UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10 - Q





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





For
the quarterly period ended March 31, 2009





OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES
      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
              
              (I.R.S.  Employerof
      incorporation or organization)
              
              Identification
      No.)





147 Keystone Drive,
Montgomeryville, Pennsylvania 18936


(Address
of principal executive offices, including zip code)





(215)
619-3600


(Registrant's
telephone number, including area code)





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


Yes x  No  ̈





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




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


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


Yes  ̈  No x





The
number of shares outstanding of the issuer's Common Stock as of May 15, 2009 was
9,005,175 shares.





PHOTOMEDEX,
INC.





INDEX TO
FORM 10-Q





PAGEPart I. Financial
    Information:ITEM
      1.  Financial Statements:a.    
      Consolidated Balance Sheets, March 31, 2009 (unaudited) and December 31,
      2008
                    3b.     
      Consolidated Statements of Operations for the three
      months ended March 31, 2009 and 2008 (unaudited)
                    4c.     
      Consolidated Statement of Stockholders’ Equity for the three months ended
      March 31, 2009 (unaudited)
                    5d.     
      Consolidated Statements of Cash Flows for the three months ended March 31,
      2009 and 2008 (unaudited)
                    6e.     
      Notes to Consolidated Financial Statements (unaudited)
                    7ITEM
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                    25ITEM
      3.  Quantitative and Qualitative Disclosure about Market
      Risk
                    41ITEM
      4.  Controls and Procedures
                    41Part II. Other Information:ITEM
      1.     Legal Proceedings
                    41ITEM
      1A.  Risk Factors
                    42ITEM
      4.     Submission of Matters to a Vote of
      Security Holders
                    43ITEM
      5.     Other Information
                    43ITEM
      6.     Exhibits
                    44Signatures
                    44Certifications
                    45


2


PART
I – Financial Information




ITEM
1. Financial Statements




PHOTOMEDEX,
INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS




March 31, 2009
                  
                  
                  December 31, 2008(Unaudited)
                  
                  
                  *ASSETSCurrent
      assets:Cash
      and cash equivalents
                  
                  $
                  4,179,320
                  
                  
                  $
                  3,658,607Restricted
      cash
                  
                  
                  78,000
                  
                  
                  
                  78,000Accounts
      receivable, net of allowance for doubtful accounts of $483,190 and
      $486,000, respectively
                  
                  
                  5,678,180
                  
                  
                  
                  5,421,688Inventories,
      net
                  
                  
                  9,202,545
                  
                  
                  
                  6,974,194Prepaid
      expenses and other current assets
                  
                  
                  296,682
                  
                  
                  
                  322,549Total
      current assets
                  
                  
                  19,434,727
                  
                  
                  
                  16,455,038Property
      and equipment, net
                  
                  
                  10,592,238
                  
                  
                  
                  10,388,406Patents
      and licensed technologies, net
                  
                  
                  8,438,614
                  
                  
                  
                  1,142,462Goodwill,
      net
                  
                  
                  19,569,199
                  
                  
                  
                  16,917,808Other
      intangible assets, net
                  
                  
                  2,470,625
                  
                  
                  
                  1,095,625Other
      assets
                  
                  
                  1,244,802
                  
                  
                  
                  714,930Total
      assets
                  
                  $
                  61,750,205
                  
                  
                  $
                  46,714,269LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Current
      portion of notes payable
                  
                  $
                  29,412
                  
                  
                  $
                  28,975Current
      portion of long-term debt
                  
                  
                  4,296,833
                  
                  
                  
                  4,663,281Accounts
      payable
                  
                  
                  5,663,259
                  
                  
                  
                  5,204,334Accrued
      compensation and related expenses
                  
                  
                  1,489,908
                  
                  
                  
                  1,487,153Other
      accrued liabilities
                  
                  
                  1,373,514
                  
                  
                  
                  864,433Deferred
      revenues
                  
                  
                  1,469,352
                  
                  
                  
                  798,675Total
      current liabilities
                  
                  
                  14,322,278
                  
                  
                  
                  13,046,851Long-term
      liabilities:Notes
      payable
                  
                  
                  69,720
                  
                  
                  
                  77,239Long-term
      debt
                  
                  
                  2,977,252
                  
                  
                  
                  3,907,752Convertible
      debt
                  
                  
                  16,468,866
                  
                  
                  
                  -Warrants
      related to convertible debt
                  
                  
                  1,459,089
                  
                  
                  
                  -Total
      liabilities
                  
                  
                  35,297,205
                  
                  
                  
                  17,031,842Commitments
      and ContingenciesStockholders’
      equity:Common
      stock, $.01 par value, 21,428,572 shares authorized; 9,005,175 and
      9,004,601 shares issued and outstanding, respectively
                  
                  
                  90,051
                  
                  
                  
                  90,046Additional
      paid-in capital
                  
                  
                  135,169,582
                  
                  
                  
                  134,912,537Accumulated
      deficit
                  
                  
                  (108,832,343
                  )
                  
                  
                  (105,320,156
                  )Accumulated
      other comprehensive income
                  
                  
                  25,710
                  
                  
                  
                  -Total
      stockholders’ equity
                  
                  
                  26,453,000
                  
                  
                  
                  29,682,427Total
      liabilities and stockholders’ equity
                  
                  $
                  61,750,205
                  
                  
                  $
                  46,714,269





*  The
December 31, 2008 balance sheet was derived from the Company’s audited financial
statements.




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


3




PHOTOMEDEX,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS




(Unaudited)




For the Three Months Ended March
      31,2009
                    
                    
                    2008Revenues:Product
      sales
                    
                    $
                    5,197,850
                    
                    
                    $
                    6,731,980Services
                    
                    
                    2,300,492
                    
                    
                    
                    1,598,8547,498,342
                    
                    
                    
                    8,330,834Cost
      of revenues:Product
      cost of revenues
                    
                    
                    2,459,348
                    
                    
                    
                    2,864,452Services
      cost of revenues
                    
                    
                    1,338,252
                    
                    
                    
                    1,253,5793,797,600
                    
                    
                    
                    4,118,031Gross
      profit
                    
                    
                    3,700,742
                    
                    
                    
                    4,212,803Operating
      expenses:Selling
      and marketing
                    
                    
                    3,900,751
                    
                    
                    
                    4,112,964General
      and administrative
                    
                    
                    2,799,180
                    
                    
                    
                    2,144,443Engineering
      and product development
                    
                    
                    201,697
                    
                    
                    
                    438,6886,901,628
                    
                    
                    
                    6,696,095Operating
      loss from continuing operations
                    
                    
                    (3,200,886
                    )
                    
                    
                    (2,483,292
                    )Other
      income (loss):Interest
      expense, net
                    
                    
                    (402,523
                    )
                    
                    
                    (227,371
                    )Change
      in fair value of warrants (see Note 1)
                    
                    
                    91,222
                    
                    
                    
                    -Loss
      from continuing operations
                    
                    
                    (3,512,187
                    )
                    
                    
                    (2,710,663
                    )Discontinued
      operations:Income
      from discontinued operations, net of nil in taxes
                    
                    
                    -
                    
                    
                    
                    168,802Net
      loss
                    
                    $
                    ( 3,512,187
                    )
                    
                    $
                    ( 2,541,861
                    )Basic
      and diluted net loss per share:Continuing
      operations
                    
                    $
                    (0.39
                    )
                    
                    $
                    (0.30
                    )Discontinued
      operations
                    
                    $
                    (0.00
                    )
                    
                    $
                    0.02Basic
      and diluted net loss per share
                    
                    $
                    (0.39
                    )
                    
                    $
                    (0.28
                    )Shares
      used in computing basic and diluted net loss per share
                    
                    
                    9,005,009
                    
                    
                    
                    9,004,601





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




4




PHOTOMEDEX,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY


FOR THE
THREE MONTHS ENDED MARCH 31, 2009




(Unaudited)




AccumulatedAdditional
                
                
                
                
                
                OtherCommon
      Stock
                
                
                Paid-In
                
                
                Accumulated
                
                
                ComprehensiveShares
                
                
                Amount
                
                
                Capital
                
                
                Deficit
                
                
                Income
                
                
                TotalBALANCE,
      DECEMBER 31, 2008
                
                
                9,004,601
                
                
                $
                90,046
                
                
                $
                134,912,537
                
                
                $
                (105,320,156
                )
                
                $
                -
                
                
                $
                29,682,427Round
      up for fractional shares due to the reverse stock split
                
                
                574
                
                
                
                5
                
                
                
                (5
                )
                
                
                -
                
                
                
                -
                
                
                
                -Stock
      options issued to consultants for services
                
                
                -
                
                
                
                -
                
                
                
                17,419
                
                
                
                -
                
                
                
                -
                
                
                
                13,736Amortization
      of expense for restricted stock
                
                
                -
                
                
                
                -
                
                
                
                103,623
                
                
                
                -
                
                
                
                -
                
                
                
                103,623Change
      in cumulative translation adjustments
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                25,710
                
                
                
                25,710Stock-based
      compensation expense related to employee options
                
                
                -
                
                
                
                -
                
                
                
                171,632
                
                
                
                -
                
                
                
                -
                
                
                
                175,315Registration
      costs
                
                
                -
                
                
                
                -
                
                
                
                (35,624
                )
                
                
                -
                
                
                
                -
                
                
                
                (35,624
                )Net
      loss for the three months ended March 31, 2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (3,512,187
                )
                
                
                -
                
                
                
                (3,512,187
                )BALANCE,
      MARCH 31, 2009
                
                
                9,005,175
                
                
                $
                90,051
                
                
                $
                135,169,582
                
                
                $
                (108,832,343
                )
                
                $
                25,710
                
                
                $
                26,453,000




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


5


PHOTOMEDEX,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)




For the Three Months Ended
                  March 31,2009
                
                
                2008Cash Flows From Operating
      Activities:Net
      loss
                
                $
                (
      3,512,187
                )
                
                $
                (
      2,541,861
                )Adjustments
      to reconcile net loss to net cash used in operating activities-continuing
      operations:Depreciation
      and amortization
                
                
                995,220
                
                
                
                1,027,668Stock
      options issued to consultants for services
                
                
                17,419
                
                
                
                46,914Stock-based
      compensation expense related to employee options and restricted
      stock
                
                
                275,255
                
                
                
                379,629Provision
      for bad debts
                
                
                26,843
                
                
                
                27,571Change
      in estimated fair value of warrant liability (See Note 1)
                
                
                (91,222
                )
                
                
                -Changes
      in operating assets and liabilities, net of effects from discontinued
      operations:Accounts
      receivable
                
                
                559,672
                
                
                
                654,562Inventories
                
                
                (554,449
                )
                
                
                417,200Prepaid
      expenses and other assets
                
                
                (279,526
                )
                
                
                237,284Accounts
      payable
                
                
                (226,854
                )
                
                
                664,919Accrued
      compensation and related expenses
                
                
                (33,151
                )
                
                
                (316,553
                )Other
      accrued liabilities
                
                
                89,897
                
                
                
                426,755Deferred
      revenues
                
                
                94,328
                
                
                
                287,290Net
      cash (used in) provided by operating activities – continuing
      operations
                
                
                (2,638,755
                )
                
                
                1,311,378Net
      cash provided by operating activities – discontinued
      operations
                
                
                -
                
                
                
                71,768Net
      cash (used in) provided by operating activities
                
                
                (2,638,755
                )
                
                
                1,383,146Cash
      Flows From Investing Activities:Purchases
      of property and equipment
                
                
                (29,756
                )
                
                
                (72,069
                )Lasers
      placed into service
                
                
                (889,444
                )
                
                
                (1,152,900
                )Acquisition
      costs, net of cash received
                
                
                (12,578,022
                )
                
                
                -Net
      cash used in investing activities – continuing operations
                
                
                (13,497,222
                )
                
                
                (1,224,969
                )Net
      cash used in investing activities – discontinued
operations
                
                
                -
                
                
                
                (36,000
                )Net
      cash used in investing activities
                
                
                (13,497,222
                )
                
                
                (1,260,969
                )Cash
      Flows From Financing Activities:Registration
      costs
                
                
                (35,624
                )
                
                
                -Payments
      on long-term debt other than line of credit
                
                
                -
                
                
                
                (32,664
                )Payments
      on notes payable
                
                
                (7,082
                )
                
                
                (126,324
                )Advances
      on line of credit
                
                
                -
                
                
                
                840,000Repayments
      on line of credit
                
                
                (1,326,314
                )
                
                
                (1,232,937
                )Proceeds
      from convertible debt
                
                
                18,000,000
                
                
                
                -Net
      cash provided by (used in) financing activities  - continuing
      operations
                
                
                16,630,980
                
                
                
                (551,925
                )Net
      cash provided by (used in) financing activities  - discontinued
      operations
                
                
                -
                
                
                
                -Net
      cash provided by (used in) financing activities
                
                
                16,630,980
                
                
                
                (551,925
                )Effect
      of exchange rate changes on cash
                
                
                25,710
                
                
                
                -Net
      increase (decrease) in cash and cash equivalents
                
                
                520,713
                
                
                
                (429,748
                )Cash
      and cash equivalents, beginning of period
                
                
                3,658,607
                
                
                
                9,837,303Cash
      and cash equivalents, end of period
                
                $
                4,179,320
                
                
                $
                9,407,555




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


6


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 currently operates in five
distinct business units, or segments (as described in Note 12): four in
Dermatology, - Domestic XTRAC®, International Dermatology Equipment, Skin Care
(ProCyte®) and Photo Therapeutics (PTL); and one in Surgical, - Surgical
Products (SLT®). The segments are distinguished by our management structure,
products and services offered, markets served or types of customers. A sixth
segment of business, the Surgical Services segment was sold on August 8, 2008
and was reported in the financial statements for 2008 as a discontinued
operation, including its related assets.




The
Domestic XTRAC segment generally derives revenues from procedures performed by
dermatologists in the United States. Under these circumstances, the Company’s
XTRAC laser system is placed in a dermatologist’s office without any initial
capital cost to the dermatologist, and the Company charges a fee-per-use to
treat skin disease. At times, however, the Company sells XTRAC lasers to
customers, due generally to customer circumstances and preferences. In
comparison to the Domestic XTRAC segment, the International Dermatology
Equipment segment generates revenues solely from the sale of equipment and parts
to dermatologists outside the United States through a network of distributors.
The Skin Care segment generates revenues by selling physician-dispensed skincare
products worldwide. The Photo Therapeutics segment, a business acquired on
February 27, 2009, generates revenues by selling light emitting diodes (“LEDs”)
and associated skin care products for the treatment of a range of clinical and
aesthetic dermatological conditions. It sells to professional users and,
recently, to the home-use consumer market. See Note 2, Acquisition.




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




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




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




Surgical
Services was a fee-based procedures business using mobile surgical laser
equipment operated by Company technicians at hospitals and surgery centers in
the United States. On August 8, 2008, the Company sold certain assets of the
business including accounts receivable, inventory and equipment, for $3,149,737.
See Note 2, Discontinued
Operations.




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




7




Liquidity
and Going Concern


As of
March 31, 2009, the Company had an accumulated deficit of $108,832,343. 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 March 31, 2009 were $4,257,320, including restricted cash
of $78,000. The Company has historically financed its operations with cash
provided by equity financing and from lines of credit. The Company is exploring
additional financing options for its domestic XTRAC program. However, there can
be no assurance that the Company will obtain such debt financing on favorable
terms or at all. In addition, the Company completed its purchase of the
subsidiaries of Photo Therapeutics Group Ltd., and the related acquisition
financing on February 27, 2009. The acquisition financing included $3 million of
incremental working capital to the Company after payments of the acquisition
costs and expenses. Management believes that the existing cash balance, together
with its other existing financial resources and any revenues from sales,
distribution, licensing and manufacturing relationships, will be sufficient to
meet the Company’s operating and capital requirements beyond the end of the
second quarter of 2010. The revised 2009 operating plan reflects anticipated
growth from both increased fee revenues for use of the XTRAC laser system based
on increased utilization and wider insurance coverage in the United States and
anticipated growth in revenues of the Company’s skin care and LED products. In
response to prevailing economic conditions, anticipated revenue growth has been
tempered, and a flexible contingency plan has been structured to match
expenditures to lowered growth.




Summary
of Significant Accounting Policies:




Quarterly
Financial Information and Results of Operations


The
financial statements as of March 31, 2009 and for the three months ended March
31, 2009 and 2008, are unaudited and, in the opinion of management, include all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the Company’s financial position as of March 31, 2009, and the
results of operations and cash flows for the three months ended March 31, 2009
and 2008. The results for the three months ended March 31, 2009 are not
necessarily indicative of the results to be expected for the entire year. While
management believes that the disclosures presented are adequate to make the
information not misleading, these consolidated financial statements should be
read in conjunction with the consolidated financial statements and the notes
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2008. The Surgical Services business segment is presented as discontinued
operations for all 2008 periods presented.




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. The former subsidiaries of Photo Therapeutics
Group Ltd. have been included in the financial statements from February 27,
2009, the closing date of the acquisition.




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 Annual Report on
Form 10-K for the year ended December 31, 2008 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.


8


Fair
Value Measurements


The
Company measures fair value in accordance with Statement of Financial Accounting
Standards (“SFAS”) No. 157, “Fair Value Measurements”(“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a
framework and gives guidance regarding the methods used for measuring fair
value, and expands disclosures about fair value measurements. SFAS No. 157
clarifies that fair value is an exit price, representing the amount that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. As such, fair value is a market-based
measurement that should be determined based on assumptions that market
participants would use in pricing an asset or liability. As a basis for
considering such assumptions there exists a three-tier fair-value hierarchy,
which prioritizes the inputs used in measuring fair value as
follows:




•
            Level
      1 - unadjusted quoted prices in active markets for identical assets or
      liabilities that the Company has the ability to access as of the
      measurement date.




•
            Level
      2 - inputs other than quoted prices included within Level 1 that are
      directly observable for the asset or liability or indirectly observable
      through corroboration with observable market
  data.




•
            Level
      3 - unobservable inputs for the asset or liability only used when there is
      little, if any, market activity for the asset or liability at the
      measurement date.




This
hierarchy requires the Company to use observable market data, when available,
and to minimize the use of unobservable inputs when determining fair
value.




The
Company’s recurring fair value measurements at March 31, 2009 were as
follows:




Fair Value as
                  of March 31,
                  2009
                
                
                Quoted Prices
                  in Active
                  Markets for
                  Identical Assets
                  (Level 1)
                
                
                Significant
                  other
                  Observable
                  Inputs
                  (Level 2)
                
                
                Significant
                  Unobservable
                  Inputs
                  (Level 3)Assets:Cash
      equivalents
                
                $
                2,932,424
                
                
                $
                -
                
                
                $
                2,932,424
                
                
                $
                -Liabilities:Derivative
      financial instruments (Note 11)
                
                $
                1,459,089
                
                
                $
                -
                
                
                $
                -
                
                
                $
                1,459,089




Derivative
Financial Instruments


The
Company recognizes all derivatives as assets or liabilities, in accordance with
Statement of Financial Accounting Standards No. 133 “Accounting for Derivative
Instruments and Hedging Activities” (“SFAS No. 133”) and measures them at fair
value with changes in fair value reflected as current period income or loss
unless the derivatives qualify as hedges or future cash flows are accounted for
as such. As a result of the Company’s adoption of Emerging Issues Task Force
Issue No. 07-5 “Determining Whether an Instrument (or Embedded Feature) is
Indexed to an Entity’s Own Stock” (“EITF 07-5”), effective January 1, 2009,
certain warrants are now accounted for as derivatives. See Note 11, Warrants.




Revenue
Recognition


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




9




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




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 a physician, but not
yet used, are deferred and recognized as a liability until the physician
performs the treatment. Unused treatments remain an obligation of the Company
because the treatments can only be performed on Company-owned equipment. Once
the treatments are delivered to a patient, this obligation has been
satisfied.




The
Company excludes all sales of treatment codes made within the last two weeks of
the period in determining the amount of procedures performed by its
physician-customers. Management believes this approach closely approximates the
actual amount of unused treatments that existed at the end of a period. For the
three months ended March 31, 2009 and 2008, the Company deferred $1,008,979 and
$883,533, respectively, under this approach.




The
Company generates revenues from its Skin Care business primarily through two
channels. The first is through product sales for skin health, hair care and
wound care, and the second, although now to a much lesser degree, is through
sales in bulk of copper peptide compound. 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.




The
Company generates revenues from its Photo Therapeutics business primarily from
two channels. The first is through product sales of LEDs and skin care products.
The second is through royalties and milestone payments from a licensing
agreement. The Company recognizes revenues from the product sales, including
sales to distributors and other customers, when the SAB 104 Criteria have been
met. The Company recognizes the milestone payments when the milestones have been
achieved and royalty revenues as they are earned from the licensee.




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




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




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 the fair value of
the asset. If the carrying amount of an asset exceeds the fair value, an
impairment charge is recognized in the amount by which the carrying amount of
the asset exceeds the fair value of the asset. Assets to be disposed of would be
separately presented in the balance sheet and reported at the lower of the
carrying amount or fair value less costs to sell, and would no longer be
depreciated. The assets and liabilities of a disposed group classified as
discontinued operations would be presented separately in the appropriate asset
and liability sections of the balance sheet. As of March 31, 2009, no such
impairment exists.




10




Patent
Costs and Licensed Technologies


Costs
incurred to obtain or defend patents and licensed technologies are capitalized
and amortized over the shorter of the remaining estimated useful lives or eight
to 12 years. Developed technology was also recorded in connection with the
acquisition of ProCyte in March 2005 and is being amortized on a straight-line
basis over seven years. Significant patent costs were recorded in connection
with the acquisition of Photo Therapeutics in February 2009 and are being
amortized on a straight-line basis over ten years. Other licenses, for example,
the Stern and Mount Sinai licenses, are capitalized and amortized over the
estimated useful lives of 10 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 March 31,
2009, 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. With the exception of the Neutrogena intangible, which has been
written down to zero, the assets are being amortized on a straight-line basis
over 5 to 10 years. In addition, other intangible assets were recorded in
connection with the acquisition of Photo Therapeutics in February 2009. These
assets are being amortized on a straight-line basis over 10 years. See Note 2, Acquisition.




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
March 31, 2009 no such write-down was required.




Goodwill


Goodwill
was recorded in connection with the acquisition of Photo Therapeutics in
February 2009, 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 March 31, 2009, 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 the case of domestic sales of XTRAC lasers, however, the Company
offers longer periods, ranging from three to four years, in order to meet
competition or meet customer demands. The Company provides for the estimated
future warranty claims on the date the product is sold. Total accrued warranty
is included in other accrued liabilities on the balance sheet. The activity in
the warranty accrual during the three months ended March 31, 2009 is summarized
as follows:




Three Months Ended
                    March 31, 2009
                    (unaudited)Accrual
      at beginning of period
                  
                  $
                  442,527Additions
      due to PTL acquisition
                  
                  
                  227,334Additions
      charged to warranty expense
                  
                  
                  80,738Expiring
      warranties
                  
                  
                  (33,865
                  )Claims
      satisfied
                  
                  
                  (31,799
                  )Accrual
      at end of period
                  
                  $
                  684,935




Income
Taxes


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




11




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 from continuing
operations is the same as basic net loss per share. Thus, no additional shares
for the potential dilution from the conversion or exercise of securities into
common stock are included in the denominator of this calculation, since the
result would be anti-dilutive. Common stock options and warrants of 2,345,651
and 1,515,609 as of March 31, 2009 and 2008, respectively, were excluded from
the calculation of fully diluted earnings per share from continuing operations
since their inclusion would have been anti-dilutive. Share amounts shown on the
consolidated balance sheet as of December 31, 2008 and share amounts and basic
and diluted net loss per share amounts shown on the consolidated statement of
operations for the three months ended March 31, 2008 have been adjusted to
reflect the reverse stock split of 1-for-7 effective January 26, 2009, excluding
the rounding up of fractional shares. For the three months ended March 31,
2008, there was income from discontinued operations, but basic net income per
share and diluted net income per share from discontinued operations for these
periods were both immaterial.




Comprehensive
Income (Loss)


Comprehensive
income (loss) is a more inclusive financial reporting method that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income (loss). Comprehensive income (loss)
is defined as net income and other changes in shareholders’ investment from
transactions and events other than with shareholders. Total comprehensive income
(loss) is as follows:




Three Months Ended March 31,
                    (unaudited)2009
                  
                  
                  2008Net
      loss
                  
                  $
                  (3,512,187
                  )
                  
                  $
                  (2,541,861
                  )Change
      in cumulative translation adjustment
                  
                  
                  25,710
                  
                  
                  
                  -Comprehensive
      loss
                  
                  $
                  (3,486,477
                  )
                  
                  $
                  (2,541,861
                  )




Share-Based
Compensation


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




Supplemental
Cash Flow Information


During
the three months ended March 31, 2009, the Company issued warrants to an
investor which manages an investment fund (“the Investor”) in conjunction with a
convertible debt arrangement which enabled the Company to purchase Photo
Therapeutics. These warrants were initially valued at $1,550,311, are carried as
a liability and result in a discount from the face of the convertible
debt.




During
the three months ended March 31, 2008, the Company financed certain insurance
policies through notes payable for $119,382.




For the
three months ended March 31, 2009 and 2008, the Company paid interest of
$287,038 and $297,015, respectively. Income taxes paid in the three months ended
March 31, 2009 and 2008 were immaterial.




12




Recent
Accounting Pronouncements


In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (FSP) APB 14-1, “Accounting for Convertible Debt Instruments That May
Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (FSP APB
14-1). FSP APB 14-1 clarifies that convertible debt instruments that may be
settled in cash upon either mandatory or optional conversion (including partial
cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14,
“Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants.”
Additionally, FSP APB 14-1 specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that will
reflect the entity’s nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB 14-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. We adopted FSP APB 14-1 beginning in
the first quarter of 2009, and this standard must be applied on a retrospective
basis. The adoption of this Statement did not have a material impact on the
Company’s consolidated results of operations and financial
condition.




In June
2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”).
Equity-linked instruments (or embedded features) that otherwise meet the
definition of a derivative as outlined in SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” are not accounted for as
derivatives if certain criteria are met, one of which is that the instrument (or
embedded feature) must be indexed to the entity’s stock. EITF 07-5 provides
guidance on determining if equity-linked instruments (or embedded features) such
as warrants to purchase our stock are considered indexed to our stock. EITF 07-5
is effective for the financial statements issued for fiscal years and interim
periods within those fiscal years, beginning after December 15, 2008 and will be
applied to outstanding instruments as of the beginning of the fiscal year in
which it is adopted. Upon adoption, a cumulative effect adjustment will be
recorded, if necessary, based on amounts that would have been recognized if this
guidance had been applied from the issuance date of the affected instruments.
The adoption of this Statement had a material impact on the on the Company’s
consolidated results of operations and financial condition. See Note 11, Warrants.




In April
2008, the FASB issued FASB Staff Position No. FSP 142-3, “Determining the Useful
Life of Intangible Assets” FSP 142-3 amends the factors to be considered in
determining the useful life of intangible assets. Its intent is to improve the
consistency between the useful life of an intangible asset and the period of
expected cash flows used to measure its fair value. FSP 142-3 is effective for
fiscal years beginning after December 15, 2008. The adoption of FSP 142-3 did
not have an impact on the Company’s financial statements.




In April
2009, the FASB issued FSP FAS No. 107-1 and Accounting Principles Board Opinion
28-1, “Interim Disclosures about Fair Value of Financial Instruments: (“APB
28-1”). This FSP amends SFAS No. 107, “Fair Value of Financial Instruments” to
require disclosures about fair value of financial instruments for interim
reporting periods in addition to the required disclosures in annual financial
statements. This FSP also amends APB Opinion 28, “Interim Financial Reporting”,
to require those disclosures in summarized financial information at interim
reporting periods. FSP FAS 107-1 and APB 28-1 are effective for interim
reporting periods ending after June 15, 2009.




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




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




13




Effective
January 1, 2008, the Company adopted SFAS No. 157, ”Fair Value Measurements“. In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2, "Effective
Date of FASB Statement No. 157", which provides a one year deferral of the
effective date of SFAS No. 157 for non-financial assets and non-financial
liabilities, except those that are recognized or disclosed in the financial
statements at fair value at least annually. Therefore, the Company has adopted
the provisions of SFAS No. 157 only with respect to its financial assets and
liabilities. SFAS No. 157 defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles and enhances
disclosures about fair value measurements. Fair value is defined under SFAS No.
157 as the exchange price that would be received for an asset or paid to
transfer a liability (an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants on the measurement date. Valuation techniques used to measure fair
value under SFAS No. 157 must maximize the use of observable inputs and minimize
the use of unobservable inputs. The standard describes a fair value hierarchy
based on three levels of inputs, of which the first two are considered
observable and the last unobservable, that may be used to measure fair value.
The adoption of this Statement did not have a material impact on the Company's
consolidated results of operations and financial condition.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations”, or SFAS No. 141R. SFAS No. 141R replaces SFAS No. 141. This
Statement establishes principles and requirements for how an acquirer recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, any non-controlling interest in the acquiree and the
goodwill acquired. For example, expenses incurred in an acquisition are to be
expensed and not capitalized. This Statement also establishes disclosure
requirements which will enable users to evaluate the nature and financial
effects of the business combination. This Statement is effective for business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008. The
acquisition of the subsidiaries of Photo Therapeutics Group Ltd. was completed
after December 31, 2008 and therefore SFAS No. 141R applies to the acquisition.
Acquisition costs amounting to $1,532,798 and incurred through December 31, 2008
were expensed as of December 31, 2008; acquisition costs amounting to $432,353
and incurred in 2009 were expensed as of February 27, 2009.




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




Note
2


Acquisition:




Photo
Therapeutics Transaction:


On
February 27, 2009, the Company completed the acquisition of the subsidiaries of
Photo Therapeutics Group Ltd. The subsidiaries are Photo Therapeutics Ltd.
(based in the United Kingdom) and Photo Therapeutics, Inc. (based in California)
and are collectively referred to herein as “Photo Therapeutics” or
“PTL”. Photo Therapeutics is a developer and provider of non-laser light
aesthetic devices for the treatment of a range of clinical and non-clinical
dermatological conditions.


14


The
Company paid an aggregate purchase price of $13 million for the Photo
Therapeutics acquisition. The fair value of the assets acquired and liabilities
assumed were based on management estimates and values derived from an outside
independent appraisal. 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
                  
                  $
                  421,978Accounts
      receivable
                  
                  
                  843,007Inventories
                  
                  
                  1,633,150Prepaid
      expenses and other current assets
                  
                  
                  187,232Property
      and equipment
                  
                  
                  80,462Patents
      and licensed technologies
                  
                  
                  7,400,000Other
      intangible assets
                  
                  
                  1,500,000Total
      assets acquired at fair value
                  
                  
                  12,065,829Accounts
      payable
                  
                  
                  (685,779
                  )Accrued
      compensation and related expenses
                  
                  
                  (35,906
                  )Other
      accrued liabilities
                  
                  
                  (419,186
                  )Deferred
      revenues
                  
                  
                  (576,349
                  )Total
      liabilities assumed
                  
                  
                  (1,717,220
                  )Net
      assets acquired
                  
                  $
                  10,348,609




The
purchase price exceeded the fair value of the net assets acquired by $2,651,391,
which was recorded as goodwill. Acquisition costs amounting to $1,532,798 and
incurred through December 31, 2008 were expensed as of December 31, 2008;
acquisition costs amounting to $432,353 and incurred in 2009 were expensed as of
February 27, 2009.




The
accompanying consolidated financial statements do not include any revenues or
expenses related to the PTL business on or prior to February 27, 2009, the
closing date of the acquisition. The Company’s unaudited pro-forma results for
the three months ended March 31, 2009 and 2008 are summarized in the following
table, assuming the acquisition had occurred on January 1, 2008:




Three Months Ended March 31,
                    (unaudited)2009
                  
                  
                  2008Net
      revenues
                  
                  $
                  8,325,751
                  
                  
                  $
                  10,431,374Net
      loss
                  
                  $
                  (4,225,350
                  )
                  
                  $
                  (3,157,934
                  )Basic
      and diluted loss per share
                  
                  $
                  (0.47
                  )
                  
                  $
                  (0.35
                  )Shares
      used in calculating basic and diluted loss per share
                  
                  
                  9,005,009
                  
                  
                  
                  9,004,601




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, 2008, nor to be
indicative of future results of operations.




Discontinued
Operations:


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




15




Prior
year financial statements for 2008 have been restated in conformity with
generally accepted accounting principles to present the operations of Surgical
Services as a discontinued operation.




Revenues
from Surgical Services for the three months ended March 31, 2008 were
$1,899,739. Income from Surgical Services for the three months ended March 31,
2008 was $168,802.




Note
3


Inventories:




Set forth
below is a detailed listing of inventories:




March 31, 2009
                    
                    
                    December 31, 2008(unaudited)Raw
      materials and work in progress
                    
                    $
                    6,418,349
                    
                    
                    $
                    5,157,455Finished
      goods
                    
                    
                    2,784,196
                    
                    
                    
                    1,816,739Total
      inventories
                    
                    $
                    9,202,545
                    
                    
                    $
                    6,974,194




Work-in-process
is immaterial, given the Company’s typically short manufacturing cycle, and
therefore is disclosed in conjunction with raw materials. As of March 31, 2009
and December 31, 2008, the Company carried specific reserves for excess and
obsolete stocks against its inventories of $2,236,065 and $1,836,441,
respectively.




Note
4


Property
and Equipment:




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




March 31, 2009
                    
                    
                    December
      31, 2008(unaudited)Lasers
      in service
                    
                    $
                    17,901,030
                    
                    
                    $
                    17,288,400Computer
      hardware and software
                    
                    
                    367,432
                    
                    
                    
                    341,407Furniture
      and fixtures
                    
                    
                    637,709
                    
                    
                    
                    562,418Machinery
      and equipment
                    
                    
                    804,461
                    
                    
                    
                    830,778Leasehold
      improvements
                    
                    
                    259,595
                    
                    
                    
                    259,59519,970,227
                    
                    
                    
                    19,282,598Accumulated
      depreciation and amortization
                    
                    
                    (9,377,989
                    )
                    
                    
                    (8,894,192
                    )Property
      and equipment, net
                    
                    $
                    10,592,238
                    
                    
                    $
                    10,388,406




Depreciation
and related amortization expense was $755,077 and $743,138 for the three months
ended March 31, 2009 and 2008, respectively.


16


Note
5


Patents
and Licensed Technologies:




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




March 31, 2009
                
                
                December 31, 2008(unaudited)Patents,
      owned and licensed, at gross costs of $7,994,919 and $583,623, net of
      accumulated amortization of $433,246 and $359,195,
      respectively.
                
                $
                7,561,673
                
                
                $
                224,428Other
      licensed or developed technologies, at gross costs of $2,328,059, net of
      accumulated amortization of $1,451,118 and $1,410,025,
      respectively.
                
                
                876,941
                
                
                
                918,034$
                8,438,614
                
                
                $
                1,142,462




Related
amortization expense was $115,113 and $52,857 for the three months ended March
31, 2009 and 2008, respectively. Included in Patents is $7,400,000 in patents,
patents pending and related know-how acquired in the Photo Therapeutics
transaction. Included in other licensed or developed technologies is $200,000 in
developed technologies acquired from ProCyte and $88,659 for the license from
the Mount Sinai School of Medicine of New York University. 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, which were acquired from
Photo Therapeutics and ProCyte and were recorded at their appraised fair market
values at the date of their respective acquisitions:




March 31, 2009
                
                
                December 31, 2008(unaudited)Customer
      Relationships, at gross cost of $2,200,000 and $1,700,000, net of
      accumulated amortization of $1,376,901 and $1,287,735,
      respectively.
                
                
                823,099
                
                
                
                412,265Tradename,
      at gross cost of $2,100,000 and $1,100,000, net of accumulated
      amortization of $452,474 and $416,640, respectively.
                
                
                1,647,526
                
                
                
                683,360$
                2,470,625
                
                
                $
                1,095,625




Related
amortization expense was $125,000 and $232,500 for the three months ended March
31, 2009 and 2008, respectively. Customer Relationships embody the value to the
Company of relationships that ProCyte and Photo Therapeutics had formed with
their customers, as well as the value of a non-compete covenant agreed to by
Photo Therapeutics Group Ltd. Tradename includes the name of “ProCyte” and
various other trademarks associated with ProCyte’s products. It also includes
the various trademarks associated with Photo Therapeutics
products.


17


Note
7


Other
Accrued Liabilities:




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




March 31, 2009
                
                
                December 31, 2008(unaudited)Accrued
      professional and consulting fees
                
                $
                244,834
                
                
                $
                186,162Accrued
      warranty
                
                
                684,935
                
                
                
                442,527Accrued
      sales taxes
                
                
                222,054
                
                
                
                196,121Accrued
      interest expense
                
                
                120,000
                
                
                
                -Accrued
      other expense
                
                
                101,691
                
                
                
                39,623Total
      other accrued liabilities
                
                $
                1,373,514
                
                
                $
                864,433




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:




March 31, 2009
                
                
                December 31, 2008(unaudited)Note
      Payable – secured creditor, interest at 6%, payable in monthly principal
      and interest installments of $2,880 through June 2012
                
                $
                99,132
                
                
                $
                106,21499,132
                
                
                
                106,214Less:
      current maturities
                
                
                (29,412
                )
                
                
                (28,975
                )Notes
      payable, net of current maturities
                
                $
                69,720
                
                
                $
                77,239




Note
9


Long-term
Debt:




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




March 31, 2009
                
                
                December 31, 2008(unaudited)Total
      borrowings on credit facility
                
                $
                7,274,085
                
                
                $
                8,571,033Less:
      current portion
                
                
                (4,296,833
                )
                
                
                (4,663,281
                )Total
      long-term debt
                
                $
                2,977,252
                
                
                $
                3,907,752




Term
Note Credit Facility


In
December 2007, the Company entered into a term-note facility with CIT Healthcare
LLC and Life Sciences Capital LLC, as equal participants (collectively, “CIT”),
for which CIT Healthcare acts as the agent. The facility had a maximum principal
amount of $12 million and for a term of one year. The stated interest rate for
any draw under the credit facility was set as 675 basis points above the
three-year Treasury rate. CIT levied no points on a draw. Each draw was secured
by specific XTRAC laser systems consigned under usage agreements with
physician-customers.




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




The
beginning principal of each component was $6,337,325 and $3,990,000,
respectively. The effective interest rate for the first draw was 12.50%. The
pay-off of each component is between 27 to 36 months. On March 31, 2008, the
Company made an additional draw under the credit facility for $840,000. This
additional draw is amortized over 36 months at an effective interest rate of
8.55%. On June 30, 2008, the Company made another draw under the credit facility
for $832,675 based on the limitations on gross borrowings under the facility.
This draw is amortized over 36 months at an effective interest rate of
9.86%.




18




On
September 30, 2008, CIT amended the credit facility to increase the amount the
Company could draw on the credit facility by $1,927,534. The interest rate for
draws against this amount was set at 850 basis points above the LIBOR rate two
days prior to the draw. Each draw was to be secured by certain XTRAC laser
systems consigned under usage agreements with physician-customers and the stream
of payments generated from such lasers. Each draw has a repayment period of
three years. On September 30, 2008, the Company made another draw under the
credit facility for the maximum amount allowable under the credit facility. This
draw is amortized over 36 months at an effective interest rate of 12.90%. CIT
also raised certain defaults of the Company, which the Company took steps to
cure and which CIT waived as of February 27, 2009.




The
Company has used its entire availability under the CIT credit facility. The
Company is considering multiple written proposals for additional debt financing,
but there can be no assurance whether any such proposals will materialize on
terms favorable to the Company or at all.




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




December
                    2007
                  
                  
                  September
                    2008Number
      of warrants
                  
                  
                  67,292
                  
                  
                  
                  27,536Exercise
      price
                  
                  $
                  7.84
                  
                  
                  $
                  3.08Fair
      value of warrants
                  
                  $
                  221,716
                  
                  
                  $
                  44,366Volatility
                  
                  
                  59.44
                  %
                  
                  
                  60.92
                  %Risk-free
      interest rate
                  
                  
                  3.45
                  %
                  
                  
                  2.98
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %Expected
      warrant life
                  
                  5
      years
                  
                  
                  5
      years




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




Year
      Ended December 31,2009
      for nine months
                  
                  $
                  3,839,8362010
                  
                  
                  3,444,7822011
                  
                  
                  811,059Total
      minimum payments
                  
                  
                  8,095,677Less:
      interest
                  
                  
                  (730,515
                  )Less:
      unamortized warrant discount
                  
                  
                  (91,077
                  )Present
      value of total minimum obligations
                  
                  $
                  7,274,085





19




Note
10


Convertible
Debt:





In the
following table is a summary of the Company’s convertible debt.




March 31, 2009(unaudited)Total
      borrowings on credit facility
                  
                  $
                  16,468,866Less:
      current portion
                  
                  
                  -Total
      long-term debt
                  
                  $
                  16,468,866





The
February 27, 2009 acquisition of Photo Therapeutics was funded simultaneously
through a convertible debt investment of $18 million from an investor which
manages an investment fund (the “Investor”). The convertible note
transaction financed the $13 million purchase price of the acquisition, and a
further $5 million in working capital at the closing of the acquisition. Under
the terms of the investment, the Investor shall make up to an additional $7
million convertible debt investment in the Company in the event additional,
earn-out consideration is payable under the terms of the Photo Therapeutics
acquisition. After the payment of approximately $2 million of transaction
expenses associated with the acquisition and the debt investment, the Company
had approximately $3 million remaining for use as working capital.




At the
closing of the convertible debt financing, and in exchange for the Investor’s
payment to the Company of the $18 million purchase price, the Company: (i)
issued the Investor (A) a convertible note in the principal amount of $18
million, and (B) a warrant to purchase 1,046,204 shares of the Company’s common
stock; and (ii) paid a transaction fee of $210,000 in cash. The conversion price
of the convertible note and the exercise price of the warrant are each
$5.16.




The note
is due in 60 months with interest payments bi-annually at 8%, due on September 1
and March 1 of each year. The interest can be paid by the issuance of additional
convertible notes. The effective interest rate is 11.62%, which takes into
account paid interest as well as accreted interest under an effective interest
method from the warrants and loan origination costs. The warrants that were
issued give rise to a discount to the debt. This discount, as well as loan
origination costs and the transaction fee paid to the Investor, are accreted as
interest expense under the effective interest method over the repayment term of
60 months.




The
Company has accounted for the Investor’s warrants as a liability under EITF
07-5, due to the “down-round” price protection provision. See Note 1, Fair Value
Measurements. The Company computed the value of the warrants using the
Black-Scholes method. The key assumptions used to value the warrants at February
27, 2009 are as follows:




Number
      of warrants
                    
                    
                    1,046,204Exercise
      price
                    
                    $
                    5.16Fair
      value of warrants
                    
                    $
                    1,550,311Volatility
                    
                    
                    87.89
                    %Risk-free
      interest rate
                    
                    
                    2.69
                    %Expected
      dividend yield
                    
                    
                    0
                    %Expected
      warrant life
                    
                    8
      years




As
security for the Company’s obligations to the Investor under the convertible
notes, the Company granted the Investor a first priority security interest in:
(i) all of the stock of (A) ProCyte Corporation, the Company’s wholly-owned
subsidiary, and (B) Photo Therapeutics, Inc., which became a wholly-owned
subsidiary of the Company upon the PTL Closing; (ii) 65% of the stock of Photo
Therapeutics Limited, which also became a wholly-owned subsidiary of the Company
upon the acquisition; and (iii) certain other assets of the Company related to
the skin care business.




20




Note
11


Warrants




The
Company adopted EITF 07-5 effective January 1, 2009. The adoption of EITF 07-5
affects the requirements of accounting for warrants and many convertible
instruments that have provisions that protect holders from a decline in the
stock price (or “down-round” provisions). For example, warrants with such
provisions will no longer be recorded in equity but as liabilities. Down-round
provisions reduce the exercise or conversion price of a warrant or convertible
instrument if a company either issues equity shares for a price that is lower
than the exercise or conversion price of those instruments or issues new
warrants or convertible instruments that have a lower exercise or conversion
price. The Company evaluated whether warrants to acquire the Company’s common
stock contain provisions that protect holders from declines in the stock price
or otherwise could result in modification of the exercise price and/or shares to
be issued under the respective warrant agreements based on a variable that is
not an input to the fair value of a “fixed-for-fixed” option.




The
warrant issued to the Investor, in conjunction with the convertible note (Note
10) contains a down-round provision. The Company concluded that such a
triggering event was not based on an input to the fair value of
“fixed-for-fixed” option and therefore is not considered indexed to the
Company’s own stock. The warrant contains a net settlement provision and because
it is not indexed to the Company’s own stock, is accounted for as a derivative
in accordance with SFAS No. 133.




In
accordance with EITF 07-5, the Company recognizes these warrants as a liability
at the fair value on each reporting date. The Company measured the fair value of
these warrants as of March 31, 2009, and recorded other income of $91,222
resulting from the reduction of the liability associated with fair value of the
warrants as of March 31, 2009. The Company determined the fair values of these
securities using the Black-Scholes valuation model with the following
assumptions:




Number
      of warrants
                    
                    
                    1,046,204Exercise
      price
                    
                    $
                    5.16Fair
      value of warrants
                    
                    $
                    1,459,089Volatility
                    
                    
                    88.67
                    %Risk-free
      interest rate
                    
                    
                    2.28
                    %Expected
      dividend yield
                    
                    
                    0
                    %Expected
      warrant life
                    
                    7.92
      years




The
Company’s recurring fair value measurements at March 31, 2009 related only to
the warrants issued to the Investor, and had a fair value of $1,459,089. The
inputs used in measuring the fair value of these warrants are of Level 3,
significant unobservable inputs.




The
warrants issued in the private placement of November 2006 and to CIT in
connection with the term-note credit facility do not contain down-round
provisions.




Recurring
Level 3 Activity and Reconciliation


The table
below provides a reconciliation of the beginning and ending balances for the
liability measured at fair value using significant unobservable inputs (Level
3). The table reflects gains and losses for the quarter for all financial
liabilities categorized as Level 3 as of March 31, 2009.




Fair
Value Measurements Using Significant Unobservable Inputs (Level 3):




Warrant
      liability:Balance
      as of January 1, 2009
                  
                  $
                  -Initial
      measurement of warrants
                  
                  
                  1,550,311Decrease
      in fair value of warrants
                  
                  
                  (91,222
                  )Balance
      as of March 31, 2009
                  
                  $
                  1,459,089
  21





Note
12


Employee
Stock Benefit Plans




The
Company has three active, stock-based compensation plans available to grant,
among other things, incentive and non-qualified stock options to employees,
directors and third-party service-providers as well as restricted stock to key
employees. At our Annual Meeting in January 26, 2009, our stockholders approved
an increase of 285,715 shares in the number of shares reserved for the 2005
Equity Compensation Plan. Under the 2005 Equity Compensation Plan, a maximum of
1,165,714 shares of the Company’s common stock have been reserved for issuance.
At March 31, 2009, 567,292 shares were available for future grants under this
plan. Under the Outside Director Plan and under the 2005 Investment Plan, 68,037
shares and 55,428 shares, respectively, were available for issuance as of March
31, 2009. The other stock options plans are frozen and no further grants will be
made from them. The foregoing figures reflect the 1-for-7 reverse
split.




Stock
option activity under all of the Company’s share-based compensation plans for
the three months ended March 31, 2009 was as follows:




Number of
                    Options
                  
                  
                  Weighted
                    Average
                    Exercise
                    PriceOutstanding,
      January 1, 2009
                  
                  
                  870,865
                  
                  
                  $
                  12.49Granted
                  
                  
                  47,507
                  
                  
                  
                  1.95Cancelled
                  
                  
                  (97,182
                  )
                  
                  
                  13.67Outstanding,
      March 31 2009
                  
                  
                  821,190
                  
                  
                  $
                  11.74Options
      excercisable at March 31, 2009
                  
                  
                  556,893
                  
                  
                  $
                  13.53




At March
31, 2009, there was $888,017 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 1.93 years. The intrinsic value of options
outstanding and exercisable at March 31, 2009 was not significant.




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 March 31,
                    (unaudited)2009
                  
                  
                  2008Risk-free
      interest rate
                  
                  
                  2.42
                  %
                  
                  
                  3.725
                  %Volatility
                  
                  
                  86.74
                  %
                  
                  
                  84.16
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %Expected
      life
                  
                  8.1
      years
                  
                  
                  8.1
      yearsEstimated
      forfeiture rate
                  
                  
                  12
                  %
                  
                  
                  12
                  %




The
Company calculates expected volatility for a share-based grant based on historic
daily stock price observations of its common stock during the period immediately
preceding the grant that is equal in length to the expected term of the grant.
For estimating the expected term of share-based grants made in the three months
ended March 31, 2009 and 2008, the Company has adopted the simplified method
authorized in Staff Accounting Bulletin No. 107. SFAS No. 123R also requires
that estimated forfeitures be included as a part of the estimate of expense as
of the grant date. The Company has used historical data to estimate expected
employee behaviors related to option exercises and forfeitures.




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




With
respect to awards of restricted stock, the Company uses the Monte-Carlo pricing
model to estimate fair value of restricted stock awards. The Company calculates
expected volatility for restricted stock based on a mirror approach, where the
daily stock price of our common stock during the seven-year period immediately
after the grant would be the mirror of the historic daily stock price of our
common stock during the seven-year period immediately preceding the grant. There
were no restricted stock awards for the three months ended March 31, 2009 and
2008.




22




Compensation
expense for the three months ended March 31, 2009 included $171,632 from stock
options grants and $103,623 from restricted stock awards. Compensation expense
for the three months ended March 31, 2008 included $276,006 from stock options
grants and $103,623 from restricted stock awards.




Compensation
expense is presented as part of the operating results in selling, general and
administrative expenses. For stock options granted to consultants, an additional
selling, general, and administrative expense in the amount of $17,419 was
recognized during the three months ended March 31, 2009. For stock options
granted to consultants an additional selling, general, and administrative
expense in the amount of $46,914 was recognized during the three months ended
March 31, 2008.




Note
12


Business
Segment and Geographic Data:




Segments
are distinguished by the Company’s management structure, products and services
offered, markets served and types of customers. The Domestic XTRAC business
derives its primary revenues from procedures performed by dermatologists in the
United States. The International Dermatology Equipment segment, in comparison,
generates revenues from the sale of equipment to dermatologists outside the
United States through a network of distributors. The Skin Care (ProCyte) segment
generates primary revenues by selling skincare products. The Photo Therapeutics
(PTL) segment generates revenues by selling LED and associated skincare products
for the treatment of a range of clinical and aesthetic dermatological conditions
and by earning milestone payments and royalties, from a licensing agreement. The
Surgical Products segment generates revenues by selling laser products and
disposables to hospitals and surgery centers on both a domestic and an
international basis. For the three months ended March 31, 2009 and 2008,
the Company did not have material revenues from any individual
customer.




Unallocated
operating expenses include costs that are not specific to a particular segment
but are general to the group; included are expenses incurred for administrative
and accounting staff, general liability and other insurance, professional fees
and other similar corporate expenses. Unallocated assets include cash, prepaid
expenses and deposits. Goodwill from the buy-out of Acculase that was carried at
$2,944,423 at March 31, 2009 and 2008 has been allocated to the domestic and
international XTRAC segments based upon its fair value as of the date of the
buy-out in the amounts of $2,061,096 and $883,327, respectively. Goodwill of
$13,973,385 at March 31, 2009 and 2008 from the ProCyte acquisition has been
entirely allocated to the Skin Care segment. Goodwill of $2,651,391 at March 31,
2009 from the Photo Therapeutics acquisition has been entirely allocated to the
PTL segment.


23


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




Three Months Ended March 31, 2009
      (unaudited)DOMESTIC
                  XTRAC
                
                
                INTERN’L
                  DERM.
                  EQUIPMENT
                
                
                SKIN CARE
                
                
                PTL *
                
                
                SURGICAL
                  PRODUCTS
                  AND OTHER
                
                
                TOTALRevenues
                
                $
                2,675,309
                
                
                $
                999,084
                
                
                $
                2,202,459
                
                
                $
                746,048
                
                
                $
                875,442
                
                
                $
                7,498,342Costs
      of revenues
                
                
                1,534,831
                
                
                
                684,863
                
                
                
                769,932
                
                
                
                179,082
                
                
                
                628,892
                
                
                
                3,797,600Gross
      profit
                
                
                1,140,478
                
                
                
                314,221
                
                
                
                1,432,527
                
                
                
                566,966
                
                
                
                246,550
                
                
                
                3,700,742Gross
      profit %
                
                
                42.6
                %
                
                
                31.5
                %
                
                
                65.0
                %
                
                
                76.0
                %
                
                
                28.2
                %
                
                
                49.4
                %Allocated
      operating expenses:Selling,
      general and administrative
                
                
                2,058,447
                
                
                
                69,162
                
                
                
                1,501,966
                
                
                
                307,550
                
                
                
                66,322
                
                
                
                4,003,447Engineering
      and product development
                
                
                -
                
                
                
                -
                
                
                
                79,516
                
                
                
                22,171
                
                
                
                100,010
                
                
                
                201,697Unallocated
      operating expenses
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,696,4842,058,447
                
                
                
                69,162
                
                
                
                1,581,482
                
                
                
                329,721
                
                
                
                166,332
                
                
                
                6,901,628Income
      (loss) from operations
                
                
                (917,969
                )
                
                
                245,059
                
                
                
                (148,955
                )
                
                
                237,245
                
                
                
                80,218
                
                
                
                (3,200,886
                )Interest
      expense, net
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (402,523
                )Change
      in fair value of warrant
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                91,222(Loss)
      income from continuing operations
                
                
                (917,969
                )
                
                
                245,059
                
                
                
                (148,955
                )
                
                
                237,245
                
                
                
                80,218
                
                
                
                (3,512,187
                )Discontinued
      operations:Income
      from discontinued operations
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      (loss) income
                
                $
                (917,969
                )
                
                $
                245,059
                
                
                $
                (148,955
                )
                
                $
                237,245
                
                
                $
                80,218
                
                
                $
                (3,512,187
                )




* From
February 27, 2009 (the date of acquisition) through March 31, 2009.





Three Months Ended March 31, 2008
      (unaudited)DOMESTIC
                                                    XTRAC
                                                  
                                                  
                                                  INTERN’L
                                                    DERM.
                                                    EQUIPMENT
                                                  
                                                  
                                                  SKIN CARE
                                                  
                                                  
                                                  PTL
                                                  
                                                  
                                                  SURGICAL
                                                    PRODUCTS
                                                    AND OTHER
                                                  
                                                  
                                                  TOTALRevenues
                                                  
                                                  $
                                                  2,110,707
                                                  
                                                  
                                                  $
                                                  1,168,205
                                                  
                                                  
                                                  $
                                                  3,274,692
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  1,777,230
                                                  
                                                  
                                                  $
                                                  8,330,834Costs
      of revenues
                                                  
                                                  
                                                  1,430,778
                                                  
                                                  
                                                  
                                                  570,649
                                                  
                                                  
                                                  
                                                  960,452
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  1,156,152
                                                  
                                                  
                                                  
                                                  4,118,031Gross
      profit
                                                  
                                                  
                                                  679,929
                                                  
                                                  
                                                  
                                                  597,556
                                                  
                                                  
                                                  
                                                  2,314,240
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  621,078
                                                  
                                                  
                                                  
                                                  4,212,803Gross
      profit %
                                                  
                                                  
                                                  32.2
                                                  %
                                                  
                                                  
                                                  51.2
                                                  %
                                                  
                                                  
                                                  70.7
                                                  %
                                                  
                                                  
                                                  N/A
                                                  
                                                  
                                                  
                                                  34.9
                                                  %
                                                  
                                                  
                                                  50.6
                                                  %Allocated
      operating expenses:Selling,
      general and administrative
                                                  
                                                  
                                                  1,991,499
                                                  
                                                  
                                                  
                                                  73,488
                                                  
                                                  
                                                  
                                                  1,924,707
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  142,271
                                                  
                                                  
                                                  
                                                  4,131,965Engineering
      and product development
                                                  
                                                  
                                                  168,214
                                                  
                                                  
                                                  
                                                  20,790
                                                  
                                                  
                                                  
                                                  141,188
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  108,496
                                                  
                                                  
                                                  
                                                  438,688Unallocated
      operating expenses
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  2,125,4422,159,713
                                                  
                                                  
                                                  
                                                  94,278
                                                  
                                                  
                                                  
                                                  2,065,895
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  250,767
                                                  
                                                  
                                                  
                                                  6,696,095Income
      (loss) from operations
                                                  
                                                  
                                                  (1,479,784
                                                  )
                                                  
                                                  
                                                  503,278
                                                  
                                                  
                                                  
                                                  248,345
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  370,311
                                                  
                                                  
                                                  
                                                  (2,483,292
                                                  )Interest
      expense, net
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (227,371
                                                  )(Loss)
      income from continuing operations
                                                  
                                                  
                                                  (1,479,784
                                                  )
                                                  
                                                  
                                                  503,278
                                                  
                                                  
                                                  
                                                  248,345
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  370,311
                                                  
                                                  
                                                  
                                                  (2,710,663
                                                  )Discontinued
      operations:Income
      from discontinued operations
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  168,802Net
      (loss) income
                                                  
                                                  $
                                                  (1,479,784
                                                  )
                                                  
                                                  $
                                                  503,278
                                                  
                                                  
                                                  $
                                                  248,345
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  370,311
                                                  
                                                  
                                                  $
                                                  (2,541,861
                                                  )





24





March 31, 2009
                  
                  
                  December 31, 2008(unaudited)Assets:Total
      assets for reportable segments
                  
                  $
                  56,542,865
                  
                  
                  $
                  42,075,242Other
      unallocated assets
                  
                  
                  5,207,340
                  
                  
                  
                  4,639,027Consolidated
      total
                  
                  $
                  61,750,205
                  
                  
                  $
                  46,714,269




For the
three months ended March 31, 2009 and 2008 there were no material net revenues
attributed to any individual foreign country. Net revenues by geographic area
were, as follows:




Three Months Ended
                    March 31, (unaudited)2009
                  
                  
                  2008Domestic
                  
                  $
                  5,313,822
                  
                  
                  $
                  6,220,557Foreign
                  
                  
                  2,184,520
                  
                  
                  
                  2,110,277$
                  7,498,342
                  
                  
                  $
                  8,330,834




The
Company discusses segmental details in its Management Discussion & Analysis
found elsewhere in its Form 10-Q for the period ending March 31,
2009.




Note
13


Significant
Alliances/Agreements:




The
Company continues in alliance with GlobalMed (Asia) Technologies Co., Inc. as
well as with the Mount Sinai School of Medicine as described in our Annual
Report on Form 10-K for the year ended December 31, 2008.




With
respect to the Clinical Trial Agreement protocol with the University of
California at San Francisco, Dr. Koo presented the favorable findings of the
study at the Hawaii Dermatology Seminar in March 2008. Dr. Koo concluded that
the XTRAC Excimer Laser may be appropriate for the majority of moderate to
severe psoriasis sufferers. It also allows dermatologists to treat those
patients with a high level of safety, as opposed to the use of many systemic
products. Other phototherapy treatments such as broadband or narrow band
ultraviolet-B (“UVB”) can also be used; however, undesirable aspects of these
treatments include exposure of healthy skin to UVB light, and the inconvenience
of extended treatment periods, which are often necessary for moderate to severe
patients. We expensed $189,000 in 2008 in payment for this study. At the annual
meeting of the American Academy of Dermatology in March 2009, Dr. Koo delivered
a follow-up presentation of his earlier favorable findings. At the meeting, the
Company introduced its XTRAC Velocity excimer laser.




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,
2008.




25




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




Introduction,
Outlook and Overview of Business Operations




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




·
            Domestic
      XTRAC,




·
            International
      Dermatology Equipment,




·
            Skin
      Care (ProCyte),




·
            Photo
      Therapeutics (PTL), and




·
            Surgical
      Products.




Domestic
XTRAC




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




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




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




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




International
Dermatology Equipment




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




26




Skin
Care (ProCyte)




Our Skin
Care segment generates revenues primarily from the sale of skin health, hair
care and wound care products. In prior periods, the sale of copper peptide
compound in bulk to Neutrogena and royalties from Neutrogena on licenses for our
patented copper peptide compound were a significant factor in our revenues. More
recently, however, Neutrogena’s sales of peptide-based products have
declined.




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




Our skin
care 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. Our skin care products are formulated, branded and
targeted at specific markets. Our 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. In 2009, we have introduced Neova® Skin Care
Systems, which are kits of Neova products that target specific conditions with
complete treatment programs. The programs are Intense Age Defense, Extremely
Clear, and Essential Eye Recovery. These kits make it simpler for physicians to
dispense the products and to ensure patient compliance and
satisfaction.




Photo
Therapeutics (PTL)




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




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




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




The
consolidated financial statements include the results of Photo Therapeutics from
February 27, 2009, the date of acquisition, through March 31, 2009.




Surgical
Products




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




27




In
September 2007, we entered into a three-year OEM agreement with AngioDynamics
under which we manufacture for AngioDynamics, on a non-exclusive basis, a
private-label, 980-nanometer diode laser system. The OEM agreement provides that
we shall supply this laser on an exclusive basis to AngioDynamics, should
AngioDynamics meet certain purchase requirements. Through June 30, 2008,
shipments to AngioDynamics exceeded the minimum purchase requirement for
delivery of lasers over the first contract year and therefore triggered
exclusivity for worldwide sale in the peripheral vascular treatment field.
Given, however, that AngioDynamics purchased the assets of a competitive diode
laser company, we anticipate that it will elect to source its diodes through the
assets so purchased instead of through us. We have not shipped any lasers to
AngioDynamics since July 1, 2008.




Sales
and Marketing




As of
March 31, 2009, our sales and marketing organization consists of 75 full-time
positions. Of the 75 sales personnel, they are directed to sales as follows: 72
in Domestic XTRAC, Skin Care and PTL and three in International Dermatology
Equipment and Surgical Products.




Sale
of Surgical Services Business




Our
Surgical Services segment was a fee-based procedures business using mobile
surgical laser equipment operated by our technicians at hospitals and surgery
centers in the United States. We decided to sell this division primarily because
the growth rates and operating margins of the division have decreased as the
business changed to rely more heavily upon procedures performed using equipment
from third-party suppliers, thereby limiting the profit potential of these
services. After preliminary investigations and discussions, our Board of
Directors decided on June 13, 2008, with the aid of our financial advisors, to
enter into substantive, confidential discussions with potential third-party
buyers and began to develop plans for implementing a disposal of the assets and
operations of the business. On August 8, 2008, we sold certain assets of the
business, including accounts receivable, inventory and equipment, for
$3,149,737.




Reverse
Stock Split




On
January 26, 2009, we completed the reverse split of our common stock in the
ratio of 1-for-7, whereby, once effective, every seven shares of our common
stock was exchanged for one share of our common stock. Our common stock began
trading at the market opening on January 27, 2009 on a split-adjusted basis. The
reverse split is intended to enable us to increase our marketability to
institutional investors and to maintain our listing on the Nasdaq Global Market,
among other benefits. As a result of the reverse stock split, as of March 31,
2009 we had 9,005,175 shares of common stock outstanding, taking into account
the rounding up of fractional shares.




Critical
Accounting Policies and Estimates




There
have been no changes to our critical accounting policies and estimates in the
three months ended March 31, 2009, except as noted below. Critical accounting
policies and the significant estimates made in accordance with them are
regularly discussed with our Audit Committee. Those policies are discussed under
“Critical Accounting Policies” in our “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” included in Item 7 of our Annual
Report on Form 10-K for the year ended December 31, 2008.




We
adopted Emerging Issues Task Force Issue No. 07-5, Determining Whether an Instrument
(or Embedded Feature) is Indexed to an Entity’s Own Stock(“EITF 07-5”)
effective January 1, 2009. The adoption of EITF 07-5’s requirements can affect
the accounting for warrants and many convertible instruments with provisions
that protect holders from a decline in the stock price (or “down-round”
provisions). For example, warrants with such provisions will no longer be
recorded as equity. Down-round provisions reduce the exercise price of a warrant
or convertible instrument if a company either issues equity shares for a price
that is lower than the exercise price of those instruments or issues new
warrants or convertible instruments that have a lower exercise price. Management
evaluated whether warrants to acquire our common stock contain provisions that
protect holders from declines in the stock price or otherwise could result in
modification of the exercise price and/or shares to be issued under the
respective warrant agreements based on a variable that is not an input to the
fair value of a “fixed-for-fixed” option. Management determined that the
warrants issued to the Investor, in conjunction with the convertible note
contain such provisions, thereby concluding they were not indexed to our stock.
In accordance with EITF 07-5, we recognize these warrants as a liability at the
fair value on each reporting date. We measured the fair value of these warrants
as of March 31, 2009, and recorded a $91,222 reduction in the liability
associated with these warrants as of March 31, 2009. We determined the fair
values of these securities using a Black-Scholes valuation model.




28




We
adopted SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”).
SFAS No. 141R replaces SFAS No. 141 effective January 1, 2009. SFAS No. 141R
establishes principles and requirements for how an acquirer recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, any non-controlling interest in an acquisition and the
goodwill acquired. For example, expenses incurred in an acquisition are to be
expensed and not capitalized. This Statement also establishes disclosure
requirements which will enable users to evaluate the nature and financial
effects of the business combination. This Statement is effective for business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15,
2008.




The
acquisition of the subsidiaries of Photo Therapeutics Group Ltd. was completed
after December 31, 2008 and therefore SFAS No. 141R applies to the acquisition.
Acquisition costs amounting to $1,532,798 and incurred through December 31, 2008
were expensed as of December 31, 2008; acquisition costs amounting to $432,353
and incurred in 2009 were expensed as of February 27, 2009.




Results
of Operations




Revenues




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




Three Months Ended
                    March 31, (unaudited)2009
                  
                  
                  2008XTRAC
      Domestic Services
                  
                  $
                  2,675,309
                  
                  
                  $
                  2,110,707International
      Dermatology Equipment Products
                  
                  
                  999,084
                  
                  
                  
                  1,168,205Skin
      Care (ProCyte) Products
                  
                  
                  2,202,459
                  
                  
                  
                  3,274,692Photo
      Therapeutics (PTL) Products
                  
                  
                  746,048
                  
                  
                  
                  -Total
      Dermatology Revenues
                  
                  
                  6,622,900
                  
                  
                  
                  6,553,604Surgical
      Products
                  
                  
                  875,442
                  
                  
                  
                  1,777,230Total
      Surgical Revenues
                  
                  
                  875,442
                  
                  
                  
                  1,777,230Total
      Revenues
                  
                  $
                  7,498,342
                  
                  
                  $
                  8,330,834




Revenues
from our Surgical Services segment, in the amount of $1,899,739 through March
31, 2008, have been accounted for in 2008 as a discontinued
operation.




Domestic XTRAC
Segment




Recognized treatment revenue for the
three months ended March 31, 2009 and 2008 for domestic XTRAC procedures was
$2,037,004 and $1,565,907, respectively, reflecting billed procedures of 35,744
and 28,819, respectively. In addition, 1,805 and 1,519 procedures were performed
in the three months ended March 31, 2009 and 2008, 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 March 31, 2009
compared to the comparable period in 2008 was largely related to our continuing
progress in securing favorable reimbursement policies from private insurance
plans and to our increased marketing programs. Increases in procedures are
dependent upon building market acceptance through marketing programs with our
physician partners and their patients that the XTRAC procedures will be of
clinical benefit and generally reimbursed.




29




We have a program to support certain
physicians who may be denied reimbursement by private insurance carriers for
XTRAC treatments. In accordance with the requirements of Staff Accounting
Bulletin No. 104, we recognize service revenue under this program from the sale
of XTRAC procedures or equivalent treatments to physicians participating in this
program only to the extent the physicians have been reimbursed for the
treatments. For the three months ended March 31, 2009, we recognized net
revenues of $26,384 (400 procedures) under this program compared to deferred net
revenues of $727 (11 procedures) for the three months ended March 31, 2008. The
change in deferred revenue under this program is presented in the table
below.




We exclude 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 March 31, 2009 and
2008, we deferred net revenues of $347,417 (5,266 procedures) and $320,197
(4,891 procedures), respectively, under this approach.




For the three months ended March 31,
2009 and 2008, domestic XTRAC laser sales were $638,305 and $544,800,
respectively. There were 14 and 10 lasers sold during these periods,
respectively. Laser sales are made for various reasons, including costs of
logistical support and customer preferences. We believe that we are able to
reach a sector of the laser market that is better suited to a sale model than a
per-procedure model at reasonable margins.




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




Three Months Ended
                    March 31, (unaudited)2009
                  
                  
                  2008Total
      revenue
                  
                  $
                  2,675,309
                  
                  
                  $
                  2,110,707Less:
      laser sales revenue
                  
                  
                  (638,305
                  )
                  
                  
                  (544,800
                  )Recognized
      treatment revenue
                  
                  
                  2,037,004
                  
                  
                  
                  1,565,907Change
      in deferred program revenue
                  
                  
                  (26,384
                  )
                  
                  
                  727Change
      in deferred unused treatments
                  
                  
                  347,417
                  
                  
                  
                  320,197Net
      billed revenue
                  
                  $
                  2,358,037
                  
                  
                  $
                  1,886,831Procedure
      volume total
                  
                  
                  37,549
                  
                  
                  
                  30,338Less:
      Non-billed procedures
                  
                  
                  1,805
                  
                  
                  
                  1,519Net
      billed procedures
                  
                  
                  35,744
                  
                  
                  
                  28,819Avg.
      price of treatments billed
                  
                  $
                  65.97
                  
                  
                  $
                  65.47Change
      in procedures with deferred program revenue, net
                  
                  
                  (400
                  )
                  
                  
                  11Change
      in procedures with deferred unused treatments, net
                  
                  
                  5,266
                  
                  
                  
                  4,891




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




30




International Dermatology
Equipment Segment




International
sales of our XTRAC and VTRAC laser systems and related parts were $999,084 for
the three months ended March 31, 2009 compared to $1,168,205 for the three
months ended March 31, 2008. We sold 15 and 23 systems in the three-month
periods ended March 31, 2009 and 2008, respectively. The average price of
dermatology equipment sold internationally varies due to the quantities of
refurbished domestic XTRAC systems and VTRACs sold. Both of these products have
lower average selling prices than new XTRAC laser systems. However, by adding
these to our product offerings along with expanding into new geographic
territories where the products are sold, we have been able to increase overall
international dermatology equipment revenues.




·
            We
      sell refurbished domestic XTRAC laser systems into the international
      market. The selling price for used equipment is substantially less than
      new equipment, some of which may be substantially depreciated in
      connection with its use in the domestic market. We sold no such used
      lasers in the three months ended March 31, 2009. We sold two such lasers
      in the three months ended March 31, 2008, at an average price of $37,500;
      and




·
            In
      addition to the XTRAC laser system (both new and used), we sell the VTRAC,
      a lamp-based, alternative UVB light source that has a wholesale sales
      price that is below our competitors’ international dermatology equipment
      and below our XTRAC laser. In the three months ended March 31, 2009, we
      sold no VTRAC systems. In the three months ended March 31, 2008, we sold
      seven VTRAC systems.




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




Three Months Ended
                    March 31, (unaudited)2009
                  
                  
                  2008Revenues
                  
                  $
                  999,084
                  
                  
                  $
                  1,168,205Less:
      part sales
                  
                  
                  (229,184
                  )
                  
                  
                  (229,205
                  )Laser/lamp
      revenues
                  
                  
                  769,900
                  
                  
                  
                  939,000Laser/lamp
      systems sold
                  
                  
                  15
                  
                  
                  
                  23Average
      revenue per laser/lamp
                  
                  $
                  51,327
                  
                  
                  $
                  40,826




Skin Care (ProCyte)
Segment




For the
three months ended March 31, 2009, our skin care (“ProCyte”) segment revenues
were $2,202,459 compared to $3,274,692 in the three months ended March 31, 2008.
These revenues are generated from the sale of various skin, hair care and wound
products and from the sale of copper peptide compound.




·
            The
      product sales decreased for the three months ended March 31, 2009 due to
      macro-economic conditions and to transitioning from our discontinued MD
      Lash Factor eyelash conditioning product to our internally developed Neova
      Advanced Essential LashTM eyelash conditioner, which was launched February
      1, 2009. This segment is more susceptible to such economic conditions than
      our other segments because cosmetic products are more likely to be
      discretionary and not medically necessary. Product sales for the three
      months ended March 31, 2009 were approximately $2.1 million, down from
      approximately $3.2 million for the three months ended March 31,
      2008.




·
            Included
      in product sales for the three months ended March 31, 2008, were $451,577
      of revenues from MD Lash Factor as part of an exclusive license to
      distribute in the United States. In the three months ended March 31, 2009,
      there were no revenues from this product as we have discontinued marketing
      MD Lash Factor as of January 31, 2009 under the terms of an agreement with
      Allergan, Inc. in settlement of certain patent litigation, and we have
      replaced it with our own peptide-based conditioner. From the launch date
      on February 1 through March 31, 2009, we sold $130,192 of Neova Advanced
      Essential Lash.




31




·
            Bulk
      compound sales decreased by $47,920 for the three months ended March 31,
      2009 compared to the three months ended March 31, 2008. Minimum
      contractual royalties from Neutrogena expired in November 2007, and as a
      result such royalties were immaterial over the two
  periods.




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




Three Months Ended
                    March 31, (unaudited)2009
                  
                  
                  2008Product
      sales
                  
                  $
                  2,121,576
                  
                  
                  $
                  3,242,692Bulk
      compound sales
                  
                  
                  79,920
                  
                  
                  
                  32,000Royalties
                  
                  
                  963
                  
                  
                  
                  -Total
      ProCyte revenues
                  
                  $
                  2,202,459
                  
                  
                  $
                  3,274,692




Photo Therapeutics (PTL)
Segment




For the
period from February 27, 2009 through March 31, 2009, our PTL segment’s revenues
were $746,048. Since PTL was acquired on February 27, 2009, there are no
corresponding revenues for the three months ended March 31, 2008. PTL revenues
are generated from the sale of LED devices and milestone payments on a licensing
agreement targeting the mass consumer acne market.




The
following table illustrates the key changes in our PTL segment for the periods
reflected below:




Three Months
                      Ended March 31,
                      2009 (unaudited)Product
      revenues
                    
                    $
                    532,943Licensing
      revenues
                    
                    
                    213,105Total
      PTL revenues
                    
                    $
                    746,048




We are
actively seeking distribution channels to reach the home-use consumer market
with our New-UTM hand-held LED device. Licensing revenues are from a license of
the Clear-U, which the licensee intends to use as a platform to attempt to
address the mass consumer acne market. We expect it to be several years over
several development milestones before the platform product may be
released.




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. Laser
fibers and laser disposables are more profitable than laser systems, but the
sales of laser systems generate subsequent recurring sales of fibers and
disposables.




For the
three months ended March 31, 2009, surgical products revenues were $875,442
compared to $1,777,230 in the three months ended March 31, 2008. The decrease in
the three-month periods was mainly related to our OEM contract with
AngioDynamics, which had initial shipments in December 2007. In the second half
of 2008, AngioDynamics purchased the assets of Diomed, a competitive diode laser
company. If AngioDynamics sources its diodes through the business which it has
purchased, our future sales of diode lasers to them may be severely limited.
Sales to AngioDynamics were $0 for the three months ended March 31, 2009,
compared to sales of $700,000 for the three months ended March 31, 2008. We
therefore do not expect the OEM business with AngioDynamics will recover in the
foreseeable future, if at all.




32




The
change in average price per laser between the periods, as set forth in the table
below, was largely due to the mix of lasers sold and partly due to the trade
level at which the lasers were sold (i.e. wholesale versus retail). Our diode
laser has replaced our Nd:YAG laser, which had a higher sales price. Included in
laser sales during the three months ended March 31, 2009 and 2008 were sales of
1 and 62 diode lasers, respectively. The diode lasers have lower sales prices
than our other types of lasers, and thus the decrease in the number of diodes
sold increased the average price per laser. We are phasing out our holmium and
CO2 laser systems.




Fiber and
other disposables sales increased 3% between the comparable three-month periods
ended March 31, 2009 and 2008. 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.




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




Three Months Ended
                    March31, (unaudited)2009
                  
                  
                  2008Revenues
                  
                  $
                  875,442
                  
                  
                  $
                  1,777,230Laser
      systems sold
                  
                  
                  2
                  
                  
                  
                  64Laser
      system revenues
                  
                  $
                  63,646
                  
                  
                  $
                  972,745Average
      revenue per laser
                  
                  $
                  31,823
                  
                  
                  $
                  15,199




Cost
of Revenues




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




Product
cost of revenues for the three months ended March 31, 2009 was $2,459,348,
compared to $2,864,452 in the comparable period in 2008. The $405,104 decrease
is due to the decreases in product cost of sales for surgical products of
$533,077 related to the decrease in laser sales, and in skincare products of
$190,520 resulting from the switch to our internally produced Neova product.
These decreases were offset, in part, by an increase in domestic XTRAC laser
sales in the amount of $25,197 and international dermatology equipment sales in
the amount of $114,214. In addition, there was an increase due to the inclusion
of $179,082 in product costs for our PTL business.




Service
cost of revenues was $1,338,252 in the three months ended March 31, 2009
compared to $1,253,579 in the comparable period in 2008 representing an increase
of $84,673. The increase is directly related to the increase in Domestic XTRAC
segment costs of $78,856.




Certain
allocable XTRAC manufacturing overhead costs are charged against the XTRAC
service revenues. Our 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.




33




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




Three Months Ended
                        March 31, (unaudited)2009
                      
                      
                      2008Product:XTRAC
      Domestic
                      
                      $
                      227,090
                      
                      
                      $
                      201,893International
      DermatologyEquipment
                      
                      
                      684,863
                      
                      
                      
                      570,649Skin
      Care
                      
                      
                      769,932
                      
                      
                      
                      960,452PTL
                      
                      
                      179,082
                      
                      
                      
                      -Surgical
      products
                      
                      
                      598,381
                      
                      
                      
                      1,131,458Total
      Product costs
                      
                      $
                      2,459,348
                      
                      
                      $
                      2,864,452Services:XTRAC
      Domestic
                      
                      $
                      1,307,741
                      
                      
                      $
                      1,228,885Surgical
      products
                      
                      
                      30,511
                      
                      
                      
                      24,694Total
      Services costs
                      
                      $
                      1,338,252
                      
                      
                      $
                      1,253,579Total
      Costs of Revenues
                      
                      $
                      3,797,600
                      
                      
                      $
                      4,118,031




Gross
Profit Analysis




Gross
profit decreased to $3,700,742 during the three months ended March 31, 2009 from
$4,212,803 during the same period in 2008. As a percent of revenues, gross
margin decreased to 49.4% for the three months ended March 31, 2009 from 50.6%
for the same period in 2008.




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




Company Profit Analysis
                    
                    Three Months Ended
                      March 31, (unaudited)2009
                    
                    
                    2008Revenues
                    
                    $
                    7,498,342
                    
                    
                    $
                    8,330,834Percent
      decrease
                    
                    
                    (10.0
                    )%Cost
      of revenues
                    
                    
                    3,797,600
                    
                    
                    
                    4,118,031Percent
      decrease
                    
                    
                    (7.8
                    )%Gross
      profit
                    
                    $
                    3,700,742
                    
                    
                    $
                    4,212,803Gross
      margin percentage
                    
                    
                    49.4
                    %
                    
                    
                    50.6
                    %




The
primary reasons for the changes in gross profit and the gross margin percentage
for the three months ended March 31, 2009, compared to the same period in 2008
were as follows:




·
            Our
      Skin Care segment is more susceptible to the macro economic conditions
      than our other segments because cosmetic products are more likely to be
      discretionary and not medically necessary. Product sales for the first
      quarter of 2009 were approximately $2.1 million down from approximately
      $3.2 million for the first quarter of
2008.




·
            In
      our Surgical Products segment there were 62 fewer laser systems sold in
      the three months ended March 31, 2009 than in the comparable period of
      2008. This included 60 sales due to our OEM arrangement, but in the second
      half of 2008, AngioDynamics purchased the assets of Diomed, a competitive
      diode laser company. Since that time, our sales to AngioDynamics have been
      $0, including for the three months ended March 31, 2009. Additionally, the
      higher manufacturing levels in 2008 caused better absorption of fixed
      overheads thereby lowering average unit costs and resulting in a higher
      gross margin in 2008 compared to
2009.




34




·
            Offsetting
      the above items that had a negative impact on gross profit, is the gross
      profit realized from our PTL segment. We acquired PTL on February 27,
      2009, so only the activity after that date is recorded in our financial
      statements. There was no activity recorded in our financial statements in
      2008.




·
            We
      sold a greater number of XTRAC treatment procedures in 2009 than in 2008.
      Procedure volume increased 24% from 28,819 to 35,744 billed procedures in
      the three months ended March 31, 2009 compared to the same period in 2008.
      Since each incremental treatment procedure carries negligible variable
      cost, this significantly enhanced profit margins. The increase in
      procedure volume was a direct result of improving insurance reimbursement
      and increased marketing efforts.




·
            We
      sold approximately $93,505 worth of additional domestic XTRAC lasers in
      the three months ended March 31, 2009 at higher margins compared to the
      same period in 2008. Certain of these lasers were previously being
      depreciated, since they were previously placements. The margin on these
      capital equipment sales was 64% in 2009 compared to 63% in
      2008.




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




XTRAC Domestic Segment
                    
                    Three Months Ended
                      March 31, (unaudited)2009
                    
                    
                    2008Revenues
                    
                    $
                    2,675,309
                    
                    
                    $
                    2,110,707Percent
      increase
                    
                    
                    26.7
                    %Cost
      of revenues
                    
                    
                    1,534,831
                    
                    
                    
                    1,430,778Percent
      increase
                    
                    
                    7.3
                    %Gross
      profit
                    
                    $
                    1,140,478
                    
                    
                    $
                    679,929Gross
      margin percentage
                    
                    
                    42.6
                    %
                    
                    
                    32.2
                    %




Gross
profit increased for this segment for the three months ended March 31, 2009 from
the comparable period in 2008 by $460,549. In addition to the overall higher
revenues between the periods, other key factors for the increases were as
follows:




·
            Key
      drivers in increasing the fee-per-procedure revenue from this segment are
      insurance reimbursement and increased direct-to-consumer advertising in
      targeted territories. Improved insurance reimbursement, together with
      greater consumer awareness of the XTRAC therapy, increased treatment
      revenue accordingly. Our clinical support specialists focus their efforts
      on increasing physicians’ utilization of the XTRAC laser system.
      Consequently, procedure volume increased 24% from 28,819 to 35,744 billed
      procedures in the three months ended March 31, 2009 compared to the same
      period in 2008. Price per procedure did not change significantly between
      the periods. Each incremental treatment procedure carries negligible
      variable cost.




·
            We
      sold approximately $93,505 worth of additional domestic XTRAC lasers in
      the three months ended March 31, 2009 at higher margins compared to the
      same period in 2008. Certain of these lasers were previously being
      depreciated, since they were previous placements. The margin on these
      capital equipment sales was 64% in the three months ended March 31, 2009
      compared to 63% in the comparable period in
  2008.




·
            The
      cost of revenues increased by $104,053 for the three months ended March
      31, 2009. This increase is due to an increase in cost of revenues related
      to laser sales of $25,197 over the comparable period in 2008.
      Additionally, there was an increase in the service expenses due to the
      increase in lasers placed in the field, of approximately $101,700.
      Offsetting the increase were decreases in certain allocable XTRAC
      manufacturing overhead costs that are charged against the XTRAC service
      revenues. The depreciation costs will continue to increase in subsequent
      periods as the business grows.




35




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




International Dermatology
                      Equipment Segment
                    
                    Three Months Ended
                      March 31, (unaudited)2009
                    
                    
                    2008Revenues
                    
                    $
                    999,084
                    
                    
                    $
                    1,168,205Percent
      decrease
                    
                    
                    (14.5
                    %)Cost
      of revenues
                    
                    
                    684,863
                    
                    
                    
                    570,649Percent
      decrease
                    
                    
                    (20.0
                    %)Gross
      profit
                    
                    $
                    314,221
                    
                    
                    $
                    597,556Gross
      margin percentage
                    
                    
                    31.5
                    %
                    
                    
                    51.2
                    %




Gross
profit for the three months ended March 31, 2009 decreased by $283,335 from the
comparable period in 2008. The key factors for the decrease were as
follows:




·
            We
      sold 15 XTRAC laser systems and no VTRAC lamp-based excimer systems during
      the three months ended March 31, 2009 and 17 XTRAC laser systems and seven
      VTRAC systems in the comparable period in 2008. Consequently, gross profit
      decreased as a result of a decrease in the volume of units sold. The gross
      margin percentage for the VTRAC is higher than for the
    XTRAC.




·
            International
      part sales, which have a higher margin percentage than system sales,
      remained consistent for the three months ended March 31, 2009 as compared
      to the same period in 2008.




·
            In
      addition, there were increases in certain allocable XTRAC manufacturing
      overhead costs that are charged against our international dermatology
      equipment revenues.




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




Skin Care (ProCyte) Segment
                    
                    Three Months Ended
                      March 31, (unaudited)2009
                    
                    
                    2008Product
      revenues
                    
                    $
                    2,121,576
                    
                    
                    $
                    3,242,692Bulk
      compound revenues
                    
                    
                    79,920
                    
                    
                    
                    32,000Royalties
                    
                    
                    963
                    
                    
                    
                    -Total
      revenues
                    
                    
                    2,202,459
                    
                    
                    
                    3,274,692Percent
      decrease
                    
                    
                    (32.7
                    )%Product
      cost of revenues
                    
                    
                    724,364
                    
                    
                    
                    937,668Bulk
      compound cost of revenues
                    
                    
                    45,568
                    
                    
                    
                    22,784Total
      cost of revenues
                    
                    
                    769,932
                    
                    
                    
                    960,452Percent
      decrease
                    
                    
                    (19.8
                    )%Gross
      profit
                    
                    $
                    1,432,527
                    
                    
                    $
                    2,314,240Gross
      margin percentage
                    
                    
                    65.0
                    %
                    
                    
                    70.7
                    %




Gross
profit decreased for the three months ended March 31, 2009 from the comparable
periods by $881,713. The key factors for the changes in this business segment
were as follows:




36




·
            The
      decrease in revenues for the three months ended March 31, 2009 is due to
      the macro economic conditions. This segment is more susceptible to such
      economic conditions than our other segments because cosmetic products are
      more likely to be discretionary and not medically necessary. Product sales
      for the first quarter of 2009 were approximately $2.1 million down from
      approximately $3.2 million for the first quarter of
  2008.




·
            Copper
      peptide bulk compound is sold at a substantially lower gross margin than
      our other skin care products.




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




PTL Segment
                    
                    Three Months
                      Ended March 31,
                      2009 (unaudited)Revenues
                    
                    $
                    746,048Percent
      increase
                    
                    
                    100
                    %Cost
      of revenues
                    
                    
                    179,082Percent
      increase
                    
                    
                    100
                    %Gross
      profit
                    
                    $
                    566,966Gross
      margin percentage
                    
                    
                    76.0
                    %




The key
factors in this business segment were as follows:




·
            Revenues
      included a milestone payment of $213,000 under a certain licensing
      arrangement for the Clear UTM hand-held device. The licensee intends to use
      the device and its technology as a platform to attempt to address the mass
      consumer acne market. There are no costs associated with this revenue
      stream.




·
            The
      business was acquired on February 27, 2009, and consequently the above
      reflects only one month of
activity.




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




Surgical Products Segment
                    
                    Three Months Ended
                      March 31, (unaudited)2009
                    
                    
                    2008Revenues
                    
                    $
                    875,442
                    
                    
                    $
                    1,777,230Percent
      decrease
                    
                    
                    (50.7
                    )%Cost
      of revenues
                    
                    
                    628,892
                    
                    
                    
                    1,156,152Percent
      decrease
                    
                    
                    (45.6
                    )%Gross
      profit
                    
                    $
                    246,550
                    
                    
                    $
                    621,078Gross
      margin percentage
                    
                    
                    28.2
                    %
                    
                    
                    34.9
                    %




Gross
profit for our Surgical Products segment in the three months ended March 31,
2009 compared to the same period in 2008 decreased by $374,528. The key factors
impacting gross profit 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.




37




·
            Revenues
      for the three months ended March 31, 2009 decreased by $901,788 from the
      three months ended March 31, 2008 while cost of revenues decreased by
      $527,260 between the same periods. There were 62 fewer laser systems sold
      in the three months ended March 31, 2009 than in the comparable period of
      2008. However, the lasers sold in the 2009 period were at higher prices
      than those sold in the comparable period in 2008. The increase in average
      price per laser was largely due to the mix of lasers sold and volume
      discounts. Included in the laser sales for the three months ended March
      31, 2009 and 2008 were sales of diode lasers of $24,000, representing 1
      system, and $888,000, representing 62 systems respectively, which have
      substantially lower list sales prices than our other types of surgical
      lasers.




·
            The
      sales of diode systems, in the three months ended March 31, 2008, included
      60 sales due to our OEM arrangement, but in the second half of 2008
      AngioDynamics purchased the assets of Diomed, a competitive diode laser
      company. Since that time, our sales to AngioDynamics have been $0,
      including for the three months ended March 31, 2009. Additionally, the
      higher manufacturing levels in 2008 caused better absorption of fixed
      overhead costs, thereby lowering average unit costs resulting in a higher
      gross margin in 2008 compared to
2009.




·
            Additionally,
      there was an increase in sales of disposables between the periods, which
      have a higher gross margin as a percent of revenues than lasers. Fiber and
      other disposables sales increased 3% between the comparable three-month
      periods ended March 31, 2009 and
2008.




Selling,
General and Administrative Expenses




For the three months ended March 31,
2009, selling, general and administrative expenses increased to $6,699,930 from
$6,471,240 for the three months ended March 31, 2008 for the following
reasons:




·
            Selling,
      general and administrative expenses related to our PTL segment accounted
      for $307,550 of the increase.




·
            We
      expensed $432,000 of additional costs under SFAS No. 141R incurred in
      connection with the acquisition of Photo
  Therapeutics.




·
            Offsetting
      the above increases was a decrease of $381,000 in salaries, benefits and
      travel expenses associated with a decrease in the sales force and
      decreased revenues which generated lower commission expenses, particularly
      in our Skin Care segment. Additionally, there was a decrease in
      amortization expense of $107,500 related to the impairment of certain
      intangibles as of the year end December 31,
  2008.




Given the
state of, and the uncertainty in, the macro economic climate, we are in process
of rationalizing our facilities and personnel costs. For example, we are
consolidating the skincare warehouse operations in Redmond to our headquarters
in Montgomeryville.




Engineering
and Product Development




Engineering
and product development expenses for the three months ended March 31, 2009
decreased to $201,697 from $438,688 for the three months ended March 31, 2008.
Engineering and product development expenses related to our PTL segment
accounted for $22,171 of the decrease. The decrease for the three months ended
March 31, 2009 was primarily due to meeting our financial sponsorship
obligations in March 2008 for the severe psoriasis study by John Koo, MD, of the
University of California at San Francisco, of $189,000. The balance of the
decrease was due to a decrease in product studies in our Skin Care
segment.


38


Interest
Expense, Net




Net
interest expense for the three months ended March 31, 2009 increased to
$402,523, as compared to $227,371 for the three months ended March 31, 2008. The
change in net interest expense was the result of the interest expense on the
convertible debt which was issued on February 27, 2009. The following table
illustrates the change in interest expense, net:




Three Months Ended March 31,
      (unaudited)2009
                  
                  
                  2008
                  
                  
                  ChangeInterest
      expense
                  
                  $
                  407,038
                  
                  
                  $
                  297,015
                  
                  
                  $
                  110,023Interest
      income
                  
                  
                  (4,515
                  )
                  
                  
                  (69,644
                  )
                  
                  
                  65,129Net
      interest expense
                  
                  $
                  402,523
                  
                  
                  $
                  227,371
                  
                  
                  $
                  175,152




Change
in fair value of warrants




Beginning
on January 1, 2009 and in accordance with EITF 07-5, we began recognizing
certain warrants as liabilities at their respective fair values on each
reporting date. We measured the fair value of these warrants as of March 31,
2009, and recognized $91,222 other income in recording the liability associated
with these warrants at their fair value as of March 31, 2009.




Net
Loss




The
aforementioned factors resulted in a net loss of $3,512,187 during the three
months ended March 31, 2009, as compared to a net loss of $2,541,862 during the
three months ended March 31, 2008, an increase of 38.2%.




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




For the three months ended March 31,
      (unaudited)2009
                  
                  
                  2008
                  
                  
                  ChangeNet
      loss
                  
                  $
                  3,512,187
                  
                  
                  $
                  2,541,861
                  
                  
                  $
                  970,326Components
      included in net loss:Acquisition
      expenses
                  
                  $
                  (432,352
                  )
                  
                  $
                  -
                  
                  
                  $
                  (432,352
                  )Depreciation
      and amortization
                  
                  
                  (995,220
                  )
                  
                  
                  (1,214,612
                  )
                  
                  
                  219,392Stock-based
      compensation
                  
                  
                  (292,674
                  )
                  
                  
                  (426,543
                  )
                  
                  
                  133,869Interest
      expense, net
                  
                  
                  (402,523
                  )
                  
                  
                  (227,371
                  )
                  
                  
                  (175,152
                  )Change
      in fair value of warrants
                  
                  
                  91,222
                  
                  
                  
                  -
                  
                  
                  
                  91,222$
                  (2,031,547
                  )
                  
                  $
                  (1,868,526
                  )
                  
                  $
                  (163,021
                  )




Liquidity
and Capital Resources




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




At March 31, 2009, our current ratio
was 1.36 compared to 1.26 at December 31, 2008. As of March 31, 2009 we had
$5,112,448 of working capital compared to $3,408,187 as of December 31, 2008.
Cash and cash equivalents were $4,257,320 as of March 31, 2009, as compared to
$3,736,607 as of December 31, 2008. We had $78,000 of cash that was classified
as restricted as of March 31, 2009 and December 31, 2008.




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




39




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




On
February 27, 2009, the Investor funded $5 million of working capital as part of
the first tranche of the convertible debt financing in connection with our
acquisition of Photo Therapeutics. A summary of the terms and activity under the
convertible debt is presented in Note 10, Convertible
Debt, of the Financial Statements included in this Report.




Net cash and cash equivalents used in
operating activities – continuing operations was $2,638,755 for the three months
ended March 31, 2009 compared to cash provided by $1,311,378 for the three
months ended March 31, 2008. The decrease was mostly due to the decreases in
accounts payable and other accrued liabilities and by increases in
inventories.




Net cash
and cash equivalents used in investing activities – continuing operations was
$13,497,222 for the three months ended March 31, 2009 compared to $1,224,969 for
the three months ended March 31, 2008. This was primarily due to acquisition
costs, net of cash received, of $12,578,022 in connection with the PTL
acquisition. The balance of the increase was mainly for the placement of lasers
into service.




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




Net cash
and cash equivalents provided by financing activities was $16,630,980 for the
three months ended March 31, 2009 compared to cash used of $551,925 for the
three months ended March 31, 2008. In the three months ended March 31, 2009 we
received $18 million in proceeds in the convertible debt financing which was
partially offset by repayment of $1,326,314 on the line of credit and $7,082 for
certain notes payable.




Commitments
and Contingencies




Except
for items discussed in Legal
Proceedings below, during the three months ended March 31, 2009, there
were no other items that significantly impacted our commitments and
contingencies as discussed in the notes to our 2008 annual financial statements
included in our Annual Report on Form 10-K.




Off-Balance
Sheet Arrangements




We have
no significant off-balance sheet arrangements.




Impact
of Inflation




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




40




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. However, the warrants
issued to the Investor are accounted for as derivatives pursuant to EITF 07-5,
which requires such accounting due to a “down-round” provision within the
warrants. See Note 1,
Fair Value
Measurements, in the financial statements.




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




ITEM
4.  Controls and Procedures




Evaluation
of Disclosure Controls and Procedures





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





Change in
Internal Control Over Financial Reporting





No change
in our internal control over financial reporting occurred during the three
months ended March 31, 2009 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, 2008 for descriptions of our legal proceedings.




In the
matter brought by us on January 4, 2004 against Ra Medical Systems, Inc. and
Dean Irwin in the United States District Court for the Southern District of
California, we have appealed to the Ninth Circuit Court of Appeals from the
district court judge’s grant of summary judgment to the defendants. Oral
argument has been set for June 4, 2009.




In the
matter which Ra Medical and Mr. Irwin brought against us on June 6, 2006 for
unfair competition and which we removed to the United States District Court for
the Southern District of California, the district court judge certified our
interlocutory appeal to the Ninth Circuit of Appeals from the judge’s dismissal
for, among other things, of our counterclaim of misappropriation. Oral argument
has been set for June 4, 2009.




On
October 29, 2008, Ra Medical and Dean Irwin brought a second malicious
prosecution action against us, and our outside counsel, in the California
Superior Court for San Diego County. The plaintiffs allege that the action we
brought in January 2004 against Ra Medical and Mr. Irwin was initiated and
maintained with malice. On January 22, 2009, we filed a demurrer to the
complaint on the grounds that it was brought while the underlying federal court
action was still on appeal before the Ninth Circuit Court of Appeals, and
therefore before the plaintiffs had secured a final and favorable judgment in
the underlying federal action, a necessary pre-condition to bringing the action.
Our demurrer was sustained by the Superior Court, but the action was not
dismissed but was stayed with leave to amend the complaint.




41




On
December 1, 2008, we filed a complaint for declaratory judgment in the United
States District Court for the Southern District of California based on the
accusations made by Ra Medical in a press release on October 30, 2008
notwithstanding that the district judge in the underlying federal action had
specifically ruled that we had not acted in the litigation vexatiously or in bad
faith. We have asked the court to rule on whether the accusations made in the
press release are true or false. The defendants moved to dismiss our complaint
based on lack of jurisdiction in the Federal court. The Federal court declined
defendants’ motion on April 29, 2009. The parties are to submit their briefs on
whether the Court should exercise its discretion in rendering a declaratory
judgment on May 29, 2009.




We
notified St. Paul Fire and Marine Insurance Company (“St. Paul”), our
general liability and umbrella liability insurer, of the suit that Ra Medical
and Mr. Irwin stated in their press release that they had brought for malicious
prosecution. St. Paul brought an action on January 29, 2009 in the California
Superior Court for San Diego County for a declaratory judgment that it has no
duty to defend us or indemnify us, asserting that it had been released from such
duties in the settlement of the first malicious prosecution action brought by Ra
Medical and also asserting that the policy should be governed by California law,
not Pennsylvania law. We removed that action to the U.S. District Court for the
Southern District of California. Notwithstanding, on March 20, 2009, St. Paul
has informed us that it will pay for the cost of defense subject to a full
reservation of rights. The Federal court has scheduled a conference among the
parties for May 21, 2009.




The
insurance policy under which we seek coverage from St. Paul is the same policy
under which St. Paul defended and indemnified us in the first malicious
prosecution action brought by Ra Medical against us. In connection with the
first malicious prosecution action, we filed a declaratory judgment action in
the U.S. District Court for the Eastern District of Pennsylvania against St.
Paul seeking a ruling that it was obligated to pay all reasonable defense costs
incurred in the defense of that action and any judgment or settlement we might
incur. We obtained a summary judgment in that action holding that, under
governing Pennsylvania law, the policy covered malicious prosecution claims and
St. Paul was required to provide full coverage (indemnity and reasonable counsel
fees) for the action brought by Ra Medical. On March 3, 2009, we filed an action
in the U.S. District Court for the Eastern District of Pennsylvania seeking a
declaratory a judgment, consistent with the earlier ruling of this
court, that the law of Pennsylvania governs the policy and that the policy
provides coverage for the latest malicious prosecution action. Our complaint was
served on St. Paul on March 4, 2009. The case has been assigned to the same
judge who granted our motion for summary judgment in the earlier declaratory
judgment action. We have filed a motion for partial summary judgment seeking a
ruling that, consistent with the earlier decision of the court, Pennsylvania law
governs construction of the policy in regard to coverage for the latest
malicious prosecution action.  St. Paul has moved to dismiss our
complaint or, in the alternative, to have our action stayed pending a decision
in the Southern District of California or to have our action transferred to the
Southern District of California. Both motions have been fully briefed and are
pending with the judge .


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




ITEM
1A. Risk Factors




There
have been no material changes in our risk factors from those disclosed in our
Annual Report on Form 10-K for the year ended December 31,
2008.


42


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




In our
definitive proxy filed December 18, 2008, we placed six non-procedural matters
on the agenda for decision by our stockholders and they were approved by our
stockholders at our 2009 annual meeting on January 26, 2009. The matters
were:




·
            The
      election to our Board of Directors each of Richard J. DePiano, Jeffrey F.
      O’Donnell, Alan R. Novak, Anthony J. Dimun, David W. Anderson, Wayne M.
      Withrow and Stephen P. Connelly. The vote tally is set forth
      below:




Votes For
                  
                  Votes Against
                  
                  Votes AbstainingRichard
      J. DePiano
                  49,386,491
                  
                  0
                  
                  6,782,122Jeffrey
      F. O’Donnell
                  47,587,186
                  
                  0
                  
                  8,581,427Alan
      R. Novak
                  49,432,545
                  
                  0
                  
                  6,736,068Anthony
      J. Dimun
                  49,443,634
                  
                  0
                  
                  6,724,979David
      W. Anderson
                  50,601,570
                  
                  0
                  
                  5,567,043Wayne
      M. Withrow
                  49,386,270
                  
                  0
                  
                  6,782,343Stephen
      P. Connelly
                  49,532,835
                  
                  0
                  
                  6,635,778




·
            The
      ratification of the appointment of Amper, Politziner & Mattia, LLP as
      our independent registered public accounting firm for the fiscal year
      ending December 31, 2008, with 55,367,056 votes for, 545,706 votes against
      and 255,850 votes abstaining.




·
            An
      amendment to our 2005 Equity Compensation Plan to increase the number of
      shares of the Company’s common stock, reserved for issuance thereunder
      from 6,160,000 to 8,160,000 shares and add provisions relating to the
      grant of performance-based stock awards that are designed to qualify as
      “qualified performance-based compensation” under Internal Revenue Code
      Section 162(m), with 28,465,404 votes for, 9,228,251 votes against ,
      128,161 votes abstaining and 18,349,797 broker
  non-votes.




·
            Issuance
      of shares of our common stock pursuant to the terms and conditions of the
      Securities Purchase Agreement, dated as of August 4, 2008, by and between
      us and Perseus Partners VII, L.P., upon conversion of the convertible note
      and exercise of the warrants,  with 36,616,728 votes for, 1,130,569
      votes against, 71,519 votes abstaining and 18,349,797 broker
      non-votes.




·
            An
      amendment to our Restated Certificate of Incorporation, as amended, to
      effect a reverse stock split of the Company’s outstanding common stock at
      an exchange ratio of 1-for-7 and to authorize the Company’s Board of
      Directors to implement the reverse stock split at any time prior to the
      2010 annual meeting of stockholders by filing an amendment to the our
      Restated Certificate of Incorporation, as amended, with 36,596,853 votes
      for, 1,149,745 votes against, 72,218 votes abstaining and 18,349,797
      broker non-votes.




·
            An
      amendment to our Restated Certificate of Incorporation, as amended, to
      increase the number of authorized shares of common stock from 100,000,000
      shares to 150,000,000, with 53,785,851 votes for, 2,284,175 votes against
      and 98,585 votes abstaining.




Following
our 2009 annual meeting, on January 26, 2009, we filed an amendment to our
Certificate of Incorporation to effect the reverse stock split and the increase
in the number of authorized shares of common stock.




ITEM
5. Other Information




None.


43


ITEM
6.  Exhibits




3.3
              Amendment
      to Restated Certificate of Incorporation, filed on January 26, 2009.
      (2)4.2
              Amendment
      No. 1 to Securities Purchase Agreement, dated February 27, 2009.
      (1)4.3
              First
      Tranche Convertible Promissory Note, dated February 27, 2009.
  (1)4.4
              Pledge
      and Security Agreement, dated February 27, 2009. (1)4.5
              First
      Tranche Warrant, dated February 27, 2009. (1)4.6
              Registration
      Rights Agreement, dated February 27, 2009 (2)10.39
              Amendment
      No. 1 to Omnibus Amendment, dated February 27 2009 (1)10.40
              Indemnification
      Agreement between PhotoMedex, Inc. and John M. Glazer (1)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 toSection 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 toSection 906 of the Sarbanes-Oxley Act of 2002








(1)
            Filed as part of our
      Current Report on Form 8-K on March 5, 2009.(2)
            Filed as part of our
      Annual Report on Form 10-K for the year ended December 31,
  2008.








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:  May
      15, 2009
              By:
              /s/  Jeffrey F.
      O’DonnellJeffrey
      F. O’DonnellPresident
      and Chief Executive OfficerDate:  May
      15, 2009
              By:
              /s/  Dennis M.
      McGrathDennis
      M. McGrathChief
      Financial Officer


44