Note 1

Basis of Presentation:

The Company:

Background

PhotoMedex, Inc. (and its subsidiaries) (the “Company”) is a Global Skin Health Solutions™ company that provides disease management and aesthetic solutions through innovative laser systems, light-based devices and science-based skincare products. Through its relationships with dermatologists and plastic surgeons, the Company's products address multiple skin diseases and skin conditions including psoriasis, vitiligo, acne and sun damage. The Company's experience in addressing these diseases and conditions in the physician market has allowed it to expand its products and services to provide skin health solutions to certain non-physician markets.

The Company's strategic focus is built upon four key components – leveraging its sales force through training focused on superior skin health expertise and incremental product offerings, expanded international capabilities, the development of alternate channels for its varied product lines and a continued commitment to innovation of its technologies.

The Company concentrates its strategic efforts primarily in the physician market, both domestically and internationally. Supporting those efforts, management is committed to innovation, whereby the Company looks to maximize the application of its technologies and utilize the scientific resources available to it in each of its product areas. In the U.S., the Company markets and sells its products through a direct sales organization capable of addressing each product area with specific expertise. The Company's focus on enhanced training of the sales organization has fostered an ability to drive sales and to support its customer base with a more cost-effective sales force. In addition, the Company looks to leverage its experience and substantial product advancements in the physician market into non-physician based markets, or alternate channels, that may benefit from those technological advancements.

The Company operates in four distinct business units or segments (as described in Note 14, Business Segments and Geographic Data): three in Dermatology – Physician Domestic, Physician International, and Other Channels; and one in Surgical – Surgical Products. The segments are distinguished by the Company's management structure and the markets or customers served.

The Physician Domestic segment generates revenues by selling XTRAC treatments and lasers, skincare and LED products. The Physician International segment generates revenues by selling dermatology equipment and skincare and LED products to international physicians through distributors. The Other Channels segment generates revenues by selling skincare and LED products to indoor tanning and spa markets and to on-line and television retail consumer markets for home use. The Surgical Products segment generates revenues by selling laser and non-laser products including disposables to hospitals and surgery centers both domestically and internationally.

Liquidity

As of September 30, 2011, the Company had an accumulated deficit of $134,899,584 and has incurred losses since inception. To date, the Company has dedicated most of its financial resources to research and development, sales and marketing, and general and administrative expenses.

Cash and cash equivalents as of September 30, 2011 were $2,417,349. The Company has historically financed its activities with cash from operations, the private placement of equity and debt securities and borrowings under lines of credit. Based on its resources available at September 30, 2011, the Company believes that it can fund operations through and beyond the fourth quarter of 2012. However, given the uncertainty in the general economic conditions and its impact on the Company's industry, and in light of the Company's historical operating losses and negative cash flows, there is no assurance that the Company will not require additional funds in order to continue as a going concern beyond the fourth quarter of 2012.

The Company paid interest due on March 1, 2011 with additional convertible notes amounting to $1,021,314 ($146,321 for the Series B-1 interest at 10% and $874,993 for the Series B-2 interest at 10%). The Company paid interest due on September 1, 2011 with additional convertible notes amounting to $1,072,380 ($153,637 for the Series B-1 interest at 10% and $918,742 for the Series B-2 interest at 10%). As of September 30, 2011, the Convertible Debt was $21,653,149. See Note 11, Convertible Debt, and Note 12, Warrants, for more information.

On March 28, 2011, Clutterbuck Funds LLC (“Clutterbuck Funds”) agreed to extend the maturity date of its loan with the Company, of which the principal of $2.5 million was to be paid at maturity. Previously, the loan matured on September 19, 2011; it will now mature on December 1, 2012. Starting in August 2011, the Company began monthly installments of principal such that the final payment at maturity will be $75,000. To induce the modifications to the terms of its loan, the Company has issued to Clutterbuck Funds a second warrant on terms similar to the first warrant that was issued on March 19, 2010, except that it is for the purchase of 109,650 shares of the Company's common stock at an exercise price of $5.70 per share. The collateral securing the first-position security interest of Clutterbuck Funds and the second-position security interest of the holder of the Company's convertible notes will remain in place. See Note 10, Long-Term Debt, for additional discussion. On August 12, 2011, Clutterbuck Funds exercised both warrants, totaling 234,650 shares of the Company's common stock, at a total exercise price of $1,375,005.

On May 28, 2011, the Company entered into a Repurchase Right Agreement (the “Repurchase Agreement”), dated as of May 27, 2011, with Perseus Partners VII, L.P., a Delaware limited partnership (the “Investor”). Pursuant to the terms of the Repurchase Agreement, the Company has the right (the “Repurchase Right”) to repurchase securities held by the Investor and its former director appointee to the board of directors of the Company, on the terms and conditions set forth in the Repurchase Agreement. Pursuant to the terms of the Repurchase Agreement, the Company has the right to repurchase all (but not less than all) of the Repurchase Securities (as defined in Note 11, Convertible Debt), in connection with the completion of a “Repurchase Transaction” (as defined in Note 11, Convertible Debt), for an amount initially equal to $19,500,000, and which amount increased by $250,000 to $19,750,000 on October 16, 2011, and which amount shall further increase by $250,000 on each of November 16, 2011, December 16, 2011, and January 16, 2012; i.e., on November 16, 2011, the repurchase price becomes $20,000,000, on December 16, 2011, the repurchase price becomes $20,250,000, and on January 16, 2012, the repurchase price shall become $20,500,000.

On July 4, 2011, the Company entered into an Agreement and Plan of Merger with Radiancy, Inc., a privately held Delaware corporation ("Radiancy") and PHMD Merger Sub, Inc. ("Merger Sub"), a Delaware corporation and majority-owned subsidiary of PhotoMedex, which was amended on October 31, 2011 as the Amended and Restated Agreement and Plan of Merger (the "Amended and Restated Merger Agreement") Pursuant to the Amended and Restated Merger Agreement and subject to customary closing conditions, Merger Sub will merge with and into Radiancy, and Radiancy will become a majority-owned subsidiary of PhotoMedex. Under the terms of the Amended and Restated Merger Agreement, the Company will issue approximately 15.1 million shares of common stock to Radiancy shareholders (other than Radiancy Ltd. which owns 137,056 shares in Radiancy, Inc.). Upon consummation of the merger transactions contemplated by the Amended and Restated Merger Agreement, Radiancy, Ltd. will continue to own 137,056 shares of Radiancy Inc. common stock (approximately 2% of Radiancy equity on an as-converted and fully diluted basis), the Company will own approximately 98% of Radiancy, and Radiancy will become a majority-owned subsidiary of the Company. The merger will be accounted for as a reverse acquisition. In addition, pursuant to the terms of the Amended and Restated Merger Agreement, Radiancy will contribute cash, which will be used in part to fully exercise PhotoMedex' option to repurchase all warrants and secured convertible promissory notes which are held by the Investor and which have an aggregate principal and accrued interest amount at September 30, 2011 of $22.7 million, but depending on the time of payment, may be repurchased at a discount to the aggregate amount of principal and accrued interest. The Amended and Restated Merger Agreement is subject to approval by PhotoMedex's shareholders. If the Amended and Restated Merger Agreement is not approved by the shareholders, PhotoMedex will be subject to pay termination fees to Radiancy, which could have a significant impact on the Company's future liquidity. See Note 2, Proposed Merger and Note 11, Convertible Debt for further discussion of the Amended and Restated MergerAgreement.

Summary of Significant Accounting Policies:

Quarterly Financial Information and Results of Operations

The condensed financial statements as of September 30, 2011 and for the three and nine months ended September 30, 2011 and 2010, are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company's financial position as of September 30, 2011, and the results of operations and cash flows for the three and nine months ended September 30, 2011 and 2010. The results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the entire year or any future period. While management believes that the disclosures presented are adequate to make the information not misleading, these consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and the notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010.

Fair Value Measurements

The Company measures fair value in accordance with Financial Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions there exists a three-tier fair-value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

	•	Level 1 - unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access as of the measurement date.
	•	Level 2 - inputs other than quoted prices included within Level 1 that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data.
	•	Level 3 - unobservable inputs for the asset or liability only used when there is little, if any, market activity for the asset or liability at the measurement date.

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

The Company's recurring fair value measurements at September 30, 2011 and December 31, 2010 are as follows:

	Fair Value as of September 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities:
Derivative financial instruments (Note 12)	$	2,380,295	$	-	$	-	$	2,380,295

	Fair Value as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities:
Derivative financial instruments (Note 12)	$	938,623	$	-	$	-	$	938,623

The fair value of cash and cash equivalents is based on its demand value, which is equal to its carrying value. The fair values of notes payable and long-term debt 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 and long-term debt 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. The carrying amount of derivative instruments is marked to fair value. See Note 12, Warrants, for additional discussion.

Revenue Recognition

The Company has two distribution channels for its phototherapy treatment equipment. The Company either (i) sells the laser through a distributor or directly to a physician or (ii) places the laser in a physician's office (at no charge to the physician) and charges the physician a fee for an agreed upon number of treatments. In some cases, the Company and the customer stipulate to a quarterly or other periodic target of procedures to be performed, and accordingly revenue is recognized ratably over the period. 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 (the “Criteria”) 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. At times, units are shipped, but revenue is not recognized until all of the Criteria have been met, and until that time, the unit is carried on the books of the Company as inventory.

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

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

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

The Company defers substantially all sales of treatment codes ordered by and delivered to its customers within the last two weeks of the reporting period in determining the amount of procedures performed by its physician-customers. Management believes this approach closely approximates the actual amount of unused treatments that existed at the end of a period. As of September 30, 2011 and 2010, the Company deferred $516,176 and $374,766 respectively, under this approach.

The Company generates revenues from its Skin Care business primarily through product sales for skin health, hair care and wound care. The Company recognizes revenues on its products and copper peptide compound when they are shipped, net of returns and allowances. The Company ships the products FOB shipping point.

The Company generates revenues from its Photo Therapeutics business primarily from product sales of LEDs and skincare products. Previously, it had also generated revenues through milestone payments and potential royalty payments from a licensing agreement that has now been discontinued. The Company recognizes revenues from the product sales, including sales to distributors and other customers, when the Criteria have been met. The Company recognized the milestone payments when the milestones had been achieved and potential royalty revenues as they were earned from the licensee.

Revenues under a now-concluded agreement for the co-promotion of a drug and related device were recognized on a net basis when the Criteria had been met.

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

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

Impairment of Long-Lived Assets and Intangibles

Long-lived assets, such as property and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the fair value of the asset. If the carrying amount of an asset exceeds the fair value, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. As of September 30, 2011, no such impairment exists. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group classified as discontinued operations would be presented separately in the appropriate asset and liability sections of the balance sheet. As of September 30, 2011, there were no assets to be disposed of.

Patent Costs and Licensed Technologies

Material costs incurred to obtain or defend licensed technologies and certain patents are capitalized and amortized over the shorter of the remaining estimated useful lives or 8 to 12 years. Developed technology was also recorded in connection with the acquisition of ProCyte Corporation (“ProCyte”) in March 2005 and is being amortized on a straight-line basis over seven years. Significant patent costs were recorded in connection with the acquisition of Photo Therapeutics, Inc. (“Photo Therapeutics”) in February 2009 and are being amortized on a straight-line basis over ten years. Other licenses, including the Stern and Mount Sinai licenses, are capitalized and amortized over the estimated useful lives of 10 years. (See Note 5, Patent and Licensed Technologies).

Management evaluates the recoverability of intangible assets based on estimates of undiscounted future cash flows over the remaining useful life of the asset. If the amount of such estimated undiscounted future cash flows is less than the net book value of the asset, the asset is written down to fair value. As of September 30, 2011, no such write-down was required. See Impairment of Long-Lived Assets and Intangibles, above.

Other Intangible Assets

Other intangible assets were recorded in connection with the acquisition of ProCyte in March 2005. The assets are being amortized on a straight-line basis over 5 to 10 years. In addition, other intangible assets were recorded in connection with the acquisition of Photo Therapeutics in February 2009. These assets are being amortized on a straight-line basis over 10 years.

Management evaluates the recoverability of such other intangible assets based on estimates of undiscounted future cash flows over the remaining useful life of the asset. If the amount of such estimated undiscounted future cash flows is less than the net book value of the asset, the asset is written down to fair value. As of September 30, 2011 no such write-down was required. See Impairment of Long-Lived Assets and Intangibles, above.

Goodwill

Goodwill was recorded in connection with the acquisition of Photo Therapeutics in February 2009, the acquisition of ProCyte in March 2005 and the acquisition of Acculase Inc. in August 2000.

Goodwill consists of the excess of cost over the fair value of net assets acquired in business combinations accounted for as purchases. Management evaluates the recoverability of such goodwill by testing for impairment, at least annually. The first step of the impairment test requires that the Company assess the fair value of each reporting unit, and compare the fair value to the reporting unit's carrying amount. To the extent the carrying amount of a reporting unit exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and the Company must perform a second, more detailed assessment. The second step in an assessment which involves allocating the reporting unit's fair value to all of its recognized and unrecognized assets and liabilities in order to determine the implied fair value of the reporting unit's goodwill as of the assessment date. The implied fair value of the reporting unit's goodwill is then compared to the carrying amount of goodwill to quantify an impairment charge as of the assessment date. There has been no impairment of goodwill recorded through September 30, 2011.

Accrued Warranty Costs

The Company offers a warranty on product sales generally for a one to two-year period. In the case of domestic sales of XTRAC lasers, however, the Company offers longer periods, ranging from three to four years, in order to meet competition or meet customer demands. The Company provides for the estimated future warranty claims on the date the product is sold. Total accrued warranty is included in other accrued liabilities on the balance sheet. The activity in the warranty accrual during the nine months ended September 30, 2011 is summarized as follows:

	Nine Months Ended September 30, 2011 (unaudited)
Accrual at beginning of period	$	1,001,236
Additions charged to warranty expense		433,994
Expiring warranties		(98,465	)
Claims satisfied		(326,642	)
Accrual at end of period	$	1,010,123

Net Loss Per Share

The Company computes net loss per share by dividing net loss available to common stockholders by the weighted average of common shares outstanding for the period. Diluted net loss per share reflects the potential dilution from the conversion or exercise into common stock of securities such as stock options and warrants.

In these condensed consolidated financial statements, diluted net loss per share is the same as basic net loss per share. Given the Company's net loss for each period presented, no additional shares for the potential dilution from the conversion of the convertible notes, or from exercise of warrants related to the convertible notes or from other warrants or from the exercise of options into common stock are treated as outstanding in the calculation of diluted net loss per share, since the result would be anti-dilutive. Common stock options and warrants of 473,869 and 638,232 as of September 30, 2011 and 2010, respectively, were excluded from the calculation of fully diluted earnings per share since their inclusion would have been anti-dilutive. Additionally, 227,484 shares of unvested restricted stock as of September 30, 2011 were excluded from the calculation of fully diluted earnings per share since their inclusion would have been anti-dilutive.

Comprehensive Loss

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

	Three Months Ended September 30, (unaudited)						Nine Months Ended September 30, (unaudited)
	2011			2010			2011			2010
Net loss	$	(3,281,186	)	$	(1,835,100	)	$	(10,335,464	)	$	(6,911,315	)
Change in cumulative translation adjustment		496			(85,047	)		2,340			(19,827	)
Comprehensive loss	$	(3,280,690	)	$	(1,920,147	)	$	(10,333,124	)	$	(6,931,142	)

Supplemental Cash Flow Information

During the nine months ended September 30, 2011, the Company paid interest payable on the convertible notes with an issuance of additional convertible debt amounting to $2,093,694. The Company also issued warrants related to the Term Note held by Clutterbuck Funds which are valued at $433,870, and which offset the carrying value of the Term Note. The Company financed certain insurance policies during the period through notes payable for $410,317.

During the nine months ended September 30, 2010, the Company paid interest payable on the convertible notes with an issuance of additional convertible debt amounting to $826,676. The Company also issued a warrant to purchase 125,000 shares of common stock related to the Term Note held by Clutterbuck Funds and which is valued at $769,754, and which offsets the carrying value of the Term Note. The Company financed certain insurance policies during the period through notes payable for $401,168.

For the nine months ended September 30, 2011 and 2010, the Company paid interest in cash of $266,114 and $362,301, respectively. Income taxes paid in the nine months ended September 30, 2011 and 2010 were immaterial.

Accounting Standards Update

ASU 2011-05 – In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 provides amendments to ASC No. 220 “Comprehensive Income”, which require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments in this update are effective retrospectively for fiscal years and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. In October 2011, the FASB announced that they are considering deferring certain provisions in ASU 2011-05 related presentation of reclassification adjustments from other comprehensive income to net income. The Company is currently assessing the impact of the adoption of this update on the Company's financial condition, results of operations and cash flows.