options and warrants issued toconsultants
                for services
            
            
            109,107
            
            
            132,624
            
            
            123,257Compensatory
                charge for stock options and restricted stock issued to employees
            
            
            1,335,773
            
            
            1,304,546
            
            
            -Non-monetary
                exchange
            
            
            -
            
            
            -
            
            
            (88,667
            )Amortization
                of deferred compensation
            
            
            -
            
            
            55,347
            
            
            76,737Changes
                in operating assets and liabilities, net of acquisition:Accounts
                receivable
            
            
            (1,864,007
            )
            
            (414,355
            )
            
            229,768Inventories
            
            
            (684,193
            )
            
            815,766
            
            
            (782,880
            )Prepaid
                expenses and other assets
            
            
            817,711
            
            
            1,138,691
            
            
            1,011,340Accounts
                payable
            
            
            172,793
            
            
            45,648
            
            
            (518,289
            )Accrued
                compensation and related expenses
            
            
            69,370
            
            
            315,508
            
            
            (246,950
            )Other
                accrued liabilities
            
            
            -
            
            
            (279,295
            )
            
            (1,023,921
            )Deferred
                revenues
            
            
            35,857
            
            
            166,143
            
            
            (266,366
            )Net
                cash (used in) provided by operating activities
            
            
            (992,858
            )
            
            60,984
            
            
            (1,729,842
            )**Cash
                Flows From Investing Activities:**Purchases
                of property and equipment
            
            
            (131,654
            )
            
            (94,976
            )
            
            (123,201
            )Lasers
                placed into service
            
            
            (4,426,963
            )
            
            (4,931,835
            )
            
            (3,461,803
            )Cash
                received from acquisition of ProCyte, net of acquisition
                costs
            
            
            -
            
            
            -
            
            
            5,578,416Net
                cash (used in) provided by investing activities
            
            
            (4,558,617
            )
            
            (5,026,811
            )
            
            1,993,412**Cash
                Flows From Financing Activities:**Proceeds
                from issuance of common stock, net
            
            
            -
            
            
            10,547,002
            
            
            (169,524
            )Proceeds
                from issuance of restricted common stock
            
            
            4,200
            
            
            8,600
            
            
            -Proceeds
                from exercise of options
            
            
            85,954
            
            
            87,271
            
            
            627,831Proceeds
                from exercise of warrants
            
            
            -
            
            
            168,000
            
            
            147,060Payments
                on long-term debt
            
            
            (96,504
            )
            
            (179,993
            )
            
            (263,442
            )Payments
                on notes payable
            
            
            (688,040
            )
            
            (900,715
            )
            
            (882,032
            )Net
                advances on line of credit
            
            
            3,314,426
            
            
            2,511,437
            
            
            1,889,487Decrease
                (increase) in restricted cash, cash equivalents and short-term
                investments
            
            
            39,000
            
            
            50,931
            
            
            (94,731
            )Net
                cash provided by financing activities
            
            
            2,659,036
            
            
            12,292,533
            
            
            1,254,649Net
                (decrease) increase in cash and cash equivalents
            
            
            (2,892,439
            )
            
            7,326,706
            
            
            1,518,219Cash
                and cash equivalents, beginning of year
            
            
            12,729,742
            
            
            5,403,036
            
            
            3,884,817Cash
                and cash equivalents, end of year
            
            $
            9,837,303
            
            $
            12,729,742
            
            $
            5,403,036




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




F-6
 *Table
          of Contents*




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS





*Note
      1*


**The
      Company and Summary of Significant Accounting Policies:**




**The
      Company:**




***Background***


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 operates in five distinct
      business units, or segments (as described in Note 11): three in Dermatology,
      -
      Domestic XTRAC®, International Dermatology Equipment, and Skin Care (ProCyte®);
      and two in Surgical, - Surgical Services (SISTM) and Surgical Products (SLT®).
      The segments are distinguished by our management structure, products and
      services offered, markets served or types of customers.




The
      Domestic XTRAC segment primarily derives revenues from procedures performed
      by
      dermatologists in the United States. The Company’s XTRAC laser system is
      generally placed in a dermatologist’s office without any initial capital cost to
      the dermatologist, and then the Company charges a fee-per-use to treat skin
      disease. The Company will also sell an XTRAC system to a new customer or to
      an
      established customer, as circumstances may dictate. The International
      Dermatology Equipment segment was formerly called the International XTRAC
      segment, but the Company re-named this segment following the addition of the
      VTRACTM lamp-based system in 2006. In comparison to the Domestic XTRAC segment,
      the International Dermatology Equipment segment generates revenues from the
      sale
      of equipment 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 and 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. In January
      2000, the Company received the first Food and Drug Administration (“FDA”)
      clearance to market an excimer laser system, the XTRAC® laser system, for the
      treatment of psoriasis. It was followed by FDA 510(k) clearance to treat
      vitiligo in March 2001, atopic dermatitis in August 2001, and leukoderma in
      May
      2002. The first XTRAC phototherapy treatment systems were commercially
      distributed in the United States in August 2000 before any of its procedures
      had
      been approved for medical insurance reimbursement. In the last several years,
      the Company has sought to obtain reimbursement for psoriasis and other
      inflammatory skin disorders. By the latter part of 2005, the Company had
      received many approvals for the reimbursement for use of the XTRAC system.
      In December 2007, the Company received approval from Blue Shield of California.
      The manufacturing facility for the XTRAC laser system is located in Carlsbad,
      California.




The
      Surgical Services segment generates revenues by providing fee-based procedures
      typically using our mobile surgical laser equipment delivered and operated
      by a
      technician at hospitals and surgery centers in the United States. 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.




The
      Skin
      Care business resulted from the acquisition of ProCyte Corporation (“ProCyte”)
      on March 18, 2005. ProCyte, located in Redmond, Washington, markets products
      for
      skin health, hair care and wound care. Many of these products incorporate
      patented copper peptide technologies. (see *Note
      2* ).




The
      Company also develops, manufactures and markets proprietary lasers and delivery
      systems for both contact and non-contact surgery and provides surgical services
      utilizing these and other manufacturers’ products. The Montgomeryville facility
      also serves as the Company’s corporate headquarters.




F-7
 *Table
          of Contents*




***Liquidity
      and Going Concern***


The
      Company has incurred significant losses and negative cash flows from operations.
      As of December 31, 2007, the Company had an accumulated deficit of $94,029,249.
      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, 2007 were $9,954,303, including restricted
      cash of $117,000. Management believes that the existing cash balance together
      with its other existing financial resources, including its credit line facility
      with a remaining availability of $1,672,675 (see Note 9), and any revenues
      from
      sales, distribution, licensing and manufacturing relationships, will be
      sufficient to meet the Company’s operating and capital requirements through the
      end of the second quarter of 2009. The 2008 operating plan reflects anticipated
      growth from an increase in per-treatment fee revenues for use of the XTRAC
      laser
      system based on increased utilization and wider insurance coverage in the United
      States and cost savings from the growth of the Company’s skincare products. The
      Company believes that it will have the necessary financing to meet its operating
      and capital requirements through 2008 and into the second quarter of 2009,
      at a
      minimum.




The
      Company’s future success depends in part upon increased patient acceptance of
      its excimer-laser-based systems for the treatment of a variety of skin
      disorders. The Company’s ability to introduce successful new products may be
      adversely affected by a number of factors, such as unforeseen costs and
      expenses, technological change, economic downturns, increased competition,
      other
      factors beyond the Company’s control or excessive costs in order to market the
      product and thus win patient acceptance. The Company is continuing to implement
      its rollout strategy for the XTRAC laser system in the United States in selected
      areas of the country where reimbursement is widely available. The success of
      the
      rollout depends on increasing physician and patient demand for the treatment.




Management
      cannot provide assurance that the Company will market the XTRAC product
      successfully or operate profitably in the future, or that it will not require
      significant additional financing in order to accomplish or exceed the objectives
      of its business plan. Consequently, 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, 2007
      and
      2006. 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.




***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
 *Table
          of Contents*




***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. Surgical
      lasers-in-service are depreciated on a straight-line basis over an estimated
      useful life of seven years if new, and five years or less if used equipment.
      The
      straight-line depreciation basis for lasers-in-service is reflective of the
      pattern of use. 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. Laser units utilized in the provision of
      surgical services are included in property and equipment under the caption
      “lasers in service” and are depreciated over a five year life, given the
      additional wear and tear that is incurred with movement from site to site.




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, 2007, 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 is being 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 AzurTec, Stern and Mount Sinai licenses,
      are capitalized and amortized over the estimated useful lives of 10
      years.




F-9
 *Table
          of Contents*




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, 2007, no such write-down was required (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, 2007, no such 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 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, 2007,
      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, 2007 and 2006 is summarized as follows:




December
                31,2007
            
            2006Accrual
                at beginning of year
            
            $
            123,738
            
            $
            204,708Additions
                charged to warranty expense
            
            
            270,000
            
            
            105,000Expiring
                warranties
            
            
            (81,899
            )
            
            (87,426
            )Claims
                satisfied
            
            
            (93,252
            )
            
            (98,544
            )Accrual
                at end of year
            
            $
            218,587
            
            $
            123,738




***Revenue
      Recognition***


The
      Company has two distribution channels for its phototherapy treatment equipment.
      The Company either (i) places the lasers in physicians’ offices (at no
      charge to the physician) and charges the physician a fee for an agreed upon
      number of treatments or (ii) to a lesser extent, sells the laser through a
      distributor or directly to a physician. 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 criteria 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 by its distributors for product
      defects or other claims.




F-10
 *Table
          of Contents*




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. 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, 2007 and 2006, the Company deferred $563,336 and
      $506,440, respectively, under this approach.




The
      Company has a program to support certain physicians in addressing treatments
      with the XTRAC laser system that may be denied reimbursement by private
      insurance carriers. The Company recognizes service revenue from the sale of
      treatment codes to physicians participating in this program only if and to
      the
      extent the physician has been reimbursed for the treatments. The Company
      estimates a contingent liability for potential refunds under this program by
      reviewing the history of denied insurance claims and appeals processed. At
      December 31, 2007 and 2006, the Company had net deferred revenues of $72,812
      and
      $80,697, respectively, under this program.




The
      Company generates revenues from its Skin Care business primarily through three
      channels. The first is through product sales for skin health, hair care and
      wound care; the second is through sales of the copper peptide compound,
      primarily to Neutrogena Corporation, a Johnson & Johnson company; and the
      third is through royalties generated by our licenses, principally to Neutrogena.
      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 businesses primarily from two
      channels. The first is through product sales of laser systems, related
      maintenance service agreements, recurring laser delivery systems and laser
      accessories, and the second is through per-procedure surgical services. 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.




For
      per-procedure surgical services, the Company recognizes revenue upon the
      completion of the procedure. 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.




The
      Company’s deferred tax asset has been fully reserved under a valuation
      allowance, reflecting the uncertainties as to realizability evidenced by the
      Company’s historical results and restrictions on the usage of the net operating
      loss carryforwards. Consistent with the rules of purchase accounting, the
      historical deferred tax asset of ProCyte was valued at zero when the Company
      acquired ProCyte. If and when components of that asset are realized in future,
      the goodwill recognized in the acquisition of ProCyte will be reduced. The
      Company does not believe that its historical or expected tax reporting positions
      when considered before applications of the valuation allowance will have a
      material impact on its consolidated financial statements.




***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.




F-11
 *Table
          of Contents*




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 10,279,254, 10,840,382 and 7,177,955 as of December 31, 2007, 2006
      and 2005, respectively, were thus excluded from the calculation of fully diluted
      earnings per share.




***Exchanges
      of Nonmonetary Assets***


Exchanges
      under SFAS No. 153, “Exchanges of Nonmonetary Assets,” are measured based on the
      fair value of the assets exchanged. Further, SFAS No. 153 eliminates the
      previous narrow exception for nonmonetary exchanges of similar productive assets
      and replaces it with a broader exception for exchanges of nonmonetary assets
      that do not have “commercial substance.” For the years ended December 31, 2007
      and 2006, the Company has not recognized any income or expense in accordance
      with this Statement. For the year ended December 31, 2005, the Company
      recognized income of $88,667 in accordance with this Statement.




***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 estimated
      undiscounted future cash flows expected to be generated by the asset. If the
      carrying amount of an asset exceeds its estimated future cash flows, 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 held
      for sale would be presented separately in the appropriate asset and liability
      sections of the balance sheet. As of December 31, 2007, no such impairment
      exists.




***Share-Based
      Compensation***


On
      January 1, 2006, The Company adopted SFAS No. 123R, “Share-Based Payment,” which
      requires all companies to measure and recognize compensation expense at fair
      value for all stock-based payments to employees and directors. SFAS No. 123R
      is
      being applied on the modified prospective basis. Prior to the adoption of SFAS
      No. 123R, the Company accounted for its stock-based compensation plans for
      employees and directors under the recognition and measurement principles of
      Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued
      to Employees”, and related interpretations, and accordingly, the Company
      recognized no compensation expense related to the stock-based plans for grants
      to employees or directors. Grants to consultants under the plans were recorded
      under SFAS No. 123.




Under
      the
      modified prospective approach, SFAS No. 123R applies to new grants of options
      and awards of stock as well as to grants of options that were outstanding on
      January 1, 2006 and that may subsequently be repurchased, cancelled or
      materially modified. Under the modified prospective approach, compensation
      cost
      recognized for the years ended December 31, 2007 and 2006 includes compensation
      cost for all share-based payments granted prior to, but not yet vested on,
      January 1, 2006, based on fair value as of the prior grant-date and estimated
      in
      accordance with the provisions of SFAS No. 123R. Prior periods were not required
      to be restated to reflect the impact of adopting the new standard.




F-12
 *Table
          of Contents*




SFAS
      No.
      123R also requires companies to calculate an initial "pool" of excess tax
      benefits available at the adoption date to absorb any tax deficiencies that
      may
      be recognized under SFAS No. 123R. The pool includes the net excess tax benefits
      that would have been recognized if the Company had adopted SFAS No. 123 for
      recognition purposes on its effective date. The Company has elected to calculate
      the pool of excess tax benefits under the alternative transition method
      described in FASB Staff Position ("FSP") No. FAS 123(R)-3, "Transition Election
      Related to Accounting for Tax Effects of Share-Based Payment Awards," which
      also
      specifies the method to calculate excess tax benefits reported on the statement
      of cash flows. The Company is in a net operating loss position; therefore,
      no
      excess tax benefits from share-based payment arrangements have been recognized
      for the years ended December 31, 2007 and 2006.




The
      pro-forma information presented in the following table illustrates the effect
      on
      net income and net income per share if the Company had applied the fair value
      recognition provisions of SFAS No. 123, “Accounting for Stock-Based
      Compensation,” as amended SFAS No. 148, “Accounting for Stock-Based Compensation
– Transition and Disclosure,” to stock-based employee compensation for the year
      ended December 31, 2005:




F-13
 *Table
          of Contents*




Year Ended
              December 31,2005Net
                loss:As
                reported
            
            $
            (3,936,044
            )Less:
                stock-based employee compensation expense included in reported net
                loss
            
            
            76,737Impact
                of total stock-based compensation expense determined under
                fair-value-based method for all grants and awards
            
            
            (1,718,296
            )Pro-forma
            
            $
            (5,577,603
            )Net
                loss per share:As
                reported
            
            $
            (0.08
            )Pro-forma
            
            $
            (0.11
            )




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




Assumptions for Option Grants
            
            Year Ended December 31,2007
            
            2006
            
            2005Risk-free
                interest rate
            
            
            4.74
            %
            
            4.62
            %
            
            4.04
            %Volatility
            
            
            85.94
            %
            
            92.48
            %
            
            97.81
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %
            
            0
            %Expected
                life
            
            
            8.1
                years
            
            
            7.50
                years
            
            
            5
                yearsEstimated
                forfeiture rate
            
            
            16
            %
            
            16
            %
            
            N/A




The
      Company calculates expected volatility for a share-based grant based on historic
      daily stock price observations of our 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, 2007 and 2006, 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. Prior to our
      adoption of SFAS No. 123R, the Company reduced pro-forma share-based
      compensation expense, presented in the notes to its financial statements, for
      actual forfeitures as they occurred.




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 made in the first and
      second quarters 2007 and the first quarter 2006 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 historic
      daily stock price observations of our common stock during the three-year period
      immediately preceding the award.




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 and $76,737 of such expense in the years ended December
      31,
      2006 and 2005, respectively.




F-14
 *Table
          of Contents*




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 $109,107, $132,624 and $123,257 was
      recognized during the years ended December 31, 2007, 2006 and 2005,
      respectively.




***Supplemental
      Cash Flow Information***


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 are 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 are 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.




In
      connection with the purchase of ProCyte in March 2005, the Company issued
      10,540,579 shares of common stock and assumed options to purchase 1,354,973
      shares of its own common stock (see *Note
      2* ).




During
      the year ended December 31, 2005, the Company financed insurance policies
      through notes payable for $978,252. During the year ended December 31, 2005,
      the
      Company issued 345,477 shares of its restricted common stock to Stern upon
      attainment of certain milestones, which is included in patents and licensed
      technologies.




For
      the
      years ended December 31, 2007, 2006 and 2005, the Company paid interest of
      $913,821, $670,839 and $403,376, respectively. Income taxes paid in the years
      ended December 31, 2007, 2006 and 2005 were immaterial.




***Recent
      Accounting Pronouncements***


In
      December 2007, the Financial
      Accounting Standards Board (“FASB”) issued
      SFAS No. 141 (revised 2007), “Business Combinations”, or SFAS No. 141R, which
      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. The Company is currently evaluating the impact that the
      adoption of SFAS No. 141R will have on its consolidated financial statements.




In
      December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
      Consolidated Financial Statements—an Amendment of Accounting Research Bulletin
      No. 51”, which 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 is currently evaluating
      the
      impact that the adoption of SFAS No. 160 will have on its consolidated financial
      statements.


In
        December 2007, the Emerging Issues Task Force (“EITF”) issued EITF Issue No.
        07-1, “Accounting for Collaborative Arrangements.” EITF 07-1 provides guidance
        concerning: determining whether an arrangement constitutes a collaborative
        arrangement within the scope of the Issue; how costs incurred and revenue
        generated on sales to third parties should be reported in the income statement;
        how an entity should characterize payments on the income statement; and what
        participants should disclose in the notes to the financial statements about
        a
        collaborative arrangement. The provisions of EITF 07-1 will be adopted in
        2009.
        The Company is in the process of evaluating the impact, if any, of adopting
        EITF
        07-1 on its financial statements.




In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities.” This Statement permits entities to
      choose to measure many financial instruments and certain other items at fair
      value that are not currently required to be measured at fair value. This
      Statement is effective for financial statements issued for fiscal years
      beginning after November 15, 2007 and will become effective for the Company
      beginning with the first quarter of 2008. The Company has not yet determined
      the
      impact of the adoption of SFAS No. 159 on its financial statements and footnote
      disclosures.




F-15
 *Table
          of Contents*




Staff
      Accounting Bulletin No. 110 (“SAB 110”), “Share-Based Payment” expresses the
      views of the staff regarding the use of a “simplified” method, as discussed in
      SAB No. 107 (“SAB No. 107”), in developing an estimate of expected term of
“plain vanilla” share options in accordance with SFAS No. 123 (revised 2004),
“Share-Based Payment”.




*Note
      2*


**Acquisitions:**




***ProCyte
      Transaction***


On
      March
      18, 2005, the Company completed the acquisition of ProCyte Corporation, which
      was organized in 1986. ProCyte develops, manufactures and markets products
      for
      skin health, hair care and wound care.  Many of the Company’s products
      incorporate its patented copper peptide technologies.




The
      aggregate purchase price of $28,086,208 consisted of the issuance of 10,540,579
      shares of the Company’s common stock valued at $2.29 per share, the assumption
      of 1,354,973 common stock options valued at $2,033,132 net of deferred
      compensation of $132,084, and the incurrence of $1,915,150 of transaction costs.
      The merger consideration was based on a fixed exchange ratio of 0.6622 shares
      of
      PhotoMedex common stock for each share of ProCyte common stock. As the exchange
      ratio was fixed, the fair value of PhotoMedex’s common stock for accounting
      purposes was based on a stock price of $2.29 per share, which was the average
      of
      the closing prices on the date of the announcement of the planned merger and
      the
      two days prior and afterwards.




F-16
 *Table
          of Contents*




Based
      on
      the purchase price allocation, the following table summarizes the estimated
      fair
      value of the assets acquired and liabilities assumed at the date of acquisition:




Cash
                and cash equivalents
            
            $
            6,272,540Accounts
                receivable
            
            
            1,137,413Inventories
            
            
            2,845,698Prepaid
                expenses and other current assets
            
            
            134,574Property
                and equipment
            
            
            340,531Patents
                and licensed technologies
            
            
            200,000Other
                intangible assets
            
            
            5,200,000Other
                assets
            
            
            38,277Total
                assets acquired
            
            
            16,169,033Accounts
                payable
            
            
            (605,520
            )Accrued
                compensation and related expenses
            
            
            (158,610
            )Other
                accrued liabilities
            
            
            (1,143,761
            )Deferred
                revenues
            
            
            (95,436
            )Other
                liabilities
            
            
            (52,883
            )Total
                liabilities assumed
            
            
            (2,056,210
            )Net
                assets acquired
            
            $
            14,112,823




The
      purchase price exceeded the fair value of the net assets acquired by
      $13,973,385, which was recorded as goodwill. The increase in goodwill recognized
      in the year ended December 31, 2006 reflects management’s best estimate of
      pre-acquisition contingencies based upon plans entered into prior to March
      18,
      2006.




The
      accompanying consolidated financial statements do not include any revenues
      or
      expenses related to the acquisition on or prior to March 18, 2005, the closing
      date. Following are the Company’s unaudited pro-forma results for the years
      ended December 31, 2007, 2006 and 2005, assuming the acquisition had occurred
      on
      January 1, 2005:




Year Ended December 31,2007
            
            2006
            
            2005Net
                revenues
            
            $
            38,713,617
            
            $
            33,189,877
            
            $
            31,354,068Net
                loss
            
            $
            (6,354,246
            )
            $
            (7,492,397
            )
            $
            (4,038,193
            )Basic
                and diluted loss per share
            
            $
            (0.10
            )
            $
            (0.14
            )
            $
            (0.08
            )Shares
                used in calculating basic and diluted loss per share
            
            
            62,810,338
            
            
            54,188,914
            
            
            50,932,410




These
      unaudited pro-forma results have been prepared for comparative purposes only
      and
      do not purport to be indicative of the results of operations which would have
      actually resulted had the acquisition occurred on January 1, 2005, nor to be
      indicative of future results of operations.




**Stern
      Laser Transaction**


On
      September 7, 2004, the Company closed the transactions provided for in the
      Master Asset Purchase Agreement (the “Master Agreement”) with Stern. In March
      2006, the Company issued an additional 101,010 shares of its restricted common
      stock to Stern based on a milestone set forth in the Master Agreement. As of
      December 31, 2006, the Company has issued an aggregate of 589,854 shares of
      its
      restricted common stock to Stern in connection with the Master Agreement. The
      Company does not expect to issue any further shares of stock to Stern, as the
      time for completing remaining milestones has expired. Stern also has served
      as
      the distributor of the Company’s XTRAC laser system in South Africa and Italy
      since 2000. The primary asset acquired from Stern in the transaction is a
      license for Stern’s lamp-based technology, which was carried on the Company’s
      books at $886,383, net, as of December 31, 2007. Amortization of this intangible
      is on a straight-line basis over 10 years and began in January 2005. In the
      year
      ended December 31, 2007, Stern purchased $85,292 of products from the
      Company.




F-17
 *Table
          of Contents*




***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 accounts 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 will 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. The Company is considering whether to grant
      Azurtec an extension of time into 2008 in which to raise the additional
      investment.




The
      Company assigned $268,291 as the fair value of the investment in AzurTec. It
      also assigned $114,982 as the fair value of the license it acquired from
      AzurTec, which is carried on the Company’s books at $94,860, net at December 31,
      2007. Amortization of this intangible is on a straight-line basis over 10 years,
      which began in April 2006.




**Mount
      Sinai License**


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 $64,248, net at December 31, 2007.
      Amortization of this intangible is on a straight-line basis over 10 years,
      which
      began in April 2006.




***MD
      Lash Factor License***


In
      July
      2007, the Company obtained a marketing license for MD Lash Factor eyelash
      conditioner. The license is for 5 years and gives the Company, among other
      things, exclusive rights to market this cosmetic conditioner to physicians
      in
      the United States and other countries. A US patent is pending on the key
      ingredient in the product, which is a unique prostaglandin analogue. The Company
      pays quarterly royalties over the life of the agreement.




*Note
      3*


**Inventories:**




Set
      forth
      below is a detailed listing of inventories.




December 31,2007
            
            2006Raw
                materials and work-in-process
            
            $
            4,527,708
            
            $
            4,433,917Finished
                goods
            
            
            3,401,834
            
            
            2,867,778Total
                inventories
            
            $
            7,929,542
            
            $
            7,301,695




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, 2007 and 2006 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, 2007 and 2006, the Company carried reserves against its inventories
      of $1,124,345 and $1,354,444, respectively.




F-18
 *Table
          of Contents*




*Note
      4*


**Property
      and Equipment:**




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




December 31,2007
            
            2006Lasers
                in service
            
            $
            19,754,416
            
            $
            16,234,834Computer
                hardware and software
            
            
            341,407
            
            
            334,490Furniture
                and fixtures
            
            
            364,319
            
            
            331,379Machinery
                and equipment
            
            
            870,986
            
            
            738,636Autos
                and trucks
            
            
            454,631
            
            
            382,690Leasehold
                improvements
            
            
            247,368
            
            
            247,36822,033,127
            
            
            18,269,397Accumulated
                depreciation and amortization
            
            
            (11,889,319
            )
            
            (9,215,299
            )Property
                and equipment, net
            
            $
            10,143,808
            
            $
            9,054,098




Depreciation
      expense was $3,595,271 in 2007, $2,939,909 in 2006 and $2,226,933 in 2005.
      At
      December 31, 2007 and 2006, net property and equipment included $471,385 and
      $380,875, respectively, of assets recorded under capitalized lease arrangements,
      of which $254,178 and $122,717, respectively, of the capital lease obligation
      was included in long-term debt at December 31, 2007 and 2006 (see *Note
      9* ).




*Note
      5*


**Patents
      and Licensed Technologies:**




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




December 31,2007
            
            2006Patents,
                owned and licensed, at gross costs of $510,942 and $501,657 net of
                accumulated amortization of $268,540 and $231,599,
                respectively
            
            $
            242,402
            
            $
            270,058Other
                licensed and developed technologies, at gross costs of $2,432,258,
                net of
                accumulated amortization of $1,266,412 and $1,006,589
                respectively
            
            
            1,165,846
            
            
            1,425,669Total
                patents and licensed technologies, net
            
            $
            1,408,248
            
            $
            1,695,727




Related
      amortization expense was $296,764, $329,138 and $257,894 for the years ended
      December 31, 2007, 2006 and 2005, respectively. Included in other licensed
      and developed technologies is $200,000 in developed technologies acquired from
      ProCyte and $114,982 for the license with AzurTec (see *Note
      2* ).
      On
      March 31, 2006, the Company closed the transaction provided for in the License
      Agreement with Mount Sinai School of Medicine of New York University (“Mount
      Sinai”). 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 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 $211,000 in 2008, $211,000 in 2009, $211,000 in 2010, $211,000 in 2011,
      $189,000 in 2012 and $374,000 thereafter.




F-19
 *Table
          of Contents*




*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
      market values:




December 31,2007
            
            2006Neutrogena
                Agreement, at gross cost of $2,400,000 net of accumulated amortization
                of
                1,338,000 and $858,000, respectively.
            
            $
            1,062,000
            
            $
            1,542,000Customer
                Relationships, at gross cost of $1,700,000 net of accumulated amortization
                of $947,739 and $607,743, respectively.
            
            
            752,261
            
            
            1,092,257Tradename,
                at gross cost of $1,100,000 net of accumulated amortization of $306,636
                and $196,632, respectively.
            
            
            793,364
            
            
            903,368$
            2,607,625
            
            $
            3,537,625




Related
      amortization expense was $930,000 for 2007 and 2006 and $732,375 for 2005.
      Estimated amortization expense for amortizable intangible assets for the next
      five years is $930,000 in 2008, $930,000 in 2009, $284,250 in 2010, $110,000
      in
      2011, $110,000 in 2012 and $243,000 thereafter. Under the Neutrogena Agreement,
      the Company has licensed to Neutrogena rights to its copper peptide technology
      and for which the Company receives royalties. Customer Relationships embody
      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.




*Note
      7*


**Other
      Accrued Liabilities:**




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




December 31,2007
            
            2006Accrued
                professional and consulting fees
            
            $
            225,820
            
            $
            320,331Accrued
                warranty
            
            
            218,587
            
            
            127,738Accrued
                sales taxes and other expenses
            
            
            229,967
            
            
            213,224Total
                other accrued liabilities
            
            $
            674,374
            
            $
            657,293




F-20
 *Table
          of Contents*




*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 31,2007
            
            2006Note
                payable – unsecured creditor, interest at 5.44%, payable in monthly
                principal and interest installments of $51,354 through February
                2008.
            
            $
            102,013
            
            $
            -Note
                payable – unsecured creditor, interest at 7.42%, payable in monthly
                principal and interest installments of $61,493 through February
                2007.
            
            
            -
            
            
            126,279Note
                payable – unsecured creditor, interest at 6%, payable in monthly principal
                and interest installments of $2,880 through June 2012.
            
            
            133,507
            
            
            159,213Note
                payable – unsecured creditor, interest at 0%, payable in monthly principal
                installments of $4,326 through October 2007
            
            
            -
            
            
            43,265235,520
            
            
            328,757Less:
                current maturities
            
            
            (129,305
            )
            
            (195,250
            )Notes
                payable, net of current maturities
            
            $
            106,215
            
            $
            133,507




Aggregate
      maturities of the notes payable as of December 31, 2007 are $129,305 in 2008,
      $28,975 in 2009, $30,762 in 2010, $32,660 in 2011 and $13,818
      thereafter.




*Note
      9*


**Long-term
      Debt:**




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




December 31, 2007
            
            December 31, 2006Total
                borrowings on credit facilities
            
            $
            10,105,608
            
            $
            6,490,077Capital
                lease obligations (see *Note 3*)
            
            
            254,178
            
            
            122,717Less:
                current portion
            
            
            (4,757,133
            )
            
            (3,018,874
            )Total
                long-term debt
            
            $
            5,602,653
            
            $
            3,593,920




***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. No draw was made in the third quarter of 2007. 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.




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
      is for $12 million and is for one year. The stated interest rate for any draw
      is
      set as 675 basis points above the three-year Treasury rate. CIT levies no points
      on a draw. Each draw is secured by 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 will be
      self-amortized over three years.




F-21
 *Table
          of Contents*




The
      beginning principal of each component was $4,724,699, $1,612,626, and
      $3,990,000, respectively. The effective interest rate for each component was
      17.16%, 15.75%, and 15%, respectively. The months to pay off of each component
      are 27, 30, and 36 months, respectively. After these draws on December 31,
      2007,
      the Company had available $1,672,675 under the credit facility.




In
      connection with the CIT facility, the Company issued 235,525 warrants to each
      of
      CIT Healthcare and Life Sciences Capital. The warrants are treated as a discount
      to the debt and are amortized under the 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
      GE warrants were redeemed and reflected as part of the refinancing charge.




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




Year Ending December 31,2008
            
            2009
            
            2010Future
                minimum payments
            
            $
            5,486,346
            
            $
            3,896,693
            
            $
            2,012,868





***Capital*** **** ***Leases***


The
      obligations under capital leases are at fixed interest rates of 7.06% to 10.68%
      and are collateralized by the related property and equipment (see Note
      4).




Future
      minimum payments for property under capital leases are as follows:




Year
                Ending December 31,2008
            
            $
            97,9842009
            
            
            57,0322010
            
            
            57,0322011
            
            
            57,0322012
            
            
            50,438Total
                minimum lease obligation
            
            
            319,518Less:
                interest
            
            
            (65,340
            )Present
                value of total minimum lease obligation
            
            $
            254,178




*Note
      10*


**Warrant
      Exercises:**




In
      the
      year ended December 31, 2007, the Company had no warrants that were exercised.




In
      the
      year ended December 31, 2006, the Company received $168,000 from the exercise
      of
      140,000 warrants. The warrants were issued in connection with a private
      placement of securities in June 2002 and bore an exercise price of
      $2.00.




In
      the
      year ended December 31, 2005, the Company received $147,060 from the exercise
      of
      73,530 warrants. The warrants were issued in connection with a private placement
      of securities in June 2002 and bore an exercise price of $2.00. See also ***Common
      Stock Warrants*** in *Note
      12* .




F-22
 *Table
          of Contents*


*Note
      11*


**Commitments
      and Contingencies:**




***Leases***


The
      Company has entered into various non-cancelable operating leases for personal
      property that expire at various dates through 2012. Rent expense was $583,372,
      $601,062 and $558,683 for the years ended December 31, 2007, 2006 and 2005,
      respectively. The future annual minimum payments under these non-cancelable
      operating leases are as follows:




Year
                Ending December 31,2008
            
            $
            556,9502009
            
            
            505,0032010
            
            
            406,096Thereafter
            
            
            306,002Total
            
            $
            1,774,051




***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 from the new judge’s grant of
      summary judgment to the defendants. The Company expects to file its brief in
      March 2008.




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 Company has filed
      a
      petition to file an interlocutory appeal from the new judge’s dismissal, among
      other things, of the Company’s counterclaim of misappropriation. The plaintiffs
      have opposed the petition. No decision has been rendered on the petition.




In
      the
      action the Company brought on January 3, 2007 against its insurance carrier
      in
      the United States District Court for the Eastern District of Pennsylvania,
      the
      Company invoked the carrier to defend and indemnify the Company in the malicious
      prosecution action brought by Ra Medical Systems and its principal. In May
      2007,
      the malicious prosecution case settled. In February 2008, the Court granted
      the
      Company’s motion for partial summary judgment and denied the motion of the
      carrier for summary judgment. The Court ruled that the extent to which the
      Company’s defense costs, amounting to more than $900,000, would be reimbursable
      by the carrier under the policy, would be governed by the law of Pennsylvania,
      based on their reasonableness, and not by the law of California, which would
      statutorily impose a cap on such fees at a level the carrier would pay in
      similar cases. A scheduling order has been issued under which the parties will
      begin discovery on the reasonableness of the fees. The Company is also
      evaluating other claims that it may have against the carrier, due, among other
      things, to the carrier’s dilatory handling of the Company’s claim for
      reimbursement under provisional application the carrier’s own, self-validated
      hourly rates for defense counsel and its other billing guidelines. The Company’s
      claim under such provisional application was for approximately $328,000, which
      the Company recorded as an offset to its expensed defense costs; approximately
      $100,000 of our claim under the provisional application remains unpaid. The
      Company has not recognized any possible reimbursements other than the
      $328,000.




On
      November 7, 2007, Allergan, Inc. brought a patent infringement suit against
      PhotoMedex, Inc., as well as against a number of other co-defendants. Suit
      was
      brought in the United States District Court for the Central District of
      California. Allergan alleges that the various eyelash conditioners of the
      defendants, including MD Lash Factor, were marketed in violation of the claims
      of US Patent No. 6,262,105. The Company has moved to have the case dismissed
      on
      the grounds that Allergan failed to join the owner-inventor of the patent in
      the
      suit and that there is no common transaction or occurrence among the various
      defendants to justify that they should be tried en masse. In January 2008,
      ProCyte Corporation filed a declaratory judgment action against Allergan and
      the
      owner-inventor of the ‘105 patent in the United States District Court for the
      Western District of Washington. ProCyte has petitioned the court to decide
      whether its marketing activities of MD Lash Factor infringed the ‘105 patent.
      Allergan has opposed the actions of PhotoMedex and of ProCyte. The
      Central District Court has ruled that it will not dismiss the action and will
      allow Allergan to amend its complaint; nevertheless, that Court has also ruled
      that the petition in the Western District Court will be recognized by the
      Central District Court as the first action to be filed in respect of ProCyte.
      The Western District Court is expected to rule later in March 2008.




F-23
 *Table
          of Contents*


On
      February 19, 2008, Cardiofocus, Inc. brought a patent infringement suit against
      PhotoMedex, Inc., as well as against a number of other co-defendants. Suit
      was
      brought in the United States District Court for Massachusetts. Cardiofocus
      alleges that the various holmium laser systems of the defendants, including
      the
      Company’s LaserPro® CTH holmium laser system, were marketed in violation of the
      claims of US Patent No. 5,843,073. The Company is presently evaluating its
      course of action.




On
      February 25, 2008, Bella Bella has brought a patent infringement suit against
      a
      number of companies in the United States District Court for the Central District
      of California. Among the defendants are Johnson & Johnson, L’Oreal, Avon,
      Sharper Image and PhotoMedex. Bella Bella alleges that the defendants have
      infringed its U.S. patents dealing with microdermabrasion. The Company
      is presently evaluating its course of action.




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, the above litigation and claims will likely be resolved without
      a
      material effect on our 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
      $1,734,896 as of December 31, 2007, based on 2007 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, 2007 was approximately $2,147,706, based on 2007 salary levels.




***Restricted
      Securities and Warrants***


If
      AzurTec succeeds in raising the additional equity capital called for in the
      Investment Agreement, then the Company may be obliged to issue to AzurTec
      warrants on 100,000 shares of the Company’s common stock. Such warrants will
      have a five-year life and be exercisable in full but the first six months of
      the
      file; the warrants will have an exercise price equal to 90% of the mean of
      the
      closing prices of PhotoMedex common stock on Nasdaq for the 30 trading days
      preceding the issuance of the 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 has occurred.




*Note
      12*


**Stockholders’
      Equity:**




***Common
      Stock***


As
      of
      December 31, 2007, the Company had issued 589,864 shares of its restricted
      common stock in connection with the Asset Purchase agreement with Stern Laser
      Srl, or Stern, of which 113,877 shares had been issued in September 2004 and
      248,395 in June 2005, 126,582 in December 2005 and 101,010 in March
      2006.




On
      June
      26, 2007, the stockholders voted to increase the number of authorized shares
      of
      common stock from 75,000,000 to 100,000,000 shares.




On
      November 3, 2006, the Company closed on a private placement for 9,760,000 shares
      of common stock at $1.17 per share resulting in gross proceeds of $11,419,200.
      The closing price of the Company’s common stock on November 1, 2006 was $1.27
      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 2,440,000
      shares of common stock at an exercise price of $1.60 per share, and Cowen &
Company, the placement agent, received warrants to purchase 244,000 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 a **** 6.5%
      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.




F-24
 *Table
          of Contents*


On
      March
      18, 2005, the Company completed the acquisition of ProCyte Corporation, paid
      through the issuance of 10,540,579 shares of common stock valued at $2.29 per
      share. The merger consideration resulted in the equivalent of a fixed ratio
      of
      0.6622 shares of PhotoMedex common stock for each share of ProCyte common
      stock.




***Common
      Stock Options***


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 500,000 options to be issued there under.




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
      20,000 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 5,000 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, 2007, the
      plan had 15,000 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 1,000,000 shares of the Company’s
      common stock, which was increased to 2,000,000 shares pursuant to the
      affirmative vote of the stockholders on June 10, 2002 and to 3,350,000 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 1,933,875 options outstanding
      at December 31, 2007.




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 250,000 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 20,000 shares of the Company’s common
      stock. The Company’s stockholders voted on June 10, 2002 to increase the number
      of reserved shares to 650,000 and also to increase the annual grant to each
      director from 20,000 to 35,000. On December 16, 2003, the stockholders voted
      to
      increase the number of reserved shares to 1,000,000,on December 28, 2005, they
      voted to increase the number of reserved shares to 1,400,000 and on June 26,
      2007, they voted to increase the number of reserved shares to 2,100,000. The
      plan is active and had 1,140,000 options outstanding at December 31,
      2007.




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 193,000, 652,795, 22,514 and 167,537
      options outstanding at December 31, 2007, respectively.




On
      December 28, 2005, the stockholders approved the 2005 Equity Compensation Plan,
      authorizing 3,160,000 shares thereto. The Company’s stockholders voted on June
      26, 2007, to increase in the number of shares reserved to 6,160,000. The plan
      is
      active and had 1,916,450 options outstanding at December 31, 2007.




On
      December 28, 2005, the stockholders approved the 2005 Investment Plan,
      authorizing 400,000 shares thereto. The plan is active and had 12,000 options
      outstanding at December 31, 2007.




In
      January 2007 and May 2007, the Company issued 210,000 and 26,250 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 262,500 restricted shares of our common stock to
      three
      of the Company’s executive officers, and on August 13, 2007, 157,500 restricted
      shares of our common stock to one of the Company’s executive officers.




F-25
 *Table
          of Contents*


Also,
      during the course of 2007, the Company granted an aggregate of 568,250 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 175,000 and 17,500 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 860,000 restricted shares of our common
      stock to two of the Company’s executive officers, and 200,000 stock options to
      one of the two executive officers.




Also,
      during the course of 2006, the Company granted an aggregate of 1,238,500 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 42,000 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 $1.72 per share. The options vest
      upon issuance and will expire ten years from the date of the grant.




In
      May
      2006, the Company granted 9,000 options to purchase common stock to executives
      in accordance with the terms of the 2005 Investment Plan.




In
      January 2005, the Company issued 210,000 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 2005, the Company granted an aggregate of 1,182,000 options
      to purchase common stock to a number of employees with a strike price equal
      to
      the quoted market value of our stock at the date of grant. The options vest
      over
      four years and expire five years from the date of grant.




In
      February 2005, the Company granted 18,000 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 $2.35 per share. The
      options vest over three years and will expire five years from the date of the
      grant. The Company recorded $31,859 of expense relating to these options for
      the
      year ended December 31, 2005.




On
      March
      18, 2005, the Company agreed to assume up to 2,063,000 common stock options
      associated with the acquisition of ProCyte Corporation valued at $2,033,132.
      These ProCyte common stock options were converted into 1,366,131 common stock
      options for PhotoMedex common stock.




In
      July
      and October 2005, the Company granted 25,000 options, each, to purchase common
      stock to consultants for services rendered. The options have an exercise price
      of $2.66 and $2.30 per share, respectively. The options vest over four years
      and
      will expire five years from the date of the grant. The Company recorded $49,120
      and $42,278, respectively, of expense relating to these options for the year
      ended December 31, 2005.


F-26
 *Table
          of Contents*


A
      summary
      of option transactions for all of the Company’s options during the years ended
      December 31, 2007, 2006 and 2005 is as follows:




Number
                of Shares
            
            Weighted
              Average
              Exercise PriceOutstanding
                at December 31, 2004
            
            
            4,210,540
            
            $
            3.48Granted
            
            
            1,460,000
            
            
            2.57Assumed
                from acquisition
            
            
            1,366,131
            
            
            1.73Exercised
            
            
            (350,189
            )
            
            1.80Expired/cancelled
            
            
            (1,608,836
            )
            
            5.83Outstanding
                at December 31, 2005
            
            
            5,077,646
            
            
            2.11Granted
            
            
            1,682,000
            
            
            1.92Exercised
            
            
            (60,750
            )
            
            1.44Expired/cancelled
            
            
            (605,171
            )
            
            1.92Outstanding
                at December 31, 2006
            
            
            6,093,725
            
            
            2.09Granted
            
            
            804,500
            
            
            1.12Exercised
            
            
            (76,153
            )
            
            1.13Expired/cancelled
            
            
            (692,401
            )
            
            1.90Outstanding
                at December 31, 2007
            
            
            6,129,671
            
            $
            2.00Exercisable
                at December 31, 2007
            
            
            4,068,033
            
            $
            2.01




As
      of
      December 31, 2007, 4,068,033 options to purchase common stock were vested and
      exercisable at prices ranging from $0.74 to $9.50 per share. As of December
      31,
      2006, 3,670,083 options to purchase common stock were vested and exercisable
      at
      prices ranging from $0.74 to $9.50 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, 2007 was immaterial .




The
      weighted average grant date fair value of options was $0.92 and $1.52 for
      options granted during the years ended December 31, 2007 and 2006, respectively.
      The total intrinsic value of options exercised during the years ended December
      31, 2007 and 2006 was $13,035 and
      $31,494, respectively.




At
      December 31, 2007, there was $3,559,917 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 2.41 years.




The
      outstanding options, including options exercisable at December 31, 2007, have
      a
      range of exercise prices and associated weighted remaining contractual life
      and
      weighted average exercise price 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      -
                $2.50
            
            
            5,546,418
            
            
            5.15
            
            $
            1.86
            
            
            3,550,905
            
            $
            1.87$2.51
                - $5.00
            
            
            488,253
            
            
            2.67
            
            $
            2.74
            
            
            422,128
            
            $
            2.74$5.01
                - $7.50
            
            
            80,000
            
            
            3.01
            
            $
            5.63
            
            
            80,000
            
            $
            5.63$7.51
                - up
            
            
            15,000
            
            
            2.34
            
            $
            9.50
            
            
            15,000
            
            $
            9.50Total
            
            
            6,129,671
            
            
            4.92
            
            $
            2.00
            
            
            4,068,033
            
            $
            2.06


F-27
 *Table
          of Contents*




The
      outstanding options will expire as follows:




Year Ending
            
            Number of Shares
            
            Weighted
              Average
              Exercise Price
            
            Exercise Price2008
            
            
            579,138
            
            $
            1.71
            
            
            $0.74 - $2.172009
            
            
            901,823
            
            
            2.03
            
            
            $0.99 - $2.702010
            
            
            1,048,174
            
            
            2.49
            
            
            $1.07 - $9.502011
            
            
            284,433
            
            
            2.91
            
            
            $1.49 - $5.632012 and later
            
            
            3,316,103
            
            
            1.80
            
            
            $0.82 - $2.766,129,671
            
            $
            2.00
            
            
            $0.74 - $9.50




***Common
      Stock Warrants***


In
      December 2007, the Company issued 235,525 warrants to purchase common stock
      to
      each of CIT Healthcare and Life Sciences Capital related to the leasing credit
      facility of December 31, 2007. The warrants have an exercise price of $1.12
      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 33,297 warrants to purchase common stock to GE Capital
      Corporation related to the leasing credit facility. The warrants had an exercise
      price of $1.28 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
      2,684,000 shares of common stock at an exercise price of $1.60 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, 20,545 shares at an exercise price of $2.06; on June 30, 2006, 24,708
      shares at an exercise price of $1.69 per share; on September 29, 2006, 25,038
      shares at an exercise price of $1.53 per share; and on December 28, 2006, 32,057
      at an exercise price of $1.20 per share. The warrants had a five-year
      term.




In
      2005,
      the Company issued warrants to purchase common stock to GE Capital Corporation
      related to the leasing credit facility in the following manner: on June 28,
      2005, 14,714 shares at an exercise price of $2.50 per share; on September 26,
      2005, 13,921 shares at an exercise price of $2.29 per share; and on December
      27,
      2005, 15,830 at an exercise price of $1.90 per share. The warrants had a
      five-year term.




A
      summary
      of warrant transactions for the years ended December 31, 2007, 2006 and 2005
      is
      as follows:




Number of Warrants
            
            Weighted
              Average
              Exercise PriceOutstanding
                at December 31, 2004
            
            
            2,168,599
            
            
            2.34Issued
            
            
            43,765
            
            
            2.22Exercised
            
            
            (73,530
            )
            
            2.00Expired/cancelled
            
            
            (38,525
            )
            
            13.43Outstanding
                at December 31, 2005
            
            
            2,100,309
            
            
            1.98Issued
            
            
            2,786,348
            
            
            1.60Exercised
            
            
            (140,000
            )
            
            2.00Expired/cancelled
            
            
            -
            
            
            -Outstanding
                at December 31, 2006
            
            
            4,746,657
            
            
            1.75Issued
            
            
            504,347
            
            
            1.13Exercised
            
            
            -
            
            
            -Expired/cancelled
            
            
            (1,101,421
            )
            
            1.89Outstanding
                at December 31, 2006
            
            
            4,149,583
            
            $
            1.64


F-28
 *Table
          of Contents*




At
      December 31, 2007, all outstanding warrants were exercisable at prices ranging
      from $1.12 to $2.00 per share.




If
      not
      previously exercised, the outstanding warrants will expire as
      follows:




Year Ending December 31,
            
            Number of Warrants
            
            Weighted Average
              Exercise Price2008
            
            
            994,533
            
            $
            2.002009
            
            
            -
            
            
            -2010
            
            
            -
            
            
            -2011
            
            
            2,684,000
            
            
            1.602012
            
            
            471,050
            
            
            1.124,149,583
            
            $
            1.64




*Note
      13*


**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 2007, 2006 and 2005 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 31,2007
            
            2006
            
            2005Federal,
                including AMT tax:Current
            
            $
            -
            
            $
            -
            
            $
            -Deferred
            
            
            (2,371,000
            )
            
            (1,805,000
            )
            
            8,887,000State:Current
            
            
            -
            
            
            -
            
            
            -Deferred
            
            
            (630,000
            )
            
            (2,131,000
            )
            
            68,000(3,001,000
            )
            
            (3,936,000
            )
            
            8,955,000Change
                in valuation allowance
            
            
            3,001,000
            
            
            3,936,000
            
            
            8,955,000Income
                tax expense
            
            $
            -
            
            $
            -
            
            $
            -


F-29
 *Table
          of Contents*




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




Year Ended December 31,2007
            
            2006
            
            2005Expected
                Federal tax benefit at statutory rate
            
            $
            2,160,000
            
            $
            2,547,000
            
            $
            1,338,000Gross
                change in valuation allowance
            
            
            (3,001,000
            )
            
            3,936,000
            
            
            (8,955,000
            )Adjustments
                of temporary differences and net operating loss expirations and
                limitations
            
            
            130,000
            
            
            (4,460,000
            )
            
            7,652,000State
                income taxes
            
            
            630,000
            
            
            278,000
            
            
            68,000Other,
                including adjustment due to State loss carryforwards
            
            
            81,000
            
            
            (2,301,000
            )
            
            (103,000
            )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, 2007, the Company had approximately $151,491,000 of federal net
      operating loss carryforwards. Included in the aggregate net operating loss
      carryforward are approximately $12,361,000 of losses sustained by SLT prior
      to
      the tax-free acquisition on December 27, 2002 and approximately $48,589,000
      of
      losses sustained by ProCyte prior to the tax-free acquisition on March 18,
      2005.
      As of December 31, 2007, the Company has estimated that only $3,421,000 of
      the
      net operating loss from SLT and $16,426,000 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
      since July 31, 2005 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 $2,035,000 of Federal tax credit
      carryforwards as of December 31, 2007. The credit carryforwards have begun,
      and
      continue, to expire over the ensuing 20 years. Under Federal rules applicable
      to
      the acquisition of SLT and ProCyte, the research credit carryforwards from
      these
      companies which are from years prior to their respective acquisitions and which
      approximate $1,419,000, 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 $23,353,000
      at December 31, 2007.


F-30
 *Table
          of Contents*


The
      changes in the deferred tax asset are as follows.




December
                31,2007
            
            2006Beginning
                balance, gross
            
            $
            46,115,000
            
            $
            50,051,000Net
                changes due to:Operating
                loss carryforwards
            
            
            1,955,000
            
            
            (6,687,000
            )Other,
                including adjustments due to state loss carryforwards and net operating
                loss limitations and expirations
            
            
            1,046,000
            
            
            2,751,000Ending
                balance, gross
            
            
            49,116,000
            
            
            46,115,000Less:
                valuation allowance
            
            
            (49,116,000
            )
            
            (46,115,000
            )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
                31,2007
            
            2006Loss
                carryforwards
            
            $
            39,411,000
            
            $
            37,456,000Carryforward
                and AMT credits
            
            
            831,000
            
            
            750,000Accrued
                employment expenses
            
            
            830,000
            
            
            557,000Amortization
                and write-offs
            
            
            1,418,000
            
            
            1,336,000Bad
                debts
            
            
            206,000
            
            
            292,000Deferred
                R&D costs
            
            
            3,291,000
            
            
            3,049,000Deferred
                revenues
            
            
            254,000
            
            
            240,000Depreciation
            
            
            1,970,000
            
            
            1,533,000Inventoriable
                costs
            
            
            86,000
            
            
            81,000Inventory
                reserves
            
            
            460,000
            
            
            567,000Other
                accruals and reserves
            
            
            359,000
            
            
            254,000Gross
                deferred tax asset
            
            
            49,116,000
            
            
            46,115,000Less:
                valuation allowance
            
            
            (49,116,000
            )
            
            (46,115,000
            )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 $5,333,000 in benefit, or that
      were
      contributed by ProCyte from periods prior to the acquisition in March 2005
      and
      that approximate $7,204,000 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
      not expected that any material tax benefit from the ProCyte acquisition will
      be
      reflected in the Statement of Operations, but a benefit of $2,389,000 from
      the
      Acculase acquisition may be realized and reflected in the Statement of
      Operations. Within the net operating loss carryforward as of December 31, 2007
      are approximately $6,651,000 of 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.


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, 2007.
  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, 2007, 2006 and 2005.
 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 2007
          and
          is also subject to various state income tax examinations for calendar years
          2002
          through 2007.


F-31
 *Table
          of Contents*


*Note
      14*


**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.




On
      March
      30, 2006, the Company entered a strategic relationship with AzurTec to resume
      development, and to undertake the manufacture and distribution, of AzurTec's
      MetaSpex Laboratory System, a light-based system designed to detect certain
      cancers of the skin. 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 represent a 14% interest in
      AzurTec on a fully diluted basis. The Company will assist
      in
      the development of FDA-compliant prototypes for AzurTec’s product. Continuing
      development of this project requires additional investment by AzurTec, which
      AzurTec has attempted to raise based on an *in
      vivo* application. The Company will resume development once the additional investment
      has been raised, and AzurTec has settled its prior indebtedness to the Company
      for development work. The Company is considering whether to grant AzurTec an
      extension of time into 2008 in which to raise the additional
      investment.




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.




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. The
      Company committed to contributing up to $200,000 towards the study.




In
      July
      2007, the Company obtained a marketing license for MD Lash Factor eyelash
      conditioner. The license is for 5 years but is cancelable at yearly intervals.
      The license gives the Company, among other things, exclusive rights to market
      this cosmetic conditioner to physicians in the United States and other
      countries. A US patent is pending on the key ingredient in the product, which
      is
      a unique prostaglandin analogue. The Company is obligated to pay royalties,
      quarterly, over the life of the agreement.




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.




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.


F-32
 *Table
          of Contents*


*Note
      15*


**Significant
      Customer Concentration:**




No
      one
      customer represented 10% or more of total revenues for the year ended December
      31, 2007, 2006 and 2005.




*Note
      16*


**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
      Services segment generates revenues by providing fee-based procedures typically
      using the Company’s mobile surgical laser equipment delivered and operated by a
      technician at hospitals and surgery centers in the United States. 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, 2007, 2006 and 2005, 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, 2007
      and 2006 has been allocated to the domestic and international XTRAC segments
      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, 2007 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-33
 *Table
          of Contents*





Year Ended December 31, 2007DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
              EQUIPMENT
            
            SKIN
              CARE
            
            SURGICAL
              SERVICES
            
            SURGICAL
              PRODUCTS
              AND OTHER
            
            TOTALRevenues
            
            $
            9,141,857
            
            
            3,256,505
            
            $
            13,471,973
            
            $
            7,667,174
            
            $
            5,176,108
            
            $
            38,713,617Costs
                of revenues
            
            
            4,654,561
            
            
            1,646,279
            
            
            4,208,287
            
            
            6,581,722
            
            
            2,977,185
            
            
            20,068,034Gross
                profit
            
            
            4,487,296
            
            
            1,610,226
            
            
            9,263,686
            
            
            1,085,452
            
            
            2,198,923
            
            
            18,645,583Allocated
                operating expenses:Selling,
                general and administrative
            
            
            6,189,047
            
            
            127,325
            
            
            5,812,185
            
            
            854,427
            
            
            614,518
            
            
            13,597,502Engineering
                and product development
            
            
            -
            
            
            -
            
            
            391,928
            
            
            -
            
            
            407,180
            
            
            799,108Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            9,631,7746,189,047
            
            
            127,325
            
            
            6,204,113
            
            
            854,427
            
            
            1,021,698
            
            
            24,028,384Loss
                from operations
            
            
            (1,701,751
            )
            
            1,482,901
            
            
            3,059,573
            
            
            231,025
            
            
            1,177,225
            
            
            (5,382,801
            )Refinancing
                charge
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (441,956
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (529,489
            )Net
                loss
            
            $
            (1,701,751
            )
            $
            1,482,901
            
            $
            3,059,573
            
            $
            231,025
            
            $
            1,177,225
            
            $
            (6,354,246
            )Segment
                assets
            
            $
            13,823,060
            
            $
            2,194,876
            
            $
            21,269,256
            
            $
            3,978,773
            
            $
            4,946,011
            
            $
            46,211,976Capital
                expenditures
            
            $
            3,324,411
            
            $
            15,679
            
            $
            6,917
            
            $
            328,934
            
            $
            72,474
            
            $
            3,748,415





Year Ended December 31, 2006DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
              EQUIPMENT
            
            SKIN
              CARE
            
            SURGICAL
              SERVICES
            
            SURGICAL
              PRODUCTS
              AND OTHER
            
            TOTALRevenues
            
            $
            5,611,387
            
            
            2,186,424
            
            $
            12,646,910
            
            $
            6,944,292
            
            $
            5,800,864
            
            $
            33,189,877Costs
                of revenues
            
            
            4,166,199
            
            
            1,268,080
            
            
            3,858,944
            
            
            5,703,925
            
            
            3,474,702
            
            
            18,471,850Gross
                profit
            
            
            1,445,188
            
            
            918,344
            
            
            8,787,966
            
            
            1,240,367
            
            
            2,326,162
            
            
            14,718,027Allocated
                operating expenses:Selling,
                general and administrative
            
            
            4,408,753
            
            
            77,639
            
            
            5,580,985
            
            
            959,848
            
            
            552,824
            
            
            11,580,049Engineering
                and product development
            
            
            -
            
            
            -
            
            
            498,602
            
            
            -
            
            
            507,998
            
            
            1,006,600Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            9,102,0074,408,753
            
            
            77,639
            
            
            6,079,587
            
            
            959,848
            
            
            1,060,822
            
            
            21,688,656Loss
                from operations
            
            
            (2,963,565
            )
            
            840,705
            
            
            2,708,379
            
            
            280,519
            
            
            1,265,340
            
            
            (6,970,629
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (521,768
            )Net
                loss
            
            $
            (2,963,565
            )
            $
            840,705
            
            $
            2,708,379
            
            $
            280,519
            
            $
            1,265,340
            
            $
            (7,492,397
            )Segment
                assets
            
            $
            11,143,750
            
            $
            1,838,558
            
            $
            21,750,716
            
            $
            4,450,302
            
            $
            4,772,302
            
            $
            43,955,628Capital
                expenditures
            
            $
            2,933,680
            
            $
            885
            
            $
            -
            
            $
            998,541
            
            $
            70,215
            
            $
            4,003,321




F-34
 *Table
          of Contents*





Year
                Ended December 31, 2005DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
              CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND OTHER
            
            TOTALRevenues
            
            $
            3,498,235
            
            $
            1,404,096
            
            $
            10,042,133
            
            $
            7,719,529
            
            $
            5,720,513
            
            $
            28,384,506Costs
                of revenues
            
            
            2,691,506
            
            
            930,574
            
            
            3,132,532
            
            
            5,675,787
            
            
            3,245,106
            
            
            15,675,505Gross
                profit
            
            
            806,729
            
            
            473,522
            
            
            6,909,601
            
            
            2,043,742
            
            
            2,475,407
            
            
            12,709,001Allocated
                operating expenses:Selling,
                general and administrative
            
            
            2,692,388
            
            
            313,713
            
            
            5,331,764
            
            
            1,192,911
            
            
            582,366
            
            
            10,113,142Engineering
                and product development
            
            
            -
            
            
            -
            
            
            442,367
            
            
            -
            
            
            685,594
            
            
            1,127,961Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            6,364,1802,692,388
            
            
            313,713
            
            
            5,774,131
            
            
            1,192,911
            
            
            1,267,960
            
            
            17,605,283Loss
                from operations
            
            
            (1,885,659
            )
            
            159,809
            
            
            1,135,470
            
            
            850,831
            
            
            1,207,447
            
            
            (4,896,282
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (342,299
            )Other
                income, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,302,537Net
                loss
            
            $
            (1,885,659
            )
            $
            159,809
            
            $
            1,135,470
            
            $
            850,831
            
            $
            1,207,447
            
            $
            (3,936,044
            )Segment
                assets
            
            $
            8,936,793
            
            $
            2,523,953
            
            $
            22,585,592
            
            $
            4,118,909
            
            $
            4,176,741
            
            $
            42,341,988Capital
                expenditures
            
            $
            3,391,376
            
            $
            14,327
            
            $
            -
            
            $
            216,633
            
            $
            80,552
            
            $
            3,702,888





December 31,2007
            
            2006Assets:Total
                assets for reportable segments
            
            $
            46,211,976
            
            $
            43,955,628Other
                unallocated assets
            
            
            10,474,727
            
            
            13,525,893Consolidated
                total
            
            $
            56,686,703
            
            $
            57,481,521




For
      the
      years ended December 31, 2007, 2006 and 2005, there were no material net
      revenues attributed to an individual foreign country. Net revenues by geographic
      area were as follows:




Year Ended December 31,2007
            
            2006
            
            2005Domestic
            
            $
            32,026,636
            
            $
            27,691,157
            
            $
            24,667,314Foreign
            
            
            6,686,981
            
            
            5,498,720
            
            
            3,717,192$
            38,713,617
            
            $
            33,189,877
            
            $
            28,384,506


F-35
 *Table
          of Contents*




*Note
      17*


**Quarterly
      Financial Data (Unaudited):**




*For
                the Quarter Ended***2007**
            
            Mar.
                31
            
            Jun.
                30
            
            Sep.
                30
            
            Dec.
                31Revenues
            
            $
            9,029,000
            
            $
            9,319,000
            
            $
            8,922,000
            
            $
            11,444,000Gross
                profit
            
            
            4,168,000
            
            
            4,370,000
            
            
            4,239,000
            
            
            5,868,000Net
                loss
            
            
            (1,883,000
            )
            
            (1,836,000
            )
            
            (1,653,000
            )
            
            (982,000
            )Basic
                and diluted net loss per share
            
            $
            (0.03
            )
            $
            (0.03
            )
            $
            (0.03
            )
            $
            (0.01
            )Shares
                used in computing basic and diluted net loss per share
            
            
            62,536,054
            
            
            62,709,147
            
            
            62,956,881
            
            
            63,032,207





**2006**
            
            Mar.
                31
            
            Jun.
                30
            
            Sep.
                30
            
            Dec.
                31Revenues
            
            $
            8,081,000
            
            $
            8,224,000
            
            $
            8,292,000
            
            $
            8,593,000Gross
                profit
            
            
            3,373,000
            
            
            4,000,000
            
            
            3,633,000
            
            
            3,712,000Net
                loss
            
            
            (2,350,000
            )
            
            (1,340,000
            )
            
            (1,693,000
            )
            
            (2,109,000
            )Basic
                and diluted net loss per share
            
            $
            (0.05
            )
            $
            (0.03
            )
            $
            (0.03
            )
            $
            (0.03
            )Shares
                used in computing basic and diluted net loss per share
            
            
            52,173,618
            
            
            52,622,189
            
            
            52,659,132
            
            
            59,239,878





**2005**
            
            Mar.
                31
            
            Jun.
                30
            
            Sep.
                30
            
            Dec.
                31Revenues
            
            $
            4,983,000
            
            $
            8,055,000
            
            $
            7,624,000
            
            $
            7,722,000Gross
                profit
            
            
            2,351,000
            
            
            3,833,000
            
            
            3,320,000
            
            
            3,205,000Net
                loss
            
            
            (1,128,000
            )
            
            (661,000
            )
            
            (1,350,000
            )
            
            (797,000
            )Basic
                and diluted net loss per share
            
            $
            (0.03
            )
            $
            (0.01
            )
            $
            (0.03
            )
            $
            (0.01
            )Shares
                used in computing basic and diluted net loss per share
            
            
            41,755,950
            
            
            50,859,562
            
            
            51,198,095
            
            
            51,322,000




*Note
      18*


**Valuation
      and Qualifying Accounts:**


Additions Charged toDescription
              
              Balance at
                Beginning
                of Period
              
              Cost and
                Expenses
              
              Other
                Accounts (1)
              
              Deductions (2)
              
              Balance at End
                of PeriodFor
                  The Year Ended December 31, 2007:Reserve
                  for Doubtful Accounts
              
              $
              508,438
              
              $
              105,796
              
              $
              -
              
              $
              71,251
              
              
              542,983For
                  The Year Ended December 31, 2006:Reserve
                  for Doubtful Accounts
              
              $
              765,440
              
              $
              66,211
              
              $
              -
              
              $
              323,213
              
              
              508,438For
                  The Year Ended December 31, 2005:Reserve
                  for Doubtful Accounts
              
              $
              736,505
              
              $
              373,964
              
              $
              121,633
              
              $
              466,662
              
              $
              765,440




(1)
            Represents
                allowance for doubtful accounts related to the acquisition of
                ProCyte.


(2)
            Represents
                write-offs of specific accounts
                receivable.




F-36