		Page
Part I

Item 1.	Business	1
Item 1A.	Risk Factors	18
Item 1B.	Unresolved Staff Comments	30
Item 2.	Properties	30
Item 3.	Legal Proceedings	31
Item 4.	Submission of Matters to a Vote of Security Holders	32

Part II

Item 5.	Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	32
Item 6.	Selected Financial Data	34
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	36
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	56
Item 8.	Financial Statements and Supplementary Data	56
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	56
Item 9A.	Controls and Procedures	56
Item 9B.	Other Information	57

Part III

Item 10.	Directors, Executive Officers and Corporate Governance	58
Item 11.	Executive Compensation	63
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	74
Item 13.	Certain Relationships and Related Transactions and Director Independence	76
Item 14.	Principal Accountant Fees and Services	76

Item IV

Item 15.	Exhibits and Financial Statement Schedules	77
	Signatures	81

Certain statements in this Annual Report on Form 10-K, 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 discussed under "Risk Factors." We undertake no obligation to update such forward- looking statements.

The Domestic XTRAC® segment derives revenues principally from procedures performed by dermatologists in the United States. Our XTRAC system is generally placed in a dermatologist’s office without any initial capital cost and then we charge a fee-per-use to treat skin disease. On occasion, however, we sell XTRAC lasers to customers, due generally to customer circumstances and preferences. Our 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 segment generates revenues by selling physician-dispensed skincare products worldwide and by earning royalties on licenses for our patented copper peptide compound.

The XTRAC laser system is designed and manufactured by us to phototherapeutically treat psoriasis, vitiligo, atopic dermatitis and leukoderma. We have secured specific 510(k) clearances from the United States Food and Drug Administration to market the XTRAC laser system for treatment of these conditions. Our first XTRAC phototherapy treatment systems were commercially distributed in the United States in August 2000 prior to any of its procedures being approved for medical insurance reimbursement. In the last several years, we have sought to obtain reimbursement for psoriasis and other inflammatory skin disorders. As a result of initiatives undertaken by the Company and the physician community, the ability for physicians to process claims efficiently and with positive payment decisions for use of the XTRAC system improved significantly during the latter part of 2005 and 2006. The XTRAC is approved by Underwriters’ Laboratories; it is also CE-marked, and accordingly a third party; regularly audits our quality system and manufacturing facility. Our manufacturing facility for the XTRAC is located in Carlsbad, California.

Our short-term goal is to establish the XTRAC system as a preferred treatment modality for psoriasis and other inflammatory skin disorders through persuasive clinical evidence and widespread private healthcare reimbursement. Our acquisition of ProCyte has added a skincare business to our Company and provided a broadened complementary product line marketed to the same customer base through a national sales force and marketing organization. Our longer-term goal is to be a world-class provider of the highest-quality, cost-effective, medical technologies, including phototherapy and surgical procedures delivered in doctors’ offices, hospitals and surgical centers. The following are the key elements of our strategy:

Establish Our XTRAC System as a Preferred Treatment Modality for Psoriasis and Other Inflammatory Skin Disorders. Several opinion leaders in the dermatological community have endorsed our XTRAC system as a preferred treatment modality for the majority of psoriasis and vitiligo patients. We are using these endorsements to accelerate the acceptance of our XTRAC system among dermatologists. We have also developed a set of medical practice tools, such as patient education videos, patient letters, sample press releases, point-of-sale displays and other advertising literature, to assist dermatologists in marketing our XTRAC system. As a result of improved reimbursement together, with the infusion of additional equity capital in November 2006, we have expanded our sales force, clinical specialists and marketing initiatives.

Achieve Widespread Private Healthcare Reimbursement. The Centers for Medicare and Medicaid Services (CMS) published national Medicare rates, effective March 1, 2003, for the newly established laser reimbursement codes for inflammatory skin disorders such as psoriasis. We mailed a data compendium of clinical and economic evidence establishing the XTRAC system as safe, efficacious, and cost-effective, to virtually all insurance plans in the United States between December 2003 and February 2004. A critical component of the mailing was a psoriasis health economic study, which concluded that the overall clinical impact of the XTRAC system has proven to be outstanding for expected treatment-free days and remission days. Further, the data compendium stated the expected costs are lower than those for other phototherapies and comparable to the most commonly used second-step topical alternatives. Because total expected annual per-patient costs, with or without the XTRAC system, are equivalent for patients who start on combination first-step therapy, payers bear no incremental procedure cost if the excimer laser is included in the overall mix of second-step care. The economic and clinical data contained therein supports the establishment of medical policies by private healthcare reimbursement plans for the treatment of mild to moderate psoriasis. As of March 15, 2007, we estimate that approximately 80% of people in the United States who are covered by a health insurance program have plans that reimburse for the treatment of psoriasis by means of the XTRAC system. We are continuing to try to develop wider private healthcare reimbursement arrangements through this marketing effort, but can give you no assurances to increasing such arrangements.

Build Broad Consumer Awareness Program to Attract Those Not Currently Seeking Treatment. Of the 7 million people in the United States who have been diagnosed with psoriasis, only about 1.5 million seek regular care. We believe that many do not seek care, largely due to the frustration caused by the limited effectiveness, inconvenience and negative side effects of treatment alternatives other than treatment with the XTRAC system. We have expended funds in print, radio and/or internet advertising to educate this frustrated segment of the population about how our XTRAC system enables more convenient and effective psoriasis treatment. As a result of recent substantive improvement in regional insurance reimbursement, we have initiated direct-to-consumer advertising efforts in targeted geographic regions that have benefited by this improvement. We are continually to evaluate the cost-effectiveness of the various components of the program.

Increase Installed Base of Our XTRAC Systems by Minimizing Economic Risk to the Dermatologists. In the United States, we generally place our XTRAC system in dermatologists' offices on a fee-per-use basis to the physician. This creates an opportunity for dermatologists to utilize our system without any up-front capital costs, thereby eliminating an inherent economic risk to them. Occasionally, favorable economic circumstances influence our decision to sell the laser system directly to dermatologists. Longer term, we also intend to market our XTRAC system on a fee-per-use basis outside of the United States in combination with continuing to sell XTRAC systems directly to dermatologists in foreign markets through distributors.

Sell the XTRAC System in Foreign Countries to be Utilized to Treat Patients on a Wider Basis. We have entered into a number of distribution relationships or agreements with respect to the sale of the XTRAC system on an international basis. We have chosen this marketing approach over a direct marketing approach because of the varying economic, regulatory, insurance reimbursement and selling channel environments outside of the United States. We intend to enter into additional agreements in other countries. However, we cannot be certain that our international distributors will be successful in marketing the XTRAC system outside of the United States or that our distributors will purchase more than the minimum contractual requirements or expected purchase levels under these agreements or relationships. Our international strategy also includes placing XTRAC systems with dermatologists to provide us a usage-based revenue stream. To date, no units have been placed in international markets that provide a usage-based revenue stream. In addition, we have added a non-laser based product line to our international offering, called the VTRAC™. This product line is a result of licensed technologies from Stern Laser srl, our distributor in Italy. The purpose of this product offering is to provide a best-in-class non-laser purchase option to compete against lower-priced lamp-based international competitors.

In March 2001, the FDA granted 501(k) clearance to market our XTRAC system for the treatment of vitiligo. In 2006, we secured exclusive rights to U.S. Patent No. 6,979,327, from the Mount Sinai School of Medicine. The patent covers, among other things, treatment of vitiligo by means of an excimer laser system. Vitiligo is a disease in which the skin loses pigment due to destruction of the pigment cells, causing areas of the skin to become lighter in color than adjacent healthy skin. This condition can be distressing to patients. Between 1% and 2% of the population suffers from the condition, and there is no known cure. The principal conventional treatments for symptoms are PUVA radiation and, to a lesser extent, topical steroids and combination therapies. According to the National Vitiligo Foundation, or NVF, the cost of PUVA treatments, over a 12 to 18 month period, can run $6,000 or more and involve 120 clinic visits. Moreover, according to the NVF, current conventional treatment methods are unsatisfactory and many patients tend to lose the pigment they were successful in gaining through PUVA therapy. Our XTRAC system can effectively re-pigment a patient's skin, allowing treated areas to become homogeneous in pigment to healthy surrounding skin and restore the patient's skin to its original condition. As treatment levels of psoriasis increase, we intend to promote use of the XTRAC for treatment of vitiligo. As part of that promotion, we shall explore whether CPT codes specific to vitiligo can be established as well as whether CMS and/or private insurance plans will establish reimbursement rates for the treatment of vitiligo.

In August 2001, the FDA granted 510(k) clearance to market our XTRAC system for the treatment of atopic dermatitis. Atopic dermatitis is a common, potentially debilitating condition that can compromise the quality of life for those it affects. The condition appears as chronic inflammation of the skin that occurs in persons of all ages, but is reported to be more common in children. Skin lesions observed in atopic dermatitis vary greatly, depending on the severity of inflammation, different stages of healing, chronic scratching and frequent secondary infections. It is reported that atopic dermatitis affects some 10% of children in the United States alone, and more than $364 million is spent annually in the treatment of this disease. Treatment options include corticosteroids, which can have negative side effects, and UVB phototherapy. The use of UVB phototherapy in the treatment of atopic dermatitis has been shown effective in published studies. Because of the controlled and targeted application provided by our XTRAC system, large areas of healthy skin are not exposed to UVB light from the XTRAC system and the corresponding potentially carcinogenic effect of other phototherapy treatments. We believe that the XTRAC system could be an alternative protocol for treating atopic dermatitis effectively. However, we do not intend to undertake clinical research that would clarify such an alternative protocol until we have secured our primary goal - wider private-payer reimbursement and increased treatment levels for psoriasis.

In May 2002, the FDA granted 510(k) clearance to market our XTRAC system for the treatment of leukoderma, commonly known as white spots, and skin discoloration from surgical scars, stretch marks, burns or injury from trauma. The XTRAC system utilizes UVB light to stimulate melanocytes, or pigment cells, deep in the skin. As these cells move closer to the outer layer of skin, re-pigmentation occurs. As with atopic dermatitis, we do not intend to undertake further clinical research for leukoderma that would clarify such an alternative protocol until we have secured our primary goal - wider private-payer reimbursement and treatment levels for psoriasis.

Our XTRAC system combines the technology of an excimer laser, or "cold" laser system (already in use for a variety of medical and cosmetic treatments), with the use of ultraviolet light therapy. The XTRAC system applies a concentrated dose of UVB radiation directly to diseased skin at a higher intensity than traditional ultraviolet light therapy. Our XTRAC system utilizes a 308-nm light wavelength, which studies have shown to be the optimal wavelength to treat psoriasis effectively. Our XTRAC system consists of the laser, which is mobile, and a hand piece attached to the laser by a liquid light guide or by a fiber optic cable, which are designed to permit direct application of the ultraviolet light and an aiming beam to psoriasis-affected skin. The XTRAC comes optionally with an adjustable hand-piece that can decrease the spot size of the operating beam to permit precise, operator-controlled irradiation of tissue.

Between March 1998 and November 1999, we initiated five seminal clinical trials of our XTRAC system at Massachusetts General Hospital. Our objective in these clinical trials was to compare our XTRAC laser technology with standard ultraviolet light therapy in the treatment of psoriasis. In January 2000, we received a 510(k) clearance to market the XTRAC system from the FDA based on the clinical results from these trials. The Massachusetts General Hospital clinical trial, which involved 13 patients, concluded that our XTRAC laser made it possible to treat psoriasis effectively in one session with moderately long remission. The study also concluded that the number of treatments to remission depended largely on the intensity of the ultraviolet light used, finding that medium intensities seemed to provide the best results with a superior balance between quick clearing and patient comfort. We supported the clinical trials with research grants of approximately $954,000.

Psoriasis is believed to be a non-contagious, autoimmune medical disorder and a chronic inflammatory skin disease diagnosed in more than 7 million Americans and between 1% and 3% of the world's population. There is no known cure for psoriasis. Although clinical symptoms and severity vary greatly between individuals over periods of time, psoriasis appears most commonly as inflamed swollen lesions covered with silvery white scales. Psoriasis patients often suffer from debilitating and painful swelling, itching, bleeding, cracking and burning, resulting in decreased mobility, depression and low self-esteem. The National Psoriasis Foundation, or NPF, estimates that, in the United States, dermatologists treat over 1.5 million psoriasis patients each year.

While the exact cause of the disease remains unknown, the emerging consensus among scientists and physicians characterizes psoriasis as an autoimmune medical disorder in which excessive "T" cell stimulation in skin cells activates an inflammatory response and excessive skin cell production. The disease causes the rate at which skin cells are produced and pushed to the outer skin layer to increase seven-fold, from every 28 days to every two to four days. The body cannot shed the skin cells fast enough and this process results in patches, or "lesions," forming on the skin's surface. Psoriasis cases are classified as mild (less than 2% of the body's surface area affected and usually localized on the knees, elbows, scalp, hands and feet), moderate (between 2% and 10% of the body's surface area affected and usually appearing on the arms, legs, torso and head) and severe (greater than 10% of the body's surface area affected and potentially involving all areas of the skin). Our initial target market is patients with mild to moderate psoriasis that represent 80% of all psoriasis cases.

For the past five years, we have sought to clear the path of obstacles and barriers to a smooth and orderly roll-out of the XTRAC system in dermatology. In 2000, the technology, which was originally designed for cardiology applications, was found to have significant therapeutic advantages for psoriasis patients who were treated with the UVB light emitted from the excimer based laser system. For the first two years we invested in establishing the clinical efficacy of the product and mechanical reliability of the equipment. Starting in 2002, under the technical leadership of Jeffrey Levatter, Ph.D., our chief technical officer, we made numerous improvements and corrections to the design of the XTRAC laser system. In the last three years we pursued - and in a number of regions, have substantially achieved - widespread reimbursement commencing with obtaining newly created CPT reimbursement codes.

Treatment of psoriasis commonly follows a step approach with topical therapy as a first-step, phototherapy as second-step, and systemic medications reserved for when all other treatments fail. The clinical body of evidence developed by us and others supports the use of the 308-nm excimer laser as safe and effective for localized plaque-type psoriasis recalcitrant to other first-step therapies, such as topical creams and ointments. In addition, an economic analysis completed in December 2003 has demonstrated that the addition of excimer laser treatment results in no expected cost increase to the payer. Further, this analysis demonstrates the cost-effectiveness of the excimer laser is superior due to the increased number of expected disease-free days and remission days.

A dermatologist generally takes delivery of our XTRAC system under the terms of our standard usage agreement. Our agreements generally do not provide the dermatologist with any purchase options, but we may offer a purchase option when favorable economic conditions exist. Title to the lasers remains either in our name or in the name of a third-party who may hold title as collateral within the context of an equipment financing transaction. There is generally no fixed amount that is to be paid over pre-set intervals of time by a dermatologist. We reserve the right to remove the laser unit from a dermatologist’s office if the parties’ economic expectations from the onset of the placement are not borne out.

The dermatologist has the right to purchase pre-paid treatments, which are generally ordered telephonically and added to the laser’s computer by way of a random access code obtained from us and input by the dermatologist. These purchased treatments may be used for multiple treatments for the same or different patients, for psoriasis, vitiligo, atopic dermatitis or leukoderma. A single treatment is then deducted from the laser’s computer upon patient treatment. Payment for access codes is usually set for 60 days. The agreement does not provide for delay in payment based on third-party reimbursement. The dermatologists retain any revenue received from patients or their medical insurance providers.

Generally, dermatologists who treat psoriasis patients refer their patients to independent treatment centers for ultraviolet light or write prescriptions for topical creams or systemic drugs. In such cases, the physician does not ordinarily share in any of the revenue generated from providing treatments to the patient. However, physicians using our XTRAC system will treat the patient in their own office and, therefore, will retain revenue that would otherwise be lost to outside providers. In addition, in most states, a trained technician, rather than the physician, may apply the treatment under the physician’s supervision, thus allowing the dermatologist to continue treating other patients, while at the same time increasing revenue from treatments using our XTRAC system. We believe that this will create an attractive incentive for dermatologists to use our XTRAC system.

Our international dermatology equipment marketing plan is based on the sale of our XTRAC system and the newly developed VTRAC system through independent, exclusive distributors. We have relationships with distributors and end users in more than 30 countries in Europe, the Middle East, the Far East and Southeast Asia, and in Australia, South Africa and parts of Central and South America. We intend to expand our products in more countries in these markets. In the longer term, we anticipate developing relationships in some countries similar to those in the United States, whereby we, acting through our distributors, place a laser system in the doctor's office for free or at minimal cost and charge the doctor a per-treatment fee.

Our products address the growing demand for skin health and hair care products, including products designed to mitigate the effects aging has on the skin and hair and to enhance appearance. Our products are formulated, branded and targeted for specific markets. Our initial products were developed to be dispensed by physicians in the dermatology, plastic and cosmetic surgery markets for use following various medical procedures. Anti-aging skin care products were added to form a comprehensive approach for a patient’s skincare regimen. Certain of these products incorporate our patented technologies, while others complement the product line such as our advanced sunscreen products that reduce the effects of sun damage and aging on the skin.

Our products are well-suited for use in the medical specialties of dermatology, plastic and cosmetic surgery. Several recent studies presented at the American Academy of Dermatology and other medical symposia have confirmed the advantages of products containing copper peptide formulations versus such other formulations as tretinoin, vitamin C, and other popular anti-aging and skin rejuvenation products. The actions of wound care gels and creams containing copper peptide have been documented in the scientific literature for their ability to stimulate collagen synthesis, new blood vessel growth and tissue repair. This has led to the development of a variety of products designed to treat the skin following certain cosmetic procedures such as microdermabrasion, laser resurfacing and hair transplantation. There are an increasing number of these cosmetic procedures performed each year as the baby boomer population ages and has a strong desire to look good and feel good. We have a series of products tailored to the needs of these types of procedures, including the GraftCyte^® System and the Complex Cu₃^®System, and have developed a series of daily use products that contain our patented copper peptide compounds to aid in maintaining the quality of the skin and hair following these procedures.

Skin Care. Our GraftCyte System was created to address the special tissue repair needs of patients following hair transplant surgery. This system continues to be the only complete solution addressing post-procedure care in the hair restoration market. We have continued to emphasize our Complex Cu₃^® Post Laser Lotion, Intensive Repair Crème, Cleanser and Hydrating Gel products used to treat patients following chemical peels, microdermabrasion and laser treatments. The Complex Cu₃ products provide a comprehensive approach to post-procedure care and allow us to differentiate our line of skincare products on the basis of our proprietary copper peptide technologies. Studies have indicated that the skin heals quicker with the use of copper peptide compounds.

We launched the successful Neova^® Therapy line of anti-aging products in response to demand from physician customers for a comprehensive approach to medically directed skincare. The Neova Therapy line of GHK Copper Peptide Complex^® products showcase elegant moisturizers and serums complemented by supporting cleansers, toners, and masks for an integrated approach to anti-aging skincare. Each year we have added new products to the product line, including Neova Microdermabrasion Scrub and Neova Therapy Crème de la Copper added in 2003 and the Neova Therapy Dual Action Lotion, a combination of GHK Copper Peptide Complex + Retinol in March 2004. The Neova Therapy line is designed to offer high-performance, cosmetically elegant lifestyle products that are premium-priced in the market.

Hair Care. We have marketed our Tricomin^® line of Triamino Copper Complex™-containing hair care products since 1998 (Tricomin Shampoos, Conditioners and Follicle Therapy Solution) as a program for the maintenance of thinning hair in men and women. Hair follicles require high concentrations of biological copper and the Tricomin products deliver copper along with amino acids for nourishing and stimulating the hair and scalp for improved health, strength and appearance. These products provide physicians with a non-drug alternative to the problem of thinning hair care for their patients. We also sell Tricomin products directly via the website, www.tricomin.com. We are currently working on the next generation of products to increase the effectiveness of the Triamino Copper Nutritional Complex™ delivery.

Chronic Wound Care. Our chronic wound care product, marketed under the Iamin^® name, has met with varying degrees of market success. The wound care market is highly fragmented, with many competitors, price constraints, and inadequate Medicare reimbursement. The wound care market also requires a significant investment in supporting a large sales organization. For these reasons, ProCyte had historically attempted to collaborate with partners to market its chronic wound care product and we will continue to do so. Additionally, we have looked for other methods of distribution and include Iamin as one of the products in the GraftCyte System used by patients following hair transplant surgery. A number of other programs have been initiated in an effort to increase utilization of the Iamin product; however, none have resulted in meaningful revenue increases to date.

We emphasize high-quality products and services, technical knowledge, and responsiveness to customer needs in our marketing activities. We educate our distributors, customers and prospective customers about our products through a series of detailed marketing brochures, technical bulletins and pamphlets, presentations, news releases and direct mail pieces. We also conduct a series of one-day educational symposia around the country to provide product updates and marketing ideas to current and potential physician customers. These activities are supplemented by advertising in industry publications, technical presentations, and exhibitions at over 30 local, national and international trade shows.

We have operated under a worldwide license agreement with Neutrogena Corporation, a Johnson & Johnson company (“Neutrogena”), for worldwide use of our patented copper peptide technology in products for skin health in the mass retail market. Our current license agreement continues until April 2010. Neutrogena develops, manufactures and markets skin and hair care products domestically and internationally. Neutrogena launched its two initial products using our technology under the brand name of Visibly Firm™ with Active Copper™ in April 2001. Since that time, it has continued to add new products using ProCyte’s patented copper peptide technology. We receive royalty payments, based on product sales by Neutrogena and revenue from the sale of the copper peptide compound used in Neutrogena’s products.

We market lasers used in surgery in such venues as hospitals, surgi-centers and doctors offices under the trademark of SLT and, to a lesser degree, the trade name of Surgical Innovations & Services. We market many of our surgical laser products using a similar business model to the marketing of our excimer laser products by charging a per-procedure fee, thereby limiting the initial outlay to the customer for capital expenditure, while ensuring continued revenue flow to us. We offer a wide range of laser services in various specialties, including urology, gynecology, orthopedics and general surgery. We are currently marketing such services under the trade name PhotoMedex Surgical Services. We also provide products that we manufacture for use in our surgical services business.

We also engage in the development, manufacture and sale of surgical products, including proprietary Contact and free-beam Laser Systems for surgery and in the provision of surgical services on a turnkey procedural basis. We introduced Contact Laser™ surgery by combining proprietary Contact Laser Delivery Systems with an Nd:YAG laser unit to create a multi-specialty surgical instrument that can cut, coagulate or vaporize tissue. Our Contact Laser Delivery Systems can be used effectively with any wavelength of laser between 532nm and 1064nm, including the KTP laser (532nm), diode laser (various wavelengths) and Nd:YAG laser (1064nm). We are currently marketing such products under the trade name PhotoMedex Surgical Products.

Our proprietary Contact Laser probe and scalpel surface treatments provide the ability to alter selectively the temperature profile of tissue, replicating the clinical effect of many different types of lasers. Through our patented Contact Laser Delivery Systems, we are able to produce a wide range of temperature gradients, which address a broad range of surgical procedures within multiple specialties. Our multiple-specialty capability reduces a hospital’s need to purchase several lasers to meet its specialists’ varied requirements. These factors, coupled with the precision, hemostasis, tactile feedback and control that our Contact Laser Delivery Systems provide, are our primary competitive strengths in surgical products.

Our Contact Laser Delivery Systems consist of proprietary fiberoptic delivery systems which deliver the laser beam from our Diode (or Nd:YAG) laser unit via an optical fiber to the tissue, either directly or through a proprietary Laser Probe or Laser Scalpel. These delivery systems can also be used with the laser systems of certain other manufacturers. Our holmium laser delivery systems consist of fiber-optic delivery systems, which deliver the laser beam from our CTH holmium laser unit to the surgical site. The CO2 laser system does not use a fiberoptic and therefore will have less of a recurrent revenue steam. However, we anticipate that in conjunction with sales of the CO2 laser, we will sell more of our CO2-related Unimax® accessories.

Most of our operations in surgical services are in the southeastern states of the United States. We also have operations in the Milwaukee, Wisconsin, Baltimore-Washington DC and Philadelphia, Pennsylvania areas. We intend to continue to expand the territory where we provide such services and shall explore how we may expand the range of surgical procedures which we can support. We see surgical services as a business with favorable prospects for revenue growth. In 2006, we entered a services contract with a nationwide consortium of hospitals which provides for a staged roll-out over the various regions of the consortium; we have begun the roll-out and are currently providing our services in the first region designated under the roll-out.

Laser Probes and Laser Scalpels. Our proprietary Laser Probes and Laser Scalpels are made of either synthetic sapphire or fused silica and have high mechanical strength, high melting temperature and appropriate thermal conductivity. Most of these Laser Probes and Laser Scalpels use our patented Wavelength Conversion Effect treatments. We offer more than 60 interchangeable Laser Probes and Laser Scalpels that provide different power densities through various geometric configurations appropriate for cutting, coagulation or vaporization. Our Laser Probes and Laser Scalpels are made with varying distal tip diameters and surface treatments, each with a different balance between cutting and coagulation, so that the instrument can be suited to the particular tissue effect desired. Additionally, but at much lesser volumes, we market side-firing and direct-firing free-beam laser probes. Instead of changing laser units, surgeons may choose a different Laser Probe or Laser Scalpel to perform a different procedure. The Laser Probes and Laser Scalpels can be re-sterilized and reused.

Laser Units. Our LaserPro Diode Laser System has replaced our CLMD line of Nd:YAG laser system. The CLMD line has been largely phased out, although we continue to handle maintenance and refurbishment of the existing base of Nd:YAG lasers. Like the Nd:YAG laser, the Diode lasers are designed for use with our Contact Laser Delivery Systems. The Diode laser unit can provide up to 20 watts of power to tissue. The laser has three versions, depending on which wavelength the user desires to be installed in the laser. The wavelengths are 810-nm, 940-nm and 980-nm. The laser unit is small and portable, but also is designed to be rugged and dependable. Acting as an original equipment manufacturer (OEM), we have provided the Diode laser to third parties to market in specialties lying outside our area of focus. We expect to cultivate additional relationships in the future.

We manufacture virtually all of our laser systems and laser delivery systems (other than those manufactured by other companies that are utilized in the provision of surgical services) at our Montgomeryville, Pennsylvania facility. The raw materials we use are generally available in adequate supply from multiple suppliers. We obtain all of our partially finished Laser Probes and Laser Scalpels from three suppliers in the United States. We perform materials processing and final assembly on the Laser Probes and Laser Scalpels using proprietary and patented treatment processes. We also manufacture the fiberoptic delivery systems, with and without handpieces. A domestic supplier manufactures our sterile gas and fluid cartridge systems on an exclusive basis in accordance with our specifications.

Our sale and post-sale support personnel includes regional managers and clinical support specialists and marketing and technical personnel. We train the regional managers and clinical support specialists in the utilization of our products and services, which allows them to provide clinical consultation regarding safety, efficacy and clinical protocols. Our marketing and technology personnel provide our link to the customer to create innovative solutions and identify new applications and product opportunities. In some areas of the United States, we use independent distributors to provide this support for surgical products.

We manufacture our phototherapy products at our new 8,000 sq. ft. facility in Carlsbad, California and our surgical products at our 42,000 sq. ft. facility in Montgomeryville, Pennsylvania. Our California and Pennsylvania facilities are ISO 13485 certified. We believe that our present manufacturing capacity at these facilities is sufficient to meet foreseeable demand for our products. We substantially outsource the manufacture of our Skin Care products. Our facility in Redmond, Washington is the final assembly center and primary warehouse for our skincare products, and likewise is operated in conformance with a quality system.

We manufacture most of our own components and utilize certain suppliers for the manufacture of selected standard components and subassemblies, which are manufactured, to our specifications. Most major components and raw materials, including optics and electro-optic devices, are available from a variety of sources. We conduct all final testing and inspection of our products. We have established a quality control program, including a set of standard manufacturing and documentation procedures intended to ensure that, where required, our instruments are manufactured in accordance with FDA Quality System Requirements and the comparable requirements of the European Community.

Patents and other proprietary rights are an element of our business. Our policy is to file patent applications and to protect technology, inventions and improvements to inventions that are commercially important to the development of our business. As patents expire and expose our inventions to public use, we seek to mitigate the impact of such expirations by improvements on the inventions embodied in the expiring patents. The patents in our Skin Care segment relate to use of our copper peptide-based technology for a variety of healthcare applications, and to the composition of certain biologically active, synthesized compounds. Our strategy has been to apply for patent protection for certain compounds and their discovered uses that are believed to have potential commercial value in countries that offer significant market potential. As of March 15, 2007, we have more than 120 domestic and foreign issued patents, which serve to help protect the technology of our businesses in phototherapy, skin health and hair care, and surgical products and services. To the same purpose, we have 40 patent applications pending in the United States and abroad. We have retrenched some applications where we do not foresee meaningful value to us.

We have licensed certain of our proprietary technology in phototherapy to Komatsu, Ltd. in connection with its manufacture of semi-conductor lithography equipment, for which we are entitled to receive royalty fees. We have licensed our copper peptide technology to Neutrogena, for which we currently receive royalties. Conversely, from time to time, we seek licenses from third parties for technology that can broaden our product and service offerings, as for example a license we secured from the Mount Sinai School of Medicine granted us for exclusive rights to a patent covering the use of excimer lasers in the treatment of vitiligo.

Our products and research and development activities are regulated by numerous governmental authorities, principally the Federal Food and Drug Administration or FDA and corresponding state and foreign regulatory agencies. Any device manufactured or distributed by us will be subject to pervasive and continuing regulation by the FDA. The Federal Food, Drug and Cosmetics Act and other federal and state laws and regulations govern the pre-clinical and clinical testing, design, manufacture, use and promotion of medical devices and drugs, including our XTRAC system, surgical lasers and other products currently under development by us. Product development and approval within this regulatory framework takes a number of years and involves the expenditure of substantial resources.

In the United States, medical devices are classified into three different classes, Class I, II and III, on the basis of controls deemed reasonably necessary to ensure the safety and effectiveness of the device. Class I devices are subject to general controls, such as labeling, pre-market notification and adherence to the FDA's good manufacturing practices, and quality system regulations. Class II devices are subject to general as well as special controls, such as performance standards, post-market surveillance, patient registries and FDA guidelines. Class III devices are those which must receive pre-market approval by the FDA to ensure their safety and effectiveness, such as life-sustaining, life-supporting and implantable devices, or new devices which have been found not to be substantially equivalent to legally marketed devices.

Before a new medical device can be marketed, marketing clearance must be obtained through a pre-market notification under Section 510(k) of the Food and Drug Modernization Act of 1997, or the FDA Act, or through a pre-market approval application under Section 515 of such FDA Act. The FDA will typically grant a 510(k) clearance if it can be established that the device is substantially equivalent to a predicate device that is a legally marketed Class I or II device or certain Class III devices. We have received FDA 510(k) clearance to market our XTRAC system for the treatment of psoriasis, vitiligo, atopic dermatitis and leukoderma. Additionally, the FDA has issued clearances to commercially market our Contact Laser System, including the laser unit, Laser Probes and Laser Scalpels and Fiberoptic Delivery Systems, in a variety of surgical specialties and procedures in gynecology, gastroenterology, urology, pulmonology, general and plastic surgery, cardio-thoracic surgery, ENT surgery, ophthalmology, neurosurgery and head and neck surgery. The FDA granted these clearances under Section 510(k) on the basis of substantial equivalence to other laser or electrosurgical cutting devices that had received prior clearances or were otherwise permitted to be used in such areas. The range of clearances for our Diode laser system is similar to the range of clearances for the CLMD Nd:YAG laser systems. We have also received FDA clearance under Section 510(k) to market our holmium laser system, including the laser unit and fiberoptic delivery systems, in a variety of surgical specialties and procedures in urology, otorhinolaryngology, discectomy and percutaneous laser disc decompression.

A pre-market approval application may be required if a proposed device is not substantially equivalent to a legally marketed Class I or II device, or for certain Class III devices. A pre-market approval application must be supported by valid scientific evidence to demonstrate the safety and effectiveness of the device, typically including the results of clinical trials, bench tests and laboratory and animal studies. In addition, the submission must include the proposed labeling, advertising literature and any training materials. The pre-market approval process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought by other companies have never been approved for marketing.

We are also subject to the Radiation Control for Health and Safety Act with laser radiation safety regulations administered by the Center for Devices and Radiological Health, or CDRH, of the FDA. These regulations require laser manufacturers to file new product reports and annual reports, to maintain quality control, product testing and sales records, to incorporate certain design and operating features in lasers sold to end users and to certify and label each laser sold, except those sold to private-label customers, as belonging to one of four classes, based on the level of radiation from the laser that is accessible to users. Various warning labels must be affixed and certain protective devices installed, depending on the class of product. The CDRH is empowered to seek fines and other remedies for violations of the regulatory requirements. To date, we have filed the documentation with the CDRH for our laser products requiring such filing, and have not experienced any difficulties or incurred significant costs in complying with such regulations.

We have received ISO 13485/EN46001 certification for our XTRAC system and our, Diode, holmium, CO2 and Nd:YAG laser systems. This certification authorizes us to affix a CE Mark to our products as evidence that they meet all European Community, or EC, quality assurance standards and compliance with applicable European medical device directives for the production of medical devices. This will enable us to market our approved products in all of the member countries of the European Union, or EU. We also will be required to comply with additional individual national requirements that are outside the scope of those required by the EU. Our products have also met the discrete requirements for marketing in various other countries. Failure to comply with applicable regulatory requirements can result in fines, injunctions, civil penalties, recalls or seizures of products, total or partial suspensions of production, refusals by foreign governments to permit product sales and criminal prosecution.

As to our products in the Skin Care business segment, the Federal Food, Drug and Cosmetic Act, and the regulations promulgated thereunder, and other federal and state statutes govern the testing, manufacture, safety, labeling, storage, record-keeping, advertising and promotion of cosmetic products as well. Our products and product candidates in the Skin Care segment may be regulated by any of a number of divisions of the FDA and in other countries by similar health and regulatory authorities. The process of obtaining and maintaining regulatory approvals for the manufacturing or marketing of our existing and potential skin care products is costly and time-consuming and is subject to unanticipated delays. Regulatory requirements ultimately imposed could also adversely affect our ability to clinically test, manufacture or market products.

In the United States, products that do not seek to make effectiveness claims based on human clinical evaluation may be subject to review and regulation under the FDA’s cosmetic, drug or 510(k) medical device guidelines. Similar guidelines exist for such products in other countries. Such 510(k) products, which include wound care dressings and certain ointments and gels, must show safety and substantial equivalency with predicate products already cleared by the FDA to be marketed. There can be no assurance that product applications submitted to the FDA or similar agencies in other countries will receive clearance to be marketed, or that the labeling claims sought will be approved, or that, if cleared, such products will be commercially successful or free from third-party claims relating to the effectiveness or safety of such products.

Our ability to market our phototherapy products successfully will depend in large part on the extent to which various third parties are willing to reimburse patients or providers for the cost of medical procedures utilizing our treatment products. These third parties include government authorities, private health insurers and other organizations, such as health maintenance organizations. Third-party payers are systematically challenging the prices charged for medical products and services. They may deny reimbursement if they determine that a prescribed device is not used in accordance with cost-effective treatment methods as determined by the payer, or is experimental, unnecessary or inappropriate. Accordingly, if less costly drugs or other treatments are available, third-party payers may not authorize or may limit reimbursement for the use of our products, even if our products are safer or more effective than the alternatives. Additionally, they may require changes to our pricing structure and revenue model before authorizing reimbursement.

Reimbursement systems in international markets vary significantly by country and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government-managed healthcare systems that control reimbursement for new devices and procedures. In most markets, there are private insurance systems, as well as government-managed systems. Our XTRAC products remain substantially without approval for reimbursement in any international markets under either government or private reimbursement systems. Reimbursement for the products and services provided by our Surgical Services and Surgical Products segments has been generally well-established and is not viewed as an obstacle to growth in those segments. Since the skincare products are primarily for cosmetic applications, reimbursement is not a critical factor in growing revenues for this product segment.

In 2006, we continued our efforts to secure private, third-party reimbursement in our domestic XTRAC business segment. Our efforts began in February 2002 when the Current Procedural Terminology Editorial Board of the American Medical Association, or AMA, approved the request by the American Academy of Dermatology to issue reimbursement codes for laser therapies in the treatment of psoriasis and other inflammatory skin diseases, which would include laser therapy using our XTRAC system to treat such conditions. In December 2002, the Centers for Medicare and Medicaid Services, or CMS, published the relative values and national Medicare reimbursement rates for each of the CPT codes. These reimbursement rates were effective January 1, 2003. However, they could not be paid sooner than March 1, 2003. The designation for laser treatment for inflammatory skin disease (psoriasis) was broken into three distinct codes, based on the total skin surface area being treated:

In addition to Medicare and Medicaid, consistent domestic private healthcare reimbursement is critical for significant growth in XTRAC system procedures. There were more than 89,000 XTRAC procedures in 2006, 60,000 XTRAC procedures in 2005 and more than 50,000 XTRAC procedures in 2004 with the majority being covered by third-party reimbursement. Historically, it has been our belief that a rapid increase in widespread adoption of private healthcare reimbursement was being thwarted by a perception that the XTRAC therapy, although widely publicized as clinically safe and efficacious, was not economically cost-effective compared to other existing therapies. We sponsored the completion of an economic and clinical study to review the clinical and economic effectiveness of the XTRAC laser as a second-step therapy for the treatment of psoriasis. The conclusions of the study are: there is no additional cost of adding XTRAC as second-line therapy in a managed care plan; XRAC is a cost-effective second-line treatment for mild-to-moderate plaque psoriasis; XTRAC provides the greatest number of treatment-free days in one year among all therapies, except for intralesional corticosteroid injections (“ICI”); XTRAC is the lowest cost per treatment-free-day with the exception of ICI; XTRAC has the lowest cost per remission day among all phototherapies; and XTRAC has the highest number of remission days among all therapies. The results of this study were compiled in a data compendium and distributed to all the major health insurers; the results have also been published in a peer-review journal. In 2005 substantive progress was made in connection with obtaining approvals for covering medically necessary targeted UVB therapy for psoriasis. As a result of certain national insurers approving the XTRAC excimer laser therapy in the latter part of 2005, we initiated– and have continued in 2006 – a direct-to-consumer advertising campaign in certain geographic regions.

We have been advised in February 2007 that the technology assessment branch of the Blue Cross Blue Shield Association has determined that among other things that phototherapy with the excimer laser is not experimental use in the treatment of up to 20% the skin surface area for psoriasis. We conjecture that this determination will positively influence some remaining subscribing private plans to cover treatment of psoriasis with the XTRAC laser. In addition, in 2007 a bill was introduced in Congress, at the urging of NPF, to increase the patient’s awareness of available treatments of psoriasis. This too should positively influence patients suffering from psoriasis to seek treatment.

The market for our XTRAC system is highly competitive. We compete with other products and methodologies used to treat the symptoms of psoriasis, vitiligo, atopic dermatitis and leukoderma, including topical treatments, systemic medications and other phototherapies. We believe that our XTRAC system will favorably compete with alternative treatments for these disorders primarily on the basis of its effectiveness, as well as on the basis of the lower out-of-pocket costs, as compared to costs associated with alternative treatments. Market acceptance of our XTRAC system treatment for these diseases is dependent on our ability to establish, with the medical and patient communities, the efficacy of our XTRAC system as a preferred treatment modality. In addition, all or a portion of patient costs for many of the alternative treatments are paid or are reimbursable by health insurance coverage or other third-party payers, such as Medicaid and Medicare. Patient costs for treatments utilizing our XTRAC system may not be initially eligible for health care coverage or reimbursement by third-party payers until such payers approve reimbursement. This may cause some patients or physicians to choose alternative treatments offered by our competitors.

Various other companies are now marketing laser-based phototherapy treatment products. One former competitor received FDA clearance to market an excimer laser for the treatment of psoriasis in the United States, and another competitor has asserted that it has such clearance - an assertion we are disputing. There have been at least three foreign-based companies which market an excimer laser for the treatment of skin disorders outside of the United States. Two others have developed pulse-dye lasers, which are being explored as treatments for psoriasis. Another company has announced FDA clearance for a standard UVB light-based system using a fiber-optic delivery system for the treatment of skin disorders. We expect that other devices will enter the market, too. All of these technologies will continue to evolve with time. We cannot say how much these technologies will impact us, but we anticipate that competitors that enter the US market will predominantly not use a fee-per-procedure model but will use an outright sales model, and will likely sell not on claims of superior quality, but on claims of lower prices and better economic returns.

Competition in the wound care, skin health and hair care markets is intense. Our competitors include well-established pharmaceutical, cosmetic and healthcare companies such as Obagi, La Roche Posay, Allergan, Pavonia, Declore and Murad. These competitors have substantially more financial and other resources, larger research and development staffs, and more experience and capabilities in researching, developing and testing products in clinical trials, in obtaining FDA and other regulatory approvals and in manufacturing, marketing and distribution than we do. In addition, a number of smaller companies are developing or marketing competitive products. Our competitors may succeed in developing and commercializing products or obtaining patent protection or other regulatory approvals for products more rapidly than we can. In addition, competitive products may be manufactured and marketed more successfully than our potential products. Such developments could render our existing or potential products less competitive or obsolete and could have a material adverse effect on our business, financial condition and results of operations.

In addition, we face competition from other surgical services companies and from product manufacturers who may offer their products through a similar per-procedure method. Additionally, we face substantial competition from well-established manufacturers of non-laser products. These well-established companies have substantially greater resources than we do and could exert considerable competitive pressure on us. We continue to monitor the concepts or products and services some companies have introduced into the market that draw on Contact Laser technology. We do not believe, however, that such concepts or products will have a significant impact on our sales.

As of March 15, 2007, we had 192 full-time employees, which consisted of 3 executive officers, 11 other senior officers or managers, 60 sales and marketing staff, 82 people engaged in manufacturing of lasers and laser-related products, 9 customer-field service personnel, 4 people engaged in research and development, 8 engineers and 15 finance and administration staff. We intend to hire additional personnel as the development of our business makes such action appropriate. The loss of the services of key employees could have a material adverse effect on our business. Since there is intense competition for qualified personnel knowledgeable in our industry, no assurances can be given that we will be successful in retaining and recruiting needed personnel.

Our future revenues and success depend significantly upon acceptance of our excimer laser systems for the treatment principally of psoriasis, but also of vitiligo, atopic dermatitis and leukoderma. Our XTRAC system for the treatment of these conditions generates revenues, but those revenues are presently insufficient to generate positive cash flows from our operations in the two XTRAC-related business segments. Our future revenues and success also depend on the continued growth of the revenue from the skin health and hair care products of our skincare products and of our surgical services business and revenue stability within our surgical products business. Our ability to market our products and services successfully and the expected benefits to be obtained from our products and services may be adversely affected by a number of factors, such as unforeseen costs and expenses, technological changes, economic downturns, competitive factors or other events beyond our control.

No independent studies with regard to the feasibility of our proposed business plan have been conducted by third parties with respect to our present and future business prospects and capital requirements. We have generated limited commercial distribution for our XTRAC system and our other products. Skincare products sales are dependent on existing strategic partners for distributing and marketing our products. We may be unsuccessful in continuing existing, or developing new, strategic partners in order to maintain or expand the markets for the skincare business’ existing or future products. Our surgical services may fail to gain market acceptance in new territories into which we expand. In addition, our infrastructure to enable such expansion, though stronger than in the past, is still limited. Even if adequate financing is available and our products are ready for market, we cannot assure you that our products and services will find sufficient acceptance in the marketplace to fulfill our long and short-term goals. Our efforts to help physicians increase patient awareness and interest in the XTRAC system may prove unavailing, as may also our efforts through our clinical specialists to improve and increase physicians’ effective utilization of the XTRAC system. We also face a risk that other companies, not necessarily direct competitors of ours, are vying for a dermatologist’s time and attention. If such other companies have products that require less time commitment from the dermatologist and yield an attractive return on the dermatologist’s time and investment (e.g. Botox injections may be such a product), we may find that our efforts to increase our base of users is hindered, or even if we place a laser with a dermatologist, we may find that insufficient time is devoted to increasing patient awareness of laser treatment of psoriasis. We therefore cannot assure you that the marketplace will be receptive to our excimer laser technology, skincare products, or our surgical services over competing products, services and therapies or that a cure will not be found for the underlying diseases we are focused on treating. Failure of our products and surgical services to achieve market acceptance could have a material adverse effect on our business, financial condition and results of operations.

While we have engaged in clinical studies for our psoriasis treatment, and based on these studies, we have gained FDA clearance, appropriate CPT reimbursement codes for treatment and suitable reimbursement rates from CMS for those codes, we may face other hurdles to market acceptance if, for example, practitioners in significant numbers wait to see longer-term studies or if it becomes necessary to conduct studies corroborating the role of the XTRAC system as a second-line therapy for treating psoriasis or if patients do not elect to undergo psoriasis treatment using the XTRAC system. We have not had sufficient time to observe the long-term effectiveness or potential side effects of our treatment system for psoriasis, vitiligo, atopic dermatitis or leukoderma nor to gauge what marketing and sales programs, if any, are effective in increasing patients’ demand for the treatment of psoriasis with the XTRAC system.

In 2003, we improved the reliability and functionality of the XTRAC system and upgraded such lasers both in the United States and overseas. In 2004, we obtained FDA 510(k) marketing clearance for a smaller, faster and more powerful XTRAC system known as the Ultra™. These efforts should help us gain market acceptance for the XTRAC system both in the United States and abroad, but do not guarantee such acceptance or that we may not encounter further problems in reliability. We have designed the XTRAC system to be user-friendly, such that a properly in-serviced medical technician in a physician’s office may, under the physician’s supervision, safely and effectively administer treatments to a patient. In fact, the CMS reimbursement rates are based on the lower labor rates achieved through such delegation. Nevertheless, whether a treatment may be delegated, and if so to whom and to what extent, are matters that may vary state by state, as these matters are within the province of the state medical boards. In states that may be more restrictive in such delegation, a physician may decline to adopt the XTRAC system into his or her practice, deeming it to be fraught with too many constraints and finding other outlets for the physician’s time and staff time to be more remunerative. There can be no assurance that we will be successful in persuading such medical boards that a liberal standard for delegation is appropriate for the XTRAC system, based on its design for ease and safety of use. If we are not successful, we may find that even if a geographic region has wide insurance reimbursement, the region’s physicians may yet balk at adopting the XTRAC system into their practices.

Our success will depend, in part, on our ability to maintain and defend our patents. However, we cannot give you any assurances that the technologies and processes covered by all of our patents may not be found to be obvious or substantially similar to prior work, which could render these patents unenforceable. Moreover, as our patents expire, competitors may utilize the technology found in such patents to commercialize their own laser systems. In offset to the expiring patents, we endeavor to secure additional patents on critical, commercially desirable improvements to the inventions of the expiring patents. There can be no assurance that we will be successful in securing such additional patents, or that such additional patents will adequately offset the effect of the expiring patents.

Of particular note is US Patent No. 4,891,818, the so-called “ ‘818 Patent”, which covers, among other things, the design of the gas chamber in the XTRAC laser. The ‘818 Patent will expire on August 31, 2007 and will thereafter no longer serve as a barrier to entry to the relatively reimbursement-rich US market. The additional patent rights we seek may serve less to bar competitors from entry and may serve more, when aggregated with other clinical and competitive strengths, to differentiate and distinguish our product (e.g. the Ultra), in both its utility and its range of applications, from those of competitors. We may therefore choose in the U.S. market to broaden our fee-per-procedure business model to include a standard direct sales option, as we have done and continue to do in the international market. Where a competitor infringes on our patent and other proprietary rights, we are prepared, our financial condition permitting, to defend those rights vigorously in the U.S. courts. If we unable through our technological innovations to preserve our proprietary rights, our ability to market the XTRAC system could be materially and adversely affected.

A U.S. patent relating to a copper peptide compound manufactured and used in products distributed by Neutrogena under the Neutrogena license agreement expired on February 5, 2005. Upon expiration of this patent, the agreement specifies that lower royalty percentages from sales of such products be used for the remaining term, the impact of which is a reduction in the average effective royalty rate. The actual amount of royalty income recognized in future periods is dependent upon the royalty percentages in effect during the period and the actual applicable sales reported by Neutrogena, which can vary from quarter to quarter. The expiration of the patent would also allow others, including Neutrogena, to apply the technology covered by that patent in their products.

Trade secrets and other proprietary information which are not protected by patents are also critical to our business. We attempt to protect our trade secrets by entering into confidentiality agreements with third parties, employees and consultants. However, these agreements can be breached and, if they are and even if we are able to prove the breach or that our technology has been misappropriated under applicable state law, there may not be an adequate remedy available to us. In addition, costly and time-consuming litigation may be necessary to enforce and determine the scope of our proprietary rights; even should we prevail in such litigation, the party we prevail over may have scant resources available to satisfy a judgment.

We cannot be sure that the products, services, technologies and advertising we employ in our business do not or will not infringe valid patents, trademarks, copyrights or other intellectual property rights held by third parties. We may be subject in the ordinary course of our business to legal proceedings and claims from time to time relating to the intellectual property or derivative rights of others. Any legal action against us claiming damages or seeking to enjoin commercial activities relating to the affected products or our methods or processes could have a material adverse effect on our business and prospects by:

Our ability to market the XTRAC system and other treatment products successfully will depend in large part on the extent to which various third parties are willing to reimburse patients or providers for the costs of medical procedures utilizing such products. These third parties include government authorities, private health insurers and other organizations, such as health maintenance organizations. Third-party payers are systematically challenging the prices charged for medical products and services. They may deny reimbursement if they determine that a prescribed device is not used in accordance with cost-effective treatment methods as determined by the payer, or is experimental, unnecessary or inappropriate. Further, although third-parties may approve reimbursement, such approvals may be under terms and conditions that discourage use of the XTRAC laser system. Accordingly, if less costly drugs or other treatments are available, third-party payers may not authorize or may limit reimbursement for the use of its products, even if our products are safer or more effective than the alternatives.

As of March 15, 2007, we estimate, based on published coverage policies and on payment practices of private and Medicare insurance plans, that approximately 80% of the insured population in the United States is covered by the insurance coverage or payment policies that reimburse physicians for using the XTRAC system for treatment of psoriasis. Based on these reports and estimates, we are continuing the implementation of a roll-out strategy for the XTRAC system in the United States in selected areas of the country where reimbursement is widely available. The success of the roll-out depends on increasing physician and patient demand for the treatment. We can give no assurance that health insurers will not adversely modify their reimbursement policies for the use of the XTRAC system in the future.

Cost containment measures instituted by healthcare providers and insurers and any general healthcare reform could affect our ability to receive revenue from the use of our XTRAC system or to market our skincare products, and surgical laser products, and may have a material adverse effect on us. We cannot predict the effect of future legislation or regulation concerning the healthcare industry and third-party coverage and reimbursement on our business. In addition, fundamental reforms in the healthcare industry in the United States and the European Union continue to be considered, although we cannot predict whether or when any healthcare reform proposals will be adopted and what impact such proposals might have on demand for our products.

We commercially introduced the XTRAC system in August 2000, but decelerated that introduction while we sought appropriate CPT codes and suitable rates of reimbursement from CMS. After we obtained CPT codes and reimbursement rates from CMS for the CPT codes, we began a roll-out strategy for the XTRAC system in the United States. To achieve increasing revenue, this product must also gain recognition and adoption by physicians who treat psoriasis and other skin disorders. The XTRAC system represents a significant departure from conventional psoriasis treatment methods. We believe that the recognition and adoption of the XTRAC system would be expedited if there were long-term clinical data demonstrating that the XTRAC system provides an effective and attractive alternative to conventional means of treatment for psoriasis. Currently, however, there are still only limited peer-reviewed clinical reports and short-term clinical follow-up data on the XTRAC system. Physicians are traditionally cautious in adopting new products and treatment practices, partially due to the anticipation of liability risks and partially due to uncertainty of third-party reimbursement. If physicians do not adopt the XTRAC system, we may never achieve significant revenues or profitability.

Our products may not be accepted if we do not produce clinical data supported by the independent efforts of clinicians. We received clearance from the FDA for the use of the XTRAC system to treat psoriasis based upon our study of a limited number of patients. Safety and efficacy data presented to the FDA for the XTRAC system was based on studies on these patients. For the treatment of vitiligo, atopic dermatitis and leukoderma, we have received clearance from the FDA for the use of the XTRAC system based primarily on equivalence of predicate devices; we may discover that physicians will expect clinical data on such treatments with the XTRAC system. We may find that data from longer-term psoriasis patient follow-up studies may be inconsistent with those indicated by our relatively short-term data. If longer-term patient studies or clinical experience indicate that treatment with the XTRAC system does not provide patients with sustained benefits or that treatment with our product is less effective or less safe than our current data suggests, our revenues could decline. We can give no assurance that we may find that our data is not substantiated in studies involving more patients; in such a case we may never achieve significant revenues or profitability.

It is important to the success of our marketing efforts to educate physicians and technicians in the techniques of using the XTRAC system. We rely on physicians to spend their time and money to attend our pre-sale educational sessions. Positive results using the XTRAC system are highly dependent upon proper physician and technician technique. If physicians and technicians use the XTRAC system suboptimally or improperly, they may have unsatisfactory patient outcomes or cause patient injury, which may give rise to negative publicity or lawsuits against us, any of which could have a material adverse effect on our reputation as a medical device company and our revenues and profitability.

Neutrogena, one of the customers for the skin health and hair care products segment that we acquired from ProCyte, accounts for a significant portion of our net revenue in that business segment. ProCyte’s net revenues from Neutrogena in 2004 were $2,768,072, or approximately 20.8% of ProCyte’s gross revenues of $13,320,200 (revenues which pre-date our acquisition and which are not reflected in our financial statements). For the year ended December 31, 2005, Skin Care’s (ProCyte) net revenues from Neutrogena were $1,421,946, or approximately 10.9% of Skin Care’s (ProCyte) gross revenues of $13,011,694 (revenues which are reflected in our financial statements to the extent that they were earned since March 19, 2005). For the year ended December 31, 2006, Skin Care’s net revenues from Neutrogena were $972,400, approximately 7.7% of Skin Care’s gross revenues of $12,646,910. We receive royalty revenues on sales of products by Neutrogena under the terms of a license agreement with Neutrogena. The royalties from Neutrogena for 2004 and for our fiscal years ended December 31, 2005 and December 31, 2006, were $1,214,073, $609,946 and $300,000, respectively. The license agreement expires in April 2010. A U.S. patent related to the Neutrogena license agreement expired February 5, 2005, the effect of which was a reduction in the percentage paid as a royalty during the remaining royalty period under the license agreement. We also receive revenues from sales of copper peptide compound to Neutrogena pursuant to a related supply agreement. ProCyte’s sales to Neutrogena under the supply agreement for 2004 and for our fiscal years ended December 31, 2005 and December 31, 2006, were $1,553,999, $812,000 and $672,400, respectively. Neutrogena has agreed to an extension of the supply agreement through October 5, 2007, on terms that we regard as generally favorable to us. We have begun discussions with Neutrogena concerning continuation of our supply relationship to Neutrogena, although we cannot say that such discussions will be successful.

Excluding niche marketing efforts, the Skin Care segment targets its sales in the U.S. market to physicians, who then mark the products up for sale to their patients. No single practice in itself is generally responsible for a significant disproportion of our sales. However, a number of practices, specializing in hair transplants, are united under the management of a single group, and this group accounts for a disproportion of our hair care products aimed at the care of a scalp that has received a hair transplant. Revenues from this customer were $1,169,892 in 2006 and $811,223 in 2005. We find as well that a few physicians re-sell our products not just to their own patients, but also at discounted prices on the internet.

Intellectual property law outside the United States is uncertain and in many countries is currently undergoing review and revision. The laws of some countries do not protect our intellectual property rights to the same extent as laws in the United States. The intellectual property rights we enjoy in one country or jurisdiction may be rejected in other countries or jurisdictions, or, if recognized there, the rights may be significantly diluted. It may be necessary or useful for us to participate in proceedings to determine the validity of our foreign intellectual property rights, or those of our competitors, which could result in substantial cost and divert our resources, efforts and attention from other aspects of our business. If we are unable to defend our intellectual property rights internationally, we may face increased competition outside the United States, which could materially and adversely affect our future business, prospects, operating results and financial results and financial condition.

Our laser products are considered medical devices and are subject to extensive regulation in the United States and in foreign countries where we intend to do business. In addition, certain of our skincare products and product candidates may be regulated by any of a number of divisions of the FDA and in other countries by similar health and regulatory authorities. Unless an exemption applies, each medical device that we wish to market in the United States and certain skincare products that we may wish to market must first receive either 510(k) clearance or pre-market approval from the FDA. Either process can be lengthy and expensive. The FDA's 510(k) clearance process may take from four to twelve months, or longer. The pre-market application approval process is much more costly, lengthy and uncertain. It may take one to three years or even longer. Delays in obtaining regulatory clearance or approval could adversely affect our revenues and profitability.

Although we have obtained 510(k) clearances for our XTRAC system for use in treating psoriasis, vitiligo, atopic dermatitis and leukoderma, and extensive 510(k) clearances for our surgical products, our clearances may be subject to revocation if post-marketing data demonstrates safety issues or lack of effectiveness. Further, more stringent regulatory requirements and/or safety and quality standards may be issued in the future with an adverse effect on our business. Although we believe that we are in compliance with all material applicable regulations of the FDA, current regulations depend heavily on administrative interpretation. Future interpretations made by the FDA or other regulatory bodies, with possible retroactive effect, may vary from current interpretations and may adversely affect our business and prospects.

Even if we obtain and maintain the necessary foreign regulatory registrations or approvals, market acceptance of our products in international markets may be dependent, in part, upon the availability of reimbursement within applicable healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government-sponsored healthcare and private insurance. We may seek international reimbursement approvals for our products, but we cannot assure you that any such approvals will be obtained in a timely manner, if at all. Failure to receive international reimbursement approvals in any given market could have a material adverse effect on the acceptance or growth of our products in that market or others.

While we now have greater financial resources due to the private placement of our securities in November 2006, we must still use those resources prudently as we expand our marketing efforts. Our prudence is heavily influenced by our marketing experience, which is still relatively limited. To increase acceptance and utilization of our XTRA system, we may have to expand the number of our sales and marketing personnel for marketing programs in the United States. Different programs may call for different strategies and talents. While we may be able to draw on currently available personnel within our organization, we also expect that we will have to increase the number of representatives devoted to the sales and marketing programs and broaden, through such representatives, the talents we have at our disposal. In some cases, we may look outside our organization for assistance in marketing our products, as for example in a program to market our surgical diode laser through the internet. We cannot predict whether the anticipated sales and marketing programs will be successful, either in design or implementation.

Although we believe that our current manufacturing facilities are adequate to support our commercial manufacturing activities for the foreseeable future, we may be required to expand or restructure our manufacturing facilities to increase capacity substantially. If we are unable to provide customers with high-quality products in a timely manner, we may not be able to achieve market acceptance for our XTRAC system, to maintain the benefits of vertical integration in the delivery of our surgical services or to achieve market acceptance and growth for our skincare products. Our inability to manufacture or commercialize our devices successfully could have a material adverse effect on our revenue.

If additional private carriers approve favorable reimbursement policies for psoriasis and our marketing programs are successful in increasing utilization of the XTRAC system, we expect to experience growth in the number of our employees and customers and the scope of our operations. This growth may place a strain on our management and operations. Our ability to manage this growth will depend upon our ability to broaden our management team and our ability to attract, hire and retain skilled employees. We also expect that compliance with the requirements of governmental and quasi-governmental bodies will grow more complex and burdensome. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational, financial and other systems, to manage multiple, concurrent customer relationships, to respond to increasing compliance requirements and to hire, train and manage our employees. Our future success is heavily dependent upon growth and acceptance of our products. If we cannot scale our business appropriately or otherwise adapt to anticipated growth and complexity and new product introductions, a key part of our strategy may not be successful.

In addition, we may acquire additional companies in the medical products and services industry. Accordingly, in the ordinary course of our business, we regularly consider, evaluate and enter into negotiations related to potential acquisition opportunities. We may pay for these acquisitions in cash or securities, including equity securities, or a combination of both. We cannot assure you that attractive acquisition targets will be available at reasonable prices, that we will have sufficient authorized but unissued securities available to effect an acquisition, or that we will be successful in any such transaction. Acquisitions involve a number of special risks, including:

Production of our XTRAC system requires specific component parts obtained from our suppliers. Production of our surgical laser systems requires some component parts that will become harder to procure, as the design of a system ages. Similarly, our skincare products may require compounds that can be efficiently produced only by a limited number of suppliers. In the event that our suppliers cannot meet our needs, we believe that we could find alternative suppliers. However, a change in suppliers or any significant delay in our ability to have access to such resources would have a material adverse effect on our delivery schedules, business, operating results and financial condition.

The medical devices industry is subject to rapid and substantial technological development and product innovations. To be successful, we must respond to new developments in technology, new applications of existing technology and new treatment methods. Our response may be thwarted if we require, but cannot secure, rights to essential third-party intellectual property. We compete against numerous companies offering alternative treatment systems to ours, some of which have greater financial, marketing and technical resources to utilize in pursuing technological development and new treatment methods. Our financial condition and operating results could be adversely affected if our medical devices fail to compete favorably with these technological developments, or if we fail to be responsive on a timely and effective basis to competitors’ new devices, applications, treatments or price strategies. The development of a cure for psoriasis, vitiligo, atopic dermatitis or leukoderma would eliminate the need for our XTRAC system for these diseases and would require us to focus on other uses of our technology, which would have a material adverse effect on our business or prospects.

In addition, competition in the skin health and hair care markets is intense. Our skincare competitors include well-established pharmaceutical, cosmetic and healthcare companies such as Obagi, La Roche Posay, Allergan, Pevonia, Declore and Murad. These competitors have substantially more financial and other resources, larger research and development staffs, and more experience and capabilities in researching, developing and testing products in clinical trials, in obtaining FDA and other regulatory approvals and in manufacturing, marketing and distribution than we do. Further, a number of smaller companies are developing or marketing competitive products. Our skincare competitors may succeed in developing and commercializing products or obtaining patent protection or other regulatory approvals for products more rapidly than we can. Further, competitive products may be manufactured and marketed more successfully than our potential skincare products. Such developments could render our existing or potential skincare products less competitive or obsolete and could have a material adverse effect on our business, financial condition and results of operations.

One or more of our products may be found to be defective after they have been shipped in volume, and require product replacement. Product returns and the potential need to remedy defects or provide replacement products or parts could result in substantial costs and have a material adverse effect on our business and results of operations. The clinical testing, manufacturing, marketing and use of our products and procedures may also expose us to product liability claims. In addition, the fact that we train technicians whom we do not supervise in the use of our XTRAC system when patients are treated and that we train and provide our technicians as part of our surgical services business may expose us to third-party claims if those doing the training are accused of providing inadequate training or if a technician is accused of negligently applying such training. We presently maintain liability insurance with coverage limits of at least $5,000,000 per occurrence. However, continuing insurance coverage may not be available at an acceptable cost, if at all. We thus may not be able to obtain insurance coverage that will be adequate to satisfy a liability that may arise. Regardless of merit or eventual outcome, product liability claims may result in decreased demand for a product, injury to its reputation, withdrawal of clinical trial volunteers and loss of revenues. As a result, regardless of whether we are insured, a product liability claim or product recall may result in losses that could have a material adverse effect upon our business, financial condition and results of operations.

We are subject to Section 203 of the Delaware General Corporation Law, which prohibits a business combination between a corporation and an interested stockholder within three years of the stockholder becoming an interested stockholder, except in limited circumstances. In addition, our bylaws contain certain provisions which require stockholders' actions to be taken at meetings and not by written consent, and also require supermajority votes of stockholders to amend our bylaws and to notice special meetings of stockholders. These anti-takeover provisions could delay or prevent actual and potential changes in control, even if they would benefit our stockholders.

Our certificate of incorporation provides, as permitted by governing Delaware law, that a director shall not be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, with certain exceptions. These provisions may discourage stockholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by stockholders on our behalf against a director. In addition, our certificate of incorporation and bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Delaware law. In addition, we have agreed to indemnify the past and present directors, officers and employees of ProCyte for certain matters, to the same extent such individuals are indemnified by ProCyte, for a period of six years following the effective date of the merger.

In the matter brought by us against RA Medical Systems, Inc. and Dean Irwin in the United States District Court for the Southern District of California, the trial judge declined to issue to defendants summary judgment based on their theory of res judicata. On the other hand, the trial judge declined to issue to us partial summary judgment for unfair competition, which had been based on the fact that RA Medical did not have the requisite permission from the State of California to market its medical device. The declination of our claim for relief was based on reasons that we believe will not bar this claim for relief in the other pending Federal action, discussed in the paragraph below. The trial judge further declined to consolidate this Federal action brought by us with the Federal action brought by RA Medical and Mr. Irwin, discussed below. Pretrial is scheduled for the Spring of 2007, but no trial date has been set. In this action, there are no counterclaims that we must defend against.

In the matter brought in California Superior Court by RA Medical and Mr. Irwin against us for unfair competition, we removed the State action to Federal court. Plaintiffs claim we did not have the requisite permission from the State of California to market our excimer medical device from our new facility in Carlsbad. We counterclaimed for, among other things, contractual interference, misappropriation of our technology and unfair competition under Federal and State statutes. The plaintiffs have brought a motion to dismiss the latter two counterclaims, based in part on an alleged bar under the applicable statutes of limitations. The trial judge has not ruled on the motion. Discovery has been stayed, pending the judge’s ruling. Among our claims of unfair competition is a claim based on RA Medical’s lack of requisite permission from the State of California to market its medical device.

In June 2006, the insurance carrier that had undertaken to indemnify us in the malicious prosecution action, discussed in the paragraph above, and that had for 18 months been defending us, recanted its undertaking to indemnify us. The carrier recanted on two grounds: first, that malicious prosecution is an intentional tort and therefore is non-indemnifiable, and second, that the alleged tort occurred after the period of coverage of its underlying policy had expired. We notified the subsequent insurance carrier in whose coverage period the alleged tort occurred. That carrier has undertaken to defend us, but has denied its duty to indemnify us, based on the same ground that malicious tort is a non-indemnifiable tort. We have rejected this ground and brought an action in the U.S. District Court for the Eastern District of Pennsylvania for breach of contract and for declaratory judgment on the issue whether malicious prosecution is indemnifiable under our insurance policy.

As of January 1, 2006, no options will be granted to employees or consultants out of any plans except the 2005 Equity Compensation Plan. Options to our outside directors will be made from the 2000 Non-Employee Director Stock Option Plan; options under the 2005 Investment Plan may be made only to executive officers. Most warrants issued by us have been to investors or placement agents, and none of them, and nor was any of the warrants issued to GE Capital Corporation, have been issued pursuant to equity compensation plans. Additionally, all outstanding options were granted as compensation for benefits inuring to us other than for benefits from capital-raising activities. With limited exceptions under Nasdaq membership requirements, we intend in the future to issue options pursuant to equity compensation plans which have already been approved by our stockholders without necessity of further, special approval by our stockholders

On November 3, 2006, we completed a private placement for 9,760,000 shares of common stock at $1.17 per share resulting in gross proceeds of $11,419,200. The closing price of our common stock on November 1, 2006 was $1.27 per share, the date we agreed to the private placement. In connection with this private placement, we paid commissions and other expenses of $864,308, resulting in net proceeds of $10,554,892. In addition, the investors received warrants to purchase 2,440,000 shares of common stock at an exercise price of $1.60 per share, and Cowen & Company, the placement agent, received warrants to purchase 244,000 shares of common stock, under the same terms and conditions as the warrants issued to the investors. All such the warrants have a five-year term and will first become exercisable on May 1, 2007. Cowen & Company is entitled to a 6.5% commission on any proceeds to us from future exercises by the investors of their warrants. The warrants issued to Cowen & Company were in consideration of its services as the placement agent and have a value under the Black Scholes method of approximately $200,000. We have used the proceeds of this financing to pay for working capital and other general corporate purposes. The shares sold in the private placement, including the shares underlying the warrants, have been registered with the Securities and Exchange Commission.

On March 31, 2006, we issued to Stern Laser srl (“Stern”) 101,010 of our restricted common stock, pursuant to a Master Asset Purchase Agreement (the “Master Agreement”) dated September 7, 2004 with Stern. As of December 31, 2006, we have issued to Stern an aggregate 589,864 shares of our restricted common stock in connection with the Master Agreement. We have also agreed to pay Stern up to an additional $250,000 based on the achievement of certain remaining milestones relating to the development and commercialization of certain licensed technology and the licensed products which may be developed under such arrangement and may have certain other obligations to Stern under these arrangements. We retain the right to pay all of these conditional sums in cash or in shares of its common stock, at our discretion. To secure the latter alternative, we have reserved for issuance, and placed into escrow, 110,136 shares of our unregistered stock. The per-share price of any future issued shares will be based on the closing price of our common stock during the 10 trading days ending on the date of achievement of a particular milestone under the terms of the Master Agreement. Stern also has served as the distributor of the XTRAC laser system in South Africa and Italy since 2000. The primary asset, which we have acquired from Stern, is a license, which was carried on our books at $1,013,009, net as of December 31, 2006. Amortization of this intangible is on a straight-line basis over 10 years, which began in January 2005. As Stern completes further milestones under the Master Agreement, we expect that the carrying value of the license will increase.

You should read the following selected historical consolidated financial data in conjunction with our consolidated financial statements included elsewhere in this Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” beginning in Item 7 below. The selected historical consolidated statements of operations data for the years ended December 31, 2006, December 31, 2005 and December 31, 2004, and the selected historical consolidated balance sheet data as of December 31, 2006 and December 31, 2005, are derived from our audited consolidated financial statements included in this Annual Report on Form 10-K. The selected historical consolidated statements of operations data for the years ended December 31, 2003 and December 31, 2002 and the selected historical consolidated balance sheet data as of December 31, 2004, December 31, 2003 and December 31, 2002 are derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The historical results presented here are not necessarily indicative of future results.

	2006			2005			2004			2003			2002
Statement of Operations Data:
Revenues	$	33,190		$	28,384		$	17,745		$	14,319		$	3,274
Costs of revenues		18,472			15,675			10,363			10,488			4,425
Gross profit (loss)		14,718			12,709			7,382			3,831			(1,151	)
Selling, general and administrative		20,682			16,477			10,426			9,451			6,191
Engineering and product development		1,006			1,128			1,802			1,777			1,757
Loss from operations before interest and other income, net		(6,970	)		(4,896	)		(4,846	)		(7,397	)		(9,099	)
Interest income		149			61			43			50			42
Interest expense		(671	)		(403	)		(181	)		(96	)		(16	)
Other income, net		-			1,302			-			-			1
Net loss		($7,492	)		($3,936	)		($4,984	)		($7,443	)		($9,072	)

Basic and diluted net loss per share		($0.14	)		($0.08	)		($0.13	)		($0.21	)		($0.34	)
Shares used in computing basic and diluted net loss per share (1)		54,189			48,786			38,835			35,134			26,566
Balance Sheet Data (At Period End):
Cash and cash equivalents	$	12,886		$	5,610		$	3,997		$	6,633		$	4,008
Working capital		16,070			11,151			6,119			8,678			6,578
Total assets		57,482			48,675			22,962			22,753			21,513
Long-term debt (net of current portion)		3,727			2,437			1,399			457			900
Stockholders’ equity	$	44,103		$	38,417		$	14,580		$	15,978		$	13,309

As part of our commercialization strategy in the United States, we provide the XTRAC laser system to targeted dermatologists at no initial capital cost to them. Unlike our international strategy, we generally do not sell the laser system domestically, but maintain ownership of the laser and earn revenue each time a dermatologist treats a patient with the equipment. We believe that this strategy will create incentives for physicians to adopt the XTRAC laser system and will increase market penetration. On occasion we have sold and will sell the laser directly to a dermatologist for certain reasons, including the costs of logistical support and customer preference.

For the past six years, we have sought to clear the path of obstacles and barriers to a roll-out of the XTRAC laser system in dermatology. In 2000, the laser system, which was originally designed for cardiology applications, was found to have significant therapeutic advantages for psoriasis patients who were treated with the UVB light emitted from the excimer-based laser system. For the first two years, we invested in establishing the clinical efficacy of the product and mechanical reliability of the equipment. In the last three years, we have pursued widespread reimbursement commencing with obtaining newly created Current Procedure Terminology (“CPT”) reimbursement codes that became effective in 2003. This was followed by a lengthy process of persuading private medical insurers to adopt a positive reimbursement policy for the procedure. Substantive progress on reimbursement was achieved in the second half of 2005. In June 2006, we received approval from Blue Cross and Blue Shield of Florida.

We increased our dermatology sales force and marketing department as part of the acquisition of ProCyte in March 2005. We now have 12 sales representatives in the domestic XTRAC segment (not including the 9 clinical specialists that we have recently hired to train and support our customers) and 19 sales representatives in the Skin Care segment. The sales representatives of each segment provide follow-up sales support and share sales leads to enhance opportunities for cross-selling. Our marketing department has been instrumental in expanding the advertising campaign for the XTRAC laser system. In November 2005, we commenced an advertising campaign in selected regions that have attained certain levels of reimbursement in order to make consumers aware of the technology and therapeutic benefits of targeted UVB laser treatment for psoriasis. We continue to analyze and adjust this campaign for effectiveness.

We do, however, see that some of our sales and marketing expenses have grown faster than the revenues on which the expenses are targeted to have positive impact. For example, we have tried various direct-to-consumer marketing programs that have positively influenced utilization, but the payback in utilization is expected to be attained over more periods than in just the period in which we incurred the expense. We have also increased the number of sales representatives and also established a cadre 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. The efforts of this cadre, if successful, will likely see the fruits of success over an extended horizon of several fiscal quarters.

In the international market, we derive revenues by selling our dermatology laser systems to distributors and directly to physicians. In this market, we have benefited from both our clinical studies and from the improved reliability and functionality of the XTRAC laser system. Compared to the domestic segment, the sales of laser systems in the international segment is influenced to a greater degree by competition from similar laser technologies as well as non-laser lamp alternatives. Over time, this competition has reduced the prices we are able to charge to international distributors for our XTRAC products. In 2005, as a result of the acquisition of worldwide rights to certain proprietary light-based technology from Stern, we also explored new product offerings in the treatment of dermatological conditions. We have expanded the international marketing of this product, called the VTRAC™, in 2006. The VTRAC is a lamp-based UVB targeted therapy, positioned at a price point lower than the XTRAC laser system so that it will effectively compete with other non-laser-based therapies for psoriasis and vitiligo.

The Surgical Products segment generates revenues by selling laser products and disposables to hospitals and surgery centers both inside and outside of the United States. Also included are various non-laser surgical products (e.g. the ClearEss® II suction-irrigation system). Although surgical product revenues increased in 2006 compared to 2005, we expect that sales of surgical laser systems and the related disposable base may begin to erode as hospitals continue to seek outsourcing solutions instead of purchasing lasers and related disposables for their operating rooms. We are working to offset this erosion by cautiously expanding our surgical services segment and by increasing sales from the Diode surgical laser introduced in 2004.

The discussion and analysis of our financial condition and results of operations in this Report are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and disclosures at the date of the financial statements. On an on-going basis, we evaluate our estimates, including, but not limited to, those related to revenue recognition, accounts receivable, inventories, impairment of property and equipment and of intangibles and accruals for warranty claims. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates. Management believes that the following critical accounting policies affect our more significant judgments and estimates in the preparation of our Consolidated Financial Statements. These critical accounting policies and the significant estimates made in accordance with these policies have been discussed with our Audit Committee.

We have two distribution channels for our phototherapy treatment equipment. We either (i) sell the laser through a distributor or directly to a physician or (ii) place the laser in a physician’s offices (at no charge to the physician) and charge the physician a fee for an agreed upon number of treatments. When we sell an XTRAC laser to a distributor or directly to a 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 we have no significant remaining obligations; (ii) persuasive evidence of an arrangement exists; (iii) the price to the buyer is fixed or determinable; and (iv) collection is probable (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 our books as inventory.

In the first quarter of 2003, we implemented a program to support certain physicians in addressing treatments with the XTRAC laser system that may be denied reimbursement by private insurance carriers. We recognize service revenue from the sale of treatment codes to physicians participating in this program only if and to the extent the physician has been reimbursed for the treatments. For the year ended December 31, 2006, we deferred an additional $124,427 less credits issued of $151,590, under this program, as all the SAB 104 Criteria for revenue recognition had not been met. At December 31, 2006, we had net deferred revenues of $80,697 under this program.

We generate revenues from our Skin Care business primarily through three channels. The first is through product sales for skin health, hair care and wound care; the second is through sales of the copper peptide compound, primarily to Neutrogena Corporation, a Johnson & Johnson company; and the third through royalties generated by our licenses, principally to Neutrogena. We recognize revenues on the products and copper peptide compound when they are shipped, net of returns and allowances. We ship the products FOB shipping point. Royalty revenues are based upon sales generated by our licensees. We recognize royalty revenue at the applicable royalty rate applied to shipments reported by our licensee.

Inventory. We account for inventory at the lower of cost (first-in, first-out) or market. Cost is determined to be purchased cost for raw materials and the production cost (materials, labor and indirect manufacturing cost) for work-in-process and finished goods. Throughout the laser manufacturing process, the related production costs are recorded within inventory. Work-in-process is immaterial, given the typically short manufacturing cycle, and therefore is disclosed in conjunction with raw materials. We perform full physical inventory counts for XTRAC and cycle counts on the other inventory to maintain controls and obtain accurate data.

Our XTRAC laser is either (i) sold to distributors or physicians directly or (ii) placed in a physician's office and remains our property. The cost to build a laser, whether for sale or for placement, is accumulated in inventory. When a laser is placed in a physician’s office, the cost is transferred from inventory to “lasers in service” within property and equipment. At times, units are shipped to distributors, but revenue is not recognized until all of the SAB 104 Criteria have been met, and until that time, the unit is carried on our books as inventory. Revenue is not recognized from these distributors until payment is either assured or paid in full.

Allowance for Doubtful Accounts. Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The majority of receivables related to phototherapy sales are due from various distributors located outside of the United States and from physicians located inside the United States. The majority of receivables related to skincare products, surgical services and surgical products are due from various customers and distributors located inside the United States. From time to time, our customers dispute the amounts due to us, and, in other cases, our customers experience financial difficulties and cannot pay on a timely basis. In certain instances, these factors ultimately result in uncollectible accounts. The determination of the appropriate reserve needed for uncollectible accounts involves significant judgment. Such factors include changes in the financial condition of our customers as a result of industry, economic or customer-specific factors. A change in the factors used to evaluate collectibility could result in a significant change in the reserve needed.

Property and Equipment. As of December 31, 2006 and 2005, we had net property and equipment of $9,054,098 and $7,044,713, respectively. The most significant component of these amounts relates to the XTRAC lasers placed by us in physicians’ offices. We own the equipment and charge the physician on a per-treatment basis for use of the equipment. The recoverability of the net carrying value of the lasers is predicated on increasing revenues from the physicians’ use of the lasers. In reflection of their improved reliability, XTRAC lasers placed in service after December 31, 2005 are depreciated on a straight-line basis over the estimated useful life of five-years; other XTRAC lasers-in-service continue to be depreciated over the original useful life of three years. Surgical lasers-in-service are depreciated on a straight-line basis over an estimated useful life of seven years if new, five years or less if used equipment. The straight-line depreciation basis for lasers-in-service is reflective of the pattern of use. For other property and equipment, including property and equipment acquired from ProCyte, depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, primarily three to seven years for computer hardware and software, furniture and fixtures, automobiles, and machinery and equipment. Leasehold improvements are amortized over the lesser of the useful lives or lease terms. Useful lives are determined based upon an estimate of either physical or economic obsolescence, or both.

Intangibles. Our balance sheet includes goodwill and other intangible assets which affect the amount of future period amortization expense and possible impairment expense that we will incur. Management’s judgments regarding the existence of impairment indicators are based on various factors, including market conditions and operational performance of our business. As of December 31, 2006 and 2005, we had $22,151,160 and $22,420,563, respectively, of goodwill and other intangibles, accounting for 39% and 46% of our total assets at the respective dates. The goodwill is not amortizable; the other intangibles are. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We test our goodwill for impairment, at least annually. This test is usually conducted in December of each year in connection with the annual budgeting and forecast process. Also, on a quarterly basis, we evaluate whether events have occurred that would negatively impact the realizable value of our intangibles or goodwill.

There has been no change in 2006 and 2005 to the carrying value of goodwill that is allocated to the XTRAC domestic segment and the XTRAC international segment in the amounts of $2,061,096 and $883,327, respectively. The allocation of goodwill to each segment was based upon the relative fair values of the two segments as of August 2000, when we bought out the minority interest in Acculase, Inc. and thus recognized the goodwill. In connection with the acquisition of ProCyte on March 18, 2005, we acquired certain intangibles recorded at fair value as of the date of acquisition and allocated fully to the Skin Care (ProCyte) segment. In 2006, we adjusted the carrying value of the goodwill from the ProCyte acquisition reflecting management’s best estimate of pre-acquisition contingencies based upon plans entered into prior to March 18, 2005. Included in these acquired intangibles were the following:

Recognized revenue for the years ended December 31, 2006, 2005, and 2004 were $5,611,387, $3,498,235 and $3,256,164, respectively. This included treatment revenue for the years ended December 31, 2006, 2005 and 2004 for domestic XTRAC procedures of $5,142,022, $3,498,235 and $3,256,164, respectively, reflecting billed procedures of 83,272, 54,255 and 47,915, respectively. In addition, 5,168, 6,371 and 4,928 procedures were performed for the years ended December 31, 2006, 2005 and 2004, respectively, without billing from us, in connection with clinical research and customer evaluations of the XTRAC laser. The increase in procedures in the year ended December 31, 2006 compared to the comparable periods in 2005 and 2004 was largely related to our continuing progress in securing favorable reimbursement policies from private insurance plans and to our increased marketing programs. Increases in revenues are dependent upon more widespread adoption of the CPT codes with comparable rates by private healthcare insurers and on instilling confidence in our physician partners that the XTRAC procedures will benefit their patients and be generally reimbursed to their practices.

In the first quarter of 2003, we implemented a program to support certain physicians who may be denied reimbursement by private insurance carriers for XTRAC treatments. In accordance with the requirements of SAB No. 104, we recognize service revenue during the program only to the extent the physician has been reimbursed for the treatments. For the year ended December 31, 2006, we deferred revenues of $124,427 (1,897 procedures) net, under this program, compared to deferred revenues of $57,302 (873 procedures) net, under this program for the year ended December 31, 2005. For the year ended December 31, 2004, we recognized revenues of $303,027, (4,562 procedures) net, under this program that were previously deferred. The change in deferred revenue under this program is presented in the table below.

	For the Year Ended December 31,
		2006			2005		2004
Total revenue	$	5,611,387		$	3,498,235	$	3,256,164
Less: laser sales revenue		(469,365	)		-		-
Recognized treatment revenue		5,142,022			3,498,235		3,256,164
Change in deferred program revenue		124,427			57,302		(303,027	)
Change in deferred unused treatments		194,869			5,371		229,300
Net billed treatment revenue		5,461,318		$	3,560,908	$	3,182,437
Procedure volume total		88,440			60,626		52,843
Less: Non-billed procedures		5,168			6,371		4,928
Net billed procedures		83,272			54,255		47,915
Avg. price of treatments sold	$	65.58		$	65.63	$	66.42
Procedures with deferred/(recognized) program revenue, net		1,897			873		(4,562	)
Procedures with deferred unused treatments, net		2,971			82		3,452

The average price for a treatment varies based upon the mix of mild and moderate psoriasis patients treated by our physician partners. We charge a higher price per treatment for moderate psoriasis patients due to the increased body surface area required to be treated, although there are fewer patients with moderate psoriasis than there are with mild psoriasis. Due to the length of treatment time required, it has not been generally practical to use our therapy to treat severe psoriasis patients. This may change going forward, as our new product, the XTRAC Ultra, has shorter treatment times. A study undertaken with the guidance of John Koo, MD, of the University of California at San Francisco, is evaluating the effectiveness of the Ultra in treating patients suffering from severe psoriasis.

International sales of our XTRAC and VTRAC laser systems and related parts were $2,186,424 for the year ended December 31, 2006 compared to $1,404,096 and $1,626,646 for the years ended December 31, 2005 and 2004, respectively. We sold 46 laser systems in the year ended December 31, 2006 compared to 26 laser systems in each of the years ended December 31, 2005 and 2004. Compared to the domestic business, the international dermatology equipment operations are more influenced by competition from similar laser technology from other manufacturers and from non-laser lamps. Such competition has caused us to reduce the prices we charge to international distributors. Furthermore, average selling prices for international dermatology equipment are influenced by the following two factors:

For the year ended December 31, 2006, ProCyte revenues were $12,646,910 compared to $10,042,132 for the year ended December 31, 2005. Inasmuch as ProCyte was acquired on March 18, 2005, the operating results of ProCyte for the year ended December 31, 2005 include activity from ProCyte from March 19, 2005 through December 31, 2005 and there are no corresponding revenues accruing to us for the year ended December 31, 2004. Skin Care revenues are generated from the sale of various skin and hair care products, from the sale of copper peptide compound and from royalties on licenses, mainly from Neutrogena. For the full year 2005, unaudited Skin care revenues were approximately $13 million compared to unaudited revenues of $13.3 million for 2004.

In the years ended December 31, 2006, 2005 and 2004, surgical service revenues were $6,944,292, $7,719,529 and $7,826,519, respectively, representing a 10% decrease and a 1.4% decrease from the comparable prior year periods. The 2006 decrease was primarily due to the six territories that we closed since January 1, 2005, the largest of which was in the fourth quarter of 2005, and business interruption in New Orleans and Alabama from the hurricanes in August and September 2005. Two of our territories were closed on the western side of Florida due to the termination of a customer contract. We closed the other four territories for insufficient profitability. During the first quarter of 2006, we have begun to work with a regional hospital system in central Florida, which we believe will generate annual revenue exceeding the annual revenue lost in the western side of the state.

As set forth in the table below, the decrease in average price per laser between the period 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 years ended December 31, 2006, 2005 and 2004 were sales of 65, 28 and 1 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.

Disposables and fiber sales decreased approximately 5% from the comparable year ended December 31, 2005. We have expected that the disposables base may continue to erode over time as hospitals continue to seek outsourcing solutions instead of purchasing lasers and related disposables for their operating rooms. We have continued to seek to offset this erosion through expansion of our surgical services. Similarly, we believe there will be continuing pressure on laser system sales as hospitals continue to outsource their laser-assisted procedures to third parties, such as our surgical services business. With the introduction of our CO2 and diode surgical lasers in the second quarter of 2004, we have sought to offset the decline in laser and disposables revenues.

Product cost of revenues during the year ended December 31, 2006 were $8,628,651, compared to $7,219,504 for the year ended December 31, 2005. The $1,409,147 increase reflected the cost of sales for the domestic XTRAC laser sales of $128,840, an increase of $726,412 in costs for the ProCyte business acquired on March 18, 2005, and therefore the operating results of ProCyte for the year ended December 31, 2005 include activity from ProCyte from March 19, 2005 through December 31, 2005. Additionally there was an increase of $216,389 for surgical products, due to increased laser system sales and a $337,506 increase in costs associated with sales of XTRAC laser equipment sold outside the United States.

Services cost of revenues was $8,456,001 and $7,038,705 in the years ended December 31, 2005 and 2004, respectively. Contributing to the $1,417,296 increase was a $616,236 increase in the Surgical Services business associated with the increase in urological procedures performed with laser systems purchased from a third-party manufacturer, which carry a higher cost of sale due to the disposable fiber purchased from the third-party manufacturer than a fiber which we manufacture. In addition, cost of revenues in the Domestic XTRAC business segment increased $801,060 due to manufacturing inefficiencies, an increase in excess and obsolete inventory reserve and increased depreciation on the lasers compared to the same period in 2004.

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

The cost of revenues increased by $1,474,693 for the year ended December 31, 2006. This increase is due to the cost of sales for the lasers of $128,840 and to an increase in depreciation on the lasers-in-service of $629,000 over the comparable prior year period, an increase in excess and obsolete inventory reserve and abnormal gas consumption, which has been corrected by software modification. The depreciation costs will continue to increase in subsequent periods as the business grows. In addition, there was an increase in certain allocable XTRAC manufacturing overhead costs that are charged against the XTRAC service revenues.

The International Dermatology Equipment operations are influenced by competition from similar laser technology from other manufacturers and from non-laser lamp alternatives for treating inflammatory skin disorders, which has served to reduce the prices we charge international distributors for our excimer products. Partially offsetting the increase in the number of laser systems sold was a decrease in the average price of the laser systems sold. After adjusting the revenue for parts sales of approximately $323,000, the average price for lasers sold during this period was approximately $40,500 in the year ended December 31, 2006, down from $46,000 in the comparable period in 2005. Contributing to the overall decrease in the average selling price in the year ended December 31, 2006 was the sale of certain used lasers which were previously deployed in the U.S. operations and sold at a discount to the list price for new equipment. We sold six of these used lasers in each year at an average price of $28,000 and $27,000, respectively for the years ended December 31, 2006 and 2005. Each of these lasers had a net book value that was less than the cost of a new XTRAC laser system.

The International Dermatology Equipment operations are more widely influenced by competition from similar laser technology from other manufacturers and from non-laser lamp alternatives for treating inflammatory skin disorders, which has served to reduce the prices we charge international distributors for our excimer products. After adjusting the revenue for parts sales of approximately $209,000, the average price for lasers sold in the year ended December 31, 2005 was approximately $46,000, down from $56,800 in the comparable period in 2004. Contributing to the overall average selling price decrease in 2005 was the sale of certain used lasers which were previously deployed in the U.S. operations and sold at a discount to the list price for new equipment. We sold six of these used lasers at an average price of $27,000. Each of these lasers had a net book value of less than standard cost of a new XTRAC system.

We have closed six territories of business due to unacceptable operating profit and one territory due to competition. Although closing these unprofitable territories will save costs and improve profitability over time, the overall costs saved for the year ended December 31, 2006 have not kept pace with the revenues lost. Nevertheless, in the case of the territory lost to competition, we have opened a new, contiguous territory in which we have secured a long-term contract from which we anticipate significant procedure volume. For that reason, we have relocated our personnel and materiel from the lost territory to the new one.

A significant part of the revenue was in urological procedures performed with laser systems we purchased from a third-party manufacturer. Such procedures included a charge for the use of the laser and the technician to operate it, as well as a charge for the third party’s proprietary fiber delivery system. This procedure has a lower gross margin as a percent of revenues than other types of procedures. As the volume of these procedures increases, the overall gross margin percentage decreases. In 2005, there was a 25% price increase on the third party’s proprietary fiber delivery system, which also contributed to the decrease in gross margin in 2005. Revenues for this procedure were $2.4 million for the year ended December 31, 2005 compared to $1.7 million for the same period in 2004.

Revenues for the year ended December 31, 2006 increased by $80,350 from the year ended December 31, 2005 while cost of revenues increased by $229,599 between the same periods. There were 33 more laser systems sold in the year ended December 31, 2006 than in the comparable period of 2005. However, the lasers sold in the 2005 period were at higher prices than in the comparable period in 2006. The decrease in average price per laser was largely due to the mix of lasers sold. Included in the laser sales for the year ended December 31, 2006 and 2005 were sales of $1,120,000 and $605,000 of diode lasers, respectively, which have substantially lower list sales prices than the other types of surgical lasers.

Revenues for the year ended December 31, 2005 increased by $684,662 from the year ended December 31, 2004 while cost of revenues increased by $949,877 between the same periods. There were 30 more laser systems sold in the year ended December 31, 2005 than in the comparable period of 2004. However, the lasers sold in the 2004 period were at higher prices than in the comparable period in 2005. The decrease in average price per laser was largely due to the mix of lasers sold. Included in the laser sales for the years ended December 31, 2005 and 2004 were sales of $532,995 and $40,000 diode lasers, respectively, which have substantially lower list sales prices than the other types of surgical lasers.

We believe that our existing cash balance together with our other existing financial resources, including access to lease financing for capital expenditures, and revenues from sales, distribution, licensing and manufacturing relationships, will be sufficient to meet our operating and capital requirements beyond the first quarter of 2008. The 2007 operating plan reflects continuing cost savings from the integration of ProCyte as well as increases in per-treatment fee revenues for use of the XTRAC system based on increased utilization of the XTRAC by physicians and on wider insurance coverage in the United States. In addition, the 2007 operating plan calls for increased revenues and profits from our newly acquired Skin Care business. In light of our recent private placement of approximately $11.4 million worth of our common stock in November 2006, we believe that we shall have the necessary financing to meet our operating and capital requirements, at a minimum, into 2008.

On June 25, 2004, we entered into a leasing credit facility from GE Capital Corporation (“GE”). The credit facility has a commitment term of three years, expiring on June 25, 2007. We account for each draw as funded indebtedness taking the form of a capital lease, with equitable ownership in the lasers remaining with us. GE retains title as a form of security over the lasers. Each draw against the credit facility has a repayment period of three years and is secured by specific lasers, which we have sold to GE and leased back for deployment in the field. A summary of the activity under the GE leasing credit facility is presented in Note 9, “Long-term Debt.”

Net cash provided by financing activities was $1,254,649 for the year ended December 31, 2005 compared to $2,694,240 for the year ended December 31, 2004. In the year ended December 31, 2005 we made payments of $1,145,474 on certain notes payable and capital lease obligations and incurred $169,524 in registration costs. These payments were offset, in part, by the advances under the lease line of credit, net of payments, of $1,889,487 and by receipts of $774,891 from the exercise of common stock options and warrants. In the year ended December 31, 2004, we received $3,296,751 from the exercise of common stock options and warrants and a net increase of $527,548 from the lapse of the bank line of credit and the initiation of the leasing line of credit from GE. These cash receipts were offset by $879,001 for the payment of certain notes payable and capital lease obligations.

Our ability to expand our business operations is currently dependent in significant part on financing from external sources. There can be no assurance that changes in our manufacturing and marketing, research and development plans or other changes affecting our operating expenses and business strategy will not require financing from external sources before we will be able to develop profitable operations. There can be no assurance that additional capital will be available on terms favorable to us, if at all. To the extent that additional capital is raised through the sale of additional equity or convertible debt securities, the issuance of such securities could result in additional dilution to our stockholders. Moreover, our cash requirements may vary materially from those now planned because of marketing results, product testing, changes in the focus and direction of our marketing programs, competitive and technological advances, the level of working capital required to sustain our planned growth, litigation, operating results, including the extent and duration of operating losses, and other factors. In the event that we experience the need for additional capital, and are not able to generate capital from financing sources or from future operations, management may be required to modify, suspend or discontinue our business plan.

Our management conducted an evaluation of the effectiveness of the system of internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our system of internal control over financial reporting was effective as of December 31, 2006. Our management's assessment of the effectiveness of our internal control over financial reporting has been audited by Amper, Politziner & Mattia, P.C., an independent registered public accounting firm, as stated in their report which is included herein.

Richard J. DePiano was appointed to our Board of Directors in May 2000 and was unanimously elected to serve as Non-Executive Chairman of the Board on January 31, 2003. Mr. DePiano has been a director of Escalon Medical Corp., a publicly traded healthcare business specializing in the development and marketing of ophthalmic devices and pharmaceutical and vascular access products, since February 1996, and has served as its Chairman and Chief Executive Officer since March 1997. Mr. DePiano has been the Chief Executive Officer of the Sandhurst Company, L.P. and Managing Director of the Sandhurst Venture Fund since 1986. Mr. DePiano was also the Chairman of the Board of Directors of SLT prior to our acquisition of SLT.

Jeffrey F. O’Donnell joined PhotoMedex in 1999 as President and CEO and has served as a member of the Board of Directors since that date. Prior to PhotoMedex, he joined Radiance Medical Systems (originally Cardiovascular Dynamics) as Vice President of Sales and Marketing from 1995 to 1997; from 1997 to 1999 he served as its President and CEO and subsequently assumed a role as non-executive chairman of the board. Previously, from 1994 to 1995 Mr. O’Donnell held the position of President and CEO of Kensey Nash Corporation. Additionally, he has held several senior sales and marketing management positions at Boston Scientific, Guidant and Johnson & Johnson Orthopedic. In addition to sitting on the Board of Directors for PhotoMedex, Mr. O’Donnell is currently an outside Board Member of Endologix, Inc., Cardiac Sciences and Replication Medical, Inc. and had served until December 28, 2004 on the Board of Escalon Medical Corp. He had served as an outside Board member of AzurTec, Inc. but resigned from that board in 2003. Mr. O’Donnell graduated from LaSalle University in 1982 with a B.S. in business administration.

Dennis M. McGrath was appointed Chief Financial Officer and Vice President-Finance and Administration in January 2000. Mr. McGrath has held several senior level positions including from February 1999 to January 2000 serving as the Chief Operating Officer of Internet Practice, the largest division for AnswerThink Consulting Group, Inc., a public company specializing in business consulting and technology integration. Concurrently, from August 1999 until January 2000, Mr. McGrath assumed the role of Chief Financial Officer of Think New Ideas, Inc., a public company specializing in interactive marketing services and business solutions. In addition to the financial reporting responsibilities, Mr. McGrath was responsible for the merger integration of Think New Ideas, Inc. and AnswerThink Consulting Group, Inc. From September 1996 to February 1999, Mr. McGrath was the Chief Financial Officer and Executive Vice-President-Operations of TriSpan, Inc., an internet commerce solutions and technology consulting company, which was acquired by AnswerThink in 1999. Mr. McGrath is currently an outside Board member of RICOMM Systems, Inc. and Noninvasive Medical Technologies, Inc. Mr. McGrath is a certified public accountant and graduated with a B.S. in accounting from LaSalle University in 1979. Mr. McGrath holds a license from the states of Pennsylvania and New Jersey as a certified public accountant.

Michael R. Stewart was appointed as our Executive Vice President of Corporate Operations on December 27, 2002, immediately following the acquisition of SLT and on July 19, 2005, he was appointed our Chief Operating Officer. From July 1999 to the acquisition, Mr. Stewart was the President and Chief Executive Officer of SLT, and from October 1990 to July 1999 he served as SLT’s Vice President Finance and Chief Financial Officer. Mr. Stewart graduated from LaSalle University with a B.S. in accounting and received an M.B.A. from LaSalle University in 1986. Mr. Stewart passed the CPA examination in New York in 1986.

Alan R. Novak was appointed to our Board of Directors in October 1997. Mr. Novak is Chairman of Infra Group, L.L.C., an international project finance and development company. He is also Chairman of Lano International, Inc., a real estate development company. Mr. Novak is a graduate of Yale University, Yale Law School, and Oxford University as a Marshall Scholar. Mr. Novak practiced law at Cravath, Swaine & Moore and Swidler & Berlin, Chartered. His public service includes three years as an officer in the United States Marine Corps, a U.S. Supreme Court clerkship with Justice Potter Stewart, Senior Counsel to Senator Edward M. Kennedy, Senior Executive Assistant to Undersecretary of State, Eugene Rostow, and the Executive Director of President Johnson’s Telecommunications Task Force. Mr. Novak was appointed by President Carter and served for five years as Federal Fine Arts Commissioner.

Warwick Alex Charlton was appointed to our Board of Directors and served as the Non-Executive Chairman of the Board of Directors from March 8, 1999 to January 31, 2003. Mr. Charlton is the Managing Director of True North Partners L.L.C., a venture capital firm with a specialty in the healthcare field. Mr. Charlton has 20 years of business experience, of which ten years were line management experience and nine years were in the consulting profession (previously with Booz Allen & Hamilton and the Wilkerson Group). Mr. Charlton received an honors degree in Marketing from the University of Newcastle and an M.B.A. from Cranfield Institute of Technology. Mr. Charlton was formerly a Vice President of CSC Healthcare, Inc. and serves as a member of the Board of Directors of Intercure, Inc. and as an advisor to the Board of Directors of Balance Pharmaceuticals, Inc.

Anthony J. Dimun was appointed to our Board of Directors on October 3, 2003. He has served since May 2001 as Chairman of Nascent Enterprises, L.L.C., a medical device venture advisory firm. He also has served since 1987 as the Managing Director and Chief Executive Officer of Strategic Concepts, Inc., a financial advisory company with specific focus on venture capital and acquisition transactions. From March 1991 to May 2001, Mr. Dimun served as Executive Vice President and Chief Financial Officer of Vital Signs, Inc., a publicly held anesthesia and respiratory medical device company. Mr. Dimun also serves as a member of the Board of Trustees of the New Jersey Center for Biomaterials, a non-profit collaboration of the three leading New Jersey universities. Prior to 1991, Mr. Dimun held positions as a Certified Public Accountant with several national accounting firms and served as Senior Vice President for an international merchant-banking firm.

David W. Anderson was appointed to our Board of Directors on September 28, 2004. Mr. Anderson has been the President and Chief Executive Officer of Gentis, Inc since November 2004. He has over twenty years of entrepreneurial management experience in the medical device, orthopedics and pharmaceutical field. He has served as President and CEO of Sterilox Technologies, Inc., the world’s leader in the development and marketing of non-toxic biocides; Bionx Implants, Inc., a publicly traded orthopedic sports medicine and trauma company, and Kensey Nash Corporation, a publicly traded cardiology and biomaterials company. In addition, Mr. Anderson was previously Vice President of LFC Financial Corp., a venture capital and leasing company, where he was responsible for LFC’s entry into the healthcare market; and was a founder and Executive Vice President of Osteotech, Inc., a high-technology orthopedic start-up.

Wayne M. Withrow was appointed to our Board of Directors on August 16, 2006. Mr. Withrow is currently Executive Vice President for SEI Investments Company, a leading global provider of outsourced asset management, investment processing and investment operation solutions. He is also the head of SEI’s Investment Advisors Segment, and a member of its Executive Committee. Mr. Withrow’s broad background was gained from over 15 years in various senior management positions with SEI Investments. Formerly, he was with the law firm of Schnader, Harrison, Segal & Lewis, where he was significantly involved in corporate securities and acquisitions. His earlier experience also included a federal judicial clerkship with the Honorable William J. Ditter as well as public accounting experience with Deloitte & Touche.

Directors who are also our employees receive no separate compensation for serving as directors or as members of Board committees. Directors who are not our employees are compensated under the 2000 Non-Employee Director Plan. Each director receives non-qualified options to purchase up to 35,000 shares of common stock on an annual basis. Each outside director receives an annual cash retainer of $20,000 and is also paid $1,000 for personal attendance at each meeting of the Board and each committee meeting held not in conjunction with meetings of the Board itself, and $500 for telephonic attendance at each Board or committee meeting, excluding meetings of limited scope and duration. We pro-rate the retainer for a director serving less than a full year. The table below sets forth non-employee directors’ compensation in 2006.

General. The Board maintains charters for select committees. In addition, the Board has adopted a written set of corporate governance guidelines and a code of business conduct and ethics and a code of conduct for our chief executive and senior financial officers that generally formalize practices that we already had in place. We have adopted a Code of Ethics on Interactions with Health Care Professionals and have adopted a related Comprehensive Compliance Program. To view the charters of the Audit, Compensation and Nominations and Corporate Governance Committees, the Code of Ethics and Comprehensive Compliance Program, the corporate governance guidelines and the codes of conduct and our whistle blower policy, please visit our website at www.photomedex.com (this website address is not intended to function as a hyperlink, and the information contained on our website is not intended to be a part of this Report). The Board determined in 2006 that all members of the Board are independent under the revised listing standards of The Nasdaq Stock Market, Inc. (“Nasdaq”), except for Mr. O'Donnell, who is also our Chief Executive Officer.

The Compensation Committee reviews executive compensation from time to time and reports to the Board of Directors, which makes all decisions. The Compensation Committee adheres to several guidelines in carrying out its responsibilities, including performance by the employees, our performance, enhancement of stockholder value, growth of new businesses and new markets and competitive levels of fixed and variable compensation. The Compensation Committee reviews and approves the annual salary and bonus for each executive officer (consistent with the terms of any applicable employment agreement), provides oversight for employee benefit plans (and changes thereto) and administers our stock option plans and such other employee benefit plans as may be adopted by us from time to time. The report of the Compensation Committee for 2006 is presented below.

Nominations and Corporate Governance Committee. Our Board has established a Nominations and Corporate Governance Committee for the purpose of reviewing all Board-recommended and stockholder-recommended nominees, determining each nominee’s qualifications and making a recommendation to the full Board as to which persons should be our Board’s nominees. Our Board has adopted a written charter for the Nominations and Corporate Governance Committee. The Nominations and Corporate Governance Committee is composed of Messrs. Novak, DePiano and Anderson. Mr. Anderson serves as the Chairman of the Nominations and Corporate Governance Committee. The Board of Directors determined in 2006 that each member of the Nominations and Corporate Governance Committee satisfies the independence requirements of the Commission and Nasdaq. The Nominations and Corporate Governance Committee held two meetings during 2006.

Our Board of Directors believes that it is necessary that the majority of our Board of Directors be comprised of independent directors and that it is desirable to have at least one audit committee financial expert serving on the Audit Committee. The Nominations and Corporate Governance Committee considers these requirements when recommending Board nominees. Our Nominations and Corporate Governance Committee utilizes a variety of methods for identifying and evaluating nominees for director. Our Nominations and Corporate Governance Committee will regularly assess the appropriate size of the Board, and whether any vacancies on the Board are expected due to retirement or other circumstances. When considering potential director candidates, the Nominations and Corporate Governance Committee also considers the candidate’s character, judgment, diversity, age, skills, including financial literacy, and experience in the context of our needs, the needs of PhotoMedex and of the existing directors. The Committee recommended to the Board that Mr. Wayne M. Withrow be invited to join the Board. The Board accepted the recommendation, and Mr. Withrow accepted the invitation in August 2006.

The Compensation Committee of the Board of Directors is composed solely of directors who are not our current or former employees, and each is independent under the revised listing standards of The Nasdaq Stock Market, Inc. The Board of Directors has delegated to the Compensation Committee the responsibility to review and approve our compensation and benefits plans, programs and policies, including the compensation of the chief executive officer and our other executive officers as well as middle-level management and other key employees. The Compensation Committee administers all of our executive compensation programs, incentive compensation plans and equity-based plans and provides oversight for all of our other compensation and benefit programs.

In order to assess whether the compensation program we had been providing to our executive officers was competitive and effective, the Compensation Committee engaged in 2005 a third-party consulting firm specializing in executive compensation. The consulting firm advised that our program was within the range of compensation programs that appeared to be offered by a group of our peer companies. The consulting firm also counseled the Compensation Committee on modifications to the compensation program which were under consideration. The primary consideration was the use of performance-based restricted stock. As an ongoing matter, the Committee does not engage a third-party consultant to advise on our compensation policies. Nor does the Committee delegate its responsibilities for reviewing and approving executive compensation, except in the case of the 2005 Investment Plan, where the Plan has pre-approved the grant of matching options to an executive who purchases shares of our common stock in the open market in accordance with the provisions of the Plan.

Bonus. At the outset of a fiscal year, the Compensation Committee establishes a bonus program for executive officers and other managers and key employees eligible to participate in the program. The program is based on a financial plan for the fiscal year and other business factors. The amount of bonus, if any, hinges on corporate performance and financial condition and on the performance of the participant in the program. A program will typically allow some partial or discretionary awards based on an evaluation of the relevant factors. Provision for bonus expense is typically made over the course of a fiscal year. The provision becomes fixed, based on the final review of the Committee, which is usually made after the financial results of the fiscal year have been reviewed by our independent accountants. For 2006, there were three factors of generally equal weight: Company revenues, the Company’s net loss or profit and a discretionary component.

Long-Term Incentives. Grants of stock options under our stock option plans are designed to provide executive officers and other managers and key employees with an opportunity to share, along with stockholders, in our long-term performance. Stock option grants are generally made annually to all executive officers, with additional grants being made following a significant change in job responsibility, scope or title or a significant achievement. The size of the option grant to each executive officer is set by the Compensation Committee at a level that is intended to create a meaningful opportunity for stock ownership based upon the individual's current position with us, the individual's personal performance in recent periods and his or her potential for future responsibility and promotion over the option term. The Compensation Committee also takes into account the number of unvested options held by the executive officer in order to maintain an appropriate level of equity incentive for that individual. The relevant weight given to each of these factors varies from individual to individual.

Prior to 2006, stock options granted under the various stock option plans generally have had a four-year vesting schedule depending upon the size of the grant, and generally have been set to expire five years from the date of grant. In 2006, the Committee determined that such grants would be for ten years and vest over five years. The exercise price of options granted under the stock option plans is at no less than 100% of the fair market value of the underlying stock on the date of grant. The number of stock options granted to each executive officer is determined by the Compensation Committee based upon several factors, including the executive officer’s salary grade, performance and the estimated value of the stock at the time of grant, but the Compensation Committee has the flexibility to make adjustments to those factors at its discretion. The options granted to executives as a rule have provisions by which vesting and exercisability are accelerated in the event of a change of control or a termination of employment initiated by the Company other than for cause.

We also have arrangements with other key employees under which we would be obliged to pay compensation upon their termination outside a context of change of control, and, for a lesser number of key employees, by virtue of a change of control. If all such executive officers and key employees were terminated other than for cause and not within a change of control, we would have had an aggregate commitment of approximately $1,677,000 at December 31, 2006 for severance and related compensation. However, the obligation for such compensation that would arise in favor of the executive officers and certain key employees by virtue of a change of control would have been approximately $2,146,000 at December 31, 2006.

As a general rule, options and/or restricted stock awards are made in the first or second quarter of a year and after the financial results for the prior year have been audited and reported to the Board of Directors. Grants and/or awards are valued, and exercise prices are set, as of the date the grant or award is made. Exceptions to the general rule may arise for grants made to recognize a promotion or to address the effect of expiring options. The Committee may elect to defer a grant until after the Company has made public disclosure of its financial results, typically in a conference call on earnings; in such a case, the exercise price is set at the higher of the closing prices on the approval date or the fixed grant date. In these deliberations, the Compensation Committee does not delegate any related function, unless to the Board of Directors as a whole, and the grants or awards made to executives are valued under the same measurement standards as for grants made to other grantees.

On January 1, 2006, we adopted SFAS No. 123R. Under this accounting standard, we are required to value stock options granted, and restricted stock awarded, in 2006 and beyond under the fair value method and expense those amounts in the income statement over the vesting period of the stock option or restricted stock. We were also required to value unvested stock options granted prior to our adoption of SFAS 123R under the fair value method and amortize such expense in the income statement over the stock option’s remaining vesting period. A material portion of such amortizing expense relates to option grants made to our executive officers, and future option grants and stock awards made in 2006 and beyond to our executive officers will also have a material impact on such expense.

Under Section 162(m) of the Internal Revenue Code, a limitation was placed on tax deductions of any publicly-held corporation for individual compensation to certain executives of such corporation exceeding $1,000,000 in any taxable year, unless the compensation is performance-based. The Compensation Committee has been advised that based upon prior stockholder approval of the material terms of our stock option plans, compensation under these plans is excluded from this limitation, provided that the other requirements of Section 162(m) are met. However, when warranted based upon competitive and other factors, the Compensation Committee may decide to exceed the tax deductible limits established under Section 162(m) Code. The base salary provided to each executive in 2004, 2005 and 2006 did not exceed the limits under Section 162(m) for tax deductibility; no executive exercised any options in 2004, 2005 or 2006.

Employment Agreement with Jeffrey F. O'Donnell. In November 1999, we entered into an employment agreement with Jeffrey F. O'Donnell to serve as our President and Chief Executive Officer and amended and restated that agreement in August 2002. This agreement has been renewed through December 31, 2007 and will expire then if due notice is given by December 1, 2007. If due notice is not given, then the agreement will renew for an additional year and thereafter on an annual basis. Mr. O'Donnell's current base salary is $350,000 per year. If we terminate Mr. O'Donnell other than for "cause" (which definition includes nonperformance of duties or competition of the employee with our business), then he will receive severance pay equal to $350,000, payable over 12 months. If a change of control occurs, Mr. O’Donnell becomes entitled to severance pay by virtue of provisions related to the change of control, then he may become entitled to severance equal to 200% of his then base salary in a lump sum.

On January 15, 2006, Mr. O’Donnell was granted 200,000 incentive stock options (having an exercise price of $2.50 and a life of 10 years, vesting ratably over the first 5 years from the 2005 Equity Compensation Plan. In the event of a sale of the Company, the options will become fully vested and exercisable). He was also awarded from the 2005 Equity Compensation Plan and as of the same date 525,000 restricted shares of our common stock, setting their purchase price at $0.01 per share. Shares that are purchased will be held in escrow by us for as long as they are subject to our right of repurchase. Our right of repurchase will continue for such shares for so long as the shares remain subject to performance restrictions and time restrictions.

As to the performance restrictions, our repurchase right will lapse if the trading price of our common stock attains certain targets above the 2005 Average Price, which by contract was set at $2.50, being higher than the average fair market value (generally the closing price of our common stock) for each of the trading days in the 90-day period ending on December 28, 2005. For the years 2006 through 2010, the Average Price will mean the average fair market value of our common stock for each of the trading days in the last three months of the calendar year. Our right of repurchase shall lapse with respect to 20% of the purchased shares if the 2006 Average Price equals or exceeds the 2006 Target Price, where the term “2006 Target Price” will equal 125% of the 2005 Average Price, or $3.13, and where the lapsing shall be effective as of December 31, 2006. The restrictions did not lapse in 2006 inasmuch as the 2006 Target Price was not attained.

Likewise, our right of repurchase will lapse with respect to 20% of the purchased shares if the 2007 Average Price equals or exceeds the 2007 Target Price, where the term “2007 Target Price” will equal 125% of the 2006 Target Price, or $3.91, and so on. For 2010, if the 2010 Average Price equals or exceeds the 2010 Target Price of $7.64, then our right of repurchase will lapse with respect to all of the purchased shares for which our repurchase right has not previously lapsed, and such lapsing will be effective as of December 31, 2010. As to time restrictions, to the extent that any of the purchased shares remain subject to our right of repurchase and therefore are unvested, they will vest ratably (i.e. one-third) on the fifth, sixth and seventh anniversaries of the award of the restricted shares.

However, in the event of a transaction that constitutes a change in control of the Company, our right of repurchase will lapse with respect to the performance restrictions on the restricted shares that are unvested immediately prior to the consummation of such transaction as follows. Where the per-share purchase price paid or deemed paid in connection with such change in control is equal to or greater than a Target Price described above, then it shall be deemed that the Target Price has been attained as of the change in control, and our repurchase rights applicable to such Target Price will lapse. Shares that have not vested on a change of control will remain subject to such repurchase restriction. Such shares still subject to repurchase shall vest ratably and monthly over the period of time (but not greater than 36 months) that the acquirer in the change in control event contracts for Mr. O’Donnell’s services. If the acquirer opts not to contract for such services, then the unvested balance of shares will vest as of the change in control event.

Employment Agreement with Dennis M. McGrath.. In November 1999, we entered into an employment agreement with Dennis M. McGrath to serve as our Chief Financial Officer and Vice President-Finance and Administration and amended and restated that agreement in August 2002. This agreement has been renewed through December 31, 2007 and will expire then if due notice is given by December 1, 2007. If due notice is not given, then the agreement will renew for an additional year and thereafter on an annual basis. Mr. McGrath's current base salary is $285,000 per year. If we terminate Mr. McGrath other than for "cause" (which definition includes nonperformance of duties or competition of the employee with our business), then he will receive severance pay equal to $285,000, payable over 12 months. If a change of control occurs, Mr. McGrath becomes entitled to severance pay by virtue of provisions related to the change of control, then he may become entitled to severance equal to 200% of his then base salary in a lump sum.

Employment Agreement with Michael R. Stewart. Effective December 27, 2002, Michael R. Stewart became the Company’s Executive Vice President of Corporate Operations, pursuant to an employment agreement. Mr. Stewart became our Chief Operating Officer on July 19, 2005, at which time he was granted 40,000 options. Mr. Stewart’s current base salary is $250,000 per year. This agreement has renewed through December 31, 2007 and will expire then if due notice is given by December 1, 2007. If due notice is not given, then the agreement will renew for an additional year and thereafter on an annual basis. If we terminate Mr. Stewart other than for “cause” (which definition includes nonperformance of duties or competition of the employee with our business), then he will receive severance pay equal to his base pay, payable over 12 months. If a change of control occurs, Mr. Stewart becomes entitled to severance pay by virtue of provisions related to the change of control, then he may become entitled to severance equal to 200% of his then base salary, payable over 12 months.

Name and Principal Position	Year		Salary ($)		Bonus ($)(1)		Option Awards ($)(3)		Equity Incentive Plan Compensation ($)(2)(3)		All Other Compensation ($)(4)		Total ($)
Jeffrey F. O’Donnell, President and Chief Executive Officer		2006		350,000		157,500		420,213		943,005		17,395		1,888,113

Dennis M. McGrath, Chief Financial Officer & Vice President - Finance/Administration		2006		285,000		102,600		377,054		601,727		15,105		1,381,486

Michael R. Stewart, Chief Operating Officer and Executive Vice President		2006		250,000		75,000		190,200		0		18,366		533,566

John F. Clifford, former Executive Vice President, Dermatology		2006		150,000		0		0		0		156,000		306,000

(3) The amounts shown for option awards and restricted stock awards relate to shares granted under our 2005 Equity Compensation Plan and 2005 Investment Plan. These amounts are equal to the aggregate grant-date fair value with respect to the awards made in 2006, computed in accordance with SFAS 123(R), before amortization and without giving effect to estimated forfeitures. The assumptions used in determining the amounts in this column are set forth in Note 1 to our consolidated financial statements. For information regarding the number of shares subject to 2006 awards, other features of those awards, and the grant-date fair value of the awards, see the Grants of Plan-Based Awards Table on p. 71.

Name	Benefit		Before Change in Control Termination w/o Cause or for Good Reason		After Change in Control Termination w/o Cause or for Good Reason		Voluntary Termination		Death (4)		Disability (4)		Change in Control

Jeffrey F. O’Donnell(1)(2)		Severance		350,000		700,000		0		0		0		N/A
		Health continuation		15,378		30,756		0		0		0		N/A
		AD&D insurance		780		1,560		0		0		0		N/A
		Executive life ins.		5,355		10,711		0		0		0		N/A
		Accelerated vesting		0		577,500		0		0		0		0

Dennis McGrath(1)(2)		Severance		285,000		570,000		0		0		0		N/A
		Health continuation		15,378		30,756		0		0		0		N/A
		AD&D insurance		780		1,560		0		0		0		N/A
		Executive life ins.		1,680		10,152		0		0		0		N/A
		Accelerated vesting		0		368,500		0		0		0		0

Michael Stewart(2)		Severance		250,000		500,000		0		0		0		N/A
		Health continuation		15,378		30,756		0		0		0		N/A
		AD&D insurance		780		1,560		0		0		0		N/A
		Executive life ins.		5,076		10,152		0		0		0		N/A
		Accelerated vesting		0		0		0		0		0		0

John Clifford(3)		Severance, consulting		N/A		N/A		202,500		N/A		N/A		N/A
		Health continuation		N/A		N/A		9,430		N/A		N/A		N/A
		AD&D insurance		N/A		N/A		0		N/A		N/A		N/A
		Executive life ins.		N/A		N/A		0		N/A		N/A		N/A

(2)

All unvested options become exercisable by reason of a change of control. However, none of the executives’ unvested options as of December 31, 2006 were in the money, and therefore there would have been no benefit as of December 31, 2006. Similarly, in the event of an involuntary termination without cause, the executive optionee becomes vested in those options that would otherwise have vested in twelve months following the date of termination. As in the hypothetical change of control, so in this case of hypothetical involuntary termination, there would have been no benefit to the optionee inasmuch as no option was in the money at December 31, 2006.

					Estimated Future Payouts Under Equity Incentive Plan Awards(2)						All Other Option Awards: Number of Securities Underlying		Exercise or Base Price of Option		Closing Price on Grant Date		Grant Date Fair Value of Stock and Option
Name	Grant Date		Approval Date (1)		Threshold (#)		Target (#)		Maximum (#)		Options (#)		Awards ($ / Sh)		($ / Sh)(3)		Awards ($)(4)
Jeffrey O’Donnell		1/15/06		12/28/05		-		525,000		-		200,000		2.50		1.83		1,245,805
		5/24/06		5/24/06								2,000		1.59		N/A		2,788
		11/20/06		11/20/06								125,000		1.11		1.11		114,625

Dennis McGrath		1/15/06		12/28/05		-		335,000		-		N/A		N/A		1.83		601,727
		3/10/06		2/28/06								140,000		2.23		1.97		266,280
		5/24/06		5/24/06								5,000		1.58		N/A		6,972
		5/25/06		5/25/06								2,000		1.63		N/A		2,932
		11/20/06		11/13/06								110,000		1.11		1.11		100,870

Michael Stewart		3/10/06		2/28/06								100,000		2.23		1.97		223,000

	Option Awards										Stock Awards
	Number of Securities Underlying Unexercised Options (#)		Number of Securities Underlying Unexercised Options (#)		Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options		Option Exercise Price		Option Expiration		Number of Shares or Units of Stock That Have Not Vested		Market Value of Shares or Units of Stock That Have Not Vested		Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested		Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested
Name	Exercisable		Unexercisable		(#)		($)		Date		(#)		($)(1)		(#)		($) (1)
Jeffrey O’Donnell		93,750		31,250		0		1.66		1/16/08		0		0		N/A		N/A
		75,000		75,000		0		2.14		1/22/09		0		0		N/A		N/A
		112,500		37,500		0		2.45		3/1/10		0		0		N/A		N/A
		0		200,000		0		2.50		N/A		0		0		525,000		582,750
		0		2,000		0		1.59		5/24/16		0		0		N/A		N/A
		0		125,000		0		1.11		11/20/16		0		0		N/A		N/A

Dennis McGrath		82,500		27,500		0		1.66		1/16/08						N/A		N/A
		62,500		62,500		0		2.14		1/22/09		0		0		N/A		N/A
		105,000		35,000		0		2.45		3/1/10		0		0		N/A		N/A
		0		N/A		0		N/A		N/A		0		0		335,000		371,850
		0		140,000		0		2.23		3/10/16		0		0		N/A		N/A
		0		5,000		0		1.58		5/24/16		0		0		N/A		N/A
		0		2,000		0		1.63		5/25/16		0		0		N/A		N/A
		0		110,000		0		1.11		11/20/16		0		0		N/A		N/A

Michael Stewart		150,000		0		0		1.85		12/27/07		0		0		N/A		N/A
		75,000		0		0		1.83		1/2/08		0		0		N/A		N/A
		75,000		37,500		0		2.14		1/22/09		0		0		N/A		N/A
		100,000		75,000		0		2.45		3/1/10		0		0		N/A		N/A
		40,000		20,000		0		2.63		7/19/10		0		0		N/A		N/A
		0		100,000		0		2.23		3/10/16		0		0		N/A		N/A

John Clifford		33,110		0		0		2.17		9/30/08		0		0		N/A		N/A
		99,330		0		0		1.16		9/30/08		0		0		N/A		N/A
		66,220		0		0		1.07		9/30/08		0		0		N/A		N/A
		66,220		0		0		1.96		9/30/08		0		0		N/A		N/A
		99,330		0		0		2.76		9/30/08		0		0		N/A		N/A
		27,591		5,519		0		1.65		9/30/08		0		0		N/A		N/A
		167,500		82,500		0		2.78		9/30/08		0		0		N/A		N/A

Our Certificate of Incorporation and Bylaws designate the relative duties and responsibilities of our officers, establish procedures for actions by directors and stockholders and other items. Our Certificate of Incorporation and Bylaws also contain extensive indemnification provisions, which will permit us to indemnify our officers and directors to the maximum extent, provided by Delaware law. Pursuant to our Certificate of Incorporation and under Delaware law, our directors are not liable to us or our stockholders for monetary damages for breach of fiduciary duty, except for liability in connection with a breach of duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, for dividend payments or stock repurchases illegal under Delaware law or any transaction in which a director has derived an improper personal benefit.

We have adopted a form of indemnification agreement, which provides the indemnitee with the maximum indemnification allowed under applicable law. Since the Delaware statutes are non-exclusive, it is possible that certain claims beyond the scope of the statute may be indemnifiable. The indemnification agreement provides a scheme of indemnification, which may be broader than that specifically provided by Delaware law. It has not yet been determined, however, to what extent the indemnification expressly permitted by Delaware law may be expanded, and therefore the scope of indemnification provided by the indemnification agreement may be subject to future judicial interpretation.

The indemnification agreement provides that we are to indemnify an indemnitee, who is or was a party or becomes a party or is threatened to be made a party to any threatened, pending or completed action or proceeding whether civil, criminal, administrative or investigative by reason of the fact that the indemnitee is or was one of our directors, officers, key employees or agents. We are to advance all expenses, judgments, fines, penalties and amounts paid in settlement (including taxes imposed on indemnitee on account of receipt of such payouts) incurred by the indemnitee in connection with the investigation, defense, settlement or appeal of any civil or criminal action or proceeding as described above. The indemnitee is to repay such amounts advanced only if it shall be ultimately determined that he or she is not entitled to be indemnified by us. The advances paid to the indemnitee by us are to be delivered within 20 days following a written request by the indemnitee. Any award of indemnification to an indemnitee, if not covered by insurance, would come directly from our assets, thereby affecting a stockholder's investment.

Name and Address Of Beneficial Owner ⁽¹⁾	Number of Shares Beneficially Owned		Percentage of Shares Beneficially Owned ⁽¹⁾
Richard J. DePiano⁽²⁾		244,300		*
Jeffrey F. O’Donnell ⁽³⁾		884,500		1.41
Dennis M. McGrath ⁽⁴⁾		647,750		1.03
Michael R. Stewart ⁽⁵⁾		372,690		*
Alan R. Novak ⁽⁶⁾		226,101		*
David W. Anderson ⁽⁷⁾		105,000		*
Warwick Alex Charlton ⁽⁸⁾		367,500		*
Anthony J. Dimun ⁽⁹⁾		276,250		*
Wayne M. Withrow ⁽¹⁰⁾		65,004		*
Corsair Reporting Persons ⁽¹¹⁾		4,417,323		7.03
Wellington Management Co., L.P. ⁽¹²⁾		8,528,259		13.57
LB I Group, Inc.⁽¹³⁾		5,271,154		8.31
Prides Capital Partners, L.L.C.⁽¹⁴⁾		3,569,821		5.71
All directors and officers as a group (9 persons)⁽¹⁵⁾		3,189,095		4.95

(1)

Beneficial ownership is determined in accordance with the rules of the SEC. Shares of common stock subject to options or warrants currently exercisable or exercisable within 60 days of March 15, 2007, are deemed outstanding for computing the percentage ownership of the stockholder holding the options or warrants, but are not deemed outstanding for computing the percentage ownership of any other stockholder. Unless otherwise indicated in the footnotes to this table, we believe stockholders named in the table have sole voting and sole investment power with respect to the shares set forth opposite such stockholder's name. Unless otherwise indicated, the officers, directors and stockholders can be reached at our principal offices. Percentage of ownership is based on 62,536,054 shares of common stock outstanding as of March 15, 2007.

(11)

Includes 4,157,029shares of common stock and warrants to purchase up to 260,294 shares. Certain of the shares are held in various denominations by Corsair Capital Partners, L.P., a Delaware limited partnership ("Corsair Capital Partners"), Corsair Long Short International, Ltd., a Cayman Islands exempted company ("Corsair International"), Corsair Select, L.P., a Delaware limited partnership ("Corsair Select"), Corsair Capital Partners 100, L.P., a Delaware limited partnership ("Corsair 100"), Corsair Capital Investors, Ltd., a Cayman Islands exempted company ("Corsair Investors", and together with Corsair Capital Partners, Corsair International, Corsair Select and Corsair 100, the "Corsair Entities"), each of which are private investment funds. Corsair Capital Management, L.L.C. ("Corsair Capital Management") is the investment manager of each of the Corsair Entities. As the investment manager of the Corsair Entities, and the manager of such other separate accounts, Corsair Capital Management has the power to vote and/or dispose of those shares of common stock held by such persons and accordingly, may be deemed to be the beneficial owner of such shares. Jay R. Petschek ("Petschek") and Steven Major ("Major," and together with the Corsair Entities, Corsair Capital Management and Petschek, the "Corsair Reporting Persons") are the controlling principals of Corsair Capital Management. Mr. Major beneficially owns 21,100 additional shares of common stock, and Mr. Petschek beneficially owns 60,000 additional shares of common stock. Accordingly, the Corsair Reporting Persons may collectively be deemed to be the beneficial owners of 4,417,323 shares of common stock, including 4,157,029 shares of common stock and warrants to purchase up to 260,294 shares. Neither the use of the terms "Corsair Entities" or "Corsair Reporting Persons" nor the aggregation of ownership interests by the Corsair Reporting Persons, as described herein, necessarily implies the existence of a group for purposes of Section 13(d)(3) of the Exchange Act or any other purpose. The foregoing information has been derived from a Schedule 13G filed on behalf of certain of the Corsair Reporting Persons, on February 14, 2007.

As defined by the Commission, (i) “audit fees” are fees for professional services rendered by our principal accountant for the audit of our annual financial statements and review of financial statements included in our Form 10-Q, or for services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years; (ii) “audit-related fees” are fees for assurance and related services by our principal accountant that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “audit fees”; (iii) “tax fees” are fees for professional services rendered by our principal accountant for tax compliance, tax advice, and tax planning; and (iv) “all other fees” are fees for products and services provided by our principal accountant, other than the services reported under audit fees,” “audit-related fees,” and “tax fees.”

Engagement of the Independent Auditor. The Audit Committee is responsible for approving every engagement of Amper, Politziner & Mattia, P.C. to perform audit or non-audit services for us before Amper, Politziner & Mattia, P.C. is engaged to provide those services. Under applicable Commission rules, the Audit Committee is required to pre-approve the audit and non-audit services performed by the independent auditors in order to ensure that they do not impair the auditors’ independence. The Commission’s rules specify the types of non-audit services that an independent auditor may not provide to its audit client and establish the Audit Committee’s responsibility for administration of the engagement of the independent auditors.

Following the footnote reference is the number of the exhibit in the original filing (e.g. “Exh 10.3”) in which it was submitted to the SEC.

2.1		Agreement and Plan of Merger, dated September 25, 2002, between PhotoMedex, Inc., J Merger Corp., Inc. and Surgical Laser Technologies, Inc. (1)
2.2		Agreement and Plan of Merger, dated December 1, 2004, between PhotoMedex, Inc., Gold Acquisition Merger Corp. and ProCyte Corporation (2)
2.3		Securities Purchase Agreement, dated October 31, 2006, by and between PhotoMedex, Inc. and each purchaser a party thereto (3)
3.1(a)		Restated Certificate of Incorporation, filed on August 8, 2000 (4)(Exh 3.1)
3.1(b)		Amendment to Restated Certificate of Incorporation, filed on January 6, 2004. (5)(Exh 3.2)
3.2		Amended and Restated Bylaws (5)(Exh 3.1E)
10.1		Lease Agreement dated May 29, 1996, between Surgical Laser Technologies, Inc. and Nappen & Associates (Montgomeryville, Pennsylvania) (5)(Exh 10.31)
10.2		Lease Renewal Agreement, dated January 18, 2001, between Surgical Laser Technologies, Inc. and Nappen & Associates (5)(Exh 10.32)
10.3		Lease Agreement, dated July 10, 2006, PhotoMedex, Inc. and Nappen & Associates (6)(Exh 10.3)
10.4		Lease Agreement (Carlsbad, California) dated August 4, 1998 (7)
10.5		Standard Industrial/Commercial Multi-Tenant Lease - Net, dated March 17, 2005 (Carlsbad, California)(8)(Exh 10.52)
10.6		Industrial Real Estate Lease, dated August 30, 1993, as amended five times (Redmond, Washington) (8) (Exh 10.53)
10.7		License and Development Agreement, dated May 22, 2002, between Surgical Laser Technologies, Inc. and Reliant Technologies, Inc. (5)(Exh 10.7)
10.8		Secured Promissory Note, dated May 22, 2002, between Surgical Laser Technologies, Inc. and Reliant Technologies, Inc. (5)(Exh 10.8)
10.9		Security Agreement, dated May 22, 2002, between Surgical Laser Technologies, Inc. and Reliant Technologies, Inc. (5)(Exh 10.9)
10.10		Agreement as to Collateral, dated May 22, 2002, among Surgical Laser Technologies, Inc., Reliant Technologies, Inc. and AmSouth Bank (5)(Exh 10.10)
10.11		Master Purchase Agreement, dated September 7, 2004, between PhotoMedex, Inc. and Stern Laser, srl (9)
10.12		Master Lease Agreement, dated June 25, 2004, between PhotoMedex, Inc. and GE Capital Corporation. (10)
10.13		Investment Agreement, dated March 30, 2006, between AzurTec, Inc. and PhotoMedex, Inc. (11)(Exh 10.56)
10.14		License Agreement, dated March 30, 3006, between AzurTec, Inc. and PhotoMedex, Inc. (11)(Exh 10.57)
10.15		License Agreement, dated March 31, 2006, and effective April 1, 1006, between Mount Sinai School of Medicine and PhotoMedex, Inc. (12)
10.16		2005 Equity Compensation Plan, approved December 28, 2005 (13)
10.17		2005 Investment Plan, approved December 28, 2005 (13)
10.18		Amended and Restated 2000 Non-Employee Director Stock Option Plan (1)
10.19		Amended and Restated 2000 Stock Option Plan (1)

10.20		2004 Stock Option Plan, assumed from ProCyte (14)
10.21		1996 Stock Option Plan, assumed from ProCyte (14)
10.22		1991 Restated Stock Option Plan for Non-Employee Directors, assumed from ProCyte (14)
10.23		1989 Restated Stock Option Plan, assumed from ProCyte (14)
10.24		Amended and Restated Employment Agreement with Jeffrey F. O'Donnell, dated August 1, 2002 (1)
10.25		Amended and Restated Employment Agreement with Dennis M. McGrath, dated August 1, 2002 (1)
10.26		Employment Agreement of Michael R. Stewart, dated December 27, 2002 (5)(Exh 10.37)
10.27		Employment Agreement of John F. Clifford, dated March 18, 2005 (2)
10.28		Employment Agreement of Robin L. Carmichael, dated March 18, 2005 (2)
10.29		Separation Agreement, effective June 30, 2006, between PhotoMedex, Inc. and John F. Clifford. (15)
10.30		Restricted Stock Purchase Agreement of Jeffrey F. O’Donnell, dated January 15, 2006 (8)(Exh 10.44)
10.31		Restricted Stock Purchase Agreement of Dennis M. McGrath, dated January 15, 2006 (8)(Exh 10.45)
10.32		Consulting Agreement dated January 21, 1998 between the Company and R. Rox Anderson, M.D. (7)(Exh 10.4)
10.33		Letter Agreement dated October 28, 2003 between PhotoMedex and True North Capital Ltd. (16)(Exh 10.41)
22.1		List of subsidiaries of the Company
23.1		Consent of Amper, Politziner & Mattia P.C.
31.1		Rule 13a-14(a) Certificate of Chief Executive Officer
31.2		Rule 13a-14(a) Certificate of Chief Financial Officer
32.1		Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)	Filed as part of our Registration Statement on Form S-4, as filed with the Commission on October 18, 2002, and as amended.

(2)	Filed as part of our Registration Statement on Form S-4/A filed with the Commission on January 21, 2005, and as amended.

(3)	Filed as part of our Current Report on Form 8-K, dated November 6, 2006.

(4)	Filed as part of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.

(5)	Filed as part of our Annual Report on Form 10-K for the year ended December 31, 2002.

(6)	Filed as part of our Annual Report on Form 10-K for the year ended December 31, 2006.

(7)	Filed as part of our Registration Statement on Form S-1, as filed with the Commission on January 28, 1998, as amended.

(8)	Filed as part of our Annual Report on Form 10-K for the year ended December 31, 2005.

(9)	Filed as part of our Current Report on Form 8-K, dated September 10, 2004.

(10)	Filed as part of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004.

(11)	Filed as part of our Current Report on Form 8-K, filed on April 6, 2006.

(12)	Filed as part of our Current Report on Form 8-K, filed on April 10, 2006.

(13)	Filed as part of our Definitive Proxy Statement on Schedule 14A, as filed with the Commission on November 15, 2005.

(14)	Filed as part of our Registration Statement on Form S-8, as filed with the Commission on April 13, 2005.

(15)	Filed as part of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006.

(16)	Filed as part of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.

We are a reporting company and file annual, quarterly and special reports, proxy statements and other information with the Commission. You may inspect and copy these materials at the Public Reference Room maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for more information on the Public Reference Room. You can also find our Commission filings at the Commission's website at www.sec.gov. You may also inspect reports and other information concerning us at the offices of the Nasdaq Stock Market at 1735 K Street, N.W., Washington, D.C. 20006. We intend to furnish our stockholders with annual reports containing audited financial statements and such other periodic reports as we may determine to be appropriate or as may be required by law.

Our primary Internet address is www.photomedex.com. Corporate information can be located by clicking on the “Investor Relations” link in the top-middle of the page, and then clicking on “SEC Filing” in the menu. We make our periodic Commission Reports (Forms 10-Q and Forms 10-K) and current reports (Form 8-K) available free of charge through our Web site as soon as reasonably practicable after they are filed electronically with the Commission. We may from time to time provide important disclosures to investors by posting them in the Investor Relations section of our Web site, as allowed by Commission’s rules. The information on the website listed above is not and should not be considered part of this Annual Report on Form 10-K and is intended to be an inactive textual reference only.

Signature	Capacity in Which Signed	Date
/s/ Richard J. DePiano	Chairman of the Board of Directors	March 16, 2007
Richard J. DePiano
/s/ Jeffrey F. O’Donnell	President, Chief Executive Officer and Director	March 16, 2007
Jeffrey F. O'Donnell
/s/ Dennis M. McGrath	Chief Financial Officer	March 16, 2007
Dennis M. McGrath
/s/ Alan R. Novak	Director	March 16, 2007
Alan R. Novak
/s/ David W. Anderson	Director	March 16, 2007
David W. Anderson
/s/ Warwick Alex Charlton	Director	March 16, 2007
Warwick Alex Charlton
/s/ Anthony J. Dimun	Director	March 16, 2007
Anthony J. Dimun
/s/ Wayne M. Withrow	Director	March 16, 2007
Wayne M. Withrow

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board of United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

We have audited management’s assessment, included in the accompanying Management’s 2006 Annual Report on Internal Controls, that PhotoMedex, Inc. and Subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on control criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

	December 31,
	2006			2005
ASSETS
Current assets:
Cash and cash equivalents	$	12,729,742		$	5,403,036
Restricted cash		156,000			206,931
Accounts receivable, net of allowance for doubtful accounts of $508,438 and $765,440		4,999,224			4,651,080
Inventories		7,301,695			8,047,444
Prepaid expenses and other current assets		534,135			621,372
Total current assets		25,720,796			18,929,863

Property and equipment, net		9,054,098			7,044,713
Patents and licensed technologies, net		1,695,727			1,577,554
Goodwill, net		16,917,808			16,375,384
Other intangible assets, net		3,537,625			4,467,625
Other assets		555,467			280,467
Total assets	$	57,481,521		$	48,675,606

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Current portion of notes payable	$	195,250		$	228,398
Current portion of long-term debt		3,018,874			1,749,969
Accounts payable		3,617,726			3,572,077
Accrued compensation and related expenses		1,529,862			867,427
Other accrued liabilities		657,293			924,968
Deferred revenues		632,175			466,032
Total current liabilities		9,651,180			7,808,871

Notes payable, net of current maturities		133,507			159,213
Long-term debt, net of current maturities		3,593,920			2,278,871
Other liabilities		-			11,623
Total liabilities		13,378,607			10,258,578

Commitment and contingencies

Stockholders' Equity:
Common Stock, $.01 par value, 75,000,000 shares authorized; 62,536,054 and 51,414,294 shares issued and outstanding at December 31, 2006 and 2005, respectively		625,360			514,143
Additional paid-in capital		131,152,557			118,140,838
Accumulated deficit		(87,675,003	)		(80,182,606	)
Deferred compensation		-			(55,347	)
Total stockholders' equity		44,102,914			38,417,028
Total liabilities and stockholders’ equity	$	57,481,521		$	48,675,606

	For the Year Ended December 31,
	2006			2005			2004

Revenues:
Product sales	$	20,352,905		$	16,544,894		$	6,497,397
Services		12,836,972			11,839,612			11,247,784
		33,189,877			28,384,506			17,745,181

Cost of revenues:
Product cost of revenues		8,628,651			7,219,504			3,324,564
Services cost of revenues		9,843,199			8,456,001			7,038,705
		18,471,850			15,675,505			10,363,269

Gross profit		14,718,027			12,709,001			7,381,912

Operating expenses:
Selling, general and administrative		20,682,056			16,477,322			10,426,256
Engineering and product development		1,006,600			1,127,961			1,801,438
		21,688,656			17,605,283			12,227,694

Loss from operations		(6,970,629)			(4,896,282	)		(4,845,782	)

Interest expense, net		(521,768	)		(342,299	)		(138,414	)
Other income, net		-			1,302,537			-

Net loss		($ 7,492,397	)		($ 3,936,044	)		($ 4,984,196	)

Basic and diluted net loss per share		($0.14	)		($0.08	)		($0.13	)

Shares used in computing basic and diluted net loss per share		54,188,914			48,786,109			38,835,356

	Common Stock				Additional Paid-In			Accumulated			Deferred
	Shares		Amount		Capital			Deficit			Compensation			Total
BALANCE, JANUARY 1, 2004		37,736,139	$	377,361	$	86,871,415			($71,262,366	)		($8,335	)	$	15,978,075

Sale of stock, net of expenses		-		-		11,199			-			-			11,199
Exercise of warrants		2,104,138		21,041		3,065,427			-			-			3,086,468
Exercise of stock options		120,865		1,209		209,074			-			-			210,283
Stock options issued to consultants for services		-		-		98,435			-			-			98,435
Reversal of unamortized portion of deferred compensation for terminated employee		-		-		(532	)		-			532			-
Registration expense for acquisition		-		-		(125,914	)		-			-			(125,914	)
Issuance of stock for Stern laser assets acquisition, net of expenses		113,877		1,139		218,066			-			-			219,205
Issuance of warrants for draws under line of credit		-		-		80,462			-			-			80,462
Amortization of deferred compensation		-		-		-			-			6,266			6,266
Net loss		-		-		-			(4,984,196	)		-			(4,984,196	)
BALANCE, DECEMBER 31, 2004		40,075,019		400,750		90,427,632			(76,246,562	)		(1,537	)		14,580,283

Exercise of warrants		73,530		735		146,325			-			-			147,060
Exercise of stock options		350,189		3,502		624,329			-			-			627,831
Issuance of stock for ProCyte merger, net of expense		10,540,579		105,406		26,197,732			-			(132,081	)		26,171,057
Stock options issued to consultants for services		-		-		123,257			-			-			123,257
Reversal of unamortized portion of deferred compensation for terminated employee		-		-		(1,534	)		-			1,534			-
Amortization of deferred compensation		-		-		-			-			76,737			76,737
Issuance of stock for Stern laser assets acquisition, net of expenses		374,977		3,750		723,300			-			-			727,050
Registration expense		-		-		(161,739	)		-			-			(161,739	)
Issuance of warrants for draws under line of credit		-		-		61,536			-			-			61,536
Net loss		-		-		-			(3,936,044	)		-			(3,936,044	)
BALANCE, DECEMBER 31, 2005		51,414,294		514,143		118,140,838			(80,182,606	)		(55,347	)		38,417,028
Reversal of deferred compensation upon adoption of SFAS 123R		-		-		(55,347	)		-			55,347			-
Exercise of warrants		140,000		1,400		166,600			-			-			168,000
Exercise of stock options		60,750		607		86,664			-			-			87,271
Sale of stock, net of expenses		9,760,000		97,600		10,449,402			-			-			10,547,002
Amortization of deferred compensation		-		-		55,347			-			-			55,347
Stock options issued to consultants for service		-		-		132,624						-			132,624
Stock-based compensation expense related to employee options		-		-		990,372			-			-			990,372
Issuance of restricted stock		860,000		8,600		314,174			-			-			322,774
Issuance of stock for Azurtec agreement		200,000		2,000		381,273			-			-			383,273
Issuance of stock for Stern laser assets acquisition, net of expenses		101,010		1,010		190,725			-			-			191,735
Stock-based compensation expense related to severance agreement		-		-		195,497			-			-			195,497
Issuance of warrants for draws under line of credit		-		-		104,388			-			-			104,388
Net loss		-		-		-			(7,492,397	)		-			(7,492,397	)
BALANCE, DECEMBER 31, 2006		62,536,054	$	625,360	$	131,152,557			($87,675,003	)		-		$	44,102,914

	For the Year Ended December 31,
	2006			2005			2004
Cash Flows From Operating Activities:
Net loss		($7,492,397	)		($3,936,044	)		($4,984,196	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		4,199,047			3,217,200			1,765,944
Loss on disposal of property and equipment		7,500			101,009			-
Provision for doubtful accounts		66,211			373,964			459,861
Stock options and warrants issued to consultants for services		132,624			123,257			98,435
Compensatory charge for stock options and restricted stock issued to employees		1,304,546			-			-
Non-monetary exchange		-			(88,667	)		-
Amortization of deferred compensation		55,347			76,737			6,266
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable		(414,355	)		229,768			(1,094,230	)
Inventories		815,766			(782,880	)		(628,257	)
Prepaid expenses and other assets		1,138,691			1,011,340			541,170
Accounts payable		45,648			(518,289	)		1,273,300
Accrued compensation and related expenses		315,508			(246,950	)		22,718
Other accrued liabilities		(279,295	)		(1,023,921	)		(51,482	)
Deferred revenues		166,143			(266,366	)		(174,750	)

Net cash provided by (used in) operating activities		60,984			(1,729,842	)		(2,765,221	)

Cash Flows From Investing Activities:
Purchases of property and equipment		(94,976	)		(123,201	)		(111,319	)
Lasers placed into service		(4,931,835	)		(3,461,803	)		(1,683,528	)
Cash received from acquisition of ProCyte, net of acquisition costs		-			5,578,416			(882,823	)

Net cash (used in) provided by investing activities		(5,026,811	)		1,993,412			(2,677,670	)

Cash Flows From Financing Activities:
Proceeds from issuance of common stock, net		10,547,002			(169,524	)		(138,858	)
Proceeds from issuance of restricted common stock		8,600			-			-
Proceeds from exercise of options		87,271			627,831			210,283
Proceeds from exercise of warrants		168,000			147,060			3,086,468
Payments on long-term debt		(179,993	)		(263,442	)		(291,840	)
Payments on notes payable		(900,715	)		(882,032	)		(587,161	)
Net advances on line of credit		2,511,437			1,889,487			527,548
Decrease (increase) in restricted cash, cash equivalents and short-term investments		50,931			(94,731	)		(112,200	)

Net cash provided by financing activities		12,292,533			1,254,649			2,694,240

Net increase (decrease) in cash and cash equivalents		7,326,706			1,518,219			(2,748,651	)

Cash and Cash Equivalents, Beginning of Year		5,403,036			3,884,817			6,633,468

Cash and Cash Equivalents, End of Year	$	12,729,742		$	5,403,036		$	3,884,817

PhotoMedex, Inc. (and its subsidiaries) (the “Company”) is a medical device and specialty pharmaceutical company focused on facilitating the cost-effective use of technologies for doctors, hospitals and surgery centers to enable their patients to achieve a higher quality of life. The Company operates in five distinct business units, or segments (as described in Note 11): three in Dermatology, - Domestic XTRAC®, International Dermatology Equipment, and Skin Care (ProCyte®); and two in Surgical, - Surgical Services (SIS™) and Surgical Products (SLT®). The segments are distinguished by our management structure, products and services offered, markets served or types of customers.

The Domestic XTRAC segment generally derives revenues from procedures performed by dermatologists in the United States. The Company’s XTRAC laser system is placed in a dermatologist’s office without any initial capital cost to the dermatologist, and then the Company charges a fee-per-use to treat skin disease. The International Dermatology Equipment segment was formerly called the International XTRAC segment, but the Company re-named this segment following the addition of the VTRAC™ lamp-based system in 2006. In comparison to the Domestic XTRAC segment, the International Dermatology Equipment segment generates revenues from the sale of equipment to dermatologists outside the United States through a network of distributors. The Skin Care segment generates revenues by selling physician-dispensed skincare products worldwide and by earning royalties on licenses for our patented copper peptide compound.

The Company designed and manufactured the XTRAC laser system to treat psoriasis, vitiligo, atopic dermatitis and leukoderma phototherapeutically. In January 2000, the Company received the first Food and Drug Administration (“FDA”) clearance to market an excimer laser system, the XTRAC® laser system, for the treatment of psoriasis. It was followed by FDA 510(k) clearance to treat vitiligo in March 2001, atopic dermatitis in August 2001, and leukoderma in May 2002. The first XTRAC phototherapy treatment systems were commercially distributed in the United States in August 2000 before any of its procedures had been approved for medical insurance reimbursement. In the last several years, the Company has sought to obtain reimbursement for psoriasis and other inflammatory skin disorders. By the latter part of 2005, the Company had received many approvals for the reimbursement for use of the XTRAC system. In June 2006, the Company received approval from Blue Cross and Blue Shield of Florida. The manufacturing facility for the XTRAC laser system is located in Carlsbad, California.

Cash and cash equivalents as of December 31, 2006 were $12,885,742, including restricted cash of $156,000. Management believes that the existing cash balance together with its other existing financial resources, including its leasing credit line facility with a remaining availability of $1,289,946 (see Note 9), and any revenues from sales, distribution, licensing and manufacturing relationships, will be sufficient to meet the Company’s operating and capital requirements through the end of the first quarter of 2008. The 2007 operating plan reflects anticipated growth from an increase in per-treatment fee revenues for use of the XTRAC laser system based on increased utilization and wider insurance coverage in the United States and continuing cost savings from the integration of business operations acquired from ProCyte and the growth of the Company’s skincare products. In light of the Company’s recent private placement (see Note 12,) of approximately $11.4 million, the Company now believes that it will have the necessary financing to meet its operating and capital requirements through 2007 and into 2008, at a minimum.

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

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

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates and be based on events different from those assumptions. Future events and their effects cannot be perceived with certainty; estimating, therefore, requires the exercise of judgment. Thus, accounting estimates change as new events occur, as more experience is acquired, or as additional information is obtained. See Revenue Recognition for discussion of updates and changes in estimates for XTRAC domestic revenues in accordance with Staff Accounting Bulletin Nos. 101 and 104 and SFAS No. 48.

The majority of the Company’s accounts receivables are due from distributors (domestic and international), hospitals, universities and physicians and other entities in the medical field. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are most often due within 30 to 90 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. The Company does not accrue interest on accounts receivable past due.

The Company's skin disorder treatment equipment will either (i) be sold to distributors or physicians directly or (ii) be placed in a physician's office and remain the property of the Company. The cost to build a laser, whether for sale or for placement, is accumulated in inventory. When a laser is placed in a physician’s office, the cost is transferred from inventory to “lasers in service” within property and equipment. At times, units are shipped to distributors, but revenue is not recognized until all of the criteria of Staff Accounting Bulletin No. 104 have been met, and until that time, the unit is carried on the books of the Company as inventory. Revenue is not recognized from these distributors until payment is either assured or paid in full. Until this time, the cost of these shipments continues to be recorded as finished goods inventory.

Property and equipment are recorded at cost. Excimer lasers-in-service are depreciated on a straight-line basis over the estimated useful life of three years. In reflection of their improved reliability, XTRAC lasers placed in service after December 31, 2005 are depreciated on a straight-line basis over the estimated useful life of five-years; other XTRAC lasers-in-service continue to be depreciated over the original useful life of three years. Surgical lasers-in-service are depreciated on a straight-line basis over an estimated useful life of seven years if new, and five years or less if used equipment. The straight-line depreciation basis for lasers-in-service is reflective of the pattern of use. For other property and equipment, depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, primarily three to seven years for computer hardware and software, furniture and fixtures, automobiles, and machinery and equipment. Leasehold improvements are amortized over the lesser of the useful lives or lease terms. Expenditures for major renewals and betterments to property and equipment are capitalized, while expenditures for maintenance and repairs are charged to operations as incurred. Upon retirement or disposition, the applicable property amounts are deducted from the accounts and any gain or loss is recorded in the consolidated statements of operations. Useful lives are determined based upon an estimate of either physical or economic obsolescence or both.

Costs incurred to obtain or defend patents and licensed technologies are capitalized and amortized over the shorter of the remaining estimated useful lives or eight to 12 years. Developed technology was recorded in connection with the purchase in August 2000 of the minority interest of Acculase, a former subsidiary of the Company, and is being amortized on a straight-line basis over seven years. Developed technology was also recorded in connection with the acquisition of ProCyte in March 2005 and is being amortized on a straight-line basis over seven years. Other licenses, for example, the AzurTec, Stern and Mount Sinai licenses, are capitalized and amortized over the estimated useful lives of 10 years.

The Company has two distribution channels for its phototherapy treatment equipment. The Company either (i) sells the laser through a distributor or directly to a physician or (ii) places the lasers in physician’s offices (at no charge to the physician) and charges the physician a fee for an agreed upon number of treatments. When the Company sells an XTRAC laser to a distributor or directly to a 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.

In the first quarter of 2003, the Company implemented a program to support certain physicians in addressing treatments with the XTRAC laser system that may be denied reimbursement by private insurance carriers. The Company recognizes service revenue from the sale of treatment codes to physicians participating in this program only if and to the extent the physician has been reimbursed for the treatments. For the year ended December 31, 2006, the Company deferred an additional $124,427, under this program, as all the SAB 104 Criteria for revenue recognition had not been met. At December 31, 2006, the Company had net deferred revenues of $80,697 under this program.

The Company generates revenues from its Skin Care business primarily through three channels. The first is through product sales for skin health, hair care and wound care; the second is through sales of the copper peptide compound, primarily to Neutrogena Corporation, a Johnson & Johnson company; and the third is through royalties generated by our licenses, principally to Neutrogena. The Company recognizes revenues on the products and copper peptide compound when they are shipped, net of returns and allowances. The Company ships the products FOB shipping point. Royalty revenues are based upon sales generated by our licensees. The Company recognizes royalty revenue at the applicable royalty rate applied to shipments reported by our licensee.

Exchanges under SFAS No. 153, “Exchanges of Nonmonetary Assets,” are measured based on the fair value of the assets exchanged. Further, SFAS No. 153 eliminates the previous narrow exception for nonmonetary exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” The Company elected to adopt this Statement in fiscal year 2005. For the year ended December 31, 2006, the Company has not recognized any income or expense in accordance with this Statement. For the year ended December 31, 2005, the Company has recognized $88,667 recorded as Other Income in accordance with this Statement.

The estimated fair values for financial instruments under SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The fair value of cash is based on its demand value, which is equal to its carrying value. The fair values of notes payable are based on borrowing rates that are available to the Company for loans with similar terms, collateral and maturity. The estimated fair values of notes payable approximate the carrying values. Additionally, the carrying value of all other monetary assets and liabilities is estimated to be equal to their fair value due to the short-term nature of these instruments.

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” long-lived assets, such as property and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. As of December 31, 2006, no such impairment exists.

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

Under the modified prospective approach, SFAS No. 123R applies to new grants of options and awards of stock as well as to grants of options that were outstanding on January 1, 2006 and that may subsequently be repurchased, cancelled or materially modified. Under the modified prospective approach, compensation cost recognized for the year ended December 31, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested on, January 1, 2006, based on fair value as of the prior grant-date and estimated in accordance with the provisions of SFAS No. 123R. Prior periods were not required to be restated to reflect the impact of adopting the new standard.

SFAS No. 123R also requires companies to calculate an initial "pool" of excess tax benefits available at the adoption date to absorb any tax deficiencies that may be recognized under SFAS No. 123R. The pool includes the net excess tax benefits that would have been recognized if the Company had adopted SFAS No. 123 for recognition purposes on its effective date. The Company has elected to calculate the pool of excess tax benefits under the alternative transition method described in FASB Staff Position ("FSP") No. FAS 123(R)-3, "Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards," which also specifies the method to calculate excess tax benefits reported on the statement of cash flows. The Company is in a net operating loss position; therefore, no excess tax benefits from share-based payment arrangements have been recognized for the year ended December 31, 2006.

The Company calculates expected volatility for a share-based grant based on historic daily stock price observations of our common stock during the period immediately preceding the grant that is equal in length to the expected term of the grant. For estimating the expected term of share-based grants made in the year ended December 31, 2006, the Company has adopted the simplified method authorized in Staff Accounting Bulletin No. 107. SFAS No. 123R also requires that estimated forfeitures be included as a part of the estimate of expense as of the grant date. The Company has used historical data to estimate expected employee behaviors related to option exercises and forfeitures. Prior to our adoption of SFAS No. 123R, the Company reduced pro-forma share-based compensation expense, presented in the notes to its financial statements, for actual forfeitures as they occurred.

During the year ended December 31, 2006, the Company financed insurance policies through notes payable for $763,982, financed certain credit facility costs for $160,279, financed a license agreement with a note payable of $77,876 and issued warrants to a leasing credit facility which are valued at $104,388, and which offset the carrying value of debt. In March 2006, the Company issued 101,010 shares of its restricted common stock to Stern Laser srl (“Stern”) due upon achievement of a milestone under the Master Purchase Agreement with Stern. The cost associated with this issuance is included in the license from Stern, which is found in patents and licensed technologies. In March 2006, the Company also issued 200,000 shares of its restricted common stock to AzurTec, Inc. (“AzurTec”) as part of an investment in the capital stock of AzurTec as well as for a license agreement on AzurTec technology, both existing and to be developed in the future.

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." This Statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will become effective for us beginning with the first quarter of 2008. We have not yet determined the impact of the adoption of SFAS No. 159 on our financial statements and footnote disclosures.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which is effective for the Company on January 1, 2008. The Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The Statement codifies the definition of fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The adoption of this Statement is not expected to have a material effect on the Company’s consolidated financial statements.

In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) Topic 1N (SAB No. 108), “Financial Statements — Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which is effective for calendar year companies as of December 31, 2006. SAB No. 108 provides guidance on how prior-year misstatements should be taken into consideration when quantifying misstatements in current-year financial statements for purposes of determining whether the financial statements are materially misstated. Under this guidance, companies should take into account both the effect of a misstatement on the current-year balance sheet as well as the impact upon the current-year income statement in assessing the materiality of a current-year misstatement. Once a current-year misstatement has been quantified, the guidance in SAB Topic 1M, “Financial Statements — Materiality,” (SAB No. 99) will be applied to determine whether the misstatement is material. The adoption of this Statement has not had a material effect on the Company’s consolidated financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not believe that its historical or expected tax reporting positions, which considered before application of the valuation allowance, will have a material impact on its consolidated financial statements. See Note 13, Income Taxes.

The aggregate purchase price of $28,086,208 consisted of the issuance of 10,540,579 shares of the Company’s common stock valued at $2.29 per share, the assumption of 1,354,973 common stock options valued at $2,033,132 net of deferred compensation of $132,084, and the incurrence of $1,915,150 of transaction costs. The merger consideration was based on a fixed exchange ratio of 0.6622 shares of PhotoMedex common stock for each share of ProCyte common stock. As the exchange ratio was fixed, the fair value of PhotoMedex’s common stock for accounting purposes was based on a stock price of $2.29 per share, which was the average of the closing prices on the date of the announcement of the planned merger and the two days prior and afterwards.

On September 7, 2004, the Company closed the transactions provided for in the Master Asset Purchase Agreement (the “Master Agreement”) with Stern. In March 2006, the Company issued an additional 101,010 shares of its restricted common stock to Stern based on a milestone set forth in the Master Agreement. As of December 31, 2006, the Company has issued an aggregate of 589,854 shares of its restricted common stock to Stern in connection with the Master Agreement. The Company also agreed to pay Stern up to an additional $250,000 based on the achievement of two remaining milestones. The Company retains the right to pay these conditional sums in cash or in shares of its common stock, at its sole discretion. To provide for the issuance of shares, the Company has reserved for issuance, and placed into escrow, 110,136 shares of its unregistered stock. The per-share price of any shares issued in the future will be the average closing price of the Company’s common stock during the 10 trading days ending on the date of achievement of a particular milestone. Stern also has served as the distributor of the Company’s XTRAC laser system in South Africa and Italy since 2000. The primary asset acquired from Stern in the transaction is a license for Stern’s lamp-based technology, which was carried on the Company’s books at $1,013,009, net, as of December 31, 2006. Amortization of this intangible is on a straight-line basis over 10 years and began in January 2005. In the year ended December 31, 2006, Stern purchased $35,333 of products from the Company.

The Company also received a license from AzurTec with respect to its existing and future technology for the MetaSpex Laboratory System. The license gives the Company rights to manufacture and market the ex vivo versions of the MetaSpex product in exchange for certain royalty obligations. The license also provides the Company certain rights on a potential in situ version of the MetaSpex product. AzurTec remains responsible for the development and clinical trial costs of the MetaSpex products, for which AzurTec is committed to raise additional equity capital. AzurTec has contracted with the Company to resume development work of the ex vivo versions of the MetaSpex product. The Company will resume, and be paid for, such work once AzurTec has raised additional equity capital and has settled its prior indebtedness owed to the Company for development work. The Company has extended by 12 months the time in which AzurTex may raise such additional capital.

On March 31, 2006, the Mount Sinai School of Medicine of New York University granted the Company an exclusive license, effective April 1, 2006, to use Mount Sinai's patented methodology for utilization of ultraviolet laser light for the treatment of vitiligo. The licensed patent is US Patent No. 6,979,327, Treatment of Vitiligo. It was issued December 27, 2005, and the inventor is James M. Spencer, MD, a member of the Company’s Scientific Advisory Board. The license is carried on the Company’s books at $72,035, net at December 31, 2006. Amortization of this intangible is on a straight-line basis over 10 years, which began in April 2006.

Work-in-process is immaterial given the typically short manufacturing cycle, and therefore is disclosed in conjunction with raw materials. Finished goods includes $0 and $69,963 as of December 31, 2006 and 2005, respectively, for laser systems shipped to distributors, but not recognized as revenue until all the criteria of Staff Accounting Bulletin No. 104 have been met. At times, units are shipped but revenue is not recognized until all of the criteria are met, and until that time, the unit is carried on the books of the Company as inventory. The Company ships most of its products FOB shipping point, although from time to time certain customers, for example governmental customers, will insist on FOB destination. Among the factors the Company takes into account in determining the proper time at which to recognize revenue are when title to the goods transfers and when the risk of loss transfers. Shipments to the distributors that do not fully satisfy the collection criteria are recognized when invoiced amounts are fully paid. As of December 31, 2006 and 2005, the Company carried reserves against its inventories of $1,354,444 and $931,719, respectively.

Related amortization expense was $329,138, $257,894 and $169,790 for the years ended December 31, 2006, 2005 and 2004, respectively. Included in other licensed and developed technologies is $200,000 in developed technologies acquired from ProCyte and $114,982 for the license with AzurTec (see Note 2). On March 31, 2006, the Company closed the transaction provided for in the License Agreement with Mount Sinai School of Medicine of New York University (“Mount Sinai”). Pursuant to the license agreement, the Company must reimburse $77,876 to Mount Sinai, over the first 18 months of the license term and at no interest, for patent prosecution costs incurred. The Company is also obligated to pay Mount Sinai a royalty on a combined base of domestic sales of XTRAC treatment codes used for psoriasis as well as for vitiligo. In the first four years of the license, however, Mount Sinai may elect to be paid royalties on an alternate base, comprised simply of treatments for vitiligo, but at a higher royalty rate than the rate applicable to the combined base. This technology is for the laser treatment of vitiligo and is included in other licensed and developed technologies.

Related amortization expense was $930,000 and $732,375 for 2006 and 2005, respectively. Estimated amortization expense for amortizable intangible assets for the next five years is $930,000 in 2007, $930,000 in 2008, $930,000 in 2009, $284,000 in 2010, $110,000 in 2011 and $353,000 thereafter. Under the Neutrogena Agreement, the Company has licensed to Neutrogena rights to its copper peptide technology and for which the Company receives royalties. Customer Relationships embody the value to the Company of relationships that ProCyte had formed with its customers. Tradename includes the name of “ProCyte” and various other trademarks associated with ProCyte’s products.

	December 31,
	2006			2005
Note payable - secured creditor, interest at 16.47%, payable in monthly principal and interest installments of $2,618 through December 2006.	$	-		$	26,736

Note payable - unsecured creditor, interest at 7.42%, payable in monthly principal and interest installments of $61,493 through February 2007.		126,279			177,450

Note payable - unsecured creditor, interest at 6%, payable in monthly principal and interest installments of $2,880 through June 2012.		159,213			183,425

Note payable - unsecured creditor, interest at 0%, payable in monthly principal installments of $4,326 through October 2007		43,265			-
		328,757			387,611
Less: current maturities		(195,250	)		(228,398	)
Notes payable, net of current maturities	$	133,507		$	159,213

	December 31, 2006			December 31, 2005
Borrowings on credit facility:
Draw 1 - effective interest at 17.79%, payable in monthly principal and interest installments of $48,156 through June 2007.	$	279,396		$	792,362
Draw 2 - effective interest at 17.14%, payable in monthly principal and interest installments of $9,957 through September 2007.		85,646			189,543
Draw 3 - effective interest at 17.61%, payable in monthly principal and interest installments of $4,797 through December 2007.		54,150			102,541
Draw 4 - effective interest at 12.62%, payable in monthly principal and interest installments of $34,859 through June 2008.		580,501			922,350
Draw 5 - effective interest at 12.94%, payable in monthly principal and interest installments of $28,757 through September 2008.		550,546			823,810
Draw 6 - effective interest at 13.36%, payable in monthly principal and interest installments of $28,923 through December 2008.		622,508			895,524
Draw 7 - effective interest at 13.74%, payable in monthly principal and interest installments of $40,887 through March 2009.		973,474			-
Draw 8 - effective interest at 13.45%, payable in monthly principal and interest installments of $40,155 through June 2009.		1,052,037			-
Draw 9 - effective interest at 13.10%, payable in monthly principal and interest installments of $40,193 through September 2009.		1,148,960			-
Draw 10 - effective interest at 12.69%, payable in monthly principal and interest installments of $36,580 through December 2009.		1,142,859			-
Total borrowings on credit facility	$	6,490,077		$	3,726,130
Capital lease obligations (see Note 4)		122,717			302,710
Less: current portion		(3,018,874	)		(1,749,969	)
Total long-term debt	$	3,593,920		$	2,278,871

The Company entered into a leasing credit facility with GE Capital Corporation (“GE”) on June 25, 2004. The credit facility has a commitment term of three years, expiring on June 25, 2007. For each year of the term, called a “tranche,” various parameters are set or re-set. The Company accounts for each draw as funded indebtedness taking the form of a capital lease, with equitable ownership in the lasers remaining with the Company. GE retains title as security for the borrowings. The Company depreciates the lasers generally over their remaining useful lives, as established when originally placed into service. Each draw against the credit facility has a self-amortizing repayment period of three years and is secured by specified lasers, which the Company has sold to GE and leased back for continued deployment in the field.

Under the first tranche, GE made available $2,500,000 under the line. A draw under that tranche is set at an interest rate based on 522 basis points above the three-year Treasury note rate. Each such draw is discounted by 7.75%; the first monthly payment is applied directly to principal. With each draw, the Company agreed to issue warrants to purchase shares of the Company’s common stock equal to 5% of the draw. The number of warrants is determined by dividing 5% of the draw by the average closing price of the Company’s common stock for the ten days preceding the date of the draw. The warrants have a five-year term from the date of each issuance and bear an exercise price set at 10% over the average closing price of the Company’s common stock for the ten days preceding the date of the draw.

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

In the matter brought by the Company against RA Medical Systems, Inc. (“RA Medical”) and Dean Irwin in the United States District Court for the Southern District of California, the trial judge declined to issue to defendants summary judgment based on their theory of res judicata. On the other hand, the trial judge declined to issue to the Company partial summary judgment for unfair competition, which had been based on the fact that RA Medical did not have the requisite permission from the State of California to market its medical device. The declination of the Company’s claim for relief was based on reasons that the Company believes will not bar this claim for relief in the other pending Federal action, discussed in the paragraph below. The trial judge further declined to consolidate this Federal action brought by the Company with the Federal action brought by RA Medical and Mr. Irwin, discussed below. Pretrial is scheduled for the Spring of 2007, but no trial date has been set. In this action, there are no counterclaims that the Company must defend against.

In the matter brought in California Superior Court by RA Medical and Mr. Irwin against the Company for unfair competition, the Company removed the State action to Federal court. Plaintiffs’ claim is that the Company did not have the requisite permission to market its excimer medical device from its new facility in Carlsbad The Company has counterclaimed for, among other things, contractual interference, misappropriation of our technology and unfair competition under Federal and State statutes. The plaintiffs brought a motion to dismiss the latter two counterclaims, based in part on an alleged bar under the applicable statutes of limitations. The trial judge has not ruled on the motion. Discovery has been stayed, pending the judge’s ruling. Among the Company’s claims of unfair competition is a claim based on RA Medical’s lack of requisite permission from the State of California to market its medical device.

In June 2006, the insurance carrier that had undertaken to indemnify the Company in the malicious prosecution action, discussed in the paragraph above, and that had for 18 months been defending the Company, recanted its undertaking to indemnify the Company. It recanted on two grounds: first, that malicious prosecution is an intentional tort and therefore is non-indemnifiable, and then later on a second ground that the alleged tort occurred after the period of coverage of its underlying policy had expired. The Company notified the subsequent insurance carrier in whose coverage period the alleged tort occurred. That carrier has undertaken to defend the Company, but has denied its duty to indemnify the Company, based on the same ground that malicious tort is a non-indemnifiable tort. The Company has rejected this ground and brought, through Morgan, Lewis & Bockius, an action in the U.S. District Court for the Eastern District of Pennsylvania for breach of contract and for declaratory judgment on the issue whether malicious prosecution is indemnifiable under our insurance policy. Counsel for the carrier has agreed with the Company’s counsel at Morgan, Lewis that the issue for declaratory judgment is a question of law.

The Company has severance agreements with certain key executives and employees that create certain liabilities in the event of their termination of employment without cause, or following a change in control of the Company. The aggregate commitment under these executive severance agreements, should all covered executives and employees be terminated other than for cause, was approximately $1,676,843 as of December 31, 2006. Should all covered executives be terminated following a change in control of the Company, the aggregate commitment under these executive severance agreements at December 31, 2006 was approximately $2,146,482.

On November 3, 2006, the Company closed on a private placement for 9,760,000 shares of common stock at $1.17 per share resulting in gross proceeds of $11,419,200. The closing price of the Company’s common stock on November 1, 2006 was $1.27 per share. In connection with this private placement, the Company paid commissions and other expenses of $864,308, resulting in net proceeds of $10,554,892. In addition, the investors received warrants to purchase 2,440,000 shares of common stock at an exercise price of $1.60 per share, and Cowen & Company, the placement agent, received warrants to purchase 244,000 shares of common stock, under the same terms and conditions as the warrants issued to the investors. As such the warrants have a five-year term and will become exercisable on May 1, 2007 (see Common Stock Warrants below). Cowen & Company is entitled to a 6.5% commission on any proceeds to the Company from future exercises by the investors of their warrants. The warrants issued to Cowen & Company were in consideration of its services as the placement agent and have a value under the Black Scholes method of approximately $200,000. The Company has used the proceeds of this financing to pay for working capital and other general corporate purposes. The shares sold in the private placement, including the shares underlying the warrants, have been registered with the Securities and Exchange Commission.

On April 10, 1998, the Company created a stock option plan for outside/non-employee members of the Board of Directors. Pursuant to the stock plan, each outside/non-employee director was to receive an annual grant of options, in addition to any other consideration he or she may receive, to purchase up to 20,000 shares of common stock as compensation, at an exercise price equal to the market price of the common stock on the last trading day of the preceding year. The options granted pursuant to this plan vested at the rate of 5,000 options per quarter during each quarter in which such person had served as a member of the Board of Directors. Since the date of adoption of the Non-Employee Director Stock Option Plan (discussed below), the Company no longer grants options to members of the Board of Directors under this plan. At December 31, 2006, the plan had 15,000 options outstanding.

In May 2000, the Company adopted the 2000 Stock Option Plan (the “2000 Plan”). The 2000 Plan initially reserved for issuance up to 1,000,000 shares of the Company’s common stock, which was increased to 2,000,000 shares pursuant to the affirmative vote of the stockholders on June 10, 2002 and to 3,350,000 shares on December 16, 2003. The reserved shares are to be used for granting of incentive stock options (“ISOs”) to employees of the Company and for granting of non-qualified stock options (“NSOs”) and other stock-based awards to employees and consultants. The option exercise price for ISOs shall not be less than the fair market value of the Company’s stock on the date of grant. All ISOs granted to less than ten-percent stockholders may have a term of up to 10 years, while ISOs granted to greater than ten-percent stockholders shall have a term of up to five years. The option exercise price for NSOs shall not be less than 85% of the fair market value of the Company’s stock on the date of grant. No NSOs shall be exercisable for more than 10 years after the date of the respective grant. The plan became inactive on December 28, 2005, and had 2,316,730 options outstanding at December 31, 2006.

In May 2000, the Company also adopted the Non-Employee Director Stock Option Plan (the “Non-Employee Director Plan”). The Non-Employee Director Plan reserved for issuance up to 250,000 shares of the Company’s common stock for the granting of non-qualified options to members of the Company’s Board of Directors. In consideration for services rendered, each director received on each of January 1, 2001 and 2002 an option to purchase 20,000 shares of the Company’s common stock. The Company’s stockholders voted on June 10, 2002 to increase the number of reserved shares to 650,000 and also to increase the annual grant to each director from 20,000 to 35,000. On December 16, 2003, the stockholders voted to increase the number of reserved shares to 1,000,000 and on December 28, 2005, they voted to increase the number of reserved shares to 1,400,000. The plan is active and had 903,750 options outstanding at December 31, 2006.

As of December 31, 2006, the Company had approximately $176 million of federal net operating loss carryforwards. Included in the aggregate net operating loss carryforward are approximately $23 million of losses sustained by SLT prior to the tax-free acquisition on December 27, 2002 and approximately $62 million of losses sustained by ProCyte prior to the tax-free acquisition on March 18, 2005. As of December 31, 2006, the Company has estimated that only $4 million of the net operating loss from SLT and $13 million of the loss from ProCyte can be realized upon, based on Federal limitations on the useabililty of such expiring losses. There have been no other changes of ownership identified by management that materially constrain the Company’s utilization of loss carryforwards. If the Company undergoes a change or ownership in the future, the utilization of the Company’s loss carryforwards may be materially constrained.

	December 31,
	2006			2005

Loss carryforwards	$	37,456,000		$	44,143,000
Carryforward and AMT credits		750,000			642,000
Accrued employment expenses		557,000			176,000
Amortization and write-offs		1,336,000			(107,000	)
Bad debts		292,000			390,000
Deferred R&D costs		3,049,000			2,607,000
Deferred revenues		240,000			177,000
Depreciation		1,533,000			1,152,000
Inventoriable costs		81,000			140,000
Inventory reserves		567,000			395,000
Other accruals and reserves		254,000			335,000
Gross deferred tax asset		46,115,000			50,051,000

Less: valuation allowance		(46,115,000	)		(50,051,000	)

Net deferred tax asset	$	-		$	-

Benefits that may be realized from components in the deferred tax asset that were contributed by Acculase from periods prior to the buy-out of the minority interest in August 2000 and that approximate $3.1 million in benefit, or that were contributed by ProCyte from periods prior to the acquisition in March 2005 and that approximate $6.5 million in benefit will first be taken to reduce the carrying value of goodwill and other intangibles that were recorded in the respective transactions. Only after such values have been fully reduced will any remaining benefit be reflected in the Company’s Statement of Operations. It is not expected that any material tax benefit from the Acculase and ProCyte acquisitions will be reflected in the Statement of Operations. Within the net operating loss carryforward as of December 31, 2006 are approximately $17.5 million of tax deductions from the exercise of Company stock options. The preponderance of these options were to employees and therefore no book expense was recognized on their grant under APB No. 25.

On March 31, 2005, the Company entered into a Sales and Marketing Agreement with GlobalMed (Asia) Technologies Co., Inc. (“GlobalMed”). Under this agreement, GlobalMed acts as master distributor in the Pacific Rim for the Company’s XTRAC excimer laser and for the Company’s LaserPro® diode surgical laser system. The Company’s diode laser will be marketed for, among other things, use in a gynecological procedure pioneered by David Matlock, MD. The Company has engaged Dr. Matlock as a consultant to explore further business opportunities for the Company. In connection with this engagement, Dr. Matlock received options to purchase up to 25,000 shares of the Company’s common stock at an exercise price which was the market value of the Company’s common stock on the date of the grant. In July 2006, the Company broadened the territory covered by the Sales and Marketing Agreement to include the United States and added Innogyn, Inc., a related party of GlobalMed, as co-distributor under the agreement.

On March 30, 2006, the Company entered a strategic relationship with AzurTec to resume development, and to undertake the manufacture and distribution, of AzurTec's MetaSpex Laboratory System, a light-based system designed to detect certain cancers of the skin. The Company issued 200,000 shares of its restricted common stock in exchange for 6,855,141 shares of AzurTec common stock and 181,512 shares of AzurTec Class A preferred stock, which represent a 14% interest in AzurTec on a fully diluted basis. The Company will assist in the development of FDA-compliant prototypes for AzurTec’s product. Continuing development of this project requires additional investment by AzurTec, which AzurTec has undertaken to raise. The Company will resume development once the additional investment has been raised, and AzurTec has settled its prior indebtedness to the Company for development work. The Company has granted AzurTec an additional 12 months in which to raise the additional investment.

Segments are distinguished by the Company’s management structure, products and services offered, markets served and types of customers. The Domestic XTRAC business derives its primary revenues from procedures performed by dermatologists in the United States. The International Dermatology Equipment segment, in comparison, generates revenues from the sale of equipment to dermatologists outside the United States through a network of distributors. The Skin Care (ProCyte) segment generates revenues by selling skincare products and by earning royalties on licenses for the Company’s patented copper peptide compound. The Surgical Services segment generates revenues by providing fee-based procedures typically using the Company’s mobile surgical laser equipment delivered and operated by a technician at hospitals and surgery centers in the United States. The Surgical Products segment generates revenues by selling laser products and disposables to hospitals and surgery centers on both a domestic and international basis. For the years ended December 31, 2006, 2005 and 2004, the Company did not have material revenues from any individual customer.

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

	Year Ended December 31, 2006
	DOMESTIC XTRAC			INTERN’L DERM. EQUIPMENT		SKIN CARE		SURGICAL SERVICES		SURGICAL PRODUCTS AND OTHER		TOTAL
Revenues	$	5,611,387			2,186,424	$	12,646,910	$	6,944,292	$	5,800,864	$	33,189,877
Costs of revenues		4,166,199			1,268,080		3,858,944		5,703,925		3,474,702		18,471,850
Gross profit		1,445,188			918,344		8,787,966		1,240,367		2,326,162		14,718,027

Allocated operating expenses:
Selling, general and administrative		4,408,753			77,639		5,580,985		959,848		552,824		11,580,049
Engineering and product development		-			-		498,602		-		507,998		1,006,600

Unallocated operating expenses		-			-		-		-		-		9,102,007
		4,408,753			77,639		6,079,587		959,848		1,060,822		21,688,656
Loss from operations		(2,963,565	)		840,705		2,708,379		280,519		1,265,340		(6,970,629	)

Interest expense, net		-			-		-		-		-		(521,768	)

Net loss		($2,963,565	)	$	840,705	$	2,708,379	$	280,519	$	1,265,340		($7,492,397	)

Segment assets	$	11,143,750		$	1,838,558	$	21,750,716	$	4,450,302	$	4,772,302	$	43,955,628
Capital expenditures	$	2,933,680		$	885	$	-	$	998,541	$	70,215	$	4,003,321

	Year Ended December 31, 2005
	DOMESTIC XTRAC			INTERN’L DERM. EQUIPMENT		SKIN CARE		SURGICAL SERVICES		SURGICAL PRODUCTS AND OTHER		TOTAL
Revenues	$	3,498,235		$	1,404,096	$	10,042,133	$	7,719,529	$	5,720,513	$	28,384,506
Costs of revenues		2,691,506			930,574		3,132,532		5,675,787		3,245,106		15,675,505
Gross profit		806,729			473,522		6,909,601		2,043,742		2,475,407		12,709,001

Allocated operating expenses:
Selling, general and administrative		2,692,388			313,713		5,331,764		1,192,911		582,366		10,113,142
Engineering and product development		-			-		442,367		-		685,594		1,127,961

Unallocated operating expenses		-			-		-		-		-		6,364,180
		2,692,388			313,713		5,774,131		1,192,911		1,267,960		17,605,283
Loss from operations		(1,885,659	)		159,809		1,135,470		850,831		1,207,447		(4,896,282	)

Other Income		-			-		-		-		-		1,302,537
Interest expense, net		-			-		-		-		-		(342,299	)

Net loss		($1,885,659	)	$	159,809	$	1,135,470	$	850,831	$	1,207,447		($3,936,044	)

Segment assets	$	8,936,793		$	2,523,953	$	22,585,592	$	4,118,909	$	4,176,741	$	42,341,988
Capital expenditures	$	3,391,376		$	14,327	$	-	$	216,633	$	80,552	$	3,702,888

	Year Ended December 31, 2004
	DOMESTIC XTRAC			INTERN’L DERM. EQUIPMENT			SKIN CARE		SURGICAL SERVICES		SURGICAL PRODUCTS AND OTHER		TOTAL
Revenues	$	3,256,164		$	1,626,646			-	$	7,826,519	$	5,035,852	$	17,745,181
Costs of revenues		1,890,446			1,177,371			-		5,000,226		2,295,226		10,363,269
Gross profit		1,365,718			449,275			-		2,826,293		2,740,626		7,381,912

Allocated operating expenses:
Selling, general and administrative		1,836,165			314,849			-		1,364,684		642,751		4,158,449
Engineering and product development		711,384			445,338			-		-		644,716		1,801,438

Unallocated operating expenses		-			-			-		-		-		6,267,807
		2,547,549			760,187			-		1,364,684		1,287,467		12,227,694
Loss from operations		(1,181,831	)		(310,912	)		-		1,461,609		1,453,159		(4,845,782	)

Interest expense, net		-			-			-		-		-		(138,414	)

Net loss		($1,181,831	)		($310,912	)		-	$	1,461,609	$	1,453,159		($4,984,196	)

Segment assets	$	6,160,831		$	2,934,306			-	$	5,012,728	$	4,440,260	$	18,547,510
Capital expenditures	$	873,723		$	4,090			-	$	826,242	$	90,793	$	1,794,848

	For the Quarter Ended
2006	Mar. 31			Jun. 30			Sep. 30			Dec. 31
Revenues	$	8,081,000		$	8,224,000		$	8,292,000		$	8,593,000
Gross profit		3,373,000			4,000,000			3,633,000			3,712,000
Net loss		(2,350,000	)		(1,340,000	)		(1,693,000	)		(2,109,000	)
Basic and diluted net loss per share		($0.05	)		($0.03	)		($0.03	)		($0.03	)
Shares used in computing basic and diluted net loss per share		52,173,618			52,622,189			52,659,132			59,239,878

2005		Mar. 31			Jun. 30			Sep. 30			Dec. 31
Revenues	$	4,983,000		$	8,055,000		$	7,624,000		$	7,722,000
Gross profit		2,351,000			3,833,000			3,320,000			3,205,000
Net loss		(1,128,000	)		(661,000	)		(1,350,000	)		(797,000	)
Basic and diluted net loss per share		($0.03	)		($0.01	)		($0.03	)		($0.01	)
Shares used in computing basic and diluted net loss per share		41,755,950			50,859,562			51,198,095			51,322,000

2004		Mar. 31			Jun. 30			Sep. 30			Dec. 31
Revenues	$	4,025,000		$	4,323,000		$	4,455,000		$	4,942,000
Gross profit		1,531,000			1,692,000			1,954,000			2,205,000
Net loss		(1,363,000	)		(1,207,000	)		(1,156,000	)		(1,258,000	)
Basic and diluted net loss per share		($0.04	)		($0.03	)		($0.03	)		($0.03	)
Shares used in computing basic and diluted net loss per share		37,773,301			38,546,338			38,960,250			40,059,503

	High		Low
Year Ended December 31, 2006:
Fourth Quarter	$	1.85	$	1.04
Third Quarter		1.65		0.99
Second Quarter		1.99		1.46
First Quarter		2.34		1.70
Year Ended December 31, 2005:
Fourth Quarter	$	2.33	$	1.50
Third Quarter		2.82		1.98
Second Quarter		3.09		2.00
First Quarter		2.88		2.16

	(A) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights		(B) Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights		(C) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column (A))
Equity compensation plans
approved by security holders		10,789,382	$	1.94		1,356,250

Equity compensations plan not
approved by security holders		51,000	$	1.66		-

Total		10,840,382	$	1.94		1,356,250

ProCyte Neutrogena Agreement	$	2,400,000
ProCyte Customer Relationships		1,700,000
ProCyte Tradename		1,100,000
ProCyte Developed Technologies		200,000
Goodwill		13,973,385
Total	$	19,373,385

	For the Year Ended December 31,
		2006			2005			2004
Revenues	$	5,800,864		$	5,720,514		$	5,035,832
Percent increase		1.4	%		13.6	%
Laser systems sold		80			47			17
Laser system revenues	$	1,801,000		$	1,594,000		$	989,000
Average revenue per laser	$	22,513		$	33,915		$	58,176

Skin Care (ProCyte) Segment	For the Year Ended December 31,
		2006			2005			2004
Product revenues	$	11,674,510		$	8,902,615		$	-
Bulk compound revenues		672,400			679,550			-
Royalties		300,000			459,967			-
Total revenues		12,646,910			10,042,132			-
Percent increase		25.9	%

Product cost of revenues		3,441,636			2,664,959			-
Bulk compound cost of revenues		417,308			467,573			-
Total cost of revenues		3,858,944			3,132,532			-
Percent increase		23.2	%
Gross profit	$	8,787,966		$	6,909,600		$	-
Percent of revenue		69.5	%		68.8	%		-

Company Margin Analysis	For the Year Ended December 31,
		2006			2005			2004
Revenues	$	33,189,877		$	28,384,506		$	17,745,181
Percent increase		16.9	%		60.0	%
Cost of revenues		18,471,850			15,675,505			10,363,269
Percent increase		17.8	%		51.3	%
Gross profit	$	14,718,027		$	12,709,001		$	7,381,913
Percent of revenue		44.3	%		44.8	%		41.6	%

XTRAC Domestic Segment	For the Year Ended December 31,
		2006			2005			2004
Revenues	$	5,611,387		$	3,498,235		$	3,256,164
Percent increase		60.4	%		7.4	%
Cost of revenues		4,166,199			2,691,506			1,890,446
Percent increase		54.8	%		42.4	%
Gross profit		1,445,188		$	806,729		$	1,365,718
Percent of revenue		25.8	%		23.1	%		41.9	%

International Dermatology Equipment Segment	For the Year Ended December 31,
		2006			2005			2004
Revenues	$	2,186,424		$	1,404,096		$	1,626,646
Percent increase (decrease)		55.7	%		(13.7	%)
Cost of revenues		1,268,080			930,574			1,177,371
Percent increase (decrease)		36.3	%		(21.0	%)
Gross profit		918,344		$	473,522		$	449,275
Percent of revenue		42.0	%		33.7	%		27.6	%

Surgical Services Segment	For the Year Ended December 31,
		2006			2005			2004
Revenues	$	6,944,292		$	7,719,529		$	7,826,519
Percent decrease		(10.0	%)		(1.4	%)
Cost of revenues		5,703,925			5,675,787			5,000,226
Percent increase		0.5	%		13.5	%
Gross profit	$	1,240,367		$	2,043,742		$	2,826,293
Percent of revenue		17.9	%		26.5	%		36.1	%

Surgical Products Segment	For the Year Ended December 31,
		2006			2005			2004
Revenues	$	5,800,864		$	5,720,514		$	5,035,852
Percent increase		1.4	%		13.6	%
Cost of revenues		3,474,702			3,245,103			2,295,226
Percent increase		7.1	%		41.4	%
Gross profit	$	2,326,162		$	2,475,411		$	2,740,626
Percent of revenue		40.1	%		43.3	%		54.4	%

	Payments due by period
Contractual Obligations		Total		Less than 1 year		1 - 3 years		4 - 5 years

Credit facility obligations	$	6,490,077	$	2,936,215	$	3,553,862	$	-
Other capital lease obligations		122,716		82,658		40,058		-
Operating lease obligations		50,345		32,523		17,822		-
Rental lease obligations		1,795,189		470,663		1,018,524		306,002
Notes payable		328,756		195,249		87,030		46,477
Total	$	8,787,895	$	3,717,308	$	4,718,108	$	352,479

Name	Position	Age

Richard J. DePiano	Non-Executive Chairman of the Board of Directors	65
Jeffrey F. O'Donnell	Director, President and Chief Executive Officer	47
Dennis M. McGrath	Chief Financial Officer and Vice President - Finance and Administration	50
Michael R. Stewart	Executive Vice President and Chief Operating Officer	49
Alan R. Novak	Director	72
Warwick Alex Charlton	Director	47
Anthony J. Dimun	Director	63
David W. Anderson	Director	54
Wayne M. Withrow	Director	51

Name	Fees Earned or Paid in Cash ($)	Option Awards ($) (1)		Total ($)

Richard J. DePiano	29,000	43,190(2	)	72,190

Alan R. Novak	26,500	43,190(2	)	69,690

Warwick Alex Charlton	27,500	43,190(2	)	70,690

Anthony J. Dimun	30,000	43,190(2	)	73,190

David W. Anderson	29,000	43,190(2	)	72,190

Wayne M. Withrow	7,500	17,045(3	)	24,545

	2006		2005
Audit Fees		343,000	$	343,000
Audit-Related Fees		35,000		20,000
Tax Fees		-		-
All Other Fees		1,250		23,000
Total	$	379,250	$	386,000


	PHOTOMEDEX, INC.

Date: March 16, 2007	By:	/s/ Jeffrey F. O’Donnell
		Jeffrey F. O’Donnell President, Chief Executive Officer and Director

	Page
Report of Independent Registered Public Accounting Firm		F-2
Report of Independent Registered Public Accounting Firm		F-3
Consolidated Balance Sheets, December 31, 2006 and 2005		F-4
Consolidated Statements of Operations, Years ended December 31, 2006, 2005 and 2004		F-5
Consolidated Statements of Stockholders’ Equity, Years ended December 31, 2006, 2005 and 2004		F-6
Consolidated Statements of Cash Flows, Years ended December 31, 2006, 2005 and 2004		F-7
Notes to Consolidated Financial Statements		F-8

	Year Ended December 31,
	2005			2004
Net loss:
As reported		($3,936,044	)		($4,984,196	)
Less: stock-based employee compensation expense included in reported net loss		76,737			6,266
Impact of total stock-based compensation expense determined under fair-value-based method for all grants and awards		(1,718,296	)		(1,540,636	)
Pro-forma		($5,577,603	)		($6,518,566	)
Net loss per share:
As reported		($0.08	)		($0.13	)
Pro-forma		($0.11	)		($0.17	)

	Year Ended December 31,
Assumptions for Option Grants	2006			2005			2004
Risk-free interest rate		4.62	%		4.04	%		3.20	%
Volatility		92.48	%		97.81	%		99.3	%
Expected dividend yield		0	%		0	%		0	%
Expected life		7.50 years			5 years			5 years
Estimated forfeiture rate		16	%		N/A			N/A

Assumptions for Stock Awards	Year Ended December 31, 2006
Risk-free interest rate		4.32	%
Volatility		70	%
Expected dividend yield		0	%
Expected Life		4.92 years

Cash and cash equivalents	$	6,272,540
Accounts receivable		1,137,413
Inventories		2,845,698
Prepaid expenses and other current assets		134,574
Property and equipment		340,531
Patents and licensed technologies		200,000
Other intangible assets		5,200,000
Other assets		38,277
Total assets acquired		16,169,033

Accounts payable		(605,520	)
Accrued compensation and related expenses		(158,610	)
Other accrued liabilities		(1,143,761	)
Deferred revenues		(95,436	)
Other liabilities		(52,883	)
Total liabilities assumed		(2,056,210	)

Net assets acquired	$	14,112,823

	Draw 7			Draw 8			Draw 9			Draw 10
Date of draw		3/29/06			6/30/06			9/29/06			12/29/06
Amount of draw	$	1,287,487		$	1,268,362		$	1,276,949		$	1,164,743
Stated interest rate		9.45	%		9.22	%		8.80	%		8.64	%
Effective interest rate		13.74	%		13.45	%		13.10	%		12.69	%
Number of warrants issued		20,545			24,708			25,038			32,057
Exercise price of warrants per share	$	2.06		$	1.69		$	1.68		$	1.20
Fair value of warrants	$	27,853		$	26,548		$	28,103		$	21,884

	Warrants granted under Draw 7			Warrants granted under Draw 8			Warrants granted under Draw 9			Warrants granted under Draw 10
Risk-free interest rate		4.79	%		5.18	%		4.59	%		4.69	%
Volatility		87.16	%		84.17	%		84.52	%		72.53	%
Expected dividend yield		0	%		0	%		0	%		0	%
Expected warrant life		5 years			5 years			5 years			5 years

Year Ending December 31,
2007	$	3,390,008
2008		2,653,838
2009		1,156,660
Total minimum lease obligation		7,200,506
Less: interest		(710,429	)
Present value of total minimum lease obligation	$	6,490,077

Year Ending December 31,
2007	$	89,742
2008		40,952
Total minimum lease obligation		130,694
Less: interest		(7,977	)
Present value of total minimum lease obligation	$	122,717

Year Ending December 31,
2007	$	503,186
2008		373,788
2009		337,178
2010		325,380
Thereafter		306,002
Total	$	1,845,534

	Number of Shares			Weighted Average Exercise Price
Outstanding at January 1, 2004		4,130,196		$	3.87
Granted		1,127,166			2.50
Exercised		(120,865	)		1.75
Expired/cancelled		(925,957	)		6.39
Outstanding at December 31, 2004		4,210,540			3.48
Granted		1,460,000			2.57
Assumed from acquisition		1,366,131			1.73
Exercised		(350,189	)		1.80
Expired/cancelled		(1,608,836	)		5.83
Outstanding at December 31, 2005		5,077,646			2.11
Granted		1,682,000			1.92
Exercised		(60,750	)		1.44
Expired/cancelled		(605,171	)		1.92
Outstanding at December 31, 2006		6,093,725		$	2.09

Options Range of Exercise Prices	Outstanding Number of Shares		Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise Price		Exercisable Number of Shares		Exercisable Weighted Avg. Exercise Price
$0 - $2.50		5,445,725		5.10	$	1.95		3,143,333	$	1.86
$2.51 - $5.00		553,000		3.64	$	2.74		431,750	$	2.75
$5.01 - $7.50		80,000		4.01	$	5.63		80,000	$	5.63
$7.51 - up		15,000		3.34	$	9.50		15,000	$	9.50
Total		6,093,725		4.95	$	2.09		3,670,083	$	2.08

Year Ending	Number of Shares		Weighted Average Exercise Price		Exercise Price
2007		379,530	$	1.72	$	1.26 - $1.89
2008		604,382		1.72	$	0.74 - $2.17
2009		1,000,473		1.97	$	1.41 - $2.70
2010		1,151,662		2.47	$	1.07 - $9.50
2011 and later		2,957,678		2.10	$	1.06 - $5.63
		6,093,725	$	2.09	$	0.74 - $5.63

	Number of Warrants			Weighted Average Exercise Price
Outstanding at January 1, 2004		4,251,083		$	1.90
Issued		33,661			3.29
Exercised		(2,104,147	)		1.47
Expired/cancelled		(11,998	)		2.08
Outstanding at December 31, 2004		2,168,599			2.34
Issued		43,765			2.22
Exercised		(73,530	)		2.00
Expired/cancelled		(38,525	)		13.43
Outstanding at December 31, 2005		2,100,309			1.98
Issued		2,786,348			1.60
Exercised		(140,000	)		2.00
Expired/cancelled		-			-
Outstanding at December 31, 2006		4,746,657		$	1.75

	December 31,
Assets:		2006		2005
Total assets for reportable segments	$	43,955,628	$	42,341,988
Other unallocated assets		13,525,893		6,333,618
Consolidated total	$	57,481,521	$	48,675,606

Description	Balance at Beginning of Period		Cost and Expenses		Other Accounts (1)		Deductions (2)		Balance at End of Period

For The Year Ended December 31, 2006:

Reserve for Doubtful Accounts	$	765,440	$	66,211	$	-	$	323,213		508,438

For The Year Ended December 31, 2005:

Reserve for Doubtful Accounts	$	736,505	$	373,964	$	121,633	$	466,662	$	765,440

For The Year Ended December 31, 2004:

Reserve for Doubtful Accounts	$	698,044	$	459,861	$	-	$	421,400	$	736,505


Dated: March 16, 2007	By:	/s/ Jeffrey F. O'Donnell
		Jeffrey F. O'Donnell Chief Executive Officer


Dated: March 16, 2007	By:	/s/ Dennis M. McGrath
		Dennis M. McGrath Chief Financial Officer