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 September 30, 1997

                                       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>

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



                    45 Hartwell Avenue, Lexington, MA 02173
                    ----------------------------------------
                    (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 of 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 October 31,  1997,  40,276,310  shares of Common  Stock,  $.01 par
value per share, were outstanding.

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

                                       1
<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                                     INDEX


PART I - FINANCIAL INFORMATION

        ITEM 1.  FINANCIAL STATEMENTS
<TABLE>
<S>     <C>                                                                                    <C>

Consolidated Condensed Balance Sheets - December 31, 1996 and September 30, 1997               P. 3

        Consolidated Statements of Operations - For the Three and Nine Months Ended
                September 30, 1996 and 1997                                                    P. 4

        Consolidated Statement of Stockholders' Equity - For the Nine Months Ended
                      September 30, 1997                                                       P. 5

        Consolidated Statements of Cash Flows - For the Nine Months Ended
                September 30, 1996 and 1997                                                    P. 6

        Notes to Consolidated Financial Statements                                             P. 8

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
        FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                          P. 16

PART II - OTHER INFORMATION

        ITEM 1.  LEGAL PROCEEDINGS                                                             P. 22

        ITEM 2.  CHANGES IN SECURITIES                                                         P. 23

        ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                               P. 23

        ITEM 4.  SUBMISSION OF MATTERS TO A VOTE
                 OF SECURITY HOLDERS                                                           P. 23

        ITEM 5.  OTHER INFORMATION                                                             P. 24

        ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                              P. 24

SIGNATURES                                                                                     P. 25
</TABLE>


                                       2
<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     Consolidated Condensed Balance Sheets
                                  (Unaudited)
<TABLE>
<S>     <C>                                                      <C>                      <C>           
                                                                 December 31,             September 30,
                                                                      1996                      1997
ASSETS

Current Assets:
        Cash and cash equivalents                                $16,172,731             $12,658,099
        Marketable securities                                      2,893,792               2,432,375
        "Accounts receivable, net"                                18,308,077              17,403,792
        "Inventories, net"                                        18,790,484              22,393,482
        Loans to officers                                            995,331               1,549,388
        Notes receivable related parties                             464,153              ---
        Other notes receivable                                       899,937              ---
        Other current assets                                       7,623,161               3,354,142
                                                                 -----------             -----------
                Total current assets                              66,147,666              59,791,278
                                                                 -----------             -----------

Property and Equipment, at Cost, Net                               8,404,605               11,396,181
                                                                 -----------               ----------

Other Assets:
        Cost in excess of net assets acquired, net                5,024,299                3,451,106
        Intangible assets, net                                    2,286,058                  778,321
        Deferred costs                                            2,895,803                1,571,603
        Long-term investments                                     3,179,554                  500,000
        Loan to related party                                     1,100,000                  ---
        Other assets                                              1,719,211                1,548,162
                                                                  ----------               ----------
                Total other assets                               16,204,925                7,849,192
                                                                 ----------               ----------

                                                                $90,757,196              $79,036,651
                                                                ===========              ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:

        Revolving lines of credit                                $4,558,052               $4,315,397
        Current portion of long-term debt                         2,783,683                4,104,793
        Accounts payable                                         14,304,285               14,311,407
        Accrued expenses                                         14,669,893               23,651,346
                                                                 ----------               ----------
                Total current liabilities                        36,315,913               46,382,943
                                                                 ----------               ----------

Long-Term Debt, Net of Current Portion                           16,204,692               18,974,067
                                                                 ----------               ----------

Minority Interest                                                   160,000                 5,148,929
                                                                 ----------                ----------

Commitments and Contingencies (Note 12)

Stockholders' Equity:
      Preferred stock, $.01 par value-                                  182                       244
         Authorized - 5,000,000 shares
         Issued and  outstanding - 
         18,151 shares and 24,397 shares
         at December 31, 1996 and September 30, 1997
      Common stock, $.01 par value-                                 305,968                   397,506
         Authorized - 100,000,000 shares
         Issued and outstanding - 30,596,812 shares
         and 39,750,574 shares 
         at December 31, 1996 and September 30, 1997
      Additional paid-in capital                                104,900,551                  143,643,354
      Accumulated deficit                                       (64,971,200)                (133,366,880)
      Unrealized loss on marketable securities                     (342,500)                 ---
      Subscriptions receivable from related party                  (604,653)                    (504,653)
      Less: Treasury stock-
         (200,000 and 345,000 shares at cost, respectively)      (1,211,757)                  (1,638,859)
                                                                  ----------                 ------------
         Total stockholders' equity                               38,076,591                   8,530,712
                                                                  ----------                 ------------
                                                                 $90,757,196                 $79,036,651
                                                                 ===========                 ============
</TABLE>
                   The accompanying note 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>

                                                                            Three Months Ended                  Nine Months Ended
                                                                                September 30,                      September 30,
                                                                          1996             1997              1996            1997
                                                                       ---------------------------       --------------------------

        Revenues                                                       $24,690,970     $18,306,413       $49,153,990    $63,206,446

        Cost of Revenues                                                20,729,923      19,106,809        42,834,703     62,311,152
                                                                       ---------------------------       --------------------------

                Gross profit (loss)                                      3,961,047        (800,396)        6,319,287        895,294
                                                                       ---------------------------       --------------------------

        Operating Expenses

                Research and development                                 1,639,712       3,584,942         5,731,009      9,508,833
                Sales and marketing                                      2,167,195       4,041,077         6,338,865     11,913,675
                General and administrative                               5,581,662       5,596,761        13,793,418     16,681,599
                Business development and other financing costs             477,380         597,181         2,419,476      2,061,339
                Pooling-of-interest expenses                                 ---             ---             443,780          ---  
                Settlement and litigation costs                              ---             ---              ---         3,550,000
                Restructuring and asset write-off costs                      ---         9,426,491            ---         9,426,491

                        Total operating expenses                         9,865,949      23,246,452        28,726,548     53,141,937

                        Loss from operations                            (5,904,902)    (24,046,848)      (22,407,261)   (52,246,643)

        Interest Expense                                                  (510,107)     (1,070,692)       (1,248,986)    (4,640,276)

        Interest Income                                                    643,898         140,719         1,847,345        664,276

        Net Gain on Trading Securities                                   1,820,311         445,647         2,548,629        995,624

        Asset writeoff                                                       ---       (13,547,759)            ---      (13,547,759)

        Other Expense                                                        ---          (847,757)            ---       (1,298,720)

        Minority Interest in Loss of Subsidiary                              1,388       1,937,121            47,059      2,905,796
                                                                          ------------------------       ---------------------------

                Net loss                                               $(3,949,412)  $ (36,989,569)     $(19,213,214)  $(67,167,702)
                                                                       ===========================       ===========================

        Net Loss Per Common Share (Note 6)                                  $(0.15)         $(1.11)           $(0.80)        $(2.15)
                                                                       ===========================       ===========================

        Weighted Average Number of
            Common Shares Outstanding                                   27,681,158      34,498,657        25,194,388     32,758,019
                                                                       ===========================       ===========================
</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                       4
<PAGE>
                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                  (Unaudited)
<TABLE>
<S>     <C>                                 <C>                  <C>           <C>         <C>             <C>           <C>
                                                   Preferred Stock             Common Stock                       Treasury Stock
                                               -----------------------------------------------------------------------------------
                                                  Number        $0.01          Number     $0.01               Number
                                                of Shares     Par Value       of Shares  Par Value          of Shares       Cost
                                               -----------------------------------------------------------------------------------

Balance, December 31, 1996                        18,151         $182         30,596,812   $305,968        (200,000)   ($1,211,757)

        Sale of common stock 
               pursuant to warants and options        --           --            733,882      7,339              --            --
        Sale of common stock for options issued 
               as legal settlement                    --           --             60,845        608              --            --
        Payments received on subscriptions   
               receivable                             --           --                 --         --              --            --
        Issuance of preferred stock               16,000          160                 --         --              --            --
        Issuance of common stock for 1996 
               employer 401(k) matching 
               contribution                           --           --             41,425        414              --            --
        Conversion of preferred stock             (9,754)         (98)         3,287,708     32,877              --            --
        Conversion of convertible debentures          --           --          4,348,082     43,481              --            --
        Issuance of common stock for investment 
               banking, merger and acquisition
               and consulting services                --           --              5,000        50               --            --
        Value ascribed to the discount feature of 
               convertible debentures issued          --           --            413,109     4,131               --            --
        Issuance of common stock for Employee Stock 
               Purchase Plan                          --           --              8,391        84               --            --
        Compensation expense related to warrants 
               issued to non-employees under
               Statement of Financial Accounting 
               Standards No. 123                      --           --                 --        --               --            --
        Unrealized loss on marketable securities      --           --                 --        --               --            --
        Preferred stock dividends                     --           --                 --        --               --            --
        Guaranteed value associated with Dermascan 
               acquisition                            --           --                 --        --               --            --
        Issuance of common stock for technology       --           --            255,320     2,553               --            --
        Purchase of treasury stock                    --           --                 --        --         (145,000)     (427,102)
        Gain related to the issuance of common stock
               by Nexar Technologies, Inc.            --           --                 --        --               --            --
        Net loss                                      --           --                 --        --               --            --
                                                  ---------------------------------------------------------------------------------

Balance, September 30, 1997                       24,397         $244         39,750,574  $397,506         (345,000)   ($1,638,859)
                                                  =================================================================================
</TABLE>
<TABLE>
<S>     <C>                                      <C>            <C>              <C>               <C>              <C>
                                                  Additional                    Unrealized (Loss)                      Total
                                                   Paid-in      Accumulated    Gain on marketable  Subscriptions    Stockholders'
                                                   Capital       Deficit          securities        Receivable        Equity
                                                 -------------------------------------------------------------------------------
Balance, December 31, 1996                       $104,900,551   ($64,971,200)    ($342,500)         ($604,653)       $38,076,591

        Sale of common stock pursuant 
            to warrants and options                 1,409,429             --            --                 --         $1,416,768
        Sale of common stock for options 
            issued as legal settlement                151,505             --            --                 --           $152,113
        Payments received on subscriptions 
            receivable                                     --             --            --            100,000           $100,000
        Issuance of preferred stock                14,999,840             --            --                 --        $15,000,000
        Issuance of common stock for 1996 
            employer 401(k) matching contribution     268,848             --            --                 --           $269,262
        Conversion of preferred stock                 275,420             --            --                 --           $308,199
        Conversion of convertible debentures        8,982,760             --            --                 --         $9,026,241
        Issuance of common stock for investment 
            banking, merger and acquisition
            and consulting services                    38,075             --            --                 --            $38,125
        Value ascribed to the discount feature 
            of convertible debentures issued        3,750,812             --            --                 --         $3,754,943
        Issuance of common stock for Employee 
            Stock Purchase Plan                        26,957             --            --                 --            $27,041
        Compensation expense related to warrants 
            issued to non-employees under 
            Statement of Financial Accounting 
            Standards No. 123                         499,465             --            --                 --           $499,465
        Unrealized loss on marketable securities           --             --       342,500                 --           $342,500
        Preferred stock dividends                          --     (1,227,978)           --                 --        ($1,227,978)
        Guaranteed value associated with Dermascan 
            aquisition                               (216,562)            --            --                 --          ($216,562)
        Issuance of common stock for technology     1,146,388             --            --                 --         $1,148,941
        Purchase of treasury stock                         --             --            --                 --          ($427,102)
        Gain related to the issuance of common stock 
            by Nexar Technologies, Inc.             7,409,866             --            --                 --         $7,409,866
        Net loss                                           --    (67,167,702)           --                 --        (67,167,702)
                                                  -------------------------------------------------------------------------------
Balance, September 30, 1997                      $143,643,354  ($133,366,880)           --          ($504,653)        $8,530,712
                                                  ===============================================================================
</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                       5
<PAGE>
                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)

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

                                                                       Nine Months Ended September 30,
                                                                           1996                1997

Cash Flows from Operating Activities
        Net loss                                                       $(19,213,214)        $(67,167,702)
        Adjustments to reconcile net loss to net cash
                used in operating activities-
                Depreciation and amortization                             2,380,297            3,552,093
                Settlement and litigation costs                                  --            2,900,000
                Restructuring and asset write-off costs                                       22,974,250
                Write-off of in-process research and development             57,212                   --
                Write-off of deferred financing costs associated with
                        redemption of convertible debentures                201,500               27,554
                Valuation allowances for notes and investments                   --            1,035,912
                Minority interest in loss of subsidiary                     (30,572)          (2,885,493)
                Accrued interest receivable on trading securities
                        and subscription receivable                        (698,378)                  --
                Foreign currency exchange gain                                   --             (546,316)
                Noncash interest expense related to convertible debentures  117,105            2,585,606
                Noncash compensation related to common stock and warrants   903,584              689,703
                Realized gain on marketable securities                     (877,632)            (195,706)
                Unrealized gain on marketable securities                 (1,670,187)            (826,142)
                Changes in assets and liabilities, net of effects
                        from business combinations;
                        Purchases of marketable securities              (10,112,596)            (152,938)
                        Sale of marketable securities and
                            interest received on marketable securities   10,077,026            1,630,578
                        Accounts receivable                             (14,990,154)          (5,564,946)
                        Inventories                                     (11,030,375)          (5,133,450)
                        Other current assets and loans to officers       (1,124,646)          (2,300,709)
                        Accounts payable                                 10,436,765            1,257,183
                        Accrued expenses                                  3,606,692            1,356,438
                                                                       -------------         ------------
                                Net cash used in operating activities   (31,967,573)         (46,764,085)
                                                                       -------------         ------------

Cash Flows from Investing Activities
        Cash paid for purchase of Comtel Electronics, Inc., 
               net of cash acquired                                        (146,586)                  --
        Net proceeds received from sale of subsidiary stock                    --              3,925,000
        Purchases of property and equipment                              (2,198,017)          (8,017,147)
        Increase in intangible assets                                      (450,005)            (351,059)
        Increase in other assets                                         (1,331,652)            (308,951)
        Loans to related parties                                         (7,433,625)          (1,250,000)
        Payments received on loans to related parties                     8,052,855              941,288
        Repurchase of Nexar Technologies, Inc. common stock                      --           (2,777,484)
        Investment in nonmarketable securities                           (5,172,488)          (2,257,631)
                                                                       -------------         ------------
                                Net cash used in investing activities    (8,679,518)         (10,095,984)


</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                       6
<PAGE>
                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (continued)

<TABLE>

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

                                                                                Nine Months Ended September 30,
                                                                                   1996                1997
Cash Flows from Financing Activities
        Net proceeds from Nexar Technologies, Inc. initial public offering               --         19,667,910
        Proceeds from issuance of convertible debentures                          6,680,751         16,715,169
        Proceeds from issuance of notes payable                                          --          3,500,000
        Redemption of convertible debentures                                       (930,000)          (196,000)
        Payments of notes payable and capital lease obligations                  (1,015,368)        (3,899,591)
        Net proceeds from revolving lines of credit                                (135,753)         1,957,345
        Proceeds from sale of common stock                                        3,276,380             27,041
        Proceeds from exercise of warrants and stock options                      6,876,830          1,416,768
        Issuance of preferred stock                                              30,913,397         15,000,000
        Deferred offering costs                                                          --           (199,541)
        Redemption of preferred stock, including accrued dividends of $71,223    (3,194,375)                --
        Purchase of treasury stock                                                       --           (427,102)
        Guaranteed value associated with Dermascan acquisition                           --           (216,562)
        Payments received on subscriptions receivable                             2,009,591                 --
                                                                                ------------        -----------
                                Net cash provided by financing activities        44,481,453          53,345,437
                                                                                ------------        -----------
Net increase (decrease) in cash and cash equivalents                              3,834,362          (3,514,632)
Cash and cash equivalents, beginning of period                                   17,138,178          16,172,731
                                                                                ------------        ------------
Cash and cash equivalents, end of period                                        $20,972,540         $12,658,099
                                                                                ============        ============

Supplemental Disclosure of Cash Flow Information
        Cash paid for interest                                                     $324,041          $1,345,984
                                                                                ============        ============

Supplemental Disclosure of Noncash Financing and Investing Activities:
        Conversion of convertible debentures and related accrued
                interest, net of financing fees                                  $1,172,763          $9,026,241
                                                                                ============        ============

        Conversion of preferred stock                                            $417,975              $308,199
                                                                                ============        ============

        Dividends payable                                                        $826,080            $1,227,978
                                                                                ============        ============

        Issuance of common stock for employer 401(k)
                matching contribution                                            $160,598              $269,262
                                                                                ============        ============

        Common stock issued for repurchase of minority interest                $1,710,000                   $--
                                                                                ============        ============

        Issuance of common stock for technology                                       $--            $1,148,941
                                                                                ============        ============

Acquisition of Comtel Electronics, Inc.
        Liabilities assumed                                                      (258,144)                  $--
        Fair value of assets acquired                                              72,661                    --
        Cash paid, net of cash acquired                                          (146,586)                   --
                                                                                ------------        ------------
Cost In Excess of Net Assets Acquired                                            (332,069)                  $--
                                                                                ============        ============

</TABLE>

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


                                       7
<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-KSB,  as amended,  as of and for the year
ended December 31, 1996.

        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  non-core
short-term financial  investments primarily through the private sale of debt and
equity securities of the Company.  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.  The
sale by the  Company  of some  of its  marketable  securities  could  result  in
additional  losses  depending on market  conditions  at the time of these sales.
Securities sold to private investors are sold at a discount to the public market
for similar securities.  It has been the Company's experience that these private
investors  require  the  Company  to make  its best  effort  to  register  these
securities for resale to the public at some future time.

2.      INVESTMENTS

        The fair values for the Company's marketable equity securities are based
on quoted market prices.  The fair values of  nonmarketable  equity  securities,
which represent  equity  investments in early stage  technology  companies,  are
based on the financial information provided by these ventures and other factors.
During the nine months ended  September 30, 1997, the Company  recorded a charge
of  $2.8  million  as a  result  of  management's  assessment  that a  permanent
impairment  had  occurred  for  some  of  the  Company's  non-marketable  equity
securities.

        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
the Company  has the  positive  intent and  ability to hold to maturity  will be
reported at amortized cost and are classified as held-to-maturity. There were no
held-to-maturity  securities  as of December  31, 1996 and  September  30, 1997.
Securities  purchased to be held for indefinite periods of time and not intended
at  the  time  of  purchase  to  be  held  until   maturity  are  classified  as
available-for-sale securities and any unrealized gains or losses are recorded as
a  component  of  stockholders'  equity.  If an  available-for-sale  security is
determined to be other than temporarily impaired, the cost basis is written down
to fair  value and the write  down is  included  in  earnings.  During the three
months ended  September 30, 1997, the Company  recorded a charge of $2.5 million
as a result of management's  assessment that a permanent impairment had occurred
of all of its available-for-sale securities. Publicly traded 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.

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

                                                        September 30, 1997

                                                  Gross             Gross
                                                  Unrealized        Unrealized          Fair
                                   Cost           Gain              Loss                Value

Trading Securities:
     Investments in publicly
     traded companies            $513,544        $2,026,176        $107,345          $2,432,375
                                 ========        ==========        ========          =========
</TABLE>


                                       8
<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:

                                   December 31,             September 30,
                                        1996                     1997
                                   ------------             -------------

          Raw materials            $13,266,204               $12,704,413
          Work in process 
            and finished goods       5,524,280                 9,689,069
                                   ------------             -------------
                                   $18,790,484               $22,393,482
                                   ============             =============

4.      PROPERTY AND EQUIPMENT


        Property and equipment consist of the following:
<TABLE>
<S>                                          <C>                      <C>
                                             December 31,             September 30,
                                                1996                       1997
                                             ------------             -------------

          Equipment under capital leases      $2,261,339               $2,519,933
          Machinery and equipment              5,429,764                8,547,696
          Furniture and fixtures               1,926,948                3,247,107
          Leasehold improvements               1,160,814                1,641,387
                                             ------------             -------------
                                              10,778,865               15,956,123

          Less:  Accumulated depreciation
                 and amortization              2,374,260                4,559,942
                                             ------------             -------------
                                              $8,404,605              $11,396,181
                                             ============             =============
</TABLE>


5.      ACCRUED EXPENSES

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

                                             December 31,             September 30,
                                                1996                       1997
                                             ------------             --------------

          Payroll and consulting costs         $3,456,311                $2,926,158
          Professional fees                       961,815                   563,878
          Settlement costs                      1,755,000                 1,640,095
          Warranty                              2,854,401                 3,224,500
          Deferred revenue/gain                   256,912                 4,289,335
          Restructuring                               ---                 2,700,000
          Other                                5,385,454                  8,307,380
                                             ------------             --------------
              Total                          $14,669,893                $23,651,346
                                             ============             ==============
</TABLE>

6.      NET LOSS PER COMMON SHARE

        For the three and nine months  ended  September  30, 1996 and 1997,  net
loss per common share has been  computed by dividing  the net loss,  as adjusted
for preferred  stock  dividends and  amortization  of the value  ascribed to the
discount feature of the Series H Preferred Stock, by the weighted average number
of  shares  of  common  stock  outstanding  during  the  period.   Common  stock
equivalents  are  not  considered  as  outstanding,   as  the  result  would  be
antidilutive.


                                       9
<PAGE>


The  calculation  of the  Company's  net loss per common share for the three and
nine months ended September 30, 1996 and 1997 is as follows:
<TABLE>
<S>                           <C>              <C>                <C>                  <C>

                                   Three Months Ended                      Nine Months Ended
                              September 30,    September 30,       September 30,       September 30,
                                   1996           1997                1996                1997
                              -------------    -------------       ------------        -------------

Net loss                       $(3,949,412)     $(36,989,569)       $(19,213,214)       $(67,167,702)
Preferred stock dividends         (317,736)         (500,754)           (826,080)         (1,227,978)
Amortization of value 
   ascribed to preferred 
   stock conversion discount           ---          (941,176)                ---          (1,882,352)
                              -------------     -------------       -------------       -------------
Adjusted net loss              $(4,267,148)     $(38,431,499)       $(20,039,294)       $(70,278,032)
                              =============     =============       =============       =============

Net loss per common share           $(0.15)           $(1.11)             $(0.80)             $(2.15)
                              =============     =============       =============       =============

Weighted average number of
 common shares outstanding      27,681,158        34,498,657          25,194,388          32,758,019
                              ============      =============       =============       =============
</TABLE>

        In March of 1997,  SFAS No. 128,  Earnings  Per Share,  was issued which
established new standards for calculating and presenting earnings per share. The
Company is required to adopt this new standard in its 1997 financial statements.
In accordance with this new standard,  basic and diluted  earnings per share for
the three  months  ended  September  30, 1996 and 1997 are $(0.15) and  $(1.11),
respectively,  and the nine months ended September 30, 1996 and 1997 are $(0.80)
and $(2.15), respectively.

7.      NOTES PAYABLE AND DEMAND LINE OF CREDIT

        Notes payable consist of the following:

                                                      December 31, September 30,
                                                         1996           1997
                                                       ----------- -------------
Dollar denominated convertible debentures             $7,288,063     $12,042,727
Swiss franc denominated convertible debentures         7,222,846       4,639,213
7.4% to 21% capital lease obligations, 
   maturities ranging from August 1997 to May 2001     2,290,847       2,062,332
Notes payable at prime plus 3%                               ---       4,200,000
Other notes payable                                    2,186,619         134,588
                                                      ----------      ----------
                                                      18,988,375      23,078,860
Less - current maturities                              2,783,683       4,104,793
                                                      ----------      ----------
                                                     $16,204,692     $18,974,067
                                                      ==========      ==========

        On January 13,  1997 the Company  issued  $1,000,000  of 5%  convertible
debentures.  The convertible debentures have a conversion price which represents
a  discount  of 15% from the price of the  Company's  average  stock  price,  as
defined.  The Company  has  ascribed a value of  $176,471  for the 15%  discount
conversion feature.

        On March  10,  1997 the  Company  issued  $5,500,000  of 5%  convertible
debentures.  The convertible  debentures have a conversion  price of 100% of the
Company's  average stock price, as defined,  within the first 90 days and 90% of
the average stock price, as defined, thereafter. In addition, after 90 days, the
debentureholder  may  convert  no more than 1/3 of the  debenture  in any 30 day
period.  The Company has  ascribed a value of  $611,111  for the 10%  conversion
discount.

        The Company has credited  this ascribed  value for the discount  feature
described  above  to  additional  paid-in  capital,  and  this  amount  is being
amortized  to  interest  expense  over  the  expected  life  of the  convertible
debentures.  In  addition,  the Company  incurred  deferred  financing  costs of
$394,333  relating to the  issuance of these  debentures.  These costs have been
reflected in deferred costs in the accompanying  consolidated  balance sheet and
are  amortized  to interest  expense  over the term of the  related  convertible
debentures. Any remaining unamortized deferred financing costs will be reflected
as a reduction to stockholder's equity.

                                       10
<PAGE>

        On March  13,  1997,  the  Company  issued  $500,000  of 6%  convertible
debentures.  The convertible  debentures have a conversion price of $11.00,  and
may not be converted for the first 180 days following issuance.  Thereafter, the
debentureholder may convert no more than 33% in any 30 day period (or 34% of the
debentures  in the last 30 day  period).  The  Company has  accounted  for these
debentures at face value.

        On  September  30, 1997 the Company  issued  $7,000,000  of  convertible
debentures.  The  debentures  bear  interest  at  varying  rates of 6% to 8%, as
defined.  The  debentureholders  were also issued 413,109 shares of common stock
related  to this  financing.  The fair  market  value of the  common  stock  was
$1,050,000 and this amount is being treated as debt discount and being amortized
to interest expense over the next ninety days. The convertible debentures have a
conversion  price of 100% of the Company's  average stock price, as defined.  In
addition,  the debentureholder may convert no more than 33% in any 30 day period
( or 34% of the  debentures  in the  last 30 day  period).  The  Company  may be
required to repay these debentures if, among other things,  the Company's common
stock is suspended  from  trading on the NASDAQ  Small Cap Market,  the required
registration  statement  is not  declared  effective  by March  30,  1998 or the
Company  disposes  of  substantially  all of its assets or merges  with  another
entity in which the holders of the  Company's  voting  stock do not own at least
50% of the surviving entity.  The Company incurred  deferred  financing costs of
$350,000  relating  to the  issuance  of these  debentures.  These costs will be
reflected in deferred  costs and amortized to interest  expense over the life of
the debt or until conversion, at which time the remaining deferred costs will be
reflected as a reduction to stockholder's equity.

        Through September 30, 1997, investors converted $4,900,000 in face value
of 4.5% convertible  debentures and $6,007,275 of 5% convertible debentures with
accrued interest of $181,485 into 4,348,082 shares of common stock. In addition,
unamortized   deferred   financing  costs  totaling   $957,545  related  to  the
convertible  debentures  has been  reflected  as a  reduction  to  stockholders'
equity.

        During the first  quarter  ended March 31, 1997,  the  Company's  Comtel
Electronics,  Inc.  ("Comtel")  subsidiary  failed to satisfy certain  financial
covenants  for its line of credit with a bank due on November 30,  1998.  In the
third  quarter the line of credit was amended  and, as of  September  30,  1997,
Comtel  was in  compliance  with  all  financial  covenants.  The new  agreement
restructured  the debt so that $2.2  million  is now a term  loan at the  bank's
prime rate plus three percent payable over 24 months beginning in November 1997.
The remaining  balance  outstanding of $1,829,360 is  collateralized by Comtel's
assets and classified as a demand line of credit.

        During the second  quarter  ended June 30, 1997,  the Company  repaid an
existing $1,200,000 bridge loan plus accrued interest.  In addition,  the bridge
loan holders were provided 99,001 shares of common stock of Nexar  Technologies,
Inc.  ("Nexar")  and a warrant to purchase  95,625 shares of the common stock of
Dynaco  Corp.  ("Dynaco")  at $1.20 per  share in  exchange  for  their  Palomar
Electronic Corporation ("PEC") warrants.  This exchange was consummated based on
the relative fair market values of Dynaco and Nexar common stock.

        On September 25, 1997 the Company borrowed  $2,000,000 in exchange for a
promissory note at prime plus three percent.  The note and all accrued  interest
totaling $13,863 was paid in full on October 17, 1997.

        On July 3, 1996, the Company raised  $7,669,442  through the issuance of
9,675 units in a convertible debenture financing.  These units are traded on the
Luxembourg  Stock  Exchange.  Each  unit  consists  of a  convertible  debenture
denominated  in 1,000  Swiss  francs and a warrant to  purchase 24 shares of the
Company's common stock at $16.50 per share and is due July 3, 2003. The warrants
are  non-detachable  and may be  exercised  only if the related  debentures  are
simultaneously  converted,  redeemed or purchased.  Interest on the  convertible
debentures accrues at a rate of 4.5% per annum and is payable quarterly in Swiss
francs. The convertible debentures may be converted by the holder or the Company
commencing  October 1, 1996 at a conversion price equal to from 100% to 77.5% of
the price per share of the Company's common stock,  calculated as defined.  This
conversion price decreases from the third anniversary to the seventh anniversary
of the Swiss franc convertible  debentures,  and in no event is less than $7.00.
This  conversion  floor was decreased by consent of the parties from an original
price of $12.00.  The Company  ascribed a value of  $1,917,360  to this discount
conversion feature of this convertible debenture.  This amount will be amortized
to interest  expense  over the  remaining  life of the Swiss  franc  convertible
debenture. (See Note 12 and Part II, Item 1, "Legal Proceedings.")

                                       11
<PAGE>

8.      STOCKHOLDERS' EQUITY

        (a) Options

     During the nine months ended September 30, 1997, the Company issued options
to certain  employees to purchase an  aggregate  of  1,165,000  shares of common
stock at prices  ranging  from $2.50 to $6.50 per share.  During the same period
the Company  cancelled  options to purchase  1,030,100 shares of common stock at
prices  ranging  from  $2.38 to $10.50  per share.  Four  individuals  exercised
options to purchase an  aggregate  of 154,000  shares of common  stock at prices
ranging  from $2.00 to $3.00.  The total  proceeds  received by the Company were
$346,575.

        During the nine months ended  September  30, 1997,  the Company  granted
options to certain Tissue  Technologies,  Inc. ("TTI")  employees to purchase an
aggregate  of 60,845  shares of common  stock at an  exercise  price of $.01 per
share in settlement  of a stock option  dispute.  The  employees  simultaneously
exercised these options. The fair market value of the common stock issued totals
$152,113  and has been  reflected as a charge in the  accompanying  consolidated
statement of operations for the three and nine months ended September 30, 1997.

        (b) Warrants

        During the nine months  ended  September  30, 1997,  the Company  issued
warrants to certain  employees  to purchase an  aggregate  of 872,500  shares of
common stock at prices ranging from $2.50 to $8.875 per share. In addition,  the
Company  issued  warrants  to certain  directors  and an officer to  purchase an
aggregate  of 650,000  shares of common  stock at prices  ranging  from $3.25 to
$4.00 per share.  During the nine months ended  September 30, 1997,  the Company
cancelled warrants issued to certain employees and  debentureholders to purchase
an aggregate of 797,200  shares of common stock at prices  ranging from $6.00 to
$16.50 per share. In addition,  the Company cancelled warrants issued to certain
directors  and an officer to purchase an aggregate  of 200,000  shares of common
stock at prices  ranging  from $6.75 to $8.00 per share.  During the nine months
ended September 30, 1997, certain warrantholders  exercised warrants to purchase
an  aggregate  559,195  shares of common  stock at prices  ranging  from $.60 to
$2.25. The Company received total proceeds of $1,070,193 related to the exercise
of the warrants.  In addition,  net warrants to purchase  20,687 share of common
stock were exercised in the nine months ending September 30, 1997.

        (c) Reserved Shares

        At  September  30, 1997,  the Company has reserved  shares of its common
stock for the following:

                                                       September 30,
                                                            1997
                                                       -------------

     Convertible debentures                              7,353,599
     Stock option plans                                  3,709,504
     Warrants                                            9,577,940
     Employee 401(k) plan                                  212,690
     Employee stock purchase plan                          991,606
     Convertible preferred stock                         6,395,151
                                                       -------------
               Total                                    28,240,490
                                                       =============

        (d) Convertible Preferred Stock

        During the nine months ended  September 30, 1997, the Company  completed
the issuance of 16,000 shares of Series H Convertible Preferred Stock ("Series H
Preferred") for $16,000,000. The Series H Preferred accrues a premium at varying
rates of 6% to 8%, as defined.  The Series H  Preferred  may be  converted  into
common stock,  including any accrued but unpaid interest, at 100% of the average
stock  price for the first 179 days from the  closing  date,  90% of the average
stock  price  for the  following  90 days  and 85% of the  average  stock  price
thereafter.  The average  stock price for the Series H Preferred  is the average
closing bid price for the ten trading days immediately  preceding the conversion
date,  but in no event  less than  $6.00 on or prior to  October  27,  1997 and,
thereafter,  at the lower of $6.00 or the  average  closing bid price for the 20
consecutive trading days prior to October 27, 1997. The conversion price is also
adjustable for certain antidilutive events, as defined. The holder is restricted


                                       12
<PAGE>

for the first 209 days following the closing date to converting no more than 33%
of the  Series  H  Preferred  in any 30 day  period  (or 34% in the  last 30 day
period).  Under  certain  conditions,  the  Company  has the right to redeem the
Series H  Preferred.  The Company  has  ascribed a value of  $2,823,529  to this
discount  conversion  feature of the Series H  Preferred.  This  amount is being
amortized as an adjustment to earnings available to common shareholders over the
most  favorable  conversion  period  attainable  to the  holders of the Series H
Preferred  (270 days from the date of issuance of the Series H  Preferred).  See
Note 6.

        During the nine months ended  September 30, 1997, the Company  converted
shares of preferred stock,  accrued premium,  dividends and interest into shares
of common stock as illustrated below:

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

                                                                         Amount Converted
                                                                         Including Accrued
        Preferred                                  Number of             Premium, Dividends       Number of Common
          Stock                                   Preferred               and Interest and             Shares
          Series                                Shares Converted         Other Related Costs       Converted Into
        ---------                               ----------------         -------------------      ----------------

           E                                        2,128                     $ 114,539               332,859
           G                                        2,316                        71,997               362,824
           H                                        5,310                       121,761             2,592,025
                                                ----------------         -------------------      ----------------
Total Converted:                                    9,754                     $ 308,297             3,287,708
                                                ================         ===================      ================
</TABLE>

        (e) Stock Purchase Program

        During the first nine  months of 1997,  the  Company  purchased  145,000
shares  of its  common  stock  at an  aggregate  cost of  $427,102  as part of a
treasury  stock  purchase  program  approved by its Board of Directors in May of
1997.

        (f) Purchased Technology

        On  February  28,  1997,  Nexar  entered  into  an  Asset  Purchase  and
Settlement  Agreement as discussed  in Note 15 to  Financial  Statements  of the
Company's  Form 10-KSB,  as amended,  as of and for the year ended  December 31,
1996.  Under the terms of this agreement the Company  previously paid $1,250,000
in cash, and paid $351,060 in cash and issued 255,320 shares of Palomar's common
stock during the second  quarter  ended June 30,  1997.  The total value of this
purchased  technology  of  $2,750,000  will be amortized  over a period of three
years.

        (g) Nexar Initial Public Offering

        On April  14,  1997  Nexar  completed  an  initial  public  offering  of
2,500,000  shares at $9.00 per  share,  for net  proceeds  of  $19,592,910.  The
Company  has  recorded an increase in  stockholders'  equity of  $7,409,866,  in
accordance  with Staff  Accounting  Bulletin  No. 51 (SAB No. 51) as a result of
Nexar's  initial  public  offering.  The Company's  accounting  policy for gains
arising  under  SAB No.  51 is to  recognize  these  gains in its  statement  of
operations  to the  extent  that such gains are  realizable  at the date of each
transaction.

        As of the effective date of Nexar's initial public offering, the Company
owned  6,100,000  shares of Nexar's  common  stock and 45,684  shares of Nexar's
convertible preferred stock. The convertible preferred stock is convertible into
408,080  shares of Nexar's  common stock.  Pursuant to an agreement  between the
Company and Nexar,  1,200,000  common shares ( the  "Contingent  Shares") of the
total 6,508,080 common and common  equivalent  shares of Nexar that are owned by
the Company are to be placed in escrow and subject to a mandatory repurchase, in
whole or part, by Nexar at $0.01 per share after the 48 month anniversary of the
initial  public  offering of Nexar common stock unless these shares are released
from escrow.  The Contingent Shares are subject to the release to the Company in
installments  of 400,000  shares each upon the  achievement  of any three of the
four milestones as specified in the agreement between the Company and Nexar. The
milestones are based on Nexar achieving  certain  revenue,  net income and stock
price levels, as defined in the agreement.

        In April 1997,  the Company  purchased  300,000  shares of Nexar  common
stock  for  $2,777,484   from  Nexar's   underwriter  in  a  private   placement
transaction.

                                       13
<PAGE>

9.      RELATED PARTY TRANSACTIONS

        At December 31, 1996 and  September 30, 1997,  $578,680 and  $1,549,388,
respectively,  including  accrued  interest  at the  rate of 7% per  annum,  was
outstanding to certain now former  directors  under the Company's now terminated
corporate loan policy.

        The Company had loans  receivable  of $186,156 and  $146,406,  including
accrued  interest,  from  two  officers  of  Dynaco,  which  were  evidenced  by
promissory  notes due upon demand,  with accrued  interest at the rate of 7% per
annum. During the third quarter these notes were exchanged for the officers' PEC
warrants to purchase  600,000 shares of PEC common stock at $.30 per share.  The
Company  has  charged  to  expense  $332,562  in the  accompanying  consolidated
statement of operations for the nine months ended  September 30, 1997 related to
this exchange.

        In the  first  quarter  of 1997,  the  Company  invested  an  additional
$250,000  in a  privately  held  medical  and  cosmetic  services  company.  The
Company's cumulative  investment as of September 30, 1997 totaled  approximately
$750,000 and represents  approximately 12% of the total equity ownership of this
company.  An officer of CTI is a former  director of the privately held company.
In return for the $250,000  investment,  the Company  received 250,000 shares of
common stock and a promissory  note for  $249,900  accruing  interest at 12% per
annum.  In September  1997, the Company fully reserved for this  investment,  as
management's  assessment is that the Company's  investment has been  permanently
impaired, resulting in a charge to operations of $750,000.

        During the nine months ended September 30, 1997, the Company sold all of
the issued and  outstanding  common  stock of its wholly  owned  subsidiary,  CD
Titles, Inc. ("CD Titles").  In exchange,  the Company received three promissory
notes for an aggregate  total of $600,000 (the "Notes") and warrants to purchase
750,000 shares of CD Titles common stock at various exercise prices ranging from
$6.00 to $10.00 per share.  The sale of CD Titles did not have a material effect
on the  Company's  financial  position  or results of  operations.  The  Company
subsequently  exchanged  the Notes for a personal  guarantee by an officer and a
director  of CD  Titles  of a  $400,000  claim  against  the  Company,  and  the
cancellation  of an  approximately  $180,000  obligation  of the  Company to the
director of CD Titles.

10.     ASSET WRITE-OFF AND RESTRUCTURING

        During the third quarter,  the Company established  reserves for certain
operating  assets  and  liabilities  that  resulted  in a charge to  expense  of
approximately  $9,426,000.  Included in the reserves,  the Company  recognized a
restructuring  charge of $2,700,000  based on the decision to  discontinue  some
business units and consolidate  others.  Management  believes this restructuring
meets 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).

        The Company also assessed its non-core  long-term assets and investments
in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121,
Accounting for the Impairment of Long-Lived  Assets and for Long-Lived Assets to
be Disposed of, and determined that some investments' carrying value will not be
realizable  due to the  Company's  change in  strategy.  The  Company  has fully
reserved  for all  such  investments  resulting  in a charge  to  third  quarter
operations of approximately $13,548,000.

11.     PRO FORMA INFORMATION

        The  results of  operations  related to Comtel have been  included  with
those of the Company since March 20, 1996.

        Unaudited  pro forma  operating  results for the  Company,  assuming the
Comtel acquisition had been made as of January 1, 1996, are as follows:


                                        Nine Months Ended September 30,
                                        -------------------------------
                                             1996                1997
                                        ---------------  --------------
          Revenue                        $49,533,990       $63,206,446
          Net loss                      $(19,243,214)     $(67,167,702)
          Net loss per common share           $(0.80)           $(2.15)

                                       14
<PAGE>

12.     COMMITMENTS AND CONTINGENCIES

        The Company has issued  guarantees  to several of its  subsidiaries  for
payment of trade payables. The total amount guaranteed at September 30, 1997 was
$750,000.

        The Company was a defendant in a lawsuit  filed on March 14, 1996 in the
United  States  District  Court  for  the  Southern  District  of  New  York  by
Commonwealth Associates ("Commonwealth"). In its suit, Commonwealth alleged that
the Company had breached a contract with Commonwealth in which  Commonwealth was
to  provide  certain   investment   banking   services  in  return  for  certain
compensation. In January 1997, Commonwealth's motion for summary judgment on its
breach of  contract  claim was  granted,  and in April 1997 the  District  Court
awarded  Commonwealth  $3,174,070  in damages.  That  judgment  was  appealed by
Palomar and on August 18, 1997 the case was settled for $1.875  million.  During
the nine months ended September 30, 1997, the Company incurred $1.875 million in
settlement  costs related to the above matter and another $1.675 million related
to several other claims and associated litigation costs.

        The Company is a defendant in litigation  involving  four of the holders
of the Company's  convertible  debentures  denominated  in Swiss  francs.  These
debentureholders claim Palomar has violated three covenants in the indenture and
are  seeking  payments  totaling  $5.1  million.  The  Company  believes  it has
meritorious defenses against the suit and a loss is not probable.  (See Part II,
Item 1, "Legal Proceedings.")

        The Company is a defendant in litigation  involving a  shareholder.  The
shareholder  claims  disclosure  errors and  omissions  in the  Company's  proxy
statement and Certificate of Incorporation, as amended and restated. The Company
believes the suit is without  merit and a loss is not  probable.  The  potential
exposure  cannot  be  estimated  at this  time.  (See  Part II,  Item 1,  "Legal
Proceedings.")

13.     SUBSEQUENT EVENTS

        In September the Company signed a letter of intent with a distributor of
medical and  cosmetic  laser  products.  Pursuant  to the letter of intent,  the
parties are drafting a definitive  agreement  pursuant to which the  distributor
will pay an up-front fee for distribution  rights to the Company's  current hair
removal  products and future cosmetic laser products and a warrant to purchase a
predetermined amount of the Company's common stock, among other things.

        Subsequent  to quarter  end, the Company  entered  into two  non-binding
letters  of  intent  with the  management  of TTI and the  management  of Dynaco
setting forth terms of a potential  management  buy-out of TTI and of Dynaco and
its  subsidiaries,  respectively.  The  divestiture of TTI is not anticipated to
have a material impact on the Company's financial statements; the divestiture of
Dynaco and its subsidiaries may have a material impact on the Company's  results
of operations.

        On October 1, 1997 the Company  issued  104,348  shares of Nexar  common
stock to an investor. In a previous  transaction,  the Company sold the investor
200,000  shares of Nexar common stock for $10.00 per share and  communicated  an
expected  initial public  offering price of $12.00 per share.  These  additional
shares were issued as consideration for the actual initial public offering price
of $9.00.

        On  October  1, 1997 the  holder of 5,000  shares of Series G  Preferred
Stock (the "G Preferred  Shares")  exchanged the G Preferred  Shares for 240,000
shares of Palomar  common stock,  956,388  shares of Nexar common  stock,  and a
$47,731 cash payment. In connection with the agreement, the Company has promised
to file a registration  statement  registering  the resale of the Palomar common
stock with the  Securities and Exchange  Commission to be declared  effective no
later than  December 31,  1997.  If the  registration  statement is not declared
effective by this date, the Company is obligated to issue  additional  shares of
its  common  stock  to  the  investor  as  defined  in the  Registration  Rights
Agreement.



                     [This space intentionally left blank.]


                                       15
<PAGE>

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

MEDICAL SEGMENT REVENUE AND GROSS MARGIN: Three months ended September 30, 1997,
compared to three months ended September 30, 1996

        For the three months ended  September 30, 1997,  the Company had medical
segment  revenues  of $5.8  million as  compared  to $5.1  million for the three
months ended  September 30, 1996. The increase in the Company's  medical segment
of $693,000 or 13% was mainly due to  additional  sales volume of  approximately
$3.3 million  associated with the  EpiLaser(tm) and other medical laser products
manufactured by the Company's wholly-owned  subsidiary Palomar Medical Products,
Inc.  ("PMP").  The Company  obtained  FDA  clearance  to market and to sell the
EpiLaser  product  for hair  removal in the United  States in March  1997.  This
increase was offset by a decline of  approximately  $2.7 million in sales volume
for the Company's  TruPulse(r) laser product.  The Company believes that overall
revenues from its medical  segment will continue to increase due to its improved
manufacturing  process,  market demand for its EpiLaser and successor  products,
and an improved distribution network.

        Gross margin in the medical segment for the three months ended September
30, 1997 was $917,000 ( 16% of  revenues)  versus $1.3 million (25% of revenues)
for the three  months  ended  September  30,  1996.  The decline in gross margin
dollars  in 1997  occurred  mainly  due to lower  revenues  associated  with the
Company's  TruPulse  product,  as discussed  above.  The decline in gross margin
percent was caused by a lower margin attained on the Company's  EpiLaser product
due to  initial  manufacturing  and  production  of this  product.  The  Company
believes that the gross margin for its EpiLaser  product should begin to improve
in 1998 as the Company obtains manufacturing  efficiencies and volume production
and revenue increases due to an improved distribution network.

ELECTRONICS  SEGMENT REVENUE AND GROSS MARGIN:  Three Months ended September 30,
1997, compared to three months ended September 30, 1996

        For  the  three  months  ended  September  30,  1997,  the  Company  had
electronics  revenues  of  $12.4  million  as  compared  to $19.5  million  (36%
decrease)  for the three months ended  September  30, 1996.  The decrease in the
Company's  electronics segment of approximately $7.1 million was principally due
to a decrease  in Nexar  sales  volume of $4.8  million,  a  decrease  in Dynaco
revenues of $1.5 million and a decrease in compact disc sales of $750,000 due to
the Company's  disposal of CD Titles.  Nexar's  decrease in revenue was due to a
delay in the  introduction of its proprietary  upgradeable XPA ("XPA")  personal
computer ("PC") in the third quarter.  The XPA was delayed due to  manufacturing
delays  caused by an offshore  supplier of  motherboards.  Nexar has solved this
problem by entering a partnership  with a leading  supplier of motherboards  and
the Company believes XPA revenues will increase going forward.  Dynaco generated
sales of  approximately  $8.1 million for the quarter  ended  September 30, 1997
compared to sales of approximately  $9.6 million for the quarter ended September
30,  1996,  due mainly to a decrease in revenue  generated  by  Dynaco's  Comtel
subsidiary.   The  revenue  at  Comtel,  a  contract  electronics  manufacturer,
decreased  due to changes in its  customer  mix,  lower  sales  volume  from its
exiting customers and restructuring of its management team.

        In the  electronics  segment of the  Company's  business,  gross  margin
decreased to negative $1.7 million for the quarter  ended  September 30, 1997 as
compared  to a gross  margin of $2.7  million  (14% of  revenues)  for the three
months ended  September 30, 1996. This decrease in gross margin is the result of
a decrease in gross  margin at both Nexar and  Dynaco.  Nexar's  negative  gross
margin of  $965,000 is due to  unabsorbed  overhead  costs at its  manufacturing
facility due to key inventory delays  discussed  above.  Comtel, a subsidiary of
Dynaco,  incurred a negative gross margin of $779,000 for the three months ended
September 30, 1997.  This gross loss was  attributable  to  unabsorbed  overhead
costs caused by Comtel's lower volume and change in customer base.

CONSOLIDATED  OPERATING  AND OTHER  EXPENSES:  Three months ended  September 30,
1997, compared to three months ended September 30, 1996

        Research  and  development  costs  increased  to  $3.6  million  (20% of
revenues) for the three months ended  September 30, 1997,  from $1.6 million (7%
of revenues) for the three months ended  September 30, 1996.  This 119% increase
in research and  development  reflects the  Company's  continuing  commitment to
research and development  for medical devices and delivery  systems for cosmetic
and other  medical  applications  using a variety  of lasers,  while  continuing
dermatology   research   utilizing   the   Company's   ruby  and  diode  lasers.
Approximately  $2.9  million of the $3.6 million  expended in the quarter  ended
September  30, 1997 is attributed to the medical  segment.  Management  believes
that research and development  expenditures  will decrease over the next year as
the Company  completes its clinical trials of its medical products and begins to


                                       16
<PAGE>

market its newly  developed  products.  The remaining  $653,000  expended in the
current year's third quarter was in the electronics  segment,  mainly due to the
continued development and improvement of Nexar's PC products.

        General and  administrative  expenses  remained constant at $5.6 million
(31% of revenues)  for the three months ended  September  30, 1997,  compared to
$5.6 million (23% of revenues)  for the three months ended  September  30, 1996.
The Company's 1996 general and  administrative  expenses included  non-recurring
charges  of  $625,000.   Excluding  the  non-recurring   charges,   general  and
administrative   expenses  increased  13%.  This  increase  is  attributable  to
increased  administrative  resources  required  to  oversee  the  growth  of the
Company's  medical  and  electronics  business  segments.  Approximately  19% of
general and administrative expense for the three months ended September 30, 1997
are   attributable   to   the   Company's   wholly-owned   Cosmetic   Technology
International,  Inc.  ("CTI")  subsidiary.  CTI is in the process of opening and
establishing  revenue  sharing sites with operating  partners.  To date, CTI has
opened 14 sites in domestic and international  markets.  The Company anticipates
general and  administrative  expense will  decrease in the future as a result of
the third quarter restructuring.

        Selling  and  Marketing  expenses  increased  to  $4.0  million  (22% of
revenues) for the three months ended  September 30, 1997,  from $2.2 million (9%
of revenues)  for the three months ended  September  30, 1996.  This increase in
substantially all areas of selling and marketing is attributable to the increase
in sales force  throughout the Company,  in anticipation of increased  revenues.
The Company  anticipates  selling and marketing  expense as a percent of revenue
will decrease in the future as a result of the third quarter  restructuring  and
an anticipated distribution agreement

        Business  Development  and Financing  Costs increased to $597,000 (3% of
revenues) for the three months ended  September  30, 1997,  from $477,000 (2% of
revenues) for the three months ended  September  30, 1996.  This 25% increase is
attributable to the Company's  restructuring  efforts. The Company has increased
efforts to divest of non-core  subsidiaries  and  continues  to utilize  outside
sources for funding of its existing core medical product subsidiaries.

        Restructuring and asset write-off costs of $9.4 million were incurred in
the  three  months  ended  September  30,  1997.  This  non-recurring  charge to
operating expenses reflects  restructuring of the Company's operations and asset
write-off costs for certain  operating assets that the Company believes were not
fully  realizable  for both core and  none-core  medical  product  subsidiaries.
Included in this charge is a $2.7 million reserve for severance costs associated
with consolidating the selling,  general and administrative  functions including
the closing of certain facilities.

        Interest  expense  increased  to $1.1 million for the three months ended
September 30, 1997, from $510,000 for the three months ended September 30, 1996.
The 1997 amount includes  $284,000 of non-cash  interest  expense related to the
value ascribed to the discount of the convertible debentures. This 110% increase
is primarily the result of an increase in convertible debenture  financings,  an
additional  outstanding line of credit  financing at Dynaco's Comtel  subsidiary
which  was  entered  into  in  December  1996,  and  interest   penalty  on  the
Commonwealth Associates lawsuit settlement.

        Interest  income  decreased  to  $141,000  for the  three  months  ended
September 30, 1997, from $644,000 for the three months ended September 30, 1996.
This  decrease is primarily  the result of a decrease in the  Company's  average
outstanding cash and cash equivalents balances.

        Net realized and  unrealized  trading  gains were $446,000 for the three
months ended  September 30, 1997,  down from gains of $1.8 million for the three
months ended  September 30, 1996. The gains reflect market  fluctuations.  It is
the  Company's  intention  to  continue  to  liquidate  a portion of its trading
investments  in the near term,  which may result in additional  trading gains or
losses in the future.

        Asset write-off costs of $13.5 million were incurred in the three months
ended  September 30, 1997.  This one time charge  reflects asset write-off costs
for  notes and  investments  in both  non-core  subsidiaries  and other  outside
entities.

        Minority  interest in the loss of  subsidiary  was $1.9  million for the
three months ended  September  30, 1997  compared to $1,000 for the three months
ended September 30, 1996. This increase in the minority  interest in the loss of
a subsidiary  is due to the  successful  completion  of Nexar's  initial  public
offering  in which  approximately  35% of Nexar's  common  stock was sold to the
public.

                                       17
<PAGE>

MEDICAL SEGMENT REVENUE AND GROSS MARGIN:  Nine months ended September 30, 1997,
compared to nine months ended September 30, 1996

        For the nine months ended  September  30, 1997,  the Company had medical
segment  revenues of $15.7  million as  compared  to $12.8  million for the nine
months ended  September 30, 1996. The increase in the Company's  medical segment
of  $2.9  million  or  23%  was  mainly  due  to  additional   sales  volume  of
approximately  $9.5 million associated with the EpiLaser and other medical laser
products  manufactured by PMP. The Company  obtained FDA clearance to market and
to sell the  EpiLaser  product  for hair  removal in the United  States in March
1997.  This  increase was offset by a decline of  approximately  $6.6 million in
sales volume for the Company's TruPulse laser product. The Company believes that
overall  revenues from its medical  segment will continue to increase due to its
improved  manufacturing  process,  market  demand for its EpiLaser and successor
products, and an improved distribution network.

        Gross margin in the medical  segment for the nine months ended September
30,  1997 was  $1.3  million  ( 8% of  revenues)  versus  $2.3  million  (18% of
revenues)  for the nine months ended  September  30, 1996.  The decline in gross
margin dollars in 1997 occurred mainly due to lower revenues associated with the
Company's  TruPulse  product,  as discussed  above.  The decline in gross margin
percentage  was  caused by lower  margins  attained  on the  Company's  EpiLaser
product due to initial manufacturing and production of this product. The Company
believes that the gross margins for its EpiLaser product should begin to improve
in 1998 as the Company obtains manufacturing  efficiencies and volume production
and revenues increase due to an improved distribution network.

ELECTRONICS  SEGMENT  REVENUE AND GROSS MARGIN:  Nine months ended September 30,
1997, compared to nine months ended September 30, 1996

        For  the  nine  months  ended   September  30,  1997,  the  Company  had
electronics  revenues  of  $47.5  million  as  compared  to $36.4  million  (31%
increase)  for the nine months ended  September  30,  1996.  The increase in the
Company's electronics segment of approximately $11.1 million was principally due
to an increase in Nexar sales volume of $11 million.  Nexar's  revenue has grown
since the  introduction  in April  1996 of its  proprietary  upgradeable  PC and
revenue at Nexar is expected to  continue to grow with the  introduction  of its
proprietary upgradeable XPA PC in the third quarter.

        In the  electronics  segment of the  Company's  business,  gross  margin
decreased  to negative  $434,000  (negative  1% of revenue)  for the nine months
ended  September  30, 1997 as compared to a gross margin of $4.1 million (11% of
revenues) for the nine months ended  September 30, 1996.  This decrease in gross
margin is the result of a  decrease  in gross  margin at both Nexar and  Dynaco.
Nexar's nine month ended  September  30, 1997 gross margin of $380,000 is due to
unabsorbed  overhead  costs at its  manufacturing  facility due to key inventory
delays  discussed  above.  Comtel,  a subsidiary of Dynaco,  incurred a negative
gross margin of $2.9 million for the nine months ended  September 30, 1997. This
gross loss was  attributable  to  unabsorbed  overhead  costs caused by Comtel's
lower volume and change in customer base.

CONSOLIDATED OPERATING AND OTHER EXPENSES: Nine months ended September 30, 1997,
compared to nine months ended September 30, 1996

        Research  and  development  costs  increased  to  $9.5  million  (15% of
revenues) for the nine months ended  September 30, 1997,  from $5.7 million (12%
of revenues) for the nine months ended  September 30, 1996. This 66% increase in
research  and  development  reflects  the  Company's  continuing  commitment  to
research and development  for medical devices and delivery  systems for cosmetic
and other  medical  applications  using a variety  of lasers,  while  continuing
dermatology   research   utilizing   the   Company's   ruby  and  diode  lasers.
Approximately $7.6 million of the $9.5 million expended in the nine months ended
September  30, 1997 is attributed to the medical  segment.  Management  believes
that research and development  expenditures  will decrease over the next year as
the Company  completes its clinical trials of its medical products and begins to
market its recently developed  products.  The remaining $1.7 million expended in
the current year was in the  electronics  segment,  mainly due to the  continued
development and improvement of Nexar PC products.

        General and  administrative  expenses increased to $16.7 million (26% of
revenues)  for the nine  months  ended  September  30,  1997,  compared to $14.2
million (29% of revenues)  for the nine months ended  September  30, 1996.  This
increase is  attributable  to  increased  administrative  resources  required to
oversee the growth of the Company's medical and electronics  business  segments.
Approximately  15% of general and  administrative  expenses  for the nine months
ended September 30, 1997 are  attributable to the Company's CTI subsidiary.  CTI


                                       18
<PAGE>

is in the  process  of  opening  and  establishing  revenue  sharing  sites with
operating  partners.   To  date,  CTI  has  opened  14  sites  in  domestic  and
international  markets.  The  Company  anticipates  general  and  administrative
expense  will  decrease  in  the  future  as  a  result  of  the  third  quarter
restructuring.

        Selling  and  Marketing  expenses  increased  to $11.9  million  (19% of
revenues) for the nine months ended  September 30, 1997,  from $6.3 million (13%
of revenues)  for the nine months ended  September  30, 1996.  This  increase in
substantially all areas of selling and marketing is attributable to the increase
in sales volume  throughout the Company,  particularly  in the medical  products
segment  as  revenues  have  begun  to  increase  now that  the  Company  has an
FDA-cleared  laser hair removal  product.  The Company  anticipates  selling and
marketing  expense  as a percent  of revenue  will  decrease  in the future as a
result  of the  third  quarter  restructuring  and an  anticipated  distribution
agreement.

        Business  Development  and Financing Costs decreased to $2.1 million (3%
of revenues) for the nine months ended September 30, 1997, from $2.4 million (5%
of revenues) for the nine months ended  September 30, 1996. This 15% decrease is
attributable  to  the  Company's  maturation.  The  Company  has  decreased  its
acquisition  and  financing  activities  and is now  focused on  developing  and
growing its existing core medical  products and exiting its non-core  electronic
businesses.

        Settlement and  Litigation  costs were $3.6 million (6% of revenues) for
the nine months ended September 30, 1997;  there were no settlement costs during
the nine months  ended  September  30,  1996.  The costs are  attributable  to a
lawsuit  brought by an investment  banker and other smaller  claims made against
the  Company.  In the suit,  the  investment  banker  alleged  that the  Company
breached a  contract  in which the  banker  was to  provide  certain  investment
banking  services in return for certain  compensation.  This case was settled on
August 18, 1997 for $1.875 million.

        Restructuring and asset write-off costs of $9.4 million were incurred in
the nine months  ended  September  30,  1997.  This one time charge to operating
expenses reflects  restructuring and asset write-off costs for certain operating
assets that the Company  believes  were not fully  realizable  for both core and
none-core  medical  product  subsidiaries.  Included  in this  charge  is a $2.7
million reserve for severance costs associated with  consolidating  the selling,
general  and  administrative   functions,   including  the  closing  of  certain
facilities.

        Interest  expense  increased  to $4.6  million for the nine months ended
September  30, 1997,  from $1.2 million for the nine months ended  September 30,
1996. This amount includes $2.6 million of non-cash  interest expense related to
the value  ascribed to the  discount of the  convertible  debentures.  This 272%
increase  is  primarily  the  result of an  increase  in  convertible  debenture
financings and an additional  outstanding  line of credit  financing at Dynaco's
Comtel subsidiary which was entered into in December 1996.

        Interest  income  decreased  to  $664,000  for  the  nine  months  ended
September  30, 1997,  from $1.8 million for the nine months ended  September 30,
1996.  This  decrease is  primarily  the result of a decrease  in the  Company's
average outstanding cash and cash equivalents balances.

        Net realized and  unrealized  trading  gains were  $996,000 for the nine
months ended  September  30, 1997,  down from gains of $2.5 million for the nine
months ended  September 30, 1996. The gains reflect market  fluctuations.  It is
the  Company's  intention  to  continue  to  liquidate  a portion of its trading
investments  in the near term,  which may result in additional  trading gains or
losses in the future.

        Asset  write-off costs of $13.5 million were incurred in the nine months
ended  September 30, 1997.  This one time charge  reflects asset write-off costs
for  notes and  investments  in both  non-core  subsidiaries  and other  outside
entities.

        Minority  interest in the loss of  subsidiary  was $2.9  million for the
nine months  ended  September  30, 1997  compared to $47,000 for the nine months
ended September 30, 1996. This increase in the minority  interest in the loss of
a subsidiary  is due to the  successful  completion  of Nexar's  initial  public
offering  in which  approximately  35% of Nexar's  common  stock was sold to the
public.

Liquidity and Capital Resources

        As of September 30, 1997,  the Company had $15.1  million in cash,  cash
equivalents  and  trading  securities  including  $2.7  million of cash and cash
equivalents held at the Company's Nexar subsidiary. During the nine months ended


                                       19
<PAGE>

September 30, 1997 the Company  generated  $16.7 million,  $15.0 million,  $19.7
million  and $3.9  million in net  proceeds  from the  issuance  of  convertible
debentures,  the sale of its preferred  stock,  the initial  public  offering of
Nexar and the sale of Palomar-owned Nexar common stock, respectively.

        The  Company's  net loss for the nine months  ended  September  30, 1997
included  the  following  non-cash  items:  $3.6  million  of  depreciation  and
amortization  expense;  $2.6 million of additional  interest expense relating to
the amortization of the discounts on the convertible debentures;  $23 million in
restructuring and asset write-off costs; and a legal settlement  accrual of $2.9
million  in  connection  with a  breach  of  contract  case  involving  a former
investment banking consultant.

        The Company  anticipates  that capital  expenditures  for the  remaining
three months of 1997 will total  approximately  $600,000,  of which  $500,000 is
attributed the purchase of laser  products for CTI's laser centers.  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.

        Dynaco has a three-year  revolving credit and security  agreement with a
financial  institution.  The  agreement  provides  for  the  revolving  sale  of
acceptable accounts  receivable,  as defined in the agreement,  with recourse at
85% of face value, up to a maximum commitment of $3 million. As of September 30,
1997, the amount of accounts receivable sold that remained uncollected totaled $
2.1 million net of related reserves and fees, as defined in the agreement.  This
amount is classified as a revolving line of credit in the  accompanying  balance
sheet as of September 30, 1997. The interest rate on such outstanding amounts is
the bank's prime rate plus 1.5%, and interest is payable monthly in arrears. The
financing  is   collateralized   by  the  purchased   accounts   receivable  and
substantially  all of Dynaco's assets.  Borrowings under this loan agreement are
guaranteed by the Company.

        On December 5, 1996,  Comtel  entered into a loan  agreement with a loan
association  which  provided  for  borrowings  up to  $5,000,000  in the form of
revolving  receivable and inventory loans and a term note payable over two years
beginning  in November  1997.  Borrowings  under the  revolving  receivable  and
inventory loans are limited by a borrowing base calculation on eligible accounts
receivable  and  inventory,  and  are  collateralized  by  accounts  receivable,
inventory,  and certain other assets.  Borrowings  bear interest at the lender's
prime rate plus 3% and amounted to $1.8 million as of  September  30, 1997.  The
loan agreement  terminates on November 30, 1998.  Borrowings under the term loan
of $2.2 million bear interest at the bank's prime rate plus 3%. The term loan is
payable in monthly installments over two years beginning in November 1997.

        A large part of the Company's  medical products business is still in the
developmental  stage,  with  significant  research  and  development  costs  and
regulatory constraints that currently limit sales of its medical products. 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 sooner.  The Company continues
to investigate several financing alternatives, including strategic partnerships,
additional bank  financing,  private debt and equity  financing,  liquidation of
assets and other  sources.  The Company  believes  that it will be successful in
obtaining  additional  financing in order to fund current operations in the near
future.

Factors That May Affect Future Results

        The matters described herein contain "forward-looking"  information,  as
that term is defined in the  Private  Securities  Litigation  Reform Act of 1995
(the "Act"), including, without limitation, statements relating to financial and
sales  projections,   divestiture  of  non-core  subsidiaries,   market  demand,
manufacturing  efficiencies,  gross  margins,  decreases  in  certain  expenses,
execution of a distribution  agreement and an improved distribution network, and
results of  operations,  restructuring  and  litigation  that  involve  risk and
uncertainties  that may  individually or mutually  impact the matters  discussed
herein.  The Company  cautions  investors  that there can be no  assurance  that


                                       20
<PAGE>

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 factors  identified in the Company's
Form  10-KSB,  as  amended,  for the  year  ended  December  31,  1996,  and the
following:

        The Company and  certain of its  subsidiaries  have a history of losses,
        and the Company expects its losses to continue.  The Company must secure
        additional   financing  to  complete   its   research  and   development
        activities,  commercialize its current and proposed medical products and
        services, and fund ongoing operations.

        The Company's future operating strategy and results are dependent on its
        ability to  successfully  divest its non-core  electronic  subsidiaries.
        There can be no assurance that the Company will be able to  successfully
        execute this plan.

        The Company's future  operating  results are dependent on its ability to
        develop,  produce and achieve Food and Drug Administration  approval for
        certain  medical  products  and market new and  innovative  products and
        services.  There are numerous  risks  inherent in this complex  process,
        including  rapid  technological  change  and the  requirement  that  the
        Company  bring to market in a timely  fashion new  products and services
        which meet customers' changing needs.

        The  Company's   business  segments  operate  in  a  highly  competitive
        environment  and  in  highly  competitive   industries,   which  include
        significant  competitive  pricing pressures and intense  competition for
        skilled employees.

        The  market  price  of the  Company's  securities  could be  subject  to
        fluctuations  in response to quarter to quarter  variations in operating
        results,  changes in analysts' earnings estimates,  market conditions in
        the high technology  sector, as well as general economic  conditions and
        other factors external to the Company.

        In July 1997, one of Nexar's two outside turn-key manufacturers notified
        Nexar of its  inability to timely  manufacture  on a going forward basis
        Nexar's proprietary  motherboards.  Nexar has made arrangements with two
        new manufacturers to assume timely production of the motherboards. Nexar
        does not believe that the transition to the new manufacturers  will have
        a long-term  material  adverse effect on Nexar, but the several weeks it
        took to resume full  production of these key components had a short-term
        negative  impact on Nexar's  results of  operations in the third quarter
        due to the  possibility  of limited  delays in the initial  shipments of
        Nexar's new XPA product,  and could similarly  impact Nexar's results of
        operations in the fourth quarter.

        The Company and its  subsidiaries  are  involved in disputes  with third
        parties.  Such disputes  have  resulted in litigation  with such parties
        and, although the Company is a plaintiff in several matters, the Company
        is subject to claims and counterclaims for damages and has incurred, and
        likely will continue to incur,  legal  expenses in connection  with such
        matters.  There can be no assurance that such  litigation will result in
        favorable  outcomes for the Company.  The Company is unable to determine
        the total  expense or possible  loss,  if any,  that may  ultimately  be
        incurred  in the  resolution  of these  proceedings.  These  matters may
        result in diversion of management time and effort from the operations of
        the business.  After  consideration  of the nature of the claims and the
        facts  relating  to these  proceedings,  the Company  believes  that the
        resolution of these  proceedings  will not have a material effect on the
        Company's  business,  financial  condition  and  results of  operations;
        however,  the  results of these  proceedings,  including  any  potential
        settlements, are uncertain and there can be no assurance to that effect.
        (See Part II, Item 1, "Legal Proceedings.")

        The Company  undertakes no obligation to release publicly the results of
any  revision 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.

                     [This space intentionally left blank]

                                       21
<PAGE>

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

        On October 7, 1996 the Company  filed a declaratory  judgment  action in
the United  States  District  Court for the  District of  Massachusetts  against
MEHL/Biophile  ("MEHL")  seeking (i) a declaration that MEHL is without right or
authority to threaten or maintain  suit against the Company or its customers for
alleged infringement of the patent held by MEHL's subsidiary Selvac Acquisitions
Corp.  ("Selvac"  and the "Selvac  Patent"),  that the Selvac Patent is invalid,
void and  unenforceable,  and that the  Company  does not  infringe  the  Selvac
patent;  (ii)  a  preliminary  and  permanent  injunction  enjoining  MEHL  from
threatening  the  Company  or its  customers  with  infringement  litigation  or
infringement;  and  (iii)  an  award  to the  Company  of  damages  suffered  in
connection with MEHL's conduct.  On March 7, 1997,  Selvac filed a complaint for
injunctive relief and damages for patent infringement and for unfair competition
against the Company,  its Spectrum Medical  Technologies and Spectrum  Financial
Services  subsidiaries,  and a New Jersey  dermatologist,  in the United  States
District Court for the District of New Jersey.  Selvac's  complaint alleges that
the Company's EpiLaser infringes the Selvac Patent and that the Company unfairly
competed by promoting  the EpiLaser for hair removal  before it had received FDA
approval for that specific application. The Company and Selvac agreed to dismiss
the Massachusetts  litigation without prejudice.  Palomar has brought in the New
Jersey action its claims that the Selvac patent is invalid, that the Company has
not  infringed  the Selvac  patent,  that MEHL  should be  enjoined  from making
further assertions concerning infringement and unfair competition,  and that the
Company should be awarded attorney fees and other appropriate  relief. Thus both
the Company's  and MEHL's claims will be tried on the merits in New Jersey.  The
court  has  granted   Palomar's   motion  to  dismiss  Selvac's  federal  unfair
competition claim so far as it depends on Palomar's  supposed  violations of FDA
rules.  The Company believes that MEHL's claims are without merit. The extent of
exposure of the Company cannot be determined at this time.

     On October 16, 1997, the Company  brought a declaratory  judgment action in
U.S.  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").  (At
current  exchange rates,  the principal  amount of the Swiss Franc Debentures is
approximately  US$ 6.75  million.) The  defendants in this action are Banque SCS
Alliance  SA,  Arbuthnot  Fund  Managers,   Ltd.,  Banca   Commerciale   Lugano,
Privatinvest  Bank AG (these four  defendants are 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.  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  are current.  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.  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.  The  Asserting  Holders
sought a temporary  restraining  order  attaching  bank accounts and barring the
Company from transferring any interest in securities of its subsidiearies.  At a
hearing on  November  6, 1997,  the Court  denied  this  motion.  A  preliminary
injunction  hearing  concerning  essentially  the same  issues is  scheduled  to
commence on November 21, 1997. As of November 13, 1997, acting under appropriate
provisions  of the  indentures,  the Company  notified  the holders of the Swiss
Franc Debentures that is is causing the conversion of all of the Debentures into
an  aggregate  of 914,024  shares of the  Company's  Common  Stock.  The Company
believes  that its  position in these  matters is correct and intends to contest
the claims of the Asserting Holders vigorously.

        On August 27, 1997,  Pamela  Siegman,  as Trustee for the Pamela Siegman
Trust,  filed an action in the Court of Chancery of the State of Delaware in and
for New Castle County against Palomar and each of its current  directors and two
former  directors.   Siegman,   purportedly  on  behalf  of  similarly  situated
shareholders, claims disclosure errors and omissions in Palomar's annual meeting
proxy  statement  concerning,  among  other  things,  the  proposals  for  (a) a
staggered board; and (b) amendments to the Company's stock option plans. Siegman
also  claims  that  all the  Company's  preferred  stock  is void  because  of a
purported  deficiency in Palomar's  Certificate  of  Incorporation.  Siegman has
abandoned her disclosure claim concerning the staggered board.  Palomar believes
that Siegman's remaining claims are without merit.

                                       22
<PAGE>

Item 2. Changes in Securities

        Convertible Debentures

        Pursuant to Section 4(2) of the Securities  Act of 1933, as amended,  on
September  30,  1997,  the Company  sold a total of  $7,000,000  in  convertible
debentures  to  three  investors;  $3,500,000  to JNC  Opportunity  Fund,  Ltd.,
$1,500,000 to Diversified  Strategies  Funds,  L.P. and $2,000,000 to Southbrook
International  Investments,  Ltd. Each investor  received shares of common stock
upon issuance of the debentures. The number of shares of common stock were equal
to 15% of the original  principal amount of the debenture divided by the average
closing bid price for the three trading days  commencing on October 1, 1997. The
debentures accrue interest at a rate of 6% over the first 179 days, 7% over days
180-269 and 8% thereafter. The convertible debentures have a conversion price of
100% of the average stock price, as defined.  The debentureholder may convert no
more  than  33% in any  30 day  period  (or  34%  in the  last  30 day  period).
Commissions on this transaction totaled $350,000.

Item 3. Defaults upon Senior Securities

        Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

        The Company held its Annual  Meeting of  Stockholders  on September  15,
1997.  At the Annual  Meeting,  Louis P.  Valente,  Buster C.  Glosson,  John M.
Deutch,  James G. Martin and A. Neil Pappalardo were elected as directors of the
Company,  to serve until the Company's  1998 Annual Meeting of  Stockholders  or
special  meeting  in lieu  thereof,  or until  their  successors  have been duly
elected and qualified. In addition, the stockholders voted upon proposals to (1)
amend the Company's  Restated  Certificate  of  Incorporation  to (i) divide the
Company's Board of Directors into three classes each class  consisting as nearly
as possible of  one-third of the whole  number of the Board of  Directors;  (ii)
require that action  required or permitted  to be taken by  stockholders  of the
Company be taken at an annual or  special  meeting  of  stockholders  and not by
written  consent  by  stockholders;  and  (iii)  provide  that,  unless  certain
conditions were met, the proposed amendments could not be amended without a vote
of the holders of 75% of the outstanding shares of stock of the Company entitled
to vote at a meeting  of  stockholders  held for the  purpose  of voting on such
amendment;  (2) amend the Company's 1991, 1993, 1995 and 1996 Stock Option Plans
to provide  that the  Committee  that  administers  those Plans  should have the
right, in its discretion,  to accelerate the date of exercise of any option; (3)
amend the Company's 1996 Employee Stock Purchase Plan to eliminate the six month
waiting period for eligibility,  and to provide that participating employees may
purchase  the  Company's  common stock for 85% of Fair Market Value on the Entry
Date or the Purchase Date of the Purchase  Period,  as defined in the Plan;  and
(4) ratify the  appointment by the Board of Directors of Arthur  Andersen LLP as
auditors of the Company for the fiscal year ending December 1997.

        A tabulation of the votes on the above-referenced matters follows:

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

                                                  Votes Against                      Broker
                                   Votes For      or Withheld         Abstentions    Non-Votes
Election of Louis P. Valente       29,298,365     1,112,495

Election of John M. Deutch         26,299,105     1,111,755

Election of Buster C. Glosson      26,297,105     1,113,755

Election of James G. Martin        26,286,145     1,124,715

Election of A. Neil Pappalardo     26,299,105     1,111,755

Charter Amendments                  7,359,788     1,713,950            323,328       18,022,294

Amendments to Stock Option Plans   23,063,902     2,434,626            475,761        1,438,071

Amendment to Employee Stock 
     Purchase Plan                 23,351,436     2,213,407            412,746        1,440,071

Ratification of 
     Arthur Andersen LLP 
     as Independent Auditors       26,664,600      458,651             296,109  
</TABLE>

                                       23
<PAGE>

Item 5. Other Information

        Not applicable.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

3.1     Certificate  of Correction of the  Certificate of  Incorporation  of the
        Company as filed with the Delaware  Secretary of State on September  23,
        1997

3.2     Certificate of Correction of the Restated  Certificate of  Incorporation
        of the  Company  as  filed  with  the  Delaware  Secretary  of  State on
        September 23, 1997

*3.3    By-laws of the Company, as amended, incorporated by reference to Exhibit
        No. 3.5 of the Company's  Annual  Report on Form  10KSB/A-4 for its year
        ending December 31, 1996

4.1     Amended 1996 Employee Stock Purchase Plan

4.2     First Supplemental Indenture

27      Financial Data Schedule

(b) Reports on Form 8-K.

        None.


        *       Previously   filed  on  August   14,   1997  as  an  exhibit  to
                Registration Statement No. 333-25209. 



                                       24
<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 November 14, 1997.

                                              PALOMAR MEDICAL TECHNOLOGIES, INC.
                                                            (Registrant)



DATE:  November 14, 1997                      By:     /s/ Louis P. Valente
                                                  ------------------------------
                                                    Louis P. Valente
                                                    President and 
                                                    Chief Executive Officer
                                                   (Principal Executive Officer)



DATE:  November 14, 1997                             /s/ Joseph P. Caruso
                                                  ------------------------------
                                                    Joseph P. Caruso  
                                                    Chief Financial Officer and
                                                    Treasurer
                                                   (Principal Financial Officer
                                                    and Principal Accounting 
                                                    Officer)