**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10 - Q**





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


**SECURITIES
      EXCHANGE ACT OF 1934**





**For
      the quarterly period ended June 30, 2006**





**OR**





**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
              59-2058100(State
                  or other jurisdiction
                of
                  incorporation or organization)
              (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 if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes x No o





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


Yes o No x





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


Yes x No o





Indicate
      by check mark 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 filero
              Accelerated
                  filerx
              Non-accelerated
                  filero




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


Yes o No x





The
      number of shares outstanding of the issuer's Common Stock as of August 8, 2006
      was 52,625,491 shares.







HOTOMEDEX,
      INC. AND SUBSIDIARIES





INDEX





Part
                I. Financial Information:
            
            PAGEITEM
                1. Financial Statements:a.
            
            Consolidated
                Balance Sheets, June 30, 2006 (unaudited) andDecember
                31, 2005
            
            3b.
            
            Consolidated
                Statements of Operations for the three monthsended
                June 30, 2006 and 2005 (unaudited)
            
            4c.
            
            Consolidated
                Statements of Operations for the six monthsended
                June 30, 2006 and 2005 (unaudited)
            
            5d.
            
            Consolidated
                Statement of Stockholders’ Equity for the six monthsended
                June 30, 2006 (unaudited)
            
            6e.
            
            Consolidated
                Statements of Cash Flows for the six monthsended
                June 30, 2006 and 2005 (unaudited)
            
            7f.
            
            Notes
                to Consolidated Financial Statements (unaudited)
            
            8ITEM
                2. Management’s Discussion and Analysis of Financial
                Conditionand
                Results of Operations
            
            28ITEM
                3. Quantitative and Qualitative Disclosure about Market
                Risk
            
            43ITEM
                4. Controls and Procedures
            
            43Part
                II. Other Information:ITEM
                1. Legal Proceedings
            
            43ITEM
                1A. Risk Factors
            
            44ITEM
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            
            44ITEM
                3. Defaults Upon Senior Securities
            
            44ITEM
                4. Submission of Matters to a Vote of Security Holders
            
            44ITEM
                5. Other Information
            
            44ITEM
                6. Exhibits
            
            44Signatures
            
            45Certifications
            
            46






2


**PART
      I - Financial Information**




**ITEM
      1. Financial Statements**




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      BALANCE SHEETS




June
                30, 2006
            
            December
                31, 2005(Unaudited)
            
            ***ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            4,132,342
            
            $
            5,403,036Restricted
                cash
            
            
            168,167
            
            
            206,931Accounts
                receivable, net of allowance for doubtful accounts of $754,080 and
                $765,440, respectively
            
            
            4,864,419
            
            
            4,651,080Inventories
            
            
            8,162,387
            
            
            8,047,444Prepaid
                expenses and other current assets
            
            
            1,146,040
            
            
            621,372Total
                current assets
            
            
            18,473,355
            
            
            18,929,863Property
                and equipment, net
            
            
            7,660,217
            
            
            7,044,713Goodwill,
                net
            
            
            16,917,808
            
            
            16,375,384Patents
                and licensed technologies, net
            
            
            1,834,206
            
            
            1,577,554Other
                intangible assets, net
            
            
            4,002,625
            
            
            4,467,625Other
                assets
            
            
            567,344
            
            
            280,467Total
                assets
            
            $
            49,455,555
            
            $
            48,675,606**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Current
                portion of notes payable
            
            $
            669,064
            
            $
            228,398Current
                portion of long-term debt
            
            
            2,515,425
            
            
            1,749,969Accounts
                payable
            
            
            4,035,373
            
            
            3,572,077Accrued
                compensation and related expenses
            
            
            1,178,321
            
            
            867,427Other
                accrued liabilities
            
            
            659,407
            
            
            936,591Deferred
                revenues
            
            
            636,739
            
            
            466,032Total
                current liabilities
            
            
            9,694,329
            
            
            7,820,494Long-term
                liabilities:Notes
                payable
            
            
            163,858
            
            
            159,213Long-term
                debt
            
            
            3,040,742
            
            
            2,278,871Total
                liabilities
            
            
            12,898,929
            
            
            10,258,578Commitments
                and ContingenciesStockholders’
                equity:Common
                stock, $.01 par value, 75,000,000 shares authorized; 52,625,491 and
                51,414,294 shares issued and outstanding, respectively
            
            
            526,255
            
            
            514,143Additional
                paid-in capital
            
            
            119,903,169
            
            
            118,140,838Accumulated
                deficit
            
            
            (83,872,798
            )
            
            (80,182,606
            )Deferred
                compensation
            
            
            -
            
            
            (55,347
            )Total
                stockholders' equity
            
            
            36,556,626
            
            
            38,417,028Total
                liabilities and stockholders’ equity
            
            $
            49,455,555
            
            $
            48,675,606




*
      The
      December 31, 2005 balance sheet was derived from our 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 June 30,2006
            
            2005Revenues:Product
                sales
            
            $
            5,008,914
            
            $
            4,955,066Services
            
            
            3,214,829
            
            
            3,100,1078,223,743
            
            
            8,055,173Cost
                of revenues:Product
                cost of revenues
            
            
            1,955,175
            
            
            2,007,870Services
                cost of revenues
            
            
            2,269,015
            
            
            2,214,3204,224,190
            
            
            4,222,190Gross
                profit
            
            
            3,999,553
            
            
            3,832,983Operating
                expenses:Selling
                and marketing
            
            
            2,604,820
            
            
            2,417,278General
                and administrative
            
            
            2,341,638
            
            
            1,780,165Engineering
                and product development
            
            
            255,179
            
            
            327,9395,201,637
            
            
            4,525,382Loss
                from operations
            
            
            (1,202,084
            )
            
            (692,399
            )Other
                income
            
            
            -
            
            
            88,667Interest
                expense, net
            
            
            (137,847
            )
            
            (56,919
            )Net
                loss
            
            
            ($
                1,339,931
            )
            
            ($
                660,651
            )Basic
                and diluted net loss per share
            
            
            ($0.03
            )
            
            ($0.01
            )Shares
                used in computing basic and diluted net loss per share
            
            
            52,622,189
            
            
            50,859,562




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




4




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS




(Unaudited)




For
                the Six Months Ended June 30,2006
            
            2005Revenues:Product
                sales
            
            $
            10,252,826
            
            $
            7,180,765Services
            
            
            6,052,079
            
            
            5,857,74016,304,905
            
            
            13,038,505Cost
                of revenues:Product
                cost of revenues
            
            
            4,276,844
            
            
            2,900,834Services
                cost of revenues
            
            
            4,655,244
            
            
            3,953,7248,932,088
            
            
            6,854,558Gross
                profit
            
            
            7,372,817
            
            
            6,183,947Operating
                expenses:Selling
                and marketing
            
            
            5,557,759
            
            
            3,797,869General
                and administrative
            
            
            4,748,877
            
            
            3,620,550Engineering
                and product development
            
            
            497,383
            
            
            514,91010,804,019
            
            
            7,933,329Loss
                from operations
            
            
            (3,431,202
            )
            
            (1,749,382
            )Other
                income
            
            
            -
            
            
            88,667Interest
                expense, net
            
            
            (258,990
            )
            
            (128,048
            )Net
                loss
            
            
            ($
                3,690,192
            )
            
            ($
                1,788,763
            )Basic
                and diluted net loss per share
            
            
            ($0.07
            )
            
            ($0.04
            )Shares
                used in computing basic and diluted net loss per share
            
            
            52,399,143
            
            
            46,322,904




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




5




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENT OF STOCKHOLDERS’ EQUITY


FOR
      THE
      SIX MONTHS ENDED JUNE 30, 2006




(Unaudited)




AdditionalCommon
                Stock
            
            Paid-In
            
            Accumulated
            
            DeferredShares
            
            Amount
            
            Capital
            
            Deficit
            
            Compensation
            
            TotalBALANCE,
                DECEMBER 31, 2005
            
            
            51,414,294
            
            $
            514,143
            
            $
            118,140,839
            
            
            ($80,182,606
            )
            
            ($
                55,347
            )
            $
            38,417,029Reversal
                of deferred compensation upon adoption of SFAS 123R
            
            
            -
            
            
            -
            
            
            (55,347
            )
            
            -
            
            
            55,347
            
            
            -Exercise
                of stock options
            
            
            50,187
            
            
            502
            
            
            75,678
            
            
            -
            
            
            -
            
            
            76,180Stock
                options issued to consultants for services
            
            
            -
            
            
            -
            
            
            93,437
            
            
            -
            
            
            -
            
            
            93,437Stock-based
                compensation expenserelated
                to employee options
            
            
            -
            
            
            -
            
            
            648,032
            
            
            -
            
            
            -
            
            
            648,032Stock-based
                compensation expenserelated
                to severance agreement
            
            
            -
            
            
            -
            
            
            195,497
            
            
            -
            
            
            -
            
            
            195,497Issuance
                of restricted stock
            
            
            860,000
            
            
            8,600
            
            
            157,088
            
            
            -
            
            
            -
            
            
            165,688Issuance
                of stock for Stern assetsacquisition
            
            
            101,010
            
            
            1,010
            
            
            190,725
            
            
            -
            
            
            -
            
            
            191,735Issuance
                of stock for AzurTec agreement
            
            
            200,000
            
            
            2,000
            
            
            381,273
            
            
            -
            
            
            -
            
            
            383,273Amortization
                of deferred compensation
            
            
            -
            
            
            -
            
            
            29,436
            
            
            -
            
            
            -
            
            
            29,436Registration
                expenses
            
            
            -
            
            
            -
            
            
            (7,890
            )
            
            -
            
            
            -
            
            
            (7,890
            )Issuance
                of warrants for draws under line of credit
            
            
            -
            
            
            -
            
            
            54,401
            
            
            -
            
            
            -
            
            
            54,401Net
                loss for the six months ended June 30, 2006
            
            
            -
            
            
            -
            
            
            -
            
            
            (3,690,192
            )
            
            -
            
            
            (3,690,192
            )BALANCE,
                JUNE 30, 2006
            
            
            52,625,491
            
            $
            526,255
            
            $
            119,903,169
            
            
            ($83,872,798
            )
            $
            -
            
            $
            36,556,626




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 Six Months Ended
              June
                30,2006
            
            2005**Cash
                Flows From Operating Activities**:Net
                loss
            
            
            ($
                3,690,192
            )
            
            ($
                1,788,763
            )Adjustments
                to reconcile net loss to net cash usedin
                operating activities:Depreciation
                and amortization
            
            
            2,054,511
            
            
            1,332,754Stock
                options issued to consultants for services
            
            
            93,437
            
            
            31,859Stock-based
                compensation expense related to employee options and restricted
                stock
            
            
            805,122
            
            
            -Amortization
                of deferred compensation
            
            
            29,436
            
            
            44,232Nonmonetary
                exchange of assets
            
            
            -
            
            
            (88,667
            )Provision
                for bad debts
            
            
            58,246
            
            
            276,124Changes
                in operating assets and liabilities, net of effects on acquired assets
                and
                liabilities:Accounts
                receivable
            
            
            (271,585
            )
            
            232,694Inventories
            
            
            (27,785
            )
            
            (587,401
            )Prepaid
                expenses and other assets
            
            
            367,049
            
            
            435,313Accounts
                payable
            
            
            463,295
            
            
            (1,281,364
            )Accrued
                compensation and related expenses
            
            
            (36,033
            )
            
            (318,453
            )Other
                accrued liabilities
            
            
            (277,184
            )
            
            (816,593
            )Deferred
                revenues
            
            
            170,707
            
            
            (105,757
            )Net
                cash used in operating activities
            
            
            (260,976
            )
            
            (2,634,022
            )**Cash
                Flows From Investing Activities:**Purchases
                of property and equipment
            
            
            (34,830
            )
            
            (61,345
            )Lasers
                placed into service
            
            
            (2,097,925
            )
            
            (1,727,800
            )Cash
                received from acquisition, net of costs incurred
            
            
            -
            
            
            5,578,416Net
                cash (used in) provided by investing activities
            
            
            (2,132,755
            )
            
            3,789,271**Cash
                Flows From Financing Activities:**Proceeds
                from issuance of restricted common stock
            
            
            8,600
            
            
            -Costs
                related to issuance of common stock
            
            
            (7,890
            )
            
            (161,739
            )Proceeds
                from exercise of options
            
            
            76,180
            
            
            298,935Proceeds
                from exercise of warrants
            
            
            -
            
            
            147,060Payments
                on long-term debt
            
            
            (113,509
            )
            
            (137,028
            )Payments
                on notes payable
            
            
            (396,547
            )
            
            (318,432
            )Net
                advancements on lease line of credit
            
            
            1,517,439
            
            
            739,055Decrease/(Increase)
                in restricted cash and cash equivalents
            
            
            38,764
            
            
            (94,602
            )Net
                cash provided by financing activities
            
            
            1,123,037
            
            
            473,249Net
                (decrease) increase in cash and cash equivalents
            
            
            (1,270,694
            )
            
            1,628,498Cash
                and cash equivalents, beginning of period
            
            
            5,403,036
            
            
            3,884,817Cash
                and cash equivalents, end of period
            
            $
            4,132,342
            
            $
            5,513,315




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




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




The
      Skin
      Care business resulted from the acquisition of ProCyte Corporation (“ProCyte”)
      on March 18, 2005. ProCyte, located in Redmond, Washington, markets products
      for
      skin health, hair care and wound care. Many of these products incorporate
      patented copper peptide technologies. In addition to a diversified product
      line,
      ProCyte has provided a national sales force and increased the Company’s
      marketing department. (see Note 2).




The
      Surgical businesses were acquired on December 27, 2002 as a result of the
      acquisition of Surgical Laser Technologies, Inc. (“SLT”), located in
      Montgomeryville, Pennsylvania. In the Surgical business, the Company
      also develops, manufactures and markets proprietary lasers and delivery systems
      for both contact and non-contact surgery and provide s
      surgical services utilizing these and other manufacturers’ products. The
      Montgomeryville facility also serves as the Company’s corporate
      headquarters.




8




***Liquidity
      and Going Concern***




The
      Company has incurred significant losses and negative cash flows from operations
      since emerging from bankruptcy in May 1995. As of June 30, 2006, the Company
      had
      an accumulated deficit of $83,872,798. The Company has historically financed
      its
      activities from operations, the private placement of equity securities and
      borrowings under lines of credit. To date, the Company has dedicated most of
      its
      financial resources to research and development, marketing and general and
      administrative expenses.




Cash
      and
      cash equivalents as of June 30, 2006 were $4,300,509, including restricted
      cash
      of $168,167. Management believes that the existing cash balance together with
      its other existing financial resources, including its leasing credit line
      facility with a remaining availability of $3,731,638 (see Note 9), and any
      revenues from sales, distribution, licensing and manufacturing relationships,
      will be sufficient to meet the Company’s operating and capital requirements
      beyond the third quarter of 2007. The 2006 operating plan reflects anticipated
      growth from an increase in per-treatment fee revenues for use of the XTRAC
      laser
      system based on wider insurance coverage in the United States and continuing
      cost savings from the integration of business operations acquired from ProCyte
      and the continued growth of our skin care products. However, depending upon
      the
      Company’s rate of growth and other operating factors, the Company may require
      additional equity or debt financing to meet its working capital requirements
      or
      capital expenditure needs for the balance of 2006. There can be no assurance
      that additional financing, if needed, will be available when required or, if
      available, can be obtained on terms satisfactory to the Company.




Since
      2002, the Company has made significant progress in obtaining more extensive
      reimbursement approval including the Centers for Medicare and Medicaid Services
      and various private health plans for the treatment of skin disorders using
      the
      XTRAC system. The Company plans to continue to focus on securing reimbursement
      from more private insurers and to concentrate sales and marketing efforts where
      such reimbursement has become available. As additional approvals for
      reimbursements are obtained, the Company will increase spending on the marketing
      of its psoriasis, vitiligo, atopic dermatitis and leukoderma treatment products
      and, if necessary, expansion of its manufacturing facilities. Even with the
      approval for reimbursement by Centers for Medicare and Medicaid Services and
      recent approvals by certain private insurers, the Company may continue to face
      resistance from remaining private healthcare insurers to adopt the
      excimer-laser-based therapy as an approved procedure or to provide adequate
      levels of reimbursement.




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




Management
      cannot provide assurance that the Company will market the XTRAC product
      successfully or operate profitably in the future, or that it will not require
      significant additional financing in order to accomplish the objectives of its
      business plan. Consequently, the Company’s historical operating results cannot
      be relied on to be an indicator of future performance, and management cannot
      predict whether the Company will obtain or sustain positive operating cash
      flow
      or generate net income in the future.




**Summary
      of Significant Accounting Policies:**




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




The
      financial statements as of June 30, 2006 and for the six months ended June
      30,
      2006 and 2005, 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 June 30, 2006, and the results
      of
      operations and cash flows for the six months ended June 30, 2006 and 2005.
      The results for the six months ended June 30, 2006 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 fiscal year ended
      December 31, 2005.




9




***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 2005 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 lasers in physician’s offices (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 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; (iv) and 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 that do not
      fully
      satisfy the collection criteria 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.




When
      the
      Company places a laser in a physician’s office, it recognizes service revenue
      based on the number of patient treatments performed by the physician. Treatments
      in the form of random laser-access codes that are sold to physicians, but not
      yet used, are deferred and recognized as a liability until the physician
      performs the treatment. Unused treatments 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 June 30, 2006 and 2005, the Company deferred $397,844 and
      $402,000, respectively, under this program.




In
      the
      first quarter of 2003, the Company implemented a program to support certain
      physicians in addressing treatments with the XTRAC 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 June 30, 2006, the Company deferred
      an
      additional $105,388 under this program, as all the SAB 104 Criteria for revenue
      recognition had not been met. At June 30, 2006, the Company had net deferred
      revenues of $187,153 under this program.




10




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
                physician practice must be in an identified location where there
                is an
                insufficiency of insurance companies reimbursing the
                procedure;




·
            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 treatment
                he
                or she purchased from the Company (our fee only) 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 sale
                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 quarter ended June 30, 2006 are subject to being credited
      or refunded to the physician. The Company estimated that 11% of the revenues
      under this program for the quarter ended June 30, 2005 were 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 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, when the SAB 104 Criteria have been met.




For
      per-procedure surgical services, the Company recognizes revenue upon the
      completion of the procedure. Revenue from maintenance service agreements is
      deferred and recognized on a straight-line basis over the term of the
      agreements. Revenue from billable services, including repair activity, is
      recognized when the service is provided.




***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 June 30, 2006, no such impairment
      existed.




11




***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
      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
      June 30, 2006, 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
      June 30, 2006, 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 June 30, 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
      six months ended June 30, 2006 is summarized as follows:




June
                30, 2006Accrual
                at beginning of period
            
            $
            204,708Additions
                charged to warranty expense
            
            
            18,750Expiring
                warranties
            
            
            (58,455
            )Claims
                paid
            
            
            (28,710
            )Accrual
                at end of period
            
            $
            136,293




***Income
      Taxes***




The
      Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
      for Income Taxes.” Under SFAS No. 109, the liability method is used for income
      taxes. Under this method, deferred tax assets and liabilities are determined
      based on differences between the financial reporting and tax basis of assets
      and
      liabilities and are measured using enacted tax rates and laws that are expected
      to be in effect when the differences reverse.




The
      Company’s deferred tax asset has been fully reserved under a valuation
      allowance, reflecting the uncertainties as to realizability evidenced by the
      Company’s historical results and restrictions on the usage of the net operating
      loss carryforwards. Consistent with the rules of purchase accounting, the
      historical deferred tax asset of ProCyte was written off when the Company
      acquired ProCyte. If and when components of that asset are realized in future,
      the acquired goodwill of ProCyte will be reduced.




12




***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 8,301,392 and 8,509,883 as of June 30, 2006 and 2005,
      respectively, were excluded from the calculation of fully diluted earnings
      per
      share since their inclusion would have been anti-dilutive.




***Exchanges
      of Nonmonetary Assets***




Exchanges
      under SFAS No. 153, “Exchanges of Nonmonetary Assets,” are measured based on the
      fair value of the assets exchanged. Further, SFAS No. 153 eliminates the
      previous narrow exception for nonmonetary exchanges of similar productive assets
      and replaces it with a broader exception for exchanges of nonmonetary assets
      that do not have “commercial substance.” The Company elected to adopt this
      Statement in fiscal year 2005. For the three and six months ended June 30,
      2006,
      the Company has not recognized any income or expense in accordance with this
      Statement. For the three and six months ended June 30, 2005, the Company
      recognized $88,667 of income in accordance with this Statement.




***Share-Based
      Compensation***




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




Under
      the
      modified prospective approach, SFAS No. 123R applies to new grants of options
      and awards of stock as well as to grants of options that were outstanding on
      January 1, 2006 and that may subsequently be repurchased, cancelled or
      materially modified. Under the modified prospective approach, compensation
      cost
      recognized for the three and six months ended June 30, 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 six months ended June 30, 2006.




The
      pro-forma information presented in the following table illustrates the effect
      on
      net income and net income per share if the Company had applied the fair value
      recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based
      Compensation,” as amended by FASB Statement No. 148, “Accounting for Stock-Based
      Compensation - Transition and Disclosure,” to stock-based employee compensation
      for the three and six months ended June 30, 2005:




13





Three
                Months Ended June 30, 2005
            
            Six
                Months Ended June 30, 2005Net
                loss:As
                reported
            
            
            ($660,651
            )
            
            ($1,788,763
            )Less:
                stock-based employee compensation expense included in reported net
                loss
            
            
            40,033
            
            
            44,232Impact
                of total stock-based compensation expense determined under
                fair-value-based method for all grants and awards
            
            
            (496,366
            )
            
            (781,468
            )Pro-forma
            
            
            ($1,116,984
            )
            
            ($2,525,999
            )Net
                loss per share:As
                reported
            
            
            ($0.01
            )
            
            ($0.04
            )Pro-forma
            
            
            ($0.02
            )
            
            ($0.05
            )




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




Assumptions
                for Option Grants
            
            Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Risk-free
                interest rate
            
            
            5.00
            %
            
            4.45
            %
            
            4.63
            %
            
            4.17
            %Volatility
            
            
            94.64
            %
            
            117.09
            %
            
            94.14
            %
            
            103.88
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %
            
            0
            %
            
            0
            %Expected
                life
            
            
            8.13
            years
            
            5
            years
            
            7.84
            years
            
            5
            yearsEstimated
                forfeiture rate
            
            
            11
            %
            
            N/A
            
            
            11
            %
            
            N/A




The
      Company calculates expected volatility for a share-based grant based on historic
      daily stock price observations of our common stock during the period immediately
      preceding the grant that is equal in length to the expected term of the grant.
      For estimating the expected term of share-based grants made in the three and
      six
      months ended June 30, 2006, the Company has adopted the simplified method
      authorized in Staff Accounting Bulletin No. 107. SFAS No. 123R also requires
      that estimated forfeitures be included as a part of the estimate of expense
      as
      of the grant date. The Company has used historical data to estimate expected
      employee behaviors related to option exercises and forfeitures. Prior to our
      adoption of SFAS No. 123R, the Company reduced pro-forma share-based
      compensation expense, presented in the notes to its financial statements, for
      actual forfeitures as they occurred.




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




With
      respect to awards of restricted stock, the Company uses the Monte-Carlo pricing
      model to estimate fair value of restricted stock awards made in the first
      quarter 2006 with the following weighted average assumptions:




Assumptions
                for Stock Awards
            
            Six
                Months Ended June 30, 2006Risk-free
                interest rate
            
            
            4.32%Volatility
            
            
            70%Expected
                dividend yield
            
            
            0%Expected
                Life
            
            
            4.92
                years






14




The
      Company calculated expected volatility for restricted stock based on historic
      daily stock price observations of our common stock during the three-year period
      immediately preceding the grant.




Options
      that were assumed from ProCyte and that were unvested as of March 18, 2005
      were
      re-measured as of March 18, 2005 under intrinsic-value-based accounting.
      Unearned or deferred compensation of $132,081 was recorded and is being
      amortized over the remaining vesting period, which is an average of two years.
      The Company recognized $14,718 and $40,033 of such expense in the three months
      ended June 30, 2006 and 2005, respectively. The Company recognized $29,436
      and
      $44,232 of such expense in the six months ended June 30, 2006 and 2005,
      respectively.




There
      was
      $336,410 and $78,544 of compensation expense related to stock options granted
      and restricted stock awarded, respectively, in the three months ended June
      30,
      2006. There was $648,034 and $157,088 of compensation expense related to stock
      options granted and restricted stock awarded, respectively, in the six months
      ended June 30, 2006. This expense is recognized in 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 $16,815 and $93,437 was recognized during the three and six months
      ended June 30, 2006, respectively. For stock options granted to consultants
      an
      additional selling, general, and administrative expense in the amount of $31,859
      was recognized during the three and six months ended June 30, 2005.




***Reclassifications***




The
      2005
      consolidated statements of operations have been revised to present product
      and
      services cost of revenues and operating expenses to the current presentation
      format.




***Supplemental
      Cash Flow Information***




During
      the six months ended June 30, 2006, the Company financed insurance policies
      through notes payable for $763,982, financed certain credit facility costs
      for
      $82,043, financed a license agreement with a note payable of $77,876 and issued
      warrants to a leasing credit facility which are valued at $54,401, and which
      offset the carrying value of debt. During the six months ended June 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.




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




During
      the six months ended June 30, 2005, the Company financed insurance policies
      through notes payable for $978,252. During the six months ended June 30, 2005,
      the Company issued 248,395 shares of its restricted common stock to Stern upon
      attainment of certain milestones, which is included in patents and licensed
      technologies




For
      the
      six months ended June 30, 2006 and 2005, the Company paid interest of $296,990
      and $162,107, respectively. Income taxes paid in the six months ended June
      30,
      2006 and 2005 were immaterial.




***Recent
      Accounting Pronouncements***




The
      Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
      Statement No. 109”. This Interpretation prescribes a recognition threshold and
      measurement attribute for the financial statement recognition and measurement
      of
      a tax position taken or expected to be taken in a tax return. This
      Interpretation also provides guidance on derecognition, classification, interest
      and penalties, accounting in interim periods, disclosure, and transition. The
      interpretation is effective for fiscal years beginning after December 15, 2006.
      The Company does not expect this adoption of this interpretation to have a
      material impact on the company's consolidated financial statements.




In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections -
      replacement of APB Opinion No. 20 and FASB Statement No. 3”. SFAS No. 154
      changes the accounting for and reporting of a change in accounting principle
      by
      requiring retrospective application to prior periods’ financial statements of
      changes in accounting principle unless impracticable. SFAS No. 154 is effective
      for accounting changes made in fiscal years beginning after December 15, 2005.




15




On
      December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” which
      is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. In March 2005,
      the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”). SAB No. 107
      expresses views of the SEC staff regarding the interaction between SFAS No.
      123R
      and certain SEC rules. SFAS No. 123R requires that the compensation cost
      relating to share-based payment transactions be recognized in financial
      statements. The cost is to be measured based on the fair value of the equity
      or
      liability instruments issued. The Company adopted SFAS No. 123R on January
      1,
      2006 using the modified prospective method. The impact of adopting this
      Statement is discussed in Note 1, under “Stock-Based Compensation”.




On
      November 24, 2004, the FASB issued SFAS No. 151, “Inventory Costs,” which is an
      amendment to Accounting Research Bulletin (ARB) No. 43, Chapter 4. It clarifies
      the accounting for abnormal amounts of idle facility expense, freight, handling
      costs, and wasted material (spoilage). Under this Statement, such costs should
      be expensed as incurred and not included in overhead. Further, SFAS No. 151
      requires that allocation of fixed production overheads to conversion costs
      should be based on normal capacity of the production facilities. SFAS No. 151
      is
      effective for inventory costs incurred during fiscal years beginning after
      June
      15, 2005. The adoption of this Statement did not have a material effect on
      the
      Company’s consolidated financial statements.




*Note
      2*




**Acquisitions:**




***ProCyte
      Transaction***




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




The
      aggregate purchase price of $28,086,208 consisted of the issuance of 10,540,579
      shares of the Company’s common stock valued at $2.29 per share, the assumption
      of 1,354,973 common stock options valued at $2,033,132 net of deferred
      compensation of $132,081, and the incurrence of $1,915,150 of transaction costs.
      The merger consideration was based on a fixed exchange ratio of 0.6622 shares
      of
      PhotoMedex common stock for each share of ProCyte common stock. As the exchange
      ratio was fixed, the fair value of PhotoMedex’s common stock for accounting
      purposes was based on a stock price of $2.29 per share, which was the average
      of
      the closing prices on the date of the announcement of the planned merger and
      the
      two days prior and afterwards.




16


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




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




The
      purchase price exceeded the fair value of the net assets acquired by
      $13,973,385, which was recorded as goodwill. The increase in goodwill recognized
      in the six months ended June 30, 2006 reflects management’s best estimate of
      pre-acquisition contingencies based upon plans entered into prior to March
      18,
      2006.




The
      accompanying consolidated financial statements do not include any revenues
      or
      expenses related to the acquisition on or prior to March 18, 2005, the closing
      date. The following are the Company’s unaudited pro-forma results for the three
      and six months ended June 30, 2006 and 2005, assuming the acquisition had
      occurred on January 1, 2005:




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Net
                revenues
            
            $
            8,223,743
            
            $
            8,055,173
            
            $
            16,304,905
            
            $
            16,008,067Net
                loss
            
            
            ($1,339,931
            )
            
            ($660,651
            )
            
            ($3,690,192
            )
            
            ($1,890,815
            )Basic
                and diluted loss per share
            
            
            ($0.03
            )
            
            ($0.01
            )
            
            ($0.07
            )
            
            ($0.04
            )Shares
                used in calculating basic and diluted loss per share
            
            
            52,622,189
            
            
            50,859,562
            
            
            52,399,143
            
            
            50,748,782




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




The
      Company’s goals for this acquisition are summarized below:




·
            the
                addition of ProCyte's sales and marketing personnel should enhance
                the
                Company’s ability to market the XTRAC system;




·
            ProCyte's
                presence in the skin health and hair care products market should
                present a
                growth opportunity for PhotoMedex to market its existing products;




·
            the
                addition of ProCyte's cash balances as of the date of acquisition
                and of
                its operations should improve PhotoMedex's operating results and
                strengthen its balance sheet;




·
            the
                combined company may recognize short-term cost savings and have the
                opportunity for additional longer-term cost efficiencies; and






17






·
            the
                combination of the senior management of ProCyte and PhotoMedex should
                allow complementary skills to strengthen the management team.




Since
      the
      acquisition date, the Company has made progress toward the achievement of these
      goals. Financial and administrative functions were transferred from Redmond
      to
      Montgomeryville in June 2005. Integration of and coordination between the sales
      forces of the Skin Care and Domestic XTRAC business units is an ongoing process.
      Mr. Clifford, who had been responsible for domestic sales and marketing of
      the
      dermatologic business segments, left the Company in the second quarter of 2006,
      but will be available to the Company on a consulting basis.




***Stern
      Laser Transaction***




On
      September 7, 2004, the Company closed the transactions provided for in the
      Master Asset Purchase Agreement (the “Master Agreement”) with Stern. In March
      2006, the Company issued an additional 101,010 shares of its restricted common
      stock to Stern based on a milestone set forth in the Master Agreement. As of
      June 30, 2006, the Company has issued an aggregate 589,854 shares of its
      restricted common stock to Stern in connection with the Master Agreement. The
      Company also agreed to pay Stern up to an additional $250,000 based on the
      achievement of two remaining milestones. The Company retains the right to pay
      these conditional sums in cash or in shares of its common stock, at its sole
      discretion. To provide for the issuance of shares, the Company has reserved
      for
      issuance, and placed into escrow, 110,136 shares of its unregistered stock.
      The
      per-share price of any shares issued in the future will be the average closing
      price of the Company’s common stock during the 10 trading days ending on the
      date of achievement of a particular milestone. Stern also has served as the
      distributor of the Company’s XTRAC laser system in South Africa and Italy since
      2000. The primary asset acquired from Stern in the transaction is a license
      for
      Stern’s lamp-based technology, which was carried on the Company’s books at
      $1,076,323, net, as of June 30, 2006. Amortization of this intangible is on
      a
      straight-line basis over 10 years and began in January 2005. In the six months
      ended June 2006, Stern purchased $28,000 of products from the
      Company.




***AzurTec
      Transaction***




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




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




The
      Company assigned $268,291 as the fair value of the investment in AzurTec. It
      also assigned $114,982 as the fair value of the license it acquired from
      AzurTec. Amortization of this intangible is on a straight-line basis over 10
      years, which began April 2006.




18


*Note
      3*




**Inventories:**




Set
      forth
      below is a detailed listing of inventories:




June 30, 2006
            
            December
                31, 2005Raw
                materials and work in progress
            
            $
            4,960,532
            
            $
            4,998,847Finished
                goods
            
            
            3,201,855
            
            
            3,048,597Total
                inventories
            
            $
            8,162,387
            
            $
            8,047,444




Work-in-process
      is immaterial, given the Company’s typically short manufacturing cycle, and
      therefore is disclosed in conjunction with raw materials. Finished goods
      includes $0 and $69,963 as of June 30, 2006 and December 31, 2005, respectively,
      for laser systems shipped to distributors, but not recognized as revenue until
      all the SAB 104 Criteria have been met. At times, units are shipped but revenue
      is not recognized until all of the 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 on FOB destination.
      Among the factors the Company takes into account in determining the proper
      time
      at which to recognize revenue are when title to the goods transfers and when
      the
      risk of loss transfers. Shipments to the distributors that do not fully satisfy
      the collection criteria are recognized when invoiced amounts are fully paid.
      As
      of June 30, 2006 and December 31, 2005, the Company carried specific reserves
      for excess and obsolesce against its inventories of $1,117,841 and $931,719,
      respectively.




*Note
      4*




**Property
      and Equipment:**




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




June
                30, 2006
            
            December
                31, 2005Lasers
                in service
            
            $
            14,278,580
            
            $
            12,657,701Computer
                hardware and software
            
            
            334,490
            
            
            334,490Furniture
                and fixtures
            
            
            341,573
            
            
            338,089Machinery
                and equipment
            
            
            680,424
            
            
            755,565Autos
                and trucks
            
            
            382,690
            
            
            382,690Leasehold
                improvements
            
            
            248,658
            
            
            238,27616,266,415
            
            
            14,706,811Accumulated
                depreciation and amortization
            
            
            (8,606,198
            )
            
            (7,662,098
            )Property
                and equipment, net
            
            $
            7,660,217
            
            $
            7,044,713




Depreciation
      expense was $1,430,093 and $946,267 for the six months ended June 30, 2006
      and 2005, respectively. At June 30, 2006 and December 31, 2005, net
      property and equipment included $445,729 and $530,191, respectively, of assets
      recorded under capitalized lease arrangements, of which $189,200 and $302,710
      was included in long-term debt at June 30, 2006 and December 31, 2005,
      respectively (see Note 9).




*Note
      5*




**Patents
      and Licensed Technologies:**




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




June
                30, 2006
            
            December
                31, 2005Patents,
                owned and licensed, at gross costs of $470,416 and $438,940, net
                of
                accumulated amortization of $213,129 and $194,660,
                respectively.
            
            $
            257,287
            
            $
            244,280Other
                licensed or developed technologies, at gross costs of $2,432,259
                and
                $2,047,665, net of accumulated amortization of $855,340 and $714,391,
                respectively.
            
            
            1,576,919
            
            
            1,333,274$
            1,834,206
            
            $
            1,577,554






19




Related
      amortization expense was $159,418 and $119,112 for the six months ended
      June 30, 2006 and 2005, respectively. Included in other licensed and
      developed technologies is $200,000 in developed technologies acquired from
      ProCyte and $114,982 for the license with AzurTec (see Note 2). On March 31,
      2006, the Company closed the transaction provided for in the License Agreement
      with Mount Sinai School of Medicine of New York University (“Mount Sinai”).
      Pursuant to the license agreement, the Company 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.





*Note
      6*




**Other
      Intangible Assets:**




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




June
                30, 2006
            
            December
                31, 2005Neutrogena
                Agreement, at gross cost of $2,400,000 net of accumulated amortization
                of
                $618,000 and $378,000, respectively.
            
            $
            1,782,000
            
            $
            2,022,000Customer
                Relationships, at gross cost of $1,700,000 net of accumulated amortization
                of $437,745 and $267,747, respectively.
            
            
            1,262,255
            
            
            1,432,253Tradename,
                at gross cost of $1,100,000 net of accumulated amortization of $141,630
                and $86,628, respectively.
            
            
            958,370
            
            
            1,013,372$
            4,002,625
            
            $
            4,467,625




Related
      amortization expense was $465,000 and $267,375 for the six months ended
      June 30, 2006 and 2005, 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
      7*




**Other
      Accrued Liabilities:**




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




June
                30, 2006
            
            December
                31, 2005Accrued
                warranty
            
            $
            136,293
            
            $
            204,708Accrued
                professional and consulting fees
            
            
            271,977
            
            
            437,396Accrued
                sales taxes
            
            
            193,988
            
            
            184,764Other
                accrued expenses
            
            
            57,149
            
            
            109,723Total
                other accrued liabilities
            
            $
            659,407
            
            $
            936,591




20




*Note
      8*




**Notes
      Payable:**




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




June
                30, 2006
            
            December
                31, 2005Note
                Payable - secured creditor, interest at 6%, payable in monthly principal
                and interest installments of $2,880 through June 2012
            
            $
            171,501
            
            $
            183,425Note
                Payable - unsecured creditor, non-interest bearing, payable in 18
                equal
                monthly installments of $4,326 through October 2007
            
            
            69,223
            
            
            -Note
                payable - secured creditor, interest at 16.47%, payable in monthly
                principal and interest installments of $2,618 through December
                2006.
            
            
            12,755
            
            
            26,736Note
                Payable - unsecured creditor, interest at 7.42%, payable in monthly
                principal and interest installments of $61,493 through March
                2006
            
            
            -
            
            
            177,450Note
                Payable - unsecured creditor, interest at 8.97%, payable in monthly
                principal and interest installments of $16,578 through November
                2006
            
            
            81,063
            
            
            -Note
                Payable - unsecured creditor, interest at 5.39%, payable in monthly
                principal and interest installments of $63,563 through February
                2007
            
            
            498,380
            
            
            -832,922
            
            
            387,611Less:
                current maturities
            
            
            (669,064
            )
            
            (228,398
            )Notes
                payable, net of current maturities
            
            $
            163,858
            
            $
            159,213




21




*Note
      9*




**Long-term
      Debt:**




Set
      forth
      below is a detailed listing of the Company’s long-term debt:




June
                30, 2006
            
            December
                31, 2005Borrowings
                on credit facility:Draw
                1 - effective interest at 17.79%, payable in monthly principal and
                interest installments of $48,156.46 through June 2007.
            
            $
            543,187
            
            $
            792,362Draw
                2 - effective interest at 17.14%, payable in monthly principal and
                interest installments of $9,957.08 through September 2007.
            
            
            138,990
            
            
            189,543Draw
                3 - effective interest at 17.61%, payable in monthly principal and
                interest installments of $4,796.60 through December 2007.
            
            
            79,021
            
            
            102,541Draw
                4 - effective interest at 12.62%, payable in monthly principal and
                interest installments of $34,859.11 through June 2008.
            
            
            755,640
            
            
            922,350Draw
                5 - effective interest at 12.94%, payable in monthly principal and
                interest installments of $28,756.93 through September
                2008.
            
            
            690,646
            
            
            823,810Draw
                6 - effective interest at 13.36%, payable in monthly principal and
                interest installments of $28,923.11 through December 2008.
            
            
            758,576
            
            
            895,524Draw
                7 - effective interest at 13.74%, payable in monthly principal and
                interest installments of $40,887.14 through March 2009.
            
            
            1,159,093
            
            
            -Draw
                8 - effective interest at 13.45%, payable in monthly principal and
                interest installments of $40,155.04 through June 2009.
            
            
            1,241,814
            
            
            -Total
                borrowings on credit facility
            
            $
            5,366,967
            
            $
            3,726,130Capital
                lease obligations (see Note 4)
            
            
            189,200
            
            
            302,710Less:
                current portion
            
            
            (2,515,425
            )
            
            (1,749,969
            )Total
                long-term debt
            
            $
            3,040,742
            
            $
            2,278,871




*Leasing
      Credit Facility*




The
      Company entered into a leasing credit facility with GE Capital Corporation
      (“GE”) on June 25, 2004. The credit facility has a commitment term of three
      years, expiring on June 25, 2007. For each year of the term, called a “tranche,”
various parameters are set or re-set. The Company accounts 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 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.




Under
      the
      first tranche, GE made available $2,500,000 under the line. A draw under that
      tranche is set at an interest rate based on 522 basis points above the
      three-year Treasury note rate. Each such draw is discounted by 7.75%; the first
      monthly payment is applied directly to principal. With each draw, the Company
      agreed to issue warrants to purchase shares of the Company’s common stock equal
      to 5% of the draw. The number of warrants is determined by dividing 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.




22




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. Exercises will increase
      the
      amount of common stock outstanding and additional paid in capital.




The
      Company obtained a second tranche under the leasing credit facility for
      $5,000,000 on June 28, 2005. The Company accounts for draws under this second
      tranche in the same manner as under the first tranche except that: (i) the
      stated interest rate is set at 477 basis points above the three-year Treasury
      note rate; (ii) each draw is discounted by 3.50%; and (iii) with each draw,
      the
      Company has agreed to issue warrants to purchase shares of the Company’s common
      stock equal to 3% of the draw. The number of warrants is determined by dividing
      3% of the draw by the average closing price of the Company’s common stock for
      the ten trading 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
      trading days preceding the date of the draw.




The
      Company obtained a third tranche under the leasing credit facility for
      $5,000,000 on June 30, 2006. The Company accounts for draws under this third
      tranche in the same manner as under the second tranche.




The
      Company made the following draws against the line for 2006, as follows:




Draw
                7
            
            Draw
                8Date
                of draw
            
            
            3/29/06
            
            
            6/30/06Amount
                of draw
            
            $
            1,287,487
            
            $
            1,268,362Stated
                interest rate
            
            
            9.45
            %
            
            9.22
            %Effective
                interest rate
            
            
            13.74
            %
            
            13.45
            %Number
                of warrants issued
            
            
            20,545
            
            
            24,708Exercise
                price of warrants per share
            
            $
            2.06
            
            $
            1.69Fair
                value of warrants
            
            $
            27,853
            
            $
            26,548




The
      fair
      value of the warrants granted under the draws is estimated using the
      Black-Scholes option-pricing model with the following weighted average
      assumptions applicable to the warrants granted:




Warrants
                granted under Draw 7
            
            Warrants
                granted under Draw 8Risk-free
                interest rate
            
            
            4.79
            %
            
            5.18
            %Volatility
            
            
            87.16
            %
            
            84.17
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %Expected
                warrant life
            
            
            5
                years
            
            
            5
                years




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.




As
      of
      June 30, 2006, the Company had available $3,731,638 from the third tranche
      of
      the line of credit from which to draw on in the future.




*Capital
      Leases*




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




23




*Note
      10*




**Employee
      Stock Benefit Plans**




The
      Company has 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.
      Under the 2005 Equity Compensation Plan (the “Plan”), a maximum of 3,160,000
      shares of the Company’s common stock are available for issuance. Following the
      approval of the Plan on December 28, 2005, the Company will not grant any new
      awards under any previously existing stock-based compensation plans, except
      the
      Outside Director Plan. At June 30, 2006, 1,182,500 shares were available for
      future grants under the Plan and 403,750 shares were available under the Outside
      Director Plan. As of June 30, 2006, 9,000 options have been issued under the
      2005 Investment Plan.




Stock
      option activity under the Company’s share-based compensation plans for the six
      months ended June 30, 2006 was as follows:




Number
                of Options
            
            Weighted
                Average Exercise Price
            
            Weighted
                Average Remaining Contractual Term (years)Outstanding,
                January 1, 2006
            
            
            5,077,646
            
            $
            2.12
            
            
            4.03Granted
            
            
            1,307,500
            
            
            2.20Exercised
            
            
            (50,187
            )
            
            1.52Cancelled
            
            
            (179,129
            )
            
            3.15Outstanding,
                June 30, 2006
            
            
            6,155,830
            
            $
            2.11
            
            
            4.84Options
                excercisable at June 30, 2006
            
            
            3,803,523
            
            $
            2.00




At
      June
      30, 2006, there was $5,149,025 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 2.72 years.




*Note
      11*




**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 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 six months ended June 30, 2006 and 2005, the Company did not
      have material revenues from any individual customer.




Unallocated
      operating expenses include costs incurred for administrative and accounting
      staff, general liability and other insurance, professional fees and other
      similar corporate expenses. Unallocated assets include cash, prepaid expenses
      and deposits. Goodwill that was carried at $2,944,423 at June 30, 2006 and
      December 31, 2005 has been allocated to the domestic and international XTRAC
      segments based upon its fair value as of the date of the Acculase buy-out in
      the
      amounts of $2,061,096 and $883,327, respectively. Goodwill of $13,973,385 at
      June 30, 2006 from the ProCyte acquisition has been entirely allocated to the
      Skin Care segment.




24


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







Three
                Months Ended June 30, 2006DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            1,328,215
            
            $
            290,616
            
            $
            3,069,827
            
            $
            1,749,315
            
            $
            1,785,770
            
            $
            8,223,743Costs
                of revenues
            
            
            879,464
            
            
            122,069
            
            
            939,795
            
            
            1,363,760
            
            
            919,102
            
            
            4,224,190Gross
                profit
            
            
            448,751
            
            
            168,547
            
            
            2,130,032
            
            
            385,555
            
            
            866,668
            
            
            3,999,553*Gross
                profit %*
            
            
            *33.8*
            *%*
            
            *58.0*
            *%*
            
            *69.4*
            *%*
            
            *22.0*
            *%*
            
            *48.5*
            *%*
            
            *48.6*
            *%*Allocated
                Operating expenses:Selling,
                general and administrative
            
            
            973,050
            
            
            44,136
            
            
            1,213,772
            
            
            253,573
            
            
            137,790
            
            
            2,622,321Engineering
                and product development
            
            
            -
            
            
            -
            
            
            126,520
            
            
            -
            
            
            128,659
            
            
            255,179Unallocated
                Operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,324,137973,050
            
            
            44,136
            
            
            1,340,292
            
            
            253,573
            
            
            266,449
            
            
            5,201,637Income
                (loss) from operations
            
            
            (524,299
            )
            
            124,411
            
            
            789,740
            
            
            131,982
            
            
            600,219
            
            
            (1,202,084
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (137,847
            )Net
                income (loss)
            
            
            ($524,299
            )
            $
            124,411
            
            $
            789,740
            
            $
            131,982
            
            $
            600,219
            
            
            ($1,339,931
            )








Three
                Months Ended June 30, 2005DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            889,171
            
            $
            314,183
            
            $
            3,522,214
            
            $
            2,003,380
            
            $
            1,326,225
            
            $
            8,055,173Costs
                of revenues
            
            
            689,990
            
            
            234,155
            
            
            1,059,336
            
            
            1,502,219
            
            
            736,490
            
            
            4,222,190Gross
                profit
            
            
            199,181
            
            
            80,028
            
            
            2,462,878
            
            
            501,161
            
            
            589,735
            
            
            3,832,983*Gross
                profit %*
            
            
            *22.4*
            *%*
            
            *25.5*
            *%*
            
            *69.9*
            *%*
            
            *25.0*
            *%*
            
            *44.5*
            *%*
            
            *47.6*
            *%*Allocated
                Operating expenses:Selling,
                general and administrative
            
            
            674,934
            
            
            92,594
            
            
            1,469,403
            
            
            330,183
            
            
            145,243
            
            
            2,712,357Engineering
                and product development
            
            
            -
            
            
            -
            
            
            153,916
            
            
            -
            
            
            174,023
            
            
            327,939Unallocated
                Operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,485,086674,934
            
            
            92,594
            
            
            1,623,319
            
            
            330,183
            
            
            319,266
            
            
            4,525,382Income
                (loss) from operations
            
            
            (475,753
            )
            
            (12,566
            )
            
            839,559
            
            
            170,978
            
            
            270,469
            
            
            (692,399
            )Other
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            88,667Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (56,919
            )Net
                income (loss)
            
            
            ($475,753
            )
            
            ($12,566
            )
            $
            839,559
            
            $
            170,978
            
            $
            270,469
            
            
            ($660,651
            )






25





Six
                Months Ended June 30, 2006DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            2,387,845
            
            $
            821,681
            
            $
            6,530,388
            
            $
            3,365,349
            
            $
            3,199,642
            
            $
            16,304,905Costs
                of revenues
            
            
            1,826,076
            
            
            452,359
            
            
            1,992,239
            
            
            2,778,338
            
            
            1,883,076
            
            
            8,932,088Gross
                profit
            
            
            561,769
            
            
            369,322
            
            
            4,538,149
            
            
            587,011
            
            
            1,316,566
            
            
            7,372,817*Gross
                profit %*
            
            
            *23.5*
            *%*
            
            *44.9*
            *%*
            
            *69.5*
            *%*
            
            *17.4*
            *%*
            
            *41.1*
            *%*
            
            *45.20*
            *%*Allocated
                Operating expenses:Selling,
                general and administrative
            
            
            2,105,001
            
            
            61,567
            
            
            2,641,946
            
            
            505,649
            
            
            278,597
            
            
            5,592,760Engineering
                and product development
            
            
            -
            
            
            -
            
            
            232,255
            
            
            -
            
            
            265,128
            
            
            497,383Unallocated
                Operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            4,713,8762,105,001
            
            
            61,567
            
            
            2,874,201
            
            
            505,649
            
            
            543,725
            
            
            10,804,019Income
                (loss) from operations
            
            
            (1,543,232
            )
            
            307,755
            
            
            1,663,948
            
            
            81,362
            
            
            772,841
            
            
            (3,431,202
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (258,990
            )Net
                income (loss)
            
            
            ($1,543,232
            )
            $
            307,755
            
            $
            1,663,948
            
            $
            81,362
            
            $
            772,841
            
            
            ($3,690,192
            )








Six
                Months Ended June 30, 2005DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                SERVICES
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            1,523,189
            
            $
            602,385
            
            
            4,145,515
            
            $
            4,074,030
            
            $
            2,693,386
            
            $
            13,038,505Costs
                of revenues
            
            
            1,093,171
            
            
            393,750
            
            
            1,285,293
            
            
            2,817,679
            
            
            1,264,665
            
            
            6,854,558Gross
                profit
            
            
            430,018
            
            
            208,635
            
            
            2,860,222
            
            
            1,256,351
            
            
            1,428,721
            
            
            6,183,947*Gross
                profit %*
            
            
            *28.2*
            *%*
            
            *34.6*
            *%*
            
            *69.0*
            *%*
            
            *30.8*
            *%*
            
            *53.0*
            *%*
            
            *47.4*
            *%*Allocated
                Operating expenses:Selling,
                general and administrative
            
            
            1,205,922
            
            
            153,627
            
            
            1,826,205
            
            
            621,299
            
            
            303,396
            
            
            4,110,449Engineering
                and product development
            
            
            -
            
            
            -
            
            
            167,713
            
            
            -
            
            
            347,197
            
            
            514,910Unallocated
                Operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            3,307,9701,205,922
            
            
            153,627
            
            
            1,993,918
            
            
            621,299
            
            
            650,593
            
            
            7,933,329Income
                (loss) from operations
            
            
            (775,904
            )
            
            55,008
            
            
            866,304
            
            
            635,052
            
            
            778,128
            
            
            (1,749,382
            )Other
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            88,667Interest
                expense (income), net
            
            
            -
            
            
            -
            
            
            4,079
            
            
            -
            
            
            -
            
            
            (128,048
            )Net
                income (loss)
            
            
            ($775,904
            )
            $
            55,008
            
            
            870,383
            
            $
            635,052
            
            $
            778,128
            
            
            ($1,788,763
            )







26





June
                30, 2006
            
            December
                31, 2005Assets:Total
                assets for reportable segments
            
            $
            43,885,892
            
            $
            42,341,988Other
                unallocated assets
            
            
            5,569,663
            
            
            6,333,618Consolidated
                total
            
            $
            49,455,555
            
            $
            48,675,606




For
      the
      three and six months ended June 30, 2006 and 2005 there were no material
      net revenues attributed to any individual foreign country. Net revenues by
      geographic area were, as follows:




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Domestic
            
            $
            7,133,862
            
            $
            7,217,589
            
            $
            13,793,240
            
            $
            11,683,255Foreign
            
            
            1,089,881
            
            
            837,584
            
            
            2,511,665
            
            
            1,355,250$
            8,223,743
            
            $
            8,055,173
            
            $
            16,304,905
            
            $
            13,038,505




*Note
      12*




**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
      July
      27, 2005, the Company entered into a Marketing Agreement with KDS Marketing,
      Inc. (“KDS”). Using money invested by each party, KDS has researched market
      opportunities for the Company’s diode laser and related delivery systems, and
      KDS is now marketing the diode laser primarily through a website that physicians
      may access for information about purchasing the lasers. KDS began marketing
      the
      laser in the first quarter 2006.




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 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 agreement covers a protocol
      for a
      phase 4, randomized, double-blinded study to evaluate the safety and efficacy
      of
      the XTRAC laser system in the treatment of moderate to severe psoriasis. John
      Koo, MD, a member of our Scientific Advisory Board, will guide the study using
      our high-powered UltraTM excimer laser.




27


**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,
      2005.*




*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**




The
      Domestic XTRAC segment is a U.S. business with revenues 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. In January 2000, we
      received approval of our 510(k) submission from the Food and Drug
      Administration, or FDA, establishing that our XTRAC laser system is
      substantially equivalent to currently marketed devices for the treatment of
      psoriasis.




As
      part
      of our commercialization strategy in the United States, we provide the XTRAC
      laser system to targeted dermatologists at no initial capital cost to them.
      Unlike our international strategy, we generally do not sell the laser system,
      but maintain ownership of the laser and earn revenue each time a physician
      treats a patient with the equipment. We believe that this strategy will create
      incentives for physicians to adopt the XTRAC laser system and will increase
      market penetration.




For
      the
      past six years, we have sought to clear the path of obstacles and barriers
      to
      the 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 newly created 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 followed this.
      Substantive progress on reimbursement was achieved in the second half of 2005.
      We received approval from Blue Cross and Blue Shield of Florida in June
      2006.




28




We
      increased our dermatology sales force and marketing department as part of the
      acquisition of ProCyte in March 2005. We now have 11 sales representatives
      in
      the domestic XTRAC segment and 19 sales representatives in the Skin Care
      segment. The representatives of each segment provide follow-up sales support
      and
      share sales leads to enhance opportunities for cross-selling. Our marketing
      department has been instrumental in expanding the advertising campaign for
      the
      XTRAC laser system. In November 2005, we commenced an advertising campaign
      in
      selected regions that have declined certain levels of reimbursement in order
      to
      make consumers aware of the technology and therapeutic benefits of targeted
      UVB
      laser treatment for psoriasis. We continue to analyze and adjust this campaign
      for cost-effectiveness.




**International
      Dermatology Equipment**




In
      the
      international market, we derive revenues by selling the 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 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 intend to expand 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)**




On
      March
      18, 2005, we completed the acquisition of ProCyte Corporation. ProCyte generates
      revenues from the sale of skin health, hair care and wound care products; the
      sale of copper peptide compound in bulk; and royalties on licenses for the
      patented copper peptide compound.




The
      operating results of ProCyte for the six months ended June 30, 2005 are included
      from March 19, 2005 through June 30, 2005. Under purchase accounting rules,
      the
      operating results of ProCyte for prior periods are not included in our Statement
      of Operations. A description of transaction and pro-forma operating results
      are
      disclosed as part of Note 2, “ *Acquisitions”,* to the
      financial statements.




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




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




ProCyte’s
      financial and administrative functions were transferred from Redmond to
      Montgomeryville in June 2005. Integration of and coordination between the sales
      forces of the Skin Care and Domestic XTRAC business units is
      ongoing.




29




**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. Although
      we
      intend to increase our investment in this business segment in 2006, we will
      continue to pursue a cautious growth strategy in order to conserve our cash
      resources for the XTRAC business segments.




We
      have
      limited marketing experience in expanding our surgical services business. The
      majority of this business is in the southeastern part of the United States.
      New
      procedures and geographical expansion, together with new customers and different
      business habits and networks, will likely pose different challenges compared
      to
      those that we have encountered in the past. Indeed, we are presently negotiating
      to provide our surgical services through a national hospital network, where
      the
      roll-out would be done serially, region by region, each with its own challenges.
      There can be no assurance that we will be able to overcome such challenges.




**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). Although surgical product revenues
      increased in 2006 compared to 2005, 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
      expanding our surgical services segment and by increasing sales from the diode
      surgical laser introduced in 2004.




**Critical
      Accounting Policies**




There
      have been no changes to our critical accounting policies in the three and six
      months ended June 30, 2006. These critical accounting policies and the
      significant estimates made in accordance with them are regularly discussed
      with
      our Audit Committee. Those policies are discussed “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, 2005.




**Results
      of Operations**




***Revenues***




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




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005*XTRAC
                Domestic Services
            
            $
            1,328,215
            
            $
            889,171
            
            $
            2,387,845
            
            $
            1,523,189International
                Dermatology Equipment Products
            
            
            290,616
            
            
            314,183
            
            
            821,681
            
            
            602,385Skin
                Care (ProCyte) Products
            
            
            3,069,827
            
            
            3,522,214
            
            
            6,530,389
            
            
            4,145,515Total
                Dermatology Revenues
            
            
            4,688,658
            
            
            4,725,568
            
            
            9,739,915
            
            
            6,271,089Surgical
                Services
            
            
            1,749,315
            
            
            2,003,380
            
            
            3,365,349
            
            
            4,074,030Surgical
                Products
            
            
            1,785,770
            
            
            1,326,225
            
            
            3,199,641
            
            
            2,693,386Total
                Surgical Revenues
            
            
            3,535,085
            
            
            3,329,605
            
            
            6,564,990
            
            
            6,767,416Total
                Revenues
            
            $
            8,223,743
            
            $
            8,055,173
            
            $
            16,304,905
            
            $
            13,038,505




*
      Since
      ProCyte was acquired on March 18, 2005, the operating results of ProCyte for
      the
      six months ended June 30, 2005 include activity from ProCyte from March 19,
      2005
      through June 30, 2005.




30




***Domestic
      XTRAC Segment***




Recognized
      revenue for the three months ended June 30, 2006 and 2005 for domestic XTRAC
      procedures was $1,328,215 and $889,171, respectively, reflecting billed
      procedures of 21,365 and 13,811, respectively. In addition, 1,479 and 1,692
      procedures were performed in the three months ended June 30, 2006 and 2005,
      respectively, without billing from us, in connection with clinical research
      and
      customer evaluations of the XTRAC laser. Recognized revenue for the six months
      ended June 30, 2006 and 2005 for domestic XTRAC procedures was $2,387,845 and
      $1,523,189, respectively, reflecting billed procedures of 40,125 and 25,115,
      respectively. In addition, 2,652 and 2,806 procedures were performed in the
      six
      months ended June 30, 2006 and 2005, respectively, without billing from us,
      in
      connection with clinical research and customer evaluations of the XTRAC laser.
      The increase in procedures in the period ended June 30, 2006 compared to the
      comparable period in 2005 was largely related to our continuing progress in
      securing favorable reimbursement policies from private insurance plans.
      Increases in these levels are dependent upon more widespread adoption of CPT
      codes with comparable rates by private healthcare insurers and 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.




In
      the
      first quarter of 2003, we implemented 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 June 30, 2006, we deferred net revenues of $105,388 under
      this program compared to $51,865 for the three months ended June 30, 2005.
      For
      the six months ended June 30, 2006, we deferred net revenues of $156,468 under
      this program compared to $32,715 for the six months ended June 30, 2005. The
      change in deferred revenue under this program is presented in the table
      below.




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




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Recognized
                revenue
            
            $
            1,328,215
            
            $
            889,171
            
            $
            2,387,845
            
            $
            1,523,189Change
                in deferred programrevenue
            
            
            105,388
            
            
            51,865
            
            
            156,468
            
            
            32,715Change
                in deferred unusedtreatments
            
            
            (23,781
            )
            
            (39,700
            )
            
            86,273
            
            
            95,800Net
                billed revenue
            
            $
            1,409,822
            
            $
            901,336
            
            $
            2,630,586
            
            $
            1,651,704Procedure
                volume total
            
            
            22,844
            
            
            15,503
            
            
            42,777
            
            
            27,921Less:
                Non-billed procedures
            
            
            1,479
            
            
            1,692
            
            
            2,652
            
            
            2,806Net
                billed procedures
            
            
            21,365
            
            
            13,811
            
            
            40,125
            
            
            25,115Avg.
                price of treatments billed
            
            $
            65.99
            
            $
            65.26
            
            $
            65.56
            
            $
            66.77Change
                in procedures with deferred/(recognized) program revenue,
                net
            
            
            1,597
            
            
            795
            
            
            2,387
            
            
            497Change
                in procedures with deferred unused treatments, net
            
            
            (360
            )
            
            (608
            )
            
            1,316
            
            
            1,457




The
      average price for a treatment may be reduced in some pre-agreed 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 will
      evaluate the effectiveness of the Ultra in treating patients suffering from
      severe psoriasis.




31




***International
      Dermatology Equipment Segment***




International
      sales of our dermatology equipment and related parts were $290,616 for the
      three
      months ended June 30, 2006 compared to $314,183 for the three months ended
      June
      30, 2005. We sold 6 laser systems in each of the three months ended June 30,
      2006 and 2005. International sales of our dermatology equipment and related
      parts were $821,681 for the six months ended June 30, 2006 compared to $602,385
      for the six months ended June 30, 2005. We sold 18 and 11 laser systems in
      the
      six months ended June 30, 2006 and 2005, respectively. Compared to the domestic
      business, the international dermatology equipment operations are more influenced
      by competition from similar laser technology from other manufacturers and from
      non-laser lamps. Such competition has reduced the prices we charge to
      international distributors. Furthermore, average selling prices for
      international dermatology equipment are influenced by the following two
      factors:




·
            We
                have begun selling refurbished domestic XTRACs laser systems into
                the
                international market. The selling price for used equipment is
                substantially less than new equipment. We sold two and five of these
                used
                lasers at an average price of $28,000 for the three and six months
                ended
                June 30, 2006, respectively; and




·
            We
                have begun 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 six
                months ended June 30, 2006, we sold two and four VTRAC systems,
                respectively.




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




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            290,616
            
            $
            314,183
            
            $
            821,681
            
            $
            602,385Laser
                systems sold
            
            
            6
            
            
            6
            
            
            18
            
            
            11Average
                revenue per laser
            
            $
            48,436
            
            $
            52,363
            
            $
            45,649
            
            $
            54,762




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




For
      the
      three months ended June 30, 2006, ProCyte revenues were $3,069,827 compared
      to
      $3,522,214 in the three months ended June 30, 2005. For the six months ended
      June 30, 2006, ProCyte revenues were $6,530,389 compared to $4,145,515 in the
      six months ended June 30, 2005. Since ProCyte was acquired on March 18, 2005,
      the operating results of ProCyte for the six months ended June 30, 2005 include
      activity from ProCyte from March 19, 2005 through June 30, 2005. ProCyte
      revenues are generated from the sale of various skin and hair care products,
      from the sale of copper peptide compound and from royalties on licenses, mainly
      from Neutrogena. For the full six months June 30, 2005, unaudited Skin Care
      revenues were approximately $7.1 million.




Bulk
      compound sales decreased $219,550 for the three months ended June 30, 2006
      to
      the comparable prior year period. These sales are mainly from Neutrogena and
      will affect future royalties earned from Neutrogena. OEM distributor sales
      decreased $183,248 for the three months ended June 30, 2006 to the comparable
      prior year period, which is included in product sales.




32


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




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Product
                sales
            
            $
            2,838,815
            
            $
            3,007,076
            
            $
            5,916,377
            
            $
            3,459,940Bulk
                compound sales
            
            
            128,000
            
            
            347,550
            
            
            384,000
            
            
            503,550Royalties
            
            
            103,012
            
            
            167,588
            
            
            230,012
            
            
            182,025Total
                ProCyte revenues
            
            $
            3,069,827
            
            $
            3,522,214
            
            $
            6,530,389
            
            $
            4,145,515




***Surgical
      Services Segment***




In
      the
      three months ended June 30, 2006 and 2005, surgical services revenues were
      $1,749,315 and $2,003,380, respectively, representing a 12.7% decrease from
      the
      comparable period in 2005. In the six months ended June 30, 2006 and 2005,
      surgical services revenues were $3,365,349 and $4,074,030, respectively,
      representing a 17.4% decrease from the comparable period in 2005. These
      decreases were primarily due to the six territories that we closed since January
      1, 2005, the largest of which was in the fourth quarter of 2005, and business
      interruption in New Orleans and Alabama from the hurricanes in August and
      September 2005. Two of our territories were closed on the western side of
      Florida due to the termination of a customer contract. We closed the other
      four
      territories for insufficient profitability. During the first quarter of 2006,
      we
      have begun work with a regional hospital system in central Florida, which we
      expect will generate annual revenue exceeding the annual revenue lost in the
      western part of the state.




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




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            1,749,315
            
            $
            2,003,380
            
            $
            3,365,349
            
            $
            4,074,030




***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 June 30, 2006, surgical products revenues were $1,785,770
      compared to $1,326,225 in the three months ended June 30, 2005. The increase
      was
      due to $230,000 in additional laser system revenues reflecting an increase
      in
      the number of systems sold (27 vs. 12), partially offset by a decline in the
      average price per laser sold. For the six months ended June 30, 2006, surgical
      products revenues were $3,199,641 compared to $2,693,385 in the six months
      ended
      June 30, 2005. The increase was due to $444,000 in additional laser system
      revenues reflecting an increase in the number of systems sold (45 vs. 17),
      partially offset by a decline in the average price per laser sold.




The
      decrease in average price per laser was largely due to the mix of lasers sold.
      Included in laser sales during the three and six months ended June 30, 2006
      were
      sales of 23 and 36 diode lasers, respectively, which have lower sales prices
      than our other types of lasers. There were sales of 8 and 9 diode lasers,
      respectively, during the three and six months ended June 30, 2005.




Disposables
      and fiber sales increased 24% and 8% between the comparable three-month and
      six-month periods ended June 30, 2006 and 2005. Despite this increase, 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. We hope to offset the decline in laser and disposables revenues by
      sales of CO2 and diode surgical lasers.




33




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




Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            1,785,770
            
            $
            1,326,225
            
            $
            3,199,641
            
            $
            2,693,385Laser
                systems sold
            
            
            27
            
            
            12
            
            
            45
            
            
            17Laser
                system revenues
            
            $
            625,590
            
            $
            395,800
            
            $
            1,092,340
            
            $
            649,695Average
                revenue per laser
            
            $
            23,170
            
            $
            32,983
            
            $
            24,274
            
            $
            38,217




***Cost
      of Revenues***




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




Product
      cost of revenues for the three months ended June 30, 2006 was $1,955,175
      compared to $2,007,870 for the three months ended June 30, 2005. The $52,695
      decrease reflected decreases of $119,541 in costs for the ProCyte business
      and
      $112,086 associated with the dermatology laser equipment sold outside the United
      States, due to decreased sales, and an offsetting increase of $178,932 for
      surgical products due to increased sales.




Product
      cost of revenues for the six months ended June 30, 2006 was $4,276,844 compared
      to $2,900,834 for the six months ended June 30, 2005. The $1,376,010 increase
      reflected an increase of $706,946 of costs for the ProCyte business acquired
      on
      March 18, 2005, and as such, the operating results of ProCyte for the six months
      ended June 30, 2005 include activity from ProCyte from March 19, 2005 through
      June 30, 2005. Additionally there was an increase of $610,456 for surgical
      products due to lower production levels that resulted in increased unabsorbed
      overhead costs and $58,608 associated with the increase in sales of dermatology
      laser equipment sold outside the United States.




Services
      cost of revenues was $2,269,015 in the three months ended June 30, 2006 compared
      to $2,214,320 in the comparable period in 2005. Contributing to the $54,695
      increase was an $189,474 increase in the Domestic XTRAC business segment due
      to
      increased depreciation on the lasers of $186,000. This was offset by a decrease
      of $134,778 in the cost of revenues for the surgical services business, due
      to
      decreased revenues.




Services
      cost of revenues was $4,655,244 in the six months ended June 30, 2006 compared
      to $3,953,724 in the comparable period in 2005. Contributing to the $701,520
      increase was an $732,905 increase in the Domestic XTRAC business segment due
      to
      increased depreciation on the lasers of $430,000 and abnormal gas consumption,
      which has been corrected by software modifications. This was offset by a
      decrease of $31,385 in the cost of revenues for the surgical services business,
      due to decreased revenues.




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.




34




***Gross
      Margin Analysis***




Gross
      margin increased to $3,999,553 during the three months ended June 30, 2006
      from
      $3,832,983 during the same period in 2005. As a percent of revenues, gross
      margin increased to 48.6% for the three months ended June 30, 2006 from 47.6%
      for the same period in 2005. Gross margin increased to $7,372,817 during the
      six
      months ended June 30, 2006 from $6,183,947 during the same period in 2005.
      As a
      percent of revenues, gross margin decreased to 45.2% for the six months ended
      June 30, 2006 from 47.4% for the same period in 2005.




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




**Company
                Margin Analysis**
            
            Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            8,223,743
            
            
            8,055,173
            
            $
            16,304,905
            
            $
            13,038,505Percent
                increase
            
            
            2.1
            %
            
            
            
            
            25.1
            %Cost
                of revenues
            
            
            4,224,190
            
            
            4,222,190
            
            
            8,932,088
            
            
            6,854,558Percent
                increase
            
            
            0.0
            %
            
            
            
            
            30.6
            %Gross
                profit
            
            $
            3,999,553
            
            $
            3,832,983
            
            $
            7,372,817
            
            $
            6,183,947Gross
                profit percentage
            
            
            48.6
            %
            
            47.6
            %
            
            45.2
            %
            
            47.4
            %




The
      primary reasons for the increase in gross margin for the three months ended
      June
      30, 2006, compared to the same period in 2005 were as follows:




·
            We
                sold a greater number of treatment procedures for the XTRAC laser.
                Each
                incremental treatment procedure carries negligible variable cost.
                The
                increase in procedure volume was a direct result of improving insurance
                reimbursement.




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




The
      primary reasons for the increase in gross margin for the six months ended June
      30, 2006, compared to the same period in 2005 were as follows:




·
            Our
                skin care business has the highest gross profit percentage of any
                of our
                business segments. However, we acquired ProCyte on March 18, 2005,
                and, as
                such, the operating results of ProCyte for the six months ended June
                30,
                2005 only included activity from March 19, 2005 through June 30,
                2005.




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




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




·
            Offsetting
                the above was an increase in depreciation of $430,000 included in
                the
                XTRAC domestic cost of sales as a result of increasing the overall
                placements of new lasers since the period ended June 30,
                2005.




·
            In
                the surgical products segment, unabsorbed labor and overhead plant
                costs,
                due to lower production levels, accounted for $387,000 of the increase
                in
                cost of goods sold for the six months ended June 30,
                2006.




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






35




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




**XTRAC
                Domestic Segment**
            
            Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            1,328,215
            
            $
            889,171
            
            $
            2,387,845
            
            $
            1,523,189Percent
                increase
            
            
            49.4
            %
            
            
            
            
            56.8
            %Cost
                of revenues
            
            
            879,464
            
            
            689,990
            
            
            1,826,076
            
            
            1,093,171Percent
                increase
            
            
            27.5
            %
            
            
            
            
            67.0
            %Gross
                profit
            
            $
            448,751
            
            $
            199,181
            
            $
            561,769
            
            $
            430,018Gross
                profit percentage
            
            
            33.8
            %
            
            22.4
            %
            
            23.5
            %
            
            28.2
            %




Gross
      margin increased for this segment for the three and six months ended June 30,
      2006 from the comparable period in 2005 by $249,570 and $131,751, respectively.
      The key factors for the increase were as follows:




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




·
            Procedure
                volume increased 55% from 13,811 to 21,365 billed procedures in the
                three
                months ended June 30, 2006 compared to the same period in 2005. Procedure
                volume increased 60% from 25,115 to 40,125 billed procedures in the
                six
                months ended June 30, 2006 compared to the same period in 2005.




·
            Price
                per procedure did not change significantly between the
                periods.




·
            The
                cost of revenues increased by $189,474 for the three months ended
                June 30,
                2006. This increase is due to an increase in depreciation on the
                lasers in
                service of $186,000 over the comparable prior year period. The cost
                of
                revenues increased by $732,905 for the six months ended June 30,
                2006.
                This increase is due to an increase in depreciation on the lasers
                in
                service of $430,000 over the comparable prior year period and abnormal
                gas
                consumption, which has been corrected by software modification. The
                depreciation costs will continue to increase in subsequent periods
                as the
                business grows. In addition, there was an increase in certain allocable
                XTRAC manufacturing overhead costs that are charged against the XTRAC
                service revenues.






36




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




**International
                Dermatology****Equipment
                Segment**
            
            Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            290,616
            
            $
            314,183
            
            $
            821,681
            
            $
            602,385Percent
                (decrease) increase
            
            
            (7.5
            %)
            
            
            
            
            36.4
            %Cost
                of revenues
            
            
            122,069
            
            
            234,155
            
            
            452,359
            
            
            393,750Percent
                (decrease) increase
            
            
            (47.9
            %)
            
            
            
            
            14.9
            %Gross
                profit
            
            $
            168,547
            
            $
            80,028
            
            $
            369,322
            
            $
            208,635Gross
                profit percentage
            
            
            58.0
            %
            
            25.5
            %
            
            44.9
            %
            
            34.6
            %




Gross
      margin for the three and six months ended June 30, 2006 increased by $88,519
      and
      $160,687 from the comparable period in 2005. The key factors for the increase
      were as follows:




·
            We
                sold four XTRAC laser systems and two VTRAC lamp-based excimer systems
                during the three months ended June 30, 2006 and six XTRAC laser systems
                in
                the comparable period in 2005. We sold fourteen XTRAC laser systems
                and
                four VTRAC lamp-based excimer systems during the six months ended
                June 30,
                2006 and eleven XTRAC laser systems in the comparable period in 2005.
                The
                VTRAC systems have a higher gross margin than the XTRAC laser
                systems.




·
            The
                International dermatology equipment operations are influenced by
                competition from similar laser technology from other manufacturers
                and
                from non-laser lamp alternatives for treating inflammatory skin disorders,
                which has served to reduce the prices we charge international distributors
                for our excimer products. Partially offsetting the increase in the
                number
                of laser systems sold was a decrease in the average price of the
                laser
                systems sold. After adjusting the revenue for parts sales of approximately
                $63,000, the average price for lasers sold during this period was
                approximately $38,000 in the three months ended June 30, 2006, down
                from
                $43,400 in the comparable period in 2005. Contributing to the overall
                decrease in the average selling price in the three months ended June
                30,
                2006 was the sale of certain used lasers which were previously deployed
                in
                the U. S. operations and sold at a discount to the list price for
                new
                equipment. We sold two of these used lasers at an average price of
                $28,000. Each of these lasers had a net book value of less than the
                cost
                of a new XTRAC laser system.




After
      adjusting the revenue for parts sales of approximately $150,000, the average
      price for lasers sold during this period was approximately $37,000 in the six
      months ended June 30, 2006, down from $46,000 in the comparable period in 2005.
      Contributing to the overall decrease in the average selling price in the six
      months ended June 30, 2006 was the sale of certain used lasers which were
      previously deployed in the US operations and sold at a discount to the list
      price for new equipment. We sold four of these used lasers at an average price
      of $28,000. Each of these lasers had a net book value of less than the cost
      of a
      new XTRAC laser system.




·
            Additionally,
                for the three months ended June 30, 2006, the gross profit percentage
                increased due to an improvement in the absorption of manufacturing
                costs.






37


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




**Skin
                Care (ProCyte) Segment**
            
            Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Product
                revenues
            
            $
            2,838,815
            
            $
            3,007,076
            
            $
            5,916,377
            
            $
            3,459,940Bulk
                compound revenues
            
            
            128,000
            
            
            347,550
            
            
            384,000
            
            
            503,550Royalties
            
            
            103,012
            
            
            167,588
            
            
            230,012
            
            
            182,025Total
                revenues
            
            
            3,069,827
            
            
            3,522,214
            
            
            6,530,389
            
            
            4,145,515Product
                cost of revenues
            
            
            860,356
            
            
            821,633
            
            
            1,753,920
            
            
            918,314Bulk
                compound cost of revenues
            
            
            79,440
            
            
            237,703
            
            
            238,320
            
            
            366,979Total
                cost of revenues
            
            
            939,795
            
            
            1,059,336
            
            
            1,992,240
            
            
            1,285,293Gross
                profit
            
            $
            2,130,032
            
            $
            2,462,878
            
            $
            4,538,149
            
            $
            2,860,222Gross
                profit percentage
            
            
            69.4
            %
            
            69.9
            %
            
            69.5
            %
            
            69.0
            %




Gross
      margin for the three months ended June 30, 2006 decreased by $332,846 for the
      comparable period in 2005. The key factor for the decrease were as
      follows:




·
            Revenues
                decreased $452,387 for the three months ended June 30, 2006 compared
                to
                the three month ended June 30, 2005. The gross margin on the decrease
                of
                revenues was approximately $316,671 since the average gross margin
                percentage is 70%.




Gross
      margin for the six months ended June 30, 2006 increased by $1,677,927 for the
      comparable period in 2005. The key factors for this business were as
      follows:




·
            Skin
                Care (ProCyte) business was acquired on March 18, 2005 and, as such,
                the
                operating results of ProCyte for the six months ended June 30, 2005
                included activity from March 19, 2005 through June 30,
                2005.




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




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




**Surgical
                Services Segment**
            
            Three
                Months Ended June 30,
            
            Six
                Months EndedJune
                30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            1,749,315
            
            $
            2,003,380
            
            $
            3,365,349
            
            $
            4,074,030Percent
                decrease
            
            
            (12.7
            %)
            
            
            
            
            (17.4
            %)Cost
                of revenues
            
            
            1,363,760
            
            
            1,502,219
            
            
            2,778,339
            
            
            2,817,679Percent
                decrease
            
            
            (9.2
            %)
            
            
            
            
            (1.4
            %)Gross
                profit
            
            $
            385,555
            
            $
            501,161
            
            $
            587,010
            
            $
            1,256,351Gross
                profit percentage
            
            
            22.0
            %
            
            25.0
            %
            
            17.4
            %
            
            30.8
            %




Gross
      margin in the Surgical Services segment for the three and six months ended
      June
      30, 2006 decreased by $115,606 and $669,341 from the comparable period in 2005.
      The key factors impacting gross margin for the Surgical Services business were
      as follows:




38




·
            We
                have closed six geographic areas of business due to unacceptable
                operating
                profit and one territory due to competition. Although closing these
                unprofitable territories will save costs and improve profitability
                over
                time, the overall costs saved for the three and six months ended
                June 30,
                2006 have not kept pace with the revenues lost. Nevertheless, in
                the case
                of the territory lost to competition, we have opened a new, contiguous
                territory in which we have secured a long-term contract from which
                we
                anticipate significant procedure volume. For that reason, we have
                relocated our personnel and material from the lost territory to the
                new
                one.




·
            We
                have suffered business interruption due to hurricanes in the New
                Orleans
                and Alabama territories during August and September 2005.




·
            Also,
                our product cost percentage has increased due to a change in the
                mix of
                procedures performed.




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




**Surgical
                Products Segment**
            
            Three
                Months Ended June 30,
            
            Six
                Months Ended June 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            1,785,770
            
            $
            1,326,225
            
            $
            3,199,641
            
            $
            2,693,386Percent
                increase
            
            
            34.7
            %
            
            
            
            
            18.8
            %Cost
                of revenues
            
            
            919,102
            
            
            736,490
            
            
            1,883,074
            
            
            1,264,665Percent
                increase
            
            
            24.8
            %
            
            
            
            
            48.9
            %Gross
                profit
            
            $
            866,668
            
            $
            589,735
            
            $
            1,316,567
            
            $
            1,428,721Gross
                profit percentage
            
            
            48.5
            %
            
            44.5
            %
            
            41.1
            %
            
            53.0
            %




Gross
      margin for the Surgical Products segment in the three months ended June 30,
      2006
      compared to the same period in 2005 increased by $276,933. The key factors
      in
      this business segment were as follows:




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




·
            Revenues
                for the three months ended June 30, 2006 increased by $459,545 from
                the
                three months ended June 30, 2005 while cost of revenues increased
                by
                $182,612 between the same periods. There were 15 more laser systems
                sold
                in the three months ended June 30, 2006 than in the comparable period
                of
                2005. However, the lasers sold in the 2005 period were at higher
                prices
                than in the comparable period in 2006. The decrease in average price
                per
                laser was largely due to the mix of lasers sold. Included in the
                laser
                sales for the three months ended June 30, 2006 and 2005 were sales
                of
                $410,790 and $179,000 of diode lasers, respectively, which have
                substantially lower list sales prices than the other types of surgical
                lasers.




·
            Disposables,
                which have a higher gross margin as a percent of revenues than lasers,
                represented a higher percentage of revenue in the three months ended
                June
                30, 2006 compared to the same period in
                2005.




Gross
      margin for the Surgical Products segment in the six months ended June 30, 2006
      compared to the same period in 2005 decreased by $112,154. The key factors
      in
      this business segment were as follows:




·
            Revenues
                for the six months ended June 30, 2006 increased by $506,255 from
                the six
                months ended June 30, 2005 while cost of revenues increased by $618,409
                between the same periods. There were 28 more laser systems sold in
                the six
                months ended June 30, 2006 than in the comparable period of 2005.
                However,
                the lasers sold in the 2005 period were at higher prices than in
                the
                comparable period in 2006. The decrease in average price per laser
                was
                largely due to the mix of lasers sold. Included in the laser sales
                for the
                six months ended June 30, 2006 and 2005 were sales of $641,290 and
                $214,000 of diode lasers, respectively, which have substantially
                lower
                list sales prices than the other types of surgical
                lasers.






39






·
            Unabsorbed
                labor and overhead plant costs, due to lower production levels, accounted
                for $387,000 of the increase in cost of goods sold for the six months
                ended June 30, 2006.




·
            This
                revenue increase was partly offset by a decrease in AzurTec project
                revenues and a decrease in sales of disposables between the periods.
                The
                AzurTec revenues recognized in 2005 had substantially no direct costs
                associated with these revenues. Disposables, which have a higher
                gross
                margin as a percent of revenues than lasers, represented a higher
                percentage of revenue in the three months ended June 30, 2006 compared
                to
                the same period in 2005.




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




For
      the
      three months ended June 30, 2006, selling, general and administrative expenses
      increased $749,015 to $4,946,458 from the three months ended June 30, 2005.
      The
      increase was caused by an increase in direct-to-consumer advertising of
      $230,000, an increase in bonus accrual of $130,000, an increase of $414,954
      for
      stock-based compensation expense following adoption of SFAS No. 123R (see Note
      1, “Stock-Based Compensation”) and $16,815 for stock options issued to
      consultants. Offsetting a portion of the increases for the three months ended
      June 30, 2006, was a reduction of legal expenses of $113,000 compared to the
      prior year period.




For
      the
      six months ended June 30, 2006, selling, general and administrative expenses
      increased $2,888,217 to $10,306,636 from the six months ended June 30, 2005.
      Selling, general and administrative expenses related to the ProCyte business
      accounted for $1,034,000 of the increase with the remaining increase related
      to
      a $187,000 increase in salaries, benefits and travel expenses associated with
      an
      increase in the sales force, particularly in the domestic XTRAC segment, an
      increase in direct-to-consumer advertising of $534,000, an increase in corporate
      insurance of $105,000, an increase in bonus accrual of $130,000, an increase
      of
      $805,122 for stock-based compensation expense following adoption of SFAS No.
      123R (see Note 1, “Stock-Based Compensation”) and $93,437 for stock options
      issued to consultants. Offsetting a portion of the increases for the six months
      ended June 30, 2006, was a reduction of legal expense of $192,000 compared
      to
      the prior year period.




***Engineering
      and Product Development***




Engineering
      and product development expenses for the three months ended June 30, 2006
      decreased to $255,179 from $327,939 for the three months ended June 30, 2005.
      Engineering and product development expenses for the six months ended June
      30,
      2006 decreased to $497,383 from $514,910 for the six months ended June 30,
      2005.
      During the 2005 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.




***Other
      Income***




Other
      income for the three and six months ended June 30, 2005 was $88,667, reflecting
      a non-monetary exchange of assets during June 2005 of two depreciable
      engineering development prototypes in exchange for four product units to be
      held
      for sale. There was no other income in the comparable periods in 2006.




***Interest
      Expense, Net***




Net
      interest expense for the three months ended June 30, 2006 increased to $137,847,
      as compared to $56,919 for the three months ended June 30, 2005. Net interest
      expense for the six months ended June 30, 2006 increased to $258,990, as
      compared to $128,048 for the six months ended June 30, 2005. The increase in
      net
      interest expense was the result of the draws on the lease line of credit during
      the second, third and fourth quarters of 2005 and the first quarter
      2006.




40




***Net
      Loss***




The
      aforementioned factors resulted in a net loss of $1,339,931 during the three
      months ended June 30, 2006, as compared to a net loss of $660,651 during the
      three months ended June 30, 2005, an increase of 103%. The aforementioned
      factors resulted in a net loss of $3,690,192 during the six months ended June
      30, 2006, as compared to a net loss of $1,788,763 during the six months ended
      June 30, 2005, an increase of 106%. These increases were primarily the result
      of
      the increase in cost of sales and resulting decrease in gross margin, stock
      option expense of $431,768 and $898,557 following the adoption of SFAS No.
      123R
      and an increase of $231,058 and $721,757 of depreciation and amortization over
      the comparable prior year three and six-month periods, respectively. The
      following table illustrates the impact of two of these major expenses, namely
      depreciation and amortization and of stock option expense following adoption
      of
      SFAS No. 123R, between the periods:




For
                the three months ended June 30,2006
            
            2005
            
            ChangeNet
                Loss
            
            $
            1,339,931
            
            $
            660,651
            
            $
            679,280Major
                Expenses:Depreciation
                and amortization
            
            
            1,037,416
            
            
            806,358
            
            
            231,058Stock-based
                compensation
            
            
            431,769
            
            
            -
            
            
            431,769$
            1,469,184
            
            $
            806,358
            
            $
            662,826







For
                the six months ended June 30,2006
            
            2005
            
            ChangeNet
                Loss
            
            $
            3,690,192
            
            $
            1,788,763
            
            $
            1,901,429Major
                Expenses:Depreciation
                and amortization
            
            
            2,054,511
            
            
            1,332,754
            
            
            721,757Stock-based
                compensation
            
            
            898,559
            
            
            -
            
            
            898,559$
            2,953,070
            
            $
            1,332,754
            
            $
            1,620,316




The
      table
      provides a non-GAAP measure of financial performance. The table should be
      considered as a supplement to results prepared under current accounting
      standards, but they are not a substitute for, nor superior to, GAAP results.
      We
      present this non-GAAP measure to enhance investors’ overall understanding of our
      current financial performance and provide further information for comparison
      to
      periods pre-dating the adoption of the new accounting standard SFAS No. 123R.
      We
      believe that the non-GAAP measure provides useful information to both management
      and investors by isolating certain expenses, gains and losses that may not
      be
      indicative of our core operating results and business outlook. In addition,
      we
      believe that non-GAAP measures that exclude stock-based compensation expense
      enhance the comparability of current results against prior periods.




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




***Liquidity
      and Capital Resources***




We
      have
      historically financed our operations with cash provided by equity financing
      and
      from lines of credit and, more recently, from positive results from operations.




41




On
      March
      18, 2005, we acquired ProCyte. The skincare products and royalties provided
      by
      ProCyte increased revenues for the three and six months ended June 30, 2006.
      We
      expect to realize cost savings from the consolidation of the administrative
      and
      marketing infrastructure of the combined company. Additionally, once the
      consolidated infrastructure is in place, we expect our revenues to grow without
      proportionately increasing the rate of growth in our fixed costs.




At
      June
      30, 2006, our current ratio was 1.91 compared to 2.42 at December 31, 2005.
      As
      of June 30, 2006, we had $8,779,026 of working capital compared to $11,109,369
      as of December 31, 2005. Cash and cash equivalents were $4,300,509 as of June
      30, 2006, as compared to $5,609,967 as of December 31, 2005. We had $168,167
      of
      cash that was classified as restricted as of June 30, 2006 compared to $206,931
      as of December 31, 2005.




We
      believe that our existing cash balance together with our 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
      beyond the third quarter of 2007. The 2006 operating plan reflects costs savings
      from the integration of ProCyte as well as increases in per-treatment fee
      revenues for use of the XTRAC system based on wider insurance coverage in the
      United States. In addition, the 2006 operating plan calls for increased revenues
      and profits from our newly acquired Skin Care business. We cannot give
      assurances that we will be able to execute our business plan, which may require
      us to obtain additional equity or debt financing to meet our working capital
      requirements or capital expenditure needs. Also, if our growth exceeds the
      business plan projections, we may require additional equity or debt financing.
      There can be no assurance that additional financing, if needed, will be
      available when required or, if available, will be on terms satisfactory to
      us.




On
      June
      25, 2004, we entered into a leasing credit facility from GE Capital Corporation
      (“GE”). The credit facility has a commitment term of three years, expiring on
      June 25, 2007. We account 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. Each draw against the
      credit facility has a repayment period of three years and is secured by specific
      lasers, which we have sold to GE and leased back for deployment in the field.
      A
      summary of the activity under the GE leasing credit facility is presented in
      Note 9, “Long-term Debt.”




Net
      cash
      used by operating activities was $260,976 for six months ended June 30, 2006,
      compared to $2,634,022 for the same period in 2005. The change was primarily
      due
      to an increase in accounts receivable.




Net
      cash
      used in investing activities was $2,132,755 for the six months ended June 30,
      2006 compared to cash provided by of $3,789,271 for the six months ended June
      30, 2005. During the six months ended June 30, 2005, we received cash of
      $5,578,416, net of acquisition costs, in the ProCyte acquisition and used
      $1,727,800 for production of our lasers-in-service compared to $2,097,925 for
      the same period in 2006.




Net
      cash
      provided by financing activities was $1,123,037 for the six months ended June
      30, 2006 compared to $473,249 for the six months ended June 30, 2005. In the
      six
      months ended June 30, 2006 we made payments of $510,055 on certain notes payable
      and capital lease obligations and $7,890 in registration costs. These payments
      were offset by the advances under the lease line of credit, net of payments,
      of
      $1,517,439, by receipts of $76,179 from the exercise of common stock options
      and
      $38,764 of restricted cash that was released from restriction. In the six months
      ended June 30, 2005, we received $739,055 from the advances under the lease
      line
      of credit, net of payments, $445,995 from the exercise of common stock options
      and warrants. These cash receipts were offset by $455,460 for the payment of
      certain notes payable, capital lease obligations and $161,739 of registration
      costs and $94,602 of additional restricted cash.




***Commitments
      and Contingencies***




During
      the three and six months ended June 30, 2006, there were no other items that
      significantly impacted our commitments and contingencies as discussed in the
      notes to our 2005 annual financial statements included in our Annual Report
      on
      Form 10-K. In addition, we have no significant off-balance sheet
      arrangements.




42


***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 functioning effectively to provide reasonable assurance
      that
      the 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. A control system
      cannot provide absolute assurance, however, that the objectives of the control
      system are met and no evaluation of controls can provide absolute assurance
      that
      all control issues and instances of fraud, if any, within a company have been
      detected.





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





No
      change
      in our internal control over financial reporting occurred during the three
      and
      six months ended June 30, 2006 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, 2005 for descriptions
      of our legal proceedings.




In
      the
      matter brought by us against RA Medical Systems, Inc. and Dean Stewart Irwin
      in
      the United States District Court for the Southern District of California, the
      discovery process has been stymied by the parties’ disagreement over what should
      be discoverable. The court has taken under advisement our motion for partial
      summary judgment, which is based on a theory that defendants have competed
      unfairly against us. We contend that RA Medical had not applied for and
      obtained, until January 2006, a license from the State of California to
      manufacture or market their medical devices. RA Medical has brought an action
      against us in California Superior Court for San Diego County, alleging: (1)
      that
      we did not have the requisite permission from the State of California for our
      new facility in Carlsbad and (2) that that our standard agreement consigning
      an
      XTRAC laser with a physician interferes with the physician’s freedom to practice
      medicine. We have removed RA Medical’s state action to Federal court and asked
      to consolidate it with the ongoing Federal action. We have moved to dismiss
      the
      second count of the removed action.




In
      the
      matter brought by RA Medical Systems, Inc. and Dean Stewart Irwin against us,
      Jenkens & Gilchrist, LLP (our outside counsel) and Michael R. Matthias, Esq.
      (litigation partner at our outside counsel), the California Supreme Court
      declined to take our appeal. We are currently evaluating our defenses and who
      can best mount those defenses without interests in conflict between our carrier
      and us.




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.




43




**ITEM
      1A. Risk Factors**




We
      noted
      in Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended
      December 31, 2005, that “we depend on our executive officers and key personnel
      to implement our business strategy and could be harmed by the loss of their
      services.” By way of update to this risk factor, we note that Mr. Clifford, our
      Executive Vice President, Dermatology, has left the Company in the second
      quarter 2006.




As
      Mr.
      Clifford’s responsibilities included domestic sales and marketing of our
      dermatology segments, his departure could adversely affect our ability to manage
      our dermatology businesses and to develop and introduce new products. We intend
      to mitigate any adverse effects by entering into a consulting arrangement with
      Mr. Clifford and by redistributing Mr. Clifford’s responsibilities, to the
      extent possible, over existing resources. There can be no assurance, however,
      that such efforts in mitigation will be successful.




**ITEM
      2. Unregistered Sales of Equity Securities and Use of
      Proceeds**




***Recent
      Issuances of Unregistered Securities***




None.




**ITEM
      3. Defaults Upon Senior Securities**




Not
      applicable.




**ITEM
      4. Submission of Matter to a Vote of Security Holders**




We
      held
      our 2006 Annual Meeting of Stockholders on June 22, 2006. Richard J. DePiano,
      Jeffrey F. O’Donnell, Warwick Alex Charlton, Alan R. Novak, Anthony J. Dimun and
      David Anderson, the director nominees set forth in the Notice of Annual Meeting,
      were elected to serve as directors. The vote tally is set forth below:




**Votes
                For**
            
            **Votes
                Against**
            
            **Votes
                Abstaining**Richard
                J. DePiano
            
            
            40,201,670
            
            
            0
            
            
            7,094,669Jeffrey
                F. O’Donnell
            
            
            40,199,105
            
            
            0
            
            
            7,097,234Warwick
                Alex Charlton
            
            
            40,201,558
            
            
            0
            
            
            7,094,781Alan
                R. Novak
            
            
            40,200,885
            
            
            0
            
            
            7,095,454Anthony
                J. Dimun
            
            
            40,201,670
            
            
            0
            
            
            7,094,781David
                W. Anderson
            
            
            40,192,105
            
            
            0
            
            
            7,104,234




Amper,
      Politziner & Mattia, P.C. was ratified to be our independent auditors for
      the year ending December 31, 2006, with 47,162,228 votes for, 95,586 votes
      against and 38,524 votes abstaining.




**ITEM
      5. Other Information**




None.




**ITEM
      6. Exhibits**




31.1
            
            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





44


**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:
              August 9, 2006
            By:
            /s/ Jeffrey
              F. O’DonnellJeffrey
              F. O’DonnellPresident
              and
              Chief Executive Officer  Date:
              August 9, 2006
            By:
            /s/ Dennis
              M.
              McGrathDennis
              M. McGrathChief
              Financial Officer




45