FORM 10-Q

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   (Mark one)

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

                    For quarterly period ended June 30, 1998

                                       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: 0-22340

                        PALOMAR MEDICAL TECHNOLOGIES, INC
               (Exact name of issuer as specified in its charter)

<TABLE>
<S>                          <C>                                                     <C>           <C>

                             Delaware                                                              04-3128178
--------------------------------------------------------------------                 ---------------------------------------
(State or other jurisdiction of incorporation or organization)                        (I.R.S. Employer Identification No.)
</TABLE>

               45 Hartwell Avenue, Lexington, Massachusetts 02421
               --------------------------------------------------
                    (Address of principal executive offices)

                                 (781) 676-7300

                 -----------------------------------------------
                (Issuer's telephone number, including area code)

         Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been subject to such filing requirements for the past 90 days. Yes  X  No
                                                                       --     --

         As of July 31, 1998,  65,558,954 shares of Common Stock, $.01 par value
per share, were outstanding.

         Transitional Small Business Disclosure Format (check one):  Yes   No X
                                                                        --    --

                                                                    Page 1 of 19
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                                      INDEX

PART I - FINANCIAL INFORMATION

         ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

         Consolidated Condensed Balance Sheets - 
               December 31, 1997 and June 30, 1998                    P.  3

         Consolidated Statements of Operations - 
               For the Three and Six Months Ended
               June 30, 1997 and 1998                                 P.  4

         Consolidated Statement of Stockholders' Deficit - 
               For the Six Months Ended
               June 30, 1998                                          P.  5

         Consolidated Statements of Cash Flows -
               For the Six Months Ended
               June 30, 1997 and 1998                                 P.  6

         Notes to Consolidated Financial Statements                   P.  7

         ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS       P. 13

PART II - OTHER INFORMATION

         ITEM 1.  LEGAL PROCEEDINGS                                   P. 17

         ITEM 2.  CHANGES IN SECURITIES                               P. 17

         ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                     P. 17

         ITEM 4.  SUBMISSION OF MATTERS TO A VOTE
                  OF SECURITY HOLDERS                                 P. 17

         ITEM 5.  OTHER INFORMATION                                   P. 17

         ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                    P. 18

SIGNATURES                                                            P. 19


<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED CONDENSED BALANCE SHEETS
                                   (Unaudited)

<TABLE>
<S>     <C>                                                                            <C>                     <C>

                                                                                          December 31,             June 30,
                                                                                             1997                    1998
                                                                                       ----------------        ----------------
ASSETS

CURRENT ASSETS:
       Cash and cash equivalents                                                           $3,003,300              $1,205,856
       Marketable securities                                                                1,449,326                 289,875
       Accounts receivable, net                                                             2,248,680               6,676,604
       Inventories                                                                          4,711,474               2,766,992
       Other current assets                                                                 2,153,941               1,408,643
                                                                                       ----------------        ----------------
            Total current assets                                                           13,566,721              12,347,970
                                                                                       ----------------        ----------------
NET ASSETS OF DISCONTINUED OPERATIONS                                                       5,825,602                  ---
                                                                                       ----------------        ----------------
PROPERTY AND EQUIPMENT, AT COST, NET                                                        6,455,586               4,087,597
                                                                                       ----------------        ----------------
OTHER ASSETS:
       Cost in excess of net assets acquired, net                                           2,302,348               2,001,166
       Deferred financing costs                                                               591,609                 103,241
       Other noncurrent assets                                                                225,706                 177,161
                                                                                       ----------------        ----------------
            Total other assets                                                              3,119,663               2,281,568
                                                                                       ----------------        ----------------
                                                                                          $28,967,572             $18,717,135
                                                                                       ================        ================

LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES:

       Current portion of long-term debt                                                   $1,640,465              $6,967,815
       Accounts payable                                                                     4,150,982               3,200,235
       Accrued liabilities                                                                 13,759,854              10,559,217
       Current portion of deferred revenue                                                  1,284,395               1,247,305
                                                                                       ----------------        ----------------
            Total current liabilities                                                      20,835,696              21,974,572
                                                                                       ----------------        ----------------
NET LIABILITIES OF DISCONTINUED OPERATIONS                                                     ---                  1,765,217
                                                                                       ----------------        ----------------
LONG-TERM DEBT, NET OF CURRENT PORTION                                                     12,445,563               3,577,667
                                                                                       ----------------        ----------------
DEFERRED REVENUE, NET OF CURRENT PORTION                                                    1,870,000               1,370,000
                                                                                       ----------------        ----------------
STOCKHOLDERS' DEFICIT:
       Preferred stock, $.01 par value-
            Authorized - 5,000,000 shares
            Issued and outstanding -
            16,397 shares and 8,603 shares
            at December 31, 1997 and June 30, 1998, respectively                                  164                      86
       Common stock, $.01 par value-
            Authorized - 120,000,000 shares
            Issued - 45,792,585 shares and 65,168,030 shares
            at December 31, 1997 and June 30, 1998, respectively                              457,926                 651,680
       Additional paid-in capital                                                         147,356,579             157,954,019
       Accumulated deficit                                                               (152,359,497)           (166,937,247)
       Less: Treasury stock - (345,000 shares at cost)                                     (1,638,859)             (1,638,859)
                                                                                       ----------------        ----------------
            Total stockholders' deficit                                                    (6,183,687)             (9,970,321)
                                                                                       ----------------        ----------------
                                                                                          $28,967,572             $18,717,135
                                                                                       ================        ================

</TABLE>

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

                                       3

<PAGE>
              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)
<TABLE>
<S>    <C><C>                                     <C>                <C>             <C>              <C>

                                                       Three Months Ended                   Six Months Ended
                                                             June 30,                            June 30,
                                                     1997             1998                1997             1998
                                                 -------------      -------------    --------------   --------------
REVENUES                                           $7,119,595         $9,090,396        $9,852,055      $16,157,801

COST OF REVENUES                                    6,425,121          4,812,456         9,440,837       11,148,701
                                                 -------------      -------------    --------------   --------------
       Gross margin                                   694,474          4,277,940           411,218        5,009,100
                                                 -------------      -------------    --------------   --------------
OPERATING EXPENSES
       Research and development                     2,693,085          1,943,523         4,873,902        4,108,523
       Sales and marketing                          1,636,186          3,526,770         2,607,165        6,029,885
       General and administrative                   4,844,972          2,359,142         9,058,749        5,203,001
       Settlement costs                               400,000             --             3,199,000           --
                                                 -------------      -------------    --------------   --------------
          Total operating expenses                  9,574,243          7,829,435        19,738,816       15,341,409
                                                 -------------      -------------    --------------   --------------

          Loss from operations                     (8,879,769)        (3,551,495)      (19,327,598)     (10,332,309)

INTEREST EXPENSE                                   (1,353,387)          (408,023)       (2,532,394)        (829,335)

OTHER (EXPENSE) INCOME                               (954,784)            (8,935)          378,539          354,509
                                                 -------------      -------------    --------------   --------------
          NET LOSS FROM CONTINUING OPERATIONS     (11,187,940)        (3,968,453)      (21,481,453)     (10,807,135)

LOSS FROM DISCONTINUED OPERATIONS (NOTE 9)

          Loss from operations                     (3,625,048)       (1,090,885)       (8,696,680)       (1,090,885)
          Loss on disposition                          --            (1,533,295)           --            (1,533,295)
                                                 -------------      -------------    --------------   --------------
          NET LOSS FROM DISCONTINUED OPERATIONS    (3,625,048)       (2,624,180)       (8,696,680)       (2,624,180)
                                                 -------------      -------------    --------------   --------------

             NET LOSS                            $(14,812,988)      $(6,592,633)     $(30,178,133)     $(13,431,315)
                                                 =============      =============    ==============   ==============
BASIC AND DILUTED NET LOSS PER COMMON SHARE:

       Continuing operations                           $(0.38)          $(0.07)           $(0.73)           $(0.21)
       Discontinued operations                          (0.11)           (0.04)            (0.28)            (0.05)
                                                 -------------      -------------    --------------   -------------
             TOTAL LOSS PER COMMON SHARE               $(0.49)          $(0.11)           $(1.01)           $(0.26)
                                                 =============      =============    ==============   =============
WEIGHTED AVERAGE NUMBER OF

    COMMON SHARES OUTSTANDING                      32,699,944        63,330,295        31,528,613        57,643,346
                                                 =============      =============    ==============   =============
</TABLE>

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

                                       4


<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
                                  (UNAUDITED)
<TABLE>
<S> <C>                                                     <C>            <C>       <C>         <C>         <C>        <C>

                                                                Preferred Stock        Common Stock            Treasury Stock
                                                            ------------------------------------------------------------------------
                                                               Number of   $0.01     Number of   $0.01        Number
                                                                Shares   Par Value    Shares     Par Value   of Shares      Cost
                                                            ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997                                      16,397     $164      45,792,585  $457,926     (345,000) $(1,638,859)

    Sale of common stock pursuant to warrants, options 
        and Employee Stock Purchase Plan                            --       --         162,582     1,626           --           -- 
    Conversion of preferred stock                               (4,728)     (47)      5,088,535    50,886           --           -- 
    Conversion of convertible debentures                            --       --       6,512,441    65,124           --           -- 
    Redemption of preferred stock                               (3,066)     (31)             --        --           --           -- 
    Issuance of common stock net of investment banking fees         --       --       7,200,000    72,000           --           -- 
    Value ascribed to warrants issued to investor                   --       --              --        --           --           -- 
    Issuance of common stock for 1997 employer 401(k) matching      --       --         311,887     3,118           --           -- 
        contribution
    Common stock issued for advisory services                       --       --         100,000     1,000           --           -- 
    Costs incurred related to issuance of common stock              --       --              --        --           --           -- 
    Preferred stock dividends                                       --       --              --        --           --           -- 
    Net loss                                                        --       --              --        --           --           -- 
                                                                 -------------------------------------------------------------------
BALANCE, JUNE 30, 1998                                           8,603      $86      65,168,030   $651,680    (345,000) $(1,638,859)
                                                                 ===================================================================
</TABLE>


<TABLE>
<S>  <C>                                                        <C>                 <C>                  <C>

                                                                 Additional                                  Total
                                                                  Paid-in            Accumulated          Stockholders'
                                                                  Capital              Deficit               Deficit
                                                            --------------------------------------------------------------

BALANCE, DECEMBER 31, 1997                                      $147,356,579        $(152,359,497)       $(6,183,687)

     Sale of common stock pursuant to warrants, options
          and Employee Stock Purchase Plan                            32,856                   --             34,482
     Conversion of preferred stock                                   429,820                   --            480,659
     Conversion of convertible debentures                          6,011,870                   --          6,076,994
     Redemption of preferred stock                                (3,066,269)                  --         (3,066,300)
     Issuance of common stock net of investment banking fees       6,768,000                   --          6,840,000
     Value ascribed to warrants issued to investor                   171,000                   --            171,000
     Issuance of common stock for 1997 employer 401(k)
          matching contributions                                     251,163                   --            254,281
     Common stock issued for advisory services                        99,000                   --            100,000
     Costs incurred related to issuance of common stock             (100,000)                  --           (100,000)
     Preferred stock dividends                                            --           (1,146,435)        (1,146,435)
     Net loss                                                             --          (13,431,315)       (13,431,315)
                                                            --------------------------------------------------------------
BALANCE, JUNE 30, 1998                                          $157,954,019        $(166,937,247)       $(9,970,321)     
                                                            ==============================================================
</TABLE>


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

                                       5

<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<S> <C>                                                          <C>            <C>

                                                                   Six Months Ended June 30,
                                                                     1997           1998
                                                                 ------------   ------------
CASH FLOWS FROM OPERATING ACTIVITIES
    Net loss                                                     $(30,178,133)  $(13,431,315)
       Less: Net loss from discontinued operations                 (8,696,680)    (2,624,180)
                                                                 ------------   ------------
    Net loss from continuing operations                           (21,481,453)   (10,807,135)
                                                                 ------------   ------------

    Adjustments to reconcile net loss from continuing 
    operations to net cash
    used in operating activities-
       Depreciation and amortization                                1,092,435      1,372,120
       Settlement and litigation costs                              2,900,000         --
       Write-off of deferred financing costs associated with
          redemption of convertible debentures                         27,554         --
       Valuation allowances for notes and investments                 435,912         --
       Foreign currency exchange gain                                (608,357)        --
       Noncash interest expense related to debt                     2,302,012        171,000
       Noncash compensation related to common 
          stock and warrants                                          371,102         --
       Realized loss on marketable securities                          49,693         --
       Unrealized gain on marketable securities                      (599,639)      (332,965)
       Changes in assets and liabilities -
          Net (purchase) sale of marketable trading securities      1,036,563      1,840,395
          Accounts receivable                                         102,906     (3,033,274)
          Inventories                                              (4,112,868)     1,785,358
          Other current assets                                     (1,574,579)       604,470
          Accounts payable                                           (174,175)      (649,765)
          Accrued expenses                                            232,459        400,354
                                                                 ------------   ------------
                Net cash used in operating activities             (20,000,435)    (8,649,442)
                                                                 ------------   ------------
CASH FLOWS FROM INVESTING ACTIVITIES
    Purchases of property and equipment                            (3,851,751)      (233,069)
    Decrease (increase) in other assets                              (307,695)      (470,252)
    Decrease in notes receivable                                      171,288        (86,818)
    Increase in intangible assets                                    (351,059)        --
    Investment in nonmarketable securities                         (2,257,631)        --
                                                                 ------------   ------------
                Net cash used in investing activities              (6,596,848)      (790,139)
                                                                 ------------   ------------
CASH FLOWS FROM FINANCING ACTIVITIES
    Proceeds from issuance of convertible debentures               10,225,169        --
    Redemption of convertible debentures                             (196,000)    (2,196,667)
    Net proceeds from the issuance of notes payable and             1,450,621      3,394,070
      advances from distributor
    Net proceeds from issuance of common stock                      1,158,677      6,874,482
    Issuance of preferred stock                                    15,000,000         --
    Purchase of treasury stock                                       (139,851)        --
    Costs incurred related to issuance of common stock                 --           (100,000)
    Redemption of preferred stock                                      --         (3,791,889)
                                                                 ------------   ------------
                Net cash provided by financing activities          27,498,616      4,179,996
                                                                 ------------   ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                  901,333     (5,259,585)
NET CASH PROVIDED BY DISCONTINUED OPERATIONS                        4,985,117      3,462,141
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD                  8,091,611      3,003,300
                                                                 ------------   ------------
CASH AND CASH EQUIVALENTS, END OF THE PERIOD                      $13,978,061     $1,205,856
                                                                 ============   ============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
    Cash paid for interest                                           $135,972     $1,022,863
                                                                 ============   ============

SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND 
INVESTING ACTIVITIES:
    Conversion of convertible debentures and related 
       accrued interest, net of financing fees                     $3,066,815     $6,076,994
                                                                 ============   ============

    Conversion of preferred stock                                    $186,492       $480,659
                                                                 ============   ============
    Issuance of common stock for 1996 and 1997 
       employer 401(k) matching contribution                         $269,262       $254,282
                                                                 ============   ============

</TABLE>

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

                                       6

<PAGE>

                       PALOMAR MEDICAL TECHNOLOGIES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       BASIS OF PRESENTATION
         ---------------------

         The accompanying  unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
information.  Accordingly,  they  do not  include  all of  the  information  and
footnotes  required by generally  accepted  accounting  principles  for complete
financial statements. The results of operations for the interim periods shown in
this report are not  necessarily  indicative of expected  results for any future
interim period or for the entire fiscal year. Palomar Medical Technologies, Inc.
(the "Company" or "Palomar") believes that the quarterly  information  presented
includes all adjustments (consisting of normal, recurring adjustments) necessary
for a  fair  presentation  in  accordance  with  generally  accepted  accounting
principles.  The accompanying  financial  statements and notes should be read in
conjunction  with the Company's Form 10-K, as of and for the year ended December
31, 1997.

         Some of the Company's  medical laser  products are in various stages of
development;  the success of future  operations  is hence subject to a number of
risks  similar to those of other  companies  in similar  stages of  development.
Principal among these risks are the successful  development and marketing of the
Company's products,  proper regulatory approval,  the need to achieve profitable
operations,  competition from substitute products and larger companies, the need
to obtain  adequate  financing to fund future  operations  and dependence on key
individuals.

         The  Company has  incurred  significant  losses  since  inception.  The
Company  continues to seek  additional  financing from issuances of common stock
and/or other prospective sources in order to fund future operations. The Company
has financed  current  operations,  expansion  of its core  business and outside
short-term financial  investments primarily through the private sale of debt and
equity securities of the Company and its subsidiaries.  The Company  anticipates
that it will require  additional  financing  throughout  the year to continue to
fund  operations and growth.  The Company may, from time to time, be required to
raise additional funds through additional private sales of the Company's debt or
equity securities and/or the liquidation of some of its marketable and long-term
investments. Securities are sold to private investors at market or a discount to
the public market for similar securities.  It has been the Company's  experience
that private investors require that the Company make its best effort to register
its  securities  for resale to the public at some future  time.  The sale by the
Company of some of its marketable  investments could result in additional losses
depending on market conditions at the time of these sales.

2.       INVESTMENTS
         -----------

         The fair values for the  Company's  marketable  equity  securities  are
based on quoted market prices.  The amount that the Company  realizes from these
investments  may  differ   significantly   from  the  amounts  recorded  in  the
accompanying unaudited consolidated financial statements.

         The Company  accounts for  investments in accordance  with Statement of
Financial   Accounting  Standards  ("SFAS")  No.  115,  ACCOUNTING  FOR  CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES.  Under SFAS No. 115,  securities that
are bought and held principally for the purpose of selling them in the near term
are classified as trading  securities.  Realized and unrealized gains and losses
relating  to trading  securities  are  included  currently  in the  accompanying
unaudited statements of operations.

                                            June 30, 1998
                         -------------------------------------------------------
                                           Gross         Gross
                                         Unrealized    Unrealized        Fair
                              Cost          Gain          Loss           Value
                         ------------  ------------  ------------   ------------
Marketable Securities:
  Investments in 
  publicly traded 
  companies                 $239,940       $49,935      $---           $289,875
                         ============  ============  ============   ============

                                       7
<PAGE>

3.       INVENTORIES
         -----------

         Inventories  are  stated  at lower  of cost  (first-in,  first-out)  or
market.  Work in process and  finished  goods  inventories  consist of material,
labor and manufacturing overhead and consist of the following:
<TABLE>
<S>                        <C>                                     <C>                 <C>


                                                                    December 31,          June 30,
                                                                        1997                1998

                                                                   ----------------    ----------------
                           Raw materials                              $2,928,350          $1,500,454
                           Work-in-process and finished goods          1,783,124           1,266,538
                                                                   ---------------     ----------------
                                                                      $4,711,474          $2,766,992
                                                                   ================    ================
</TABLE>

4.       PROPERTY AND EQUIPMENT
         ----------------------

         Property and equipment consist of the following:
<TABLE>
<S>                        <C>                                     <C>                 <C>

                                                                    December 31,          June 30,
                                                                        1997                1998

                                                                   ----------------    ---------------
                            Machinery and equipment                   $6,328,442          $4,983,171
                            Furniture and fixtures                     1,018,931             963,647
                            Leasehold improvements                       480,453             431,766
                                                                   ----------------    ---------------
                                                                       7,827,826           6,378,584
                            Less:  Accumulated depreciation
                                       and amortization                1,372,240           2,290,987
                                                                   ----------------    ---------------
                                                                      $6,455,586          $4,087,597
                                                                   ================    ===============
</TABLE>

5.       ACCRUED LIABILITIES
         -------------------

         Accrued liabilities consist of the following:
<TABLE>
<S>                        <C>                                     <C>                 <C>    

                                                                    December 31,          June 30,
                                                                        1997                1998

                                                                   ----------------    ---------------
                            Payroll and employee costs                $1,535,013          $1,300,713
                            Royalties                                    853,808           1,226,991
                            Settlement costs                           1,457,020             520,454
                            Warranty                                   2,583,677           3,056,790
                            Restructuring                              1,981,907           1,035,622
                            Interest and preferred stock dividends     1,659,709           1,499,603
                            Other                                      3,688,720           1,919,044
                                                                   ================    ===============
                                Total                                $13,759,854         $10,559,217
                                                                   ================    ===============
</TABLE>


                                       8
<PAGE>

6.       NET LOSS PER COMMON SHARE
         -------------------------

         In March 1997, the Financial  Accounting  Standards Board (FASB) issued
SFAS No. 128,  EARNINGS PER SHARE.  This  statement  establishes  standards  for
computing  and  presenting  earnings  per share and  applies  to  entities  with
publicly  traded  common  stock or potential  common  stock.  This  statement is
effective  for fiscal years ending after  December 15, 1997.  Basic net loss per
share was  determined by dividing net income by the weighted  average  shares of
common stock  outstanding  during the period.  Diluted net loss per share is the
same as basic net loss per share  because  the  Company's  potentially  dilutive
securities,  primarily stock options,  warrants,  redeemable preferred stock and
convertible  debentures,  are  antidilutive.  The  Company's net loss per common
share from  continuing  operations  for the three and six months  ended June 30,
1997 and 1998 is as follows:
<TABLE>
<S><C>                                   <C>               <C>             <C>               <C>

                                               Three Months Ended                  Six Months Ended

                                                    June 30,                           June 30,
                                              1997             1998             1997              1998
                                         ---------------   --------------  ---------------   ---------------
   Net loss from continuing operations    $(11,187,940)     $(3,968,453)    $(21,481,453)     $(10,807,135)
   Amortization of value ascribed to
       preferred stock conversion 
       discount                               (941,176)         ---             (941,176)         ---
   Preferred stock dividends                  (432,228)        (401,614)        (727,224)       (1,146,435)
                                         ---------------   --------------  ---------------   ---------------
   Adjusted net loss                      $(12,561,344)     $(4,370,067)    $(23,149,853)     $(11,953,570)
                                         ===============   ==============  ===============   ===============

   Basic net loss per common share from
       continuing operations                     $(.38)           $(.07)           $(.73)            $(.21)
                                         ===============   ==============  ===============   ===============

   Weighted average number of
       common shares outstanding            32,699,944       63,330,295       31,528,613        57,643,346
                                         ===============   ==============  ===============   ===============
</TABLE>


         As of June 30,  1997 and  1998,  25,285,938,  and  27,496,581  weighted
average common equivalent shares, respectively, were not included in the diluted
weighted average shares outstanding as they were antidilutive.

7.       NOTES PAYABLE
         -------------

         Notes payable consist of the following:
<TABLE>
<S>                                                                                         <C>              <C>

                                                                                              December 31,       June 30,
                                                                                                 1997             1998
                                                                                            ---------------- ---------------
Convertible debentures                                                                         $10,683,440      $2,500,000
Note payable issued in connection with guaranty on behalf of discontinued subsidiary             3,233,000       2,694,167
Short-term notes payable from distributor                                                          ---           4,000,000
Advance from distributor                                                                           ---           1,351,315
Other notes payable                                                                                169,588         ---
                                                                                            ---------------- ---------------
                                                                                                14,086,028      10,545,482

Less - current maturities                                                                       (1,640,465)     (6,967,815)
                                                                                            ---------------  ---------------
                                                                                               $12,445,563      $3,577,667
                                                                                            ================ ===============
</TABLE>


                                       9
<PAGE>


(a)      CONVERTIBLE DEBENTURES

         During the six months ended June 30, 1998, the Company  converted:  the
remaining $100,000 of its 4.5% convertible debentures due October 21, 1999, 2000
and 2001 into  60,809  shares  of the  Company's  common  stock;  the  remaining
$3,084,344 of its 5% convertible  debentures due December 31, 2001,  January 13,
2002 and March 10, 2002 into 3,646,092 shares of the Company's common stock; and
$160,000 of its 6%, 7% and 8% convertible debentures due September 30, 2002 into
103,021 shares of the Company's common stock. Accrued interest totaling $158,685
was included in the above conversions.  The Company amortized deferred financing
costs  totaling  $245,878  to  additional   paid-in  capital  related  to  these
conversions.

         During the second quarter of 1998, the Company converted  $2,840,000 of
6%, 7% and 8%  convertible  debentures  due  September  30, 2002 into  2,702,519
shares of the Company's  common stock.  Accrued interest  totaling  $107,999 was
included in the above  conversions.  The Company  amortized  deferred  financing
costs  totaling   $128,156  to  additional   paid-in  capital  related  to  this
conversion.

         During the first  quarter of 1998,  the  Company  redeemed  $2,000,000,
including  interest and premium,  of 6%, 7% and 8%  convertible  debentures  due
September 30, 2002 for $2,196,667.  Deferred financing cost totaling $95,000 was
charged to interest expense upon redemption.

(b)      SHORT-TERM NOTES PAYABLE

         On May 22 and  June 22,  1998,  the  Company  borrowed  $3,000,000  and
$1,000,000,  respectively,  from the Company's worldwide distributor.  The notes
are due on October 15, 1998 and accrue interest at 8.5% per annum. The notes are
secured by all of the inventory owned by the Company's Star Medical Technologies
Inc. subsidiary.

(c)      ADVANCE FROM DISTRIBUTOR

         The Company's worldwide laser distributor advanced funds to the Company
during  1998.  The  advances  are  secured  by  specific   accounts   receivable
outstanding at the time of the advance by the distributor. Payments against this
advance are made as the distributor  collects  receivables  from the end user of
the Company's products.

8.       STOCKHOLDERS' DEFICIT
         ---------------------

(a)      ISSUANCE OF COMMON STOCK

         In February 1998, the Company sold 7,200,000  shares of common stock to
a group of investors for  $7,200,000.  In addition,  the Company issued callable
warrants to the  investors  to purchase  7,200,000  shares of common stock at an
exercise price of $3.00 per share. The callable warrants are not exercisable for
the first six months after issuance and, thereafter, are callable by the Company
if the closing price of the  Company's  common stock equals or exceeds $5.00 for
ten consecutive  trading days.  Under the terms of this private  placement,  the
Company  is  obligated  to pay  the  investors  a fee of 5% per  annum  (payable
quarterly) of the dollar value  invested in the Company as long as the investors
continue  to hold  their  common  stock in their  name.  The  Company  paid a 5%
commission of $360,000  related to this issuance  which has been netted  against
the proceeds through a reduction in additional paid-in capital.

(b)      CONVERTIBLE PREFERRED STOCK

         During the first quarter of 1998,  the Company  converted 268 shares of
Series G Preferred  Stock and accrued  dividends  and  interest of $30,255  into
283,507 shares of the Company's common stock.  Also, during the first quarter of
1998,  the Company  converted  3,840 shares of its Series H Preferred  Stock and
accrued  dividends of $359,807 into  4,103,650  shares of the  Company's  common
stock.

         During the first quarter of 1998, the Company  redeemed 2,200 shares of
Series H Preferred  Stock including  related accrued  dividends and premiums for
$2,673,850.

                                       10
<PAGE>

         During the second quarter of 1998, the Company  converted 536 shares of
Series G Preferred  Stock and accrued  dividends  and  interest of $66,485  into
616,378 shares of the Company's common stock. During the second quarter of 1998,
the  Company  converted  84  shares  of Series H  Preferred  Stock  and  accrued
dividends of $24,112 into 85,000 shares of the Company's common stock.

         During the second quarter of 1998,  the Company  redeemed 866 shares of
Series H Preferred  Stock including  related accrued  dividends and premiums for
$1,118,039.

(c)      OPTIONS TO PURCHASE COMMON STOCK

         During  the six months  ended  June 30,  1998,  the  Company  cancelled
options to purchase  2,871,400  shares of the Company's common stock at exercise
prices ranging from $1.50 to $8.00 per share.  In addition,  the Company granted
2,198,900  options at above market  prices.  No options were issued or exercised
during the six months ended June 30, 1998.

(d)      WARRANTS TO PURCHASE COMMON STOCK

         During  the six months  ended  June 30,  1998,  the  Company  cancelled
warrants to purchase  1,175,000 shares of the Company's common stock at exercise
prices  ranging  from $2.50 to $6.75 per share and issued  warrants  to purchase
9,385,000  shares of the Company's  common stock at exercise prices ranging from
$.01 to $3.25 per share.  During the six months  ended June 30,  1998, a warrant
for  125,000  shares was  exercised  for  $1,250.  This  warrant  was held by an
investor.

(e)      RESERVED SHARES

         As of June 30,  1998,  the  Company had  reserved  shares of its common
stock for the following:
<TABLE>
<S>          <C>                                                            <C>    

                                                                               June 30,
                                                                                 1998

                                                                            ---------------
             Convertible debentures                                              3,739,915
             Stock option plans                                                  6,707,655
             Warrants                                                           17,508,030
             Employee 401(k) plan                                                  554,787
             Employee stock purchase plan                                          449,041
             Convertible preferred stock                                         5,132,041
             Common stock reserved for guarantee                                 3,250,000
                 issued in connection with note                             
                 payable on behalf of discontinued
                 subsidiary                                                 ---------------
                                   Total                                        37,341,469
                                                                            ===============
</TABLE>

9.       DISCONTINUED OPERATIONS
         -----------------------

         During the fourth  quarter of 1997,  the  Company's  Board of Directors
approved a plan to dispose of the Company's electronics business segment. During
the second quarter of 1998,  the Company sold all of the issued and  outstanding
common  stock of Dynaco  Corp.  ("Dynaco")  for net  proceeds  of  approximately
$2,381,000.  Due to the delay in the sale of Dynaco the Company was  required to
fund Dynaco with an additional  $500,000 for  operations in excess of the amount
accrued  for at year  end.  Accordingly,  the  Company  recognized  a loss  from
discontinued operations of approximately $1,091,000 related to the operations of
Dynaco  through  disposition.  During the second  quarter of 1998,  the  Company
recorded a charge to  discontinued  operations of $1,525,000 due to management's
decision  to  write  down  the  carrying   value  of  its  investment  in  Nexar
Technologies, Inc. ("Nexar").

                                       11
<PAGE>

         Pursuant  to  Accounting  Principles  Board  ("APB")  Opinion  No.  30,
REPORTING  THE RESULTS OF  OPERATIONS  - REPORTING  THE EFFECTS OF DISPOSAL OF A
SEGMENT OF A BUSINESS  AND  EXTRAORDINARY,  UNUSUAL AND  INFREQUENTLY  OCCURRING
EVENTS AND TRANSACTIONS,  the consolidated  financial  statements of the Company
have been  reclassified to reflect the  disposition of the electronics  segment.
Accordingly,  the assets and liabilities,  revenues and expenses, and cash flows
of the  electronics  segment have been excluded from the respective  captions in
the Consolidated Condensed Balance Sheets, Consolidated Statements of Operations
and Consolidated Statements of Cash Flows. The net assets / liabilities of these
entities  have  been  reported  as "Net  Assets /  Liabilities  of  Discontinued
Operations" in the accompanying  Consolidated  Condensed Balance Sheets; the net
operating  losses  of these  entities  have  been  reported  as "Net  Loss  from
Discontinued   Operations"  in  the  accompanying   Consolidated   Statement  of
Operations; the net cash flows of these entities have been reported as "Net Cash
Provided by Discontinued Operations" in the accompanying Consolidated Statements
of Cash Flows.

         Summarized financial  information for the discontinued  operations were
as follows:
<TABLE>
<S>  <C>                                      <C>                 <C>                <C>                  <C>

                                                  Three Months Ended June 30,                 Six Months Ended June 30,
                                                   1997                1998               1997                    1998
                                              ----------------    ----------------   ----------------      --------------------
     Revenues                                   $17,654,000         $2,125,580         $35,047,978               $5,745,750
     Net Loss from Discontinued Operations      ($3,625,048)       ($2,624,180)        ($8,696,680)             ($2,624,180)
</TABLE>

10.      RESTRUCTURING
         -------------

         In the third quarter of 1997,  the Company  recognized a  restructuring
charge of  $2,700,000  based on the  decision  to  discontinue  certain  medical
product and service business units and consolidate others. The majority of these
amounts  related  to  severance   benefits.   All  expenses   accounted  for  as
restructuring charges were in accordance with the criteria set forth in Emerging
Task Force Issue 94-3,  LIABILITY  RECOGNITION FOR CERTAIN EMPLOYEE  TERMINATION
BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY  (INCLUDING  CERTAIN COSTS INCURRED
IN A  RESTRUCTURING),  and are exclusive of the charges  related to discontinued
operations.  During the six months  ended June 30,  1998,  the Company  paid out
approximately  $946,000  of  severance  leaving  a  restructuring  liability  of
approximately   $1,036,000  at  June  30,  1998.  This  remaining  restructuring
liability will be paid during the remainder of 1998.

11.      SUBSEQUENT EVENTS
         -----------------

         In July 1998,  the Company sold  3,000,000  shares of common stock to a
group of investors for $3,000,000.  In addition,  the Company issued warrants to
the investors to purchase  3,000,000 shares of common stock at an exercise price
of $3.00 per share. The callable  warrants are not exercisable for the first six
months  after  issuance  and,  thereafter,  are  callable  by the Company if the
closing  price of the  company's  common stock  equals or exceeds  $5.00 for ten
consecutive trading days. Under the terms of this private placement, the Company
is obligated to pay the  investors a 5% annual fee  (payable  quarterly)  of the
dollar value  invested in the Company as long as the investors  continue to hold
their common stock in their name.

                     [This space intentionally left blank.]

                                       12
<PAGE>


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

REVENUE AND GROSS MARGIN: THREE MONTHS ENDED JUNE 30, 1998, COMPARED TO
                          THREE MONTHS ENDED JUNE 30, 1997

         For the three months  ended June 30, 1998,  the Company had revenues of
$9.1  million as compared to $7.1  million for the three  months  ended June 30,
1997.  The  increase in the  Company's  revenue of $2.0  million or 28% from the
quarter  ended June 30, 1997 was mainly due to  additional  sales volume of $8.1
million  associated  with the  introduction  of the  LightSheer(TM)  diode laser
system  combined  with a decrease in revenue of  approximately  $6.1  million in
other cosmetic product revenue principally related to the Company's  EpiLaser(R)
laser hair removal  system.  The decrease in sales  volume  associated  with the
Company's  EpiLaser(R)  laser hair removal system was due to the Company's focus
on bringing  the  LightSheer(TM)  diode  laser  system to market  while  further
developing the technology  related to the EpiLaser(R) laser hair removal system.
The Company obtained FDA clearance to market and sell its  LightSheer(TM)  diode
laser system for hair removal and leg vein treatment in the United States at the
end of 1997.  In addition,  in July 1998 the Company  obtained FDA  clearance to
market and sell its  EpiLaser(R)  laser hair removal system in the United States
for "permanent hair reduction." The Company believes that revenues will continue
to increase due to its improved manufacturing process, growing market demand for
its LightSheer(TM) diode laser system, and an improved distribution network as a
result of the Company's exclusive distribution  arrangement with Coherent,  Inc.
("Coherent").

         Gross margin for the three months ended June 30, 1998 was approximately
$4.3 million (47% of revenues)  versus  $694,000 (10% of revenues) for the three
months  ended June 30,  1997.  The  increase in gross  margin  dollars and gross
margin  percentage was caused by the  introduction of the  LightSheer(TM)  diode
laser system.  The Company  believes that its gross margin dollar and percentage
will  continue  to improve  as the  Company  achieves  higher  revenue  from its
LightSheer(TM)  diode laser  system.  This new laser system has a  significantly
higher gross margin than the Company's EpiLaser(R) laser hair removal system.

OPERATING AND OTHER EXPENSES: THREE MONTHS ENDED JUNE 30, 1998, COMPARED TO 
                              THREE MONTHS ENDED JUNE 30, 1997

         Research and  development  costs were $1.9 million for the three months
ended June 30, 1998 and $2.7  million for the three  months ended June 30, 1997.
Research and  development  expenses as a percent of revenue  totaled 21% for the
three  months  ended June 30, 1998 and 38% for the three  months  ended June 30,
1997.  The decline in spending is primarily the result of the Company  receiving
FDA clearance for the LightSheer(TM)  diode laser system at the end of 1997. The
continued spending on research and development reflects the Company's commitment
to research  and  development  for  medical  devices  and  delivery  systems for
cosmetic laser  applications and other medical  applications  using a variety of
lasers,  while continuing  dermatology research utilizing the Company's ruby and
diode lasers.  Management  believes that research and  development  expenditures
will remain constant over the next year as the Company continues clinical trials
of its medical products and develops additional  applications for its lasers and
delivery systems. However,  management anticipates that research and development
as a percentage  of net revenues  will  decrease as revenues  increase  with the
commercialization of its laser medical products.

         Selling  and  marketing  expenses  increased  to $3.5  million  (39% of
revenues)  for the three  months ended June 30, 1998,  from  approximately  $1.6
million (23% of revenues) for the three months ended June 30, 1997. The increase
in selling and marketing  expenses is attributable to the costs  associated with
the Company's  distribution  agreement  with Coherent.  The Company  anticipates
selling and  marketing  expense  dollars will  increase in the future,  but will
remain  relatively  constant as a percent of revenue as the Company realizes the
benefits of Coherent's worldwide distribution network.

         General and  administrative  expenses decreased to $2.4 million (26% of
revenues)  for the three months  ended June 30,  1998,  compared to $4.8 million
(68% of revenues)  for the three months  ended June 30, 1997.  This  decrease is
attributable to the Company's  successful  restructuring  and  consolidation  of
administrative  functions in the third and fourth  quarters of 1997. In previous
years, the Company focused management time and allocated resources to developing
business  outside of the medical and cosmetic laser industry and financing those
businesses.  Beginning in the fourth  quarter of 1997,  the Company  focused its
efforts on its core business. The Company anticipates general and administrative
expense will continue to decrease in the future as the benefits of the third and
fourth quarter restructuring are realized.


                                       13
<PAGE>

         For the three  months  ended June 30,  1998,  the Company did not incur
settlement  expenses.  Settlement  costs of $400,000  were incurred in the three
months  ended June 30, 1997.  These  charges  represented  an  additional  legal
accrual  related to a case  involving  an  investment  bank which was settled on
August 18, 1997.

         Interest expense  decreased to $408,000 for the three months ended June
30, 1998,  from $1.4 million for the three months ended June 30, 1997.  This 70%
decrease  is  primarily  the  result  of a  decrease  in  convertible  debenture
financings  and the Company's  increased use of  conventional  financing.  Also,
operations did not require as much financing in 1998 as compared to 1997.

         The loss from  discontinued  operations for the three months ended June
30,  1998 was $1.1  million  compared  to a loss of $3.6  million  for the three
months ended June 30, 1997.  The loss from  discontinued  operations in 1998 was
due to a delay in the  disposition  of Dynaco  resulting in  operating  expenses
above the $850,000  estimated at December  31,  1997. A loss on  disposition  of
discontinued  entities  for the three months ended June 30, 1998 of $1.5 million
was incurred.  The majority of this charge relates to  management's  decision to
write down the carrying value of its investment in Nexar.

REVENUE AND GROSS MARGIN: SIX MONTHS ENDED JUNE 30, 1998, COMPARED TO 
                          SIX MONTHS ENDED JUNE 30, 1997

         For the six months  ended June 30,  1998,  the Company had  revenues of
$16.2  million as  compared to $9.9  million  for the six months  ended June 30,
1997. The increase in the Company's  revenue of $6.3 million or 64% from the six
months  ended  June 30,  1997 was mainly due to  additional  sales  volume of $9
million  associated  with the  introduction  of the  LightSheer(TM)  diode laser
system  combined  with a decrease in revenue of  approximately  $2.7  million in
other cosmetic product revenue. The decrease in sales volume associated with the
Company's  EpiLaser(R)  laser hair removal system was due to the Company's focus
on bringing  the  LightSheer(TM)  diode  laser  system to market  while  further
developing the technology  related to the EpiLaser(R) laser hair removal system.
The Company obtained FDA clearance to market and sell its  LightSheer(TM)  diode
laser system for hair removal and leg vein treatment in the United States at the
end of 1997.  In addition,  in July 1998 the Company  obtained FDA  clearance to
market and sell its  EpiLaser(R)  laser hair removal system in the United States
for "permanent hair reduction." The Company believes that revenues will continue
to increase due to its improved manufacturing process, growing market demand for
its LightSheer(TM) diode laser system, and an improved distribution network as a
result of the Company's exclusive distribution arrangement with Coherent.

         Gross margin for the six months  ended June 30, 1998 was  approximately
$5 million (31% of revenues) versus $411,000 (4% of revenues) for the six months
ended June 30, 1997.  The  increase in gross margin and gross margin  percentage
was caused by the  introduction of the  LightSheer(TM)  diode laser system.  The
Company  believes that its gross margin dollar and  percentage  will continue to
improve as the Company  achieves  higher revenue from its  LightSheer(TM)  diode
laser system. This new laser system has a significantly higher gross margin than
the Company's EpiLaser(R) laser hair removal system.

OPERATING AND OTHER EXPENSES: SIX MONTHS ENDED JUNE 30, 1998, COMPARED TO 
                              SIX MONTHS ENDED JUNE 30, 1997

         Research  and  development  costs were $4.1  million for the six months
ended June 30, 1998 and $4.9 million for June 30, 1997. Research and development
expenses as a percent of revenue  totaled 25% for the six months  ended June 30,
1998 and 49% for the six months ended June 30, 1997.  The decline in spending is
primarily   the  result  of  the  Company   receiving   FDA   approval  for  the
LightSheer(TM)  diode laser system at the end of 1997. The continued spending on
research  and  development  reflects the  Company's  persevering  commitment  to
research and development  for medical devices and delivery  systems for cosmetic
laser  applications  and other medical  applications  using a variety of lasers,
while  continuing  dermatology  research  utilizing the Company's ruby and diode
lasers.  Management  believes that research and  development  expenditures  will
remain constant over the next year as the Company  continues  clinical trials of
its medical  products and develops  additional  applications  for its lasers and
delivery systems. However,  management anticipates that research and development
as a percentage  of net revenues  will  decrease as revenues  increase  with the
commercialization of its laser medical products.

                                       14
<PAGE>

         Selling  and  marketing  expenses  increased  to  $6  million  (37%  of
revenues)  for the six  months  ended June 30,  1998,  from  approximately  $2.6
million (26% of revenues)  for the six months ended June 30, 1997.  The increase
in selling and marketing  expenses is attributable to the costs  associated with
the Company's  distribution  agreement  with Coherent.  The Company  anticipates
selling and  marketing  expenses  will  increase in the future,  but will remain
relatively  constant  as a  percentage  of revenue as the Company  realizes  the
benefits of Coherent's worldwide distribution network.

         General and  administrative  expenses decreased to $5.2 million (32% of
revenues)  for the six months ended June 30,  1998,  as compared to $9.1 million
(92% of  revenues)  for the six months  ended June 30,  1997.  This  decrease is
attributable to the Company's  successful  restructuring  and  consolidation  of
administrative  functions in the third and fourth  quarters of 1997. In previous
years, the Company used management's time and allocated  resources to developing
businesses  outside of the medical and cosmetic laser industry and financing the
non-core  businesses.  Beginning  in the  fourth  quarter of 1997,  the  Company
focused its efforts on its core business.  The Company  anticipates  general and
administrative  expense will  continue to decrease in the future as the benefits
of the third and fourth quarter restructuring are realized.

         For the six  months  ended June 30,  1998,  the  Company  did not incur
settlement  expenses.  Settlement costs of $3.2 million were incurred in the six
months ended June 30, 1997.  These charges  consisted  mainly of a legal accrual
related to a legal settlement with an investment bank.

         Interest  expense  decreased  to $829,000 for the six months ended June
30, 1998,  from $2.5  million for the six months  ended June 30, 1997.  This 67%
decrease  is  primarily  the  result  of a  decrease  in  convertible  debenture
financings  and the Company's  increased use of  conventional  financing.  Also,
operations did not require as much financing in 1998 as compared to 1997.

         The loss from discontinued operations for the six months ended June 30,
1998 was $1.1  million  compared  to a loss of $8.7  million  for the six months
ended June 30, 1997. The loss from discontinued  operations in 1998 was due to a
delay in the  disposition  of Dynaco  resulting in operating  expenses above the
$850,000  estimated at December 31, 1997. A loss on disposition of  discontinued
entities for the six months  ended June 30, 1998 of $1.5  million was  incurred.
The majority of this charge relates to  management's  decision to write down the
carrying value of its investment in Nexar.

LIQUIDITY AND CAPITAL RESOURCES

         As of June 30,  1998,  the  Company  had  $1.5  million  in cash,  cash
equivalents  and trading  securities.  During the six months ended June 30, 1998
the Company  generated  $6.9 million and $3.4  million in net proceeds  from the
issuance  of common  stock  and  short-term  notes  payable,  respectively.  The
Company's  net cash used in operating  activities  for the six months ended June
30, 1998 was approximately $8.7 million.

         The  Company's net loss for the six months ended June 30, 1998 included
approximately $1.4 million of non-cash depreciation and amortization expense.

         The Company anticipates that capital expenditures for the remaining six
months of 1998 will total approximately $500,000. The Company will finance these
expenditures  with cash on hand and equipment leasing lines, or the Company will
seek to raise  additional  funds.  However,  there can be no assurance  that the
Company will be able to raise the funds.

         In connection with the disposition of Comtel, Inc. ("Comtel"), a former
wholly-owned  subsidiary  in the  electronics  segment,  the Company  guaranteed
$2,500,000  of a $3,300,000  line of credit  extended by a loan  association  to
Biometric  Technologies Corp. ("BTC"),  the buyer of Comtel. The stockholders of
BTC have personally  guaranteed to the Company payment for any amounts  borrowed
under this line of credit in excess of approximately $1,500,000 in the event the
Company is obligated to honor this guaranty.  The  stockholders  of BTC, who are
former  officers and  directors  of a former  subsidiary  of the  Company,  have
collateralized this guaranty of the Company with certain assets personally owned
by them.  The  amount BTC has  outstanding  under the line of credit at June 30,
1998 was approximately $2,979,000.

                                       15
<PAGE>

         The  Company's  strategic  plan is to  continue  to fund  research  and
development  for its medical and  cosmetic  laser  products.  This  research and
development  effort entails extensive  clinical trials.  These activities are an
important  part of the Company's  business  plan.  Due to the nature of clinical
trials and research and  development  activities,  it is not possible to predict
with any certainty the timetable for completion of these research  activities or
the total amount of funding  required to commercialize  products  developed as a
result of such research and development.  The rate of research and the number of
research  projects  underway are dependent to some extent upon external funding.
While the Company is regularly  reviewing  potential funding sources in relation
to these ongoing and proposed research projects,  there can be no assurance that
the current  levels of funding or additional  funding will be available,  or, if
available, on terms satisfactory to the Company.

         The Company has had significant losses to date and expects these losses
to continue for the near future.  Therefore, the Company must continue to secure
additional  financing  to complete  its  research  and  development  activities,
commercialize  its current and proposed medical products and services,  and fund
ongoing operations. There can be no assurance that events in the future will not
require the Company to seek  additional  financing.  The  Company  continues  to
investigate several financing  alternatives,  including strategic  partnerships,
additional bank financing,  private debt and equity  financing,  sale of assets,
including  the  Company's  marketable  securities  consisting  of Nexar  and the
American  Materials & Technology  Corporation,  and other sources.  Based on its
historical  ability  to  raise  funds  as  necessary  and  ongoing   preliminary
discussions with potential financing sources,  the Company believes that it will
be successful in obtaining  additional  financing in order to fund operations in
the  near  future.  Although  the  Company  believes  it will be  successful  in
obtaining  additional  financing,  there  can  be no  assurance  that  any  such
financing will be available on terms satisfactory to the Company.  The report of
the Company's  independent  public  accountants in connection with the Company's
Consolidated  Balance  Sheets at  December  31,  1997 and 1996,  and the related
Consolidated  Statements of Operations,  Stockholders' Equity (Deficit) and Cash
Flows for the three  years ended  December  31,  1997  includes  an  explanatory
paragraph  stating  that  the  Company's   recurring  losses,   working  capital
deficiency  and  stockholders'   deficit  raises  substantial  doubt  about  the
Company's ability to continue as a going concern.

         The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium (year 2000) approaches. The "year
2000" problem is pervasive and complex,  as virtually  every computer  operation
will be affected in the same way by the  rollover of the two digit year value to
00. The issue is whether computer systems will properly recognize date sensitive
information  when  the  year  changes  to  2000.  Systems  that do not  properly
recognize such  information  could generate  erroneous data or cause a system to
fail.  The Company is at this time  utilizing  internal  resources  to identify,
correct or reprogram,  and test the systems for year 2000  compliance.  However,
there can be no  assurance  that the  systems  of other  companies  on which the
Company's  systems rely will also be  converted  in a timely  manner or that any
such failure to convert by another  company would not have an adverse  effect on
the Company's  systems.  Management is in the process of assessing the year 2000
compliance costs; however,  based on information to date (excluding the possible
impact of  vendor  systems),  management  does not  believe  that it will have a
material effect on the Company's earnings.

FACTORS THAT MAY AFFECT FUTURE RESULTS

         From time to time,  information  provided by the Company or  statements
made by its employees may contain "forward-looking" information, as that term is
defined in the Private  Securities  Litigation  Reform Act of 1995 (the  "Reform
Act").  This  report  may  also  contain   statements  that  are  deemed  to  be
forward-looking information under the Reform Act, including, without limitation,
statements  relating to financial  projections;  gross margin,  distribution and
product improvements; growing market demand; additional financings; increases in
revenues;  and  research and  development,  selling and  marketing,  general and
administrative  and capital  expenditures.  Readers are  cautioned  not to place
undue reliance on these forward-looking  statements,  which speak only as of the
date  hereof.  The Company  undertakes  no  obligation  to release  publicly the
results of any revisions to these forward-looking statements that may be made to
reflect  events  or  circumstances  after  the date  hereof  or to  reflect  the
occurrence of unanticipated  events.  The Company cautions  investors that there
can be no assurance that actual results or business  conditions  will not differ
materially from those projected or suggested in such forward-looking  statements
as a result of various  factors,  including  but not limited to the risk factors
identified  in the  Company's  Annual  Report  on Form  10-K for the year  ended
December  31,  1997,  which  cautionary  statements  are  made  pursuant  to the
provisions of the Reform Act and with the intention of obtaining the benefits of
safe harbor provisions of the Reform Act.

                                       16
<PAGE>

                           PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS
         -----------------

         On March 7, 1997, Selvac Acquisition Corp. ("Selvac"),  a subsidiary of
Mehl Biophile  International,  Inc.  ("Mehl"),  filed a complaint for injunctive
relief and damages for patent  infringement  and for unfair  competition  in the
United States District Court for the District of New Jersey against the Company,
two of its  subsidiaries  and a New  Jersey  dermatologist.  Selvac's  complaint
alleged that the Company's  EpiLaser(R)  laser hair removal  system  infringed a
patent  licensed to Selvac (the "Selvac  Patent") and that the Company  unfairly
competed by promoting the EpiLaser(R) laser hair removal system for hair removal
before it had received FDA approval for that  specific  application.  On May 18,
1998 the court granted the Company's  motion for partial summary judgment on the
ground that the Selvac patent is invalid  because prior art  anticipated it. The
court has since  denied  Selvac's  motion  for  reconsideration  of the  summary
judgment ruling. On August 6, 1998, Mehl's principal  unsecured creditor filed a
petition for involuntary bankruptcy against Mehl.

         On October 16, 1997, the Company brought a declaratory  judgment action
in United States  District Court for the District of  Massachusetts  against the
holders and the indenture trustee of the Company's 4.5% Subordinated Convertible
Debentures due 2003, denominated in Swiss francs (the "Swiss Franc Debentures").
The  defendants  in this  action are  Banque SCS  Alliance  SA,  Arbuthnot  Fund
Managers,  Ltd.,  Banca  Commerciale  Lugano,  Privatinvest  Bank AG (these four
defendants  being  referred to  collectively  as the "Asserting  Holders"),  CUF
Finance S.A., Fibi Bank (Schweiz) AG, Teawood Nominees, Ltd., JS Gadd & CIE, SA,
Swedbank  (Luxembourg)  SA,  Christiana Bank Luxembourg SA, (now known as Credit
Agricole Indosuez),  Landatina Financiera SA and American Stock Transfer & Trust
Co., as trustee ("Trustee").  Just prior to this suit, the Asserting Holders had
alleged that the Company is in breach of certain protective  covenants under the
indenture.  The Company  believes that it is not in default under any protective
covenants,  and the Company's  action seeks a declaration from the Court to that
effect.  All payments on the Swiss Franc  Debentures were current to the time of
suit. On October 22, 1997, the Asserting Holders sued the Company and all of its
principal  subsidiaries  in the same court;  the October  16th and October  22nd
cases  have  been  assigned  to the same  judge,  and the  dispute  between  the
Asserting Holders and the Company is proceeding under the October 22nd case. The
Asserting  Holders  claim  that the  Company  has  breached  certain  protective
indenture  covenants  and that the  Asserting  Holders are entitled to immediate
payment of their indebtedness under the Swiss Franc Debentures (which amounts to
about  US$5,000,000 at recent exchange rates).  As of November 13, 1997,  acting
under applicable  provisions of the indenture,  the Company notified the holders
of the Swiss Franc  Debentures  that it is causing the  conversion of all of the
Swiss Franc  Debentures  into an  aggregate of 914,028  shares of the  Company's
common stock.  Palomar filed a motion for summary  judgment,  asserting that its
conversion of the  debentures  into Palomar common stock deprives the plaintiffs
of standing to bring a claim. That motion has been denied without prejudice, and
the court also denied the plaintiffs'  motion for summary judgment.  The case is
scheduled for trial in October 1998.  The Company  believes that its position in
these  matters is correct  and  intends to contest  the claims of the  Asserting
Holders vigorously.

ITEM 2.  CHANGES IN SECURITIES
         ---------------------

         Not applicable.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
         -------------------------------

         Not applicable.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
         ---------------------------------------------------

         Not applicable.

ITEM 5.  OTHER INFORMATION
         -----------------

         Not applicable.


                                       17
<PAGE>


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K
         --------------------------------

(a)      EXHIBITS

10.1     Second Amended 1996 Employee Stock Purchase Plan.

10.2     Second Loan Agreement between Palomar Medical Technologies, Inc. and 
         Coherent, Inc., dated May 7, 1998.

10.3     Loan Agreement between Palomar Medical Technologies, Inc. and Coherent,
         Inc., dated May 22, 1998.  (Portions  omitted pursuant to a request for
         confidential treatment.)

27.1     Financial Data Statement, Restated, for the period ended June 30, 1997.

27.2     Financial  Data  Statement,  for the  period  ended  June 30,  1998.


(b)      REPORTS ON FORM 8-K.

         Form 8-K filed June 3, 1998.


                                       18
<PAGE>

                                   SIGNATURES

         Pursuant  to the  requirements  of the  Securities  Act  of  1934,  the
Registrant  certifies  that it has caused this Report to be signed on its behalf
by the undersigned,  thereunto duly authorized,  in the Town of Lexington in the
Commonwealth of Massachusetts on August 14, 1998.

                                              PALOMAR MEDICAL TECHNOLOGIES, INC.
                                                        (Registrant)

DATE:  August 14, 1998                        By:   /S/ LOUIS P. VALENTE
                                                 -------------------------------
                                                    Louis P. Valente
                                                    Chief Executive Officer
                                                   (Principal Executive Officer)

DATE:  August 14, 1998                              /S/ JOSEPH P. CARUSO
                                                 -------------------------------
                                                    Joseph P. Caruso
                                                    Chief Financial Officer 
                                                    and Treasurer
                                                   (Principal Financial Officer 
                                                    and Principal Accounting
                                                    Officer)