**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10 - Q**





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




**For
      the quarterly period ended September 30, 2007**





**OR**





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




**For
      the transition period from _________ to ___________**





Commission
      File Number 0-11365





**PHOTOMEDEX,
      INC.**


(Exact
      name of registrant as specified in its charter)




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





147
      Keystone Drive, Montgomeryville, Pennsylvania 18936


(Address
      of principal executive offices, including zip code)





(215)
      619-3600


(Registrant's
      telephone number, including area code)





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




Yes
x No  ̈





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




Large
      accelerated filer  ̈  Accelerated
      filer x Non-accelerated
      filer  ̈





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




Yes  ̈ No
x





The
      number of shares outstanding of the issuer's Common Stock as of November 9,
      2007
      was 63,032,207 shares.








PHOTOMEDEX,
      INC.





INDEX
      TO
      FORM 10-Q


PAGEPart
                  I. Financial Information:ITEM
                  1. Financial Statements:a.
              Consolidated
                  Balance Sheets, September 30, 2007 (unaudited) and December 31,
                  2006
              
              3b.
              Consolidated
                  Statements of Operations for the three months ended September 30,
                  2007 and
                  2006 (unaudited)
              
              4c.
              Consolidated
                  Statements of Operations for the nine months ended September 30,
                  2007 and
                  2006 (unaudited)
              
              5c.
              Consolidated
                  Statement of Stockholders’ Equity for the nine months ended September 30,
                  2007 (unaudited)
              
              6d.
              Consolidated
                  Statements of Cash Flows for the nine months ended September 30,
                  2007 and
                  2006 (unaudited)
              
              7e.
              Notes
                  to Consolidated Financial Statements (unaudited)
              
              8ITEM
                  2. Management’s Discussion and Analysis of Financial Condition and Results
                  of Operations
              
              24ITEM
                  3. Quantitative and Qualitative Disclosure about Market
                  Risk
              
              39ITEM
                  4. Controls and Procedures
              
              39Part
                  II. Other Information:ITEM
                  1.
              Legal
                  Proceedings
              
              39ITEM
                  1A.
              Risk
                  Factors
              
              40ITEM
                  6.
              Exhibits
              
              40Signatures
              
              41Certifications




2


**PART
      I - Financial Information**




**ITEM
      1. Financial Statements**




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      BALANCE SHEETS




September
                30, 2007
            
            December
                31, 2006(Unaudited)
            
            ***ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            8,159,473
            
            $
            12,729,742Restricted
                cash
            
            
            117,000
            
            
            156,000Accounts
                receivable, net of allowance for doubtful accounts of $548,446 and
                $508,438, respectively
            
            
            5,828,110
            
            
            4,999,224Inventories
            
            
            7,999,879
            
            
            7,301,695Prepaid
                expenses and other current assets
            
            
            657,993
            
            
            534,135Total
                current assets
            
            
            22,762,455
            
            
            25,720,796Property
                and equipment, net
            
            
            10,056,058
            
            
            9,054,098Goodwill,
                net
            
            
            16,917,808
            
            
            16,917,808Patents
                and licensed technologies, net
            
            
            1,461,103
            
            
            1,695,727Other
                intangible assets, net
            
            
            2,840,125
            
            
            3,537,625Other
                assets
            
            
            499,749
            
            
            555,467Total
                assets
            
            $
            54,537,298
            
            $
            57,481,521**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Current
                portion of notes payable
            
            $
            308,505
            
            $
            195,250Current
                portion of long-term debt
            
            
            3,601,684
            
            
            3,018,874Accounts
                payable
            
            
            3,778,882
            
            
            3,617,726Accrued
                compensation and related expenses
            
            
            1,327,799
            
            
            1,529,862Other
                accrued liabilities
            
            
            736,957
            
            
            657,293Deferred
                revenues
            
            
            1,110,105
            
            
            632,175Total
                current liabilities
            
            
            10,863,932
            
            
            9,651,180Long-term
                liabilities:Notes
                payable
            
            
            113,191
            
            
            133,507Long-term
                debt
            
            
            3,514,157
            
            
            3,593,920Total
                liabilities
            
            
            14,491,280
            
            
            13,378,607Commitments
                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
            
            
            132,462,910
            
            
            131,152,557Accumulated
                deficit
            
            
            (93,047,214
            )
            
            (87,675,003
            )Total
                stockholders’ equity
            
            
            40,046,018
            
            
            44,102,914Total
                liabilities and stockholders’ equity
            
            $
            54,537,298
            
            $
            57,481,521




*
      The
      December 31, 2006 balance sheet was derived from the Company’s audited financial
      statements.





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




3




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS




(Unaudited)




For
                the Three Months Ended
              September
                30,2007
            
            2006Revenues:Product
                sales
            
            $
            5,191,918
            
            $
            5,165,901Services
            
            
            3,729,953
            
            
            3,125,6468,921,871
            
            
            8,291,547Cost
                of revenues:Product
                cost of revenues
            
            
            2,154,566
            
            
            2,097,500Services
                cost of revenues
            
            
            2,528,223
            
            
            2,561,4364,682,789
            
            
            4,658,936Gross
                profit
            
            
            4,239,082
            
            
            3,632,611Operating
                expenses:Selling
                and marketing
            
            
            3,157,730
            
            
            2,678,419General
                and administrative
            
            
            2,390,599
            
            
            2,220,985Engineering
                and product development
            
            
            202,163
            
            
            267,0625,750,492
            
            
            5,166,466Loss
                from operations
            
            
            (1,511,410
            )
            
            (1,533,855
            )Interest
                expense, net
            
            
            (141,562
            )
            
            (159,180
            )Net
                loss
            
            
            ($
                1,652,972
            )
            
            ($
                1,693,035
            )Basic
                and diluted net loss per share
            
            
            ($0.03
            )
            
            ($0.03
            )Shares
                used in computing basic and diluted net loss per share
            
            
            62,956,881
            
            
            52,659,132




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




4




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS




(Unaudited)




For
                the Nine Months Ended September 30,2007
            
            2006Revenues:Product
                sales
            
            $
            16,464,329
            
            $
            15,418,727Services
            
            
            10,804,831
            
            
            9,177,72527,269,160
            
            
            24,596,452Cost
                of revenues:Product
                cost of revenues
            
            
            6,703,250
            
            
            6,374,344Services
                cost of revenues
            
            
            7,788,637
            
            
            7,216,68014,491,887
            
            
            13,591,024Gross
                profit
            
            
            12,777,273
            
            
            11,005,428Operating
                expenses:Selling
                and marketing
            
            
            9,730,157
            
            
            8,236,179General
                and administrative
            
            
            7,435,744
            
            
            6,969,862Engineering
                and product development
            
            
            603,636
            
            
            764,44517,769,537
            
            
            15,970,486Loss
                from operations
            
            
            (4,992,264
            )
            
            (4,965,058
            )Interest
                expense, net
            
            
            (379,947
            )
            
            (418,170
            )Net
                loss
            
            
            ($
                5,372,211
            )
            
            ($
                5,383,228
            )Basic
                and diluted net loss per share
            
            
            ($0.09
            )
            
            ($0.10
            )Shares
                used in computing basic and diluted net loss per share
            
            
            62,735,569
            
            
            52,486,758




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




5




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENT OF STOCKHOLDERS’ EQUITY


FOR
      THE
      NINE MONTHS ENDED SEPTEMBER 30, 2007




(Unaudited)




AdditionalCommon
                Stock
            
            Paid-In
            
            AccumulatedShares
            
            Amount
            
            Capital
            
            Deficit
            
            TotalBALANCE,
                DECEMBER 31, 2006
            
            
            62,536,054
            
            $
            625,360
            
            $
            131,152,557
            
            
            ($87,675,003
            )
            $
            44,102,914Stock
                options issued to consultants for services
            
            
            -
            
            
            -
            
            
            93,429
            
            
            -
            
            
            93,429Stock-based
                compensation expenserelated
                to employee options
            
            
            -
            
            
            -
            
            
            827,337
            
            
            -
            
            
            827,337Exercise
                of stock options
            
            
            76,153
            
            
            762
            
            
            85,192
            
            
            -
            
            
            85,954Issuance
                of restricted stock
            
            
            420,000
            
            
            4,200
            
            
            276,384
            
            
            -
            
            
            280,584Issuance
                of warrants for draws underline
                of credit
            
            
            -
            
            
            -
            
            
            28,011
            
            
            -
            
            
            28,011Net
                loss for the nine months ended September 31, 2007
            
            
            -
            
            
            -
            
            
            -
            
            
            (5,372,211
            )
            
            (5,372,211
            )BALANCE,
                SEPTEMBER 30, 2007
            
            
            63,032,207
            
            $
            630,322
            
            $
            132,462,910
            
            
            ($93,047,214
            )
            $
            40,046,018




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





6




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF CASH FLOWS


(Unaudited)




For
                the Nine Months Ended
              September
                30,2007
            
            2006**Cash
                Flows From Operating Activities**:Net
                loss
            
            
            ($
                5,372,211
            )
            
            ($
                5,383,228
            )Adjustments
                to reconcile net loss to net cash (used in) provided byoperating
                activities:Depreciation
                and amortization
            
            
            3,563,026
            
            
            3,101,689Stock
                options issued to consultants for services
            
            
            93,429
            
            
            111,706Stock-based
                compensation expense related to employee options and restricted
                stock
            
            
            1,103,721
            
            
            1,136,405Amortization
                of deferred compensation
            
            
            -
            
            
            44,155Provision
                for bad debts
            
            
            103,064
            
            
            66,211Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (931,950
            )
            
            (136,471
            )Inventories
            
            
            (724,448
            )
            
            612,427Prepaid
                expenses and other assets
            
            
            648,793
            
            
            710,407Accounts
                payable
            
            
            317,155
            
            
            393,196Accrued
                compensation and related expenses
            
            
            (202,063
            )
            
            110,464Other
                accrued liabilities
            
            
            91,286
            
            
            (130,306
            )Deferred
                revenues
            
            
            477,930
            
            
            198,758Other
                liabilities
            
            
            (11,624
            )
            
            (17,415
            )Net
                cash (used in) provided by operating activities
            
            
            (843,892
            )
            
            817,998**Cash
                Flows From Investing Activities:**Purchases
                of property and equipment
            
            
            (108,640
            )
            
            (60,910
            )Lasers
                placed into service
            
            
            (3,416,732
            )
            
            (3,485,269
            )Net
                cash used in investing activities
            
            
            (3,525,372
            )
            
            (3,546,179
            )**Cash
                Flows From Financing Activities:**Proceeds
                from issuance of restricted common stock
            
            
            4,200
            
            
            8,600Costs
                related to issuance of common stock
            
            
            -
            
            
            (7,890
            )Proceeds
                from exercise of options
            
            
            85,954
            
            
            76,180Proceeds
                from exercise of warrants
            
            
            -
            
            
            168,000Payments
                on long-term debt
            
            
            (65,033
            )
            
            (153,597
            )Payments
                on notes payable
            
            
            (501,884
            )
            
            (656,130
            )Net
                advancements on lease lines of credit
            
            
            236,758
            
            
            2,120,508Decrease
                in restricted cash and cash equivalents
            
            
            39,000
            
            
            50,931Net
                cash (used in) provided by financing activities
            
            
            (201,005
            )
            
            1,606,602Net
                decrease in cash and cash equivalents
            
            
            (4,570,269
            )
            
            (1,121,579
            )Cash
                and cash equivalents, beginning of period
            
            
            12,729,742
            
            
            5,403,036Cash
                and cash equivalents, end of period
            
            $
            8,159,473
            
            $
            4,281,457




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




7




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


NOTES
      TO
      UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS




*Note
      1*




**Basis
      of Presentation:**




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




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 (e.g., the
      ClearESS® II suction-irrigation system).




The
      Company designed and manufactured the XTRAC laser system to treat psoriasis,
      vitiligo, atopic dermatitis and leukoderma phototherapeutically. The Company
      has
      received clearances from the U.S. Food and Drug Administration (“FDA”) to market
      the XTRAC laser system for each of these indications. The 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. As
      a
      result of initiatives undertaken by the Company and by the physician community,
      the ability for physicians to process claims efficiently and receive positive
      payment decisions for use of the XTRAC system improved significantly during
      the
      latter part of 2005 and 2006. In March 2007, the Blue Cross Blue Shield
      Association (“BCBSA”) published a National Reference Policy that now recommends
      reimbursement coverage for treatment of psoriasis by means of lasers, including
      the XTRAC, as first-step therapy for moderate to severe psoriasis comprising
      less than 20% of body surface area. The Company is now seeking adoption of
      this
      National Reference Policy by the remaining state Blue Cross Blue Shield Health
      Insurance Plans, which currently do not have a positive payment policy for
      the
      XTRAC. The XTRAC is approved by Underwriters’ Laboratories; it is also
      CE-marked, and accordingly a third party regularly audits the Company’s quality
      system and manufacturing facility. The manufacturing facility for the XTRAC
      is
      located in Carlsbad, California.




***Liquidity
      and Going Concern***




As
      of
      September 30, 2007, the Company had an accumulated deficit of $93,047,214.
      Cash
      and cash equivalents, including restricted cash of $117,000, was $8,276,473.
      The
      Company has historically financed its operations with cash provided by equity
      financing and from lines of credit and, more recently but not yet consistently,
      from positive cash flow generated from operations. The 2007 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 2007 operating plan reflects
      increased revenues and profits from the Skin Care business. Management of the
      Company believes that the Company’s existing cash balance together with other
      existing financial resources, including access to lease financing for capital
      expenditures, and revenues from sales, distribution, licensing and manufacturing
      relationships, will be sufficient to meet the Company’s operating and capital
      requirements, at a minimum, beyond the third quarter of 2008.




8




**Summary
      of Significant Accounting Policies:**




***Quarterly
      Financial Information and Results of Operations***




The
      financial statements as of September 30, 2007 and for the three and nine months
      ended September 30, 2007 and 2006, are unaudited and, in the opinion of
      management, include all adjustments (consisting only of normal recurring
      adjustments) necessary to present fairly the financial position as of September
      30, 2007, and the results of operations and cash flows for the three and nine
      months ended September 30, 2007 and 2006. The results for the three and nine
      months ended September 30, 2007 are not necessarily indicative of the results
      to
      be expected for the entire year. While management of the Company believes that
      the disclosures presented are adequate to make the information not misleading,
      these consolidated financial statements should be read in conjunction with
      the
      consolidated financial statements and the notes included in the Company's Annual
      Report on Form 10-K for the year ended December 31, 2006.




***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 predicted 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.




See
      “Summary of Significant Accounting Policies” in the Company’s 2006 Annual Report
      on Form 10-K for a discussion of the estimates and judgments necessary in the
      Company’s accounting for cash and cash equivalents, accounts receivable,
      inventories, property, equipment and depreciation, product development costs
      and
      fair value of financial instruments.




***Revenue
      Recognition***




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




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




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.




9




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 a physician, but
      not
      yet used, are deferred and recognized as a liability until the physician
      performs the treatment. Unused treatments 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
      three months ended September 30, 2007 and 2006, the Company deferred $899,075
      and $512,254, 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. For the three
      months ended September 30, 2007, the Company deferred an additional $19,494,
      under this program, as all the SAB 104 Criteria for revenue recognition had
      not
      been met. At September 30, 2007, the Company had net deferred revenues of
      $177,936 under this program.




Under
      this program, the Company may reimburse qualifying doctors for the cost of
      the
      Company’s fee but only if they are ultimately denied reimbursement after appeal
      of their claim with the insurance company. The key components of the program
      are
      as follows:




·
            The
                program only covers medically necessary treatments of psoriasis as
                determined by the treating
                physician;




·
            The
                patient must have medical insurance and a claim for the treatment
                must be
                timely filed with the patient’s insurance company;




·
            Upon
                denial by the insurance company (generally within 30 days of filing
                a
                claim), a standard insurance form called an EOB (“Explanation of
                Benefits”) must be submitted to the Company’s in-house appeals group, who
                will then prosecute the appeal. The appeal process can take 6 to
                9
                months;




·
            After
                all appeals have been exhausted by the Company and the claim remains
                unpaid, the physician is entitled to receive credit for the fee for
                the
                treatment he or she purchased from the Company on behalf of the patient;
                and




·
            Physicians
                are still obligated to make timely payments for treatments purchased,
                irrespective of whether reimbursement is paid or denied. Future sales
                of
                treatments to a physician can be denied if timely payments are not
                made,
                even if a patient’s appeal is still in process.




The
      Company estimates a contingent liability for potential refunds under this
      program by reviewing the history of denied insurance claims and appeals
      processed. The Company estimates that approximately 4% of the revenues under
      this program for the quarters ended September 30, 2007 and 2006 are subject
      to
      being credited or refunded to the physician.




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 in bulk 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.




10




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.




***Impairment
      of Long-Lived Assets and Intangibles***




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 the fair value less costs to sell, and would no longer be
      depreciated. The assets and liabilities of a disposed group would be classified
      as held for sale and would be presented separately in the appropriate asset
      and
      liability sections of the balance sheet. As of September 30, 2007 and during
      2006, no such impairment existed.





***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 8
      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
      the
      skincare business (ProCyte) in March 2005 and is being amortized on a
      straight-line basis over seven years.




Management
      evaluates the recoverability 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 the
      net
      book value of the asset, the asset is written down to fair value. As of
      September 30, 2007, no such write-down was required. (See ***Impairment
      of Long-Lived Assets and Intangibles*** ).




***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
      September 30, 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 September 30, 2007
      and
      during 2006, no such write-down was required.




***Accrued
      Warranty Costs***




The
      Company offers a warranty on product sales generally for a one to two-year
      period. In some cases, however, the Company offers longer periods in order
      to
      meet competition. The Company provides for the estimated future warranty claims
      on the date the product is sold. The activity in the warranty accrual during
      the
      nine months ended September 30, 2007 is summarized as follows:




September
                30, 2007Accrual
                at beginning of period
            
            $
            123,738Additions
                charged to warranty expense
            
            
            207,500Expiring
                warranties
            
            
            (56,388
            )Claims
                satisfied
            
            
            (64,065
            )Accrual
                at end of period
            
            $
            210,785




11




***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 realization 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 written off when the Company
      acquired ProCyte. If and when components of that asset are realized in the
      future, the acquired goodwill of ProCyte will be reduced.




Utilization
      of the Company’s net operating loss carryforwards is subject to various
      limitations of the Internal Revenue Code, of which the principal constraint
      is
      Section 382. Loss carryforwards from previous acquisitions (e.g. SLT, ProCyte)
      have already been constrained by this provision. If there is a subsequent change
      of ownership under Section 382, the utilization of the Company’s loss
      carryforwards may be further materially constrained.




Effective
      January 1, 2007, the Company adopted Financial Interpretation (“FIN”) No. 48,
“Accounting for Uncertainty in Income Taxes - An Interpretation of FASB
      Statement No. 109.” This financial 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.
      The
      interpretation contains a two-step approach to recognizing and measuring
      uncertain tax positions accounted for in accordance with SFAS No. 109. The
      first
      step is to evaluate the tax position for recognition by determining if the
      weight of available evidence indicates it is more likely than not that the
      position will be sustained on audit, including resolution of related appeals
      or
      litigation processes, if any. The second step is to measure the tax benefit
      as
      the largest amount which is more than fifty percent likely of being realized
      upon ultimate settlement. The interpretation also provides guidance on
      derecognition, classification, interest and penalties, and other matters. The
      adoption did not have an effect on the consolidated financial statements. There
      continues to be no liability related to unrecognized tax benefits at September
      30, 2007, and no effect on the effective tax rate. No tax-related interest
      and
      penalties have been recognized in the financial statements. Virtually all tax
      years have net operating losses and therefore remain open to examination by
      the
      major taxing jurisdictions to which the Company is subject.




***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 of common shares outstanding for the period. Diluted net loss per share
      reflects the potential dilution from the conversion or exercise into common
      stock of securities such as stock options and warrants.




In
      these
      consolidated financial statements, diluted net loss per share is the same as
      basic net loss per share. No additional shares for the potential dilution from
      the conversion or exercise of securities into common stock are included in
      the
      denominator, since the result would be anti-dilutive. Common stock options
      and
      warrants of 10,267,093 and 8,195,191 as of September 30, 2007 and 2006,
      respectively, were excluded from the calculation of fully diluted earnings
      per
      share since their inclusion would have been anti-dilutive.




***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.




12




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 three and nine months ended September 30, 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.




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 three and nine months ended September 30, 2007.




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




Three
                Months Ended September 30,
            
            Nine
                Months Ended September 30,Assumptions
                for Option Grants
            
            2007
            
            2006
            
            2007
            
            2006Risk-free
                interest rate
            
            
            4.83
            %
            
            4.94
            %
            
            4.78
            %
            
            4.63
            %Volatility
            
            
            85.39
            %
            
            91.01
            %
            
            86.02
            %
            
            93.27
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %
            
            0
            %
            
            0
            %Expected
                life
            
            
            8.1
                years
            
            
            7.65
                years
            
            
            8.1
              years
            
            
            7.39
                yearsEstimated
                forfeiture rate
            
            
            12
            %
            
            11
            %
            
            12
            %
            
            11
            %




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 three and
      nine months ended September 30, 2007, the Company has adopted the simplified
      method authorized in Staff Accounting Bulletin No. 107. SFAS No. 123R also
      requires that estimated forfeitures be included as a part of the estimate of
      expense as of the grant date. The Company has used historical data to estimate
      expected employee behaviors related to option exercises and forfeitures.




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 second
      and
      third quarters 2007 with the following weighted average
      assumptions:





Assumptions
                for Stock Awards
            
            Three
                and Nine Months Ended September 30, 2007Risk-free
                interest rate
            
            
            4.52
            %Volatility
            
            
            74.64
            %Expected
                dividend yield
            
            
            0
            %Expected
                Life
            
            
            5.07
                years




13




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




Compensation
      expense for the three months ended September 30, 2007 included $275,759 from
      stock options grants and $103,623 from restricted stock awards. Compensation
      expense for the three months ended September 30, 2006 included $252,740 from
      stock options grants and $78,544 from restricted stock awards.




Compensation
      expense for the nine months ended September 30, 2007 included $827,337 from
      stock options grants and $276,384 from restricted stock awards. Compensation
      expense for the nine months ended September 30, 2006 included $900,773 from
      stock options grants and $235,632 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 $15,678 and
      $93,429 was recognized during the three and nine months ended September 30,
      2007, respectively. For stock options granted to consultants an additional
      selling, general, and administrative expense in the amount of $18,269 and
      $111,706 was recognized during the three and nine months ended September 30,
      2006, respectively.





***Supplemental
      Cash Flow Information***




During
      the nine months ended September 30, 2007, the Company financed certain credit
      facility costs for $36,840, financed insurance policies through notes payable
      for $606,180 and issued warrants to a leasing credit facility which are valued
      at $28,011, 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 nine months ended September 30, 2006, the Company financed insurance
      policies through notes payable for $763,982, financed certain credit facility
      costs for $122,860, financed a license agreement with a note payable of $77,876
      and issued warrants to a leasing credit facility which are valued at $82,503,
      and which offset the carrying value of debt. During the nine months ended
      September 30, 2006, the Company issued 101,010 shares of its restricted common
      stock to Stern Laser srl (“Stern”) due upon achievement of another milestone
      under the Master Purchase Agreement. The cost associated with this issuance
      is
      included in the license from Stern, which is found in patents and licensed
      technologies. In March 2006, the Company also issued 200,000 shares of its
      restricted common stock to AzurTec, Inc. (“AzurTec”) as part of an investment in
      the capital stock of AzurTec as well as for a license agreement on AzurTec
      technology, both existing and to be developed in the future.




For
      the
      nine months ended September 30, 2007 and 2006, the Company paid interest of
      $700,383 and $475,610, respectively. Income taxes paid in the nine months ended
      September 30, 2007 and 2006 were immaterial.




***Recent
      Accounting Pronouncements***




In
      February 2007, the Financial Accounting Standards Board (“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.




14


*Note
      2*




**Inventories:**




Set
      forth
      below is a detailed listing of inventories:




September
                30, 2007
            
            December
                31, 2006Raw
                materials and work in progress
            
            $
            4,704,944
            
            $
            4,433,917Finished
                goods
            
            
            3,294,935
            
            
            2,867,778Total
                inventories
            
            $
            7,999,879
            
            $
            7,301,695




Work-in-process
      is immaterial, given the Company’s typically short manufacturing cycle, and
      therefore is disclosed in conjunction with raw materials. As of September 30,
      2007 and December 31, 2006, the Company carried specific reserves for excess
      and
      obsolete stocks against its inventories of $1,340,340 and $1,354,444,
      respectively.




*Note
      3*




**Property
      and Equipment:**




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




September
                30, 2007
            
            December
                31, 2006Lasers
                in service
            
            $
            18,934,855
            
            $
            16,234,834Computer
                hardware and software
            
            
            341,407
            
            
            334,490Furniture
                and fixtures
            
            
            347,843
            
            
            331,379Machinery
                and equipment
            
            
            849,237
            
            
            738,636Autos
                and trucks
            
            
            454,631
            
            
            382,690Leasehold
                improvements
            
            
            247,368
            
            
            247,36821,175,341
            
            
            18,269,397Accumulated
                depreciation and amortization
            
            
            (11,119,283
            )
            
            (9,215,299
            )Property
                and equipment, net
            
            $
            10,056,058
            
            $
            9,054,098




Depreciation
      expense was $2,621,617 and $2,159,912 for the nine months ended September 30,
      2007 and 2006, respectively. At September 30, 2007 and December 31, 2006, net
      property and equipment included $532,486 and $380,875, respectively, of assets
      recorded under capitalized lease arrangements, of which $285,624 and $122,717
      was included in long-term debt at September 30, 2007 and December 31, 2006,
      respectively (see Note 8).




*Note
      4*




**Patents
      and Licensed Technologies:**




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




September
                30, 2007
            
            December
                31, 2006Patents,
                owned and licensed, at gross costs of $510,942 and $501,657, net
                of
                accumulated amortization of $259,306 and $231,599,
                respectively.
            
            $
            251,636
            
            $
            270,058Other
                licensed or developed technologies, at gross costs of $2,432,258,
                net of
                accumulated amortization of $1,222,791 and $1,006,589,
                respectively.
            
            
            1,209,467
            
            
            1,425,669$
            1,461,103
            
            $
            1,695,727




Related
      amortization expense was $243,909 and $244,277 for the nine months ended
      September 30, 2007 and 2006, 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. 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 must reimburse $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 or developed technologies.




15




*Note
      5*




**Other
      Intangible Assets:**




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




September
                30, 2007
            
            December
                31, 2006Neutrogena
                Agreement, at gross cost of $2,400,000 net of accumulated amortization
                of
                $1,218,000 and $858,000, respectively.
            
            $
            1,182,000
            
            $
            1,542,000Customer
                Relationships, at gross cost of $1,700,000 net of accumulated amortization
                of $862,740 and $607,743, respectively.
            
            
            837,260
            
            
            1,092,257Tradename,
                at gross cost of $1,100,000 net of accumulated amortization of $279,135
                and $196,632, respectively.
            
            
            820,865
            
            
            903,368$
            2,840,125
            
            $
            3,537,625




Related
      amortization expense was $697,500 for the nine months ended September 30, 2007
      and 2006, respectively. Under the Neutrogena Agreement, the Company licenses
      to
      Neutrogena rights to its copper peptide technology 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
      6*




**Other
      Accrued Liabilities:**




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




September
                30, 2007
            
            December
                31, 2006Accrued
                warranty
            
            $
            210,785
            
            $
            123,738Accrued
                professional and consulting fees
            
            
            183,425
            
            
            320,331Accrued
                sales taxes and other accrued liabilities
            
            
            222,747
            
            
            213,224Cash
                deposits
            
            
            120,000
            
            
            -Total
                other accrued liabilities
            
            $
            736,957
            
            $
            657,293





16




*Note
      7*




**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:




September
                30, 2007
            
            December
                31, 2006Note
                Payable - secured creditor, interest at 6%, payable in monthly principal
                and interest installments of $2,880 through June 2012
            
            $
            140,078
            
            $
            159,213Note
                Payable - unsecured creditor, non-interest bearing, payable in 18
                equal
                monthly installments of $4,326 through October 2007
            
            
            4,326
            
            
            43,265Note
                Payable - unsecured creditor, interest at 8.72%, payable in monthly
                principal and interest installments of $12,120 through November
                2007
            
            
            23,978
            
            
            -Note
                Payable - unsecured creditor, interest at 5.44%, payable in monthly
                principal and interest installments of $51,354 through February
                2008
            
            
            253,314
            
            
            -Note
                Payable - unsecured creditor, interest at 7.42%, payable in monthly
                principal and interest installments of $61,493 through March
                2007
            
            
            -
            
            
            126,279421,696
            
            
            328,757Less:
                current maturities
            
            
            (308,505
            )
            
            (195,250
            )Notes
                payable, net of current maturities
            
            $
            113,191
            
            $
            133,507




*Note
      8*




**Long-term
      Debt:**




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




September
                30, 2007
            
            December
                31, 2006Total
                borrowings on credit facilities
            
            $
            6,830,217
            
            $
            6,490,077Capital
                lease obligations (see Note 3)
            
            
            285,624
            
            
            122,717Less:
                current portion
            
            
            (3,601,684
            )
            
            (3,018,874
            )Total
                long-term debt
            
            $
            3,514,157
            
            $
            3,593,920




*Leasing
      Credit Facility*




The
      long-term debt is comprised largely of borrowings under a leasing credit
      facility that the Company entered into with GE Capital Corporation (“GE”) on
      June 25, 2004. The credit facility expired on June 25, 2007. The Company
      accounted for each draw as funded indebtedness taking the form of a capital
      lease, with equitable ownership in the lasers remaining with the Company. GE
      retains title as security for the borrowings. The Company depreciates the lasers
      generally over their remaining useful lives, as established when originally
      placed into service. Each draw against the credit facility has a self-amortizing
      repayment period of three years and is secured by specified lasers, which the
      Company has sold to GE and leased back for continued deployment in the field.
      The Company does not plan on any future draws from GE; the Company will continue
      to pay down the outstanding indebtedness to GE.




Draws
      under the credit facility were set at an interest rate, which ranged from 577
      basis points above the three-year Treasury note rate in the first year of the
      term to 400 basis points above the three-year Treasury rate in the third year
      of
      the term. Each draw in the first year of the term was discounted 7.75%; draws
      made by the second and third years were discounted 3.5%. The monthly payment
      set
      for a draw is self-amortizing.




17




The
      following table summarizes the future minimum payments that the Company expects
      to make for the 11 draws made under the credit facility:




Quarter
                Ending
            
            Year
                Ending December 31,12/31/07
            
            2008
            
            2009
            
            2010Future
                minimum payments
            
            $
            875,147
            
            $
            3,842,332
            
            $
            2,297,838
            
            $
            457,080




18


With
      each
      draw, the Company issued warrants to purchase shares of the Company’s common
      stock which ranged from a high of 5% of the draw in the first year to 3% in
      the
      third year. The number of warrants was determined by dividing either 3% or
      5% of
      the draw by the average closing price of the Company’s common stock for the ten
      days preceding the date of the draw. The warrants have a five-year term from
      the
      date of each issuance and bear an exercise price set at 10% over the average
      closing price of the Company’s common stock for the ten days preceding the date
      of the draw. Taking the above factors into account, each draw has an effective
      interest rate that ranges from17.79% to 12.62%.




For
      reporting purposes, the carrying value of the liability is reduced at the time
      of each draw by the value ascribed to the warrants. This reduction will be
      amortized at the effective interest rate to interest expense over the term
      of
      the draw. 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. Future
      exercises and forfeitures will reduce the amount of warrants outstanding.
      Exercises will increase the amount of common stock outstanding and additional
      paid in capital.




In
      the
      quarter ending June 30, 2007, the Company entered into a term loan with LEAF
      Financial Corporation (“LEAF” ) in the amount of $1,755,000. The effective
      interest rate was 11.53%. LEAF will be granted a first-priority lien on XTRAC
      lasers, and their associated cash flows from consignment agreements, which
      are
      pledged by the Company and which are free of, or have been released from,
      security interests of GE. The Company will retain ownership of all of the lasers
      pledged. The term loans are granted with self-amortizing payment terms of 3
      years.




The
      Company is currently evaluating multiple proposals for future financing for
      XTRAC laser placements, one of which is a written commitment for $6 million.
      The
      Company has secured a separate source to finance the acquisition of surgical
      lasers.




*Capital
      Leases*




The
      obligations under capital leases are at fixed interest rates and are
      collateralized by the related property and equipment (see Note 3).




*Note
      9*




**Employee
      Stock Benefit Plans**




The
      Company has three active, stock-based compensation plans available to grant,
      among other things, incentive and non-incentive stock options to employees,
      directors and third-party service-providers as well as restricted stock to
      key
      employees. As of September 26, 2007, the stockholders approved an increase
      in
      the number of shares reserved for the 2005 Equity Compensation Plan and for
      the
      Outside Director Plan. Under the 2005 Equity Compensation Plan, a maximum of
      6,160,000 shares of the Company’s common stock have been reserved for issuance.
      At September 30, 2007, 2,995,250 shares were available for future grants under
      this plan. Under the Outside Director Plan and under the 2005 Investment Plan,
      905,000 shares and 388,000 shares, respectively, were available for issuance
      as
      of September 30, 2007. The other stock options plans are frozen and no further
      grants will be made from them.




Stock
      option activity under all of the Company’s share-based compensation plans for
      the nine months ended September 30, 2007 was as follows:




Number
                of Options
            
            Weighted
                Average Exercise PriceOutstanding,
                January 1, 2007
            
            
            6,093,725
            
            $
            2.09Granted
            
            
            758,000
            
            
            1.13Exercised
            
            
            (76,153
            )
            
            1.13Cancelled
            
            
            (401,386
            )
            
            1.90Outstanding,
                September 30, 2007
            
            
            6,374,186
            
            $
            2.00Options
                excercisable at September 30, 2007
            
            
            4,205,610
            
            $
            2.07




19




At
      September 30, 2007, there was $3,763,525 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 2.63 years. The intrinsic value
      of
      options outstanding and exercisable at September 30, 2007 was not
      significant.




*Note
      10*




**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 three and nine months ended September 30, 2007 and 2006, the Company
      did not have material revenues from any individual customer.




Unallocated
      operating expenses include costs that are not specific to a particular segment
      but are general to the group; included are expenses 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 from the buy-out of Acculase that was carried
      at
      $2,944,423 at September 30, 2007 and December 31, 2006 has been allocated to
      the
      domestic and international XTRAC segments based upon its fair value as of the
      date of the buy-out in the amounts of $2,061,096 and $883,327, respectively.
      Goodwill of $13,973,385 at September 30, 2007 from the ProCyte acquisition
      has
      been entirely allocated to the Skin Care segment.




20


The
      following tables reflect results of operations from our business segments for
      the periods indicated below:




Three
                Months Ended September 30, 2007DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            2,025,148
            
            $
            819,442
            
            $
            3,065,905
            
            $
            1,899,200
            
            $
            1,112,176
            
            $
            8,921,871Costs
                of revenues
            
            
            1,009,237
            
            
            538,292
            
            
            903,688
            
            
            1,545,437
            
            
            686,135
            
            
            4,682,789Gross
                profit
            
            
            1,015,911
            
            
            281,150
            
            
            2,162,217
            
            
            353,763
            
            
            426,041
            
            
            4,239,082*Gross
                profit %*
            
            
            *50.2*
            *%*
            
            *34.3*
            *%*
            
            *70.5*
            *%*
            
            *18.6*
            *%*
            
            *38.3*
            *%*
            
            *47.5*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            1,496,326
            
            
            40,809
            
            
            1,323,172
            
            
            170,374
            
            
            144,548
            
            
            3,175,229Engineering
                and product development
            
            
            -
            
            
            -
            
            
            103,696
            
            
            -
            
            
            98,467
            
            
            202,163Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,373,1001,496,326
            
            
            40,809
            
            
            1,426,868
            
            
            170,374
            
            
            243,015
            
            
            5,750,492Income
                (loss) from operations
            
            
            (480,415
            )
            
            240,341
            
            
            735,349
            
            
            183,389
            
            
            183,026
            
            
            (1,511,410
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (141,562
            )Net
                income (loss)
            
            
            ($480,415
            )
            $
            240,341
            
            $
            735,349
            
            $
            183,389
            
            $
            183,026
            
            
            ($1,652,972
            )




Three
                Months Ended September 30, 2006DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            1,601,125
            
            $
            616,342
            
            $
            3,050,249
            
            $
            1,793,088
            
            $
            1,230,743
            
            $
            8,291,547Costs
                of revenues
            
            
            1,224,007
            
            
            320,502
            
            
            913,012
            
            
            1,409,453
            
            
            791,962
            
            
            4,658,936Gross
                profit
            
            
            377,118
            
            
            295,840
            
            
            2,137,237
            
            
            383,635
            
            
            438,781
            
            
            3,632,611*Gross
                profit %*
            
            
            *23.6*
            *%*
            
            *48.0*
            *%*
            
            *70.1*
            *%*
            
            *21.4*
            *%*
            
            *35.7*
            *%*
            
            *43.8*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            987,163
            
            
            60,876
            
            
            1,300,536
            
            
            226,436
            
            
            120,908
            
            
            2,695,919Engineering
                and product development
            
            
            -
            
            
            -
            
            
            144,996
            
            
            -
            
            
            122,066
            
            
            267,062Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,203,485987,163
            
            
            60,876
            
            
            1,445,532
            
            
            226,436
            
            
            242,974
            
            
            5,166,466Income
                (loss) from operations
            
            
            (610,045
            )
            
            234,964
            
            
            691,705
            
            
            157,199
            
            
            195,808
            
            
            (1,533,855
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (159,180
            )Net
                income (loss)
            
            
            ($610,045
            )
            $
            234,964
            
            $
            691,705
            
            $
            157,199
            
            $
            195,808
            
            
            ($1,693,035
            )





21





Nine
                Months Ended September 30, 2007DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            6,048,000
            
            $
            2,117,213
            
            $
            9,646,312
            
            $
            5,727,528
            
            $
            3,730,107
            
            $
            27,269,160Costs
                of revenues
            
            
            3,117,850
            
            
            1,318,430
            
            
            2,931,419
            
            
            4,809,101
            
            
            2,315,087
            
            
            14,491,887Gross
                profit
            
            
            2,930,150
            
            
            798,783
            
            
            6,714,893
            
            
            918,427
            
            
            1,415,020
            
            
            12,777,273*Gross
                profit %*
            
            
            *48.4*
            *%*
            
            *37.7*
            *%*
            
            *69.6*
            *%*
            
            *16.0*
            *%*
            
            *37.9*
            *%*
            
            *46.9*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            4,489,067
            
            
            110,208
            
            
            4,090,291
            
            
            642,006
            
            
            451,085
            
            
            9,782,657Engineering
                and product development
            
            
            -
            
            
            -
            
            
            294,787
            
            
            -
            
            
            308,849
            
            
            603,636Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            7,383,2444,489,067
            
            
            110,208
            
            
            4,385,078
            
            
            642,066
            
            
            759,935
            
            
            17,769,537Income
                (loss) from operations
            
            
            (1,558,917
            )
            
            688,575
            
            
            2,329,815
            
            
            276,421
            
            
            655,085
            
            
            (4,992,264
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (379,947
            )Net
                income (loss)
            
            
            ($1,558,917
            )
            $
            688,575
            
            $
            2,329,815
            
            $
            276,421
            
            $
            655,085
            
            
            ($5,372,211
            )




Nine
                Months Ended September 30, 2006DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            3,988,970
            
            $
            1,438,023
            
            $
            9,580,637
            
            $
            5,158,437
            
            $
            4,430,385
            
            $
            24,596,452Costs
                of revenues
            
            
            3,050,083
            
            
            772,861
            
            
            2,905,252
            
            
            4,187,792
            
            
            2,675,036
            
            
            13,591,024Gross
                profit
            
            
            938,887
            
            
            665,162
            
            
            6,675,385
            
            
            970,645
            
            
            1,755,349
            
            
            11,005,428*Gross
                profit %*
            
            
            *23.5*
            *%*
            
            *46.3*
            *%*
            
            *69.7*
            *%*
            
            *18.8*
            *%*
            
            *39.6*
            *%*
            
            *44.7*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            3,092,163
            
            
            122,443
            
            
            3,942,482
            
            
            732,085
            
            
            399,506
            
            
            8,288,679Engineering
                and product development
            
            
            -
            
            
            -
            
            
            377,251
            
            
            -
            
            
            387,194
            
            
            764,445Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            6,917,3623,092,163
            
            
            122,443
            
            
            4,319,733
            
            
            732,085
            
            
            786,700
            
            
            15,970,486Income
                (loss) from operations
            
            
            (2,153,276
            )
            
            542,719
            
            
            2,355,652
            
            
            238,560
            
            
            968,649
            
            
            (4,965,058
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (418,170
            )Net
                income (loss)
            
            
            ($2,153,276
            )
            $
            542,719
            
            $
            2,355,652
            
            $
            238,560
            
            $
            968,649
            
            
            ($5,383,228
            )




22




September
                30, 2007
            
            December
                31, 2006Assets:Total
                assets for reportable segments
            
            $
            45,501,441
            
            $
            43,955,628Other
                unallocated assets
            
            
            9,035,857
            
            
            13,525,893Consolidated
                total
            
            $
            54,537,298
            
            $
            57,481,521




For
      the
      three and nine months ended September 30, 2007 and 2006 there were no material
      net revenues attributed to any individual foreign country. Net revenues by
      geographic area were, as follows:




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Domestic
            
            $
            7,232,506
            
            
            6,731,703
            
            $
            22,614,086
            
            $
            20,524,943Foreign
            
            
            1,689,365
            
            
            1,559,844
            
            
            4,655,074
            
            
            4,071,509$
            8,921,871
            
            $
            8,291,547
            
            $
            27,269,160
            
            $
            24,596,452




The
      Company discusses segmental details in its Management Discussion & Analysis
      found elsewhere in its Form 10-Q for the period ending September 30,
      2007.




*Note
      11*




**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 undertaken to raise. The Company has granted AzurTec an additional
      12 months (i.e. until December 30, 2007) in which to raise the additional
      investment. 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.




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.




On
      April
      14, 2006, the Company entered into a Clinical Trial Agreement protocol with
      the
      University of California at San Francisco. The protocol was originally 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. The
      protocol has been revised to be an open-label study in order to facilitate
      greater patient recruitment into the study. John Koo, MD, a member of our
      Scientific Advisory Board, is guiding the study using our high-powered UltraTM
excimer laser.




23




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




*Certain
      statements in this Quarterly Report on Form 10-Q, 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 that are discussed under the section entitled
“Risk
      Factors,” in our Annual Report on Form 10-K for the year ended December 31,
      2006.*




*The
      following discussion and analysis should be read in conjunction with the
      consolidated financial statements and related notes included elsewhere in this
      Report.*




**Introduction,
      Outlook and Overview of Business Operations**




We
      view
      our 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. In 2000, the laser system,
      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, we invested in establishing the clinical efficacy of the product and
      mechanical reliability of the equipment. In the last three years, we have
      pursued widespread reimbursement commencing with obtaining Current Procedure
      Terminology (“CPT”) reimbursement codes that became effective in 2003. This was
      followed by a lengthy process of persuading private medical insurers to adopt
      a
      positive reimbursement policy for the procedure. As a result of initiatives
      undertaken by the Company and by the physician community, the ability for
      physicians to process claims efficiently and receive positive payment decisions
      for use of the XTRAC system improved significantly during the latter part of
      2005 and during 2006. In March 2007, 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. The Blue
      Cross Blue Shield Insurance plans have now adopted positive payment policies
      in
      Illinois, New Mexico, Oklahoma and Texas. The Company is now seeking adoption
      of
      this National Reference Policy by the remaining state Blue Cross Blue Shield
      Health Insurance Plans which currently do not have a positive payment policy
      for
      the XTRAC.




24




Our
      23-person XTRAC sales organization includes 13 sales representatives, 8 clinical
      specialists and 2 marketing support personnel. Our 26-person skin care sales
      organization includes 19 sales representatives, 5 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.




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 also
      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.




**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 have 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.




Due
      to
      the significant financial investment requirements,  we
      did
      not implement an international XTRAC and/or VTRAC fee-per-use revenue model,
      similar to our domestic revenue model. However, as reimbursement in the domestic
      market has become more widespread, we have recently started to offer a version
      of this model overseas.




**Skin
      Care (ProCyte)**




Skin
      Care
      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.




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. Looking
      to the future, we shall seek growth from a stream of new dermatological
      products, and support the new products with intellectual property where
      appropriate and where feasible.ProCyte has also expanded the use of its
      novel copper peptide technologies into the mass retail market for skin and
      hair
      care through targeted technology licensing and supply agreements.




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




25




**Surgical
      Services**




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. We
      are
      continuing a cautious strategy in this segment in order to conserve our cash
      resources for the XTRAC business segments.




**Surgical
      Products**




The
      Surgical Products segment generates revenues by selling laser products and
      disposables to hospitals and surgery centers both inside and outside of the
      United States. Also included are various non-laser surgical products (e.g.
      the
      ClearEss® II suction-irrigation system). We expect that sales of surgical laser
      systems and the related disposable base may begin to erode as hospitals continue
      to seek outsourcing solutions instead of purchasing lasers and related
      disposables for their operating rooms. We are working to offset this erosion
      by
      cautiously expanding our surgical services segment and by increasing sales
      from
      the diode surgical laser introduced in 2004, including OEM
      arrangements.




**Critical
      Accounting Policies**




There
      have been no changes to our critical accounting policies in the three and nine
      months ended September 30, 2007. Critical accounting policies and the
      significant estimates made in accordance with them are regularly discussed
      with
      our Audit Committee. Those policies are discussed under “Critical Accounting
      Policies” in our “Management’s Discussion and Analysis of Financial Condition
      and Results of Operations” included in Item 7 of our Annual Report on Form 10-K
      for the year ended December 31, 2006.




26


**Results
      of Operations**




***Revenues***




The
      following table presents revenues from our five business segments for the
      periods indicated below:




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006XTRAC
                Domestic Services
            
            $
            2,025,148
            
            $
            1,601,125
            
            $
            6,048,000
            
            $
            3,988,970International
                Dermatology Equipment Products
            
            
            819,442
            
            
            616,342
            
            
            2,117,213
            
            
            1,438,023Skin
                Care (ProCyte) Products
            
            
            3,065,905
            
            
            3,050,249
            
            
            9,646,312
            
            
            9,580,637Total
                Dermatology Revenues
            
            
            5,910,495
            
            
            5,267,716
            
            
            17,811,525
            
            
            15,007,630Surgical
                Services
            
            
            1,899,200
            
            
            1,793,088
            
            
            5,727,528
            
            
            5,158,437Surgical
                Products
            
            
            1,112,176
            
            
            1,230,743
            
            
            3,730,107
            
            
            4,430,385Total
                Surgical Revenues
            
            
            3,011,376
            
            
            3,023,831
            
            
            9,457,635
            
            
            9,588,822Total
                Revenues
            
            $
            8,921,871
            
            $
            8,291,547
            
            $
            27,269,160
            
            $
            24,596,452




Domestic
      XTRAC Segment




Recognized
      treatment revenue for the three months ended September 30, 2007 and 2006 for
      domestic XTRAC procedures was $1,716,383 and $1,263,000, respectively,
      reflecting billed procedures of 27,858 and 20,043, respectively. In addition,
      1,229 and 2,161 procedures were performed in the three months ended September
      30, 2007 and 2006, respectively, without billing from us, in connection with
      clinical research and customer evaluations of the XTRAC laser. Recognized
      treatment revenue for the nine months ended September 30, 2007 and 2006 for
      domestic XTRAC procedures was $4,711,075 and $3,650,845, respectively,
      reflecting billed procedures of 80,651 and 60,168, respectively. In addition,
      3,677 and 4,813 procedures were performed in the nine months ended September
      30,
      2007 and 2006, respectively, without billing from us, in connection with
      clinical research and customer evaluations of the XTRAC laser. The increase
      in
      procedures in the periods ended September 30, 2007 compared to the comparable
      periods in 2006 was largely related to our continuing progress in securing
      favorable reimbursement policies from private insurance plans. Increases in
      procedures are dependent upon on 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
      Staff Accounting Bulletin No. 104, we recognize service revenue during this
      program from the sale of XTRAC procedures or equivalent treatments to physicians
      participating in this program only to the extent the physician has been
      reimbursed for the treatments. For the three months ended September 30, 2007,
      we
      deferred net revenues of $19,494 under this program compared to $54,211of
      additional recognized revenues for the three months ended September 30, 2006.
      For the nine months ended September 30, 2007, we deferred net revenues of
      $173,369 under this program compared to $102,257 for the nine months ended
      September 30, 2006. The change in deferred revenue under this program is
      presented in the table below.




For
      the
      three and nine months ended September 30, 2007, domestic XTRAC laser sales
      were
      $308,765 and $1,336,925, respectively. There were 5 and 28 lasers sold,
      respectively. For the three and nine months ended September 30, 2006 domestic
      XTRAC laser sales were $338,125. We began selling lasers in the quarter ended
      September 30, 2006, and 8 lasers were sold. 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 respectable
      margins, a sector of the market that is better suited to a sale model than
      a
      per-procedure model.




27




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Total
                revenue
            
            $
            2,025,148
            
            $
            1,601,125
            
            $
            6,048,000
            
            $
            3,988,970Less:
                laser sales revenue
            
            
            (308,765
            )
            
            (338,125
            )
            
            (1,336,925
            )
            
            (338,125
            )Recognized
                treatment revenue
            
            
            1,716,383
            
            
            1,263,000
            
            
            4,711,075
            
            
            3,650,845Change
                in deferred program
              Revenue
            
            
            19,494
            
            
            (54,211
            )
            
            173,369
            
            
            102,257Change
                in deferred unused
              Treatments
            
            
            71,893
            
            
            114,410
            
            
            392,635
            
            
            200,683Net
                billed revenue
            
            $
            1,807,770
            
            $
            1,323,199
            
            $
            5,277,079
            
            $
            3,953,785Procedure
                volume total
            
            
            29,087
            
            
            22,204
            
            
            84,328
            
            
            64,981Less:
                Non-billed procedures
            
            
            1,229
            
            
            2,161
            
            
            3,677
            
            
            4,813Net
                billed procedures
            
            
            27,858
            
            
            20,043
            
            
            80,651
            
            
            60,168Avg.
                price of treatments billed
            
            $
            64.89
            
            $
            66.02
            
            $
            65.43
            
            $
            65.71Change
                in procedures with deferred/(recognized) program revenue,
                net
            
            
            300
            
            
            (821
            )
            
            2,650
            
            
            1,556Change
                in procedures with deferred unused treatments, net
            
            
            1,108
            
            
            1,733
            
            
            6,001
            
            
            3,054




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 Blue Cross Blue Shield Association (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 dermatology equipment and related parts were $819,442 for the
      three
      months ended September 30, 2007 compared to $616,342 for the three months ended
      September 30, 2006. We sold 15 and 13 pieces of dermatology equipment (i.e.
      lasers and lamps) in the three months ended September 30, 2007 and 2006,
      respectively. International sales of our dermatology equipment and related
      parts
      were $2,117,213 for the nine months ended September 30, 2007 compared to
      $1,438,023 for the nine months ended September 30, 2006. We sold 40 and 31
      laser
      and lamp systems in the nine months ended September 30, 2007 and 2006,
      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 to reduce the prices we charge to international distributors.
      Furthermore, average selling prices for international dermatology equipment
      are
      influenced by the following two factors:




·
            We
                began selling refurbished domestic XTRAC laser systems into the
                international market. The selling price for used equipment is
                substantially less than new equipment. We sold one and four such
                used
                lasers in the three and nine months ended September 30, 2007,
                respectively, and one and six such lasers in the three and nine months
                ended September 30, 2006, respectively;
                and




28




·
            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. In the three and nine
                months ended September 30, 2007, we sold one and ten VTRAC systems,
                respectively. In the three and nine months ended September 30, 2006,
                we
                sold six and ten VTRAC systems,
                respectively.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            819,442
            
            $
            616,342
            
            $
            2,117,213
            
            $
            1,438,023Less:
                part sales
            
            
            (112,152
            )
            
            (82,542
            )
            
            (381,223
            )
            
            (232,463
            )Laser
                revenues
            
            
            707,290
            
            
            533,800
            
            
            1,735,990
            
            
            1,205,560Laser
                systems sold
            
            
            15
            
            
            13
            
            
            40
            
            
            31Average
                revenue per laser
            
            $
            47,153
            
            $
            41,062
            
            $
            43,400
            
            $
            38,889




Skin
      Care (ProCyte) Segment




For
      the
      three months ended September 30, 2007, ProCyte revenues were $3,065,905 compared
      to $3,050,249 in the three months ended September 30, 2006. For the nine months
      ended September 30, 2007, ProCyte revenues were $9,646,312 compared to
      $9,580,637 in the nine months ended September 30, 2006. ProCyte revenues are
      generated from the sale of various skin, hair care and wound products, from
      the
      sale of copper peptide compound and from royalties on licenses, mainly from
      Neutrogena.




Bulk
      compound sales decreased by $160,400 for the nine months ended September 30,
      2007 compared to the nine months ended September 30, 2006. These sales are
      mainly from Neutrogena and will affect future royalties earned from Neutrogena.
      Minimum contractual royalties from Neutrogena are scheduled to expire in
      November 2007.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Product
                sales
            
            $
            2,894,905
            
            $
            2,901,891
            
            $
            9,085,312
            
            $
            8,818,267Bulk
                compound sales
            
            
            96,000
            
            
            112,400
            
            
            336,000
            
            
            496,400Royalties
            
            
            75,000
            
            
            35,958
            
            
            225,000
            
            
            265,970Total
                ProCyte revenues
            
            $
            3,065,905
            
            $
            3,050,249
            
            $
            9,646,312
            
            $
            9,580,637




We
      engaged a new senior officer to direct the operations of our Skin Care segment.
      The new officer has devised plans to increase existing product sales and to
      introduce new products of our own (e.g. Neova® Skin Brightening Serum) and
      third-party products we have licensed (e.g. MD Lash FactorTM conditioner). Sale
      of MD Lash Factor conditioner in the quarter ended September 30, 2007 were
      $255,108.




Surgical
      Services Segment




In
      the
      three months ended September 30, 2007 and 2006, surgical services revenues
      were
      $1,899,200 and $1,793,088, respectively. In the nine months ended September
      30,
      2007 and 2006, surgical services revenues were $5,727,528 and $5,158,437,
      respectively. These increases were primarily due to an increase in revenue
      from
      urology 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.




29




Surgical
      Products Segment




Surgical
      Products revenues include revenues derived from the sale 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
      three months ended September 30, 2007, surgical products revenues were
      $1,112,176 compared to $1,230,743 in the three months ended September 30, 2006.
      The decrease was largely due to a lower average selling price for the 19 lasers
      sold in the three months ended September 30, 2007. For the nine months ended
      September 30, 2007, surgical products revenues were $3,730,107 compared to
      $4,430,385 in the nine months ended September 30, 2006. The decrease was partly
      due to $278,800 less laser system revenues, as a result of a decrease in the
      number of systems sold (55 vs. 61) and a decrease in the average price per
      laser.




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, which has a lower sales
      price than our other types of lasers, has largely replaced our Nd:YAG laser,
      which had a higher sales price. Included in laser sales during the three and
      nine months ended September 30, 2007 were sales of 19 and 47 diode lasers.
      There
      were sales of 14 and 50 diode lasers, during the three and nine months ended
      September 30, 2006. We expect that we will continue to sell more diode lasers
      than our other types of lasers in the near future, including under OEM
      (“Original Equipment Manufacturer) arrangements.




Fiber
      and
      other disposables sales decreased 11% and 15% between the comparable three-month
      and nine-month periods ended September 30, 2007 and 2006. This is due to the
      fact that in the nine months ended September 30, 2006 we had a one-time order
      of
      approximately $250,000. We expect that our disposables base may erode over
      time
      as hospitals continue to seek outsourcing solutions instead of purchasing lasers
      and related disposables for their operating rooms. We continue to seek to offset
      this erosion through expansion of our surgical services. Similarly, we believe
      there will be continuing pressure on laser system sales as hospitals continue
      to
      outsource their laser-assisted procedures to third parties, such as our surgical
      services business. Any decline in laser and disposables revenues is partly
      offset by sales of holmium, CO2 and diode surgical lasers.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            1,112,176
            
            $
            1,230,743
            
            $
            3,730,107
            
            $
            4,430,385Laser
                systems sold
            
            
            19
            
            
            16
            
            
            55
            
            
            61Laser
                system revenues
            
            $
            285,995
            
            $
            305,625
            
            $
            1,120,035
            
            $
            1,397,965Average
                revenue per laser
            
            $
            15,052
            
            $
            19,102
            
            $
            20,364
            
            $
            22,917




***Cost
      of Revenues***




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




30




Product
      cost of revenues for the three months ended September 30, 2007 was $2,154,566,
      which was relatively level with the $2,097,500 of product cost of revenues
      for
      the three months ended September 30, 2006.




Product
      cost of revenues for the nine months ended September 30, 2007 was $6,703,250
      compared to $6,374,344 for the nine months ended September 30, 2006. The
      increase of $328,906 is proportionate to the increase in revenues between the
      periods with slight differences being accounted for by a change in the mix
      of
      products sold.




Services
      cost of revenues was $2,528,222 in the three months ended September 30, 2007
      compared to $2,561,436 in the comparable period in 2006 representing a decrease
      of $33,214. These costs did not increase proportionate to the increase in
      service revenues largely due to the improved manufacturing efficiencies in
      our
      XTRAC plant.




Services
      cost of revenues was $7,788,637 in the nine months ended September 30, 2007
      compared to $7,216,680 in the comparable period in 2006. The increase of
      $571,957 is proportionate to the increase in revenues between the periods with
      slight differences being accounted for by a change in the mix of products sold.




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. The unabsorbed costs 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:




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Product:XTRAC
                Domestic
            
            $
            53,295
            
            $
            96,333
            
            $
            219,550
            
            $
            96,333International
                Dermatology
              Equipment
            
            
            538,292
            
            
            320,502
            
            
            1,318,430
            
            
            772,861Skin
                Care
            
            
            903,688
            
            
            913,012
            
            
            2,931,419
            
            
            2,905,252Surgical
                products
            
            
            659,291
            
            
            767,653
            
            
            2,233,851
            
            
            2,599,898Total
                Product costs
            
            $
            2,154,566
            
            $
            2,097,500
            
            $
            6,703,250
            
            $
            6,374,344Services:XTRAC
                Domestic
            
            $
            955,942
            
            $
            1,127,674
            
            $
            2,898,300
            
            $
            2,953,750Surgical
                Services
            
            
            1,572,280
            
            
            1,433,762
            
            
            4,890,337
            
            
            4,262,930Total
                Services costs
            
            $
            2,528,222
            
            $
            2,,561,436
            
            $
            7,788,637
            
            $
            7,216,680Total
                Costs of Revenues
            
            $
            4,682,788
            
            $
            4,658,936
            
            $
            14,491,887
            
            $
            13,591,024




***Gross
      Profit Analysis***




Gross
      profit increased to $4,239,083 during the three months ended September 30,
      2007
      from $3,632,611 during the same period in 2006. As a percent of revenues, gross
      margin increased to 47.5% for the three months ended September 30, 2007 from
      43.8% for the same period in 2006.




Gross
      profit increased to $12,777,273 during the nine months ended September 30,
      2007
      from $11,005,428 during the same period in 2006. As a percent of revenues,
      gross
      margin increased to 46.9% for the nine months ended June 30, 2007 from 44.7%
      for
      the same period in 2006.




31


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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,**Company
                Profit Analysis**
            
            2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            8,921,871
            
            $
            8,291,547
            
            $
            27,269,160
            
            $
            24,596,452Percent
                increase
            
            
            7.6
            %
            
            
            
            
            10.9
            %Cost
                of revenues
            
            
            4,682,788
            
            
            4,658,936
            
            
            14,491,887
            
            
            13,591,024Percent
                increase
            
            
            0.5
            %
            
            
            
            
            6.6
            %Gross
                profit
            
            $
            4,239,083
            
            $
            3,632,611
            
            $
            12,777,273
            
            $
            11,005,428Gross
                margin percentage
            
            
            47.5
            %
            
            43.8
            %
            
            46.9
            %
            
            44.7
            %




The
      primary reasons for the increase in gross profit for the three months ended
      September 30, 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. 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.




·
            The
                margin on XTRAC lasers sold domestically were higher in the three
                months
                ended September 30, 2007 (83%) than in the three months ended September
                30, 2006 (72%).




The
      primary reasons for the increase in gross profit for the nine months ended
      September 30, 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.




·
            We
                sold approximately $1 million more lasers domestically in the nine
                months
                ended September 30, 2007 at high margins compared to the same period
                in
                2006. Certain of these lasers were previously being
                depreciated.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,**XTRAC
                Domestic Segment**
            
            2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            2,025,148
            
            $
            1,60,1125
            
            $
            6,048,000
            
            $
            3,988,970Percent
                increase
            
            
            26.5
            %
            
            
            
            
            51.6
            %Cost
                of revenues
            
            
            1,009,237
            
            
            1,224,007
            
            
            3,117,850
            
            
            3,050,083Percent
                (decrease)/increase
            
            
            (17.5
            %)
            
            
            
            
            2.2
            %Gross
                profit
            
            $
            1,015,911
            
            $
            377,118
            
            $
            2,930,150
            
            $
            938,887Gross
                margin percentage
            
            
            50.2
            %
            
            23.6
            %
            
            48.4
            %
            
            23.5
            %




Gross
      profit increased for this segment for the three and nine months ended September
      30, 2007 from the comparable periods in 2006 by $638,793 and $1,991,263. The
      key
      factors for the increases 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.




32




·
            Procedure
                volume increased 39% from 20,043 to 27,858 billed procedures in the
                three
                months ended September 30, 2007 compared to the same period in 2006.
                Price
                per procedure did not change significantly between the periods. Procedure
                volume increased 34% from 60,168 to 80,651 billed procedures in the
                nine
                months ended September 30, 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.




·
            The
                margin on XTRAC lasers sold domestically were higher in the three
                months
                ended September 30, 2007 (83%) than in the three months ended September
                30, 2006 (72%). We sold approximately $1 million more lasers domestically
                in the nine months ended September 30, 2007 at high margins compared
                to
                the same period in 2006. Certain of these lasers were previously
                being
                depreciated.




·
            The
                cost of revenues decreased by $214,770 for the three months ended
                September 30, 2007. This decrease is due to the absorption of additional
                allocable XTRAC manufacturing overhead costs due to the increased
                production. In addition, there was a decrease in the cost of sales
                for the
                lasers sold domestically of $43,038. The cost of revenues increased
                by
                $67,767 for the nine months ended September 30, 2007, mainly due
                to an
                increase in the cost of sales for the lasers sold domestically of
                $123,217.




33




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,**International
                Dermatology**
              **Equipment
                Segment**
            
            2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            819,442
            
            $
            616,342
            
            $
            2,117,213
            
            $
            1,438,023Percent
                increase
            
            
            33.0
            %
            
            
            
            
            47.2
            %Cost
                of revenues
            
            
            538,292
            
            
            320,502
            
            
            1,318,430
            
            
            772,861Percent
                increase
            
            
            68.0
            %
            
            
            
            
            70.6
            %Gross
                profit
            
            $
            281,150
            
            $
            295,840
            
            $
            798,783
            
            $
            665,162Gross
                margin percentage
            
            
            34.3
            %
            
            48.0
            %
            
            37.7
            %
            
            46.3
            %




Gross
      profit for the three months ended September 30, 2007 decreased by $14,690 from
      the comparable period in 2006. The key factors for the decrease were as
      follows:




·
            We
                sold fourteen XTRAC laser systems and one VTRAC lamp-based excimer
                system
                during the three months ended September 30, 2007 and seven XTRAC
                laser
                systems and six VTRAC systems in the comparable period in 2006. A
                new
                VTRAC system has a lower price point but a higher gross margin percentage
                than a new XTRAC Ultra system.




·
            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.




Gross
      profit for the nine months ended September 30, 2007 increased by $133,621 from
      the comparable periods in 2006. The key factors for the increase were as
      follows:




·
            We
                sold thirty XTRAC laser systems and ten VTRAC lamp-based excimer
                systems
                during the nine months ended September 30, 2007 and twenty-one XTRAC
                laser
                systems and ten 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 nine months ended September
                30,
                2007 compared to the nine months ended September 30, 2006 and the
                average
                selling price was approximately 5%
                higher.




34


The
      following table analyzes the gross profit for our SkinCare (ProCyte) segment
      for
      the periods presented below:




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,**Skin
                Care (ProCyte) Segment**
            
            2007
            
            2006
            
            2007
            
            2006Product
                revenues
            
            $
            2,894,905
            
            $
            2,901,891
            
            $
            9,085,312
            
            $
            8,818,267Bulk
                compound revenues
            
            
            96,000
            
            
            112,400
            
            
            336,000
            
            
            496,400Royalties
            
            
            75,000
            
            
            35,958
            
            
            225,000
            
            
            265,970Total
                revenues
            
            
            3,065,905
            
            
            3,050,249
            
            
            9,646,312
            
            
            9,580,637Product
                cost of revenues
            
            
            835,336
            
            
            843,253
            
            
            2,699,497
            
            
            2,597,174Bulk
                compound cost of revenues
            
            
            68,352
            
            
            69,759
            
            
            231,922
            
            
            308,078Total
                cost of revenues
            
            
            903,688
            
            
            913,012
            
            
            2,931,419
            
            
            2,905,252Gross
                profit
            
            $
            2,162,217
            
            $
            2,137,237
            
            $
            6,714,893
            
            $
            6,675,385Gross
                margin percentage
            
            
            70.5
            %
            
            70.1
            %
            
            69.6
            %
            
            69.5
            %




Gross
      profit for the three and nine months ended September 30, 2007 was relatively
      level with the comparable periods in 2006.






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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,**Surgical
                Services Segment**
            
            2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            1,899,200
            
            $
            1,793,088
            
            $
            5,727,528
            
            $
            5,158,437Percent
                increase
            
            
            5.9
            %
            
            
            
            
            11.0
            %Cost
                of revenues
            
            
            1,545,437
            
            
            1,409,453
            
            
            4,809,101
            
            
            4,187,792Percent
                increase
            
            
            9.6
            %
            
            
            
            
            14.8
            %Gross
                profit
            
            $
            353,763
            
            $
            383,635
            
            $
            918,427
            
            $
            970,645Gross
                margin percentage
            
            
            18.6
            %
            
            21.4
            %
            
            16.0
            %
            
            18.8
            %




Gross
      profit in the Surgical Services segment for the three and nine months ended
      September 30, 2007 decreased by $29,872 and $52,218, respectively, from the
      comparable periods in 2006. The key factor impacting gross margin for the
      Surgical Services business was:


·
              For
                  the three months ended September 30, 2007 compared to the three
                  months
                  ended September 30, 2006, the Company incurred incremental costs
                  in
                  technicians of $43,000, outside contractors of $24,000 and incremental
                  depreciation of $59,000.




·
              For
                  the nine months ended September 30, 2007 compared to the nine months
                  ended
                  September 30, 2006, the Company incurred incremental costs in technicians
                  of $69,000, repairs of $62,000, outside contractors of $92,000
                  and
                  incremental depreciation of
                  $168,000.




35


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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,**Surgical
                Products Segment**
            
            2007
            
            2006
            
            2007
            
            2006Revenues
            
            $
            1,112,176
            
            $
            1,230,743
            
            $
            3,730,107
            
            $
            4,430,385Percent
                decrease
            
            
            (9.6
            %)
            
            
            
            
            (15.8
            %)Cost
                of revenues
            
            
            686,135
            
            
            791,962
            
            
            2,315,087
            
            
            2,675,036Percent
                decrease
            
            
            (13.4
            %)
            
            
            
            
            (13.5
            %)Gross
                profit
            
            $
            426,041
            
            $
            438,781
            
            $
            1,415,020
            
            $
            1,755,349Gross
                margin percentage
            
            
            38.3
            %
            
            35.7
            %
            
            37.9
            %
            
            39.6
            %




Gross
      profit for the Surgical Products segment in the three and nine months ended
      September 30, 2007 compared to the same periods in 2006 decreased by $12,740
      and
      $340,329. The key factors impacting gross margin 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 three months ended September 30, 2007 decreased by $118,567
                from
                the three months ended September 30, 2006 while cost of revenues
                decreased
                by $105,827 between the same periods. There were three more laser
                systems
                sold in the three months ended September 30, 2007 than in the comparable
                period of 2006, although, the lasers sold in the 2007 period were
                at lower
                prices than in the comparable period in 2006. The decrease in average
                price per laser was largely due to the mix of lasers
                sold.




·
            Revenues
                for the nine months ended September 30, 2007 decreased by $700,278
                from
                the nine months ended September 30, 2006 while cost of revenues decreased
                by $359,949 between the same periods. There were six less laser systems
                sold in the nine months ended September 30, 2007 than in the comparable
                period of 2006. Additionally, the lasers sold in the 2007 period
                were at
                lower prices than in the comparable period in 2006. The decrease
                in
                average price per laser was largely due to the mix of lasers sold.




·
            Additionally
                there was a decrease in sales of disposables between the periods.
                Disposables, which have a higher gross margin as a percent of revenues
                than lasers. Fiber and other disposables sales decreased 11% and
                15%
                between the comparable three-month and nine-month periods ended September
                30, 2007 and 2006. This is due to in part to having a one-time order
                of
                approximately $250,000 in the nine months ended September 30,
                2006.




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




For
      the
      three months ended September 30, 2007, selling, general and administrative
      expenses increased $648,925 to $5,548,329 from the three months ended September
      30, 2006. The increase was caused by higher sales costs due to increased
      staffing and related travel of $355,000, and increases in marketing/advertising
      expense of $125,000, legal expense of $122,000 and stock-based compensation
      expense of $46,000.




For
      the
      nine months ended September 30, 2007, selling, general and administrative
      expenses increased $1,959,860 to $17,165,901 from the nine months ended
      September 30, 2006. The increase was caused by higher sales costs due to
      increased staffing and related travel of $1,327,000, and increases in consulting
      expenses of $100,000 and legal of $430,000.




36




***Engineering
      and Product Development***




Engineering
      and product development expenses for the three months ended September 30, 2007
      decreased to $202,163 from $267,062 for the three months ended September 30,
      2006. Engineering and product development expenses for the nine months ended
      September 30, 2007 decreased to $603,636 from $764,445 for the nine months
      ended
      September 30, 2006. The decreases were due to changes in staffing levels. 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.




***Interest
      Expense, Net***




Net
      interest expense for the three months ended September 30, 2007 decreased to
      $141,562, as compared to $159,180 for the three months ended September 30,
      2006.
      Net interest expense for the nine months ended September 30, 2007 decreased
      to
      $379,947, as compared to $418,170 for the nine months ended September 30, 2006.
      The change in net interest expense was the result of the interest earned on
      cash
      reserves offsetting an increase in interest expense due to draws on the lease
      line of credit during the third and fourth quarters of 2006 and the first and
      second quarters of 2007.




***Net
      Loss***




The
      aforementioned factors resulted in a net loss of $1,652,972 during the three
      months ended September 30, 2007, as compared to a net loss of $1,693,035 during
      the three months ended September 30, 2006, a decrease of 2.4%. The
      aforementioned factors resulted in a net loss of $5,372,211 during the nine
      months ended September 30, 2007, as compared to a net loss of $5,383,228 during
      the nine months ended September 30, 2006, a decrease of .2%.




The
      following table illustrates the impact of major expenses, namely depreciation,
      amortization and stock option expense between the periods:




For
                the three months ended September 30,2007
            
            2006
            
            ChangeNet
                loss
            
            $
            1,652,972
            
            $
            1,693,035
            
            
            ($40,063
            )Major
                expenses included in net loss:Depreciation
                and amortization
            
            
            1,231,111
            
            
            1,047,178
            
            
            183,933Stock-based
                compensation
            
            
            395,058
            
            
            349,553
            
            
            45,505Total
                major expenses
            
            $
            1,626,169
            
            $
            1,396,731
            
            $
            229,438




For
                the nine months ended September 30,2007
            
            2006
            
            ChangeNet
                Loss
            
            $
            5,372,211
            
            $
            5,383,228
            
            
            ($11,017
            )Major
                Expenses:Depreciation
                and amortization
            
            
            3,563,026
            
            
            3,101,689
            
            
            461,337Stock-based
                compensation
            
            
            1,197,150
            
            
            1,248,111
            
            
            (50,961
            )$
            4,760,176
            
            $
            4,349,800
            
            $
            410,376




37




***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 flows from
      operations.




At
      September 30, 2007, our current ratio was 2.10 compared to 2.66 at December
      31,
      2006. As of September 30, 2007, we had $11,898,523 of working capital compared
      to $16,069,616 as of December 31, 2006. Cash and cash equivalents were
      $8,276,473 as of September 30, 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
      September 30, 2007 compared to $156,000 as of December 31, 2006. ****




As
      of
      September 30, 2007, we had an accumulated deficit of $93,047,214, and cash
      and
      cash equivalents were $8,276,473, including restricted cash of $117,000,
      reflecting the private placement of our common stock in November 2006. We have
      historically financed our operations with cash provided by equity financing
      and
      from lines of credit and, more recently but not yet consistently, from positive
      cash flow generated from operations . The
      2007
      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 2007 operating
      plan calls for increased revenues and profits from the Skin Care business.
      Management of the Company believes that our existing cash balance together
      with
      other existing financial resources, including access to lease financing for
      capital expenditures, and revenues from sales, distribution, licensing and
      manufacturing relationships, will be sufficient to meet our operating and
      capital requirements, at a minimum, beyond the third quarter of 2008.




On
      June
      25, 2004, we entered into a leasing credit facility from GE Capital Corporation
      (“GE”). The credit facility expired on June 25, 2007. We accounted for each draw
      as funded indebtedness taking the form of a capital lease, with equitable
      ownership in the lasers remaining with us. GE retains title as a form of
      security over the lasers. We continue to make the monthly payments scheduled
      for
      each outstanding draw. A summary of the activity under the GE leasing credit
      facility is presented in Note 8, “ *Long-term
      Debt* ”.
      We do
      not plan on any future draws from GE.




In
      the
      quarter ending June 30, 2007, we entered into a term loan from LEAF in the
      amount of $1,755,000. The effective interest rate was 11.53%. LEAF has a first
      priority lien on XTRAC lasers, and the associated cash flows from consignment
      agreements which are pledged by us. The term loans are granted with
      self-amortizing payment terms of 3 years.




We
      are
      currently evaluating multiple proposals for future financing for XTRAC laser
      placements, one of which is a written commitment for $6 million.




Net
      cash
      used by operating activities was $843,852 for nine months ended September 30,
      2007, compared to cash provided by $817,998 for the same period in 2006. The
      change was primarily due to an increase in inventory, an increase in accounts
      receivable and a decrease in accrued compensation expense.




Net
      cash
      used in investing activities was $3,525,572 for the nine months ended September
      30, 2007 compared to cash used of $3,546,179 for the nine months ended September
      30, 2006. This was primarily for the placement of lasers into
      service.




Net
      cash
      used by financing activities was $201,005 for the nine months ended September
      30, 2007 compared to cash provided of $1,606,602 for the nine months ended
      September 30, 2006. In the nine months ended September 30, 2007 we made payments
      of $566,917 on certain notes payable and capital lease. These payments were
      offset, in part, by the advances under the lease line of credit, net of
      payments, of $236,758.




***Commitments
      and Contingencies***




Except
      for items discussed in ***Legal
      Proceedings*** below,
      during the three and nine months ended September 30, 2007, there were no other
      items that significantly impacted our commitments and contingencies as discussed
      in the notes to our 2006 annual financial statements included in our Annual
      Report on Form 10-K. In addition, we have no significant off-balance sheet
      arrangements.




38




***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
      3. 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 treasury risk management issues in connection with
      changes in interest rates and foreign currency rates.




**ITEM
      4. Controls and Procedures**




***Evaluation
      of Disclosure Controls and Procedures***





Our
      management, with the participation of our Chief Executive Officer and Chief
      Financial Officer, evaluated the effectiveness of our disclosure controls and
      procedures as of the end of the period covered by this Report. Based on that
      evaluation, the Chief Executive Officer and Chief Financial Officer concluded
      that our disclosure controls and procedures as of the end of the period covered
      by this Report are effective such that information required to be disclosed
      by
      us in reports filed under the Securities Exchange Act of 1934 is (i) recorded,
      processed, summarized and reported within the time periods specified in the
      Securities and Exchange Commission’s rules and forms and (ii) accumulated and
      communicated to our management, including the Chief Executive Officer and Chief
      Financial Officer, as appropriate to allow timely decisions regarding
      disclosure.





***Change
      in Internal Control Over Financial Reporting***





No
      change
      in our internal control over financial reporting occurred during the three
      and
      nine months ended September 30, 2007 that has materially affected, or is
      reasonably likely to materially affect, our internal control over financial
      reporting.




**PART
      II - Other Information**




**ITEM
      1. Legal Proceedings**




Reference
      is made to Item 3, ***Legal
      Proceedings*** ,
      in our
      Annual Report on Form 10-K for the year ended December 31, 2006 for descriptions
      of our legal proceedings.




In
      the
      matter we brought against RA Medical Systems, Inc. and Dean Irwin in the United
      States District Court for the Southern District of California, a new trial
      judge
      has been assigned to the case. The new judge heard oral argument on defendants’
motion for summary judgment, and on October 29, 2007, granted the motion. We
      are
      reviewing the judge’s opinion and evaluating our next course of action
      based on business and legal factors.




In
      the
      matter brought by RA Medical and Mr. Irwin against us and removed to the United
      States District Court for the Southern District of California, the same new
      trial judge in the forgoing action was assigned to this case as well. The new
      judge heard oral argument on plaintiffs’ motion to dismiss various counterclaims
      brought by us, and on October 29, 2007, granted the motion without prejudice.
      Plaintiffs’ claim against us of unfair competition and our counterclaim of
      contractual interference against the plaintiffs were not affected by the grant
      of the motion. We are reviewing the judge’s opinion and evaluating our next
      course of action
      based on business and legal factors.




In
      the
      matter we have brought against our insurance carrier in the United States
      District Court for the Eastern District of Pennsylvania for declaratory judgment
      and breach of contract, we are awaiting the decision of the trial judge in
      the
      parties’ cross-motions for summary judgment. Discovery in the case has been
      stayed pending the judge’s rulings.




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
      such litigation and claims will be resolved without a material effect on our
      consolidated financial position, results of operations or liquidity.




39


**ITEM
      1A. Risk Factors**




There
      have been no material changes in our risk factors from those disclosed in our
      Annual Report on Form 10-K for the year ended December 31, 2006.




**ITEM
      6. Exhibits**




10.39
            
            Restricted
                Stock Agreement, dated August 13, 2007, between PhotoMedex, Inc.
                and
                Michael R. Stewart31.1
            
            Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer31.2
            
            Rule 13a-14(a)/15d-14(a) Certification 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




40




**SIGNATURES**





Pursuant
      to the requirements 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:
              November 9, 2007
            By:
            /s/
              Jeffrey F. O’DonnellJeffrey
                F. O’Donnell
              President
                and Chief Executive Officer




Date:
              November 9, 2007
            By:
            /s/
              Dennis M. McGrathDennis
                M. McGrath
              Chief
                Financial Officer




41