Back to GetFilings.com






UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10 - Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _________ TO ___________


Commission File Number 0-11365

PHOTOMEDEX, INC.
----------------
(Exact name of registrant as specified in its charter)

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

147 Keystone Drive, Montgomeryville, Pennsylvania 18936
-------------------------------------------------------
(Address of principal executive offices, including zip code)

(215) 619-3600
--------------
(Registrant's telephone number, including area code)




Indicate by check mark whether the registrant: (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (ii) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.)
Yes [X] No [ ]

The number of shares outstanding of the issuer's Common Stock as of August 6,
2004, was 38,766,233 shares.






PHOTOMEDEX, INC. AND SUBSIDIARIES

INDEX

Part I. Financial Information: PAGE
- ------------------------------ ----

ITEM 1. Financial Statements:

a. Consolidated Balance Sheets, June 30, 2004 (unaudited) and
December 31, 2003 (derived from audited financial statements) 3

b. Consolidated Statements of Operations for the three months
ended June 30, 2004 and 2003 (unaudited) 4

c. Consolidated Statements of Operations for the six months
ended June 30, 2004 and 2003 (unaudited) 5

d. Consolidated Statements of Cash Flows for the six months
ended June 30, 2004 and 2003 (unaudited) 6

e. Notes to Consolidated Financial Statements (unaudited) 7

ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 18

ITEM 3. Quantitative and Qualitative Disclosure about Market Risk 27

ITEM 4. Controls and Procedures 28

Part II. Other Information:
- ---------------------------

ITEM 1. Legal Proceedings 28
ITEM 2. Changes in Securities and Use of Proceeds 28
ITEM 3. Defaults Upon Senior Securities 28
ITEM 4. Submission of Matters to a Vote of Security Holders 28
ITEM 5. Other Information 28
ITEM 6. Exhibits and Reports on Form 8-K 29

Signatures 30




2




PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


PHOTOMEDEX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS





June 30, December 31,
2004 2003
------------ ------------
ASSETS (Unaudited) *

Current assets:
Cash and cash equivalents $ 5,687,975 $ 6,633,468
Accounts receivable, net of allowance for doubtful accounts of
$625,232 and $698,044, respectively 3,617,921 3,483,030
Inventories 4,141,828 4,522,462
Prepaid expenses and other current assets 791,546 334,002
------------ ------------
Total current assets 14,239,270 14,972,962

Property and equipment, net 4,521,194 4,005,205

Goodwill, net 2,944,423
2,944,423

Patents and licensed technologies, net 675,319 758,655

Other assets 241,931 71,486
------------ ------------
Total assets $ 22,622,137 $ 22,752,731
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Current portion of notes payable $ 392,064 $ 101,066
Current portion of long-term debt 724,758 1,269,759
Accounts payable 2,132,398 2,218,993
Accrued compensation and related expenses 850,728 940,352
Other accrued liabilities 842,875 975,536
Deferred revenues 933,640 811,712
------------ ------------
Total current liabilities 5,876,463 6,317,418
------------ ------------

Notes payable 39,618 51,489
Long-term debt 1,392,762 405,749

Commitments and Contingencies

Stockholders' equity:
Common stock, $.01 par value, 75,000,000 shares authorized; 38,741,402
and 37,736,139 shares issued and outstanding,
respectively 387,414 377,361
Additional paid-in capital 88,763,589 86,871,415
Accumulated deficit (73,832,615) (71,262,366)
Deferred compensation (5,094) (8,335)
------------ ------------
Total stockholders' equity 15,313,294 15,978,075
------------ ------------
Total liabilities and stockholders' equity $ 22,622,137 $ 22,752,731
============ ============


* The December 31, 2003 balance sheet was derived from our audited financial
statements.

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

3



PHOTOMEDEX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)




For the Three Months Ended
June 30,
------------------------------
2004 2003
------------ ------------

Revenues:
Product sales $ 1,629,357 $ 2,089,132
Services 2,693,777 1,753,567
------------ ------------
4,323,134 3,842,699

Cost of revenues:
Product cost of revenues 932,621 1,048,095
Services cost of revenues 1,698,748 1,618,137
------------ ------------
2,631,369 2,666,232
------------ ------------

Gross profit 1,691,765 1,176,467
------------ ------------

Operating expenses:
Selling, general and administrative 2,406,453 2,387,020
Engineering and product development 481,243 465,134
------------ ------------
2,887,696 2,852,154
------------ ------------

Loss from operations before interest expense, net (1,195,931) (1,675,687)

Interest expense, net 11,236 10,415
------------ ------------

Net loss $ (1,207,167) $ (1,686,102)
============ ============


Basic and diluted net loss per share $ (0.03) $ (0.05)
============ ============

Shares used in computing basic and diluted net loss per share 38,546,338 33,644,326
============ ============





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



4




PHOTOMEDEX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)




For the Six Months Ended
June 30,
------------------------------
2004 2003
------------ ------------

Revenues:
Product sales $ 3,421,757 $ 3,958,424
Services 4,926,607 3,357,752
------------ ------------
8,348,364 7,316,176

Cost of revenues:
Product cost of revenues 1,765,105 1,992,977
Services cost of revenues 3,360,330 3,083,513
------------ ------------
5,125,435 5,076,490
------------ ------------

Gross profit 3,222,929 2,239,686
------------ ------------

Operating expenses:
Selling, general and administrative 4,876,877 4,681,612
Engineering and product development 897,193 877,066
------------ ------------
5,774,070 5,558,678
------------ ------------

Loss from operations before interest expense, net (2,551,141) (3,318,992)

Interest expense, net 19,108 41,438
------------ ------------

Net loss $ (2,570,249) $ (3,360,430)
============ ============


Basic and diluted net loss per share $ (0.07) $ (0.10)
============ ============

Shares used in computing basic and diluted net loss per share 38,159,819 32,547,784
============ ============




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



5



PHOTOMEDEX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)




For the Six Months Ended
June 30,
----------------------------
2004 2003
----------- -----------

Operating activities:
Net loss $(2,570,249) $(3,360,430)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 878,890 1,026,733
Stock options issued to consultants for services 48,192 38,164
Amortization of deferred compensation 3,241 3,223
Provision for bad debts 82,157 246,029
Loss on disposal of assets -- 7,574
Changes in operating assets and liabilities:
Accounts receivable (217,048) (573,253)
Inventories 90,397 445,043
Prepaid expenses and other assets 70,279 72,916
Accounts payable (86,595) (637,988)
Accrued compensation and related expenses (89,625) 66,179
Other accrued liabilities (132,660) (400,583)
Deferred revenues 121,928 401,733
----------- -----------

Net cash used in operating activities (1,801,093) (2,664,660)
----------- -----------

Investing activities:
Purchases of property and equipment (55,527) (17,999)
Lasers placed into service (845,790) (1,035,419)
----------- -----------

Net cash used in investing activities (901,307) (1,053,418)
----------- -----------

Financing activities:
Proceeds from issuance of common stock, net 11,199 9,500,046
Proceeds from exercise of options 62,212 1,531
Proceeds from exercise of warrants 1,718,592 --
Payments on long-term debt (152,907) (90,584)
Payments on notes payable (251,869) (314,151)
Net repayments on bank line of credit (1,000,000) (1,792,591)
Net advances on leasing line of credit 1,369,680 --
Decrease in restricted cash, cash equivalents and short-term
investments -- 2,000,000
----------- -----------

Net cash provided by financing activities 1,756,907 9,304,251
----------- -----------

Net (decrease) increase in cash and cash equivalents (945,493) 5,586,173

Cash and cash equivalents, beginning of period 6,633,468 4,008,051
----------- -----------

Cash and cash equivalents, end of period $ 5,687,975 $ 9,594,224
=========== ===========





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



6




PHOTOMEDEX, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1
THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

THE COMPANY:

BACKGROUND
PhotoMedex, Inc. and subsidiaries (the "Company") is a medical device company
focused on facilitating the cost-effective use of technologies for doctors,
hospitals and surgery centers. The Company develops, manufactures and markets
excimer-laser-based instrumentation designed to phototherapeutically treat
psoriasis, vitiligo, atopic dermatitis and leukoderma. In January 2000, the
Company received the first Food and Drug Administration ("FDA") clearance to
market an excimer laser system, the XTRAC(R) system, for the treatment of
psoriasis. In March 2001, the Company received FDA clearance to treat vitiligo;
in August 2001, the Company received FDA clearance to treat atopic dermatitis;
and in May 2002, the FDA granted 510(k) clearance to market the XTRAC system for
the treatment of leukoderma. The Company launched the XTRAC phototherapy
treatment system commercially in the United States in August 2000.

Through the acquisition of Surgical Laser Technologies, Inc. ("SLT") on December
27, 2002, the Company also develops, manufactures and markets proprietary lasers
and delivery systems for both contact and non-contact surgery and provides
surgical services utilizing these and other manufacturers' products.

LIQUIDITY AND GOING CONCERN
The Company has incurred significant losses and has had negative cash flows from
operations since emerging from bankruptcy in May 1995. As of June 30, 2004, the
Company had an accumulated deficit of $73,832,615. The Company has historically
financed its activities from the private placement of equity securities. To
date, the Company has dedicated most of its financial resources to research and
development and general and administrative expenses. During the first quarter of
2003, the Company re-launched the marketing of its XTRAC system in the United
States following the issuance of common procedural terminology ("CPT") codes and
associated reimbursement rates by Center for Medicare and Medicaid Services
("CMS"). The Company has focused the re-launch on securing approval by various
private health plans to reimburse for treatments of psoriasis using the XTRAC.

The Company expects to incur operating losses for 2004 as it plans to continue
to focus on securing reimbursement from more private insurers and to devote
sales and marketing efforts in the areas where such reimbursement has become
available. Once favorable momentum has been achieved, the Company contemplates
spending substantial amounts on the marketing of its psoriasis, vitiligo, atopic
dermatitis and leukoderma treatment products and expansion of its manufacturing
operations. Notwithstanding the approval by CMS for Medicare and Medicaid
reimbursement and recent approvals by certain private insurers, the Company may
continue to face resistance from private healthcare insurers to adopt the
excimer-laser-based therapy as an approved procedure. Management cannot provide
assurance that the Company will market the product successfully, operate
profitably in the future, or that it will not require significant additional
financing in order to accomplish its business plan. Nevertheless, the Company
was successful in reducing its operating losses for the six months ended June
30, 2004 by $790,181.

The Company's future revenues and success depend upon its excimer-laser-based
systems for the treatment of a variety of skin disorders. The Company's
excimer-laser-based system for the treatment of psoriasis, vitiligo, atopic
dermatitis and leukoderma is currently generating revenues in both the United
States and abroad. The Company's ability to introduce successful new products
based on its business focus and the expected benefits to be obtained from these
products may be adversely affected by a number of factors, such as unforeseen
costs and expenses, technological change, economic downturns, competitive
factors or other events beyond the Company's control. Consequently, the
Company's historical operating results cannot be relied upon as indicators of
future performance, and management cannot predict whether the Company will
obtain or sustain positive operating cash flow or generate net income in the
future.

Cash and cash equivalents were $5,687,975 as of June 30, 2004. Management
believes that the existing cash balance together with its existing financial
resources, including the leasing credit line facility (see Note 7), and any
revenues from sales, distribution, licensing and manufacturing relationships,

7



will be sufficient to meet the Company's operating and capital requirements
through the second quarter of 2005. The 2004 operating plan reflects anticipated
revenue growth from the use of the XTRAC system based on growing private
insurance coverage in the United States and continuing cost savings from the
integration of the combined companies. However, depending upon the Company's
rate of growth and other operating factors, the Company may require additional
equity or debt financing to meet its working capital requirements or capital
expenditure needs. There can be no assurance that additional financing, if
needed, will be available when required or, if available, could be obtained on
terms satisfactory to the Company.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

QUARTERLY FINANCIAL INFORMATION AND RESULTS OF OPERATIONS
The financial statements as of June 30, 2004 and for the three and six months
ended June 30, 2004 and 2003, are unaudited and, in the opinion of management,
include all adjustments (consisting only of normal recurring adjustments)
necessary to present fairly the financial position as of June 30, 2004, and the
results of operations and cash flows for the three and six months ended June 30,
2004 and 2003. The results for the three and six months ended June 30, 2004 are
not necessarily indicative of the results to be expected for the entire year.
While management of the Company believes that the disclosures presented are
adequate to make the information not misleading, these consolidated financial
statements should be read in conjunction with the consolidated financial
statements and the notes included in the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2003.

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

USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates and be based on events different from those assumptions.

CASH AND CASH EQUIVALENTS
The Company invests its excess cash in highly liquid, short-term investments.
The Company considers short-term investments that are purchased with an original
maturity of three months or less to be cash equivalents. Cash and cash
equivalents consisted of cash and money market accounts at June 30, 2004 and
December 31, 2003.

INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out basis) 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.

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. For lasers that are placed in a
physician's office, the cost is transferred from inventory to "lasers in
service" within property and equipment. The Company earns revenue each time the
laser is used for a patient treatment. Lasers that are not placed in a
physician's office are maintained in inventory until the unit is sold.

Reserves for slow moving and obsolete inventories are provided based on
historical experience and product demand. Management evaluates the adequacy of
these reserves periodically based on forecasted sales and market trend.

PROPERTY, EQUIPMENT AND DEPRECIATION
Property and equipment are recorded at cost. Depreciation is calculated on a
straight-line basis over the estimated useful lives of the assets, primarily
three to seven years for lasers in service, 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 relieved from the accounts and any gain or loss is recorded in the
consolidated statements of operations.

8



Laser units and laser accessories located at medical facilities for sales
evaluation and demonstration purposes or those units/accessories used for
development and medical training are included in property and equipment under
the caption "machinery and equipment." These units and accessories are being
depreciated over a period of up to five years. Laser units utilized in the
provision of surgical services are included in property and equipment under the
caption "lasers in service."

Management evaluates the realizability of property and equipment based on
estimates of undiscounted future cash flows over the remaining useful life of
the asset. If the amount of such estimated undiscounted future cash flows is
less than the net book value of the asset, the asset is written down to fair
value. As of June 30, 2004, no such write-down was required (see Impairment of
Long-Lived Assets below).

PATENT COST AND LICENSED TECHNOLOGIES
Costs incurred to obtain or defend patents 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.

Management evaluates the realizability of intangible assets based on estimates
of undiscounted future cash flows over the remaining useful life of the asset.
If the amount of such estimated undiscounted future cash flows is less than the
net book value of the asset, the asset is written down to fair value. As of June
30, 2004, no such write-down was required (see Impairment of Long-Lived Assets
below).

ACCRUED WARRANTY COSTS
The Company offers a warranty on product sales generally for a one to two-year
period. The Company provides for the estimated future warranty claims on the
date the product is sold. The activity in the warranty accrual during the six
months ended June 30, 2004 is summarized as follows:

June 30,
2004
---------
Accrual at beginning of period $ 316,714
Additions charged to warranty expense 227,688
Claims paid and other charges against the accrual (176,353)
---------
Accrual at end of period $ 368,049
=========

REVENUE RECOGNITION
The Company has two distribution channels for its phototherapy treatment
equipment. The Company will either (i) sell the laser through a distributor or
directly to a physician or (ii) place the laser in a physician's office (at no
charge to the physician) and charge the physician a fee for an agreed upon
number of treatments. When the Company sells an XTRAC laser to a distributor or
directly to a physician, revenue is recognized when the following four criteria
under Staff Accounting Bulletin No. 104 have been met: the product has been
shipped and the Company has no significant remaining obligations; persuasive
evidence of an arrangement exists; the price to the buyer is fixed or
determinable; and collection is probable. At times, units are shipped but
revenue is not recognized until all of the criteria have been met.

Under the terms of the distributor agreements, the distributors do not have the
right to return any unit which they have purchased. However, the Company does
allow products to be returned by its distributors in redress of product defects
or other claims.

When the Company places the laser in a physician's office, it recognizes service
revenue based on an estimate of patient treatments. Treatment codes sold to
physicians but not yet used are deferred and recognized as a liability until the
treatment occurs.

In the first quarter of 2003, the Company implemented a limited program to
support certain physicians in addressing treatments with the XTRAC system that
may be denied reimbursement by private insurance carriers. The Company
recognizes service revenue during the program 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. During the three and six
months ended June 30, 2004, the Company deferred revenues of $106,490 and
$249,761 under this program and at June 30, 2004 had total deferred revenues of
$849,465 under this program.

9



Through its surgical businesses, the Company generates revenues primarily from
three channels. The first is through sales of recurring laser delivery systems
and accessories; the second is through the per-procedure surgical services; and
the third is through the sale of laser systems and related maintenance service
agreements. The Company recognizes revenues from surgical laser and other
product sales, including sales to distributors, when the following four criteria
under Staff Accounting Bulletin No. 104 have been met: products have been
shipped and the Company has no significant remaining obligations; persuasive
evidence of an arrangement exists; the price to the buyer is fixed or
determinable; and collection is probable. At times, units are shipped but
revenue is not recognized until all of the criteria have been met.

For per-procedure surgical services, the Company recognizes revenue upon the
completion of the procedure. Revenue from maintenance service agreements is
deferred and recognized on a straight-line basis over the term of the
agreements. Revenue from billable services, including repair activity, is
recognized when the service is provided.

PRODUCT DEVELOPMENT COSTS
Costs of research, new product development and product redesign are charged to
expense as incurred.

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

The Company's deferred tax asset has been fully reserved under a valuation
allowance, reflecting the uncertainties as to realizability evidenced by the
Company's historical results and restrictions on the usage of the net operating
loss carryforwards.

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

In these consolidated financial statements, diluted net loss per share is the
same as basic net loss per share. No additional shares for the potential
dilution from the conversion or exercise of securities into common stock are
included in the denominator, since the result would be anti-dilutive.

RECLASSIFICATIONS
The 2003 consolidated statements of operations have been revised to present
product and services cost of revenues and operating expenses to the current
presentation format.

The 2003 property and equipment footnote (Note 3) has been revised to reallocate
the categories to the current year format. No change to the net book value was
made.

FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values for financial instruments under SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments," are determined at
discrete points in time based on relevant market information. These estimates
involve uncertainties and cannot be determined with precision. The fair value of
cash is based on its demand value, which is equal to its carrying value. The
fair 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 equal to its fair
value due to the short-term nature of these instruments.



10




IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," long-lived assets, such as property and equipment, and
purchased intangibles subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the asset. If the
carrying amount of an asset exceeds its estimated future cash flows, an
impairment charge is recognized by the amount by which the carrying amount of
the asset exceeds the fair value of the asset. Assets to be disposed of would be
separately presented in the balance sheet and reported at the lower of the
carrying amount or fair value less costs to sell, and would no longer be
depreciated. The assets and liabilities of a disposed group classified as held
for sale would be presented separately in the appropriate asset and liability
sections of the balance sheet. As of June 30, 2004, no such impairment existed.

STOCK OPTIONS
The Company applies the intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations, to account for its fixed-plan stock
options. Under this method, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeds the
exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation,"
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans. As allowed by
SFAS No. 123, as amended in SFAS No. 148, "Accounting for Stock-Based
Compensation," the Company has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only
the disclosure requirements of SFAS No. 123 and SFAS No. 148.

Had stock compensation cost for the Company's common stock options been
determined based upon the fair value of the options at the date of grant, as
prescribed under SFAS No. 123, as amended by SFAS No. 148, the Company's net
loss and net loss per share would have been increased to the following pro-forma
amounts:



Three Months Ended June 30, Six Months Ended June 30,
-------------------------------- ----------------------------
2004 2003 2004 2003
------------ --------------- ------------ -----------

Net loss:
As reported $ (1,207,167) $ ( 1,686,102) $ (2,570,249) $(3,360,430)

Less: stock-based employee
compensation expense included
in reported net loss 1,621 1,621 3,241 3,233

Impact of total stock-based
compensation expense determined
under fair-value-based method
for all grants and awards
(427,720) (437,317) (872,523) (847,500)
------------ --------------- ------------ -----------
Pro-forma $ (1,633,266) $ (2,121,798) $ (3,439,531) $(4,204,697)
============ =============== ============ ===========
Net loss per share:
As reported $ (0.03) $ (0.05) $ (0.07) $ (0.10)
============ =============== ============ ===========
Pro-forma $ (0.04) $ (0.06) $ (0.09) $ (0.13)
============ =============== ============ ===========


The above pro-forma amounts may not be indicative of future pro-forma amounts
because future options are expected to be granted.

The fair value of the options granted is estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions applicable
to options granted in the three-month and six-month periods:



Three Months Ended June 30, Six Months Ended June 30,
--------------------------------- ---------------------------------
2004 2003 2004 2003
--------------- -------------- ------------- ----------------

Risk-free interest rate 3.07% 2.943% 3.07% 2.977%
Volatility 99.9% 100% 99.9% 100%
Expected dividend yield 0% 0% 0% 0%
Expected option life 5 years 5 years 5 years 5 years



11




SUPPLEMENTAL CASH FLOW INFORMATION
During the six months ended June 30, 2004, the Company financed insurance
policies through note payables for $530,977, financed vehicle purchases of
$120,000 under capital leases, financed certain credit facility costs for
$167,270 and issued warrants to a leasing credit facility which are valued at
$62,032, and which offset the carrying value of debt.

During the six months ended June 30, 2003, the Company financed vehicle and
equipment purchases of $329,351 under capital leases, financed insurance
policies through notes payable for $466,995 and financed certain acquisition
costs which were included in accounts payable at December 31, 2002, through a
note payable for $171,000.

RECENT ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46 (revised December 2003), "Consolidation of Variable
Interest Entities," ("VIEs") ("FIN 46R") which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and accordingly should consolidate
the entity. FIN 46R replaces FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," which was issued in January 2003. The Company has
adopted FIN 46R as of March 31, 2004 for variable interests in VIEs. For any
VIEs that must be consolidated under FIN 46R that were created before January 1,
2004, the assets, liabilities and noncontrolling interests of the VIE initially
would be measured at their carrying amounts with any difference between the net
amount added to the balance sheet and any previously recognized interest being
recognized as the cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R first
applies may be used to measure the assets, liabilities and noncontrolling
interest of the VIE. The adoption of FIN 46R did not have an effect on the
consolidated financial statements in such as the Company has no interests in any
VIEs.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective July 1, 2003. The adoption of SFAS No.
150 did not have a material impact on the Company's consolidated financial
statements, as the Company does not have the types of financial instruments
which would require consideration under this Statement.

Note 2
INVENTORIES:

Set forth below is a detailed listing of inventories.

June 30, December 31,
2004 2003
---------- ----------
Raw materials and work in progress $2,599,139 $2,586,347
Finished goods 1,542,689 1,936,115
---------- ----------
Total inventories $4,141,828 $4,522,462
========== ==========




12




Note 3
PROPERTY AND EQUIPMENT:

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

June 30, December 31,
2004 2003
----------- -----------
Lasers in service $ 8,360,767 $ 7,266,707
Computer hardware and software 256,340 256,340
Furniture and fixtures 198,558 327,575
Machinery and equipment 317,075 237,776
Autos and trucks 348,920 224,135

Leasehold improvements 110,441 110,441
----------- -----------
9,592,101 8,422,974
Accumulated depreciation and
amortization (5,070,910) (4,417,769)
----------- -----------
Property and equipment, net $ 4,521,194 $ 4,005,205
=========== ===========


Depreciation expense was $795,554 and $942,023 for the six months ended June 30,
2004 and 2003, respectively. At June 30, 2004 and December 31, 2003, net
property and equipment included $752,961 and $716,651, respectively, of assets
recorded under capitalized lease arrangements, of which $642,602 and $675,508
was included in long-term debt at June 30, 2004 and December 31, 2003,
respectively (see Note 7).

Note 4
PATENTS AND LICENSED TECHNOLOGIES:

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



June 30, December 31,
2004 2003
-------- --------

Patents, owned and licensed, net of accumulated amortization of
$133,074 and $113,744 $269,949 $289,279

Other licensed or developed technologies, net of accumulated
amortization of $431,630 and $367,624 405,370 469,376
-------- --------
Total patents and licensed technologies, net $675,319 $758,655
======== ========


Amortization expense was $83,336 and $84,710 for the six months ended June 30,
2004 and 2003, respectively.

Note 5
OTHER ACCRUED LIABILITIES:

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

June 30, December 31,
2004 2003
-------- --------
Accrued warranty $368,049 $316,714
Accrued liability from matured notes 246,720 247,108
Accrued professional and consulting fees 118,199 203,699
Cash deposits -- 125,500
Other accrued expenses 109,908 82,515
-------- --------

Total other accrued liabilities $842,876 $975,536
======== ========

During 2002, SLT resumed direct control of $223,000 of funds previously set
aside for the payment of SLT's subordinated notes, which matured and ceased to
bear interest on July 30, 1999, and $31,000 of funds set aside to pay related
accrued interest. As of June 30, 2004 and December 31, 2003, the matured
principal and related interest was $246,720 and $247,108, respectively.




13




Note 6
NOTES PAYABLE:

Set forth below is a detailed listing of notes payable.



June 30, December 31,
2004 2003
--------- ---------

Note payable - unsecured creditor, interest at 5.75%, payable in monthly
principal and interest installments of $46,058
through January 2005 $ 314,312 $ --

Note payable - secured creditor, interest at 16.47%, payable in monthly
principal and interest installments of $2,618 through
December 2006 62,427 72,382

Note payable - unsecured creditor, interest at 6.25%, payable in monthly
principal and interest installments of $18,505
through September 2004 54,943 --

Note payable - unsecured creditor, interest at 7.47%, payable in monthly
principal and interest installments of $7,827
through June 2004 -- 40,907

Note payable - unsecured creditor, repaid in January 2004 -- 37,409

Note payable - unsecured creditor, repaid in January 2004 -- 1,857
--------- ---------
431,682 152,555
Less: current maturities (392,064) (101,066)
--------- ---------
Notes payable, net of current maturities $ 39,618 $ 51,489
========= =========


Note 7
LONG-TERM DEBT:

Set forth below is a detailed listing of the Company's long-term debt.

June 30, December 31,
2004 2003
----------- -----------
Borrowings on credit facility $ 1,474,918 $ 1,000,000
Capital lease obligations (see Note 3) 642,602 675,508
Less: current portion (724,758) (1,269,759)
----------- -----------
Total long-term debt $ 1,392,762 $ 405,749
=========== ===========

The Company obtained a $2,500,000 leasing credit facility from GE Capital
Corporation on June 25, 2004. The credit facility has a commitment term of three
years, expiring on June 25, 2007. 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. The draw is set at an interest rate based on 522 basis points
above the three-year Treasury note rate. Each draw is discounted by 7.75%. With
each draw, the Company has agreed to issue warrants to purchase shares of the
Company's common stock equal to 5% of the draw. The number of warrants is
determined by dividing 5% of the draw by the average closing price of the
Company's common stock for the ten days preceding the date of the draw. The
warrants have a five-year term from the date of each issuance and bear an
exercise price set at 10% over the average closing price for the ten days
preceding the date of the draw. As of June 30, 2004, the Company had drawn
$1,536,950 against the credit facility, at an interest rate of 8.47%, and has
issued warrants to purchase 23,903 shares of common stock with an exercise price
of $3.54 per share. For reporting purposes, the carrying value of the liability
is reduced by the value ascribed to the warrants, $62,032, at the time of the
draw. This reduction will be accreted to interest expense over the term of the
draw.

Concurrent with the SLT acquisition, the Company assumed a $3,000,000 credit
facility from a bank. The credit facility had a commitment term of four years,
which expired May 31, 2004, permitted deferment of principal payments until the
end of the commitment term, and was secured by SLT's business assets, including
collateralization (until May 13, 2003) of $2,000,000 of SLT's cash and cash
equivalents and short-term investments. The bank agreed to allow the Company to
apply the cash collateral to a paydown of the facility in 2003. The credit
facility had an interest rate of the 30 day LIBOR plus 2.25%.

14



The obligations under capital leases are at fixed interest rates and are
collateralized by the related property and equipment (see Note 3).

Note 8
WARRANT EXERCISES:

In the six months ended June 30, 2004, 976,263 warrants on the common stock of
the Company were exercised, resulting in an increase to the Company's shares
outstanding as of the end of the period by the same amount. The Company received
$1,720,842 in cash proceeds from the exercises. Of these proceeds, $803,450 was
from the exercise of warrants that were exercisable at $1.77 per share and were
set to expire on March 31, 2004.

Note 9
BUSINESS SEGMENT AND GEOGRAPHIC DATA:

The Company is engaged in four business segments: Domestic XTRAC, International
XTRAC, Surgical Services, and Surgical Products and Other. The Company markets
its offering through traditional product sales as well as through the provision
of fee-based medical procedures services. The Company's customers are primarily
doctors, hospitals and surgery centers. For the three and six months ended June
30, 2004 and 2003, the Company did not have material net revenues from any
individual customer.



Three Months Ended June 30, 2004
-----------------------------------------------------------------------------
SURGICAL
PRODUCTS
DOMESTIC INTERN'L SURGICAL AND
XTRAC XTRAC SERVICES OTHER TOTAL
----------- ----------- ----------- ----------- -----------

Revenues $ 719,263 $ 454,770 $ 1,933,936 $ 1,215,165 $ 4,323,134
Costs of revenues 540,841 322,380 1,121,165 646,983 2,631,369
----------- ----------- ----------- ----------- -----------
Gross profit 178,422 132,390 812,771 568,182 1,691,765
----------- ----------- ----------- ----------- -----------

Allocated operating expenses:
Selling, general and
administrative 460,135 122,945 341,076 178,460 1,102,616
Engineering and product
development 180,426 112,949 -- 187,868 481,243

Unallocated operating expenses -- -- -- -- 1,303,837
----------- ----------- ----------- ----------- -----------
640,561 235,894 341,076 366,328 2,887,696
----------- ----------- ----------- ----------- -----------
Income (loss) from operations (462,139) (103,505) 471,695 201,854 (1,195,931)

Interest expense, net -- -- -- -- 11,236
----------- ----------- ----------- ----------- -----------

Net income (loss) $ (462,139) $ (103,505) $ 471,695 $ 201,854 $(1,207,167)
=========== =========== =========== =========== ===========




15







Three Months Ended June 30, 2003
-----------------------------------------------------------------------------
SURGICAL
PRODUCTS
DOMESTIC INTERN'L SURGICAL AND
XTRAC XTRAC SERVICES OTHER TOTAL
----------- ----------- ----------- ----------- -----------



Revenues $ 202,749 $ 770,720 $ 1,507,832 $ 1,361,398 $ 3,842,699
Costs of revenues 687,652 340,073 915,485 723,022 2,666,232
----------- ----------- ----------- ----------- -----------
Gross profit (loss) (484,903) 430,647 592,347 638,376 1,176,467
----------- ----------- ----------- ----------- -----------

Allocated operating expenses:
Selling, general and
administrative 368,310 230,456 254,112 149,415 1,002,293
Engineering and product
development 247,784 96,360 -- 120,990 465,134

Unallocated operating expenses -- -- -- -- 1,384,727
----------- ----------- ----------- ----------- -----------
616,102 326,816 254,112 270,405 2,852,150
----------- ----------- ----------- ----------- -----------
Income (loss) from operations (1,101,005) 103,831 338,235 367,971 (1,675,687)

Interest expense, net -- -- -- -- 10,415
----------- ----------- ----------- ----------- -----------

Net income (loss) $(1,101,005) $ 103,831 $ 338,235 $ 367,971 $(1,686,102)
=========== =========== =========== =========== ===========






Six Months Ended June 30, 2004
-----------------------------------------------------------------------------
SURGICAL
PRODUCTS
DOMESTIC INTERN'L SURGICAL AND
XTRAC XTRAC SERVICES OTHER TOTAL
----------- ----------- ----------- ----------- -----------



Revenues $ 1,269,864 $ 1,035,514 $ 3,573,540 $ 2,469,446 $ 8,348,364
Costs of revenues 1,027,127 692,760 2,260,075 1,145,473 5,125,435
----------- ----------- ----------- ----------- -----------
Gross profit 242,737 342,754 1,313,465 1,323,973 3,222,929
----------- ----------- ----------- ----------- -----------

Allocated operating expenses:
Selling, general and
administrative 960,875 251,046 667,067 302,914 2,181,902
Engineering and product
development 343,220 214,860 -- 339,113 897,193

Unallocated operating expenses -- -- -- -- 2,694,975
----------- ----------- ----------- ----------- -----------
1,304,095 465,906 667,067 642,027 5,774,070
----------- ----------- ----------- ----------- -----------
Income (loss) from operations (1,061,358) (123,152) 646,398 681,946 (2,551,141)

Interest expense, net -- -- -- -- 19,108
----------- ----------- ----------- ----------- -----------

Net income (loss) $(1,061,358) $ (123,152) $ 646,398 $ 681,946 $(2,570,249)
=========== =========== =========== =========== ===========




16







Six Months Ended June 30, 2003
-----------------------------------------------------------------------------
SURGICAL
PRODUCTS
DOMESTIC INTERN'L SURGICAL AND
XTRAC XTRAC SERVICES OTHER TOTAL
----------- ----------- ----------- ----------- -----------


Revenues $ 355,913 $ 934,020 $ 2,913,633 $ 3,112,610 $ 7,316,176
Costs of revenues 1,269,611 465,205 1,783,902 1,557,772 5,076,490
----------- ----------- ----------- ----------- -----------
Gross profit (loss) (913,698) 468,815 1,129,731 1,554,838 2,239,686
----------- ----------- ----------- ----------- -----------

Allocated operating expenses:
Selling, general and
administrative 747,406 299,042 553,279 383,427 1,983,154
Engineering and product
development 455,644 177,195 -- 244,227 877,066

Unallocated operating expenses -- -- -- -- 2,698,458
----------- ----------- ----------- ----------- -----------
1,203,050 476,237 553,279 627,654 5,558,678
----------- ----------- ----------- ----------- -----------
Income (loss) from operations (2,116,748) (7,422) 576,452 927,184 (3,318,992)

Interest expense, net -- -- -- -- 41,438
Other income, net -- -- -- -- --
----------- ----------- ----------- ----------- -----------

Net income (loss) $(2,116,748) $ (7,422) $ 576,452 $ 927,184 $(3,360,430)
=========== =========== =========== =========== ===========




June 30, December 31,
2004 2003
----------- -----------

Assets:
Total assets for reportable segments $16,081,048 $15,602,758
Other unallocated assets 6,541,089 7,149,973
----------- -----------
Consolidated total $22,622,137 $22,752,731
=========== ===========

For the three and six months ended June 30, 2004 and 2003, there were no
material net revenues attributed to an individual foreign country. Net revenues
by geographic area were as follows:

For the Three Months Ended For the Six Months Ended
June 30, June 30,
------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Domestic $3,687,091 $2,695,689 $6,956,838 $5,630,769

Foreign 636,043 1,147,010 1,391,526 1,685,407
---------- ---------- ---------- ----------
$4,323,134 $3,842,699 $8,348,364 $7,316,176
========== ========== ========== ==========


Note 10
SIGNIFICANT ALLIANCES/AGREEMENTS:

TNC AGREEMENT
The Company entered into an agreement with True North Capital Ltd. (the "TNC
Agreement"), dated as of October 28, 2003, pursuant to which True North Capital
had agreed to assist the Company in identifying and evaluating proposed
strategic growth transactions relating to the healthcare industry. True North
Capital is a fund management group, which provides management and acquisition
advisory services with a specialty in the healthcare industry. Assisting True
North Capital was its former affiliate, True North Partners LLC. One of the
Company's directors had been a senior member of the executive management staff
of True North Capital and held approximately a 20.3% equity interests in True
North Capital and also in True North Partners, LLC.

In the event of the completion of an acquisition or merger transaction, the
Company had agreed to pay True North Capital a "success fee" equal to the
greater of: (i) $250,000, or (ii) the sum of (a) 5% of the aggregate purchase,
if the aggregate consideration is equal to or greater than $5,000,000 and less
than $10,000,000; plus, (b) 3% of the aggregate consideration from $10,000,000
to $50,000,000; plus, (c) 2.5% of the aggregate consideration from $50,000,000
to $100,000,000; plus, (d) 2% of the aggregate consideration from $100,000,000
to $150,000,000; plus, (e) 1.5% of the aggregate consideration in excess of
$150,000,000. The Company, True North Capital and True North Partners have
recently agreed that a success fee would be divided evenly between True North
Capital and True North Partners. In 2003, the Company paid True North Capital a
one-time $20,000 expense reimbursement for the deployment of its personnel and
resources in the fulfillment of the goals set forth in the TNC Agreement. The
Company also agreed to reimburse True North Capital the cost of out-of-pocket
expenses which it incurs in performance of the agreement and which the Company
has approved beforehand. The Company reimbursed out of pocket expenses of $2,875
and $13,870 in 2003 and in the first six months of 2004, respectively. The TNC
Agreement may be canceled upon 30 days' notice from either party.



17


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

Certain statements in this Quarterly Report on Form 10-Q, or the
Report, are "forward-looking statements." These forward-looking statements
include, but are not limited to, statements about the plans, objectives,
expectations and intentions of PhotoMedex, Inc., a Delaware corporation
(referred to in this Report as "we," "us," "our" or "registrant") and other
statements contained in this Report that are not historical facts.
Forward-looking statements in this Report or hereafter included in other
publicly available documents filed with the Securities and Exchange Commission,
or the Commission, reports to our stockholders and other publicly available
statements issued or released by us involve known and unknown risks,
uncertainties and other factors which could cause our actual results,
performance (financial or operating) or achievements to differ from the future
results, performance (financial or operating) or achievements expressed or
implied by such forward-looking statements. Such future results are based upon
management's best estimates based upon current conditions and the most recent
results of operations. When used in this Report, the words "expect,"
"anticipate," "intend," "plan," "believe," "seek," "estimate" and similar
expressions are generally intended to identify forward-looking statements,
because these forward-looking statements involve risks and uncertainties. There
are important factors that could cause actual results to differ materially from
those expressed or implied by these forward-looking statements, including our
plans, objectives, expectations and intentions and other factors discussed under
the section entitled "Risk Factors," in our Annual Report on Form 10-K for the
year ended December 31, 2003.

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

INTRODUCTION
Our primary focus in 2003 was to secure from private health plans
favorable reimbursement policies for treatment of psoriasis using the XTRAC(R)
excimer laser. In March 2003, we had re-introduced the XTRAC and, based on the
establishment of CPT codes by the AMA and reimbursement rates from the Centers
for Medicare and Medicaid Services, we began efforts to secure such favorable
policies. To persuade such plans to adopt favorable policies, we also
commissioned a clinical and economic study of the use of the XTRAC laser as a
second-step therapy for psoriasis. In December 2003, we deployed the findings of
the study through a Data Compendium and mailed a copy of the Data Compendium to
a number of medical insurance plans in our ongoing marketing efforts to secure
favorable reimbursement policies.

Moving into 2004, we have expanded our deployment of the study. From
feedback we have received from the medical insurers to the Data Compendium, we
anticipate that the study, coupled with our other marketing efforts, will
succeed in gaining a place on the agenda of private plans as they consider their
coverage and reimbursement policies. We have already secured such approval in
2004 from three significant plans, Regence, Wellpoint, and Aetna and are under
consideration by other plans. We cannot at this time provide assurance that
other plans will adopt the favorable policies that we desire, and if they do
not, what further requirements may be asked of us. In addition to reimbursement,
our focus in 2004 will be to continue to improve care for those suffering from
psoriasis, and to obtain a larger body of satisfied practitioners using the
XTRAC and to increase our domestic XTRAC revenues.

We integrated the business of SLT in 2003. We acquired two revenue
streams from SLT: one from surgical services, the other from surgical products;
these supplemented our own discrete product lines, XTRAC Domestic and XTRAC
International. We view our business as comprised of four business segments:
Domestic XTRAC, International XTRAC, Surgical Services and Surgical Products.

We experienced revenue growth in Surgical Services in 2003 from 2002
and expect continuing growth in 2004. Our plan in 2003 was to grow in a
controlled fashion such that capital expenditures necessary for that growth
would come from these operations. We anticipate that this will continue in 2004.
In this manner, we intend to conserve our cash resources for the Domestic XTRAC
business segment.

In 2003, our revenues from Surgical Products remained stable and
contributed to maintaining our staying power in our two growth business
segments. Our surgical products enjoy a reputation for quality. We believe that
this reputation for quality will continue to generate revenues for us in 2004.

18



The surgical product revenues decreased by $146,233 and $643,164 in the three
and six months of 2004 when compared to 2003, respectively. Revenues from
surgical products were reasonably stable in disposables in the first quarter of
2004, but declined in the second quarter of 2004. The Company has expected that
the disposable base might continue to erode over time, as hospitals continue to
seek outsourcing solutions instead of purchasing lasers and related disposables
for their operating rooms. The Company has continued to seek an offset to this
through expanding its surgical services. There was a decline in surgical laser
sales, but such sales vary from quarter to quarter. Some of this decrease is
related to the trend of hospitals to outsource their laser-assisted procedures
to third parties, like our surgical services segment. With the introduction of
the CO2 and diode surgical lasers in the second quarter of 2004, we hope to
offset the decline in lasers and have a further offset to the erosion of
disposables revenues.

In the second quarter 2004, we received from the FDA concurrence under
a 510(K) to market two new surgical lasers: the LaserPro Diode Laser System, and
the LaserPro CO2 Laser System. Each system has been designed for rugged use in
our Surgical Services business; each system will also complement the Surgical
Products business, finding end-user buyers here and abroad. We are also
exploring opportunities for supplying the lasers on an OEM basis or under
manufacturing-marketing collaborations.

Our revenues from International XTRAC sales provided needed working
capital in 2003 and continue to do so in 2004. We have enjoyed some distinction
in the market from our clinical studies and the physician researchers involved
in such studies. However, the international XTRAC operations are more widely
influenced by competition from similar laser technology from other manufacturers
and non-laser lamp alternatives for treating inflammatory skin disorders. Over
time, competition has served to reduce the international prices we charge
distributors for our excimer products. While the average price per laser was
less in the three and six months ended June 30, 2004 than in the same periods of
2003, the number of lasers sold was greater. The XTRAC laser sales vary form
quarter to quarter. We have also benefited in 2003 and into 2004 from the
improved reliability and functionality of the XTRAC.

Finally, in July 2004, we entered into a Development Agreement with
AzurTec, Inc. AzurTec is a development-stage company based outside Philadelphia.
AzurTec's product in development is a device that seeks to rapidly and
accurately detect the presence of cancerous cells in excised tissue. Azurtec's
target customer is generally the dermatologist and particularly is the MOHS
surgeon. We intend to assist in the development of FDA-compliant prototypes for
AzurTec's product. Initial payments under the agreement are fixed amounts,
aggregating $175,000, at fixed intervals of time, up through October 31, 2004.
Payments thereafter are made based on time spent on the project at agreed
billing rates. Through arrangements such as this, we hope to identify and
nurture opportunities that match our business strategy.

OVERVIEW OF BUSINESS OPERATIONS

We are engaged in the development, manufacturing and marketing of our
proprietary XTRAC(R), or XTRAC, excimer laser and delivery systems and
techniques directed toward the treatment of inflammatory skin disorders. In
addition, through the acquisition of SLT on December 27, 2002, we also engage in
the development, manufacture and sale of surgical products, including free-beam
laser systems for surgery and in the provision of surgical services on a
turn-key procedural basis.

In connection with our current business plan, the initial medical
applications for our excimer laser technology are intended for the treatment of
psoriasis, vitiligo, atopic dermatitis and leukoderma. In January 2000, we
received approval of our 510(k) submission from the Food and Drug
Administration, or FDA, relating to the use of our XTRAC system for the
treatment of psoriasis. The 510(k) establishes that our XTRAC system has been
determined to be substantially equivalent to currently marketed devices for
purposes of treating psoriasis.

In February 2002, the Current Procedural Terminology Editorial Board of
the AMA approved the request by the American Academy of Dermatology to issue
reimbursement codes for the laser therapies in the treatment of psoriasis and
other inflammatory diseases, which would include laser therapy using the XTRAC
system to treat such conditions. The AMA published three CPT code numbers
covering the treatment of psoriasis and other inflammatory skin diseases with
the XTRAC system. These new codes were effective in the first quarter of 2003.
We believe that the publication of these codes, together with a compilation of
clinical and economic studies (Data Compendium) mailed during the first quarter
to almost all private healthcare insurers throughout the United States will
facilitate our ability to obtain broader approvals for reimbursement for
treatment of psoriasis and other inflammatory skin diseases using the XTRAC
system. We have already secured in 2004 approval from three significant
insurance groups, and are under consideration by other groups and plans. We

19



anticipate that the approvals will positively influence other private plans to
adopt favorable reimbursement policies. Such influence and possible momentum
from it can help in 2004 to overcome resistance and inertia that we encountered
in 2003. However, there can be no assurance that these effects will transpire.

As part of our commercialization strategy in the United States, we are
providing the XTRAC system to targeted dermatologists at no initial capital cost
to them. We believe that this strategy will create incentives for these
dermatologists to adopt the XTRAC system and will increase market penetration.
This strategy will require us to identify and target appropriate dermatologists
and to balance the planned roll-out of our XTRAC lasers during 2004 against
uncertainties in acceptance by physicians, patients and health plans and
constraints on the number of XTRAC systems we are able to provide. Our marketing
force has limited experience in dealing with such challenges. We also expect
that we will face increasing competition as more private insurance plans adopt
favorable policies for reimbursement for treatment of psoriasis. Outside of the
United States, our strategy includes selling XTRAC systems directly to
dermatologists through distributors and, potentially, placing XTRAC systems with
dermatologists to provide us with a usage-based revenue stream. To date, no
units have been placed in international markets that provide a usage-based
revenue stream.

In similar fashion, we have growing, but still limited marketing
experience in expanding our surgical services business. The preponderance of
this business is in the southeastern part of the United States. New procedures
and new geographies, customers and different business habits and networks will
likely pose different challenges than the ones we have encountered in the past.
There can be no assurance that our experience will be sufficient to overcome
such challenges.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of
operations in this report are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets and liabilities, revenues and expense 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
receivables, 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 the Company's
consolidated financial statements. These critical accounting policies and the
significant estimates made in accordance with them have been discussed with our
Audit Committee.

REVENUE RECOGNITION. We have two distribution channels for our
phototherapy treatment equipment. We will either (i) sell the laser through a
distributor or directly to a physician or (ii) place the laser in a physician's
office (at no charge to the physician) and charge the physician a fee for an
agreed upon number of treatment cards or equivalent access codes. When we sell a
laser to a distributor or directly to a physician, revenue is recognized when
the product is shipped and the Company has no significant remaining obligations,
persuasive evidence of an arrangement exists, the price to the buyer is fixed or
determinable, and collection is probable. At times, units are shipped but
revenue is not recognized until all of the criteria are met. Under the terms of
the distributor agreements, the distributors do not have the right to return any
unit. However, we do allow products to be returned by our distributors in
redress of product defects or other claims. When we place a laser in a
physician's office, service revenues are recognized based on an estimate of
patient treatments. To use the laser, the physician purchases treatment codes
that allow performance of a specified number of treatments. This amount is
included in deferred revenues on the accompanying consolidated balance sheets
until the treatment occurs or is estimated to have occurred.

In the first quarter of 2003, we implemented a limited program to
support certain physicians in addressing treatments with the XTRAC system that
may be denied reimbursement by private insurance carriers. We recognize service
revenue during the program for the sale of treatment codes to physicians
participating in this program only if and to the extent the physician has been
reimbursed for the treatments. In the three and six months ended June 30, 2004,
we deferred revenues of $106,490 and $249,761 under this program.

Through our surgical businesses, we generate revenues primarily from
three channels. The first is through sales of recurring laser delivery systems
and accessories; the second is through the per-procedure surgical services; and
the third is through the sale of laser systems and related maintenance service
agreements. We recognize revenues from product sales, including sales to

20



distributors, when products are shipped and we have no significant remaining
obligations, persuasive evidence of an arrangement exists, the price to the
buyer is fixed or determinable, and collection is probable. At times, units are
shipped but revenue is not recognized until all of the criteria are met.

For per-procedure surgical services, we recognize revenue upon the
completion of the procedure. Revenue from maintenance service agreements is
deferred and recognized on a straight-line basis over the term of the
agreements. Revenue from billable services, including repair activity, is
recognized when the service is provided.

As a result of the 2003 audit, our independent auditors issued a letter
identifying a material weakness in our internal controls. That material weakness
arises under the revenue recognition criteria of Staff Accounting Bulletin No.
104 as it relates to collectibility of laser shipments. While we believed that
we have adequate policies for proper recognition of revenue, we agreed with our
independent auditors that our implementation of those policies, especially in
evaluating the collectibility of discrete sales of laser units, needed to be
improved. We have re-evaluated the various factors, and the relative weights we
ascribe to the factors, which we take into account in determining
collectibility. We have implemented in the first quarter of 2004 these and
additional procedures to evaluate not only new distributors and customers, but
past customers as well.

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 at production cost (materials, labor and indirect manufacturing cost) for
work-in-process and finished goods. We perform full physical inventory counts
for XTRAC and cycle counts on all the other inventory to maintain controls and
to have accurate data. Reserves for slow moving and obsolete inventories are
provided based on historical experience and product demand. Management evaluates
the adequacy of these reserves periodically based on forecasted sales and market
trend.

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

PROPERTY AND EQUIPMENT. As of June 30, 2004 and December 31, 2003, we
had net property and equipment of $4,521,194 and $4,005,205, respectively. The
most significant component of these amounts relates to the lasers placed by us
in physicians' offices. We own the equipment and charge the physician on a
per-treatment basis for use of the equipment. The realizability of the net
carrying value of the lasers is predicated on increasing revenues from the
physicians' use of the lasers. We believe that such usage will increase in the
future based on the recently approved CPT codes and expected increases in
insurance reimbursement.

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 its business. As of June 30,
2004 and December 31, 2003, we had $3,619,742 and $3,703,078, respectively, of
goodwill and other intangibles, accounting for 16% of our total assets at the
respective dates. The determination of the value of such intangible assets
requires management to make estimates and assumptions that affect our
consolidated financial statements. The Company regularly evaluates its
intangibles to determine the realizibility of its intangibles and continues to
conclude that there has been no impairment to the intangibles.

WARRANTY ACCRUALS. We establish a liability for warranty repairs based
on estimated future claims for XTRAC systems and based on historical analysis of
the cost of the repairs for surgical laser systems. However, future returns on
defective laser systems and related warranty liability could differ
significantly from estimates and historical patterns, which would adversely
affect our operating results.

21



RESULTS OF OPERATIONS

REVENUES

We generated revenues of $4,323,134 during the three months ended June
30, 2004, of which $3,149,101 was from the products and services operations of
SLT. The balance of revenues was from phototherapy products and services,
including $454,770 from XTRAC international sales of excimer systems and parts
and $719,263 from domestic XTRAC procedures. We generated revenues of $3,842,699
during the three months ended June 30, 2003, of which $2,869,230 was from the
products and services operations of SLT. The balance of revenues was from
phototherapy products and services, including $770,720 from XTRAC international
sales of excimer systems and parts and $202,749 from domestic XTRAC procedures.

We generated revenues of $8,348,364 during the six months ended June
30, 2004, of which $6,042,986 was from the products and services operations of
SLT. The balance of revenues was from phototherapy products and services,
including $1,035,514 from XTRAC international sales of excimer systems and parts
and $1,269,864 from domestic XTRAC procedures. We generated revenues of
$7,316,176 during the six months ended June 30, 2003 of which $6,026,243 was
from the products and services operations of SLT. The balance of revenues was
from phototherapy products and services, including $934,020 from XTRAC
international sales of excimer systems and parts and $355,913 from domestic
XTRAC procedures.

In the first quarter of 2003, we implemented a limited program to
support certain physicians in addressing treatments with the XTRAC system that
may be denied reimbursement by private insurance carriers. Following the
requirements of Staff Accounting Bulletin No. 104, we recognize service revenue
during the program from the sale of XTRAC procedures, or equivalent treatment
codes, to physicians participating in this program only if and to the extent the
physician has been reimbursed for the treatments. In the three and six months
ended June 30, 2004, the Company deferred revenues of $106,490 and $249,761
under this program. In the three and six months ended June 30, 2003, the Company
deferred revenues of $339,748 and $462,504 under this program.

Recognized revenue for the three months ended June 30, 2004 and 2003
for domestic XTRAC procedures was $719,263 and $202,749, respectively. Total
XTRAC procedures for the same periods were approximately 12,700 and 8,000,
respectively, including 810 and 667 procedures, respectively, which were
performed by customers without billing from us as the procedures were performed
in connection with customer evaluations of the XTRAC laser as well as for
clinical research. Recognized revenue for the six months ended June 30, 2004 and
2003 for domestic XTRAC procedures was $1,269,864 and $355,913, respectively.
Total XTRAC procedures for the same periods were approximately 23,400 and
12,000, respectively, including 1,900 and 752 procedures, respectively, which
were performed by customers without billing from us as the procedures were
performed in connection with customer evaluations of the XTRAC laser as well as
for clinical research. The ramp in procedures in the three and six months ended
June 30, 2004 was related to our continuing progress in securing favorable
reimbursement policies from private insurance plans. Increases in these levels
are dependent upon more widespread adoption of these CPT codes and comparable
rates by private healthcare insurers.

International XTRAC sales of our excimer laser system and related parts
were $454,770 for the three months ended June 30, 2004 compared to $770,720 for
the three months ended June 30, 2003. We sold six laser systems in the three
months ended June 30, 2004 compared to 10 laser systems in the three months
ended June 30, 2003. International XTRAC sales of our excimer laser system and
related parts were $1,035,514 for the six months ended June 30, 2004 compared to
$934,020 for the six months ended June 30, 2003. We sold 16 laser systems in the
six months ended June 30, 2004 compared to 12 laser systems in the six months
ended June 30, 2003. The international XTRAC operations are more widely
influenced by competition from similar laser technology from other manufacturers
and non-laser lamp alternatives for treating inflammatory skin disorders. Over
time, competition has served to reduce the international prices we charge
distributors for our excimer products. While the average price per laser was
less in the three and six months ended June 30, 2004 than in the same periods of
2003, the number of lasers sold was greater. In addition, four lasers which had
been shipped before the first quarter of 2004 but not recognized as sales due to
the application of the recognition criteria of Staff Accounting Bulletin No. 104
were recognized in the first quarter of 2004.

In the three months ended June 30, 2004 and 2003, surgical service
revenues were $1,933,936 and $1,507,832, respectively. In the six months ended
June 30, 2004 and 2003, surgical service revenues were $3,573,540 and
$2,913,633, respectively. Revenues in surgical services grew in significant part
due to growth in urological procedures performed with a laser system
manufactured by a third party. Such procedures include 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.

22



In the three months ended June 30, 2004 and 2003, surgical product
revenues were $1,174,587 and $1,318,412, respectively. In the six months ended
June 30, 2004 and 2003, surgical product revenues were $2,386,246 and
$3,024,404, respectively. Revenues from surgical products were reasonably stable
in disposables in the first quarter of 2004, but declined in the second quarter
of 2004. The Company has expected that the disposable base might continue to
erode over time, as hospitals continue to seek outsourcing solutions instead of
purchasing lasers and related disposables for their operating rooms. The Company
has continued to seek an offset to this through expanding its surgical services.
There was a decline in surgical laser sales, but such sales vary from quarter to
quarter. Some of this decrease is related to the trend of hospitals to outsource
their laser-assisted procedures to third parties, like our surgical services
segment. With the introduction of the CO2 and diode surgical lasers in the
second quarter of 2004, we hope to offset the decline in lasers and have a
further offset to the erosion of disposables revenues.

COST OF REVENUES

Product cost of revenues for the three months ended June 30, 2004 were
$932,621, compared to $1,048,095 for the three months ended June 30, 2003.
Included in these costs were $610,241 and $708,022, respectively, related to
surgical product revenues, for the three months ended June 30, 2004 and 2003.
The remaining product cost of revenues during these periods of $322,380 and
$340,073, respectively, related primarily to the production costs of the XTRAC
laser equipment sold outside of the United States.

Product cost of revenues for the six months ended June 30, 2004 were
$1,765,105, compared to $1,992,977 for the six months ended June 30, 2003.
Included in these costs were $1,072,345 and $1,527,772, respectively, related to
surgical product revenues, for the six months ended June 30, 2004 and 2003. The
remaining product cost of revenues during these periods of $692,760 and
$465,205, respectively, related primarily to the production costs of the XTRAC
laser equipment sold outside of the United States.

The decrease in the product cost of sales for the three and six months
ended June 30, 2004, corresponds directly to a decrease in surgical laser sales.

Service cost of revenues was $1,698,748 and $1,618,137 in the three
months ended June 30, 2004 and 2003, respectively. Included in these costs were
$1,157,907 and $930,485, respectively, related to surgical segment revenues, for
the three months ended June 30, 2004 and 2003. The remaining services cost of
revenues of $540,841 and $687,652 during the periods ended June 30, 2004 and
2003, respectively, represented manufacturing costs, depreciation and field
service costs on the lasers in service.

Service cost of revenues was $3,360,330 and $3,083,513 in the six
months ended June 30, 2004 and 2003, respectively. Included in these costs were
$2,333,203 and $1,813,902, respectively, related to surgical segment revenues,
for the six months ended June 30, 2004 and 2003. The remaining services cost of
revenues of $1,027,127 and $1,269,611 during the periods ended June 30, 2004 and
2003, respectively, represented manufacturing costs, depreciation and field
service costs on the lasers in service.

The increase in the services cost of sales for the surgical segment
costs for the three months ended June 30, 2004, relates to an increase in
technician costs of $30,000 and supplies of $36,000, which are all due to the
increases in service revenue. There was also a change in the mix of services
provided, increasing the product costs by $162,000.

The increase in the services cost of sales for the surgical segment
costs for the six months ended June 30, 2004, relates to an increase in
technician costs of $122,000, supplies of $73,000 and depreciation costs of
$42,000 which are all due to the increases in service revenue. There was also a
change in the mix of services provided, increasing the product costs by
$257,000.

GROSS MARGIN ANALYSIS

Comparing the three months ended June 30, 2004 verses the same period
for 2003, gross margin increased by $515,000, revenues increased by $480,000
while the cost to produce those revenues decreased by $35,000. Overall gross
profit percentage increased to 39% in the three months ended June 30, 2004 from
31% in the same period in 2003. The reasons for the changes are as follows:

o The domestic XTRAC gross margin improved from the prior year period
by approximately $660,000 during the quarter. This improvement in gross margin
was accomplished by revenue increases of $516,500, and cost of revenue decreases
of $147,000.

23



o Surgical services gross margin increased by $220,000 over the prior
year period. This increase was due to the increases in revenues.
o The surgical product segment had revenue decreases with commensurate
cost of revenue decreases keeping the gross margin percent relatively consistent
from period to period. This segment includes surgical products and laser
maintenance of customer-owned lasers not under contract with surgical services.
o The international XTRAC gross margin decreased by $299,000 for the
three months ended June 30, 2004 as compared to the same period in 2003. This
decrease is directly related to the decrease in revenues of $316,000 due to less
lasers sold in the current period.

For the six months ended June 30, 2004, gross margin increased by
$983,000, and revenues increased by $1,032,000 with the cost to produce those
revenues also increasing by $49,000 as compared to the same period in 2003.
Overall gross profit percentage increased to 39% in the six months ended June
30, 2004 from 31% in the same period in 2003. The reasons for these changes are
as follows:

o The domestic XTRAC gross margin improved from the six months ended
June 30, 2003 to the six months ended June 30, 2004 by approximately $1,160,000.
This improvement in gross margin was accomplished by revenue increases of
$914,000 and cost of revenue decreases of $242,000.
o Surgical services gross margin increased by $184,000 over the prior
year period. This increase is due to the increases in revenues.
o The surgical product segment had revenue decreases with commensurate
cost of revenue decreases keeping the gross margin percent relatively consistent
from period to period.. This segment includes surgical products and laser
maintenance of customer-owned lasers not under contract with surgical services.
o The international XTRAC gross margin decreased by $126,000 for the
six months ended June 30, 2004 as compared to the same period in 2003. This
decrease is directly related to the increase in overall manufacturing costs for
the current period.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses for the three months ended
June 30, 2004 were $2,406,453, compared to $2,387,020 for the three months ended
June 30, 2003, an increase of 1%.

Selling, general and administrative expenses for the six months ended
June 30, 2004 were $4,876,877, compared to $4,681,612 for the six months ended
June 30, 2003, an increase of 4%. This increase was due to the fees of $156,000
related to the lawsuits in the six months of 2004 over the legal fees in the six
months of 2003.

Regarding specifically allocated selling, general and administrative
expenses by business segment, the domestic XTRAC segment, for the three and six
months ended June 30, 2004, included higher commission expense on increased
revenues and increased marketing expenses to advance our insurance reimbursement
initiatives, as compared to the same periods in 2003. Selling, general and
administrative expenses allocated to the international XTRAC segment decreased
for the three and six months in 2004 compared to the same periods in 2003 due to
accrued warranty expenses, which were driven by the decrease in revenues in that
segment. In the surgical services segment the increase in specifically allocated
selling, general and administrative expenses from the three and six months ended
June 30, 2003 to 2004 is largely related to higher commission expense on
increased revenues and additional training and education staff.

ENGINEERING AND PRODUCT DEVELOPMENT

Engineering and product development expenses for the three months ended
June 30, 2004 increased to $481,243 from $465,134 for the three months ended
June 30, 2003. Engineering and product development expenses for the six months
ended June 30, 2004 increased to $897,193 from $877,066 for the six months ended
June 30, 2003. The expenses remained generally consistent levels from period to
period.

Allocations of the California facility engineering and product
development expenses between domestic and international XTRAC are based upon the
planned manufactured output of XTRAC laser for the year.

24



INTEREST EXPENSE, NET

Net interest expense during for the three months ended June 30, 2004
increased to $11,236, as compared to $10,415 for the three months ended June 30,
2003.

Net interest expense during for the six months ended June 30, 2004
increased to $19,108, as compared to $41,438 for the six months ended June 30,
2003. This decrease relates to our larger average balance of cash and cash
equivalents in the current period compared to the corresponding period in the
prior year.

NET LOSS

The aforementioned factors resulted in a net loss of $1,207,167 during
the three months ended June 30, 2004, as compared to a net loss of $1,686,102
during the three months ended June 30, 2003, a decrease of 28%. The
aforementioned factors resulted in a net loss of $2,570,249 during the six
months ended June 30, 2004, as compared to a net loss of $3,360,430 during the
six months ended June 30, 2003, a decrease of 24%. These decreases were
primarily the result of the increase in revenues and resulting gross margin.

Income taxes are immaterial, given the Company's current period losses
and its operating loss carryforwards.



25




LIQUIDITY AND CAPITAL RESOURCES

We have historically financed our operations through the use of working
capital provided from equity financing. From September 1997 through May 2003, we
issued certain securities, including shares of our common stock and other
securities convertible or exercisable into shares of common stock, in order to
finance our business operations.

On May 28, 2003, we closed on a private placement for 5,982,352 shares
of common stock at $1.70 per share resulting in gross proceeds of $10,170,000.
The closing price of our common stock on May 28, 2003 was $2.07 per share. In
connection with this private placement, we paid commissions and other expenses
of $692,454, resulting in net proceeds of $9,477,546. In addition, the investors
received warrants to purchase 1,495,588 shares of common stock at an exercise
price of $2.00 per share. The warrants have a five-year term and became
exercisable on November 29, 2003. We have used, and will continue to use, the
proceeds of this financing to pay for working capital and other general
corporate purposes.

On December 27, 2002, we acquired SLT. The surgical products and
services provided by SLT increased revenues for 2003 and into 2004. We also
saved costs from the consolidation of the administrative and marketing
infrastructure of the combined company. Additionally, with the consolidated
infrastructure in place, our revenues, both in phototherapy and surgical
products and services, grew, without commensurate growth in our fixed costs. The
established revenues from surgical products and services helped to absorb the
costs of the infrastructure of the combined company.

At June 30, 2004, the ratio of current assets to current liabilities
was 2.42 to 1.00 compared to 2.37 to 1.00 at December 31, 2003. As of June 30,
2004, we had $8,362,807 of working capital compared to $8,655,544 as of December
31, 2003. Cash and cash equivalents were $5,687,975 as of June 30, 2004, as
compared to $6,633,468 as of December 31, 2003.

We believe that our existing cash balance together with our other
existing financial resources, including access to lease financing for capital
expenditures, and any revenues from sales, distribution, licensing and
manufacturing relationships, will be sufficient to meet our operating and
capital requirements through the second quarter of 2005. The 2004 operating plan
reflects anticipated growth from an increase in per-treatment fee revenues for
use of the XTRAC system based on the recent approval of applicable reimbursement
codes and wider insurance coverage in the United States and continuing costs
savings from the integration of the combined companies. However, the projected
cost of our business plan may require us to obtain additional equity or debt
financing to meet our working capital requirements or capital expenditure needs.
Similarly, if our growth outstrips the business plan, we may require additional
equity or debt financing. There can be no assurance that additional financing,
if needed, will be available when required or, if available, will be on terms
satisfactory to us. In such an event, we would further rationalize our plans and
operations to seek to balance cash inflows and outflows.

As discussed in Note 7 to the financial statements, we obtained a
$2,500,000 leasing credit facility from GE Capital Corporation on June 25, 2004.
The credit facility has a commitment term of three years, expiring on June 25,
2007. Each draw against the credit facility has a self-amortizing repayment
period of three years and is secured by lasers which we have sold to GE and
leased back for continued deployment in the field. The draw is set at an
interest rate based on 522 basis points above the three-year Treasury note rate.
Each draw is discounted by 7.75%. With each draw, we have agreed to issue
warrants to purchase shares of our common stock equal to 5% of the draw. The
number of warrants is determined by dividing 5% of the draw by the average
closing price of the Company's common stock for the ten days preceding the date
of the draw. The warrants have a five-year term from the date of each issuance
and bear an exercise price set at 10% over the average closing price for the ten
days preceding the date of the draw. As of June 30, 2004, we had drawn
$1,536,950 against the credit facility and has issued warrants to purchase
23,903 shares of common stock with an average weighted exercise price of $3.54
per share. For reporting purposes, the carrying value of the liability is
reduced by the value ascribed to the warrants, $62,032, at the time of the draw.
This reduction will be accreted to interest expense over the term of the draw.

Concurrent with the SLT acquisition, we assumed a $3,000,000 credit
facility from a bank. The credit facility had a commitment term which expired
May 31, 2004, permitted deferment of principal payments until the end of the
commitment term, and was secured by SLT's business assets, including
collateralization (until May 13, 2003) of $2,000,000 of SLT's cash and cash
equivalents and short-term investments. The bank allowed us to apply the cash
collateral to pay down of the facility in 2003. The credit facility had an
interest rate equal to the 30-day LIBOR plus 2.25%.

26



Operating cash flow for the six months ended June 30, 2004 compared to
the six months ended June 30, 2003 improved mostly due to a $1,032,000 increase
in revenues. This resulted in net cash used in operating activities of
$1,801,093, for the six months ended June 30, 2004, compared to $2,664,660 for
the same period in 2003. In the six months ended June 30, 2004, changes in
operating assets and liabilities used $243,000 of cash compared to the
$626,000 usage of cash for the same period in 2003.

Net cash used in investing activities was $901,307 and $1,053,418 for
the six months ended June 30, 2004 and 2003, respectively. During the six months
ended June 30, 2004 and 2003, we utilized $845,780 and $1,035,419, respectively,
for production of our lasers in service.

Net cash provided by financing activities was $1,756,907 and $9,304,251
for the six months ended June 30, 2004 and 2003, respectively. In the six months
ended June 30, 2004 we received $1,780,804 from the exercise of options and
warrants and a net increase of $369,680 from the lapse of the bank line of
credit and the initiation of the leasing line of credit from GE. These increases
were partially offset by $404,776 for the payment of certain notes payable and
capital lease obligations. In the six months ended June 30, 2003, we received
$9,500,046 from the issuance of common stock. In addition we received $2,000,000
from the release of restrictions of cash, cash equivalents and short-term
investments related to SLT's prior credit facility. These receipts were offset
by a net payment of $1,792,591 on the bank line of credit, and $404,735 for the
payment of certain debts.

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

We expect to incur operating losses in fiscal 2004 because we plan to
spend substantial amounts on securing broader reimbursement for psoriasis by
private healthcare plans and in expanding, in controlled fashion, our
operations, both in phototherapy and in surgical services. We expect, based on
our current business plan and our present outlook, that we will have the
resources to market our current products and services through the second quarter
of 2005. Nevertheless, we cannot assure you that we will market any products
successfully, operate profitably in the future, or that we may not require
significant additional financing in order to accomplish our business plan.

During the six months ended June 30, 2004, there have been no items
that significantly impact our commitments and contingencies as discussed in the
notes to the 2003 annual financial statements as filed on Form 10-K. We have
made arrangements to continue, through June 30, 2004, in our facility in
Carlsbad, California under generally the same terms and conditions as presently
prevail. In addition, we have no significant off-balance sheet arrangements.

IMPACT OF INFLATION

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are not currently exposed to market risks due to changes in interest
rates and foreign currency rates and, therefore, we do not use derivative
financial instruments to address treasury risk management issues in connection
with changes in interest rates and foreign currency rates.



27




ITEM 4. CONTROLS AND PROCEDURES

Our management, led by our Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of our disclosure controls and
procedures as of June 30, 2004. To remedy a material weakness in our internal
controls dealing with proper recognition of revenue from the sale of laser
units, we have implemented in the first quarter 2004 modified procedures for
evaluating the recognizability of revenue from such sales, and in particular in
evaluating the collectibility of such sales. We have also implemented additional
procedures to evaluate new distributors and customers as well as past customers.
Based on this evaluation of our controls and procedures as improved and
implemented, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information we are required to disclose in the
reports we file under the Securities Exchange Act of 1934, within the time
periods specified in the SEC's rules and forms. Such evaluation did not identify
any unaddressed change in the quarter ended June 30, 2004 that has materially
affected, or is reasonable likely to materially affect, our internal control
over financial reporting.

The Company is presently undertaking an analysis of its internal
controls, as required by Section 404 of the Sarbanes Oxley Act of 2002.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Reference is made to Item 3, Legal Proceedings, in our Annual Report on
Form 10-K for the year ended December 31, 2003 for descriptions of our legal
proceedings.

In the action brought by the Company against RA Medical Systems, Inc.
and Dean Stewart Irwin in the Superior Court for San Diego County, California,
the Court awarded, in addition to statutory costs of $9,976, Defendants'
attorney's fees and costs in the amount of $83,129. The Company has filed its
notice of appeal from this award.

In the action brought by the Company against Edwards Lifesciences
Corporation and Baxter Healthcare Corporation in the Superior Court for Orange
County, California, the Defendants had demurred to the Company's complaint,
seeking dismissal on several grounds, and the Company filed its opposition to
the demurrer. The Court has denied the Defendants' demurrer. The Defendants have
answered the Company`s complaint, citing numerous defenses but bringing no
counterclaims.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Recent Issuances of Unregistered Securities

On June 30, 2004, we issued warrants to GE in connection with our draw
under the credit facility to purchase 23,903 shares of common stock. The
warrants have an exercise price of $3.54 per share, have a five-year term and
are exercisable immediately.

We believe that all of the foregoing issuances of securities were
exempt from registration under the Securities Act of 1933, as amended.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

Not applicable.



28




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A. Reports on Form 8-K

On May 27, 2004, we filed a Report on Form 8-K with respect to our
press release, dated May 25, 2004, with respect to Aetna, a private health plan,
which had approved for reimbursement procedures using the XTRAC(R) excimer laser
to treat psoriasis.

On June 17, 2004, we filed a Report on Form 8-K with respect to our
press release, dated June 9, 2004, with respect to changing our independent
auditors.

On July 27, 2004, we filed a Report on Form 8-K with respect to our
press release, dated July 27, 2004, with respect to a change in the membership
of our Board of Directors.

B. Other Exhibits

10.42 Master Lease Agreement dated June 25, 2004 between GE Capital
Corporation and PhotoMedex, Inc.

31.1 Rule 13a-14(a) Certificate of Chief Executive Officer

31.2 Rule 13a-14(a) Certification 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




29


DOCUMENTS INCORPORATED BY REFERENCE

We are currently subject to the reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith file reports, proxy statements and other information with
the Commission. Such reports, proxy statements and other information may be
inspected and copied at the public reference facilities of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Washington D.C. 20549; at its New York
Regional Office, 233 Broadway, New York, New York 10297; and its Chicago
Regional Office, 175 West Jackson Boulevard, Suite 900, Chicago, Illinois 60604,
and copies of such materials can be obtained from the Public Reference Section
of the Commission at its principal office in Washington, D.C., at prescribed
rates. In addition, such materials may be accessed electronically at the
Commission's site on the World Wide Web, located at http://www.sec.gov. We
intend to furnish our stockholders with annual reports containing audited
financial statements and such other periodic reports as we determine to be
appropriate or as may be required by law.



SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.



PHOTOMEDEX, INC.



Date: August 9, 2004 By: /s/ Jeffrey F. O'Donnell
---------------------------------------
Jeffrey F. O'Donnell
President and Chief Executive Officer


Date: August 9, 2004 By: /s/ Dennis M. McGrath
---------------------------------------
Dennis M. McGrath
Chief Financial Officer




30