**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10 - Q**
  **ý** **QUARTERLY
            REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**
 **SECURITIES
            EXCHANGE ACT OF 1934**
 
 **For
            the quarterly period ended June 30, 2005**
 
 **OR**
 
 ** ̈** **TRANSITION
            REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE**
 **SECURITIES
            EXCHANGE ACT OF 1934**
 **For
        the transition period from _________ to ___________**
 
 
 Commission
        File Number 0-11365
 
 **PHOTOMEDEX,
        INC.**
 (Exact
        name of registrant as specified in its charter)
 
 **Delaware**
              **59-2058100**(State
                  or other jurisdiction of
              (I.R.S.
                  Employerincorporation
                  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 ý No  ̈
 
 Indicate
        by check mark whether the registrant is an accelerated filer (as defined
        in Rule
        12b-2 of the Exchange Act.)
 Yes ý No  ̈
 
 The
        number of shares outstanding of the issuer's Common Stock as of August 8,
        2005 was 51,190,797 shares.
 
 1
  PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 
 INDEX
 
 Part
                    I. Financial Information:
                PAGEITEM
                    1.
                Financial
                    Statements:
  a.
                  Consolidated
                      Balance Sheets, June 30, 2005 (unaudited) and December 31,
                      2004
                  3b.
                  Consolidated
                      Statements of Operations for the three months ended June 30,
                      2005 and 2004
                      (unaudited)
                  4c.
                  Consolidated
                      Statements of Operations for the six months ended June 30,
                      2005 and 2004
                      (unaudited)
                  5d.
                  Consolidated
                      Statement of Stockholders’ Equity for the six months ended June 30, 2005
                      (unaudited)
                  6e.
                  Consolidated
                      Statements of Cash Flows for the six months ended June 30,
                      2005 and 2004
                      (unaudited)
                  7f.
                  Notes
                      to Consolidated Financial Statements (unaudited)
                  8
  ITEM
                      2.
                  Management’s
                      Discussion and Analysis of Financial Condition and Results
                      of
                      Operations
                  26ITEM
                      3.
                  Quantitative
                      and Qualitative Disclosure about Market Risk
                  47ITEM
                      4.
                  Controls
                      and Procedures
                  47Part
                      II. Other Information:ITEM
                      1.
                  Legal
                      Proceedings
                  47ITEM
                      2.
                  Unregistered
                      Sales of Equity Securities and Use of Proceeds
                  48ITEM
                      3.
                  Defaults
                      Upon Senior Securities
                  48ITEM
                      4.
                  Submission
                      of Matters to a Vote of Security Holders
                  48ITEM
                      5.
                  Other
                      Information
                  48ITEM
                      6.
                  Exhibits
                  49Signatures
                  49Certifications
                  83
  2
  **PART
        I - Financial Information**
  **ITEM
        1. Financial Statements**
  PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 CONSOLIDATED
        BALANCE SHEETS
  June
                  30, 2005
              
              December
                  31, 2004(Unaudited)
              
              ***ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              5,513,315
              
              $
              3,884,817Restricted
                  cash
              
              
              206,802
              
              
              112,200Accounts
                  receivable, net of allowance for doubtful accounts of $676,732
                  and
                  $736,505, respectively
              
              
              4,745,994
              
              
              4,117,399Inventories
              
              
              8,108,142
              
              
              4,585,631Prepaid
                  expenses and other current assets
              
              
              1,023,068
              
              
              401,989Total
                  current assets
              
              
              19,597,321
              
              
              13,102,036Property
                  and equipment, net
              
              
              6,179,352
              
              
              4,996,688Goodwill,
                  net
              
              
              16,375,384
              
              
              2,944,423Patents
                  and licensed technologies, net
              
              
              1,569,322
              
              
              929,434Other
                  intangible assets, net
              
              
              4,932,625
              
              
              -Other
                  assets
              
              
              296,400
              
              
              989,345Total
                  assets
              
              $
              48,950,404
              
              $
              22,961,926**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  liabilities:Current
                  portion of notes payable
              
              $
              743,455
              
              $
              69,655Current
                  portion of long-term debt
              
              
              1,216,072
              
              
              873,754Accounts
                  payable
              
              
              2,839,449
              
              
              3,515,293Accrued
                  compensation and related expenses
              
              
              795,924
              
              
              963,070Other
                  accrued liabilities
              
              
              1,119,249
              
              
              924,054Deferred
                  revenues
              
              
              626,641
              
              
              636,962Total
                  current liabilities
              
              
              7,340,790
              
              
              6,982,788Long-term
                  liabilities:Notes
                  payable
              
              
              12,755
              
              
              26,736Long-term
                  debt
              
              
              1,692,228
              
              
              1,372,119Other
                  liabilities
              
              
              24,670
              
              
              -Total
                  liabilities
              
              
              9,070,443
              
              
              8,381,643Commitments
                  and ContingenciesStockholders’
                  equity:Common
                  stock, $.01 par value, 75,000,000 shares authorized; 51,099,196
                  and
                  40,075,019 shares issued and outstanding, respectively
              
              
              510,992
              
              
              400,750Additional
                  paid-in capital
              
              
              117,493,680
              
              
              90,427,632Accumulated
                  deficit
              
              
              (78,035,325
              )
              
              (76,246,562
              )Deferred
                  compensation
              
              
              (89,386
              )
              
              (1,537
              )Total
                  stockholders' equity
              
              
              39,879,961
              
              
              14,580,283Total
                  liabilities and stockholders’ equity
              
              $
              48,950,404
              
              $
              22,961,926
  *
        The
        December 31, 2004 balance sheet was derived from our audited financial
        statements.
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
  3
 PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF OPERATIONS
  (Unaudited)
  For
                  the Three Months Ended June 30,2005
              
              2004Revenues:Product
                  sales
              
              $
              4,955,066
              
              $
              1,629,357Services
              
              
              3,100,107
              
              
              2,693,7778,055,173
              
              
              4,323,134Cost
                  of revenues:Product
                  cost of revenues
              
              
              1,990,996
              
              
              932,621Services
                  cost of revenues
              
              
              2,214,320
              
              
              1,698,7484,205,316
              
              
              2,631,369Gross
                  profit
              
              
              3,849,857
              
              
              1,691,765Operating
                  expenses:Selling,
                  general and administrative
              
              
              4,322,706
              
              
              2,406,453Engineering
                  and product development
              
              
              219,550
              
              
              481,2434,542,256
              
              
              2,887,696Loss
                  from operations
              
              
              (692,399
              )
              
              (1,195,931
              )Other
                  income
              
              
              88,667
              
              
              -Interest
                  expense, net
              
              
              (56,919
              )
              
              (11,236
              )Net
                  loss
              
              
              ($
                  660,651
              )
              
              ($
                  1,207,167
              )Basic
                  and diluted net loss per share
              
              
              ($0.01
              )
              
              ($0.03
              )Shares
                  used in computing basic and diluted net loss per share
              
              
              50,859,562
              
              
              38,546,338
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
 
 4
  PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF OPERATIONS
  (Unaudited)
  For
                  the Six Months Ended June 30,2005
              
              2004Revenues:Product
                  sales
              
              
              7,180,765
              
              $
              3,421,757Services
              
              
              5,857,740
              
              
              4,926,60713,038,505
              
              
              8,348,364Cost
                  of revenues:Product
                  cost of revenues
              
              
              2,883,960
              
              
              1,765,105Services
                  cost of revenues
              
              
              3,953,724
              
              
              3,360,3306,837,684
              
              
              5,125,435Gross
                  profit
              
              
              6,200,821
              
              
              3,222,929Operating
                  expenses:Selling,
                  general and administrative
              
              
              7,543,682
              
              
              4,876,877Engineering
                  and product development
              
              
              406,521
              
              
              897,1937,950,203
              
              
              5,774,070Loss
                  from operations
              
              
              (1,749,382
              )
              
              (2,551,141
              )Other
                  income
              
              
              88,667
              
              
              -Interest
                  expense, net
              
              
              (128,048
              )
              
              (19,108
              )Net
                  loss
              
              
              ($
                  1,788,763
              )
              
              ($
                  2,570,249
              )Basic
                  and diluted net loss per share
              
              
              ($0.04
              )
              
              ($0.07
              )Shares
                  used in computing basic and diluted net loss per share
              
              
              46,322,904
              
              
              38,159,819
 
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
  5
 PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENT OF STOCKHOLDERS’ EQUITY
 FOR
        THE
        SIX MONTHS ENDED JUNE 30, 2005
  (Unaudited)
   AdditionalCommon
                  Stock
              
              Paid-In
              
              Accumulated
              
              DeferredShares
              
              Amount
              
              Capital
              
              Deficit
              
              Compensation
              
              TotalBALANCE,
                  DECEMBER 31, 2004
              
              
              40,075,019
              
              $
              400,750
              
              $
              90,427,632
              
              
              ($76,246,562
              )
              
              ($
                  1,537
              )
              $
              14,580,283Exercise
                  of warrants
              
              
              73,530
              
              
              736
              
              
              146,324
              
              
              -
              
              
              -
              
              
              147,060Exercise
                  of stock options
              
              
              161,673
              
              
              1,616
              
              
              297,319
              
              
              -
              
              
              -
              
              
              298,935Stock
                  options issued to consultants for services
              
              
              
              
              
              
              
              
              31,859
              
              
              
              
              
              
              
              
              31,859Issuance
                  of stock
              
              
              
              
              
              2,484
              
              
              531,201
              
              
              
              
              
              
              
              
              533,685Issuance
                  of stock in connection with the acquisition of ProCyte
              
              
              10,540,579
              
              
              105,406
              
              
              26,197,732
              
              
              -
              
              
              (132,081
              )
              
              26,171,057Amortization
                  of deferred compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              44,232
              
              
              44,232Registration
                  expenses
              
              
              -
              
              
              -
              
              
              (161,739
              )
              
              -
              
              
              -
              
              
              (161,739
              )Issuance
                  of warrants
              
              
              
              
              
              
              
              
              23,352
              
              
              
              
              
              
              
              
              23,352Net
                  loss for the six months ended June 30, 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,788,763
              )
              
              -
              
              
              (1,788,763
              )BALANCE,
                  JUNE 30, 2005
              
              
              50,850,801
              
              $
              510,992
              
              $
              117,493,680
              
              
              ($78,035,325
              )
              
              ($89,386
              )
              $
              39,879,961
 
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
  6
 PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF CASH FLOWS
 (Unaudited)
  For
                  the Six Months Ended
                June
                  30,2005
              
              2004**Cash
                  Flows From Operating Activities**:Net
                  loss
              
              
              ($
                  1,788,763
              )
              
              ($
                  2,570,249
              )Adjustments
                  to reconcile net loss to net cash usedin
                  operating activities:Depreciation
                  and amortization
              
              
              1,332,754
              
              
              878,890Stock
                  options issued to consultants for services
              
              
              31,859
              
              
              48,192Amortization
                  of deferred compensation
              
              
              44,232
              
              
              3,241Nonmonetary
                  exchange of assets
              
              
              (88,667
              )
              
              -Provision
                  for bad debts
              
              
              276,124
              
              
              82,157Changes
                  in operating assets and liabilities, net of effects on acquired
                  assets and
                  liabilities:Accounts
                  receivable
              
              
              232,694
              
              
              (217,048
              )Inventories
              
              
              (587,401
              )
              
              90,397Prepaid
                  expenses and other assets
              
              
              435,313
              
              
              70,279Accounts
                  payable
              
              
              (1,281,364
              )
              
              (86,595
              )Accrued
                  compensation and related expenses
              
              
              (318,453
              )
              
              (89,625
              )Other
                  accrued liabilities
              
              
              (788,380
              )
              
              (132,660
              )Deferred
                  revenues
              
              
              (105,757
              )
              
              121,928Other
                  liabilities
              
              
              (28,213
              )
              
              -Net
                  cash used in operating activities
              
              
              (2,634,022
              )
              
              (1,801,093
              )**Cash
                  Flows From Investing Activities:**Purchases
                  of property and equipment
              
              
              (61,345
              )
              
              (55,527
              )Lasers
                  placed into service
              
              
              (1,727,800
              )
              
              (845,780
              )Cash
                  received from acquisition, net of costs incurred
              
              
              5,578,416
              
              
              -Net
                  cash provided by (used in) investing activities
              
              
              3,789,271
              
              
              (901,307
              )**Cash
                  Flows From Financing Activities:**Proceeds
                  from issuance of common stock, net of direct issuance
                  costs
              
              
              (161,739
              )
              
              11,199Proceeds
                  from exercise of options
              
              
              298,935
              
              
              62,212Proceeds
                  from exercise of warrants
              
              
              147,060
              
              
              1,718,592Payments
                  on long-term debt
              
              
              (137,028
              )
              
              (152,907
              )Payments
                  on notes payable
              
              
              (318,432
              )
              
              (251,869
              )Net
                  repayments on bank line of credit
              
              
              -
              
              
              (1,000,000
              )Net
                  advancements on lease line of credit
              
              
              739,055
              
              
              1,369,680Increase
                  in restricted cash and cash equivalents
              
              
              (94,602
              )
              
              -Net
                  cash provided by financing activities
              
              
              473,249
              
              
              1,756,907Net
                  increase (decrease) in cash and cash equivalents
              
              
              1,628,498
              
              
              (945,493
              )Cash
                  and cash equivalents, beginning of period
              
              
              3,884,817
              
              
              6,633,468Cash
                  and cash equivalents, end of period
              
              $
              5,513,315
              
              $
              5,687,975
 
  
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
  7
 PHOTOMEDEX,
        INC. AND SUBSIDIARIES
 NOTES
        TO
        UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  *Note
        1*
  **The
        Company and Summary of Significant Accounting Policies:**
  **The
        Company:**
  ***Background***
 PhotoMedex,
        Inc. and 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 develops, manufactures and
        markets excimer-laser-based instrumentation designed to phototherapeutically
        treat psoriasis, vitiligo, atopic dermatitis and leukoderma. In January 2000,
        the Company received the first Food and Drug Administration (“FDA”) clearance to
        market an excimer laser system, the XTRAC® system, for the treatment of
        psoriasis. In March 2001, the Company received FDA clearance to treat vitiligo;
        in August 2001, the Company received FDA clearance to treat atopic dermatitis;
        and in May 2002, the FDA granted 510(k) clearance to market the XTRAC system
        for
        the treatment of leukoderma. The Company launched the XTRAC phototherapy
        treatment system commercially in the United States in August 2000.
  Beginning
        with the acquisition of Surgical Laser Technologies, Inc. (“SLT”) on December
        27, 2002, the Company also develops, manufactures and markets proprietary
        lasers
        and delivery systems for both contact and non-contact surgery and provides
        surgical services utilizing these and other manufacturers’ products.
  Through
        the acquisition of ProCyte Corporation (“ProCyte”) on March 18, 2005, the
        Company also develops, manufactures and markets products for skin health,
        hair
        care and wound care.  Many of the Company’s products incorporate its
        patented copper peptide technologies.
  ***Liquidity
        and Going Concern***
 The
        Company has incurred significant losses and has had negative cash flows from
        operations since emerging from bankruptcy in May 1995. As of June 30, 2005,
        the
        Company had an accumulated deficit of $78,035,325. However, the Company was
        successful in reducing its net loss for the three months ended June 30,
        2005 by $546,516, a 45% improvement, compared to the three months ended
        June 30, 2004. The Company also reduced its net loss for the six months
        ended June 30, 2005 by $781,583, a 30% improvement, compared to the six months
        ended June 30, 2004. The Company has historically financed its activities
        from
        operations and the private placement of equity securities. To date, the Company
        has dedicated most of its financial resources to research and development,
        marketing and general and administrative expenses.
  To
        increase patient acceptance of targeted UVB therapy for skin disorders using
        the
        XTRAC, the Company needed to obtain current procedural terminology (“CPT”) codes
        from the American Medical Association, which established such codes in the
        latter part of 2002. By early 2003, the Centers for Medicare and Medicaid
        Services (“CMS”) had approved rates of reimbursement for these new CPT codes.
        The Company also needed private health insurance carriers to adopt medical
        policies to reimburse patients for the treatment. The Company therefore began
        to
        focus its efforts on securing approval by various private health plans to
        reimburse for treatments of psoriasis using the XTRAC. Simultaneously the
        Company re-launched the marketing of its XTRAC system in the United States.
  The
        Company plans to continue to focus on securing reimbursement from more private
        insurers and to devote sales and marketing efforts in the areas where such
        reimbursement has become available. As favorable momentum is achieved and
        maintained, the Company will spend substantial amounts on the marketing of
        its
        psoriasis, vitiligo, atopic dermatitis and leukoderma treatment products
        and
        expansion of its manufacturing efforts. Notwithstanding the approval by CMS
        for
        Medicare and Medicaid reimbursement and recent approvals by certain private
        insurers, the Company may continue to face resistance from some private
        healthcare insurers to adopt the excimer-laser-based therapy as an approved
        procedure or resistance from plans that adopt favorable policies but set
        the
        reimbursement rates so low that physicians are discouraged from performing
        such
        procedures Management cannot provide assurance that the Company will market
        the
        product successfully or operate profitably in the future, or that it will
        not
        require significant additional financing in order to accomplish its business
        plan.
  The
        Company’s future revenues and success depends in part upon increased patient
        acceptance of its excimer-laser-based systems for the treatment of a variety
        of
        skin disorders. The Company’s excimer-laser-based system for the treatment of
        psoriasis, vitiligo, atopic dermatitis and leukoderma is currently generating
        revenues in both the United States and abroad. The Company’s ability to
        introduce successful new products based on its business focus and the expected
        benefits to be obtained from these products may be adversely affected by
        a
        number of factors, such as unforeseen costs and expenses, technological change,
        economic downturns, competitive factors or other events beyond the Company’s
        control. Consequently, the Company’s historical operating results cannot be
        relied upon as indicators of future performance, and management cannot predict
        whether the Company will obtain or sustain positive operating cash flow or
        generate net income in the future.
  8
 Cash
        and
        cash equivalents were $5,720,117, including restricted cash of $206,802,
        as of
        June 30, 2005. Management believes that the existing cash balance
        together
        with its existing financial resources, including the leasing credit line
        facility (see Note 9), and any revenues from sales, distribution, licensing
        and
        manufacturing relationships, will be sufficient to meet the Company’s operating
        and capital requirements beyond the second quarter of 2006. The 2005 operating
        plan reflects anticipated growth from an increase in per-treatment fee revenues
        for use of the XTRAC system based on wider insurance coverage in the United
        States and continuing costs savings from the integration of business operations
        acquired from ProCyte. In addition, the 2005 operating plan calls for increased
        revenues and profits from the ProCyte business and the continued growth of
        its
        skin care products. However, depending upon the Company’s rate of growth and
        other operating factors, the Company may require additional equity or debt
        financing to meet its working capital requirements or capital expenditure
        needs
        for the balance of 2005. There can be no assurance that additional financing,
        if
        needed, will be available when required or, if available, can be obtained
        on
        terms satisfactory to the Company.
  **Summary
        of Significant Accounting Policies:**
  ***Quarterly
        Financial Information and Results of Operations***
 The
        financial statements as of June 30, 2005 and for the six months ended
        June 30, 2005 and 2004, are unaudited and, in the opinion of management,
        include all adjustments (consisting only of normal recurring adjustments)
        necessary to present fairly the financial position as of June 30,
        2005, and
        the results of operations and cash flows for the six months ended June 30,
        2005 and 2004. The results for the six months ended June 30, 2005
        are not
        necessarily indicative of the results to be expected for the entire year.
        While
        management of the Company believes that the disclosures presented are adequate
        to make the information not misleading, these consolidated financial statements
        should be read in conjunction with the consolidated financial statements
        and the
        notes included in the Company's Annual Report on Form 10-K for the fiscal
        year
        ended December 31, 2004.
  ***Principles
        of Consolidation***
 The
        consolidated financial statements include the accounts of the Company and
        its
        wholly-owned subsidiaries. All significant intercompany balances and
        transactions have been eliminated.
  ***Use
        of Estimates***
 The
        preparation of the consolidated financial statements in conformity with
        accounting principles generally accepted in the United States requires
        management to make estimates and assumptions that affect amounts reported
        in the
        financial statements and accompanying notes. Actual results could differ
        from
        those estimates and be based on events different from those assumptions.
        Future
        events and their effects cannot be perceived with certainty; estimating,
        therefore, requires the exercise of judgment. Thus, accounting estimates
        change
        as new events occur, as more experience is acquired, or as additional
        information is obtained. See ***Revenue
        Recognition*** for
        discussion of updates and changes in estimates for XTRAC domestic revenues
        in
        accordance with Staff Accounting Bulletin Nos. 101 and 104 and Statement
        of
        Financial Accounting Standards (“SFAS”) No. 48.
  ***Cash
        and Cash Equivalents***
 The
        Company invests its excess cash in highly liquid, short-term investments.
        The
        Company considers short-term investments that are purchased with an original
        maturity of three months or less to be cash equivalents. Cash and cash
        equivalents consisted of cash and money market accounts at June 30,
        2005
        and December 31, 2004 .
        Cash
        that is pledged to secure obligations is disclosed separately as restricted
        cash. The Company maintains its cash and cash equivalents in accounts in
        several
        banks, the balances of which at times may exceed federally insured
        limits.
  ***Accounts
        Receivable***
 The
        majority of the Company’s accounts receivables are due from distributors
        (domestic and international), hospitals, universities and physicians and
        other
        entities in the medical field. Credit is extended based on evaluation of
        a
        customer’s financial condition and, generally, collateral is not required.
        Accounts receivable are most often due within 30 to 90 days and are stated
        at
        amounts due from customers net of an allowance for doubtful accounts. Accounts
        outstanding longer than the contractual payment terms are considered past
        due.
        The Company determines its allowance by considering a number of factors,
        including the length of time trade accounts receivable are past due, the
        customer’s previous loss history, the customer’s current ability to pay its
        obligation to the Company, and the condition of the general economy and the
        industry as a whole. The Company writes off accounts receivable when they
        become
        uncollectible, and payments subsequently received on such receivables are
        credited to the bad debt expense. The Company does not accrue interest on
        accounts receivable that are past due.
  9
 ***Inventories***
 Inventories
        are stated at the lower of cost (first-in, first-out basis) or market. Costs
        are
        determined to be purchased cost for raw materials and the production cost
        (materials, labor and indirect manufacturing cost) for work-in-process and
        finished goods. Throughout the laser manufacturing process, the related
        production costs are recorded within the cost of inventory. Work-in-process
        is
        immaterial, given the typically short manufacturing cycle, and therefore
        is
        disclosed in conjunction with raw materials. The Company performs full physical
        inventory counts for XTRAC and cycle counts on the other inventory to maintain
        controls and obtain accurate data.
  The
        Company's skin disorder treatment equipment will either (i) be sold to
        distributors or physicians directly or (ii) be placed in a physician's office
        and remain the property of the Company. The cost to build a laser, whether
        for
        sale or for placement, is accumulated in inventory. When a laser is placed
        in a
        physician’s office, the cost is transferred from inventory to “lasers in
        service” within property and equipment. At times, units are shipped to
        distributors, but revenue is not recognized until all of the criteria of
        Staff
        Accounting Bulletin No. 104 have been met, and until that time, the cost
        of the
        unit is carried on the books of the Company as finished goods inventory.
        Revenue
        is not recognized from these distributors until payment is either assured
        or
        paid in full.
  Reserves
        for slow moving and obsolete inventories are provided based on historical
        experience and product demand. Management evaluates the adequacy of these
        reserves periodically based on forecasted sales and market trend.
  ***Property,
        Equipment and Depreciation***
 Property
        and equipment are recorded at cost. Excimer lasers-in-service are depreciated
        on
        a straight-line basis over the estimated useful life of three years. Surgical
        lasers-in-service are depreciated on a straight-line basis over an estimated
        useful life of seven years if the equipment is new, and five years or less
        if it
        is used. The straight-line depreciation basis for lasers-in-service is
        reflective of the pattern of use. For other property and equipment, depreciation
        is calculated on a straight-line basis over the estimated useful lives of
        the
        assets, primarily three to seven years for computer hardware and software,
        furniture and fixtures, automobiles, and machinery and equipment. Leasehold
        improvements are amortized over the lesser of the useful lives or lease terms.
        Expenditures for major renewals and betterments to property and equipment
        are
        capitalized, while expenditures for maintenance and repairs are charged to
        operations as incurred. Upon retirement or disposition, the applicable property
        amounts are deducted from the accounts and any gain or loss is recorded in
        the
        consolidated statements of operations.
  Laser
        units and laser accessories located at medical facilities for sales evaluation
        and demonstration purposes or those units and accessories used for development
        and medical training are included in property and equipment under the caption
        “machinery and equipment.” These units and accessories are being depreciated
        over a period of up to five years. Laser units utilized in the provision
        of
        surgical services or in the treatment of skin disorders are included, as
        discussed above, in property and equipment under the caption “lasers in
        service.”
  Management
        evaluates the realizability of property and equipment based on estimates
        of
        undiscounted future cash flows over the remaining useful life of the asset.
        If
        the amount of such estimated undiscounted future cash flows is less than
        the net
        book value of the asset, the asset is written down to its net realizable
        value.
        As of June 30, 2005, no such write-down was required (see ***Impairment
        of Long-Lived Assets*** below).
  ***Patent
        Costs and Licensed Technologies***
 Costs
        incurred to obtain or defend patents and licensed technologies are capitalized
        and amortized over the shorter of the remaining estimated useful lives or
        8 to
        12 years. Developed technology was recorded in connection with the purchase
        in
        August 2000 of the minority interest of Acculase, a former subsidiary of
        the
        Company, and is being amortized on a straight-line basis over seven years.
        Developed technology was recorded in connection with the acquisition of ProCyte
        in March 2005 and is being amortized on a straight-line basis over seven
        years.
  10
 Management
        evaluates the realizability of intangible assets based on estimates of
        undiscounted future cash flows over the remaining useful life of the asset.
        If
        the amount of such estimated undiscounted future cash flows is less than
        the net
        book value of the asset, the asset is written down to fair value. As of
        June 30, 2005, no such write-down was required (see ***Impairment
        of Long-Lived Assets*** below).
  ***Other
        Intangible Assets***
 Other
        intangible assets were recorded in connection with the acquisition of ProCyte
        in
        March 2005. The assets are being amortized on a straight-line basis over
        5 to 10
        years.
  Management
        evaluates the realizability of such other intangible assets based on estimates
        of undiscounted future cash flows over the remaining useful life of the asset.
        If the amount of such estimated undiscounted future cash flows is less than
        the
        net book value of the asset, the asset is written down to fair value. As
        of
        June 30, 2005, no such write-down was required (see ***Impairment
        of Long-Lived Assets*** below).
  ***Accrued
        Warranty Costs***
 The
        Company offers a warranty on product sales generally for a one to two-year
        period. The Company provides for the estimated future warranty claims on
        the
        date the product is sold. The activity in the warranty accrual during the
        six
        months ended June 30, 2005 is summarized as follows:
  June
                  30, 2005Accrual
                  at beginning of period
              
              $
              196,890Additions
                  charged to warranty expense
              
              
              42,000Claims
                  paid and expiring warranties
              
              
              (26,288
              )Accrual
                  at end of period
              
              $
              212,602
  ***Revenue
        Recognition***
 The
        Company has two distribution channels for its phototherapy treatment equipment.
        The Company will either (i) sell the laser through a distributor or directly
        to
        a physician or (ii) place the laser in a physician’s office (at no charge to the
        physician) and charge the physician a fee for an agreed upon number of
        treatments. When the Company sells an XTRAC laser to a distributor or directly
        to a physician, revenue is recognized when the following four criteria under
        Staff Accounting Bulletin No. 104 have been met: the product has been shipped
        and the Company has no significant remaining obligations; persuasive evidence
        of
        an arrangement exists; the price to the buyer is fixed or determinable; and
        collection is probable (the “SAB 104 Criteria”). At times, units are shipped but
        revenue is not recognized until all of the criteria have been met, and until
        that time, the unit is carried on the books of the Company as inventory.
        The
        Company ships most of its products FOB shipping point, although from time
        to
        time certain customers, for example governmental customers, will insist on
        FOB
        destination. Among the factors the Company takes into account in determining
        the
        proper time at which to recognize revenue are when title to the goods transfers
        and when the risk of loss transfers. Shipments to distributors that do not
        fully
        satisfy the collection criteria are recognized when invoiced amounts are
        fully
        paid.
  Under
        the
        terms of the distributor agreements, the distributors do not have the right
        to
        return any unit that they have purchased. However, the Company does allow
        products to be returned by its distributors in redress of 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 used by the physician. Treatments
        in
        the form of random laser-access codes that are sold to physicians but not
        yet
        used are deferred and recognized as a liability until the physician performs
        the
        treatment. Unused treatments remain an obligation of the Company inasmuch
        as the
        treatments can only be performed on Company-owned equipment. Once the treatments
        are delivered to a patient, this obligation has been satisfied.
  Until
        the
        fourth quarter of 2004, unused treatments had been based upon an estimate
        that
        at the end of each accounting period, 15 unused treatments existed at each
        laser
        location. This was based upon the reasoning that the Company generally sells
        treatments in packages of 30 treatments. Fifteen treatments generally represents
        about one-half the purchased quantity by a physician or approximately a one-week
        supply for 6 to 8 patients. This policy had been used on a consistent basis.
        The
        Company believed this approach to have been reasonable and systematic given
        that: physicians have little motivation to purchase quantities (which they
        are
        obligated to pay for irrespective of actual use and are unable to seek a
        credit
        or refund for unused treatments) that will not be used in a relatively short
        period of time, particularly since in most cases they can obtain incremental
        treatments instantaneously over the phone; and senior management regularly
        reviews purchase patterns by physicians to identify unusual buildup of unused
        treatment codes at a laser site. Moreover, the Company continually looks
        at its
        estimation model based upon data received from its customers.
  11
 In
        the
        fourth quarter of 2004, the Company updated the calculations for the estimated
        amount of unused treatments to reflect recent purchasing patterns by physicians
        near year-end. The Company estimated the amount of unused treatments at December
        31, 2004 to include all sales of treatment codes made within the last two
        weeks
        of the period. Management believes that the actual amount of unused treatments
        that existed at that date is more closely approximated by its present approach
        than by the previous approach. Accounting Principles Board (“APB”) Opinion No.
        20 provides that accounting estimates change as new events occur, as more
        experience is acquired, or as additional information is obtained and that
        the
        effect of the change in accounting estimate should be accounted for in the
        current period and the future periods that it affects. The Company accounted
        for
        this change in the estimate of unused treatments in accordance with APB No.
        20
        and SFAS No. 48. Accordingly, the Company’s change in accounting estimate was
        reported in revenues for the fourth quarter of 2004, and was not accounted
        for
        by restating amounts reported in financial statements of prior periods or
        by
        reporting proforma amounts for prior periods.
  The
        Company has continued this approach or method for estimating the amount of
        unused treatments at June 30, 2005. Due to this updated approach in estimates,
        XTRAC domestic revenues were increased by $60,000 for the three months ended
        June 30, 2005 and decreased by $62,000 for the six months ended June 30,
        2005,
        as compared to the prior method of estimation.
  In
        the
        first quarter of 2003, the Company implemented a program to support certain
        physicians by addressing treatments with the XTRAC system that may be denied
        reimbursement by private insurance carriers. The Company recognizes service
        revenue from the sale of treatment codes to physicians participating in this
        program only if and to the extent the physician has been reimbursed for the
        treatments. The Company must estimate the extent to which a physician
        participating in the program has been reimbursed. For the three and six months
        ended June 30, 2005, the Company’s XTRAC domestic revenues were reduced by
        an additional $51,865 and $32,715, respectively, under this program as all
        the
        criteria for revenue recognition were not met.
  Under
        this program, qualifying doctors can be reimbursed for the cost of the Company’s
        fee only if they are ultimately denied reimbursement after appeal of their
        claim
        with the insurance company. The key components of the program are as
        follows:
  ·
              The
                  physician practice must qualify to be in the program (i.e. it must
                  be in
                  an identified location where there is still an insufficiency of
                  insurance
                  companies reimbursing the
                  procedure);
  ·
              The
                  program only covers medically necessary treatments of psoriasis
                  as
                  determined by the treating
                  physician;
  ·
              The
                  patient must have medical insurance, and a claim for the treatment
                  must be
                  timely filed with the patient’s insurance company;
  ·
              Upon
                  denial by the insurance company (generally within 30 days of filing
                  the
                  claim), a standard insurance form called an EOB (“Explanation of
                  Benefits”) must be submitted to the Company’s in-house appeals group, who
                  will then prosecute the appeal. The appeal process can take 6 to
                  9
                  months;
  ·
              After
                  all appeals have been exhausted by the Company, if the claim remains
                  unpaid, then the physician is entitled to receive refund or credit
                  for the
                  treatment he or she purchased from the Company (the Company’s fee only) on
                  behalf of the patient; and
  ·
              Physicians
                  are still obligated to make timely payments for treatments purchased,
                  irrespective of whether reimbursement is paid or denied. Future
                  sale of
                  treatments to the physician can be denied if timely payments are
                  not made,
                  even if a patient’s appeal is still in
                  process.
  12
  Historically,
        the Company estimated this contingent liability for potential refund by
        estimating when the physician was paid for the insurance claim. In the absence
        of a two-year historical trend and a large pool of homogeneous transactions
        to
        reliably predict the estimated claims for refund as required by Staff Accounting
        Bulletin Nos. 101 and 104, the Company previously deferred revenue recognition
        of 100% of the current quarter revenues from the program to allow for the
        actual
        denied claims to be identified after processing with the insurance companies.
        After more than 91,000 treatments in the last two years and detailed record
        keeping of denied insurance claims and appeals processed, the Company can
        reliably estimate that approximately 11% of a current quarter’s revenues under
        this program are subject to being credited or refunded to the physician.
  As
        of
        December 31, 2004, the Company updated its estimation procedure to reflect
        this
        level of estimated refunds. This change from the past process of deferring
        100%
        of the current quarter revenues from the program represents a change in
        accounting estimate and we have recorded this change in accordance with the
        relevant provisions of SFAS No. 48 and APB No. 20. These requirements state
        that
        the effect of a change in accounting estimate should be accounted for in
        the
        current period and the future periods that it affects. A change in accounting
        estimate should not be accounted for by restating amounts reported in financial
        statements of prior periods or by reporting proforma amounts for prior periods.
        Due to this updated approach in estimates, XTRAC domestic revenues were
        increased by $154,000 and $56,000 for the three and six months ended June
        30,
        2005 as compared to the prior method of estimation.
  The
        net
        impact on revenue recognized for the XTRAC domestic segment as a result of
        the
        above two changes in accounting estimate was to increase revenues by
        approximately $214,000 for the three months ended June 30, 2005 and to decrease
        revenues by approximately $6,000 for the six months ended June 30, 2005.
  Through
        its surgical businesses, the Company generates revenues primarily from two
        channels. The first is through product sales of laser systems, related
        maintenance service agreements, recurring laser delivery systems and laser
        accessories; the second is through per-procedure surgical services. The Company
        recognizes revenues from surgical laser and other product sales, including
        sales
        to distributors, when the SAB 104 Criteria have been met.
  For
        per-procedure surgical services, the Company recognizes revenue upon the
        completion of the procedure. Revenue from maintenance service agreements
        is
        deferred and recognized on a straight-line basis over the term of the
        agreements. Revenue from billable services, including repair activity, is
        recognized when the service is provided.
  The
        Company generates revenues from the acquired business of ProCyte primarily
        through three channels. The first is through product sales for skin health,
        hair
        care and wound care; the second is through sales of the copper peptide compound,
        primarily to Neutrogena; and the third is through royalties generated by
        our
        licenses, principally to Neutrogena. The Company recognizes revenues on the
        products and copper peptide compound when they are shipped, net of returns
        and
        allowances. The Company ships the products FOB shipping point. Royalty revenues
        are based upon sales generated by our licensees. The Company recognizes royalty
        revenue at the applicable royalty rate applied to shipments reported by our
        licensee.
  ***Product
        Development Costs***
 Costs
        of
        research, new product development and product redesign are charged to expense
        as
        incurred.
  ***Income
        Taxes***
 The
        Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
        for Income Taxes.” Under SFAS No. 109, the liability method is used for income
        taxes. Under this method, deferred tax assets and liabilities are determined
        based on differences between the financial reporting and tax basis of assets
        and
        liabilities and are measured using enacted tax rates and laws that are expected
        to be in effect when the differences reverse.
  The
        Company’s deferred tax asset has been fully reserved under a valuation
        allowance, reflecting the uncertainties as to realizability evidenced by
        the
        Company’s historical results and restrictions on the usage of the net operating
        loss carryforwards. Consistent with the rules of purchase accounting, the
        historical deferred tax asset of ProCyte was written off when the Company
        acquired ProCyte. If and when components of that asset are realized in future,
        the acquired goodwill of ProCyte will be reduced.
  13
 ***Net
        Loss Per Share***
 The
        Company computes net loss per share in accordance with SFAS No. 128, “Earnings
        per Share.” In accordance with SFAS No. 128, basic net loss per share is
        calculated by dividing net loss available to common stockholders by the weighted
        average number of common shares outstanding for the period. Diluted net loss
        per
        share reflects the potential dilution from the conversion or exercise into
        common stock of securities such as stock options and warrants.
  In
        these
        consolidated financial statements, diluted net loss per share is the same
        as
        basic net loss per share. No additional shares for the potential dilution
        from
        the conversion or exercise of securities into common stock are included in
        the
        denominator, since the result would be anti-dilutive. Common stock options
        and
        warrants of 8,509,883 and 9,316,850 as of June 30, 2005 and 2004,
        respectively, were excluded from the calculation of fully diluted earnings
        per
        share since their inclusion would have been anti-dilutive.
  ***Fair
        Value of Financial Instruments***
 The
        estimated fair values for financial instruments under SFAS No. 107, “Disclosures
        about Fair Value of Financial Instruments,” are determined at discrete points in
        time based on relevant market information. These estimates involve uncertainties
        and cannot be determined with precision. The fair value of cash is based
        on its
        demand value, which is equal to its carrying value. The fair value of notes
        payable is based on borrowing rates that are available to the Company for
        loans
        with similar terms, collateral and maturity. The estimated fair value of
        notes
        payable approximate the carrying values. Additionally, the carrying value
        of all
        other monetary assets and liabilities is equal to their fair value due to
        the
        short-term nature of these instruments.
  ***Impairment
        of Long-Lived Assets***
 In
        accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
        Long-Lived Assets,” long-lived assets, such as property and equipment, and
        purchased intangibles subject to amortization, are reviewed for impairment
        whenever events or changes in circumstances indicate that the carrying amount
        of
        an asset may not be recoverable. Recoverability of assets to be held and
        used is
        measured by a comparison of the carrying amount of an asset to estimated
        undiscounted future cash flows expected to be generated by the asset. If
        the
        carrying amount of an asset exceeds its estimated future cash flows, an
        impairment charge is recognized by the amount by which the carrying amount
        of
        the asset exceeds the fair value of the asset. Assets to be disposed of would
        be
        separately presented in the balance sheet and reported at the lower of the
        carrying amount or fair value less costs to sell, and would no longer be
        depreciated. The assets and liabilities of a disposed group classified as
        held
        for sale would be presented separately in the appropriate asset and liability
        sections of the balance sheet. As of June 30, 2005, no such impairment
        existed.
  ***Exchanges
        of Nonmonetary Assets***
 Exchanges
        under SFAS No. 153, “Exchanges of Nonmonetary Assets,” should be measured based
        on the fair value of the assets exchanged. Further, SFAS No. 153 eliminates
        the
        narrow exception for nonmonetary exchanges of similar productive assets and
        replaces it with a broader exception for exchanges of nonmonetary assets
        that do
        not have “commercial substance.” SFAS No. 153 is generally effective for
        financial statements for fiscal years beginning after June 15, 2005. The
        Company
        has elected to adopt this Statement for the current fiscal year. For the
        three
        and six months ended June 30, 2005, the Company has recognized $88,667 recorded
        as Other Income in accordance with this Statement.
  ***Stock
        Options***
 The
        Company applies the intrinsic-value-based method of accounting prescribed
        by APB
        Opinion No. 25, “Accounting for Stock Issued to Employees,” and related
        interpretations, to account for its fixed-plan stock options. Under this
        method,
        compensation expense is recorded on the date of grant only if the current
        market
        price of the underlying stock exceeds the exercise price. Under the provisions
        of SFAS No. 123 (revised 2004), “Share Based Payment,” the Company will,
        starting January 1, 2006, discontinue intrinsic-value-based accounting and
        recognize compensation expense for stock options under fair-value-based
        accounting.
  14
 Options
        that were assumed from ProCyte and that were unvested as of March 18, 2005
        were
        re-measured as of March 18, 2005 under intrinsic-value-based accounting.
        Unearned compensation of $132,081 was recorded and will be amortized over
        the
        remaining vesting period, which is an average of two years.
  Had
        stock
        compensation cost for the Company’s common stock options been determined based
        upon the fair value of the options at the date of grant, as prescribed under
        SFAS No. 123, the Company’s net loss and net loss per share would have been
        increased to the following pro-forma amounts:
 
 Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Net
                  loss:As
                  reported
              
              
              ($660,651
              )
              
              ($1,207,167
              )
              
              ($1,788,763
              )
              
              ($2,570,249
              )Less:
                  stock-based employee compensation expense included in reported
                  net
                  loss
              
              
              40,033
              
              
              1,621
              
              
              44,232
              
              
              3,241Impact
                  of total stock-based compensation expense determined under
                  fair-value-based method for all grants and awards
              
              
              (496,366
              )
              
              (427,720
              )
              
              (781,468
              )
              
              (872,523
              )Pro-forma
              
              
              ($1,116,984
              )
              
              ($1,633,266
              )
              
              ($2,525,999
              )
              
              ($3,439,531
              )Net
                  loss per share:As
                  reported
              
              
              ($0.01
              )
              
              ($0.03
              )
              
              ($0.04
              )
              
              ($0.07
              )Pro-forma
              
              
              ($0.02
              )
              
              ($0.04
              )
              
              ($0.05
              )
              
              ($0.09
              )
  The
        above
        pro-forma amounts may not be indicative of future pro-forma amounts because
        future options are expected to be granted.
  The
        fair
        value of the options granted is estimated using the Black-Scholes option-pricing
        model with the following weighted average assumptions applicable to options
        granted in the three-month and six-month periods:
  Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Risk-free
                  interest rate
              4.45%
              
              3.07%
              
              4.17%
              
              3.07%Volatility
              117.09%
              
              99.9%
              
              103.88%
              
              99.9%Expected
                  dividend yield
              0%
              
              0%
              
              0%
              
              0%Expected
                  option life
              5
                  years
              
              5
                  years
              
              5
                  years
              
              5
                  years
  ***Supplemental
        Cash Flow Information***
 In
        connection with the purchase of ProCyte in March 2005, the Company issued
        10,540,579 shares of common stock and assumed options of 1,354,973 shares
        of
        common stock (see Note 2).
  During
        the six months ended June 30, 2005, the Company financed insurance
        policies
        through notes payable for $978,252. During the six months ended June 30,
        2004, the Company financed insurance policies through notes payable for
        $530,997. During the six months ended June 30, 2005, the Company issued 248,395
        shares of common stock to Stern upon attainment of certain milestones, which
        is
        included in patents and licensed technologies.
  For
        the
        six months ended June 30, 2005 and 2004, the Company paid interest of $162,107
        and $41,746, respectively. Income taxes paid in the six months ended June
        30,
        2005 and 2004 were immaterial.
  ***Recent
        Accounting Pronouncements***
 In
        May
        2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154,
“Accounting Changes and Error Corrections - replacement of APB Opinion No.
        20
        and FASB Statement No. 3” was issued. SFAS No. 154 changes the accounting for
        and reporting of a change in accounting principle by requiring retrospective
        application to prior periods’ financial statements of changes in accounting
        principle unless impracticable. SFAS No. 154 is effective for accounting
        changes
        made in fiscal years beginning after December 15, 2005. Management believes
        the
        adoption of this Statement will not have an effect on the consolidated financial
        statements.
  15
 On
        December 16, 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which
        is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. In March
        2005
        the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 expresses
        views of the SEC staff regarding the interaction between SFAS 123R and certain
        SEC rules. SFAS No. 123(R) requires all share-based payments to employees,
        including grants of employee stock options, to be valued at fair value on
        the
        date of grant, and to be expensed over the applicable vesting period. Pro-forma
        disclosure of the income statement effects of share-based payments will no
        longer be an alternative. SFAS No. 123(R) is effective for all stock-based
        awards granted on or after January 1, 2006. In addition, companies must also
        recognize compensation expense related to any awards that are not fully vested
        as of the effective date. Compensation expense for the unvested awards will
        be
        measured based on the fair value of the awards previously calculated in
        developing the pro-forma disclosures in accordance with the provisions of
        SFAS
        No. 123.
  The
        Company plans to adopt SFAS No. 123(R) on January 1, 2006. The Company has
        not
        completed the calculation of the impact of applying SFAS No. 123(R). The
        Company
        currently accounts for share-based payments to its employees using the intrinsic
        value method; consequently the results of operations have not included the
        recognition of compensation expense for the issuance of stock option awards.
  On
        November 24, 2004, the FASB issued SFAS No. 151, “Inventory Costs,” which is an
        amendment to ARB No. 43, Chapter 4. It clarifies the accounting for abnormal
        amounts of idle facility expense, freight, handling costs, and wasted material
        (spoilage). Under this Statement, these costs should be expensed as incurred
        and
        not included in overhead. Further, SFAS No. 151 requires that allocation
        of
        fixed production overheads to conversion costs should be based on normal
        capacity of the production facilities. SFAS No. 151 is effective for inventory
        costs incurred during fiscal years beginning after June 15, 2005. Management
        believes the adoption of this Statement will not have an effect on the
        consolidated financial statements.
  In
        December 2003, the FASB issued FASB Interpretation No. 46 (revised December
        2003), “Consolidation of Variable Interest Entities,” (“VIEs”) (“FIN 46R”) which
        addresses how a business enterprise should evaluate whether it has a controlling
        financial interest in an entity through means other than voting rights and
        accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation
        No. 46, “Consolidation of Variable Interest Entities,” which was issued in
        January 2003. The Company has adopted FIN 46R as of March 31, 2004 for variable
        interests in VIEs. For any VIEs that were created before January 1, 2004
        and
        that must therefore be consolidated under FIN 46R, the assets, liabilities
        and
        noncontrolling interests of the VIE initially would be measured at their
        carrying amounts with any difference between the net amount added to the
        balance
        sheet and any previously recognized interest being recognized as the cumulative
        effect of an accounting change. If determining the carrying amounts is not
        practicable, fair value at the date FIN 46R first applies may be used to
        measure
        the assets, liabilities and noncontrolling interest of the VIE. The adoption
        of
        FIN 46R did not have an effect on the consolidated financial statements inasmuch
        as the Company has no interests in any VIEs.
  *Note
        2*
 **Acquisitions:**
  ***ProCyte
        Transaction***
 ProCyte
        is a Washington corporation organized in 1986. ProCyte develops, manufactures
        and markets products for skin health, hair care and wound care.  Many
        of
        the Company’s products incorporate its patented copper peptide
        technologies.  ProCyte’s
        focus since 1996 has been to bring unique products primarily based upon patented
        technologies such as GHK and AHK copper peptide technologies, to selected
        markets. ProCyte currently sells its products directly to the dermatology,
        plastic and cosmetic surgery and spa markets. The Company has also expanded
        the
        use of its novel copper peptide technologies into the mass retail market
        for
        skin and hair care through specifically targeted technology licensing and
        supply
        agreements.
  ProCyte’s
        products address the growing demand for skin health and hair care products,
        including products designed to address the effects aging has on the skin
        and
        hair and to enhance appearance. ProCyte’s products are formulated, branded for
        and targeted at specific markets. ProCyte’s initial products in this area
        addressed the dermatology, plastic and cosmetic surgery markets for use
        following various procedures. Anti-aging skin care products were added to
        expand
        into a comprehensive approach for incorporation into a patient’s skin care
        regimen. Certain of these products incorporate ProCyte’s patented technologies,
        while others complement the product line such as ProCyte’s advanced sunscreen
        products that reduce the effects of sun damage and aging on the
        skin.
  16
 The
        aggregate purchase price was $27,543,784 and was paid through the issuance
        of
        10,540,579 shares of common stock valued at $2.29 per share, the assumption
        of
        1,354,973 common stock options valued at $2,033,132, net of deferred
        compensation of $132,081, and the incurrence of $1,372,726 of transaction
        costs.
        The merger consideration resulted in the equivalent of a fixed ratio of 0.6622
        shares of PhotoMedex common stock for each share of ProCyte common stock.
        As the
        exchange ratio was fixed, the fair value of PhotoMedex common stock for
        accounting purposes was based upon a five-day average stock price of $2.29
        per
        share. The five-day average included the closing prices on the date of the
        announcement of the planned merger and the two days prior and
        afterwards.
  Based
        on
        the purchase price allocation, the following table summarizes the estimated
        fair
        value of the assets acquired and liabilities assumed at the date of acquisition.
  Cash
                  and cash equivalents
              
              $
              6,272,540Accounts
                  receivable
              
              
              1,137,413Inventories
              
              
              2,845,698Prepaid
                  expenses and other current assets
              
              
              134,574Property
                  and equipment
              
              
              340,531Patents
                  and licensed technologies
              
              
              200,000Other
                  intangible assets
              
              
              5,200,000Other
                  assets
              
              
              38,277Total
                  assets acquired
              
              
              16,169,033Accounts
                  payable
              
              
              (605,520
              )Accrued
                  compensation and related expenses
              
              
              (158,610
              )Other
                  accrued liabilities
              
              
              (1,143,761
              )Deferred
                  revenues
              
              
              (95,436
              )Other
                  liabilities
              
              
              (52,883
              )Total
                  liabilities assumed
              
              
              (2,056,210
              )Net
                  assets acquired
              
              $
              14,112,823
  The
        purchase price exceeded the fair value of the net assets acquired by
        $13,430,961, resulting in goodwill in the same amount.
  The
        accompanying consolidated financial statements do not include any revenues
        or
        expenses related to the acquisition on or prior to March 18, 2005, the closing
        date. Following are the Company’s unaudited pro-forma results for the three and
        six months ended June 30, 2005 and 2004, assuming the acquisition had occurred
        on January 1, 2004.
  Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Net
                  revenues
              
              $
              8,055,173
              
              $
              8,007,812
              
              $
              16,008,067
              
              $
              15,252,802Net
                  loss
              
              
              (660,651
              )
              
              (1,446,587
              )
              
              (1,890,815
              )
              
              (2,949,889
              )Basic
                  and diluted loss per share
              
              
              (0.01
              )
              
              (0.03
              )
              
              (0.04
              )
              
              (0.06
              )Shares
                  used in calculating basic and diluted loss per share
              
              
              50,859,562
              
              
              49,086,917
              
              
              50,748,782
              
              
              48,700,398
  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, 2004, nor to
        be
        indicative of future results of operations.
  17
 **Stern
        Laser Transaction**
 On
        September 7, 2004, the Company closed the transactions set forth in a Master
        Asset Purchase Agreement (the “Master Agreement”) with Stern Laser srl
        (“Stern”). As of June 30, 2005, the Company has issued to Stern 362,272 shares
        of its restricted common stock in connection with the execution of the Master
        Agreement. The Company also agreed to pay Stern up to an additional $650,000
        based on the achievement of certain remaining milestones relating to the
        development and commercialization of certain licensed technology and the
        licensed products which may be developed under such arrangement and may have
        certain other obligations to Stern under these arrangements. The Company
        retains
        the right to pay all of these conditional sums in cash or in shares of its
        common stock, in its discretion. To secure the latter alternative, the Company
        has reserved for issuance, and placed into escrow, 337,728 shares of its
        unregistered stock. The per-share price of any future issued shares will
        be
        based on the average closing price of the Company’s common stock during the 10
        trading days ending on the date of achievement of a particular milestone
        under
        the terms of the Master Agreement. Stern also has served as the distributor
        of
        the Company’s XTRAC laser system in South Africa and Italy since 2000.
  The
        Company assigned $874,254 as the fair value of the license it acquired from
        Stern. Amortization of this intangible is on a straight-line basis over 10
        years, which began in January 2005. As Stern completes further milestones
        under
        the Master Agreement, the Company expects to continue to increase the carrying
        value of the license.
  *Note
        3*
 **Inventories:**
  Set
        forth
        below is a detailed listing of inventories.
  June 30, 2005
              
              December 31, 2004Raw
                  materials and work in progress
              
              $
              4,057,222
              
              $
              2,968,728Finished
                  goods
              
              
              4,050,920
              
              
              1,616,903Total
                  inventories
              
              $
              8,108,142
              
              $
              4,585,631
  Work-in-process
        is immaterial, given the typically short manufacturing cycle, and therefore
        is
        disclosed in conjunction with raw materials. Finished goods includes $31,774
        and
        $84,000 as of June 30, 2005 and December 31, 2004, respectively, for
        laser
        systems shipped to distributors, but not recognized as revenue until all
        the SAB
        104 Criteria have been met.
  *Note
        4*
 **Property
        and Equipment:**
  Set
        forth
        below is a detailed listing of property and equipment.
  June
                  30, 2005
              
              December
                  31, 2004Lasers
                  in service
              
              $
              11,136,888
              
              $
              9,333,591Computer
                  hardware and software
              
              
              393,266
              
              
              256,340Furniture
                  and fixtures
              
              
              309,884
              
              
              239,520Machinery
                  and equipment
              
              
              625,003
              
              
              522,643Autos
                  and trucks
              
              
              382,690
              
              
              400,570Leasehold
                  improvements
              
              
              110,441
              
              
              110,44112,958,172
              
              
              10,863,105Accumulated
                  depreciation and amortization
              
              
              (6,778,820
              )
              
              (5,866,417
              )Property
                  and equipment, net
              
              $
              6,179,352
              
              $
              4,996,688
  Depreciation
        expense was $946,267 and $795,554 for the six months ended June 30,
        2005
        and 2004, respectively. At June 30, 2005 and December 31, 2004, net
        property and equipment included $617,883 and $666,326, respectively, of assets
        recorded under capitalized lease arrangements, of which $428,218 and $565,245
        was included in long-term debt at June 30, 2005 and December 31, 2004,
        respectively (see Note 9).
  18
  *Note
        5*
 **Patents
        and Licensed Technologies:**
  Set
        forth
        below is a detailed listing of patents and licensed technologies.
  June
                  30, 2005
              
              December
                  31, 2004Patents,
                  owned and licensed, at gross costs of $428,338 and $403,023, net
                  of
                  accumulated amortization of $176,157 and $155,522
                  respectively
              
              $
              252,181
              
              $
              247,501Other
                  licensed or developed technologies, at gross costs of $1,911,254
                  and
                  $1,177,568, net of accumulated amortization of $594,113 and $495,635
                  respectively
              
              
              1,317,141
              
              
              681,933$
              1,569,322
              
              $
              929,434
  Related
        amortization expense was $119,112 and $83,336 for the six months ended
        June 30, 2005 and 2004, respectively. Included in other licensed and
        developed technologies is $200,000 in developed technologies acquired from
        ProCyte.
  *Note
        6*
 **Other
        Intangible Assets:**
  Set
        forth
        below is a detailed listing of other intangible assets, all of which were
        acquired from ProCyte and which have been recorded at their appraised fair
        market values.
  June
                  30, 2005Neutrogena
                  Agreement, at gross costs of $2,400,000 net of accumulated amortization
                  of
                  $138,000.
              
              $
              2,262,000Customer
                  Relationships, at gross costs of $1,700,000 net of accumulated
                  amortization of $97,750.
              
              
              1,602,250Tradename,
                  at gross costs of $1,100,000 net of accumulated amortization of
                  $31,625.
              
              
              1,068,375$
              4,932,625
  Related
        amortization expense was $267,375 for the six months ended June 30,
        2005.
        Under the Neutrogena Agreement, the Company has licensed to Neutrogena rights
        to
        its copper peptide technology and for which the Company receives royalties.
        Customer Relationships embody the value to the Company of relationships that
        ProCyte had formed with its customers. Tradename includes the name of “ProCyte”
        and various other trademarks associated with ProCyte’s products.
  *Note
        7*
 **Other
        Accrued Liabilities:**
  Set
        forth
        below is a detailed listing of other accrued liabilities.
  June
                  30, 2005
              
              December
                  31, 2004Accrued
                  warranty
              
              $
              212,603
              
              $
              196,890Accrued
                  liability from matured notes
              
              
              244,988
              
              
              245,849Accrued
                  professional and consulting fees
              
              
              355,247
              
              
              412,019Accrued
                  sales taxes
              
              
              146,619
              
              
              61,142Other
                  accrued expenses
              
              
              159,792
              
              
              8,154Total
                  other accrued liabilities
              
              $
              1,119,249
              
              $
              924,054
  During
        2002, SLT resumed direct control of $223,000 of funds previously set aside
        for
        the payment of SLT’s subordinated notes, which matured and ceased to bear
        interest on July 30, 1999, and $31,000 of funds set aside to pay related
        accrued
        interest. As of June 30, 2005 and December 31, 2004, the matured principal
        and related interest was $244,988. After July 30, 2005, the outstanding notes,
        and the related funds, are no longer redeemable.
  19
 *Note
        8*
 **Notes
        Payable:**
  Set
        forth
        below is a detailed listing of notes payable. The stated interest rate
        approximates the effective cost of funds from the notes.
  June
                  30, 2005
              
              December
                  31, 2004Note
                  payable - secured creditor, interest at 16.47%, payable in monthly
                  principal and interest installments of $2,618 through December
                  2006.
              
              $
              39,618
              
              $
              51,489Note
                  payable - unsecured creditor, interest at 5.75%, payable in monthly
                  principal and interest installments of $44,902 through January
                  2005.
              
              
              -
              
              
              44,902Note
                  payable - unsecured creditor, interest at 7.42%, payable in monthly
                  principal and interest installments of $21,935 through November
                  2005
              
              
              107,668
              
              
              -Note
                  payable - unsecured creditor, interest at 7.42%, payable in monthly
                  principal and interest installments of $15,600 through November
                  2005
              
              
              76,575
              
              
              -Note
                  Payable - unsecured creditor, interest at 7.42%, payable in monthly
                  principal and interest installments of $61,493 through March
                  2006
              
              
              532,349
              
              
              -756,210
              
              
              96,391Less:
                  current maturities
              
              
              (743,455
              )
              
              (69,655
              )Notes
                  payable, net of current maturities
              
              $
              12,755
              
              $
              26,736
  *Note
        9*
 **Long-term
        Debt:**
  Set
        forth
        below is a detailed listing of the Company’s long-term debt.
  June
                  30, 2005
              
              December
                  31, 2004Borrowings
                  on credit facility
              
              $
              2,480,082
              
              $
              1,680,627Capital
                  lease obligations (see Note 4)
              
              
              428,218
              
              
              565,246Less:
                  current portion
              
              
              (1,216,072
              )
              
              (873,754
              )Total
                  long-term debt
              
              $
              1,692,228
              
              $
              1,372,119
  The
        Company obtained a leasing credit facility from GE Capital Corporation (“GE”) on
        June 25, 2004. The credit facility has a commitment term of three years,
        expiring on June 25, 2007. The Company accounts for each draw as funded
        indebtedness taking the form of a capital lease, with equitable ownership
        in the
        lasers remaining with the Company. GE retains title as a form of security
        over
        the lasers. The Company continues to depreciate the lasers over their remaining
        useful lives, as established when originally placed into service. Each draw
        against the credit facility has a self-amortizing repayment period of three
        years and is secured by specified lasers, which the Company has sold to GE
        and
        leased back for continued deployment in the field.
  Under
        the
        first tranche, GE made available $2,500,000 under the line. A draw under
        that
        tranche is set at an interest rate based on 522 basis points above the
        three-year Treasury note rate. Each such draw is discounted by 7.75%; the
        first
        monthly payment is applied directly to principal. With each draw, the Company
        agreed to issue warrants to purchase shares of the Company’s common stock equal
        to 5% of the draw. The number of warrants is determined by dividing 5% of
        the
        draw by the average closing price of the Company’s common stock for the ten days
        preceding the date of the draw. The warrants have a five-year term from the
        date
        of each issuance and bear an exercise price set at 10% over the average closing
        price for the ten days preceding the date of the draw.
  20
 As
        of
        June 30, 2005, the Company had made three draws against the first tranche
        of the
        line.
  Draw
                  1
              
              Draw
                  2
              
              Draw
                  3Date
                  of draw
              6/30/04
              
              9/24/04
              
              12/30/04Amount
                  of draw
              $1,536,950
              
              $320,000
              
              $153,172Stated
                  interest rate
              8.47%
              
              7.97%
              
              8.43%Effective
                  interest rate
              17.79%
              
              17.14%
              
              17.61%Number
                  of warrants issued
              23,903
              
              6,656
              
              3,102Exercise
                  price of warrants per share
              $3.54
              
              $2.64
              
              $2.73Fair
                  value of warrants
              $62,032
              
              $13,489
              
              $5,946
  The
        fair
        value of the warrants granted is estimated using the Black-Scholes
        option-pricing model with the following weighted average assumptions applicable
        to the warrants granted:
  Warrants
                    granted under:Draw
                    1
                
                Draw
                    2
                
                Draw
                    3Risk-free
                    interest rate
                3.81%
                
                3.70%
                
                3.64%Volatility
                99.9%
                
                100%
                
                99.3%Expected
                    dividend yield
                0%
                
                0%
                
                0%Expected
                    option life
                5
                    years
                
                5
                    years
                
                5
                    years
  For
        reporting purposes, the carrying value of the liability is reduced at the
        time
        of each draw by the value ascribed to the warrants. This reduction will be
        amortized at the effective interest rate to interest expense over the term
        of
        the draw.
  The
        Company obtained from GE a second tranche under the leasing credit facility
        for
        $5,000,000 on June 28, 2005. The Company accounts for draws under this second
        tranche in the same manner as under the first tranche except that: (i) the
        stated interest rate is set at 477 basis points above the three-year Treasury
        note rate; (ii) each draw is discounted by 3.50%; and (iii) with each draw,
        the
        Company has agreed to issue warrants to purchase shares of the Company’s common
        stock equal to 3% of the draw. The number of warrants is determined by dividing
        3% of the draw by the average closing price of the Company’s common stock for
        the ten days preceding the date of the draw. The warrants have a five-year
        term
        from the date of each issuance and bear an exercise price set at 10% over
        the
        average closing price for the ten days preceding the date of the draw. As
        of
        June 30, 2005, the Company had made its first draw against the second tranche
        of
        the line (which is Draw 4 under the line), as follows:
  Draw
                    4Date
                    of draw
                6/28/05Amount
                    of draw
                $1,113,326Stated
                    interest rate
                8.42%Effective
                    interest rate
                12.63%Number
                    of warrants issued
                14,714Exercise
                    price of warrants per share
                $2.50Fair
                    value of warrants
                $23,352
  The
        fair
        value of the warrants granted under Draw 4 is estimated using the Black-Scholes
        option-pricing model with the following weighted average assumptions applicable
        to the warrants granted:
  Warrants
                  granted under:Draw
                  4Risk-free
                  interest rate
              4.17%Volatility
              94.6%Expected
                  dividend yield
              0%Expected
                  option life
              5
                  years
  21
 The
        carrying value of the liability under Draw 4 is, for reporting purposes,
        reduced
        at the time of the draw by the value ascribed to the warrants. This reduction
        will be amortized at the effective interest rate to interest expense over
        the
        term of Draw 4.
  Concurrent
        with the SLT acquisition, the Company assumed a $3,000,000 credit facility
        from
        a bank. The credit facility had a commitment term of four years, which expired
        May 31, 2004, permitted deferment of principal payments until the end of
        the
        commitment term, and was secured by SLT’s business assets, including
        collateralization (until May 13, 2003) of $2,000,000 of SLT’s cash and cash
        equivalents and short-term investments. The bank agreed to allow the Company
        to
        apply the cash collateral to a paydown of the facility in 2003. The credit
        facility had an interest rate of the 30-day LIBOR plus 2.25%.
  The
        obligations under capital leases are at fixed interest rates and are
        collateralized by the related property and equipment (see Note 4).
  *Note
        10*
 **Warrant
        Exercises:**
  In
        the
        six months ended June 30, 2005, the Company received $147,060 from the exercise
        of 73,530 warrants. The warrants were issued in connection with a private
        placement of securities in June 2002 and bore an exercise price of
        $2.00.
  In
        the
        six months ended June 30, 2004, 976,263 warrants on the common stock of the
        Company were exercised, resulting in an increase to the Company’s shares
        outstanding as of the end of the period by the same amount. The Company received
        $1,720,842 in cash proceeds from the exercises. Of these proceeds, $803,450
        was
        from the exercise of warrants that were exercisable at $1.77 per share and
        were
        set to expire on March 31, 2004.
  *Note
        11*
 **Business
        Segment and Geographic Data:**
  Segments
        are distinguished primarily by the organization of the Company’s management
        structure. Industry considerations and the business model used to generate
        revenues also influence distinctions. The Domestic XTRAC segment is a
        procedure-based business model used to date only in the United States with
        revenues derived from procedures performed by dermatologists. The International
        XTRAC segment presently generates revenues from the sale of equipment to
        dermatologists through a network of distributors outside the United States.
        The
        Surgical Services segment generates revenues by providing fee-based procedures
        generally using the Company’s mobile surgical laser equipment delivered and
        operated by a technician at hospitals and surgery centers in the United States.
        The Surgical Products segment generates revenues by selling laser products
        and
        disposables to hospitals and surgery centers on both a domestic and
        international basis. The Skin Care (ProCyte) segment generates revenues by
        selling skincare products and by royalties on licenses for the patented copper
        peptide compound. For the three and six months ended June 30, 2005
        and
        2004, the Company did not have material net revenues from any individual
        customer.
  Unallocated
        operating expenses include costs incurred for administrative and accounting
        staff, general liability and other insurance, professional fees and other
        similar corporate expenses. Unallocated assets include cash, prepaid expenses
        and deposits. Goodwill that is carried at $2,944,423 at June 30, 2005
        and
        December 31, 2004 has been allocated to the domestic and international XTRAC
        segments based upon its fair value as of the date of the Acculase buy-out
        in the
        amounts of $2,061,096 and $883,327, respectively. Goodwill of $13,430,961
        at
        June 30, 2005 from the ProCyte acquisition has been allocated to the Skin
        Care
        (ProCyte) segment.
  22
 
 Three
                  Months Ended June 30, 2005DOMESTIC
                XTRAC
              
              INTERN’L
                XTRAC
              
              SURGICALSERVICES
              
              SURGICALPRODUCTS
                AND
                  OTHER
              
              SKIN
                  CARE
              
              TOTALRevenues
              
              $
              889,171
              
              $
              314,183
              
              $
              2,003,380
              
              $
              1,326,225
              
              $
              3,522,214
              
              $
              8,055,173Costs
                  of revenues
              
              
              689,990
              
              
              234,155
              
              
              1,502,219
              
              
              736,490
              
              
              1,042,462
              
              
              4,205,316Gross
                  profit
              
              
              199,181
              
              
              80,028
              
              
              501,161
              
              
              589,735
              
              
              2,479,752
              
              
              3,849,857*Gross
                  profit %*
              
              
              *22.4*%**
              
              
              *25.5%*
              
              
              *25.0%*
              
              
              *44.5%*
              
              
              *70.4%*
              
              
              *47.8%*Allocated
                  Operating expenses:Selling,
                  general and administrative
              
              
              674,934
              
              
              92,594
              
              
              330,183
              
              
              145,243
              
              
              1,594,667
              
              
              2,837,621Engineering
                  and product development
              
              
              -
              
              
              -
              
              
              -
              
              
              174,023
              
              
              45,527
              
              
              219,550Unallocated
                  Operating expenses
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,485,085674,934
              
              
              92,594
              
              
              330,183
              
              
              319,266
              
              
              1,640,194
              
              
              4,542,256Income
                  (loss) from operations
              
              
              (475,753
              )
              
              (12,566
              )
              
              170,978
              
              
              270,469
              
              
              839,558
              
              
              (692,399
              )Other
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              88,667Interest
                  expense, net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (56,919
              )Net
                  income (loss)
              
              
              ($475,753
              )
              
              ($12,566
              )
              $
              170,978
              
              $
              270,469
              
              $
              839,558
              
              
              ($660,651
              )
 
 
 Three
                  Months Ended June 30, 2004DOMESTIC
                XTRAC
              
              INTERN’L
                XTRAC
              
              SURGICAL
                  SERVICES
              
              SURGICAL
                  PRODUCTS
                AND
                  OTHER
              
              SKIN
                  CARE
              
              TOTALRevenues
              
              $
              719,263
              
              $
              454,770
              
              $
              1,933,936
              
              $
              1,215,165
              
              
              -
              
              $
              4,323,134Costs
                  of revenues
              
              
              540,841
              
              
              322,380
              
              
              1,121,165
              
              
              646,983
              
              
              -
              
              
              2,631,369Gross
                  profit
              
              
              178,422
              
              
              132,390
              
              
              812,771
              
              
              568,182
              
              
              -
              
              
              1,691,765*Gross
                  profit %*
              
              
              *24.8%*
              
              
              *29.1%*
              
              
              *42.0%*
              
              
              *46.8%*
              
              
              *-%*
              
              
              *39.1%*Allocated
                  Operating expenses:Selling,
                  general and administrative
              
              
              460,135
              
              
              122,945
              
              
              341,076
              
              
              178,460
              
              
              -
              
              
              1,102,616Engineering
                  and product development
              
              
              180,426
              
              
              112,949
              
              
              -
              
              
              187,868
              
              
              -
              
              
              481,243Unallocated
                  Operating expenses
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,303,837640,561
              
              
              235,894
              
              
              341,076
              
              
              366,328
              
              
              -
              
              
              2,887,696Income
                  (loss) from operations
              
              
              (462,139
              )
              
              (103,504
              )
              
              471,695
              
              
              201,854
              
              
              -
              
              
              (1,195,931
              )Interest
                  expense, net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (11,236
              )Net
                  income (loss)
              
              
              ($462,139
              )
              
              ($103,504
              )
              $
              471,695
              
              $
              201,854
              
              
              -
              
              
              ($1,207,167
              )
  23
  
 Six
                  Months Ended June 30, 2005DOMESTIC
                XTRAC
              
              INTERN’L
                XTRAC
              
              SURGICAL
                  SERVICES
              
              SURGICAL
                  PRODUCTS
                AND
                  OTHER
              
              SKIN
                  CARE
              
              TOTALRevenues
              
              $
              1,523,189
              
              $
              602,385
              
              $
              4,074,030
              
              $
              2,693,386
              
              $
              4,145,515
              
              $
              13,038,505Costs
                  of revenues
              
              
              1,093,171
              
              
              393,750
              
              
              2,817,679
              
              
              1,264,665
              
              
              1,268,419
              
              
              6,837,684Gross
                  profit
              
              
              430,018
              
              
              208,635
              
              
              1,256,351
              
              
              1,428,721
              
              
              2,877,096
              
              
              6,200,821*Gross
                  profit %*
              
              
              *28.2%*
              
              
              *34.6%*
              
              
              *30.8%*
              
              
              *53.0%*
              
              
              *69.4%*
              
              
              *47.6%*Allocated
                  Operating expenses:Selling,
                  general and administrative
              
              
              1,205,922
              
              
              153,627
              
              
              621,299
              
              
              303,396
              
              
              1,951,469
              
              
              4,235,713Engineering
                  and product development
              
              
              -
              
              
              -
              
              
              -
              
              
              347,197
              
              
              59,324
              
              
              406,521Unallocated
                  Operating expenses
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              3,307,9691,205,922
              
              
              153,627
              
              
              621,299
              
              
              650,593
              
              
              2,010,793
              
              
              7,950,203Income
                  (loss) from operations
              
              
              (775,904
              )
              
              55,008
              
              
              635,052
              
              
              778,128
              
              
              866,303
              
              
              (1,749,382
              )Other
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              88,667Interest
                  expense, net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (128,048
              )Net
                  income (loss)
              
              
              ($775,904
              )
              $
              55,008
              
              $
              635,052
              
              $
              778,128
              
              $
              866,303
              
              
              ($1,788,763
              )
 
 
 Six
                  Months Ended June 30, 2004DOMESTIC
                XTRAC
              
              INTERN’L
                XTRAC
              
              SURGICAL
                  SERVICES
              
              SURGICAL
                  PRODUCTS
                AND
                  OTHER
              
              SKIN
                  CARE
              
              TOTALRevenues
              
              $
              1,269,864
              
              $
              1,035,514
              
              $
              3,573,540
              
              $
              2,469,446
              
              
              -
              
              $
              8,348,364Costs
                  of revenues
              
              
              1,027,127
              
              
              692,760
              
              
              2,260,075
              
              
              1,145,473
              
              
              -
              
              
              5,125,435Gross
                  profit
              
              
              242,737
              
              
              342,754
              
              
              1,313,465
              
              
              1,323,973
              
              
              -
              
              
              3,222,929*Gross
                  profit %*
              
              
              *19.1%*
              
              
              *33.1%*
              
              
              *36.8%*
              
              
              *53.6%*
              
              
              *-%*
              
              
              *38.6%*Allocated
                  Operating expenses:Selling,
                  general and administrative
              
              
              960,875
              
              
              251,046
              
              
              667,067
              
              
              302,914
              
              
              -
              
              
              2,181,902Engineering
                  and product development
              
              
              343,220
              
              
              214,860
              
              
              -
              
              
              339,113
              
              
              -
              
              
              897,193Unallocated
                  Operating expenses
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              2,694,9751,304,095
              
              
              465,906
              
              
              667,067
              
              
              642,027
              
              
              -
              
              
              5,774,070Income
                  (loss) from operations
              
              
              (1,061,358
              )
              
              (123,152
              )
              
              646,398
              
              
              681,946
              
              
              -
              
              
              (2,551,141
              )Interest
                  expense (income), net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (19,108
              )Net
                  income (loss)
              
              
              ($1,061,358
              )
              $
              (123,152
              )
              $
              646,398
              
              $
              681,946
              
              
              -
              
              
              ($2,570,249
              )
 
 
 June
                  30, 2005
              
              December
                  31, 2004Assets:Total
                  assets for reportable segments
              
              $
              42,166,914
              
              $
              18,547,510Other
                  unallocated assets
              
              
              6,783,491
              
              
              4,414,416Consolidated
                  total
              
              $
              48,950,405
              
              $
              22,961,926
  24
 For
        the
        three and six months ended June 30, 2005 and 2004, there were no material
        net revenues attributed to an individual foreign country. Net revenues by
        geographic area were as follows:
  For
                  the Three Months EndedJune 30,
              
              For
                  the Six Months Ended
                June
                  30,2005
              
              2004
              
              2005
              
              2004Domestic
              
              $
              7,217,589
              
              $
              3,687,091
              
              $
              11,683,255
              
              $
              6,956,838Foreign
              
              
              837,584
              
              
              636,043
              
              
              1,355,250
              
              
              1,391,526$
              8,055,173
              
              $
              4,323,134
              
              $
              13,038,505
              
              $
              8,348,364
  *Note
        12*
 **Significant
        Alliances/Agreements:**
  On
        March
        31, 2005, the Company entered into a Sales and Marketing Agreement with
        GlobalMed (Asia) Technologies Co., Inc. Under this Agreement, GlobalMed will
        act
        as master distributor in the Pacific Rim for the Company’s XTRAC excimer laser,
        including the UltraTM excimer laser, as well as for the Company’s LaserPro® diode
        surgical laser system. The Company’s diode laser will be marketed for, among
        other things, use in a gynecological procedure pioneered by David Matlock,
        MD. The
        Company will engage Sanders Ergas, who is a principal of GlobalMed, and Dr.
        Matlock as consultants to explore further business opportunities for the
        Company. In connection with this engagement, each consultant will receive
        25,000
        options in the common stock of the Company, issued at fair market
        value.
  On
        July
        27, 2005, the Company entered a Marketing Agreement with KDS Marketing, Inc.
        Using money invested by each party, KDS will research market opportunities
        for
        the Company’s diode laser and related delivery systems; based on such research,
        KDS will market the diode laser, subject to guidelines established by the
        Company. The hub of the marketing program will be a website which physicians
        may
        access for information about the laser and which they may use to purchase
        the
        laser. KDS’s return on its investment will be based primarily on commissions
        earned on diode lasers that are sold under the program.
  25
  **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, 2004 and that
        are
        discussed with respect to risks relevant to the acquisition and business
        operations of ProCyte Corporation under the section entitled “Risks Factors” in
        Pre-Effective Amendment No. 1 to our Registration Statement No. 333-121864
        on
        Form S-4 filed with the Commission on January 21, 2005.*
  *The
        following discussion and analysis should be read in conjunction with the
        consolidated financial statements and related notes included elsewhere in
        this
        Report.*
  **Introduction,
        Outlook and Overview of Business Operations**
  We
        presently view our business as comprised of five business segments:
  ·
              Domestic
                  XTRAC,
  ·
              International
                  XTRAC,
  ·
              Surgical
                  Services,
  ·
              Surgical
                  Products, and
  ·
              Skin
                  Care (ProCyte).
  These
        segments are distinguished primarily by the organization of our management
        structure. Industry considerations and the business model used to generate
        revenues also influence distinctions.
  ·
              The
                  Domestic XTRAC segment is a procedure-based business model used
                  only in
                  the United States with revenues derived from procedures performed
                  by
                  dermatologists.
  ·
              The
                  International XTRAC segment presently generates revenues from the
                  sale of
                  equipment to dermatologists through a network of distributors outside
                  the
                  United States.
  ·
              The
                  Surgical Services segment generates revenues by providing fee-based
                  procedures generally using our mobile surgical laser equipment
                  delivered
                  and operated by a technician at hospitals and surgery centers in
                  the
                  United States.
  ·
              The
                  Surgical Products segment generates revenues by selling (but not
                  as
                  fee-per-procedure) laser products and disposables to hospitals
                  and surgery
                  centers on both a domestic and international basis.
  ·
              The
                  Skin Care (ProCyte) segment generates revenues by selling skincare
                  products, by selling bulk copper peptide compound, and by royalties
                  on our
                  licenses to both the domestic and international
                  markets.
  26
 **Domestic
        XTRAC**
  We
        are
        engaged in the development, manufacturing and marketing of our proprietary
        XTRAC® excimer laser and delivery systems and techniques directed toward the
        treatment of inflammatory skin disorders. **** In
        connection with our current business plan, the initial medical applications
        for
        our excimer laser technology are intended for the treatment of psoriasis,
        vitiligo, atopic dermatitis and leukoderma. In January 2000, we received
        approval of our 510(k) submission from the Food and Drug Administration,
        or FDA,
        relating to the use of our XTRAC system for the treatment of psoriasis. The
        510(k) establishes that our XTRAC system has been determined to be substantially
        equivalent to currently marketed devices for purposes of treating
        psoriasis.
  As
        part
        of our commercialization strategy in the United States, we are providing
        the
        XTRAC system to targeted dermatologists at no initial capital cost to them.
        We
        maintain ownership of the laser and earn revenue each time the physician
        treats
        a patient with the equipment. We believe that this strategy will create
        incentives for these dermatologists to adopt the XTRAC system and will increase
        market penetration. This strategy has and will continue to require us to
        identify and target appropriate dermatologists and to balance the planned
        roll-out of our XTRAC lasers during 2005 against uncertainties in acceptance
        by
        physicians, patients and health plans and the constraints on the number of
        XTRAC
        systems we are able to provide. Our marketing force has limited experience
        in
        dealing with such challenges. We also expect that we will face increasing
        competition as more private insurance plans adopt favorable policies for
        reimbursement for treatment of psoriasis.
  Starting
        in March 2003, we had introduced a more reliable version of the XTRAC and,
        based
        on the establishment of CPT codes by the AMA and reimbursement rates from
        the
        CMS, we began efforts to secure such favorable policies from private insurance
        plans. To persuade such plans to adopt favorable policies, we also commissioned
        a clinical and economic study of the use of the XTRAC laser as a second-step
        therapy for psoriasis. In December 2003, we deployed the findings of the
        study
        through a Data Compendium and mailed a copy of the Data Compendium to a number
        of medical insurance plans in our ongoing marketing efforts to secure favorable
        reimbursement policies.
  Our
        primary focus in 2004 was to secure from private health plans favorable
        reimbursement policies for treatment of psoriasis using the XTRAC® excimer
        laser. **** We
        therefore **** expanded
        our deployment of the study. From feedback we have received from the medical
        insurers to the Data Compendium, we anticipate that the study, coupled with
        our
        other marketing efforts, will continue to gain a place on the agenda of private
        plans as they consider their coverage and reimbursement policies. As of the
        date
        of this report, we have received approval from seven significant plans, Regence,
        Wellpoint, Aetna, Anthem, Cigna, United Healthcare and Independence Blue
        Cross
        of Pennsylvania, and we are under consideration by other plans. We cannot
        at
        this time provide assurance that other plans will adopt the favorable policies
        that we desire, and if they do not, what further requirements may be asked
        of
        us.
  In
        October 2004, we received from the FDA concurrence under a 510(k) to market
        the
        new XTRAC UltraTM, a smaller-size dermatology laser with increased functionality
        for inflammatory skin disorders. We introduced this product at the American
        Academy of Dermatology trade show in February 2005 in New Orleans. The increased
        functionality of the laser will allow shorter treatment times. While the
        Ultra
        comes within our core excimer intellectual property, the increased functionality
        of the laser is based on proprietary improvements, which extend its utility
        and
        broaden its clinical applications.
  In
        2005,
        we intend to continue our efforts on securing a wider base of private insurance
        coverage for psoriasis patients in the United States. In addition, we intend
        to
        expand our selling efforts for the XTRAC in combination with the increased
        dermatology sales force obtained in connection with the ProCyte merger. We
        have
        integrated and cross-trained the sales force and reorganized it to be able
        to
        increase the XTRAC installed base and the procedures performed in that base.
  **International
        XTRAC**
  Our
        revenues from International XTRAC sales provided needed working capital in
        2004
        and have continued to do so in 2005. Unlike the domestic market, we derive
        revenues from the XTRAC in the international market by selling the dermatology
        laser system to distributors, or in certain countries, directly to physicians.
        We have benefited in the international market from our clinical studies and
        the
        physician researchers involved in such studies. We have also benefited from
        the
        improved reliability and functionality of the XTRAC.  Due
        to
        the revenue model used overseas, the international XTRAC operations are more
        widely influenced by competition from similar laser technologies from other
        manufacturers and non-laser lamp alternatives for treating inflammatory skin
        disorders. Over time, competition has also served to reduce the prices we
        charge
        international distributors for our XTRAC products.
  27
 XTRAC
        laser sales vary from quarter to quarter. While the number of lasers sold
        was
        equal for the three months ended June 30, 2005 as in the same period for
        2004,
        the average price per laser system and parts was less in the 2005 period
        ($52,364) than in the 2004 period ($75,795). While the average price per
        laser
        system and parts was relatively equal for the six months ended June 30, 2005
        ($54,762) as in the same period for 2004 ($64,720), the number of lasers
        sold
        was less in the 2005 period than in the 2004 period. In addition, of the
        16
        lasers recognized in the six months ended June 30, 2004, four of those lasers
        had been shipped in 2003, but not recognized as sales due to the application
        of
        the SAB 104 Criteria.
  Due
        to
        the financial resources required,  we
        were
        reluctant in 2004 to implement an international XTRAC fee-per-use revenue
        model,
        similar to the domestic revenue model, but as reimbursement in the domestic
        market has become more widespread, we have recently begun to implement a
        pilot
        version of this model overseas.
  In
        2005,
        we also are exploring new product offerings to our international customers
        as a
        result of our recent acquisition of worldwide rights to certain proprietary
        light-based technology from Stern Laser. The technology may play a role in
        expanding our product offerings in the treatment of dermatological
        conditions . The
        technology based on these newly acquired rights could be introduced by the
        second half of 2005, depending on favorable technical progress and marketing
        analyses, but it is more likely that it will be not be introduced until
        2006.
  **Surgical
        Services**
  We
        experienced revenue growth in Surgical Services in 2004 and are experiencing
        continued growth in 2005, showing revenue increases of $69,444 and $500,490
        in
        the three and six months ended June 30, 2005 over the comparable periods
        in
        2004, respectively. Our plan in 2004 was to grow in a controlled fashion
        such
        that capital expenditures necessary for that growth would come from these
        operations. Although we intend to increase our investment in this business
        segment for 2005, we will continue to be very deliberate and controlled with
        capital expenditures to grow this business. In this manner, we intend to
        conserve our cash resources for the XTRAC business segments.
  We
        have
        growing, but still limited marketing experience in expanding our surgical
        services business. The preponderance of this business is in the southeastern
        part of the United States. New procedures and geographies, together with
        new
        customers and different business habits and networks, will likely pose different
        challenges than the ones we have encountered in the past. There can be no
        assurance that our experience will be sufficient to overcome such challenges.
  **Surgical
        Products**
  Although
        the surgical product revenues increased by $111,060 and $223,940 in the three
        and six months ended June 30, 2005, respectively, when compared to the same
        periods in 2004, we expect that sales of surgical laser systems will vary
        from
        quarter to quarter, and we also expect that the surgical laser systems and
        the
        related disposable base may erode over time, as hospitals continue to seek
        outsourcing solutions instead of purchasing lasers and related disposables
        for
        their operating rooms. We have continued to seek an offset to this erosion
        through expanding our surgical services segment. With the introduction of
        the
        CO2 and diode surgical lasers in the second quarter of 2004, we hope to offset
        any decline in laser sales and have a further offset to the erosion of
        disposables revenues.
  In
        the
        second quarter 2004, we received from the FDA concurrence under a 510(k)
        to
        market two new surgical lasers: the LaserPro® Diode Laser System and the
        LaserPro® CO2 Laser System. Each system has been designed for rugged use in our
        Surgical Services business. Each system will also complement the Surgical
        Products business in assisting us in finding end-user buyers domestically
        and
        overseas. We are also actively exploring opportunities for supplying the
        lasers
        on an OEM basis or under manufacturing-marketing collaborations.
  28
 Furthermore,
        in July 2004, we entered into a development agreement with AzurTec, Inc.
        AzurTec
        is a development-stage company based outside Philadelphia. AzurTec’s product in
        development is a device that seeks to rapidly and accurately detect the presence
        of cancerous cells in excised tissue. AzurTec’s target customers are generally
        the dermatologist and particularly the MOHS surgeon. We intend to assist
        in the
        development of FDA-compliant prototypes for AzurTec’s product. We have collected
        payments under the agreement aggregating $240,000 through June 30, 2005.
        In the
        three and six months ended June 30, 2005, we recognized $0 and $124,000,
        respectively, in other revenue under this agreement, but we have suspended
        recognition of $89,751 in revenues due to the uncertainty of collection.
        Continuing development of this project requires additional investment by
        AzurTec. We will resume development once this investment has been satisfied.
  **Skin
        Care (ProCyte)**
  On
        March
        18, 2005, we completed the acquisition of ProCyte Corporation. We acquired
        three
        revenue streams: one from the sale of skin health, hair care and wound care
        products; the second from the sale of copper peptide compound in bulk; and
        the
        third from royalties on license for the patented copper peptide
        compound.
  The
        operating results of ProCyte for the six months ended June 30, 2005 include
        activity from ProCyte from March 19, 2005 through June 30, 2005. Under purchase
        accounting rules, however, the operating results of ProCyte for prior periods
        are not included in our Statement of Operations for such prior periods. Proforma
        operating results are disclosed as part of Note 2, *Acquisitions* to the
        financial statements.
  We
        accounted for our acquisition of ProCyte as a purchase under generally accepted
        accounting principles. We allocated the purchase price based on the fair
        value
        of ProCyte's acquired assets and assumed liabilities. We consolidated the
        operating results of ProCyte with our own operating results, beginning as
        of the
        date the parties completed the merger. The allocation of the purchase price
        was
        as follows: $8,712,823 of acquired assets, net of assumed liabilities,
        $5,400,000 of other acquired intangibles and $13,430,961 of goodwill. As
        of June
        30, 2005, goodwill increased by $436,034 for acquisition expenses incurred
        in
        connection with severances for departing employees, appraisal costs on the
        assets acquired, investment banking expenses, relocation of a ProCyte executive,
        final legal expenses, and cancellation of certain insurance policies.
  ProCyte
        has been in operation since 1986. ProCyte develops, manufactures and markets
        products for skin health, hair care and wound care. Many of the Company’s
        products incorporate its patented copper peptide technologies.
  ProCyte’s
        focus has been to bring unique products, primarily based upon patented
        technologies such as GHK and AHK copper peptide technologies, to selected
        markets. ProCyte currently sells its products directly to the dermatology,
        plastic and cosmetic surgery and spa markets. ProCyte has also expanded the
        use
        of its novel copper peptide technologies into the mass retail market for
        skin
        and hair care through specifically targeted technology licensing and supply
        agreements.
  ProCyte’s
        products address the growing demand for skin health and hair care products,
        including products designed to address the effects aging has on the skin
        and
        hair and to enhance appearance. ProCyte’s products are formulated, branded for
        and targeted at specific markets. ProCyte’s initial products in this area
        addressed the dermatology, plastic and cosmetic surgery markets for use
        following various procedures. Anti-aging skin care products were added to
        expand
        into a comprehensive approach for incorporation into a patient’s skin care
        regimen. Certain of these products incorporate ProCyte’s patented technologies,
        while others, such as our advanced sunscreen products that reduce the effects
        of
        sun damage and aging on the skin, complement the product line.
  Our
        goals
        from this acquisition are summarized below:
  ·
              ProCyte's
                  presence in the skin health and hair care products market will
                  present a
                  growth opportunity for PhotoMedex to market its existing
                  products;
  29
  ·
              the
                  addition of ProCyte's sales and marketing personnel will enhance
                  our
                  ability to market the XTRAC excimer
                  laser;
  ·
              the
                  addition of ProCyte's operations and existing cash balances will
                  enhance
                  PhotoMedex's operating results and balance
                  sheet;
  ·
              the
                  combination of the senior management of ProCyte and PhotoMedex
                  will allow
                  complimentary skills to strengthen the overall management team;
                  and
  ·
              the
                  combined company may reap short-term cost savings and have the
                  opportunity
                  for additional longer-term cost efficiencies, thus providing additional
                  cash flow for operations.
  We
        have
        begun to realize each of these goals. After the acquisition, we had also
        targeted significant growth in revenues from ProCyte’s skin care products, but
        have yet to realize this expected growth while the sales forces are in the
        process of being integrated. As we gain a deeper understanding of the dynamics
        of the Skin Care segment, we expect that we will modify the amount of emphasis
        and expenditure that are presently devoted to some of the components of this
        segment.
  ProCyte
        has 48 employees, consisting of 20 in sales, 13 in marketing, eight in
        warehouse/research and development and seven in finance and administration.
        We
        are integrating the sales personnel from the Skin Care and the Domestic XTRAC
        segments under John F. Clifford, who will be our Executive Vice President
        for
        Dermatology. We are in the process of transferring ProCyte’s finance functions
        to Montgomeryville, Pennsylvania.
  **Critical
        Accounting Policies**
  The
        discussion and analysis of our financial condition and results of operations
        in
        this Report are based upon our Consolidated Financial Statements, which have
        been prepared in accordance with accounting principles generally accepted
        in the
        United States. The preparation of financial statements requires management
        to
        make estimates and judgments that affect the reported amounts of assets and
        liabilities, revenues and expenses and related disclosures at the date of
        the
        financial statements. On an on-going basis, we evaluate our estimates,
        including, but not limited to, those related to revenue recognition, accounts
        receivable, inventories, impairment of property and equipment and of intangibles
        and accruals for warranty claims. We use authoritative pronouncements,
        historical experience and other assumptions as the basis for making estimates.
        Actual results could differ from those estimates. Management believes that
        the
        following critical accounting policies affect our more significant judgments
        and
        estimates in the preparation of our Consolidated Financial Statements. These
        critical accounting policies and the significant estimates made in accordance
        with them have been discussed with our Audit Committee.
  ***Revenue
        Recognition***
  *XTRAC-Related
        Operations*
  We
        have
        two distribution channels for our phototherapy treatment equipment. We either
        (i) sell the laser through a distributor or directly to a physician, or (ii)
        place the laser in a physician’s office (at no charge to the physician) and
        charge the physician a fee for an agreed upon number of treatments. When
        we sell
        an XTRAC laser to a distributor or directly to a physician, revenue is
        recognized when the following four criteria under Staff Accounting Bulletin
        No.
        104 have been met: (i) the product has been shipped and we have no significant
        remaining obligations; (ii) persuasive evidence of an arrangement exists;
        (iii)
        the price to the buyer is fixed or determinable; and (iv) collection is probable
        (“SAB 104 Criteria”). At times, units are shipped, but revenue is not recognized
        until all of the criteria are met, and until that time, the unit is carried
        on
        our books as inventory. We ship most of our products FOB shipping point,
        although from time to time certain customers, for example, governmental
        customers, will insist on FOB destination. Among the factors we take into
        account in determining the proper time at which to recognize revenue are
        when
        title to the goods transfers and when the risk of loss transfers. Shipments
        to
        the distributors that do not fully satisfy the collection criteria are
        recognized when invoiced amounts are fully paid.
  30
 Under
        the
        terms of the distributor agreements, our distributors do not have the right
        to
        return any unit that they have purchased. However, we allow products to be
        returned by our distributors in redress of product defects or other claims.
  When
        we
        place a laser in a physician’s office, we recognize service revenue based on the
        number of patient treatments used by the physician. Treatments in the form
        of
        random laser-access codes that are sold to physicians, but not yet used,
        are
        deferred and recognized as a liability until the physician performs the
        treatment. Unused treatments remain our obligation inasmuch as the treatments
        can only be performed on equipment made by us. Once the treatments are delivered
        to a patient, this obligation has been satisfied.
  The
        calculation of unused treatments has historically been based upon an estimate
        that at the end of each accounting period, 15 unused treatments existed at
        each
        laser location. This was based upon the reasoning that we generally sell
        treatments in packages of 30 treatments. Fifteen treatments generally represents
        about one-half the purchase quantity by a physician or approximately a one-week
        supply for 6-8 patients. This policy had been used on a consistent basis.
        We
        believed this approach to have been reasonable and systematic given that:
        (a)
        physicians have little motivation to purchase quantities (which they are
        obligated to pay for irrespective of actual use and are unable to seek a
        refund
        for unused treatments) that will not be used in a relatively short period
        of
        time, particularly since in most cases they can obtain incremental treatments
        instantaneously over the phone; and (b) senior management regularly reviews
        purchase patterns by physicians to identify unusual buildup of unused treatment
        codes at a laser site. Moreover, we continually look at our estimation model
        based upon data received from our customers.
  In
        the
        fourth quarter of 2004, we updated the calculations for the estimated amount
        of
        unused treatments to reflect recent purchasing patterns by physicians near
        year-end. We have estimated the amount of unused treatments at December 31,
        2004
        to include all sales of treatment codes made within the last two weeks of
        the
        period. We believe this approach more closely approximates the actual amount
        of
        unused treatments that existed at that date than the previous approach. APB
        No.
        20 provides that accounting estimates change as new events occur, as more
        experience is acquired, or as additional information is obtained and that
        the
        effect of the change in accounting estimate should be accounted for in the
        current period and the future periods that it affects. We accounted for this
        change in the estimate of unused treatments in accordance with APB No. 20
        and
        SFAS No. 48. Accordingly, our change in accounting estimate was reported
        in
        revenues for the fourth quarter of 2004 and was not accounted for by restating
        amounts reported in financial statements of prior periods or by reporting
        proforma amounts for prior periods.
  We
        have
        continued this approach or method for estimating the amount of unused treatments
        at June 30, 2005. Due to this updated approach in estimates, XTRAC domestic
        revenues were increased by $60,000 for the three months ended June 30, 2005
        and
        decreased by $62,000 for the six months ended June 30, 2005, as compared
        to the
        prior method of estimation.
  In
        the
        first quarter of 2003, we implemented a program to support certain physicians
        in
        addressing treatments with the XTRAC system that may be denied reimbursement
        by
        private insurance carriers. We recognize service revenue from the sale of
        treatment codes to physicians participating in this program only if and to
        the
        extent the physician has been reimbursed for the treatments. For the three
        and
        six months ended June 30, 2005, we deferred additional revenues of $51,865
        and
        $32,715, respectively, under this program. At June 30, 2005, we had net deferred
        revenues of $146,506 under this program.
  Under
        this program, we may reimburse qualifying doctors for the cost of our fee
        but
        only if they are ultimately denied reimbursement after appeal of their claim
        with the insurance company. The key components of the program are as
        follows:
  ·
              The
                  physician practice must qualify to be in the program (i.e. it must
                  be in
                  an identified location where there is still an insufficiency of
                  insurance
                  companies reimbursing the
                  procedure);
  ·
              The
                  program only covers medically necessary treatments of psoriasis
                  as
                  determined by the treating
                  physician;
  31
  ·
              The
                  patient must have medical insurance and a claim for the treatment
                  must be
                  timely filed with the patient’s insurance company;
  ·
              Upon
                  denial by the insurance company (generally within 30 days of filing
                  the
                  claim), a standard insurance form called an EOB (“Explanation of
                  Benefits”) must be submitted to our in-house appeals group, who will then
                  prosecute the appeal. The appeal process can take 6-9
                  months;
  ·
              After
                  all appeals have been exhausted by us, if the claim remains unpaid,
                  then
                  the physician is entitled to receive credit for the treatment he
                  or she
                  purchased from us (our fee only) on behalf of the patient;
                  and
  ·
              Physicians
                  are still obligated to make timely payments for treatments purchased,
                  irrespective of whether reimbursement is paid or denied. Future
                  sale of
                  treatments to the physician can be denied if timely payments are
                  not made,
                  even if a patient’s appeal is still in
                  process.
  Historically,
        we estimated a contingent liability for potential refunds under this program
        by
        estimating when the physician was paid for the insurance claim. In the absence
        of a two-year historical trend and a large pool of homogeneous transactions
        to
        reliably predict the estimated claims for refund as required by Staff Accounting
        Bulletin Nos. 101 and 104, we previously deferred revenue recognition of
        100% of
        the current quarter revenues from the program to allow for the actual denied
        claims to be identified after processing with the insurance companies. After
        more than 106,000 treatments in the last 2 years and detailed record keeping
        of
        denied insurance claims and appeals processed, we have estimated that
        approximately 11% of a current quarter’s revenues under this program are subject
        to being credited or refunded to the physician.
  As
        of
        December 31, 2004, we updated our analysis to reflect this level of estimated
        refunds. This change from the past process of deferring 100% of the current
        quarter revenues from the program represents a change in accounting estimate,
        and we recorded this change in accordance with the relevant provisions of
        SFAS
        No. 48 and APB No. 20. These pronouncements state that the effect of a change
        in
        accounting estimate should be accounted for in the current period and the
        future
        periods that it affects. A change in accounting estimate should not be accounted
        for by restating amounts reported in financial statements of prior periods
        or by
        reporting proforma amounts for prior periods.  Due
        to
        this updated approach in estimates, XTRAC domestic revenues were increased
        by
        $154,000 and $56,000 for the three and six months ended June 30, 2005,
        respectively, as compared to the prior method of estimation.
  The
        net
        impact on revenue recognized for the XTRAC domestic segment as a result of
        the
        above two changes in accounting estimate was to increase revenues by
        approximately $214,000 for the three months ended June 30, 2005 and to decrease
        revenues by approximately $6,000 for the six months ended June 30,
        2005.
  In
        April
        2005, we entered a long-term lease for approximately 8,000 square feet in
        Carlsbad, California. We moved our excimer manufacturing facility into this
        space in July 2005, after tenant improvements had been completed. Our share
        of
        the cost of the improvements is $195,000, for which we have agreed to pay
        $2,880
        monthly over a self-amortizing five-year term. We have posted a stand-by
        letter
        of credit to secure this obligation. Monthly rent and operating expenses
        for our
        new space amounts to $8,880, whereas for our former space rent and operating
        expenses amounted to $11,900.
  *Surgical
        Products and Service Operations*
  Through
        our surgical businesses, we generate revenues primarily from two
        channels:
  ·
              Product
                  sales of laser systems, related maintenance service agreements,
                  recurring
                  laser delivery systems and laser accessories.
  ·
              Per-procedure
                  surgical services.
  We
        recognize revenues from surgical lasers and other product sales, including
        sales
        to distributors, when the SAB 104 Criteria have been met. At times, units
        are
        shipped but revenue is not recognized until all of the criteria are met,
        and
        until that time, the unit is carried on our books of as inventory. We ship
        most
        of our products FOB shipping point, although from time to time certain
        customers, for example governmental customers, will insist on FOB destination.
        Among the factors we take into account in determining the proper time at
        which
        to recognize revenue are when title to the goods transfers and when the risk
        of
        loss transfers.
  32
 For
        per-procedure surgical services, we recognize revenue upon the completion
        of the
        procedure. Revenue from maintenance service agreements is deferred and
        recognized on a straight-line basis over the term of the agreements. Revenue
        from billable services, including repair activity, is recognized when the
        service is provided.
  *Skin
        Care Operations*
  Through
        the acquisition of ProCyte, we generate revenues primarily through three
        channels:
  ·
              The
                  first is through product sales for skin health, hair care and wound
                  care.
  ·
              The
                  second is through sales of the copper peptide compound, primarily
                  to
                  Neutrogena.
  ·
              The
                  third is through royalties generated by our licenses, principally
                  to
                  Neutrogena.
  We
        recognize revenues on the products and copper peptide compound when they
        are
        shipped. We ship the products FOB shipping point. Royalty revenues are based
        upon sales generated by our licensees. We recognize royalty revenue at the
        applicable royalty rate applied to shipments reported by our
        licensee.
  ***Inventory*** **.** We
        account for inventory at the lower of cost (first-in, first-out) or market.
        Cost
        is determined to be the purchased cost for raw materials and the production
        cost
        (materials, labor and indirect manufacturing cost) for work-in-process and
        finished goods. Throughout the laser manufacturing process, the related
        production costs are recorded within inventory. Work-in-process is immaterial,
        given the typically short manufacturing cycle and therefore is disclosed
        in
        conjunction with raw materials. We perform full physical inventory counts
        for
        the XTRAC and cycle counts on the other inventory to maintain controls and
        obtain accurate data.
  Our
        XTRAC
        laser is either (i) sold to distributors or physicians directly or (ii) placed
        in a physician's office and remains our property. The cost to build a laser,
        whether for sale or for placement, is accumulated in inventory. When a laser
        is
        placed in a physician’s office, the cost is transferred from inventory to
“lasers in service” within property and equipment. At times, units are shipped
        to distributors, but revenue is not recognized until all of the SAB 104 criteria
        have been met, and until that time, the cost of the unit is carried on our
        books
        as finished goods inventory. Revenue is not recognized from these distributors
        until payment is either assured or paid in full.
  Reserves
        for slow moving and obsolete inventories are provided based on historical
        experience and product demand. Management evaluates the adequacy of these
        reserves periodically based on forecasted sales and market trend.
  ***Allowance
        for Doubtful Accounts*** **.** Accounts
        receivable are reduced by an allowance for amounts that may become uncollectible
        in the future. The majority of receivables related to phototherapy sales
        are due
        from various distributors located outside of the United States and from
        physicians located inside the United States. The majority of receivables
        related
        to surgical services, surgical products and skin care products are due from
        various customers and distributors located inside the United States. From
        time
        to time, our customers dispute the amounts due to us, and, in other cases,
        our
        customers experience financial difficulties and cannot pay on a timely basis.
        In
        certain instances, these factors ultimately result in uncollectible accounts.
        The determination of the appropriate reserve needed for uncollectible accounts
        involves significant judgment. A change in the factors used to evaluate
        collectibility could result in a significant change in the reserve needed.
        Such
        factors include changes in the financial condition of our customers as a
        result
        of industry, economic or customer-specific factors.
  ***Property
        and Equipment.*** As of
        June 30, 2005 and December 31, 2004, we had net property and equipment of
        $6,179,352 and $4,996,688, respectively. The most significant component of
        these
        amounts relates to the XTRAC lasers placed by us in physicians’ offices. We own
        the equipment and charge the physician on a per-treatment basis for use of
        the
        equipment. The realizability of the net carrying value of the lasers is
        predicated on increasing revenues from the physicians’ use of the lasers. We
        believe that such usage will increase in the future based on the approved
        CPT
        codes, recent approvals of private health plans of our XTRAC procedure and
        expected increases in performed, reimbursed procedures. XTRAC lasers-in-service
        are depreciated on a straight-line basis over the estimated useful life of
        three
        years. Surgical lasers-in-service are depreciated on a straight-line basis
        over
        an estimated useful life of seven years if new, five years or less if used
        equipment. The straight-line depreciation basis for lasers-in-service is
        reflective of the pattern of use. For other property and equipment, including
        property and equipment acquired from ProCyte, depreciation is calculated
        on a
        straight-line basis over the estimated useful lives of the assets, primarily
        three to seven years for computer hardware and software, furniture and fixtures,
        automobiles, and machinery and equipment. Leasehold improvements are amortized
        over the lesser of the useful lives or lease terms. Useful lives are determined
        based upon an estimate of either physical or economic obsolescence.
  33
 ***Intangibles*** **.** Our
        balance sheet includes goodwill and other intangible assets that affect the
        amount of future period amortization expense and possible impairment expense
        that we will incur. Management’s judgment regarding the existence of impairment
        indicators is based on various factors, including market conditions and
        operational performance of our business. As of June 30, 2005 and December
        31,
        2004, we had $22,877,332 and $3,873,857, respectively, of goodwill and other
        intangibles, accounting for 47% and 17% of our total assets at the respective
        dates. The determination of the value of such intangible assets requires
        management to make estimates and assumptions that affect our consolidated
        financial statements. We test our goodwill for impairment, at least annually.
        This test is usually conducted in December of each year in connection with
        the
        annual budgeting and forecast process. Also, on a quarterly basis, we evaluate
        whether events have occurred that would negatively impact the realizable
        value
        of our intangibles or goodwill.
  There
        has
        been no change to the carrying value of goodwill that is allocated to the
        XTRAC
        domestic segment and the XTRAC international segment in the amounts of
        $2,061,096 and $883,327, respectively. The allocation of goodwill to each
        segment was based upon the relative fair values of the two segments as of
        August
        2000, when we bought out the minority interest in Acculase and thus recognized
        the goodwill. In connection with the acquisition of ProCyte on March 18,
        2005,
        we acquired certain intangibles recorded at fair value as of the date of
        acquisition and allocated fully to the Skin Care (ProCyte) segment. Included
        in
        these acquired intangibles were the following:
  ProCyte
                  Neutrogena Agreement
              
              $
              2,400,000ProCyte
                  Customer Relationships
              
              
              1,700,000ProCyte
                  Tradename
              
              
              1,100,000ProCyte
                  Developed Technologies
              
              
              200,000Goodwill
              
              
              13,430,961Total
              
              $
              18,830,961
  ***Deferred
        Income Taxes.*** We
        have a
        deferred tax asset that is fully reserved by a valuation account. We have
        not
        recognized the deferred tax asset, given our historical losses and the lack
        of
        certainty of future taxable income. However, if and when we become profitable
        and can reasonably foresee continuing profitability, then under SFAS No.
        109 we
        may recognize some of the deferred tax asset. The recognized portion may
        go in
        some measure to a reduction of acquired goodwill and in some measure to benefit
        the statements of operations.
  ***Warranty
        Accruals*** **.** We
        establish a liability for warranty repairs based on estimated future claims
        for
        XTRAC systems and based on historical analysis of the cost of the repairs
        for
        surgical laser systems. However, future returns on defective laser systems
        and
        related warranty liability could differ significantly from estimates, and
        historical patterns, which would adversely affect our operating
        results.
  **Results
        of Operations**
  ***Revenues***
  We
        generated revenues of $8,055,173 during the three months ended June 30, 2005,
        of
        which $3,329,606 was from the surgical laser products and services operations
        and $3,522,214 was from the ProCyte operations. The balance of revenues was
        from
        phototherapy products and services, including $314,183 from XTRAC international
        sales of excimer systems and parts and $889,171 from domestic XTRAC procedures.
        We generated revenues of $4,323,134 during the three months ended June 30,
        2004,
        of which $3,149,101 was from the surgical product and services operations.
        The
        balance of revenues was from phototherapy products and services, including
        $454,770 from XTRAC international sales of excimer systems and parts and
        $719,263 from domestic XTRAC procedures.
  34
 We
        generated revenues of $13,038,505 during the six months ended June 30, 2005,
        of
        which $6,767,416 was from the surgical laser products and services operations
        and $4,145,515 was from the ProCyte operations. The balance of revenues was
        from
        phototherapy products and services, including $602,385 from XTRAC international
        sales of excimer systems and parts and $1,523,189 from domestic XTRAC
        procedures. We generated revenues of $8,348,364 during the six months ended
        June
        30, 2004, of which $6,042,986 was from the surgical product and services
        operations. The balance of revenues was from phototherapy products and services,
        including $1,035,514 from XTRAC international sales of excimer systems and
        parts
        and $1,269,864 from domestic XTRAC procedures.
  The
        following table illustrates revenues from our five business segments for
        the
        periods listed below:
  Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004XTRAC
                    Domestic Services
                
                $
                889,171
                
                $
                719,263
                
                $
                1,523,189
                
                $
                1,269,864XTRAC
                    International Products
                
                
                314,183
                
                
                454,770
                
                
                602,385
                
                
                1,035,514Total
                    XTRAC Revenues
                
                
                1,203,354
                
                
                1,174033
                
                
                2,125,574
                
                
                2,305,378Surgical
                    Services
                
                
                2,003,380
                
                
                1,933,936
                
                
                4,074,030
                
                
                3,573,540Surgical
                    Products
                
                
                1,326,225
                
                
                1,215,165
                
                
                2,693,386
                
                
                2,469,446Total
                    Surgical Products
                
                
                3,329,605
                
                
                3,149,101
                
                
                6,767,416
                
                
                6,042,986Skin
                    Care (ProCyte) Revenues
                
                
                3,522,214
                
                
                -
                
                
                4,145,515
                
                
                -Total
                    Revenues
                
                $
                8,055,173
                
                $
                4,323,134
                
                $
                13,038,505
                
                $
                8,348,364
  ***Domestic
        XTRAC Segment***
  Recognized
        revenue for the three months ended June 30, 2005 and 2004 for domestic XTRAC
        procedures was $889,171 and $719,263, respectively. Total XTRAC procedures
        for
        the same periods were approximately 15,500 and 12,700, respectively, of which
        1,692 and 810 procedures, respectively, were performed by customers without
        billing from us. These procedures were performed in connection with customer
        evaluations of the XTRAC laser, as well as for clinical research. Recognized
        revenue for the six months ended June 30, 2005 and 2004 for domestic XTRAC
        procedures was $1,523,189 and $1,269,864, respectively. Total XTRAC procedures
        for the same periods were approximately 27,900 and 23,400, respectively,
        of
        which 2,806 and 1,900 procedures, respectively, were performed by customers
        without billing from us. These procedures were performed in connection with
        customer evaluations of the XTRAC laser, as well as for clinical research.
        The
        increase in procedures in the periods ended June 30, 2005 was related to
        our
        continuing progress in securing favorable reimbursement policies from private
        insurance plans. Increases in these levels are dependent upon more widespread
        adoption of the CPT codes with comparable rates by private healthcare insurers
        and on instilling confidence in our physician partners that the XTRAC procedures
        will benefit their patients and be generally reimbursed to their
        practices.
  In
        the
        first quarter of 2003, we implemented a program to support certain physicians
        in
        addressing treatments with the XTRAC system that may be denied reimbursement
        by
        private insurance carriers. Applying the requirements of Staff Accounting
        Bulletin No. 104 to the program, we recognize service revenue during the
        program
        from the sale of XTRAC procedures, or equivalent treatment codes, to physicians
        participating in this program only, if and to the extent the physician has
        been
        reimbursed for the treatments. For the three and six months ended June 30,
        2005,
        we deferred net revenues of $51,865 (795 procedures) and $32,715 (497
        procedures), respectively, under this program. For the three and six months
        ended June 30, 2004, we deferred net revenues of $106,490, (1,541 procedures)
        and $249,761 (3,593 procedures), respectively, under this program.
  35
 In
        the
        first three and six months of 2005, recognized revenues for the domestic
        XTRAC
        segment increased by approximately $154,000 and $56,000, respectively, due
        to a
        change in accounting estimate for potential credits or refunds under the
        reimbursement program. In addition, in the first three and six months of
        2005,
        recognized revenues for the domestic XTRAC segment increased by approximately
        $60,000 and decreased by approximately $62,000, respectively, due to a change
        in
        accounting estimate for unused physician treatments that existed at June
        30,
        2005. The net effect of these two changes in accounting estimates, as detailed
        in the discussion of our revenue recognition policy, was to increase revenue
        for
        this segment for the three months ended June 30, 2005 by approximately $214,000
        and to decrease revenue for this segment for the six months ended June 30,
        2005
        by approximately $6,000.
  The
        following table illustrates the above analysis for the Domestic XTRAC segment
        for the periods reflected below:
  Three
                        Months Ended June 30,
                    
                    Six
                        Months Ended June 30,2005
                    
                    2004
                    
                    2005
                    
                    2004Recognized
                        revenue
                    
                    $
                    889,171
                    
                    $
                    719,263
                    
                    $
                    1,523,189
                    
                    $
                    1,269,864Change
                        in deferred program revenue
                    
                    
                    51,865
                    
                    
                    106,490
                    
                    
                    32,715
                    
                    
                    249,761Change
                        in deferred unused treatments
                    
                    
                    (39,700
                    )
                    
                    (4,800
                    )
                    
                    95,800
                    
                    
                    (23,350
                    )Net
                        billed revenue
                    
                    $
                    901,336
                    
                    $
                    820,953
                    
                    $
                    1,651,704
                    
                    $
                    1,496,275Procedure
                        volume total
                    
                    
                    15,503
                    
                    
                    12,688
                    
                    
                    27,921
                    
                    
                    23,425Less:
                        Non-billed procedures
                    
                    
                    1,692
                    
                    
                    810
                    
                    
                    2,806
                    
                    
                    1,900Net
                        billed procedures
                    
                    
                    13,811
                    
                    
                    11,878
                    
                    
                    25,115
                    
                    
                    21,525Avg.
                        price of treatments billed
                    
                    $
                    65.26
                    
                    $
                    69.12
                    
                    $
                    65.77
                    
                    $
                    69.51Change
                        in procedures with deferred program revenue, net
                    
                    
                    795
                    
                    
                    1,541
                    
                    
                    497
                    
                    
                    3,593Change
                        in procedures with deferred/(recognized) unused treatments,
                        net
                    
                    
                    (608
                    )
                    
                    (69
                    )
                    
                    1,457
                    
                    
                    (336
                    )
  The
        average price for a treatment can vary from quarter to quarter 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. As a percentage of
        the
        psoriasis patient population, there are fewer patients with moderate psoriasis
        than there are with mild psoriasis. Due to the amount of treatment time
        required, it has not been generally practical to use our therapy to treat
        severe
        psoriasis patients. However, this may change going forward, as our new product,
        the XTRAC Ultra, has shorter treatment times.
  ***International
        XTRAC Segment***
  International
        XTRAC sales of our excimer laser system and related parts were $314,183 for
        the
        three months ended June 30, 2005 compared to $454,770 for the three months
        ended
        June 30, 2004. We sold six laser systems in each of the three months ended
        June
        30, 2005 and 2004. International XTRAC sales of our excimer laser system
        and
        related parts were $602,385 for the six months ended June 30, 2005 compared
        to
        $1,035,514 for the six months ended June 30, 2004. We sold 11 laser systems
        in
        the six months ended June 30, 2005 compared to 16 laser systems in the six
        months ended June 30, 2004. The international XTRAC operations are more widely
        influenced by competition from similar laser technology from other manufacturers
        and from non-laser lamp alternatives for treating inflammatory skin disorders.
        Over time, competition has also served to reduce the prices we charge
        international distributors for our excimer products. In addition, of the
        16
        lasers recognized in the six months ended June 30, 2004, four of those lasers
        had been shipped in 2003, but not recognized as sales due to the application
        of
        the SAB 104 Criteria.
  36
  The
        following table illustrates the key changes in the International XTRAC segment
        for the periods reflected below:
  Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                314,183
                
                $
                454,770
                
                $
                602,385
                
                $
                1,035,514Laser
                    systems sold
                
                
                6
                
                
                6
                
                
                11
                
                
                16Average
                    revenue per laser
                
                $
                52,364
                
                $
                75,795
                
                $
                54,762
                
                $
                64,720
  ***Surgical
        Services Segment***
  In
        the
        three months ended June 30, 2005 and 2004, surgical services revenues were
        $2,003,380 and $1,933,936, respectively. In the six months ended June 30,
        2005
        and 2004, surgical services revenues were $4,074,030 and $3,573,540,
        respectively. Revenues in surgical services grew for the three and six months
        ended June 30, 2005 from 2004 by 3.6% and 14%, respectively, primarily due
        to
        growth in urological procedures performed with laser systems purchased from
        a
        third-party manufacturer. Such procedures included a charge for the use of
        the
        laser and the technician to operate it, as well as a charge for the third
        party’s proprietary fiber delivery system.
  The
        following table illustrates the key changes in the Surgical Services segment
        for
        the periods reflected below:
  Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                2,003,380
                
                $
                1,933,936
                
                $
                4,074,030
                
                $
                3,573,540Percent
                    increase
                
                
                3.6%
                
                
                
                
                
                14.0%Cost
                    of revenues
                
                
                1,502,219
                
                
                1,121,165
                
                
                2,817,679
                
                
                2,260,075Gross
                    profit
                
                $
                501,161
                
                $
                812,771
                
                $
                1,256,351
                
                $
                1,313,465Percent
                    of revenue
                
                
                25.0%
                
                
                42.0%
                
                
                30.8%
                
                
                36.8%
  ***Products
        Segment***
  For
        the
        three months ended June 30, 2005 and 2004, surgical products revenues were
        $1,326,225 and $1,215,165, respectively. Surgical products revenues include
        revenues derived from the sales of surgical laser systems together with sales
        of
        related laser fibers and laser disposables. Sales of disposables and fibers
        are
        more profitable than laser systems. However, sales of laser systems create
        recurring sales of laser fibers and laser disposables. We had 12 sales of
        surgical laser systems aggregating approximately $395,800 for the three months
        ended June 30, 2005 compared to six surgical laser system sales aggregating
        approximately $290,000 for the three months ended June 30, 2004.
  For
        the
        six months ended June 30, 2005 and 2004, surgical products revenues were
        $2,693,386 and $2,469,446, respectively. Surgical products revenues include
        revenues derived from the sales of surgical laser systems together with sales
        of
        related laser fibers and laser disposables. We had 17 sales of surgical laser
        systems aggregating approximately $650,000 for the six months ended June
        30,
        2005 compared to nine surgical laser system sales aggregating approximately
        $460,000 for the six months ended June 30, 2004.
  The
        decrease in average price per laser was due to the mix of lasers sold. Included
        in the laser sales for the three and six months ended June 30, 2005 were
        sales
        of eight and nine diode lasers, respectively, which have lower sales prices
        than
        the other types of lasers. There was only one sale of these lasers for the
        three
        and six months ended June 30, 2004, since they were introduced in June 2004.
        Disposable and fiber sales were relatively level between the comparable
        three-month periods. The change in the laser sale product mix contributed
        to a
        slightly higher margin in the three and six months ended June 30, 2005 compared
        to the same period in the prior year.
  37
 Sales
        of
        surgical laser systems vary quarter by quarter. There is significant competition
        for the types of surgical laser systems we offer for sale. Additionally,
        we have
        expected that the disposables base might continue to erode over time as
        hospitals continue to seek outsourcing solutions instead of purchasing lasers
        and related disposables for their operating rooms. We have continued to seek
        an
        offset to this erosion through expansion of our surgical services. Similarly,
        some of the decrease in laser system sales is related to the trend of hospitals
        to outsource their laser-assisted procedures to third parties, such as our
        surgical services business. With the introduction of our CO2 and diode surgical
        lasers in the second quarter of 2004, we hope to offset the decline in lasers
        and have a further offset to the erosion of disposables revenues.
  The
        following table illustrates the key changes in the Surgical Products segment
        for
        the periods reflected below:
  Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                1,326,225
                
                $
                1,215,165
                
                $
                2,693,386
                
                $
                2,469,446Percent
                    increase
                
                
                9.1%
                
                
                
                
                
                9.1%Laser
                    systems sold
                
                
                12
                
                
                6
                
                
                17
                
                
                9Laser
                    system revenues
                
                $
                395,800
                
                $
                289,644
                
                $
                649,695
                
                $
                460,302Average
                    revenue per laser
                
                $
                32,983
                
                $
                48,274
                
                $
                38,217
                
                $
                51,145
  ***Skin
        Care (ProCyte) Segment***
  For
        the
        three and six months ended June 30, 2005, ProCyte revenues were $3,522,214
        and
        $4,145,515. Since ProCyte was acquired on March 18, 2005, there are no
        corresponding revenues for the three and six months ended June 30, 2004.
        ProCyte
        revenues are generated from the sale of various skin and hair care products,
        from the sale of copper peptide compound and from royalties on licenses,
        mainly
        from Neutrogena.
  The
        following table illustrates the key changes in the Skin Care (ProCyte) segment
        for the periods reflected below:
  Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Product
                    sales
                
                $
                3,007,076
                
                $
                -
                
                $
                3,459,940
                
                $
                -Bulk
                    compound sales
                
                
                347,550
                
                
                -
                
                
                503,550
                
                
                -Royalties
                
                
                167,588
                
                
                
                
                
                182,025Total
                    ProCyte revenues
                
                $
                3,522,214
                
                $
                -
                
                
                4,145,515
                
                $
                -
  ***Cost
        of Revenues***
  Product
        cost of revenues for the three months ended June 30, 2005 were $1,990,996
        compared to $932,621 for the three months ended June 30, 2004. Included in
        the
        costs for the three months ended June 30, 2005 was $1,042,462 from the recently
        acquired skincare business. There were no corresponding costs in the three
        months ended June 30, 2004.
  Also
        included in these costs were $714,379 and $610,241, related to surgical product
        revenues, for the three months ended June 30, 2005 and 2004, respectively.
        The
        remaining product cost of revenues during these periods of $234,155 and
        $322,380, respectively, related primarily to the production costs of the
        XTRAC
        laser equipment sold outside of the United States.
  Product
        cost of revenues for the six months ended June 30, 2005 were $2,883,960 compared
        to $1,765,105 for the six months ended June 30, 2004. Included in these costs
        were $1,221,791 and $1,072,345, related to surgical product revenues, for
        the
        six months ended June 30, 2005 and 2004, respectively. Also included in the
        costs for the six months ended June 30, 2005 was $1,268,419 from the recently
        acquired skincare business. There were no corresponding costs in the three
        months ended June 30, 2004. The remaining product cost of revenues during
        these
        periods of $393,750 and $692,760, respectively, related primarily to the
        production costs of the XTRAC laser equipment sold outside of the United
        States.
  38
 The
        increase in the product cost of sales for the three and six months ended
        June
        30, 2005, excluding Skin Care product costs, were due to an increase in surgical
        product laser system sales, which have higher costs associated with them
        than
        other products. This increase was offset, in part, by a decrease in the
        unabsorbed manufacturing costs due to the manufacturing efficiencies of our
        newly designed excimer technology. The increase for the six months ended
        June
        30, 2005 was also offset, in part, by a decrease in product cost of sales
        for
        the international XTRAC revenues for the six months ended June 30, 2005.
  Services
        cost of revenues was $2,214,320 and $1,698,748 in the three months ended
        June
        30, 2005 and 2004, respectively. Included in these costs for the same periods
        were $1,524,330 and $1,157,907, respectively, related to surgical services
        revenues. The remaining services cost of revenues of $689,990 and $540,841
        during the periods ended June 30, 2005 and 2004, respectively, were primarily
        attributable to manufacturing, depreciation and field service costs on the
        lasers in service for XTRAC domestic revenues.
  Services
        cost of revenues was $3,953,724 and $3,360,330 in the six months ended June
        30,
        2005 and 2004, respectively. Included in these costs for the same periods
        were
        $2,860,553 and $2,333,203, respectively, related to surgical services revenues.
        The remaining services cost of revenues of $1,093,171 and $1,027,127 during
        the
        periods ended June 30, 2005 and 2004, respectively, were primarily attributable
        to manufacturing, depreciation and field service costs on the lasers in service
        for XTRAC domestic revenues.
  The
        increase in the service cost of sales related primarily to the surgical services
        cost of sales. The growth in revenues related primarily to the urological
        procedures performed with laser systems purchased from a third-party
        manufacturer, which carry a higher cost of sale due to the disposable fiber
        purchased from the third-party manufacturer. The increase was also due to
        the
        depreciation on additional lasers placed in served and to the incremental
        increases in salaries, benefits and travel expense for the increased field
        technicians.
  Certain
        allocable XTRAC manufacturing overhead costs are charged against the XTRAC
        service revenues. The manufacturing facility in Carlsbad, California is used
        exclusively for the production of the XTRAC lasers, which are placed in
        physicians’ offices domestically or sold internationally. The unabsorbed costs
        are allocated to the domestic XTRAC and the international XTRAC segments
        based
        on actual production of lasers for each segment. Included in these allocated
        manufacturing costs are unabsorbed labor and direct plant costs.
  ***Gross
        Margin Analysis***
  Gross
        margin increased to $3,849,857 during the three months ended June 30, 2005
        from
        $1,691,765 during the same period in 2004, or an increase of $2,158,092.
        Revenues increased during the three months ended June 30, 2005 to $8,055,173
        from $4,323,134 during the same period in 2004, or an increase of $3,732,039.
        The cost to produce those revenues increased during the three months ended
        June
        30, 2005 to $4,205,316 from $2,631,369 during the same period in 2004, or
        an
        increase of $1,573,947. Overall gross margin increased for the three months
        ended June 30, 2005 to 47.8% from 39.1% for the same period in 2004. The
        greatest single factor contributing to the increase in revenues, increase
        in
        cost of revenues, and increase in margin for the three months ended June
        30,
        2005 was the addition of the ProCyte business acquired on March 18,
        2005.
  Gross
        margin increased to $6,200,821 during the six months ended June 30, 2005
        from
        $3,222,929 during the same period in 2004, or an increase of $2,977,892.
        Revenues increased during the six months ended June 30, 2005 to $13,038,505
        from
        $8,348,364 during the same period in 2004, or an increase of $4,690,141.
        The
        cost to produce those revenues increased during the six months ended June
        30,
        2005 to $6,837,684 from $5,125,435 during the same period in 2004, or an
        increase of $1,712,249. Overall gross margin increased for the six months
        ended
        June 30, 2005 to 47.6% from 38.6% for the same period in 2004. The greatest
        single factor contributing to the increase in revenues, increase in cost
        of
        revenues, and increase in margin for the six months ended June 30, 2005 was
        the
        addition of the ProCyte business acquired on March 18, 2005.
  39
 The
        following table analyzes changes in our gross margin for the periods reflected
        below:
  **Company
                  Margin Analysis**
              
              Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Revenues
              
              $
              8,055,173
              
              $
              4,323,134
              
              $
              13,038,505
              
              $
              8,348,364Percent
                  increase
              
              
              86.3%
              
              
              
              
              
              56.2%Cost
                  of revenues
              
              
              4,205,316
              
              
              2,631,369
              
              
              6,837,684
              
              
              5,125,435Percent
                  increase
              
              
              59.8%
              
              
              
              
              
              33.4%Gross
                  profit
              
              $
              3,849,857
              
              $
              1,691,765
              
              $
              6,200,821
              
              $
              3,222,929Percent
                  of revenue
              
              
              47.8%
              
              
              39.1%
              
              
              47.6%
              
              
              38.6%
  The
        primary reasons for improvement in gross margin for the three and six months
        ended June 30, 2005, compared to the same periods in 2004 were as
        follows:
  ·
              We
                  acquired ProCyte on March 18, 2005, so only the activity after
                  that date
                  is recorded in our financial statements. There was no comparative
                  activity
                  recorded in our financial statements in
                  2004.
  ·
              We
                  increased treatment procedures and lowered field service costs
                  for the
                  XTRAC laser. The increase in procedure volume was a direct result
                  of
                  improving insurance reimbursement. The lower field service costs
                  were a
                  direct result of the planned quality upgrades in 2003 and 2004
                  for all
                  lasers-in-service.
  ·
              We
                  continued to increase the volume of sales to existing customers
                  and add
                  new customers to our existing base.
  ·
              We
                  benefited from the manufacturing efficiencies due to the newly
                  designed
                  XTRAC Ultra laser, which resulted in less unabsorbed manufacturing
                  costs.
  The
        following table analyzes our gross margin for our Domestic XTRAC segment
        for the
        periods reflected below:
  **XTRAC
                    Domestic Segment**
                
                Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                889,171
                
                $
                719,263
                
                $
                1,523,189
                
                $
                1,269,864Percent
                    increase
                
                
                23.6%
                
                
                
                
                
                19.9%Cost
                    of revenues
                
                
                689,990
                
                
                540,841
                
                
                1,093,171
                
                
                1,027,127Percent
                    increase
                
                
                27.6%
                
                
                
                
                
                6.4%Gross
                    profit
                
                $
                199,181
                
                $
                178,422
                
                $
                430,018
                
                $
                242,737Percent
                    of revenue
                
                
                22.4%
                
                
                24.8%
                
                
                28.2%
                
                
                19.1%
  We
        increased the gross margin for this segment for the three and six months
        ended
        June 30, 2005 over the comparable periods in 2004 by $20,759 and $187,281,
        primarily due to increases in revenues in the 2005 periods from the comparable
        2004 periods. The key factors were as follows:
  ·
              A
                  key driver in increased revenue in this segment is insurance
                  reimbursement. In 2004, we focused on private health insurance
                  plans
                  adopting the XTRAC laser therapy for psoriasis as an approved medical
                  procedure. Since January 2004, several major health insurance plans
                  instituted medical policies to pay claims for the XTRAC therapy,
                  including
                  Regence, Wellpoint, Aetna, Anthem, Cigna, United Healthcare and
                  Independence Blue Cross of
                  Pennsylvania.
  ·
              Procedure
                  volume increased 16% from 11,878 to 13,811 billed procedures in
                  the three
                  months ended June 30, 2005 compared to the same period in 2004.
                  Procedure
                  volume increased 17% from 21,525 to 25,115 billed procedures in
                  the six
                  months ended June 30, 2005 compared to the same period in
                  2004.
  40
  ·
              Price
                  per procedure was not a meaningful component of the revenue change
                  between
                  the periods.
  ·
              In
                  the first quarter of 2003, we implemented a limited program to
                  support
                  certain physicians in addressing treatments with the XTRAC system
                  that may
                  be denied reimbursement by private insurance carriers. We recognize
                  service revenue under the program for the sale of treatment codes
                  to
                  physicians participating in this program only if and to the extent
                  the
                  physician has been reimbursed for the treatments. For the three
                  months
                  ended June 30, 2005, we deferred net revenues of $51,865, under
                  the
                  program compared to $106,490 for the three months ended June 30,
                  2004. For
                  the six months ended June 30, 2005, we deferred net revenues of
                  $32,715,
                  under the program compared to $249,761 for the three months ended
                  June 30,
                  2004.
  ·
              The
                  cost of revenues increased by $149,149 and $66,044 for the three
                  and six
                  months ended June 30, 2005. An incremental procedure at a physician’s
                  office does not increase our operating costs associated with that
                  laser.
                  Even though there was a reduction in unabsorbed manufacturing costs,
                  the
                  domestic segment was allocated a higher percentage of those costs
                  (76% in
                  2005 vs. 62% in 2004) due to increased production for the domestic
                  segment.
  The
        following table analyzes our gross margin for our International XTRAC segment
        for the periods reflected below:
  **XTRAC
                    International Segment**
                
                Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                314,183
                
                $
                454,770
                
                $
                602,385
                
                $
                1,035,514Percent
                    decrease
                
                
                (30.9%)
                
                
                
                
                
                (41.8%)Cost
                    of revenues
                
                
                234,155
                
                
                322,380
                
                
                393,750
                
                
                692,760Percent
                    decrease
                
                
                (27.4%)
                
                
                
                
                
                (43.2%)Gross
                    profit
                
                $
                80,028
                
                $
                132,390
                
                $
                208,635
                
                $
                342,754Percent
                    of revenue
                
                
                25.5%
                
                
                29.1%
                
                
                34.6%
                
                
                33.1%
  The
        gross
        profit for the three and six months ended June 30, 2005 decreased by $52,362
        and
        $134,119, respectively, from the comparable period in 2004. The key factors
        in
        this business segment were as follows:
  ·
              We
                  sold six XTRAC laser systems during the three months ended June
                  30, 2005
                  and six lasers in the comparable period in 2004. We sold 11 XTRAC
                  laser
                  systems during the six months ended June 30, 2005 and 16 lasers
                  in the
                  comparable period in 2004. In addition, four lasers for a total
                  of
                  $310,000, which had been shipped in 2003, were not recognized as
                  sales
                  until the first quarter of 2004 due to the application of the SAB
                  104
                  Criteria.
  ·
              The
                  International XTRAC operations are more widely influenced by competition
                  from similar laser technology from other manufacturers and from
                  non-laser
                  lamp alternatives for treating inflammatory skin disorders. Over
                  time,
                  competition has also served to reduce the prices we charge international
                  distributors for our excimer products. After adjusting the revenue
                  for the
                  three months ended June 30, 2005 for parts sales of approximately
                  $54,000,
                  the average price for lasers sold during this period was approximately
                  $43,400. After adjusting the revenue for the three months ended
                  June 30,
                  2004 for part sales of approximately $67,000, the average price
                  for lasers
                  sold during this period was approximately $64,600. After adjusting
                  the
                  revenue for the six months ended June 30, 2005 for parts sales
                  of
                  approximately $90,000, the average price for lasers sold during
                  this
                  period was approximately $46,500. After adjusting the revenue for
                  the six
                  months ended June 30, 2004 for part sales of approximately $77,000,
                  the
                  average price for lasers sold during this period was approximately
                  $59,900.
  41
  ·
              Although
                  the individual standard cost per unit was relatively level between
                  the
                  comparable periods, increased production levels served to reduce
                  the
                  average cost per laser produced. The difference between standard
                  manufacturing costs and total cost of goods sold represents unabsorbed
                  overhead costs charged to cost of goods sold in the period of the
                  sale.
  The
        following table analyzes our gross margin for our Surgical Services segment
        for
        the periods reflected below:
  **Surgical
                    Services Segment**
                
                Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                2,003,380
                
                $
                1,933,936
                
                $
                4,074,030
                
                $
                3,573,540Percent
                    increase
                
                
                3.6%
                
                
                
                
                
                14.0%Cost
                    of revenues
                
                
                1,502,219
                
                
                1,121,165
                
                
                2,817,679
                
                
                2,260,075Percent
                    increase
                
                
                34.0%
                
                
                
                
                
                24.7%Gross
                    profit
                
                $
                501,161
                
                $
                812,771
                
                $
                1,256,351
                
                $
                1,313,465Percent
                    of revenue
                
                
                25.0%
                
                
                42.0%
                
                
                30.8%
                
                
                36.8%
  Gross
        margin in the Surgical Services segment for the three and six months ended
        June
        30, 2005 decreased by $311,610 and $57,114, respectively, from the comparable
        period in 2004. The key factors impacting gross margin for the Surgical Services
        business were as follows:
  ·
              A
                  significant part of the revenue was in urological procedures performed
                  with laser systems we purchased from a third party manufacturer.
                  Such
                  procedures included a charge for the use of the laser and the technician
                  to operate it, as well as a charge for the third party’s proprietary fiber
                  delivery system. This procedure has a lower gross margin than other
                  types
                  of procedures. As the volume increases, the overall gross margin
                  percent
                  decreases.
  ·
              We
                  have closed three geographic areas of business due to unacceptable
                  operating profit from these territories. Although by closing these
                  territories we will save costs and improve profitability over time,
                  the
                  costs saved for the three months ended June 30, 2005 have not kept
                  pace
                  with the revenues lost by closing these territories during the
                  three
                  months ended June 30, 2005.
  The
        following table analyzes our gross margin for our Surgical Products segment
        for
        the periods reflected below:
  **Surgical
                    Products Segment**
                
                Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004
                
                2005
                
                2004Revenues
                
                $
                1,326,225
                
                $
                1,215,165
                
                $
                2,693,386
                
                $
                2,469,446Percent
                    increase
                
                
                9.1%
                
                
                
                
                
                9.1%Cost
                    of revenues
                
                
                736,490
                
                
                646,983
                
                
                1,264,665
                
                
                1,145,473Percent
                    increase
                
                
                13.8%
                
                
                
                
                
                10.4%Gross
                    profit
                
                $
                589,735
                
                $
                568,182
                
                $
                1,428,721
                
                $
                1,323,973Percent
                    of revenue
                
                
                44.5%
                
                
                46.8%
                
                
                53.0%
                
                
                53.6%
  Gross
        margin for the Surgical Products segment in the three and six months ended
        June
        30, 2005 compared to the same periods in 2004 increased by $21,553 and $104,748,
        respectively. The key factors in this business segment were as
        follows:
  ·
              This
                  segment includes product sales of surgical laser systems and laser
                  disposables. Disposables are more profitable than laser systems.
                  However,
                  the sale of laser systems generates the subsequent recurring sale
                  of laser
                  disposables.
  42
  ·
              Revenues
                  for the three months ended June 30, 2005 increased by $111,060
                  from the
                  three months ended June 30, 2004. Cost of revenues increased by
                  $89,507
                  between the same periods. There were seven more laser system sales
                  in the
                  three months ended June 30, 2005 than in the comparable period
                  of 2004.
                  Revenues for the six months ended June 30, 2005 increased by $223,940
                  from
                  the six months ended June 30, 2004. Cost of revenues increased
                  by $119,192
                  between the same periods. There were nine more laser system sales
                  in the
                  six months ended June 30, 2005 than in the comparable period of
                  2004.
                  However, the lasers sold in the 2004 period were at higher prices
                  than in
                  the comparable period in 2005. This revenue increase was partly
                  offset by
                  a decrease in disposables between the
                  periods.
  ·
              Disposables,
                  which have a higher gross margin than lasers, represented a lower
                  percentage of revenue in the three and six months June 30, 2005
                  compared
                  to the same periods in 2004.
  The
        following table analyzes our gross margin for our SkinCare (ProCyte) segment
        for
        the periods reflected below:
  **Skin
                    Care (ProCyte) Segment**
                
                Three
                    Months Ended June 30,
                
                Six
                    Months Ended June 30,2005
                
                2004Product
                    revenues
                
                $
                3,007,076
                
                $
                -
                
                $
                3,459,940
                
                $
                -Bulk
                    compound revenues
                
                
                347,550
                
                
                -
                
                
                503,550
                
                
                -Royalties
                
                
                167,558
                
                
                -
                
                
                182,025
                
                
                -Total
                    revenues
                
                
                3,522,214
                
                
                -
                
                
                4,145,515
                
                
                -Product
                    cost of revenues
                
                
                804,759
                
                
                -
                
                
                901,440
                
                
                -Bulk
                    compound cost of revenues
                
                
                237,703
                
                
                -
                
                
                366,979
                
                
                -Total
                    cost of revenues
                
                
                1,042,462
                
                
                -
                
                
                1,268,419
                
                
                -Gross
                    profit
                
                $
                2,479,752
                
                $
                -
                
                $
                2,877,096
                
                $
                -Percent
                    of revenue
                
                
                70.4
                %
                
                
                
                
                69.4
                %
  The
        key
        factors in this business segment were as follows:
  ·
              Copper
                  Peptide bulk compound is sold at a substantially lower gross margin
                  than
                  skin care products, while revenues generated from licensees have
                  no
                  significant costs associated with this revenue
                  stream.
  ·
              Product
                  revenues come primarily from U.S. customers, which tend to be
                  dermatologists.
  ·
              Lesser
                  product revenues come from sales directed to consumers at spas
                  and from
                  marketing directly to the consumer (e.g.
                  infomercials).
  ***Selling,
        General and Administrative Expenses***
  For
        the
        three months ended June 30, 2005, selling, general and administrative expenses
        were $4,322,706 compared to $2,406,453 for the three months ended June 30,
        2004,
        or an increase of 79.6%. $1,594,667 of these costs were ProCyte-related selling,
        general and administrative expenses. The remaining increase was related to
        an
        increase in domestic sales force of approximately $140,000 in salaries, benefits
        and travel expenses; an increase in legal and accounting expenses of $150,000;
        and an increase in corporate insurance of $76,000. Offsetting some of the
        increases for the three months ended June 30, 2005, were the settlement of
        past
        audit fee claims for $130,000 less than the accrued amounts together with
        the
        settlement of past royalty claims for $32,000 less than the accrued
        amount.
  For
        the
        six months ended June 30, 2005, selling, general and administrative expenses
        were $7,543,682 compared to $4,876,877 for the six months ended June 30,
        2004,
        or an increase of 54.7%. $1,951,469 of these costs were ProCyte-related selling,
        general and administrative expenses. The remaining increase was related to
        an
        increase in domestic sales force of approximately $196,000 in salaries, benefits
        and travel expenses; an increase in legal and accounting expenses of $390,000
        and an increase in corporate insurance of $89,000. Offsetting some of the
        increases for the six months ended June 30, 2005, were the settlement of
        past
        audit fee claims for $130,000 less than the accrued amounts together with
        the
        settlement of past royalty claims for $32,000 less than the accrued
        amount.
  43
 ***Engineering
        and Product Development***
  Engineering
        and product development expenses for the three months ended June 30, 2005
        decreased to $219,550 from $481,243 for the three months ended June 30, 2004.
        Engineering and product development expenses for the six months ended June
        30,
        2005 decreased to $406,521 from $897,193 for the six months ended June 30,
        2004.
        The decreases are mainly due to the fact that in 2004, our California
        engineering resources dedicated much of their time to product development
        for
        the Ultra, the new smaller and faster excimer laser. For the three and six
        months ended June 30, 2005, the development of the Ultra was completed, thus
        allowing these California resources to devote more time to
        manufacturing.
  ***Other
        Income***
  Other
        income for the three and six months ended June 30, 2005 was $88,667. This
        was
        due to a non-monetary exchange of assets during June 2005 of two depreciable
        engineering development prototypes in exchange for four product units to
        be held
        for sale. There was no other income in the comparable periods in 2004.
  ***Interest
        Expense, Net***
  Net
        interest expense for the three months ended June 30, 2005 increased to $56,919,
        as compared to $11,236 for the three months ended June 30, 2004. Net interest
        expense for the six months ended June 30, 2005 increased to $128,048, as
        compared to $19,108 for the six months ended June 30, 2004. The increase
        in net
        interest expense was direct result of the draws on the lease line of credit
        during the second, third and fourth quarters of 2004.
  ***Net
        Loss***
  The
        aforementioned factors resulted in a net loss of $660,651 during the three
        months ended June 30, 2005, as compared to a net loss of $1,207,167 during
        the
        three months ended June 30, 2004, a decrease of 45.3%. The aforementioned
        factors resulted in a net loss of $1,788,763 during the six months ended
        June
        30, 2005, as compared to a net loss of $2,570,249 during the six months ended
        June 30, 2004, a decrease of 30.4%. These decreases were primarily the result
        of
        the increase in revenues and resulting gross margin, mainly related to the
        acquisition of ProCyte.
  Income
        taxes were immaterial, given our current period losses and operating loss
        carryforwards.
  ***Liquidity
        and Capital Resources***
  We
        have
        historically financed our operations through the use of working capital provided
        from equity financing and from lines of credit.
  On
        March
        18, 2005, we acquired ProCyte. The skincare products and royalties provided
        by
        ProCyte increased revenues for the three and six months ended June 30, 2005
        and
        we expect the combined companies to cause revenues to increase throughout
        2005
        as compared to 2004. We expect to save costs from the consolidation of the
        administrative and marketing infrastructure of the combined company.
        Additionally, once the consolidated infrastructure is in place, we expect
        our
        revenues to grow without proportionately increasing the rate of growth in
        our
        fixed costs. The established revenues from ProCyte will help to absorb the
        costs
        of the infrastructure of the combined company.
  At
        June
        30, 2005, the ratio of current assets to current liabilities was 2.67 to
        1.00
        compared to 1.88 to 1.00 at December 31, 2004. As of June 30, 2005, we had
        $12,256,531 of working capital compared to $6,119,248 as of December 31,
        2004.
        Cash and cash equivalents were $5,720,117 as March 31, 2005, as compared
        to
        $3,997,017 as of December 31, 2004. These increases were mainly due to the
        acquisition of ProCyte. $206,802 of cash was classified as restricted as
        of June
        30, 2005 compared to $112,200 at December 31, 2004.
  44
 We
        believe that our existing cash balance together with our other existing
        financial resources, including access to lease financing for capital
        expenditures, and revenues from sales, distribution, licensing and manufacturing
        relationships, will be sufficient to meet our operating and capital requirements
        beyond the second quarter of 2006. The 2005 operating plan reflects anticipated
        growth from an increase in per-treatment fee revenues for use of the XTRAC
        system based on wider insurance coverage in the United States and costs savings
        from the integration of ProCyte and PhotoMedex. In addition, the 2005 operating
        plan calls for increased revenues and profits from our newly acquired business,
        ProCyte, and the continued growth of its skin care products. We cannot give
        assurances that our business plan will not encounter obstacles which may
        require
        us to obtain additional equity or debt financing to meet our working capital
        requirements or capital expenditure needs. Similarly, if our growth outstrips
        the business plan, we may require additional equity or debt financing. There
        can
        be no assurance that additional financing, if needed, will be available when
        required or, if available, will be on terms satisfactory to us.
  We
        obtained a leasing credit facility from GE Capital Corporation (“GE”) on June
        25, 2004. The credit facility has a commitment term of three years, expiring
        on
        June 25, 2007. We account for each draw as funded indebtedness taking the
        form
        of a capital lease, with equitable ownership in the lasers remaining with
        us. GE
        retains title as a form of security over the lasers. We continue to depreciate
        the lasers over their remaining useful lives, as established when originally
        placed into service. Each draw against the credit facility has a self-amortizing
        repayment period of three years and is secured by specified lasers, which
        we
        have sold to GE and leased back for continued deployment in the field.
  Under
        the
        first tranche, GE made available $2,500,000 under the line. A draw under
        that
        tranche is set at an interest rate based on 522 basis points above the
        three-year Treasury note rate. Each such draw is discounted by 7.75%; the
        first
        monthly payment is applied directly to principal. With each draw, we agreed
        to
        issue warrants to purchase shares of our common stock equal to 5% of the
        draw.
        The number of warrants is determined by dividing 5% of the draw by the average
        closing price of our common stock for the ten days preceding the date of
        the
        draw. The warrants have a five-year term from the date of each issuance and
        bear
        an exercise price set at 10% over the average closing price for the ten days
        preceding the date of the draw.
  As
        of
        June 30, 2005, we have made three draws against the first tranche of the
        line.
  Draw
                  1
              
              Draw
                  2
              
              Draw
                  3Date
                  of draw
              6/30/04
              
              9/24/04
              
              12/30/04Amount
                  of draw
              $1,536,950
              
              $320,000
              
              $153,172Stated
                  interest rate
              8.47%
              
              7.97%
              
              8.43%Effective
                  interest rate
              17.79%
              
              17.14%
              
              17.61%Number
                  of warrants issued
              23,903
              
              6,656
              
              3,102Exercise
                  price of warrants per share
              $3.54
              
              $2.64
              
              $2.73Fair
                  value of warrants
              $62,032
              
              $13,489
              
              $5,946
  The
        fair
        value of the warrants granted is estimated using the Black-Scholes
        option-pricing model with the following weighted average assumptions applicable
        to the warrants granted:
  Warrants
                    granted under:Draw
                    1
                
                Draw
                    2
                
                Draw
                    3Risk-free
                    interest rate
                3.81%
                
                3.70%
                
                3.64%Volatility
                99.9%
                
                100%
                
                99.3%Expected
                    dividend yield
                0%
                
                0%
                
                0%Expected
                    option life
                5
                    years
                
                5
                    years
                
                5
                    years
  For
        reporting purposes, the carrying value of the liability is reduced at the
        time
        of each draw by the value ascribed to the warrants. This reduction will be
        amortized at the effective interest rate to interest expense over the term
        of
        the draw.
  45
 We
        obtained from GE a second tranche under the leasing credit facility for
        $5,000,000 on June 28, 2005. We account for draws under this second tranche
        in
        the same manner as under the first tranche except that: (i) the stated interest
        rate is set at 477 basis points above the three-year Treasury note rate;
        (ii)
        each draw is discounted by 3.50%; and (iii) with each draw, we have agreed
        to
        issue warrants to purchase shares of our common stock equal to 3% of the
        draw.
        The number of warrants is determined by dividing 3% of the draw by the average
        closing price of our common stock for the ten days preceding the date of
        the
        draw. The warrants have a five-year term from the date of each issuance and
        bear
        an exercise price set at 10% over the average closing price for the ten days
        preceding the date of the draw. As of June 30, 2005, we have made our first
        draw
        against the second tranche of the line (which is Draw 4 under the line),
        as
        follows:
  Draw
                  4Date
                  of draw
              
              
              6/28/05Amount
                  of draw
              
              $
              1,113,326Stated
                  interest rate
              
              
              8.42%Effective
                  interest rate
              
              
              12.63%Number
                  of warrants issued
              
              
              14,714Exercise
                  price of warrants per share
              
              $
              2.50Fair
                  value of warrants
              
              $
              23,352
  Concurrent
        with the SLT acquisition, we assumed a $3,000,000 credit facility from a
        bank.
        The credit facility had a commitment term of four years, which expired May
        31,
        2004, permitted deferment of principal payments until the end of the commitment
        term, and was secured by SLT’s business assets, including collateralization
        (until May 13, 2003) of $2,000,000 of SLT’s cash and cash equivalents and
        short-term investments. The bank agreed to allow us to apply the cash collateral
        to a paydown of the facility in 2003. The credit facility had an interest
        rate
        of the 30-day LIBOR plus 2.25%.
  Operating
        cash flow for the six months ended June 30, 2005 compared to the six months
        ended June 30, 2004 decreased mostly due to the payment of various previously
        recorded costs associated with the acquisition and increases in inventory
        for
        the new products. Net cash used in operating activities was $2,634,022 for
        six
        months ended June 30, 2005, compared to $1,801,093 for the same period in
        2004.
  Net
        cash
        provided by investing activities was $3,789,271 for the six months ended
        June
        30, 2005 compared to cash used of $901,307 for the six months ended June
        30,
        2004. During the six months ended June 30, 2005, we received cash of $5,578,416,
        net of acquisition costs, in the ProCyte acquisition. During the six months
        ended June 30, 2005 and 2004, we utilized $1,727,800 and $845,780, respectively,
        for production of our lasers in service.
  Net
        cash
        provided by financing activities was $473,249 for the six months ended June
        30,
        2005 compared to $1,756,907 for the six months ended June 30, 2004. In the
        six
        months ended June 30, 2005 we made payments of $455,460 on certain notes
        payable
        and capital lease obligations and $161,737 in registration costs. These payments
        were offset, in part, by the advances under the lease line of credit, net
        of
        payments, of $739,055 and by receipts of $445,995 from the exercise of common
        stock options. In the six months ended June 30, 2004, we received $1,780,804
        from the exercise of common stock options and warrants and a net increase
        of
        $369,680 from the lapse of the bank line of credit and the initiation of
        the
        leasing line of credit from GE. These cash receipts were offset by $404,776
        for
        the payment of certain notes payable and capital lease obligations.
  Our
        ability to expand our business operations is currently dependent in significant
        part on financing from external sources. There can be no assurance that changes
        in our manufacturing and marketing, engineering and product development plans
        or
        other changes affecting our operating expenses and business strategy will
        not
        require financing from external sources before we will be able to develop
        profitable operations. There can be no assurance that additional capital
        will be
        available on terms favorable to us, if at all. To the extent that additional
        capital is raised through the sale of additional equity or convertible debt
        securities, the issuance of such securities could result in additional dilution
        to our stockholders. Moreover, our cash requirements may vary materially
        from
        those now planned because of results of marketing, product testing, changes
        in
        the focus and direction of our marketing programs, competitive and technological
        advances, the level of working capital required to sustain our planned growth,
        litigation, operating results, including the extent and duration of operating
        losses, and other factors. In the event that we experience the need for
        additional capital, and are not able to generate capital from financing sources
        or from future operations, management may be required to modify, suspend
        or
        discontinue our business plan.
  46
 ***Commitments
        and Contingencies***
  During
        the three and six months ended June 30, 2005, there were no items that
        significantly impacted our commitments and contingencies as discussed in
        the
        notes to our 2004 annual financial statements included in our Annual Report
        on
        Form 10-K. In addition, 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.
  **ITEM
        3. Quantitative and Qualitative Disclosure about Market
        Risk**
  We
        are
        not currently exposed to market risks due to changes in interest rates and
        foreign currency rates and, therefore, we do not use derivative financial
        instruments to address treasury risk management issues in connection with
        changes in interest rates and foreign currency rates.
  **ITEM
        4. Controls and Procedures**
  ***Disclosure
        Controls***
  We
        maintain disclosure controls and procedures that are designed to ensure that
        information required to be disclosed in our reports filed or submitted pursuant
        to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is to
        be recorded, processed, summarized and reported within the time periods
        specified in the Securities and Exchange Commission’s rules and forms.
        Disclosure controls and procedures include, without limitations, controls
        and
        procedures designed to ensure that such information is accumulated and
        communicated to our management, including our Chief Executive Officer and
        Chief
        Financial Officer, as appropriate, to allow timely decisions regarding required
        disclosure.
  Our
        management, including the Chief Executive Officer and Chief Financial Officer,
        conducted an evaluation of the effectiveness of our disclosure controls and
        procedures as of June 30, 2005. Based upon the evaluation, the Chief Executive
        Officer and Chief Financial Officer concluded that our disclosure controls
        and
        procedures were effective as of June 30, 2005.
  ***Changes
        in Internal Controls***
  There
        has
        been no significant change in our internal controls over financial reporting
        that occurred during the second quarter 2005 that has materially affected,
        or is
        reasonably likely to materially affect, our internal control over financial
        reporting, except for the addition of ProCyte’s internal control structures.
        Management has processed ProCyte transactions through existing ProCyte internal
        control structures through the second quarter of this year, and will process
        such transactions through existing PhotoMedex internal control structures
        beginning with the third quarter of this year. Management will evaluate in
        2005
        the other ProCyte internal control structures and determine what structures
        should be adopted, conformed or eliminated.
  **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, 2004 for descriptions
        of our legal proceedings.
  In
        the
        action brought by the Company against Edwards Lifesciences Corporation and
        Baxter Healthcare Corporation in the Superior Court for Orange County,
        California, the defendants demurred to our amended complaint. The court heard
        the matter on July 29, 2005. The Court rejected the demurrer with respect
        to our
        counts under breach of good faith and fair dealing, money had and received,
        unjust enrichment and breach of constructive trust and sustained the demurrer
        with respect to our counts under breach of contract, beach of fiduciary duty
        and
        conversion. The defendants must now answer.
  In
        the
        matter brought against us by City National Bank of Florida, our former landlord
        in Orlando, Florida, our motion for summary judgment will be heard on August
        23,
        2005, and if the motion is not granted, the trial will commence promptly
        thereafter.
 47
 In
        the
        matter brought by us against RA Medical Systems, Inc. and Dean Stewart Irwin
        in
        the Superior Court for San Diego County, California, the California Supreme
        Court declined to hear our appeal from the award of attorneys’ fees to the
        defendants. On July 1, 2005, we satisfied the judgment of April 27, 2004,
        awarding costs and attorney’s fees, plus interest accrued to the date of
        satisfaction. Defendants have petitioned the Superior Court for further fees
        and
        costs incurred in collecting the judgment and defending against our appeal.
  In
        the
        matter brought for malicious prosecution by RA Medical Systems and Dean Irwin
        against PhotoMedex, Inc., et al., our appeal brief is to be filed with the
        appellate court on August 10, 2005.
  On
        May
        13, 2005, Vida Brown brought suit in the Circuit Court, 20 th Judicial
        Circuit for Charlotte County, Florida, for injuries sustained during a surgical
        laser procedure on her lower back. Ms. Brown has sued, among others, the
        surgeon, the anesthesiologist, the supplier of the laser delivery system
        (viz.
        Clarus Medical LLC) and the supplier of the holmium laser system and technician
        (viz. our former subsidiary, Surgical Innovations & Services, Inc.). The
        laser delivery system supplied by Clarus proved defective in the course of
        the
        procedure, notwithstanding which the surgeon continued to perform the procedure.
        The holmium laser provided by SIS did not perform deficiently. Ms. Brown
        has
        alleged that we failed to provide a properly trained operator for the holmium
        laser and that our operator failed to warn the surgeon of the danger of
        continuing to use a defective laser delivery system. Our insurance carrier
        is
        providing a defense for us in this matter.
  **ITEM
        2. Unregistered Sales of Equity Securities and Use of
        Proceeds**
  ***Recent
        Issuances of Unregistered Securities***
  In
        June
        2005, we issued 248,395 restricted shares of our common stock to Stern Laser
        srl
        in connection with the achievement of certain milestones under our Master
        Agreement with Stern Laser. The securities were issued pursuant to exemption
        from registration under Section 4(2) of the Securities Act.
  **ITEM
        3. Defaults Upon Senior Securities**
  Not
        applicable.
  **ITEM
        4. Submission of Matter to a Vote of Security Holders**
  None.
  **ITEM
        5. Other Information**
  On
        March
        31, 2005, we entered into a Sales and Marketing Agreement with GlobalMed
        (Asia)
        Technologies Co., Inc. Under this Agreement, GlobalMed will act as master
        distributor in the Pacific Rim for our XTRAC excimer laser, including the
        UltraTM
        excimer laser, as well as for our LaserPro® diode surgical laser system. The
        diode laser will be marketed for, among other things, use in a gynecological
        procedure pioneered by David Matlock, MD. We will
        engage Sanders Ergas, who is a principal of GlobalMed, and Dr. Matlock as
        our
        consultants to explore further business opportunities. In connection with
        this
        engagement, each consultant will receive 25,000 options in our common stock,
        issued at fair value.
  On
        July
        27, 2005, we entered a Marketing Agreement with KDS Marketing, Inc. Using
        money
        invested by each party, KDS will research market opportunities for our LaserPro®
        diode laser and related delivery systems; based on such research, KDS will
        market the diode laser, subject to guidelines which we establish. The hub
        of the
        marketing program will be a website which physicians may access for information
        about the laser and which they may use to purchase the laser. KDS’s return on
        its investment will be based primarily on commissions earned on diode lasers
        that are sold under the program.
  We
        have
        adopted a Code of Ethics on Interactions with Health Care Professionals,
        to take
        effect on July 1, 2005. We also have adopted a related Comprehensive Compliance
        Program. The Code and Program can be viewed on our website at
        www.photomedex.com, under Corporate Governance.
  48
  **ITEM
        6. Exhibits**
  10.42
              
              Standard
                  Industrial/Commercial Multi-Tenant Lease - Net, dated March 17,
                  2005, by
                  and between PhotoMedex, Inc. and Wells Fargo Bank, N.A. as Trustee
                  for the
                  Hutton Trust.10.43
              
              Code
                  of Ethics on Interactions with Health Care Professionals, adopted
                  June 30,
                  2005, and related Comprehensive Compliance Program.31.1
              
              Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer31.2
              
              Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.1
              
              Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                Section 906 of the Sarbanes-Oxley Act of 200232.2
              
              Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                Section 906 of the Sarbanes-Oxley Act of 2002
 ——————
  **SIGNATURES**
 
 Pursuant
        to the requirements of the Securities Act of 1934, the registrant has duly
        caused this Report to be signed on its behalf by the undersigned, thereunto
        duly
        authorized.
 
 PHOTOMEDEX,
                  INC.Date: August
                  9, 2005
                By:
                /s/ Jeffrey
                  F. O’DonnellJeffrey
                  F. O’DonnellPresident
                  and Chief Executive Officer
 Date: August
                9, 2005
              By:
              /s/ Dennis
                M. McGrathDennis
                M. McGrathChief
                  Financial Officer






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