**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 September 30, 2008**





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





147
      Keystone Drive, Montgomeryville, Pennsylvania 18936


(Address
      of principal executive offices, including zip code)





(215)
      619-3600


(Registrant's
      telephone number, including area code)




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


Yes ý No  ̈





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




Large accelerated filer o
            Accelerated filer oNon-accelerated filer o
            Smaller reporting company ý




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


Yes  ̈ No ý





The
      number of shares outstanding of the issuer's Common Stock as of November 7,
      2008
      was 63,032,207 shares.




1




PHOTOMEDEX,
      INC.




INDEX
      TO
      FORM 10-Q




Part
                  I. Financial Information:
              PAGEITEM
                  1.
              Financial
                  Statements:a.
              Consolidated
                  Balance Sheets, September 30, 2008 (unaudited) andDecember
                  31, 2007
              3b.
              Consolidated
                  Statements of Operations for the three monthsended
                  September 30, 2008 and 2007 (unaudited)
              4c.
              Consolidated
                  Statements of Operations for the nine monthsended
                  September 30, 2008 and 2007 (unaudited)
              5c.
              Consolidated
                  Statement of Stockholders’ Equity for the nine monthsended
                  September 30, 2008 (unaudited)
              6d.
              Consolidated
                  Statements of Cash Flows for the nine monthsended
                  September 30, 2008 and 2007 (unaudited)
              7e.
              Notes
                  to Consolidated Financial Statements (unaudited)
              8ITEM
                  2.
              Management’s
                  Discussion and Analysis of Financial Conditionand
                  Results of Operations
              25ITEM
                  3.
              Quantitative
                  and Qualitative Disclosure about Market Risk
              40ITEM
                  4.
              Controls
                  and Procedures
              41Part
                  II. Other Information:ITEM
                  1.
              Legal
                  Proceedings
              41ITEM
                  1A.
              Risk
                Factors
              42ITEM
                  5.
              Other
                  Information
              42ITEM
                  6.
              Exhibits
              42Signatures
              43Certifications
              44




2




**PART
      I - Financial Information**




**ITEM
      1. Financial Statements**




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      BALANCE SHEETS




September
                30, 2008
            
            December
                31, 2007(Unaudited)
            
            ***ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            6,730,793
            
            $
            9,837,303Restricted
                cash
            
            
            78,000
            
            
            117,000Accounts
                receivable, net of allowance for doubtful accounts of $521,000 and
                $526,000, respectively
            
            
            6,721,994
            
            
            5,797,620Inventories,
                net
            
            
            7,185,888
            
            
            6,980,180Prepaid
                expenses and other current assets
            
            
            589,389
            
            
            508,384Current
                assets held for sale
            
            
            -
            
            
            1,910,802Total
                current assets
            
            
            21,306,064
            
            
            25,151,289Property
                and equipment, net
            
            
            9,893,399
            
            
            8,024,461Patents
                and licensed technologies, net
            
            
            1,307,756
            
            
            1,408,248Goodwill,
                net
            
            
            16,917,808
            
            
            16,917,808Other
                intangible assets, net
            
            
            1,910,125
            
            
            2,607,625Deferred
                costs on proposed acquisition
            
            
            1,762,501
            
            
            -Other
                assets
            
            
            431,709
            
            
            448,046Assets
                held for sale
            
            
            -
            
            
            2,129,226Total
                assets
            
            $
            53,529,362
            
            $
            56,686,703**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Current
                portion of notes payable
            
            $
            260,518
            
            $
            129,305Current
                portion of long-term debt
            
            
            4,997,958
            
            
            4,757,133Accounts
                payable
            
            
            4,869,361
            
            
            3,634,519Accrued
                compensation and related expenses
            
            
            1,480,317
            
            
            1,581,042Other
                accrued liabilities
            
            
            1,045,424
            
            
            674,374Deferred
                revenues
            
            
            1,140,948
            
            
            668,032Total
                current liabilities
            
            
            13,794,526
            
            
            11,444,405Long-term
                liabilities:Notes
                payable
            
            
            84,646
            
            
            106,215Long-term
                debt
            
            
            4,921,364
            
            
            5,602,653Total
                liabilities
            
            
            18,800,536
            
            
            17,153,273Commitments
                and ContingenciesStockholders’
                equity:Common
                stock, $.01 par value, 100,000,000 shares authorized; 63,032,207
                shares
                issued and outstanding
            
            
            630,322
            
            
            630,322Additional
                paid-in capital
            
            
            134,064,422
            
            
            132,932,357Accumulated
                deficit
            
            
            (99,965,918
            )
            
            (94,029,249
            )Total
                stockholders’ equity
            
            
            34,728,826
            
            
            39,533,430Total
                liabilities and stockholders’ equity
            
            $
            53,529,362
            
            $
            56,686,703





*
      The
      December 31, 2007 balance sheet was derived from the Company’s audited financial
      statements.




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




3




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS




(Unaudited)




For
                the Three Months Ended September 30,2008
            
            2007Revenues:Product
                sales
            
            $
            6,789,127
            
            $
            5,191,918Services
            
            
            2,077,999
            
            
            1,830,7538,797,126
            
            
            7,022,671Cost
                of revenues:Product
                cost of revenues
            
            
            2,828,986
            
            
            2,154,567Services
                cost of revenues
            
            
            1,240,670
            
            
            982,7864,069,656
            
            
            3,137,353Gross
                profit
            
            
            4,727,470
            
            
            3,885,318Operating
                expenses:Selling
                and marketing
            
            
            3,622,002
            
            
            2,987,356General
                and administrative
            
            
            2,587,099
            
            
            2,390,599Engineering
                and product development
            
            
            224,236
            
            
            202,1636,433,337
            
            
            5,580,118Loss
                from continuing operations before interest expense, net
            
            
            (1,705,867
            )
            
            (1,694,800
            )Interest
                expense, net
            
            
            (251,883
            )
            
            (141,562
            )Loss
                from continuing operations
            
            
            (1,957,750
            )
            
            (1,836,362
            )Discontinued
                operations:Income
                from discontinued operations, net of nil in taxes
            
            
            39,059
            
            
            183,390Decrease
                in estimated loss on sale of discontinued operations
            
            
            131,186
            
            
            -Net
                loss
            
            
            ($
                1,787,505
            )
            
            ($
                1,652,972
            )Basic
                and diluted net loss per share:Continuing
                operations
            
            
            ($0.03
            )
            
            ($0.03
            )Discontinued
                operations
            
            
            ($0.00
            )
            
            ($0.00
            )Basic
                and diluted net loss per share
            
            
            ($0.03
            )
            
            ($0.03
            )Shares
                used in computing basic and diluted net loss per share
            
            
            63,032,207
            
            
            62,956,881




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




4




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS




(Unaudited)




For
                the Nine Months Ended
              September
                30,2008
            
            
            2007Revenues:Product
                sales
            
            $
            20,549,712
            
            $
            16,464,329Services
            
            
            5,968,027
            
            
            5,077,30326,517,739
            
            
            21,541,632Cost
                of revenues:Product
                cost of revenues
            
            
            8,682,917
            
            
            6,703,251Services
                cost of revenues
            
            
            3,539,872
            
            
            2,979,53612,222,789
            
            
            9,682,787Gross
                profit
            
            
            14,294,950
            
            
            11,858,845Operating
                expenses:Selling
                and marketing
            
            
            11,490,801
            
            
            9,088,150General
                and administrative
            
            
            6,968,801
            
            
            7,435,744Engineering
                and product development
            
            
            881,268
            
            
            603,63619,340,870
            
            
            17,127,530Loss
                from continuing operations before interest expense, net
            
            
            (5,045,920
            )
            
            (5,268,685
            )Interest
                expense, net
            
            
            (761,020
            )
            
            (379,947
            )Loss
                from continuing operations
            
            
            (5,806,940
            )
            
            (5,648,632
            )Discontinued
                operations:Income
                from discontinued operations, net of nil in taxes
            
            
            284,929
            
            
            276,421Loss
                on sale of discontinued operations
            
            
            (414,658
            )
            
            -Net
                loss
            
            
            ($
                5,936,669
            )
            
            ($
                5,372,211
            )Basic
                and diluted net loss per share:Continuing
                operations
            
            
            ($0.09
            )
            
            ($0.09
            )Discontinued
                operations
            
            
            ($0.00
            )
            
            ($0.00
            )Basic
                and diluted net loss per share
            
            
            ($0.09
            )
            
            ($0.09
            )Shares
                used in computing basic and diluted net loss per share
            
            
            63,032,207
            
            
            62,735,569




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




5




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENT OF STOCKHOLDERS’ EQUITY


FOR
      THE
      NINE MONTHS ENDED SEPTEMBER 30, 2008




(Unaudited)




AdditionalCommon
                Stock
            
            Paid-In
            
            AccumulatedShares
            
            Amount
            
            Capital
            
            Deficit
            
            TotalBALANCE,
                DECEMBER 31, 2007
            
            
            63,032,207
            
            $
            630,322
            
            $
            132,932,357
            
            
            ($94,029,249
            )
            $
            39,533,430Stock
                options issued to consultants for services
            
            
            -
            
            
            -
            
            
            78,015
            
            
            -
            
            
            78,015Stock-based
                compensation expenserelated
                to employee options
            
            
            -
            
            
            -
            
            
            698,816
            
            
            -
            
            
            698,816Issuance
                of restricted stock and amortization of expense for restricted
                stock
            
            
            -
            
            
            -
            
            
            310,868
            
            
            -
            
            
            310,868Issuance
                of warrants for draws underline
                of credit
            
            
            
            
            
            
            
            
            44,366
            
            
            
            
            
            44,366Net
                loss for the nine months ended September 30, 2008
            
            
            -
            
            
            -
            
            
            -
            
            
            (5,936,669
            )
            
            (5,936,669
            )BALANCE,
                SEPTEMBER 30, 2008
            
            
            63,032,207
            
            $
            630,322
            
            $
            134,064,422
            
            
            ($99,965,918
            )
            $
            34,728,826




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




6




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF CASH FLOWS


(Unaudited)




For
                the Nine Months Ended
              September
                30,2008
            
            2007**Cash
                Flows From Operating Activities**:Net
                loss
            
            
            ($
                5,936,669
            )
            
            ($
                5,372,211
            )Adjustments
                to reconcile net loss to net cash used in operating activities-continuing
                operations:Depreciation
                and amortization
            
            
            3,078,475
            
            
            2,827,620Loss
                on sale of discontinued operations
            
            
            414,658
            
            
            -Stock
                options issued to consultants for services
            
            
            78,015
            
            
            93,429Stock-based
                compensation expense related to employee options and restricted
                stock
            
            
            1,009,684
            
            
            1,103,721Provision
                for bad debts
            
            
            89,259
            
            
            103,064Changes
                in operating assets and liabilities, net of effects from discontinued
                operations:Accounts
                receivable
            
            
            (1,013,633
            )
            
            (919,636
            )Inventories
            
            
            (254,490
            )
            
            (608,398
            )Prepaid
                expenses and other assets
            
            
            642,448
            
            
            649,637Accounts
                payable
            
            
            1,053,352
            
            
            317,155Accrued
                compensation and related expenses
            
            
            (100,725
            )
            
            (202,063
            )Other
                accrued liabilities
            
            
            371,049
            
            
            91,285Deferred
                revenues
            
            
            472,916
            
            
            477,930Other
                liabilities
            
            
            -
            
            
            (11,623
            )Net
                cash used in operating activities - continuing operations
            
            
            (95,661
            )
            
            (1,450,090
            )Net
                cash provided by operating activities - discontinued
                operations
            
            
            766,328
            
            
            606,198Net
                cash provided by operating activities
            
            
            670,667
            
            
            (843,892
            )**Cash
                Flows From Investing Activities:**Purchases
                of property and equipment
            
            
            (229,942
            )
            
            (108,640
            )Lasers
                placed into service
            
            
            (3,852,917
            )
            
            (3,159,739
            )Proceeds
                from disposition of discontinued operations
            
            
            3,149,736
            
            
            -Deferred
                costs on proposed acquisition
            
            
            (1,762,501
            )
            
            -Net
                cash used in investing activities - continuing operations
            
            
            (2,695,624
            )
            
            (3,268,379
            )Net
                cash used in investing activities - discontinued
                operations
            
            
            (68,462
            )
            
            (256,993
            )Net
                cash used in investing activities
            
            
            (2,764,086
            )
            
            (3,525,372
            )**Cash
                Flows From Financing Activities:**Proceeds
                from issuance of restricted common stock
            
            
            -
            
            
            4,200Proceeds
                from exercise of options
            
            
            -
            
            
            85,954Payments
                on long-term debt
            
            
            (107,376
            )
            
            (65,033
            )Payments
                on notes payable
            
            
            (672,399
            )
            
            (501,884
            )Net
                (repayments)/advances on lease lines of credit
            
            
            (272,316
            )
            
            236,758Decrease
                in restricted cash and cash equivalents
            
            
            39,000
            
            
            39,000Net
                cash used in financing activities - continuing operations
            
            
            (1,013,091
            )
            
            (201,005
            )Net
                cash used in financing activities - discontinued
                operations
            
            
            -
            
            
            -Net
                cash used in financing activities
            
            
            (1,013,091
            )
            
            (201,005
            )Net
                decrease in cash and cash equivalents
            
            
            (3,106,510
            )
            
            (4,570,269
            )Cash
                and cash equivalents, beginning of period
            
            
            9,837,303
            
            
            12,729,742Cash
                and cash equivalents, end of period
            
            $
            6,730,793
            
            $
            8,159,473




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




7




PHOTOMEDEX,
      INC. AND SUBSIDIARIES


NOTES
      TO
      UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS




*Note
      1*




**Basis
      of Presentation:**




**The
      Company:**




***Background***


PhotoMedex,
      Inc. (and its subsidiaries) (the “Company”) is a medical device and specialty
      pharmaceutical company focused on facilitating the cost-effective use of
      technologies for doctors, hospitals and surgery centers to enable their patients
      to achieve a higher quality of life. The Company currently operates in four
      distinct business units, or segments (as described in Note 10): three in
      Dermatology, - Domestic XTRAC®, International Dermatology Equipment, and Skin
      Care (ProCyte®); and one in Surgical, - Surgical Products (SLT®). The segments
      are distinguished by our management structure, products and services offered,
      markets served or types of customers. A fifth segment of business, the Surgical
      Services segment, is reported as a discontinued operation, and its related
      assets as held for sale, in these financial statements.




Surgical
      Services is a fee-based procedures business using mobile surgical laser
      equipment operated by Company technicians at hospitals and surgery centers
      in
      the United States. After preliminary investigations and discussions, the Board
      of Directors of the Company decided on June 13, 2008 to develop plans for
      implementing a disposal of the assets and operations of the business. The
      Company accordingly classified this former segment as held for sale in
      accordance with SFAS No. 144. On August 1, 2008, the Company entered into a
      definitive agreement to sell specific assets of the business including accounts
      receivable, inventory and equipment, for $3,500,000, subject to certain closing
      adjustments. See Note 2, ***Discontinued
      Operations*** .




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




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




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




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




8




***Liquidity
      and Going Concern***


As
      of
      September 30, 2008, the Company had an accumulated deficit of $99,965,918.
      Cash
      and cash equivalents, including restricted cash of $78,000, was $6,808,793.
      The
      Company has historically financed its operations with cash provided by equity
      financing and from lines of credit and, more recently but not yet consistently,
      from positive cash flow generated from operations. The Company is exploring
      expressions of interest from third party lenders, including CIT Healthcare,
      to
      offer further debt financing for the domestic XTRAC program, thought there
      can
      be no assurance that any such expressions of interest will materialize on terms
      favorable to the Company. Management believes that the existing cash balance
      together with its other existing potential financial resources and any revenues
      from sales, distribution, licensing and manufacturing relationships, will be
      sufficient to meet the Company’s operating and capital requirements beyond the
      end of the fourth quarter of 2009. The 2008 operating plan reflects anticipated
      growth from both increased fee revenues for use of the XTRAC laser system based
      on increased utilization and wider insurance coverage in the United States
      and
      anticipated growth in revenues of the Company’s skincare products.




**Summary
      of Significant Accounting Policies:**




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


The
      financial statements as of September 30, 2008 and for the three and nine months
      ended September 30, 2008 and 2007, are unaudited and, in the opinion of
      management, include all adjustments (consisting only of normal recurring
      adjustments) necessary to present fairly the financial position as of September
      30, 2008, and the results of operations and cash flows for the three and nine
      months ended September 30, 2008 and 2007. The results for the three and nine
      months ended September 30, 2008 are not necessarily indicative of the results
      to
      be expected for the entire year. While management of the Company believes that
      the disclosures presented are adequate to make the information not misleading,
      these consolidated financial statements should be read in conjunction with
      the
      consolidated financial statements and the notes included in the Company's Annual
      Report on Form 10-K for the year ended December 31, 2007. The surgical services
      business segment is presented as discontinued operations for all periods
      presented.




***Principles
      of Consolidation***


The
      consolidated financial statements include the accounts of the Company and its
      wholly-owned subsidiaries. All significant intercompany balances and
      transactions have been eliminated.




***Use
      of Estimates***


The
      preparation of the consolidated financial statements in conformity with
      accounting principles generally accepted in the United States requires
      management to make estimates and assumptions that affect amounts reported in
      the
      financial statements and accompanying notes. Actual results could differ from
      those estimates and be based on events different from those assumptions. Future
      events and their effects cannot be predicted with certainty; estimating,
      therefore, requires the exercise of judgment. Thus, accounting estimates change
      as new events occur, as more experience is acquired, or as additional
      information is obtained.




See
      “Summary of Significant Accounting Policies” in the Company’s 2007 Annual Report
      on Form 10-K for a discussion of the estimates and judgments necessary in the
      Company’s accounting for cash and cash equivalents, accounts receivable,
      inventories, property, equipment and depreciation, product development costs
      and
      fair value of financial instruments.




***Revenue
      Recognition***


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




9




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




Under
      the
      terms of the Company’s distributor agreements, distributors do not have a
      unilateral right to return any unit that they have purchased. However, the
      Company does allow products to be returned by its distributors for product
      defects or other claims.




When
      the
      Company places a laser in a physician’s office, it recognizes service revenue
      based on the number of patient treatments performed by the physician. Treatments
      in the form of random laser-access codes that are sold to a physician, but
      not
      yet used, are deferred and recognized as a liability until the physician
      performs the treatment. Unused treatments remain an obligation of the Company
      because the treatments can only be performed on Company-owned equipment. Once
      the treatments are delivered to a patient, this obligation has been satisfied.




The
      Company excludes all sales of treatment codes made within the last two weeks
      of
      the period in determining the amount of procedures performed by its
      physician-customers. Management believes this approach closely approximates
      the
      actual amount of unused treatments that existed at the end of a period. For
      the
      three and nine months ended September 30, 2008 and 2007, the Company deferred
      $1,038,213 and $899,075, respectively, under this approach.




The
      Company generates revenues from its Skin Care business primarily through two
      channels. The first is through product sales for skin health, hair care and
      wound care and the second is through sales in bulk of the copper peptide
      compound, primarily to Neutrogena Corporation, a Johnson & Johnson company.
      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 its
      licensees. The Company recognizes royalty revenue at the applicable royalty
      rate
      applied to shipments reported by its licensee.




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




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




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


In
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets”, long-lived assets, such as property and equipment, and
      purchased intangibles subject to amortization, are reviewed for impairment
      whenever events or changes in circumstances indicate that the carrying amount
      of
      an asset may not be recoverable. Recoverability of assets to be held and used
      is
      measured by a comparison of the carrying amount of an asset to estimated
      undiscounted future cash flows expected to be generated by the asset. If the
      carrying amount of an asset exceeds its estimated future cash flows, an
      impairment charge is recognized in the amount by which the carrying amount
      of
      the asset exceeds the fair value of the asset. Assets to be disposed of are
      separately presented in the balance sheet and reported at the lower of the
      carrying amount or the fair value less costs to sell, and would no longer be
      depreciated. The assets and liabilities of Surgical Services segment are
      classified as held for sale for the December 31, 2007 period and are presented
      separately in the appropriate asset and liability sections of the balance sheet.
      As of September 30, 2008 and December 31, 2007, no such impairment existed
      related to continuing operations.





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




10




Management
      evaluates the recoverability of intangible assets based on estimates of
      undiscounted future cash flows over the remaining useful life of the asset.
      If
      the amount of such estimated undiscounted future cash flows is less than the
      net
      book value of the asset, the asset is written down to fair value. As September
      30, 2008, no such write-down was required. (See ***Impairment
      of Long-Lived Assets and Intangibles*** ).




***Other
      Intangible Assets***


Other
      intangible assets were recorded in connection with the acquisition of ProCyte
      in
      March 2005. The assets are being amortized on a straight-line basis over 5
      to 10
      years.




Management
      evaluates the recoverability of such other intangible assets based on estimates
      of undiscounted future cash flows over the remaining useful life of the asset.
      If the amount of such estimated undiscounted future cash flows is less than
      the
      net book value of the asset, the asset is written down to fair value. As of
      September 30, 2008 no such write-down was required.




***Goodwill***


Goodwill
      was recorded in connection with the acquisition of ProCyte in March 2005 and
      the
      acquisition of Acculase in August 2000.




Management
      evaluates the recoverability of such goodwill based on estimates of undiscounted
      future cash flows over the remaining useful life of the asset. If the amount
      of
      such estimated undiscounted future cash flows is less than the net book value
      of
      the asset, the asset is written down to fair value. As of September 30, 2008
      no
      such write-down was required.




***Accrued
      Warranty Costs***


The
      Company offers a warranty on product sales generally for a one to two-year
      period. In the case of domestic sales of XTRAC lasers, however, the Company
      offers longer periods in order to meet competition or meet customer demands.
      The
      Company provides for the estimated future warranty claims on the date the
      product is sold. The activity in the warranty accrual during the nine months
      ended September 30, 2008 is summarized as follows:




September
                30, 2008Accrual
                at beginning of period
            
            $
            218,587Additions
                charged to warranty expense
            
            
            255,600Expiring
                warranties
            
            
            (17,861
            )Claims
                satisfied
            
            
            (65,518
            )Accrual
                at end of period
            
            $
            390,808




***Income
      Taxes***


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




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




Utilization
      of the Company’s net operating loss carryforwards is subject to various
      limitations of the Internal Revenue Code, principally Section 382. Utilization
      of loss carryforwards from previous acquisitions (e.g. Acculase, SLT, ProCyte)
      have already been limited by this provision by the acquisition itself and by
      any
      later changes of ownership in the parent company. If the Company should undergo
      a further change of ownership under Section 382, the utilization of the
      Company’s loss carryforwards may be materially limited.




11




***Net
      Loss Per Share***


The
      Company computes net loss per share in accordance with SFAS No. 128, “Earnings
      per Share.” In accordance with SFAS No. 128, basic net loss per share is
      calculated by dividing net loss available to common stockholders by the weighted
      average of common shares outstanding for the period. Diluted net loss per share
      reflects the potential dilution from the conversion or exercise into common
      stock of securities such as stock options and warrants.




In
      these
      consolidated financial statements, diluted net loss per share from continuing
      operations is the same as basic net loss per share. Thus, no additional shares
      for the potential dilution from the conversion or exercise of securities into
      common stock are included in the denominator of this calculation, since the
      result would be anti-dilutive. Common stock options and warrants of 9,417,772
      and 10,267,093 as of September 30, 2008 and 2007, respectively, were excluded
      from the calculation of fully diluted earnings per share from continuing
      operations since their inclusion would have been anti-dilutive. The same
      considerations apply to net loss per share from discontinued operations for
      the
      three and nine months ended September 30, 2008. For the three and nine months
      ended September 30, 2007, however, there was income from discontinued
      operations, but basic net income per share and diluted net income per share
      from
      discontinued operations for these periods were both immaterial.




***Share-Based
      Compensation***


The
      Company measures and recognizes compensation expense at fair value for all
      stock-based payments to employees and directors as required by SFAS No. 123R
      applied on the modified prospective basis.




Under
      the
      modified prospective approach, SFAS No. 123R applies to new grants of options
      and awards of stock as well as to grants of options that were outstanding on
      January 1, 2006, the date of adoption, and that may subsequently be repurchased,
      cancelled or materially modified. Under the modified prospective approach,
      compensation cost recognized for the three and nine months ended September
      30,
      2008 and 2007 includes compensation cost for all share-based payments granted
      prior to, but not yet vested on, January 1, 2006, based on fair value as of
      the
      prior grant-date and estimated in accordance with the provisions of SFAS No.
      123R.




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




Assumptions
                for Option Grants
            
            Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Risk-free
                interest rate
            
            
            3.86
            %
            
            4.83
            %
            
            3.73
            %
            
            4.78
            %Volatility
            
            
            82.14
            %
            
            85.39
            %
            
            84.13
            %
            
            86.02
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %
            
            0
            %
            
            0
            %Expected
                life
            
            
            8.1
                years
            
            
            8.1
                years
            
            
            8.1
                years
            
            
            8.1
                yearsEstimated
                forfeiture rate
            
            
            12
            %
            
            12
            %
            
            12
            %
            
            12
            %




The
      Company calculates expected volatility for a share-based grant based on historic
      daily stock price observations of its common stock during the period immediately
      preceding the grant that is equal in length to the expected term of the grant.
      For estimating the expected term of share-based grants made in the three and
      nine months ended September 30, 2008 and 2007, the Company has adopted the
      simplified method authorized in Staff Accounting Bulletin No. 107. SFAS No.
      123R
      also requires that estimated forfeitures be included as a part of the estimate
      of expense as of the grant date. The Company has used historical data to
      estimate expected employee behaviors related to option exercises and
      forfeitures.




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




12




With
      respect to awards of restricted stock, the Company uses the Monte-Carlo pricing
      model to estimate fair value of restricted stock awards. There were no
      restricted stock awards for the three and nine months ended September 30, 2008.
      The awards made in the first and second quarters 2007 were estimated with the
      following weighted average assumptions:





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




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




Compensation
      expense for the three months ended September 30, 2008 included $262,971 from
      stock options grants and $103,623 from restricted stock awards. Compensation
      expense for the three months ended September 30, 2007 included $275,759 from
      stock options grants and $103,623 from restricted stock awards.




Compensation
      expense for the nine months ended September 30, 2008 included $698,816 from
      stock options grants and $310,868 from restricted stock awards. Compensation
      expense for the nine months ended September 30, 2007 included $827,337 from
      stock options grants and $276,384 from restricted stock awards.




Compensation
      expense is presented as part of the operating results in selling, general and
      administrative expenses. For stock options granted to consultants, an additional
      selling, general, and administrative expense in the amount of $15,635 and
      $78,015 was recognized during the three and nine months ended September 30,
      2008. For stock options granted to consultants an additional selling, general,
      and administrative expense in the amount of $15,678 and $93,429 was recognized
      during the three and nine months ended September 30, 2007.





***Supplemental
      Cash Flow Information***


During
      the nine months ended September 30, 2008, the Company financed certain insurance
      policies through notes payable for $635,243 and issued warrants to a leasing
      credit facility which are valued at $44,366, and which offset the carrying
      value
      of debt.




During
      the nine months ended September 30, 2007, the Company financed certain credit
      facility costs for $36,840, financed insurance policies through notes payable
      for $606,180 and issued warrants to a leasing credit facility which are valued
      at $28,011, and which offset the carrying value of debt. In addition, the
      Company financed vehicle purchases of $71,941 and laser purchases of $156,000
      under capital leases.




For
      the
      nine months ended September 30, 2008 and 2007, the Company paid interest of
      $892,932 and $700,383, respectively. Income taxes paid in the nine months ended
      September 30, 2008 and 2007 were immaterial.




***Recent
      Accounting Pronouncements***




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




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




13




Effective
      January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements".
      In
      February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB
      Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157", which
      provides a one year deferral of the effective date of SFAS No. 157 for
      non-financial assets and non-financial liabilities, except those that are
      recognized or disclosed in the financial statements at fair value at least
      annually. Therefore, the Company has adopted the provisions of SFAS No. 157
      with
      respect to its financial assets and liabilities only. SFAS No. 157 defines
      fair
      value, establishes a framework for measuring fair value under generally accepted
      accounting principles and enhances disclosures about fair value measurements.
      Fair value is defined under SFAS No. 157 as the exchange price that would be
      received for an asset or paid to transfer a liability (an exit price) in the
      principal or most advantageous market for the asset or liability in an orderly
      transaction between market participants on the measurement date. Valuation
      techniques used to measure fair value under SFAS No. 157 must maximize the
      use
      of observable inputs and minimize the use of unobservable inputs. The standard
      describes a fair value hierarchy based on three levels of inputs, of which
      the
      first two are considered observable and the last unobservable, that may be
      used
      to measure fair value. The input levels are as follows:




Level
      1—Quoted prices in active markets for identical assets or liabilities.




Level
      2—Inputs other than Level 1 that are observable, either directly or indirectly,
      such as quoted prices for similar assets or liabilities; quoted prices in
      markets that are not active; or other inputs that are observable or can be
      corroborated by observable market data for substantially the full term of the
      assets or liabilities.




Level
      3—Unobservable inputs that are supported by little or no market activity and
      that are significant to the fair value of the assets or liabilities.




The
      adoption of this Statement did not have a material impact on the Company's
      consolidated results of operations and financial condition.




In
      December 2007, the FASB issued
      SFAS No. 141 (revised 2007), “Business Combinations”, or SFAS No. 141R. SFAS No.
      141R replaces SFAS No. 141. This Statement establishes principles and
      requirements for how an acquirer recognizes and measures in its financial
      statements the identifiable assets acquired, the liabilities assumed, any
      non-controlling interest in the acquiree and the goodwill acquired. This
      statement also establishes disclosure requirements which will enable users
      to
      evaluate the nature and financial effects of the business combination. This
      Statement is effective for business combinations for which the acquisition
      date
      is on or after the beginning of the first annual reporting period beginning
      on
      or after December 15, 2008. This Statement will have an impact on future
      acquisitions. If, for example, the proposed acquisition of the subsidiaries
      of
      Photo Therapeutics Group Ltd. should be consummated after December 31, 2008,
      then the Company will be obliged to record an estimate of the earn-out payment
      the Company expects to pay and to expense its costs incurred in the acquisition.
      As of September 30, 2008, these costs amounted to $1,762,501 and are under
      the
      balance sheet caption “deferred costs on proposed acquisition”. If the proposed
      acquisition is consummated prior to December 31, 2008, the costs incurred in
      the
      transaction will be capitalized as part of the purchase price.




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




14




*Note
      2*


**Discontinued
      Operations:**




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




The
      accompanying consolidated financial statements reflect the operating results
      and
      balance sheet items of the discontinued operations separately from continuing
      operations. Prior year financial statements for 2007 have been restated in
      conformity with generally accepted accounting principles to present the
      operations of Surgical Services as a discontinued operation. The Company
      recognized a loss of $414,658 on the sale of the discontinued operations in
      the
      nine months ended September 30, 2008, representing the difference between the
      adjusted net purchase price and the carrying value of the assets being sold.




Revenues
      from Surgical Services for the three months ended September 30, 2008 and 2007
      were $736,298 and $1,899,200, respectively. Income from surgical services for
      the three months ended September 30, 2008 and 2007 were $39,059 and $183,390,
      respectively.




Revenues
      from Surgical Services for the nine months ended September 30, 2008 and 2007
      were $4,398,047 and $5,727,528, respectively. Income from surgical services
      for
      the nine months ended September 30, 2008 and 2007 were $284,929 and $276,421,
      respectively. No income tax provision was recognized by the Company against
      income from Surgical Services over the two comparable nine-month
      periods.




The
      net
      assets of Surgical Services are classified as assets held for sale. The net
      assets, after recognition of the write-down to estimated recoverable value,
      were
      comprised of the following:




December
                31, 2007Current
                assets held for sale:Accounts
                receivable
            
            $
            961,440Inventories
            
            
            949,362Total
                current assets held for sale
            
            
            1,910,802Long
                term assets held for sale:Property,
                plant and equipment, net
            
            
            2,119,347Deposits
            
            
            9,879Total
                long term assets held for sale
            
            
            2,129,226Total
                net assets held for sale
            
            $
            4,040,028




15




*Note
      3*


**Inventories:**




Set
      forth
      below is a detailed listing of inventories:




September
                30, 2008
            
            December
                31, 2007Raw
                materials and work in progress
            
            $
            4,585,998
            
            $
            4,527,708Finished
                goods
            
            
            2,599,890
            
            
            2,452,472Total
                inventories
            
            $
            7,185,888
            
            $
            6,980,180




Work-in-process
      is immaterial, given the Company’s typically short manufacturing cycle, and
      therefore is disclosed in conjunction with raw materials. As of September 30,
      2008 and December 31, 2007, the Company carried specific reserves for excess
      and
      obsolete stocks against its inventories of $1,254,350 and $1,124,345,
      respectively.




*Note
      4*


**Property
      and Equipment:**




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




September
                30, 2008
            
            December
                31, 2007Lasers
                in service
            
            $
            18,375,245
            
            $
            15,055,730Computer
                hardware and software
            
            
            341,407
            
            
            341,407Furniture
                and fixtures
            
            
            539,885
            
            
            361,174Machinery
                and equipment
            
            
            836,896
            
            
            870,986Leasehold
                improvements
            
            
            247,369
            
            
            247,36820,340,802
            
            
            16,876,665Accumulated
                depreciation and amortization
            
            
            (10,447,403
            )
            
            (8,852,204
            )Property
                and equipment, net
            
            $
            9,893,399
            
            
            8,024,461




Depreciation
      and related amortization expense was $2,221,936 and $1,886,221 for the nine
      months ended September 30, 2008 and 2007, respectively.




*Note
      5*


**Patents
      and Licensed Technologies:**




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




September
                30, 2008
            
            December
                31, 2007Patents,
                owned and licensed, at gross costs of $561,617 and $510,942, net
                of
                accumulated amortization of $296,241 and $268,540,
                respectively.
            
            $
            265,375
            
            $
            242,402Other
                licensed or developed technologies, at gross costs of $1,603,124
                and
                $1,595,258, net of accumulated amortization of $560,743 and $429,412,
                respectively.
            
            
            1,042,381
            
            
            1,165,846$
            1,307,756
            
            $
            1,408,248




Related
      amortization expense was $159,037 and $243,909 for the nine months ended
      September 30, 2008 and 2007, respectively. Included in other licensed and
      developed technologies is $200,000 in developed technologies acquired from
      ProCyte, $114,982 for the license with AzurTec and $85,742 for the license
      from
      the Mount Sinai School of Medicine of New York University. The Company is also
      obligated to pay Mount Sinai a royalty on a combined base of domestic sales
      of
      XTRAC treatment codes used for psoriasis as well as for vitiligo. In the first
      four years of the license, however, Mount Sinai may elect to be paid royalties
      on an alternate base, comprised simply of treatments for vitiligo, but at a
      higher royalty rate than the rate applicable to the combined base. This
      technology is for the laser treatment of vitiligo and is included in other
      licensed or developed technologies.




16


*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 recorded at their appraised fair market values
      at the date of the acquisition:




September
                30, 2008
            
            December
                31, 2007Neutrogena
                Agreement, at gross cost of $2,400,000 net of accumulated amortization
                of
                $1,698,000 and 1,338,000, respectively.
            
            $
            702,000
            
            $
            1,062,000Customer
                Relationships, at gross cost of $1,700,000 net of accumulated amortization
                of $1,202,736 and $947,739, respectively.
            
            
            497,264
            
            
            752,261Tradename,
                at gross cost of $1,100,000 net of accumulated amortization of $389,139
                and $306,636, respectively.
            
            
            710,861
            
            
            793,364$
            1,910,125
            
            $
            2,607,625




Related
      amortization expense was $697,500 for the nine months ended September 30, 2008
      and 2007, respectively. Under the Neutrogena Agreement, the Company licenses
      to
      Neutrogena rights to its copper peptide technology for which the Company
      receives royalties. Customer Relationships embody the value to the Company
      of
      relationships that ProCyte had formed with its customers. Tradename includes
      the
      name of “ProCyte” and various other trademarks associated with ProCyte’s
      products.




*Note
      7*


**Other
      Accrued Liabilities:**




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




September
                30, 2008
            
            December
                31, 2007Accrued
                warranty
            
            $
            390,808
            
            $
            218,587Accrued
                professional and consulting fees
            
            
            427,700
            
            
            225,820Accrued
                sales taxes and other accrued liabilities
            
            
            226,916
            
            
            229,967Total
                other accrued liabilities
            
            $
            1,045,424
            
            $
            674,374





*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:




September
                30, 2008
            
            December
                31, 2007Note
                Payable - secured creditor, interest at 6%, payable in monthly principal
                and interest installments of $2,880 through June 2012
            
            $
            113,191
            
            $
            133,507Note
                Payable - unsecured creditor, interest at 5.44%, payable in monthly
                principal and interest installments of $51,354 through February
                2008
            
            
            -
            
            
            102,013Note
                Payable - unsecured creditor, interest at 4.8%, payable in monthly
                principal and interest installments of $65,736 through December
                2008
            
            
            195,657
            
            
            -Note
                Payable - unsecured creditor, interest at 4.8%, payable in monthly
                principal and interest installments of $12,202 through December
                2008
            
            
            36,316
            
            
            -345,164
            
            
            235,520Less:
                current maturities
            
            
            (260,518
            )
            
            (129,305
            )Notes
                payable, net of current maturities
            
            $
            84,646
            
            $
            106,215




17




*Note
      9*


**Long-term
      Debt:**




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




September
                30, 2008
            
            December
                31, 2007Total
                borrowings on credit facilities
            
            $
            9,919,322
            
            $
            10,105,608Capital
                lease obligations
            
            
            -
            
            
            254,178Less:
                current portion
            
            
            (4,997,958
            )
            
            (4,757,133
            )Total
                long-term debt
            
            $
            4,921,364
            
            $
            5,602,653




*Leasing
      Credit Facility, Term Note Facility*


The
      Company entered into a leasing credit facility with GE Capital Corporation
      (“GE”) on June 25, 2004. Eleven draws were made against the facility, the last
      of which was in March 2007. In June 2007, the Company entered a term-note
      facility with Leaf Financial Corporation (“Leaf”) and made its single draw
      against that facility. In December 2007, the Company extinguished its
      outstanding indebtedness under the GE and Leaf facilities, recognizing as costs
      (including termination costs and acceleration of the amortization of debt
      issuance costs and the debt discount) of such extinguishments as a refinancing
      charge under APB No. 26 of $441,956, including $178,699 related to the premium
      paid for the buyback of its warrants issued to GE. The GE warrants issued
      through the date of extinguishments were redeemed and reflected as part of
      the
      refinancing charge.




In
      connection with the pay-off of the GE and Leaf facilities, on December 31,
      2007,
      the Company entered a term-note facility with CIT Healthcare LLC and Life
      Sciences Capital LLC, as equal participants (collectively, “CIT”), for which CIT
      Healthcare acts as the agent. The facility is for $12 million. The Company
      may
      draw against it for one year. The stated interest rate for any draw is set
      at
      675 basis points above the three-year Treasury rate. Each draw is secured by
      certain XTRAC laser systems consigned under usage agreements with
      physician-customers and the stream of payments generated from such lasers. Each
      draw has a repayment period of three years.




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




The
      beginning principal of each component was $4,724,699, $1,612,626, and
      $3,990,000, respectively. The effective interest rate for the first draw was
      12.50%. The pay-off of each component is 27, 30, and 36 months, respectively.
      On
      March 31, 2008, the Company made a draw under the credit facility for $840,000.
      This draw is amortized over 36 months at an effective interest rate of 8.55%.
      On
      June 30, 2008, the Company made a draw under the credit facility for $832,675
      based on the limitations on gross borrowings under the facility. This draw
      is
      amortized over 36 months at an effective interest rate of 9.86%.




On
      September 30, 2008, CIT amended the credit facility to increase the amount
      the
      Company could draw on the credit facility by $1,927,534. The interest rate
      for
      draws against this amount was set at 850 basis points above the LIBOR rate
      two
      days prior to the draw. Each draw is secured by certain XTRAC laser systems
      consigned under usage agreements with physician-customers and the stream of
      payments generated from such lasers. Each draw has a repayment period of three
      years. On September 30, 2008, the Company made a draw under the credit facility
      for the maximum amount allowable under the credit facility. This draw is
      amortized over 36 months at an effective interest rate of 12.90%. The Company
      has used its entire availability under the CIT credit facility and is
      considering multiple written proposals for additional debt financing but there
      can be no assurance whether any such proposals will materialize on terms
      favorable to the Company.




18




In
      connection with the CIT facility, the Company issued 235,525 warrants to each
      of
      CIT Healthcare and Life Sciences Capital in December 2007. In connection with
      the amendment to the CIT facility, the Company issued 192,753 warrants to CIT
      Healthcare in September 2008. The warrants are treated as a discount to the
      debt
      and are amortized under the effective interest method over the repayment term
      of
      36 months. The Company has accounted for these warrants as equity instruments
      in
      accordance with EITF 00-19, "Accounting for Derivative Financial Instruments
      Indexed to, and Potentially Settled in, a Company's Own Stock" since there
      is no
      option for cash or net-cash settlement when the warrants are exercised. The
      Company computed the value of the warrants using the Black-Scholes method.
      The
      key assumptions used to value the warrants are as follows:




December
                2007
            
            March
                2008Number
                of warrants
            
            
            235,525
            
            
            192,753Exercise
                price
            
            $
            1.12
            
            $
            0.44Fair
                Value of warrants
            
            $
            110,858
            
            $
            44,366Volatility
            
            
            59.44
            %
            
            60.92
            %Risk-free
                interest rate
            
            
            3.45
            %
            
            2.98
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %Expected
                warrant life
            
            
            5
                years
            
            
            5
                years




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




Three
                months ended December 31, 2008
            
            $
            1,627,216Year
                Ended December 31,2009
            
            
            5,375,7882010
            
            
            3,444,7822011
            
            
            811,059Total
                minimum payments
            
            
            11,258,845Less:
                interest
            
            
            (1,184,561
            )Less:
                warrant discount
            
            
            (154,962
            )Present
                value of total minimum obligations
            
            $
            9,919,322




*Capital
      Leases*


The
      obligations under capital leases are at fixed interest rates and are
      collateralized by the related property and equipment. The Company paid off
      the
      capital leases on equipment that the Company sold in connection with its
      discontinued operations .




*Note
      10*


**Employee
      Stock Benefit Plans**




The
      Company has three active, stock-based compensation plans available to grant,
      among other things, incentive and non-qualified stock options to employees,
      directors and third-party service-providers as well as restricted stock to
      key
      employees. As of September 26, 2007, the stockholders approved an increase
      in
      the number of shares reserved for the 2005 Equity Compensation Plan and for
      the
      Outside Director Plan. Under the 2005 Equity Compensation Plan, a maximum of
      6,160,000 shares of the Company’s common stock have been reserved for issuance.
      At September 30, 2008, 2,103,750 shares were available for future grants under
      this plan. Under the Outside Director Plan and under the 2005 Investment Plan,
      695,000 shares and 388,000 shares, respectively, were available for issuance
      as
      of September 30, 2008. The other stock options plans are frozen and no further
      grants will be made from them.




19




Stock
      option activity under all of the Company’s share-based compensation plans for
      the nine months ended September 30, 2008 was as follows:




Number
                of Options
            
            Weighted
                Average Exercise PriceOutstanding,
                January 1, 2008
            
            
            6,129,671
            
            $
            2.00Granted
            
            
            1,158,200
            
            
            0.90Cancelled
            
            
            (1,217,902
            )
            
            1.85Outstanding,
                September 30, 2008
            
            
            6,069,969
            
            $
            1.82Options
                excercisable at September 30, 2008
            
            
            3,817,591
            
            $
            2.05




At
      September 30, 2008, there was $3,175,125 of total unrecognized compensation
      cost
      related to non-vested option grants and stock awards that is expected to be
      recognized over a weighted-average period of 2.36 years. The intrinsic value
      of
      options outstanding and exercisable at September 30, 2008 was not
      significant.




*Note
      11*


**Business
      Segment and Geographic Data:**




Segments
      are distinguished by the Company’s management structure, products and services
      offered, markets served and types of customers. The Domestic XTRAC business
      derives its primary revenues from procedures performed by dermatologists in
      the
      United States. The International Dermatology Equipment segment, in comparison,
      generates revenues from the sale of equipment to dermatologists outside the
      United States through a network of distributors. The Skin Care (ProCyte) segment
      generates revenues by selling skincare products and by earning royalties on
      licenses for the Company’s patented copper peptide compound. The Surgical
      Products segment generates revenues by selling laser products and disposables
      to
      hospitals and surgery centers on both a domestic and an international basis.
      For
      the three and nine months ended September 30, 2008 and 2007, the Company
      did not have material revenues from any individual customer.




Unallocated
      operating expenses include costs that are not specific to a particular segment
      but are general to the group; included are expenses incurred for administrative
      and accounting staff, general liability and other insurance, professional fees
      and other similar corporate expenses. Unallocated assets include cash, prepaid
      expenses and deposits. Goodwill from the buy-out of Acculase that was carried
      at
      $2,944,423 at September 30, 2008 and December 31, 2007 has been allocated to
      the
      domestic and international XTRAC segments based upon its fair value as of the
      date of the buy-out in the amounts of $2,061,096 and $883,327, respectively.
      Goodwill of $13,973,385 at September 30, 2008 from the ProCyte acquisition
      has
      been entirely allocated to the Skin Care segment.




20


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




Three
                Months Ended September 30, 2008DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            3,001,878
            
            $
            1,096,853
            
            $
            3,627,940
            
            $
            1,070,455
            
            $
            8,797,126Costs
                of revenues
            
            
            1,620,060
            
            
            586,865
            
            
            1,288,946
            
            
            573,785
            
            
            4,069,656Gross
                profit
            
            
            1,381,818
            
            
            509,988
            
            
            2,338,994
            
            
            496,670
            
            
            4,727,470*Gross
                profit %*
            
            
            *46.0*
            *%*
            
            *46.5*
            *%*
            
            *64.5*
            *%*
            
            *46.4*
            *%*
            
            *53.7*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            1,933,848
            
            
            68,665
            
            
            1,486,800
            
            
            151,690
            
            
            3,641,003Engineering
                and product development
            
            
            -
            
            
            -
            
            
            114,336
            
            
            109,900
            
            
            224,236Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,568,0981,933,848
            
            
            68,665
            
            
            1,601,136
            
            
            261,590
            
            
            6,433,337Income
                (loss) from operations
            
            
            (552,030
            )
            
            441,323
            
            
            737,858
            
            
            235,080
            
            
            (1,705,867
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (251,883
            )(Loss)
                income from continuing operations
            
            
            (552,030
            )
            
            441,323
            
            
            737,858
            
            
            235,080
            
            
            (1,957,750
            )Discontinued
                operations:Income
                from discontinued operations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            39,059Sale
                of discontinued operations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            131,186Net
                (loss) income
            
            
            ($552,030
            )
            $
            441,323
            
            $
            737,858
            
            $
            235,080
            
            
            ($1,787,505
            )








Three
                Months Ended September 30, 2007DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            2,025,148
            
            $
            819,442
            
            $
            3,065,905
            
            $
            1,112,176
            
            $
            7,022,671Costs
                of revenues
            
            
            1,009,237
            
            
            538,292
            
            
            903,688
            
            
            686,136
            
            
            3,137,353Gross
                profit
            
            
            1,015,911
            
            
            281,150
            
            
            2,162,217
            
            
            426,040
            
            
            3,885,318*Gross
                profit %*
            
            
            *50.2*
            *%*
            
            *34.3*
            *%*
            
            *70.5*
            *%*
            
            *38.3*
            *%*
            
            *55.3*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            1,496,326
            
            
            40,809
            
            
            1,323,172
            
            
            144,548
            
            
            3,004,855Engineering
                and product development
            
            
            -
            
            
            -
            
            
            103,696
            
            
            98,467
            
            
            202,163Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,373,1001,496,326
            
            
            40,809
            
            
            1,426,868
            
            
            243,015
            
            
            5,580,118Income
                (loss) from operations
            
            
            (480,415
            )
            
            240,341
            
            
            735,349
            
            
            183,025
            
            
            (1,694,800
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (141,562
            )(Loss)
                income from continuing operations
            
            
            (480,415
            )
            
            240,341
            
            
            735,349
            
            
            183,025
            
            
            (1,836,362
            )Discontinued
                operations:Income
                from discontinued operations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            183,390Net
                (loss) income
            
            
            ($480,415
            )
            $
            240,341
            
            $
            735,349
            
            $
            183,025
            
            
            ($1,652,972
            )





21





Nine
                Months Ended September 30, 2008DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            8,546,583
            
            $
            2,963,031
            
            $
            10,327,189
            
            $
            4,680,936
            
            $
            26,517,739Costs
                of revenues
            
            
            4,534,644
            
            
            1,493,553
            
            
            3,429,410
            
            
            2,765,182
            
            
            12,222,789Gross
                profit
            
            
            4,011,939
            
            
            1,469,478
            
            
            6,897,779
            
            
            1,915,754
            
            
            14,294,950*Gross
                profit %*
            
            
            *46.9*
            *%*
            
            *49.6*
            *%*
            
            *66.8*
            *%*
            
            *40.9*
            *%*
            
            *54.0*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            5,989,789
            
            
            206,546
            
            
            4,891,899
            
            
            459,568
            
            
            11,547,802Engineering
                and product development
            
            
            168,214
            
            
            20,790
            
            
            361,970
            
            
            330,294
            
            
            881,268Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            6,911,8006,158,003
            
            
            227,336
            
            
            5,253,869
            
            
            789,862
            
            
            19,340,870Income
                (loss) from operations
            
            
            (2,146,064
            )
            
            1,242,142
            
            
            1,643,910
            
            
            1,125,892
            
            
            (5,045,920
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (761,020
            )(Loss)
                income from continuing operations
            
            
            (2,146,064
            )
            
            1,242,142
            
            
            1,643,910
            
            
            1,125,892
            
            
            (5,806,940
            )Discontinued
                operations:Income
                from discontinued operations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            284,929Sale
                of discontinued operations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (414,658
            )Net
                (loss) income
            
            
            ($2,146,064
            )
            $
            1,242,142
            
            $
            1,643,910
            
            $
            1,125,892
            
            
            ($5,936,669
            )








Nine
                Months Ended September 30, 2007DOMESTIC
              XTRAC
            
            INTERN’L
              DERM.
                EQUIPMENT
            
            SKIN
                CARE
            
            SURGICAL
                PRODUCTS
              AND
                OTHER
            
            TOTALRevenues
            
            $
            6,048,000
            
            $
            2,117,213
            
            $
            9,646,312
            
            $
            3,730,107
            
            $
            21,541,632Costs
                of revenues
            
            
            3,117,850
            
            
            1,318,430
            
            
            2,931,419
            
            
            2,315,088
            
            
            9,682,787Gross
                profit
            
            
            2,930,150
            
            
            798,783
            
            
            6,714,893
            
            
            1,415,019
            
            
            11,858,845*Gross
                profit %*
            
            
            *48.4*
            *%*
            
            *37.7*
            *%*
            
            *69.6*
            *%*
            
            *37.9*
            *%*
            
            *55.1*
            *%*Allocated
                operating expenses:Selling,
                general and administrative
            
            
            4,489,067
            
            
            110,208
            
            
            4,090,291
            
            
            451,085
            
            
            9,140,651Engineering
                and product development
            
            
            -
            
            
            -
            
            
            294,787
            
            
            308,849
            
            
            603,636Unallocated
                operating expenses
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            7,383,2434,489,067
            
            
            110,208
            
            
            4,385,078
            
            
            759,934
            
            
            17,127,530Income
                (loss) from operations
            
            
            (1,558,917
            )
            
            688,575
            
            
            2,329,815
            
            
            655,085
            
            
            (5,268,685
            )Interest
                expense, net
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (379,947
            )(Loss)
                income from continuing operations
            
            
            (1,558,917
            )
            
            688,575
            
            
            2,329,815
            
            
            655,085
            
            
            (5,648,632
            )Discontinued
                operations:Income
                from discontinued operations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            276,421Net
                (loss) income
            
            
            ($1,558,917
            )
            $
            688,575
            
            $
            2,329,815
            
            $
            655,085
            
            
            ($5,372,211
            )




22




September
                30, 2008
            
            December
                31, 2007Assets:Total
                assets for reportable segments
            
            $
            44,379,024
            
            $
            42,171,948Assets
                held for sale
            
            
            -
            
            
            4,040,028Other
                unallocated assets
            
            
            9,150,338
            
            
            10,474,727Consolidated
                total
            
            $
            53,529,362
            
            $
            56,686,703




For
      the
      three and nine months ended September 30, 2008 and 2007 there were no material
      net revenues attributed to any individual foreign country. Net revenues by
      geographic area were, as follows:




Three
                Months Ended September 30,
            
            Nine
                Months Ended September 30,2008
            
            2007
            
            2008
            
            2007Domestic
            
            $
            6,702,085
            
            $
            5,333,306
            
            $
            20,766,092
            
            $
            16,886,558Foreign
            
            
            2,095,041
            
            
            1,689,365
            
            
            5,751,647
            
            
            4,655,074$
            8,797,126
            
            $
            7,022,671
            
            $
            26,517,739
            
            $
            21,541,632




The
      Company discusses segmental details in its Management Discussion & Analysis
      found elsewhere in its Form 10-Q for the period ending September 30,
      2008.




*Note
      12*


**Significant
      Alliances/Agreements:**




The
      Company continues in alliance with GlobalMed (Asia) Technologies Co., Inc.
      as
      well as with the Mount Sinai School of Medicine and with AzurTec, Inc., as
      described in our Annual Report on Form 10-K for the year ended December 31,
      2007.




With
      respect to the Clinical Trial Agreement protocol with the University of
      California at San Francisco, Dr. Koo presented the favorable findings of the
      study at the Hawaii Dermatology Seminar in March 2008. Dr. Koo concluded that the
      XTRAC
      Excimer Laser may be appropriate for the majority of moderate to severe
      psoriasis sufferers. It also allows dermatologists to treat those patients
      with
      a high level of safety, as opposed to the use of many systemic products. Other
      phototherapy treatments such as broadband or narrow band UVB can also be used;
      however, undesirable aspects of these treatments include exposure of healthy
      skin to UVB light, and the inconvenience of extended treatment periods, which
      are often necessary for moderate to severe patients .
      We
      expensed $189,000 in the nine months ended September 30, 2008 in payment for
      this study.




*Note
      13*


**Pending
      Acquisition and Financing:**




On
      August
      4, 2008, the Company entered into a Purchase Agreement with Photo Therapeutics
      Group, Limited (“Photo
      Therapeutics”) and
      a
      Securities Purchase Agreement with an affiliate of Perseus, L.L.C. (“Perseus”). Under
      the
      Purchase Agreement with Photo Therapeutics, the Company will acquire from Photo
      Therapeutics the common stock of its subsidiaries (Photo Therapeutics Limited
      in
      the United Kingdom and Photo Therapeutics, Inc. in California) for $13 million
      in cash at closing, and up to an additional $7 million in cash if certain gross
      profit milestones are met by the Photo Therapeutics subsidiaries between July
      1,
      2008 and June 30, 2009, subject to customary adjustments. Under the Securities
      Purchase Agreement with Perseus, an investment fund managed by Perseus will
      fund
      the acquisition of the Photo Therapeutics subsidiaries through a convertible
      debt investment of up to $25 million (with associated warrants), to be made
      in
      two tranches as described below.




Photo
      Therapeutics had unaudited revenues of approximately $6.3 million for the year
      ended December 31, 2007 and approximately $6.9 million for the nine months
      ended
      September 30, 2008.




23




The
      proposed acquisition and investment are subject to customary closing conditions,
      including approval by the shareholders of Photo Therapeutics of the proposed
      acquisition and approval by the Company’s stockholders of the proposed
      investment by Perseus and of a reverse split of the outstanding shares of the
      Company’s common stock at a ratio as may be agreed between the Company and
      Perseus. The shareholders of Photo Therapeutics have approved the transaction.
      The proposed acquisition and the first tranche of the proposed investment by
      Perseus are expected to close concurrently in the first quarter of 2009. If
      the
      closing is held in 2009, then the provisions of SFAS No. 141R will apply,
      obliging us to estimate and record the expected payment for the earnout and
      to
      expense, rather than capitalize, costs related to the acquisition. Such costs
      amount to $1,762,501 as of September 30, 2008.




The
      Company has agreed under its Securities Purchase Agreement, subject to
      stockholder approval, to issue to Perseus (i) convertible promissory notes
      (the
“Notes”) in the aggregate principal amount of up to $25 million, convertible
      into shares of the Company’s common stock, (ii) warrants to purchase shares of
      common stock (the “Warrants”), and (iii) 327,521 shares of common stock (the
“First Tranche Shares” and together with the Warrants, the Notes and any shares
      of the Company’s common stock issued upon conversion of the Notes or exercise of
      the Warrants, the “Securities”), in exchange for Perseus’ payment to the Company
      of an aggregate purchase price of up to $25 million (the “Financing
      Transaction”). The consummation of the Financing Transaction will occur in two
      tranches.




The
      closing of the first tranche of the Financing Transaction (the “First Tranche
      Closing”) will occur simultaneously with the closing of the Photo Therapeutics
      closing. In the event that the First Tranche Closing occurs, in exchange for
      Perseus’ investment of $18 million, the Company will issue to Perseus (i) a Note
      in the principal amount of $18 million (the “First Tranche Note”), convertible
      into 24,411,414 shares of its common stock at a conversion price per share
      equal
      to $0.73736 (the “First Tranche Conversion Price”), each subject to adjustment
      upon certain conditions, (ii) a Warrant to purchase 7,323,424 shares of the
      Company’s common stock (the “First Tranche Warrant”), at an exercise price per
      share equal to the First Tranche Conversion Price, each subject to adjustment
      upon certain conditions, and (iii) the First Tranche Shares. The First Tranche
      Conversion Price is subject to anti-dilution provisions in connection with
      certain future issuances of our securities as well as adjustments for stock
      splits and similar actions. The First Tranche Note will mature on the fifth
      anniversary of the date of the First Tranche Closing and will accrue interest
      at
      8% per annum. Interest is payable in cash or through our issuance of an
      additional Note at the Company’s election, on the six-month anniversary of the
      date of the First Tranche Closing and on each six-month period
      thereafter.




In
      the
      event that the Second Tranche Closing occurs, in exchange for Perseus’
investment of a maximum of $7 million, the Company will issue to Perseus (i)
      a
      Note (the “Second Tranche Note”) in the principal amount of the investment
      amount, convertible into a number of shares of the Company’s common stock at the
      Second Tranche Conversion Price (as defined below), subject to adjustment upon
      certain conditions, and (ii) a Warrant to purchase a number of shares of its
      common stock equal to 30% of the shares of its common stock into which the
      Second Tranche Note is convertible, at an exercise price per share equal to
      the
      Second Tranche Conversion Price, subject to adjustment upon certain conditions
      (the “Second Tranche Warrant”). The “Second Tranche Conversion Price” will equal
      the lesser of (i) 150% of the conversion price then in effect with respect
      to
      the First Tranche Note, and (ii) the market price of the Company’s common stock
      measured in accordance with the terms of the Securities Purchase Agreement.
      The
      Second Tranche Conversion Price is subject to anti-dilution provisions in
      connection with certain future issuances of our securities at a lower price
      per
      share of common stock as well as adjustments for stock splits and similar
      actions. The Second Tranche Note will mature on the fifth anniversary
      of the date of the First Tranche Closing and will accrue interest at 8% per
      annum. Interest is payable in cash or through our issuance of an additional Note
      at the Company’s election, on the six-month anniversary of the date of the
      Second Tranche Closing and on each six-month period thereafter.




Each
      of
      the First Tranche Note and the Second Tranche Note will provide that if on
      any date that occurs 31 trading days after the date of issuance, the market
      price for the Company’s common stock, as determined in accordance with the terms
      and conditions of the Securities Purchase Agreement, exceeds 300% of the
      then-effective conversion price of each Note, then the entire principal amount
      and all accrued but unpaid interest under such Note will automatically convert
      into shares of the Company’s common stock at the then-effective conversion price
      (the “Mandatory Conversion Feature”).




The
      First
      Tranche Warrant and the Second Tranche Warrant are exercisable at any time
      after
      the issue date for a period of 8 years thereafter.




24




**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,
      2007.*




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




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




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




·
            Domestic
                XTRAC,




·
            International
                Dermatology Equipment,




·
            Skin
                Care (ProCyte), and




·
            Surgical
                Products.




**Domestic
      XTRAC**




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




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




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




25




Our
      32-person XTRAC sales organization includes 20 sales representatives, 9 clinical
      specialists and 3 marketing support personnel. Our 25-person skin care sales
      organization includes 19 sales representatives, 4 customer service
      representatives and 2 marketing support personnel. The sales representatives
      in
      each segment provide follow-up sales support and share sales leads to enhance
      opportunities for cross-selling. Our marketing department has been instrumental
      in expanding the advertising campaign for the XTRAC laser system.




While
      our
      sales and marketing expenses have grown at nearly the same rate as the revenues
      on which the expenses are targeted to have positive impact, we expect to
      increase our overall revenue and productivity as a result of these expenditures
      in the long term. For example, we have tried various direct-to-consumer
      marketing programs that have positively influenced utilization, but the increase
      in utilization is expected to be attained in periods subsequent to the period
      in
      which we incurred the expense. We have also increased the number of sales
      representatives and established a group of clinical support specialists to
      optimize utilization levels and better secure the willingness and interest
      of
      patients to seek follow-up courses of treatment after the effect of the first
      battery of treatment sessions starts to wear off.




**International
      Dermatology Equipment**




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




**Skin
      Care (ProCyte)**




Skin
      Care
      generates revenues from the sale of skin health, hair care and wound care
      products; the sale of copper peptide compound in bulk; and royalties on licenses
      for the patented copper peptide compound.




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




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




Our
      customers have displayed strong interest in MD Lash FactorTM eyelash conditioner.
      The growth in revenues from this product, however, have been offset, in part,
      by
      legal costs we incurred in the suit brought by Allergan against us and other
      companies marketing eyelash conditioners.




**Surgical
      Products**




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




26




In
      September 2007, we entered into a three-year OEM agreement with AngioDynamics
      under which we manufacture for AngioDynamics, on a non-exclusive basis, a
      private-label, 980-nanometer diode laser system. The OEM agreement provides
      that
      we shall supply this laser on an exclusive basis to AngioDynamics, should
      AngioDynamics meet certain purchase requirements. Through September 30, 2008
      shipments to AngioDynamics exceeded the minimum purchase requirement for
      delivery of lasers over the first contract year and therefore triggering
      exclusivity for worldwide sale in the peripheral vascular treatment field.
      Recently, however, AngioDynamics purchased the assets of a competitive diode
      laser company, and if it elects to source its diodes through the assets so
      purchased, our future sales of diode lasers to AngioDynamics under this
      exclusive arrangement may be severely limited. There were no shipments to
      AngioDynamics in the quarter ended September 30, 2008.




**Sale
      of Surgical Services Business**




Surgical
      Services is a fee-based procedures business using mobile surgical laser
      equipment operated by our technicians at hospitals and surgery centers in the
      United States. We decided to sell this division primarily because the growth
      rates and operating margins of the division have decreased as the business
      had
      changed to rely more heavily upon procedures performed using equipment from
      third-party suppliers, thereby limiting the profit potential of these services.
      After preliminary investigations and discussions, our Board of Directors decided
      on June 13, 2008 to enter into, with the aid of its investment banker,
      substantive, confidential discussions with potential third-party buyers and
      began to develop plans for implementing a disposal of the assets and operations
      of the business. On August 1, 2008, we entered into a definitive agreement
      to
      sell specific assets of the business including accounts receivable, inventory
      and equipment, for $3,500,000, subject to certain closing adjustments. The
      sale
      closed on August 8, 2008 and such closing adjustments resulted in net proceeds
      to us of $3,149,737.




**Proposed
      Acquisition of the Subsidiaries of Photo Therapeutics Group, Limited and
      Proposed Investment by Perseus, L.L.C.**




On
      August
      4, 2008, we entered into a Purchase Agreement with Photo Therapeutics Group,
      Limited (“Photo
      Therapeutics”) and
      a
      Securities Purchase Agreement with an affiliate of Perseus, L.L.C. (“Perseus”). Under
      the
      Purchase Agreement with Photo Therapeutics, we will acquire from Photo
      Therapeutics the common stock of its subsidiaries (Photo Therapeutics Limited
      in
      the United Kingdom and Photo Therapeutics, Inc. in California) for $13 million
      in cash at closing, and up to an additional $7 million in cash if certain gross
      profit milestones are met by the Photo Therapeutics subsidiaries between July
      1,
      2008 and June 30, 2009, subject to customary adjustments. Under the Securities
      Purchase Agreement with Perseus, an investment fund managed by Perseus will
      fund
      the acquisition of the Photo Therapeutics subsidiaries through a convertible
      debt investment of up to $25 million (with associated warrants), to be made
      in
      two tranches as described below.




The
      proposed acquisition and investment are subject to customary closing conditions,
      including approval by the shareholders of Photo Therapeutics of the proposed
      acquisition and approval by our stockholders of the proposed investment by
      Perseus and of a reverse split of the outstanding shares of our common stock
      at
      a ratio as may be agreed between us and Perseus. The shareholders of Photo
      Therapeutics have approved the transaction. The proposed acquisition and the
      first tranche of the proposed investment by Perseus are expected to close
      concurrently, most likely in the first quarter of 2009.




We
      have
      agreed under our Securities Purchase Agreement, subject to stockholder approval,
      to issue to Perseus (i) convertible promissory notes (the “Notes”) in the
      aggregate principal amount of up to $25 million, convertible into shares of
      our
      common stock, (ii) warrants to purchase shares of our common stock (the
“Warrants”), and (iii) 327,521 shares of common stock (the “First Tranche
      Shares” and together with the Warrants, the Notes and any shares of our common
      stock issued upon conversion of the Notes or exercise of the Warrants, the
      “Securities”), in exchange for Perseus’ payment to us of an aggregate purchase
      price of up to $25 million (the “Financing Transaction”).  The consummation
      of the Financing Transaction will occur in two tranches.




The
      closing of the first tranche of the Financing Transaction (the “First Tranche
      Closing”) will occur simultaneously with the closing of the Photo Therapeutics
      closing. In the event that the First Tranche Closing occurs, in exchange for
      Perseus’ investment of $18 million, we will issue to Perseus (i) a Note in the
      principal amount of $18 million (the “First Tranche Note”), convertible into
      24,411,414 shares of our common stock at a conversion price per share equal
      to
      $0.73736 (the “First Tranche Conversion Price”), each subject to adjustment upon
      certain conditions, (ii) a Warrant to purchase 7,323,424 shares of our common
      stock (the “First Tranche Warrant”), at an exercise price per share equal to the
      First Tranche Conversion Price, each subject to adjustment upon certain
      conditions, and (iii) the First Tranche Shares. The First Tranche Conversion
      Price is subject to anti-dilution provisions in connection with certain future
      issuances of our securities as well as adjustments for stock splits and similar
      actions. The First Tranche Note will mature on the fifth anniversary of the
      date
      of the First Tranche Closing and will accrue interest at 8% per annum. Interest
      is payable in cash or through our issuance of an additional Note at our
      election, on the six month anniversary of the date of the First Tranche Closing
      and on each six month period thereafter.




27




In
      the
      event that the Second Tranche Closing occurs, in accordance with the terms
      and
      conditions of the Securities Purchase Agreement, in exchange for Perseus’
investment of a maximum of $7 million, we will issue to Perseus (i) a Note
      (the
“Second Tranche Note”) in the principal amount of the investment amount,
      convertible into a number of shares of our common stock at the Second Tranche
      Conversion Price (as defined below), subject to adjustment upon certain
      conditions, and (ii) a Warrant to purchase a number of shares of our common
      stock equal to 30% of the shares of our common stock into which the Second
      Tranche Note is convertible, at an exercise price per share equal to the Second
      Tranche Conversion Price, subject to adjustment upon certain conditions (the
      “Second Tranche Warrant”). The “Second Tranche Conversion Price” will equal the
      lesser of (i) 150% of the conversion price then in effect with respect to the
      First Tranche Note, and (ii) the market price of our common stock measured
      in
      accordance with the terms of the Securities Purchase Agreement. The Second
      Tranche Conversion Price is subject to anti-dilution provisions in connection
      with certain future issuances of our securities at a lower price per share
      of
      common stock as well as adjustments for stock splits and similar actions. The
      Second Tranche Note will mature on the fifth anniversary of the date of the
      First Tranche Closing and will accrue interest at 8% per annum. Interest is
      payable in cash or though our issuance of an additional Note at our election,
      on
      the six-month anniversary of the date of the Second Tranche Closing and on
      each
      six-month period thereafter.




Each
      of
      the First Tranche Note and the Second Tranche Note will provide that if on
      any date that occurs 31 trading days after the date of issuance, the market
      price for our common stock, as determined in accordance with the terms and
      conditions of the Securities Purchase Agreement, exceeds 300% of the
      then-effective conversion price of each Note, then the entire principal amount
      and all accrued but unpaid interest under such Note will automatically convert
      into shares of our common stock at the then-effective conversion price (the
      “Mandatory Conversion Feature”).




The
      First
      Tranche Warrant and the Second Tranche Warrant are exercisable at any time
      after
      the issue date for a period of 8 years thereafter.




We
      have
      begun to act as a distributor of Omnilux® products of Photo Therapeutics in the
      United States. We have also leased additional office space in Carlsbad,
      California and sublet some of that space to Photo Therapeutics, Inc. as its
      previous lease was about to expire.




Further
      information on the acquisition and investment can be obtained from our Current
      Report filed on Form 8-K on August 4, 2008.




**Critical
      Accounting Policies**




There
      have been no changes to our critical accounting policies in the three and nine
      months ended September 30, 2008. Critical accounting policies and the
      significant estimates made in accordance with them are regularly discussed
      with
      our Audit Committee. Those policies are discussed under “Critical Accounting
      Policies” in our “Management’s Discussion and Analysis of Financial Condition
      and Results of Operations” included in Item 7 of our Annual Report on Form 10-K
      for the year ended December 31, 2007.




28




**Results
      of Operations**




***Revenues***




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007XTRAC
                Domestic Services
            
            $
            3,001,878
            
            $
            2,025,148
            
            $
            8,546,583
            
            $
            6,048,000International
                Dermatology Equipment Products
            
            
            1,096,853
            
            
            819,442
            
            
            2,963,031
            
            
            2,117,213Skin
                Care (ProCyte) Products
            
            
            3,627,940
            
            
            3,065,905
            
            
            10,327,189
            
            
            9,646,312Total
                Dermatology Revenues
            
            
            7,726,671
            
            
            5,910,495
            
            
            21,836,803
            
            
            17,811,525Surgical
                Products
            
            
            1,070,455
            
            
            1,112,176
            
            
            4,680,936
            
            
            3,730,107Total
                Surgical Revenues
            
            
            1,070,455
            
            
            1,112,176
            
            
            4,680,936
            
            
            3,730,107Total
                Revenues
            
            $
            8,797,126
            
            $
            7,022,671
            
            $
            26,517,739
            
            $
            21,541,632




Domestic
      XTRAC Segment




Recognized
      treatment revenue for the three months ended September 30, 2008 and 2007 for
      domestic XTRAC procedures was $1,967,748 and $1,716,383, respectively,
      reflecting billed procedures of 36,079 and 27,858, respectively. In addition,
      1,800 and 1,229 procedures were performed in the three months ended September
      30, 2008 and 2007, respectively, without billing from us, in connection with
      clinical research and customer evaluations of the XTRAC laser. Recognized
      treatment revenue for the nine months ended September 30, 2008 and 2007 for
      domestic XTRAC procedures was $5,870,803 and $4,711,075, respectively,
      reflecting billed procedures of 98,374 and 80,651, respectively. In addition,
      4,449 and 3,677 procedures were performed in the nine months ended September
      30,
      2008 and 2007, respectively, without billing from us, in connection with
      clinical research and customer evaluations of the XTRAC laser. The increase
      in
      procedures in the periods ended September 30, 2008 compared to the comparable
      periods in 2007 was largely related to our continuing progress in securing
      favorable reimbursement policies from private insurance plans and to our
      increased marketing programs. Increases in procedures are dependent upon
      building market acceptance through marketing programs with our physician
      partners and their patients that the XTRAC procedures will be of clinical
      benefit and be generally reimbursed.




We
      have a
      program to support certain physicians who may be denied reimbursement by private
      insurance carriers for XTRAC treatments. In accordance with the requirements
      of
      Staff Accounting Bulletin No. 104, we recognize service revenue during this
      program from the sale of XTRAC procedures or equivalent treatments to physicians
      participating in this program only to the extent the physician has been
      reimbursed for the treatments. For the three months ended September 30, 2008,
      we
      deferred net revenues of $15,496 (238 procedures) under this program compared
      to
      $19,494 (300 procedures) for the three months ended September 30, 2007. For
      the
      nine months ended September 30, 2008, we deferred net revenues of $74,343 (1,139
      procedures) under this program compared to $173,369 (2,650 procedures) for
      the
      nine months ended September 30, 2007. The change in deferred revenue under
      this
      program is presented in the table below.




For
      the
      three and nine months ended September 30, 2008, domestic XTRAC laser sales
      were
      $1,034,130 and $2,675,780, respectively. There were 21 and 51 lasers sold,
      respectively. For the three and nine months ended September 30, 2007 domestic
      XTRAC laser sales were $308,765 and $1,336,925, respectively. There were 5
      and
      28 lasers sold, respectively. Included in the three and nine months ended
      September 30, 2008 laser sales was a sale of one Omnilux ® product
      for which we are now a distributor. Laser sales are made for various reasons,
      including costs of logistical support and customer preferences. We are finding
      that through sales of lasers we are able to reach, at reasonable margins, a
      sector of the market that is better suited to a sale model than a per-procedure
      model.




29


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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Total
                revenue
            
            $
            3,001,878
            
            $
            2,025,148
            
            $
            8,546,583
            
            $
            6,048,000Less:
                laser sales revenue
            
            
            (1,034,130
            )
            
            (308,765
            )
            
            (2,675,780
            )
            
            (1,336,925
            )Recognized
                treatment revenue
            
            
            1,967,748
            
            
            1,716,383
            
            
            5,870,803
            
            
            4,711,075Change
                in deferred programRevenue
            
            
            15,496
            
            
            19,494
            
            
            74,343
            
            
            173,369Change
                in deferred unusedTreatments
            
            
            367,199
            
            
            71,893
            
            
            474,877
            
            
            392,635Net
                billed revenue
            
            $
            2,350,443
            
            $
            1,807,770
            
            $
            6,420,023
            
            $
            5,277,079Procedure
                volume total
            
            
            37,879
            
            
            29,087
            
            
            102,823
            
            
            84,328Less:
                Non-billed procedures
            
            
            1,800
            
            
            1,229
            
            
            4,449
            
            
            3,677Net
                billed procedures
            
            
            36,079
            
            
            27,858
            
            
            98,374
            
            
            80,651Avg.
                price of treatments billed
            
            $
            65.15
            
            $
            64.89
            
            $
            65.26
            
            $
            65.43Change
                in procedures with deferred program revenue, net
            
            
            238
            
            
            300
            
            
            1,139
            
            
            2,650Change
                in procedures with deferred unused treatments, net
            
            
            5,636
            
            
            1,108
            
            
            7,277
            
            
            6,001




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




International
      Dermatology Equipment Segment




International
      sales of our XTRAC and VTRAC systems and related parts were $1,096,853 for
      the
      three months ended September 30, 2008 compared to $819,442 for the three months
      ended September 30, 2007. We sold 25 and 15 systems in the three month periods
      ended September 30, 2008 and 2007, respectively. International sales of our
      XTRAC and VTRAC systems were $2,963,031 for the nine months ended September
      30,
      2008 compared to $2,117,213 for the nine months ended September 30, 2007. We
      sold 63 and 40 systems in the nine months ended September 30, 2008 and 2007,
      respectively. The average price of dermatology equipment sold internationally
      varies due to the quantities of refurbished domestic XTRAC systems and VTRACs
      sold. Both of these products have lower average selling prices than new XTRAC
      laser systems. However, by adding these to our product offerings along with
      expanding into new geographic territories where the products are sold, we have
      been able to increase overall international dermatology equipment
      revenues.




·
            We
                sell refurbished domestic XTRAC laser systems into the international
                market. The selling price for used equipment is substantially less
                than
                new equipment, some of which may be substantially depreciated in
                connection with its use in the domestic market. We sold two and six
                such
                used lasers in the three and nine months ended September 30, 2008,
                respectively, at an average price of $32,500 and $31,667, respectively.
                We
                sold one and four such lasers in the three and nine months ended
                September
                30, 2007, respectively, at an average price of $44,790 and $36,197,
                respectively; and




·
            In
                addition to the XTRAC laser system (both new and used) we sell the
                VTRAC,
                a lamp-based, alternative UVB light source that has a wholesale sales
                price that is below our competitors’ international dermatology equipment
                and below our XTRAC laser. In the three and nine months ended September
                30, 2008, we sold nine and nineteen VTRAC systems respectively. In
                the
                three and nine months ended September 30, 2007, we sold one and ten
                VTRAC
                systems, respectively.




30




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Revenues
            
            $
            1,096,853
            
            $
            819,442
            
            $
            2,963,031
            
            $
            2,117,213Less:
                part sales
            
            
            (138,853
            )
            
            (112,152
            )
            
            (530,031
            )
            
            (381,223
            )Laser/lamp
                revenues
            
            
            958,000
            
            
            707,290
            
            
            2,433,000
            
            
            1,735,990Laser/lamp
                systems sold
            
            
            25
            
            
            15
            
            
            63
            
            
            40Average
                revenue per laser/lamp
            
            $
            38,320
            
            $
            47,153
            
            $
            38,619
            
            $
            43,400




Skin
      Care (ProCyte) Segment




For
      the
      three months ended September 30, 2008, ProCyte revenues were $3,627,940 compared
      to $3,065,905 in the three months ended September 30, 2007. For the nine months
      ended September 30, 2008, ProCyte revenues were $10,327,189 compared to
      $9,646,312 in the nine months ended September 30, 2007. ProCyte revenues are
      generated from the sale of various skin, hair care and wound products, from
      the
      sale of copper peptide compound and from royalties on licenses, mainly from
      Neutrogena.




Bulk
      compound sales decreased by $80,000 for the nine months ended September 30,
      2008
      compared to the nine months ended September 30, 2007. Minimum contractual
      royalties from Neutrogena expired in November 2007 and as such the royalties
      decreased $73,387 and $220,200 for the three and nine months ended September
      30,
      2008, respectively, compared to the same periods in the prior year.




·
            Included
                in Product sales for the three months ended September 30, 2008 were
                $1,139,204 of revenues from MD Lash Factor, an eyelash conditioning
                product, as part of an exclusive license to distribute in the United
                States. For the nine months ended September 30, 2008, there were
                $2,247,038 revenues from MD Lash Factor. In the comparable periods
                in 2007
                there were only $257,124 revenues as the product was launched in
                August
                2007. The supply chain for this product remains threatened through
                litigation brought by Allergan. We understand that the domestic supplier
                for a key ingredient in the product has settled with Allergan and
                undertaken to cease supplying such ingredient domestically to our
                licensor. This could disrupt, or even interdict, our ability to be
                timely
                and reliably supplied with the product.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Product
                sales
            
            $
            3,530,327
            
            $
            2,894,905
            
            $
            10,066,389
            
            $
            9,085,312Bulk
                compound sales
            
            
            96,000
            
            
            96,000
            
            
            256,000
            
            
            336,000Royalties
            
            
            1,613
            
            
            75,000
            
            
            4,800
            
            
            225,000Total
                ProCyte revenues
            
            $
            3,627,940
            
            $
            3,065,905
            
            $
            10,327,189
            
            $
            9,646,312




31




Surgical
      Products Segment




Surgical
      Products revenues include revenues derived from the sale of surgical laser
      systems together with sales of related laser fibers and laser disposables.
      Laser
      fibers and laser disposables are more profitable than laser systems, but the
      sales of laser systems create the recurring revenue stream from fibers and
      disposables.




For
      the
      three months ended September 30, 2008, surgical products revenues were
      $1,070,455 compared to $1,112,176 in the three months ended September 30, 2007.
      For the nine months ended September 30, 2008, surgical products revenues were
      $4,680,936 compared to $3,730,107 in the nine months ended September 30, 2007.
      The increase in the nine-month periods was mainly due to our OEM contract with
      AngioDynamics, which had initial shipments in December 2007. Recently, however,
      AngioDynamics purchased the assets of a competitive diode laser, and if it
      elects to source its diodes through the assets which it has purchased, our
      future sales of diode lasers to AngioDynamics may be severely limited. Sales
      to
      AngioDynamics were $0 for the three months ended September 30, 2008. Sales
      to
      AngioDynamics were $1.4 million for the nine months ended September 30, 2008.
      There were no comparable sales in the prior year period.




The
      change in average price per laser between the periods, as set forth in the
      table
      below, was largely due to the mix of lasers sold and partly due to the trade
      level at which the lasers were sold (i.e. wholesale versus retail). Our diode
      laser has replaced our Nd:YAG laser, which had a higher sales price. Included
      in
      laser sales during the three months ended September 30, 2008 and 2007 were
      sales
      of 7 and 19 diode lasers, respectively. Included in laser sales during the
      nine
      months ended September 30, 2008 and 2007 were sales of 130 and 47 diode lasers,
      respectively. The diode lasers have lower sales prices than our other types
      of
      lasers, and thus the increase in the number of diodes sold reduced the average
      price per laser. We expect that we will continue to sell more diode lasers
      than
      our other types of lasers into the near future.




Fiber
      and
      other disposables sales decreased 3% between the comparable nine-month periods
      ended September 30, 2008 and 2007. We expect that our disposables base may
      erode
      over time as hospitals continue to seek outsourcing solutions instead of
      purchasing lasers and related disposables for their operating rooms.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Revenues
            
            $
            1,070,455
            
            $
            1,112,176
            
            $
            4,680,936
            
            $
            3,730,107Laser
                systems sold
            
            
            8
            
            
            19
            
            
            134
            
            
            55Laser
                system revenues
            
            $
            171,393
            
            $
            285,995
            
            $
            2,080,133
            
            $
            1,120,035Average
                revenue per laser
            
            $
            21,424
            
            $
            15,052
            
            $
            15,523
            
            $
            20,364




***Cost
      of Revenues***




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




Product
      cost of revenues for the three months ended September 30, 2008 was $2,828,986,
      compared to $2,154,567 in the comparable period in 2007. The $674,419 increase
      is due to the increases in product cost of sales for domestic XTRAC laser sales
      in the amount of $271,321 and international dermatology equipment sales in
      the
      amount of $130,569, both due to an increased number of laser sales. In addition,
      there was an increase in product costs in skincare products of $385,258 due
      to
      increased product sales. These increases were offset, in part, by a decrease
      in
      surgical products of $112,729.




32




Product
      cost of revenues for the nine months ended September 30, 2008 was $8,682,917
      compared to $6,703,251 for the nine months ended September 30, 2007. The
      increase of $1,979,666 is proportionate to the increase in product cost of
      sales
      for domestic XTRAC laser sales in the amount of $590,315, international
      dermatology equipment sales in the amount of $441,553 and surgical products
      of
      $449,807, all due to increased number of laser sales. In addition, there was
      an
      increase in product costs in skincare products of $497,991 due to increased
      product sales.




Services
      cost of revenues was $1,240,670 in the three months ended September 30, 2008
      compared to $982,786 in the comparable period in 2007 representing an increase
      of $257,884. The increase is directly related to the increase in Domestic XTRAC
      segment costs of $257,506.




Services
      cost of revenues was $3,539,872 in the nine months ended September 30, 2008
      compared to $2,979,536 in the comparable period in 2007 representing an increase
      of $560,336. The increase is directly related to the increase in Domestic XTRAC
      segment costs of $560,049.




Certain
      allocable XTRAC manufacturing overhead costs are charged against the XTRAC
      service revenues. The manufacturing facility in Carlsbad, California is used
      exclusively for the production of the XTRAC lasers. The unabsorbed costs are
      allocated to the domestic XTRAC and the international dermatology equipment
      segments based on actual production of lasers for each segment. Included in
      these allocated manufacturing costs are unabsorbed labor and direct plant costs.




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




Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Product:XTRAC
                Domestic
            
            $
            406,612
            
            $
            135,291
            
            $
            1,076,295
            
            $
            485,980International
                DermatologyEquipment
            
            
            586,865
            
            
            456,296
            
            
            1,493,553
            
            
            1,052,000Skin
                Care
            
            
            1,288,946
            
            
            903,688
            
            
            3,429,410
            
            
            2,931,419Surgical
                products
            
            
            546,563
            
            
            659,292
            
            
            2,683,659
            
            
            2,233,852Total
                Product costs
            
            $
            2,828,986
            
            $
            2,154,567
            
            $
            8,682,917
            
            
            6,703,251Services:XTRAC
                Domestic
            
            $
            1,213,448
            
            $
            955,942
            
            $
            3,458,349
            
            $
            2,898,300Surgical
                products
            
            
            27,222
            
            
            26,844
            
            
            81,523
            
            
            81,236Total
                Services costs
            
            $
            1,240,670
            
            $
            982,786
            
            $
            3,539,872
            
            $
            2,979,536Total
                Costs of Revenues
            
            $
            4,069,656
            
            $
            3,137,353
            
            $
            12,222,789
            
            $
            9,682,787




***Gross
      Profit Analysis***




Gross
      profit increased to $4,727,470 during the three months ended September 30,
      2008
      from $3,885,318 during the same period in 2007. As a percent of revenues, gross
      margin decreased to 53.7% for the three months ended September 30, 2008 from
      55.3% for the same period in 2007.




Gross
      profit increased to $14,294,950 during the nine months ended September 30,
      2008
      from $11,858,845 during the same period in 2007. As a percent of revenues,
      gross
      margin decreased to 53.9% for the nine months ended September 30, 2008 from
      55.1% for the same period in 2007.




33


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




**Company
                Profit Analysis**
            
            Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Revenues
            
            $
            8,797,126
            
            $
            7,022,671
            
            $
            26,517,739
            
            $
            21,541,632Percent
                increase
            
            
            25.3
            %
            
            
            
            
            23.1
            %Cost
                of revenues
            
            
            4,069,656
            
            
            3,137,353
            
            
            12,222,789
            
            
            9,682,787Percent
                increase
            
            
            29.7
            %
            
            
            
            
            26.2
            %Gross
                profit
            
            $
            4,727,470
            
            $
            3,885,318
            
            $
            14,294,950
            
            $
            11,858,845Gross
                margin percentage
            
            
            53.7
            %
            
            55.3
            %
            
            53.9
            %
            
            55.1
            %




The
      primary reasons for the changes in gross profit and the gross margin percentage
      for the three months ended September 30, 2008, compared to the same period
      in
      2007 were as follows




·
            XTRAC
                Domestic deferred revenues increased $291,308 between the periods
                without
                any offset in the cost of revenues which is consistent with a
                procedures-based model.




·
            We
                sold approximately $725,000 worth of additional domestic XTRAC lasers
                in
                the three months ended September 30, 2008 at higher margins compared
                to
                the same period in 2007. Certain of these lasers were previously
                being
                depreciated, since they were previously placements. The margin on
                these
                capital equipment sales was 61% in 2008 compared to 56% in
                2007.




·
            We
                sold a greater number of XTRAC treatment procedures in 2008 than
                in 2007.
                An incremental treatment procedure sold to any particular customer
                carries
                negligible variable cost. The increase in procedure volume was a
                direct
                result of improving insurance reimbursement and increased marketing
                efforts.






The
      primary reasons for the changes in gross profit and the gross margin percentage
      for the nine months ended September 30, 2008, compared to the same period in
      2007 were as follows




·
            An
                increase in depreciation of $394,400 included in the XTRAC Domestic
                cost
                of sales as a result of increasing the overall placements.




·
            XTRAC
                Domestic deferred revenues decreased $16,304 between the periods
                without
                any offset in the cost of revenues which is consistent with a
                procedures-based model.




·
            We
                sold approximately $1,339,000 worth of additional domestic XTRAC
                lasers in
                the nine months ended September 30, 2008 at lower margins compared
                to the
                same period in 2007. Certain of these lasers were previously being
                depreciated, since they were previously placements. The margin on
                these
                capital equipment sales was 60% in 2008 compared to 64% in
                2007.




·
            We
                sold a greater number of XTRAC treatment procedures in 2008 than
                in 2007.
                An incremental treatment procedure sold to any particular customer
                carries
                negligible variable cost. The increase in procedure volume was a
                direct
                result of improving insurance reimbursement and increased marketing
                efforts.




34




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




**XTRAC
                Domestic Segment**
            
            Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Revenues
            
            $
            3,001,878
            
            $
            2,025,148
            
            $
            8,546,583
            
            $
            6,048,000Percent
                increase
            
            
            48.2
            %
            
            
            
            
            41.3
            %Cost
                of revenues
            
            
            1,620,060
            
            
            1,091,233
            
            
            4,534,644
            
            
            3,384,280Percent
                increase
            
            
            48.5
            %
            
            
            
            
            34.0
            %Gross
                profit
            
            $
            1,381,818
            
            $
            933,915
            
            $
            4,011,939
            
            $
            2,663,720Gross
                margin percentage
            
            
            46.0
            %
            
            46.1
            %
            
            46.9
            %
            
            44.0
            %




Gross
      profit increased for this segment for the three and nine months ended September
      30, 2008 from the comparable periods in 2007 by $447,903 and $1,348,219,
      respectively. In addition to the overall higher revenues between the periods,
      other key factors for the increases were as follows:




·
            XTRAC
                Domestic deferred revenues increased $291,308 between the three-month
                periods without any offset in the cost of revenues which is consistent
                with a procedures-based model. XTRAC Domestic deferred revenues decreased
                $16,304 between the nine-month periods without any offsetting reduction
                in
                the cost of revenues which is consistent with a procedures-based
                model.




·
            We
                sold approximately $725,000 worth of additional domestic XTRAC lasers
                in
                the three months ended September 30, 2008 at higher margins compared
                to
                the same period in 2007. Certain of these lasers were previously
                being
                depreciated, since they were previously placements. The margin on
                these
                capital equipment sales was 61% in the three months ended September
                30,
                2008 compared to 56% in the comparable three- month period in 2007.
                We
                sold approximately $1,339,000 worth of additional domestic XTRAC
                lasers in
                the nine months ended September 30, 2008 at lower margins compared
                to the
                same period in 2007. Certain of these lasers were previously being
                depreciated, since they were placements. The margin on these capital
                equipment sales was 60% in the nine months ended September 30, 2008
                compared to 64% in the comparable six-month period in
                2007.




·
            The
                cost of revenues increased by $528,827 for the three months ended
                September 30, 2008. This increase is due to an increase in depreciation
                on
                the lasers-in-service of $87,500 and an increase in cost of revenues
                related to the laser sales of $271,300 over the comparable prior
                three-month period. In addition, there were increases in certain
                allocable
                XTRAC manufacturing overhead costs that are charged against the XTRAC
                service revenues. The depreciation costs will continue to increase
                in
                subsequent periods as the business
                grows.




·
            The
                cost of revenues increased by $1,150,364 for the nine months ended
                September 30, 2008. This increase is due to an increase in depreciation
                on
                the lasers-in-service of $394,400 and an increase in cost of revenues
                related to the laser sales of $590,300 over the comparable prior
                nine-month period. The depreciation costs will continue to increase
                in
                subsequent periods as the business
                grows.




·
            Key
                drivers in increasing the fee-per-procedure revenue from this segment
                are
                insurance reimbursement and increased direct-to-consumer advertising
                in
                targeted territories. Improved insurance reimbursement, together
                with
                greater consumer awareness of the XTRAC therapy, increase treatment
                revenue accordingly. Our clinical support specialists focus their
                efforts
                on increasing physicians’ utilization of the XTRAC laser system.
                Consequently procedure volume increased 30% from 27,858 to 36,079
                billed
                procedures in the three months ended September 30, 2008 compared
                to the
                same period in 2007. Procedure volume increased 22% from 80,651 to
                98,374
                billed procedures in the nine months ended September 30, 2008 compared
                to
                the same period in 2007. Price per procedure did not change significantly
                between the periods. Each incremental treatment procedure carries
                negligible variable cost.




35




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




**International
                Dermatology**
              **Equipment
                Segment**
            
            Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Revenues
            
            $
            1,096,853
            
            $
            819,442
            
            $
            2,963,031
            
            $
            2,117,213Percent
                increase
            
            
            33.9
            %
            
            
            
            
            39.9
            %Cost
                of revenues
            
            
            586,865
            
            
            456,296
            
            
            1,493,553
            
            
            1,052,000Percent
                increase
            
            
            28.6
            %
            
            
            
            
            42.0
            %Gross
                profit
            
            $
            509,988
            
            $
            363,146
            
            $
            1,469,478
            
            $
            1,065,213Gross
                margin percentage
            
            
            46.5
            %
            
            44.3
            %
            
            49.6
            %
            
            50.3
            %




Gross
      profit for the three and nine months ended September 30, 2008 increased by
      $146,842 and $404,265, respectively, from the comparable periods in 2007. The
      key factors for the increase were as follows:




·
            We
                sold 16 XTRAC laser systems and 9 VTRAC lamp-based excimer systems
                during
                the three months ended September 30, 2008 and 14 XTRAC laser systems
                and 1
                VTRAC system in the comparable period in 2007. Consequently, gross
                profit
                increased as a result of an increase in the volume of units sold.
                The
                gross margin percentage for the VTRAC is higher than the
                XTRAC.




·
            We
                sold 44 XTRAC laser systems and 19 VTRAC lamp-based excimer systems
                during
                the nine months ended September 30, 2008 and 30 XTRAC laser systems
                and 10
                VTRAC systems in the comparable period in 2007. Consequently, gross
                profit
                increased as a result of an increase in the volume of units sold.
                The
                gross margin percentage for the VTRAC is higher than the
                XTRAC.




·
            International
                part sales, which have a higher margin percentage than system sales,
                increased for the three and nine months ended September 30, 2008
                by
                approximately $27,000 and $149,000, respectively compared to the
                same
                period in 2007.




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




**Skin
                Care (ProCyte) Segment**
            
            Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Product
                revenues
            
            $
            3,530,327
            
            $
            2,894,905
            
            $
            10,066,389
            
            $
            9,085,312Bulk
                compound revenues
            
            
            96,000
            
            
            96,000
            
            
            256,000
            
            
            336,000Royalties
            
            
            1,613
            
            
            75,000
            
            
            4,800
            
            
            225,000Total
                revenues
            
            
            3,627,940
            
            
            3,065,905
            
            
            10,327,189
            
            
            9,646,312Product
                cost of revenues
            
            
            1,220,594
            
            
            835,336
            
            
            3,247,138
            
            
            2,699,497Bulk
                compound cost of revenues
            
            
            68,352
            
            
            68,352
            
            
            182,272
            
            
            231,922Total
                cost of revenues
            
            
            1,288,946
            
            
            903,688
            
            
            3,429,410
            
            
            2,931,419Gross
                profit
            
            $
            2,338,994
            
            $
            2,162,217
            
            $
            6,897,779
            
            $
            6,714,893Gross
                margin percentage
            
            
            64.5
            %
            
            70.5
            %
            
            66.8
            %
            
            69.6
            %




36




Gross
      profit increased for the three and nine months ended September 30, 2008 from
      the
      comparable periods by $176,777 and $182,886, respectively. In addition to higher
      revenues between the periods, other key factors for the increases were as
      follows:




·
            The
                decrease in gross margin percentage is related to the product mix
                of
                revenues. For the three months ended September 30, 2008 and 2007
                product
                revenues include $1,139,204 and $257,124, respectively, under a licensing
                agreement which are manufactured by a third-party supplier. The margin
                of
                these licensed products has a lower margin than other brands which
                we
                distribute.




·
            For
                the nine months ended September 30, 2008 and 2007 product revenues
                include
                $2,247,038 and $257,124, respectively, of products which are manufactured
                by a third-party supplier in conjunction with a licensing agreement.
                The
                margin of these licensed products has a lower margin than other brands
                which we distribute.




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




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




**Surgical
                Products Segment**
            
            Three
                Months Ended
              September
                30,
            
            Nine
                Months Ended
              September
                30,2008
            
            2007
            
            2008
            
            2007Revenues
            
            $
            1,070,455
            
            $
            1,112,176
            
            $
            4,680,936
            
            $
            3,730,107Percent
                (decrease)/increase
            
            
            (3.8
            %)
            
            
            
            
            25.5
            %Cost
                of revenues
            
            
            573,785
            
            
            686,135
            
            
            2,765,182
            
            
            2,315,088Percent
                (decrease)/ increase
            
            
            (16.4
            %)
            
            
            
            
            19.4
            %Gross
                profit
            
            $
            496,670
            
            $
            426,041
            
            $
            1,915,754
            
            $
            1,415,019Gross
                margin percentage
            
            
            46.4
            %
            
            38.3
            %
            
            40.9
            %
            
            37.9
            %




Gross
      profit for the Surgical Products segment in the three and nine months ended
      September 30, 2008 compared to the same periods in 2007 increased by $70,629
      and
      $500,735, respectively. The key factors impacting gross profit were as
      follows:




·
              This
                  segment includes product sales of surgical laser systems and laser
                  disposables. Disposables are more profitable than laser systems,
                  but the
                  sale of laser systems generates the subsequent recurring sale of
                  laser
                  disposables.
  ·
              Revenues
                  for the three months ended September 30, 2008 decreased by $41,721
                  from
                  the three months ended September 30, 2007 while cost of revenues
                  decreased
                  by $112,350 between the same periods. There were 11 less laser
                  systems
                  sold in the three months ended September 30, 2008 than in the comparable
                  period of 2007. However, the lasers sold in the 2008 period were
                  at higher
                  prices than those sold in the comparable period in 2007. The increase
                  in
                  average price per laser was largely due to the mix of lasers sold
                  and
                  volume discounts. Included in the laser sales for the three months
                  ended
                  September 30, 2008 and 2007 were sales of $111,000, representing
                  7
                  systems, and $286,000, representing 19 systems, of diode lasers,
                  respectively, which have substantially lower list sales prices
                  than the
                  other types of surgical lasers.
  ·
              Revenues
                  for the nine months ended September 30, 2008 increased by $950,829
                  from
                  the nine months ended September 30, 2007 while cost of revenues
                  increased
                  by $450,094 between the same periods. There were 79 more laser
                  systems
                  sold in the nine months ended September 30, 2008 than in the comparable
                  period of 2007. However, the lasers sold in the 2007 period were
                  at higher
                  prices than those sold in the comparable period in 2008. The decrease
                  in
                  average price per laser was largely due to the mix of lasers sold
                  and
                  volume discounts. Included in the laser sales for the nine months
                  ended
                  September 30, 2008 and 2007 were sales of $1,870,000, representing
                  130
                  systems, and $686,000, representing 47 systems, of diode lasers,
                  respectively, which have substantially lower list sales prices
                  than the
                  other types of surgical lasers. The sales of diode systems included
                  100
                  sales due to our OEM arrangement. Despite the lower average sales
                  price of
                  the laser systems sold compared to the prior year, the higher
                  manufacturing levels in 2008 caused better absorption of fixed
                  overheads
                  thereby lowering average unit costs resulting in a higher gross
                  margin in
                  2008 compared to 2007.
  ·
              Additionally
                  there was a decrease in sales of disposables between the periods.
                  Disposables, which have a higher gross margin as a percent of revenues
                  than lasers. Fiber and other disposables sales decreased 3% between
                  the
                  comparable nine-month periods ended September 30, 2008 and 2007.
  37
  **Selling,
        General and Administrative Expenses**
  For
        the
        three months ended September 30, 2008, selling, general and administrative
        expenses increased to $6,209,101 from $5,377,955 for the three months ended
        September 30, 2007 for the following reasons:
  ·
              The
                  majority of the increase related to a $636,000 increase in salaries,
                  benefits and travel expenses associated with an increase in the
                  sales
                  force, marketing programs and increased revenues which generate
                  higher
                  commission expense, particularly in the Domestic XTRAC and SkinCare
                  segments.
  For
        the
        nine months ended September 30, 2008, selling, general and administrative
        expenses increased to $18,459,602 from $16,523,894 for the nine months ended
        September 30, 2007 for the following reasons:
  ·
              The
                  majority of the increase related to a $2,400,000 increase in salaries,
                  benefits and travel expenses associated with an increase in the
                  sales
                  force, marketing programs and increased revenues which generate
                  higher
                  commission expense, particularly in the Domestic XTRAC and SkinCare
                  segments;
  ·
              These
                  increases were offset, in part, by a lawsuit settlement for reimbursement
                  of legal costs of $345,000 and a decrease in option expense of
                  $110,000.
  ***Engineering
        and Product Development***
  Engineering
        and product development expenses for the three months ended September 30,
        2008
        increased to $224,236 from $202,163 for the three months ended September
        30,
        2007. Engineering and product development expenses for the nine months ended
        September 30, 2008 increased to $881,268 from $603,636 for the nine months
        ended
        September 30, 2007. The increase for the nine months was due to meeting our
        financial sponsorship obligations in March 2008 for the severe psoriasis
        study
        by John Koo, MD, of the University of California at San Francisco, of $189,000.
        During the 2008 and 2007 periods, the engineers at the Carlsbad plant were
        primarily focused on manufacturing efforts, and therefore, their costs have
        been
        reflected in cost of goods sold.
  ***Interest
        Expense, Net***
  Net
        interest expense for the three months ended September 30, 2008 increased
        to
        $251,883, as compared to $141,562 for the three months ended September 30,
        2007.
        Net interest expense for the nine months ended September 30, 2008 increased
        to
        $761,020, as compared to $379,947 for the nine months ended September 30,
        2007.
        The change in net interest expense was the result of the interest earned
        on cash
        reserves in the three and nine months ended September 30, 2007 due to the
        equity
        financing in November 2006, which offset interest expense in those periods
        due
        to draws on the line of credit during the fourth quarter of 2007 and the
        first,
        second and third quarters of 2008. The following table illustrates the change
        in
        interest expense, net:
  Three
                  Months EndedSeptember
                  30, 2008
              
              September
                  30, 2007
              
              ChangeInterest
                  expense
              
              $
              276,590
              
              $
              236,728
              
              $
              39,862Interest
                  income
              
              
              (24,707
              )
              
              (95,166
              )
              
              70,459Net
                  interest expense
              
              $
              251,883
              
              $
              141,562
              
              $
              110,321
  Nine
                  Months EndedSeptember
                  30, 2008
              
              September
                  30, 2007
              
              ChangeInterest
                  expense
              
              $
              892,932
              
              $
              700,383
              
              $
              192,549Interest
                  income
              
              
              (131,913
              )
              
              (320,436
              )
              
              188,523Net
                  interest expense
              
              $
              761,019
              
              $
              379,947
              
              $
              381,072
  38
  ***Net
        Loss***
  The
        aforementioned factors resulted in a net loss of $1,787,505 during the three
        months ended September 30, 2008, as compared to a net loss of $1,652,972
        during
        the three months ended September 30, 2007, an increase of 8.1%. The
        aforementioned factors resulted in a net loss of $5,936,669 during the nine
        months ended September 30, 2008, as compared to a net loss of $5,372,211
        during
        the nine months ended September 30, 2007, an increase of 10.5%. The three
        months
        ended September 30, 2008 included a change in the loss on sale of discontinued
        operations of $131,186. The nine months ended September 30, 2008 included
        a loss
        on sale of discontinued operations of $414,658.
  The
        following table illustrates the impact of major expenses, namely depreciation,
        amortization and stock option expense between the periods:
  For
                  the three months ended September 30,2008
              
              2007
              
              ChangeNet
                  loss
              
              $
              1,787,505
              
              $
              1,652,972
              
              $
              134,533Select
                  major expenses included in net loss:Depreciation
                  and amortization
              
              
              1,038,428
              
              
              1,231,111
              
              
              (192,683
              )Stock-based
                  compensation
              
              
              382,228
              
              
              395,058
              
              
              (12,830
              )Total
                  select major expenses
              
              $
              1,420,656
              
              $
              1,626,169
              
              
              ($205,513
              )
  For
                  the Nine months ended September 30,2008
              
              2007
              
              ChangeNet
                  loss
              
              $
              5,936,669
              
              $
              5,372,211
              
              $
              564,458Select
                  major expenses included in net loss:Depreciation
                  and amortization
              
              
              3,447,891
              
              
              3,563,026
              
              
              (115,135
              )Stock-based
                  compensation
              
              
              1,087,699
              
              
              1,197,150
              
              
              (109,451
              )Total
                  select major expenses
              
              $
              4,535,590
              
              $
              4,760,176
              
              
              ($224,586
              )
  ***Liquidity
        and Capital Resources***
  We
        have
        historically financed our operations with cash provided by equity financing
        and
        from lines of credit and, more recently, occasionally from positive cash
        flows
        from operations.
  At
        September 30, 2008, our current ratio was 1.54 compared to 2.20 at December
        31,
        2007. As of September 30, 2008, we had $7,511,538 of working capital compared
        to
        $13,705,775 as of December 31, 2007. Cash and cash equivalents were $6,808,793
        as of September 30, 2008, as compared to $9,954,303 as of December 31, 2007.
        We
        had $78,000 and $117,000 of cash that was classified as restricted as of
        September 30, 2008 and December 31, 2007, respectively.
  39
  We
        believe that our existing cash balance together with our other existing
        potential financial resources and any revenues from sales and distribution,
        will
        be sufficient to meet our operating and capital requirements beyond the end
        of
        fourth quarter of 2009. The 2008 operating plan reflects anticipated growth
        from
        both increased fee revenues for use of the XTRAC system based on increased
        utilization of the XTRAC by physicians and on wider insurance coverage in
        the
        United States. In addition, the 2008 operating plan calls for increased revenues
        and profits from our Skin Care business, much of which will be based on new
        products recently introduced into the market.
  On
        December 31, 2007, we entered into a term-note credit facility from CIT
        Healthcare and Life Sciences Capital (collectively “CIT”). The credit facility
        has a commitment term of one year, expiring on December 31, 2008. We account
        for
        each draw as funded indebtedness, with ownership in the lasers remaining
        with
        us. CIT holds a security interest in the lasers and in their revenue streams.
        Each draw against the credit facility has a repayment period of three years,
        except for legacy components from GE and Leaf in the first draw. The facility
        was amended to permit us to make a fourth draw of $1.9 million in the third
        quarter of 2008; Life Sciences Capital did not participate in the fourth
        draw. The
        Company has used its entire availability under the CIT credit facility and
        is
        considering multiple written proposals, including from CIT, for additional
        debt
        financing, however, no assurance can be given that any such proposal will
        materialize on terms favorable to us. We also have proposal from Perseus,
        LLC to
        fund $5 million of working capital as part of the first tranche of the
        convertible debt contemplated for its acquisition of Photo Therapeutics.
        A
        summary of the terms and activity under the CIT credit facility is presented
        in
        Note 9, “ *Long-term
        Debt* ”,
        of the
        Financial Statements included in this Report.
  Net
        cash
        and cash equivalents used in operating activities - continuing operations
        was
        $95,661 for the nine months ended September 30, 2008 compared to cash used
        of
        $1,450,090 for the nine months ended September 30, 2007. The decrease was
        mostly
        due to the increases in accounts payable and other accrued liabilities offset,
        in part, by increases in accounts receivables.
  Net
        cash
        and cash equivalents used in investing activities - continuing operations
        was
        $4,082,859 for the nine months ended September 30, 2008 compared to $3,268,379
        for the nine months ended September 30, 2007. This was primarily for the
        placement of lasers into service.
  When
        we
        retire a laser from service, we transfer the laser into inventory and then
        write
        off the net book value of the laser, which is typically negligible. Over
        the
        last few years, in fact, the retirements of lasers from service have been
        minor
        or immaterial and, therefore, they are reported with placements on a net
        basis.
  Net
        cash
        and cash equivalents used in financing activities was $1,013,091 for the
        nine
        months ended September 30, 2008 compared to $201,005 for the nine months
        ended
        September 30, 2007. In the nine months ended September 30, 2008 we repaid
        $272,316 on the lease and term-note lines of credit, net of advances and
        $779,775 for the payment of certain notes payable and capital lease
        obligations.
  ***Commitments
        and Contingencies***
  Except
        for items discussed in ***Legal
        Proceedings*** below,
        during the three and nine months ended September 30, 2008, there were no
        other
        items that significantly impacted our commitments and contingencies as discussed
        in the notes to our 2007 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.
  40
  **ITEM
        4. Controls and Procedures**
  ***Evaluation
        of Disclosure Controls and Procedures***
 
 Our
        management, with the participation of our Chief Executive Officer and Chief
        Financial Officer, evaluated the effectiveness of our disclosure controls
        and
        procedures as of the end of the period covered by this Report. Based on that
        evaluation, the Chief Executive Officer and Chief Financial Officer concluded
        that our disclosure controls and procedures as of the end of the period covered
        by this Report are effective such that information required to be disclosed
        by
        us in reports filed under the Securities Exchange Act of 1934 is (i) recorded,
        processed, summarized and reported within the time periods specified in the
        Securities and Exchange Commission’s rules and forms and (ii) accumulated and
        communicated to our management, including the Chief Executive Officer and
        Chief
        Financial Officer, as appropriate to allow timely decisions regarding
        disclosure.
 
 ***Change
        in Internal Control Over Financial Reporting***
 
 No
        change
        in our internal control over financial reporting occurred during the three
        and
        nine months ended September 30, 2008 that has materially affected, or is
        reasonably likely to materially affect, our internal control over financial
        reporting.
  **PART
        II - Other Information**
  **ITEM
        1. Legal Proceedings**
  Reference
        is made to Item 3, ***Legal
        Proceedings*** ,
        in our
        Annual Report on Form 10-K for the year ended December 31, 2007 for descriptions
        of our legal proceedings.
  In
        the
        matter brought by the Company in January 2004 against Ra Medical Systems,
        Inc.
        and Dean Irwin in the United States District Court for the Southern District
        of
        California, we appealed from the new judge’s grant of summary judgment to the
        defendants. All parties have filed their briefs with the Ninth Circuit of
        Appeals, and we continue to await a date for oral argument.
  In
        the
        matter which Ra Medical brought against the Company in June 2006 for unfair
        competition and which the Company removed to the United States District Court
        for the Southern District of California, the Company has filed a new notice
        of
        appeal to the Ninth Circuit from the new judge's dismissal, among other things,
        of the Company's counterclaims of misappropriation. Our opening brief on
        appeal
        is currently due January 20, 2009. Ra Medical filed a motion for summary
        adjudication in the District Court on its sole claim that we had violated
        provisions of the California Health & Safety Code and thus violated Section
        17200 of the California Business & Professions Code. The District Court has
        partially granted that motion, finding as a matter of fact which requires
        no
        further proof that we operated our business for a period of time without
        the
        required licensing under California law. The plaintiffs, however, failed
        to
        prove that the lack of such a license constituted unfair competition under
        Section 17200. We are in process of bringing our own motion for summary judgment
        that our actions did not amount to unfair competition under that section
        of the
        California Code.
  In
        the
        patent infringement suit brought in November 2007, Allergan, Inc. brought
        an
        infringement suit under the Johnstone ‘105 patent against PhotoMedex, Inc., as
        well as against a number of other co-defendants, in the United States District
        Court for the Central District of California. Allergan has also amended its
        complaint, alleging that PhotoMedex and others have also infringed its US
        Patent
        No. 7,351,404, the Woodward ‘404 patent and that ProCyte Corporation infringes
        both the ‘105 and ‘404 patents. Discovery continues in the case at considerable
        cost. We understand that the co-defendant domestic supplier for a key ingredient
        in the product has settled with Allergan and undertaken to cease supplying
        such
        ingredient domestically to our licensor. We are concerned that this could
        disrupt, or interdict, our ability to be timely and reliably supplied with
        the
        product.
  In
        the
        patent infringement action brought in February 2008 by Cardiofocus, Inc.
        against
        PhotoMedex, Inc., as well as against a number of other co-defendants, we
        have
        settled the matter with Cardiofocus on July 16, 2008, on terms fair and
        favorable to us.
  41
  In
        the
        patent infringement action brought by Bella Bella, Inc. against a number
        of
        companies, including PhotoMedex, Inc. and ProCyte Corporation, in the United
        States District Court for the Central District of California, plaintiff’s
        attorneys have allowed the case to be dismissed without prejudice on July
        11,
        2008.
  We
        are
        involved in certain other legal actions and claims arising in the ordinary
        course of business. We believe, based on discussions with legal counsel,
        the
        above litigation and claims will likely be resolved without a material effect
        on
        our consolidated financial position, results of operations or
        liquidity.
  **ITEM
        1A. Risk Factors**
  In
        response to turmoil in the stock markets in October 2008, Nasdaq has suspended,
        until January 16, 2009, the enforcement of its minimum bid requirement. We
        expect that Nasdaq will issue a delisting notice to us on January 22, 2009
        if we
        have not regained compliance by that time.
  Consummation
        of the acquisition of Photo Therapeutics is contingent on obtaining financing
        for it. The proposed financing from Perseus is contingent on approval of
        our
        stockholders not only of the terms of that financing, but also of a reverse
        split of our shares and of an increase in the number of our authorized shares
        of
        common stock. We have filed a preliminary proxy with the SEC to effect these
        and
        other matters; the SEC has elected to review our proxy, and this review will
        have the likely effect of moving the necessary meeting of stockholders into
        2009.
  Current
        economic conditions may cause a decline in business and consumer spending
        which
        could adversely affect our business and financial performance. Our operating
        results are impacted by the health of the North American economies. Our business
        and financial performance, including collection of our accounts receivable,
        realization of inventory, recoverability of assets including investments,
        may be
        adversely affected by current and future economic conditions, such as a
        reduction in the availability of credit, financial market volatility, recession,
        etc. Additionally, we may experience difficulties in scaling our operations
        to
        react to economic pressures in the United States.
  **ITEM
        5. Other Information**
  The
        SEC
        has elected to review our preliminary proxy filing, filed October 2, 2008.
        We
        are in the process of responding to the SEC’s comments. It will be impracticable
        to hold the Stockholders’ meeting in November 2008; it is uncertain whether we
        will be able to hold a meeting for non-routine matters by December 31,
        2008.
  **ITEM
        6. Exhibits**
  10.43
              Asset
                  Purchase Agreement, dated August 1, 2008, by and between PhotoMedex,
                  Inc.
                  and PRI Medical Technologies, Inc., filed August 4, 2008, on Form
                  8-K
                  Current Report.10.44
              Purchase
                  Agreement, dated August 4, 2008, by and among PhotoMedex, Inc.,
                  Photo
                  Therapeutics Group Limited and Neil Crabb, filed August 4, 2008,
                  on Form
                  8-K Current Report.10.45
              Securities
                  Purchase Agreement, dated August 4, 2008, by and between PhotoMedex,
                  Inc.
                  and Perseus Partners VII, LP, filed August 4, 2008 on Form 8-K
                  Current
                  Report.31.1
              Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer31.2
              Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.1
              Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 200232.2
              Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002
  42
  **SIGNATURES**
 
 Pursuant
        to the requirements of the Securities Act of 1934, the registrant has duly
        caused this Report to be signed on its behalf by the undersigned, thereunto
        duly
        authorized.
  PHOTOMEDEX,
                INC.Date:
                November 7,
                2008
              By:
              /s/ Jeffrey
                F. O’DonnellJeffrey
                  F. O’Donnell
                President
                  and Chief Executive Officer
  Date: November
                7, 2008
              By:
              /s/ Dennis
                M.
                McGrathDennis
                  M. McGrath
                Chief
                  Financial Officer
  43