|UNITED STATES
                                                  SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549



FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the quarterly period ended September 30, 2005.



Commission file number 0-22340

Palomar Medical Technologies, Inc.(Exact name of registrant as specified in its charter)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                        | 
|--------------------------------------- | 
|Delaware                                | 
|(State
      or other jurisdiction      | 
|of incorporation
      or organization) | 

|82
      Cambridge Street Burlington, Massachusetts 01803-4107(Address
      of principal executive offices)
|------------------------------------------------------------------------------------------------------------

|
|

|(781) 993-2300(Registrants
        telephone number, including area code)
|--------------------------------------------------------------------------

|Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ý No oIndicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
 Yesý No o

As of October 30, 2005, 16,978,840 shares of common stock were issued and outstanding.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|Palomar Medical
Technologies, Inc. and Subsidiaries

Table of Contents
|----------------------------------------------------------------------

|                               |                                                                                                                                      |  | Page No.
|------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------ |  | --------
|PART I - Financial Information |                                                                                                                                      |  |         
|                               |                                                                                                                                      |  |         
|Item 1.                        | Financial Statements                                                                                                                 |  |         
|                               | Unaudited Condensed Consolidated Balance Sheets for the periods ending
              September 30, 2005 and December 31, 2004        |  | 1       
|                               | Unaudited Condensed Consolidated Statements of Income for the periods ending
              September 30, 2005 and September 30, 2004 |  | 2       
|                               | Unaudited Condensed Consolidated Statements of Cash Flows                                                                            |  | 3       
|                               | Notes to Unaudited Condensed Consolidated Financial Statements                                                                       |  | 4       
|Item 2.                        | Management's Discussion and Analysis of Financial Condition and the
              Results of Operations                              |  | 11      
|                               | Cautionary Statements                                                                                                                |  | 18      
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                                                                           |  | 30      
|Item 4.                        | Controls and Procedures                                                                                                              |  | 30      
|                               |                                                                                                                                      |  |         
|PART II - Other Information    |                                                                                                                                      |  |         
|                               |                                                                                                                                      |  |         
|Item 1.                        | Legal Proceedings                                                                                                                    |  | 30      
|Item 2.                        | Changes in Securities, Use of Proceeds and Issuer Purchases of Securities                                                            |  | 31      
|Item 3.                        | Defaults Upon Senior Securities                                                                                                      |  | 31      
|Item 4.                        | Submission of Matters to a Vote of Security Holders                                                                                  |  | 31      
|Item 5.                        | Other Information                                                                                                                    |  | 31      
|Item 6.                        | Exhibits and Reports on Form 8-K                                                                                                     |  | 31      
|SIGNATURES                     |                                                                                                                                      |  | 32      

|i





Palomar Medical
Technologies, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)
|------------------------------------------------------------------------------------------------------------

|                                                                        | September 30,
2005 | December 31,
2004
|----------------------------------------------------------------------- | ------------------ | -----------------
|Assets                                                                  |                    |                  
|Current assets:                                                         |                    |                  
|Cash and cash equivalents                                               |                    |                  
|Available-for-sale investments, at market value                         |                    |                  
|Accounts receivable, net                                                |                    |                  
|Inventories                                                             |                    |                  
|Other current assets                                                    |                    |                  
|                                                                        |                    |                  
|Total current assets                                                    |                    |                  
|                                                                        |                    |                  
|Property and equipment, net                                             |                    |                  
|                                                                        |                    |                  
|Other assets                                                            |                    |                  
|                                                                        |                    |                  
|Total Assets                                                            |                    |                  
|                                                                        |                    |                  
|Liabilities and Stockholders' Equity                                    |                    |                  
|Current liabilities:                                                    |                    |                  
|Accounts payable                                                        |                    |                  
|Accrued liabilities                                                     |                    |                  
|Deferred revenue                                                        |                    |                  
|                                                                        |                    |                  
|Total current liabilities                                               |                    |                  
|                                                                        |                    |                  
|Commitments and Contingencies                                           |                    |                  
|                                                                        |                    |                  
|Stockholders' equity:                                                   |                    |                  
|Preferred stock, $.01 par value-                                        |                    |                  
|Authorized - 1,500,000 shares                                           |                    |                  
|Issued -  none                                                          |                    |                  
|Common stock, $.01 par value-                                           |                    |                  
|Authorized - 45,000,000 shares                                          |                    |                  
|Issued and outstanding-  16,978,840 and 16,231,502 shares, respectively |                    |                  
|Additional paid-in capital                                              |                    |                  
|Accumulated deficit                                                     |                    |                  
|                                                                        |                    |                  
|Total stockholders' equity                                              |                    |                  
|                                                                        |                    |                  
|Total liabilities and stockholders equity                              |                    |                  
|                                                                        |                    |                  

|The accompanying notes are an integral part of these consolidated financial statements
1
|----------------------------------------------------------------------------------------

|Palomar Medical Technologies, Inc. and Subsidiaries
         Condensed Consolidated Statements of Income
                          (Unaudited)
|----------------------------------------------------------------------------------------------------------------------------------------------

|                                               | Three Months Ended
September 30, | Nine Months Ended
September, 30 |   |           
|---------------------------------------------- | -------------------------------- | ------------------------------- | - | ----------
|
|Revenues:                                      |                                  |                                 |   |           
|Product revenues                               |                                  |                                 | $ | 16,726,018
|Royalty revenues                               |                                  |                                 |   | 1,211,547 
|Funded product development revenues            |                                  |                                 |   | 1,341,108 
|                                               |                                  |                                 |   |           
|Total revenues                                 |                                  |                                 |   | 19,278,673
|                                               |                                  |                                 |   |           
|Costs and expenses:                            |                                  |                                
|Cost of product revenues                       |                                  |                                 |   | 5,220,270 
|Cost of royalty revenues                       |                                  |                                 |   | 484,619   
|Research and development                       |                                  |                                 |   | 3,162,199 
|Selling and marketing                          |                                  |                                 |   | 4,335,302 
|General and administrative                     |                                  |                                 |   | 1,712,847 
|                                               |                                  |                                 |   |           
|Total costs and expenses                       |                                  |                                 |   | 14,915,237
|                                               |                                  |                                 |   |           
|Income from operations                         |                                  |                                 |   | 4,363,436 
|                                               |                                  |                                 |   |           
|Interest income                                |                                  |                                 |   | 312,116   
|Other income (expense), net                    |                                  |                                 |   | 3,000     
|                                               |                                  |                                 |   |           
|Income before income taxes                     |                                  |                                 |   | 4,678,552 
|                                               |                                  |                                 |   |           
|Provision for income taxes                     |                                  |                                 |   | 90,677    
|                                               |                                  |                                 |   |           
|Net income                                     |                                  |                                 | $ | 4,587,875 
|                                               |                                  |                                 |   |           
|Net income per share:                          |                                  |                                
|Basic                                          |                                  |                                 | $ | 0.27      
|                                               |                                  |                                 |   |           
|Diluted                                        |                                  |                                 | $ | 0.24      
|                                               |                                  |                                 |   |           
|Weighted average number of shares outstanding: |                                  |                                
|Basic                                          |                                  |                                 |   | 16,942,280
|                                               |                                  |                                 |   |           
|Diluted                                        |                                  |                                 |   | 19,115,171
|                                               |                                  |                                 |   |           

|The accompanying notes are an integral part of these consolidated financial statements
2
|----------------------------------------------------------------------------------------

|Palomar Medical Technologies, Inc. and Subsidiaries
                                          Condensed Consolidated Statements of Cash Flow
                                                            (Unaudited)
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                                   | Nine Months Ended September 30, | 
|---------------------------------------------------------------------------------- | ------------------------------- | 
|
|Cash flows from operating activities:                                              |                                 | 
|Net income                                                                         |                                 | 
|                                                                                   |                                 | 
|Adjustments to reconcile net income  to net cash provided by operating activities: |                                 | 
|Depreciation and amortization                                                      |                                 | 
|Provision for bad debt                                                             |                                 | 
|Tax benefit from the exercise of stock options                                     |                                 | 
|Changes in assets and liabilities:                                                 |                                 | 
|Accounts receivable                                                                |                                 | 
|Inventories                                                                        |                                 | 
|Other current assets                                                               |                                 | 
|Accounts payable                                                                   |                                 | 
|Accrued liabilities                                                                |                                 | 
|Deferred revenue                                                                   |                                 | 
|                                                                                   |                                 | 
|Net cash from operating activities                                                 |                                 | 
|                                                                                   |                                 | 
|Cash flows used in investing activities:                                           |                                 | 
|Purchases of property and equipment                                                |                                 | 
|Purchases of available-for-sale investments                                        |                                 | 
|Proceeds from sale of available-for-sale investments                               |                                 | 
|                                                                                   |                                 | 
|Net cash used in investing activities                                              |                                 | 
|                                                                                   |                                 | 
|Cash flows from financing activities:                                              |                                 | 
|Proceeds from the exercise of stock options, warrants and employee stock           |                                 | 
|purchase plan                                                                      |                                 | 
|Costs incurred related to issuance of common stock                                 |                                 | 
|                                                                                   |                                 | 
|Net cash from financing activities                                                 |                                 | 
|                                                                                   |                                 | 
|Net increase (decrease) in cash and cash equivalents                               |                                 | 
|Cash and cash equivalents, beginning of the period                                 |                                 | 
|                                                                                   |                                 | 
|Cash and cash equivalents, end of the period                                       |                                 | 
|                                                                                   |                                 | 
|Supplemental disclosure of cash flow information:                                  |                                 | 
|                                                                                   |                                 | 
|Cash paid for income taxes                                                         |                                 | 
|                                                                                   |                                 | 
|Supplemental disclosure of noncash financing and investing activities:             |                                 | 
|                                                                                   |                                 | 
|Issuance of stock for employer 401(k) matching contribution                        |                                 | 
|                                                                                   |                                 | 

|The accompanying notes are an integral part of these consolidated financial statements
3








Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements


Note 1           Basis
of presentation


The
accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States for interim
information. The consolidated balance sheet at December 31, 2004 has been derived from the
audited balance sheet at that date; however, the accompanying financial statements do not
include all of the information and footnotes required by accounting principles generally
accepted in the United States 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. and its subsidiaries ( Palomar) believes that the quarterly
information presented includes all adjustments (consisting of normal, recurring
adjustments) necessary for a fair presentation in accordance with accounting principles
generally accepted in the United States. The accompanying condensed consolidated financial
statements and notes should be read in conjunction with Palomars Form 10-K for the
year ended December 31, 2004.


Note 2  Stock
based compensation


Palomar
follows the intrinsic value method under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related interpretations, in
accounting for its stock-based compensation plans, rather than the alternative fair value
accounting method provided for under SFAS No. 123, Accounting for Stock-Based
Compensation. Under APB 25, when the exercise price of options granted under these
plans equals the market price of the underlying stock on the date of grant, no
compensation expense is required. In accordance with EITF 96-18, Palomar records
compensation expense equal to the fair value of options and warrants granted to
non-employees over the vesting period, which is generally the period of service.


The
following table illustrates the effect on net income and earnings per share if Palomar
applied the fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation. Palomar has computed the pro forma disclosures required under SFAS No. 123
for all stock options granted to employees of Palomar for the three and nine months ended
September 30, 2005 and 2004, using the Black-Scholes option-pricing model prescribed by
SFAS No. 123.


Pro forma disclosure


The
pro forma effect on Palomar of applying SFAS No. 123 for all options and warrants to
purchase common stock of Palomar would be as follows:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                                                  | Three Months Ended
September 30, | Nine Months Ended
September 30, |   |          
|------------------------------------------------------------------------------------------------- | -------------------------------- | ------------------------------- | - | ---------
|
|Net income as reported                                                                            |                                  |                                 | $ | 4,587,875
|Less:  Total stock-based                                                                          |                                  |                                
|employee compensation expense determined under fair value based method for all awards, net of tax |                                  |                                 | $ | (180,161 
|                                                                                                  |                                  |                                 |  
|Pro forma net income (loss)                                                                       |                                  |                                 | $ | 4,407,714
|                                                                                                  |                                  |                                 |  
|Net income (loss) per share:                                                                      |                                  |                                
|Basic - as reported                                                                               |                                  |                                 | $ | 0.27     
|Basic - pro forma                                                                                 |                                  |                                 | $ | 0.26     
|Diluted - as reported                                                                             |                                  |                                 | $ | 0.24     
|Diluted - pro forma                                                                               |                                  |                                 | $ | 0.23     

|4






Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements


On
May 11, 2005, Palomar granted 645,000 options that were fully vested as of date of grant
to employees and directors with exercise prices equal to fair market value on the date of
grant, or $24.63 per share, and expire ten years from the date of grant. Of the $8,108,
909 pro forma expense for the nine months ended September 30, 2005, $7,568,817 relates to
these options. In accordance with newly issued Statement of Financial Accounting Standards
No. 123(R) (SFAS 123R), had Palomar granted these options with longer time-based vesting,
Palomar would have incurred significant stock-based payment expenses in future years upon
adoption of SFAS 123R.


For
the twelve months ended December 31, 2004, Palomar granted 1,968,000 options that were
also fully vested in 2004 to employees and directors with exercise prices equal to fair
market value on the date of grant, ranging from $13.66 to $26.00, and expire ten years
from the date of grant. Of the $18,476,383 pro forma expense in 2004, $17,623,462 relates
to these options. In accordance with newly issued Statement of Financial Accounting
Standards No. 123(R) (SFAS 123R), had Palomar granted these options with longer time-based
vesting, Palomar would have incurred significant stock-based payment expenses in future
years upon adoption of SFAS 123R.


For
the twelve months ended December 31, 2004, Palomar granted 1,440,000 performance based
options to employees and directors with exercise prices equal to fair market value on the
date of grant of $16.53, and expire ten years from the date of grant. 815,000 of these
options vest upon the election of Gillette to continue commercialization of a patented
home-use, light based hair removal device for women pursuant to our Development and
License Agreement with Gillette dated February 14, 2003, and 625,000 of these options vest
twelve months after Gillettes election (See Note 9, Development and License
Agreement with Gillette). Palomar will incur a stock-based payment expense upon the
vesting of these performance based options.


Recent Accounting
Pronouncement


In
December 2004, the FASB issued SFAS 123(R), Share-Based Payment. SFAS No.
123(R) revises SFAS 123, Accounting for Stock-Based Compensation, and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS 123(R) will require compensation costs related to
share-based payment transactions to be recognized in the financial statements (with
limited exceptions). The amount of compensation cost will be measured based on the
grant-date fair value of the equity or liability instruments issued. Compensation cost
will be recognized over the period that an employee provides service in exchange for the
award. On April 14, 2005, SFAS No. 123R was amended to allow companies to adopt the
standard at the beginning of the fiscal year that begins after June 15, 2005. Palomar will
adopt the standard as of the effective date.


Note 3  Inventories


Inventories
are valued at the lower of cost (first in, first-out method) or market, and includes
material, labor and manufacturing overhead. Inventories consisted of the following:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                 | September 30,
2005 | December 31,
2004
| | --------------- | ------------------ | -----------------
| | Raw materials   | $2,800,441         | $3,613,032       
| | Work in process | 1,391,565          | 840,795          
| | Finished goods  | 2,707,954          | 1,412,667        
| |                 |                   
| |                 | $6,899,960         | $5,866,494       
| |                 |                   

|Note 4  Property
and equipment


Property
and equipment are recorded at cost. Repairs and maintenance costs are expensed as
incurred. Depreciation and amortization are provided using the straight-line method over
their estimated useful lives. Property and equipment consisted of the following:


5




Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | September 30,
2005 | December 31,
    2004 | Estimated
useful life                            
|------------------------------ | ------------------ | --------------------- | -------------------------------------------------
|Machinery and equipment        | $    1,418,644     | $    1,376,668        | 3-8 years                                        
|Furniture and fixtures         | 2,124,077          | 1,936,779             | 5 years                                          
|Leasehold improvements         | 293,555            | 293,555               | Shorter of estimated useful life or term of lease
|                               |                   
|                               | 3,836,276          | 3,607,002            
|Less: accumulated depreciation | 2,969,400          | 2,707,634             |                                                  
|                               |                   
|Total                          | $   866,876        | $   899,368          
|                               |                   

|Note 5  Warranty
costs


Palomar
typically offers a one-year warranty for all of its products. Palomar provides for the
estimated cost of product warranties at the time product revenue is recognized. Factors
that affect the Palomars warranty reserves include the number of units sold,
historical and anticipated rates of warranty repairs and the cost per repair. Palomar
assesses the adequacy of the warranty provision and Palomar may adjust this provision if
necessary.


The
following table provides the detail of the change in Palomars product warranty
accrual, which is a component of other accrued liabilities on the consolidated balance
sheets at September 30, 2005 and December 31, 2004:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                     | September 30,
2005 | December 31,
2004
|---------------------------------------------------- | ------------------ | -----------------
|Warranty accrual, beginning of period                |                    |                  
|Charged to costs and expenses  relating to new sales |                    |                  
|Costs incurred / write-offs                          |                    |                  
|                                                     |                   
|Warranty accrual, end of period                      |                    |                  
|                                                     |                   

|Note 6  Segment
information


Product
revenue from international sources was $5.0 million and $5.4 million for the three months
ended September 30, 2005 and 2004, respectively, and $14.8 million and $13.4 million for
the nine months ended September 30, 2005 and 2004, respectively. The following table
represents the percentage of product revenue by geographic region from customers for the
three and nine months ended September 30, 2005 and 2004:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                             | Three Months Ended
September 30, | Nine Months Ended
September 30, |     |    
|---------------------------- | -------------------------------- | ------------------------------- | --- | ---
|
|United States                |                                  | 69                              | .9% | 53 
|Canada                       |                                  | 8                               | .1% | 13 
|Japan                        |                                  | 8                               | .0% | 11 
|Asia / Pacific / Middle East |                                  | 5                               | .3% | 6  
|Europe                       |                                  | 5                               | .7% | 9  
|Australia                    |                                  | 1                               | .4% | 5  
|South and Central America    |                                  | 1                               | .6% | 1  
|                             |                                 
|Total                        |                                  | 100                             | .0% | 100

|Note 7  Net income
per common share



6




Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements



Basic
net income per share was determined by dividing net income by the weighted average common
shares outstanding during the period. Diluted net income per share was determined by
dividing net income by diluted weighted average shares outstanding. Diluted weighted
average shares reflect the dilutive effect, if any, of common stock options and warrants
based on the treasury stock method.


A
reconciliation of basic and diluted shares is as follows:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                    | Three Months Ended
September 30, | Nine Months Ended
September 30, |            |           
|----------------------------------- | -------------------------------- | ------------------------------- | ---------- | ----------
|
|Basic weighted average number of    |                                  |                                 |            |           
|shares outstanding                  | 16,942,280                       | 15,878,521                      | 16,815,519 | 15,547,683
|Potential common shares pursuant to
|stock options and warrants          | 2,172,891                        | 1,915,274                       | 2,228,487  | 1,969,663 
|                                    |                                 
|Diluted weighted average number of  |                                  |                                 |            |           
|shares outstanding                  | 19,115,171                       | 17,793,795                      | 19,044,006 | 17,517,346
|                                    |                                 

|Diluted
weighted average shares outstanding do not include options and warrants outstanding to
purchase 50,000 common equivalent shares for the nine months ended September 30, 2005 and
7,826 and 1,711,100 common equivalent shares for the three months and nine months ended
September 30, 2004, respectively, as their effect would have been antidilutive.


Note 8  Research
and development arrangement with Massachusetts General Hospital


In
August 1995, Palomar entered into an agreement with The Massachusetts General Hospital
Corporation whereby Massachusetts General Hospital agreed to conduct clinical trials on a
laser treatment technology for hair removal/reduction developed at Wellman Laboratories of
Photomedicine (the Clinical Trial Agreement). In July 1999, Palomar amended
this agreement to extend it for an additional five years, until August 2004, and to cover
the additional fields of non-invasive, electromagnetic targeting of subcutaneous fat, and
treatment of sebaceous glands and related skin disorders (e.g., acne) using infrared light
except when externally applied chromophores are used. Palomar has the right to exclusively
license, on royalty terms to be negotiated, Palomar-funded inventions that were discovered
during this research. Under the terms of the Clinical Trial Agreement, Palomar paid
Massachusetts General Hospital $475,000 on an annual basis through August 2004. On August
1, 2004, Palomar and Massachusetts General Hospital entered into a new agreement (the
Research Agreement) whereby Massachusetts General Hospital agreed to conduct
clinical and non-clinical research in the field of photo thermal removal or reduction of
hair, using light (hereinafter referred to, as hair removal). The Research
Agreement has a term of three years, until August 2007, and Palomar will provide
Massachusetts General Hospital at least $230,000 on an annual basis to cover the direct
and indirect costs of the research. Palomar has the right to exclusively license, on
royalty terms to be negotiated, Palomar-funded inventions that are discovered during this
research.


Note 9 
Development and license agreement with Gillette


Effective
as of February 14, 2003, Palomar entered into a Development and License Agreement with
Gillette to complete the development and commercialize a home-use, light based hair
removal device for women. The agreement provided for up to $7 million in support of
research and development to be paid by Gillette over approximately 30 months. Effective as
of June 28, 2004, Palomar and Gillette completed the initial phase of the agreement and
both parties decided to move onto the next phase. Accompanying this decision, Palomar and
Gillette amended the original agreement, whereby, Gillette will provide $2.1 million in
additional development funding to further technical innovations over a 9-month extension
of the development phase, which is now planned to be completed by August 31, 2006.


At
the end of the 30-month period, or such later date as regulatory clearance is obtained for
the device, Gillette will decide whether or not to continue with the project based on all
the information known at that time. Upon Gillette deciding to continue, Gillette will be
obligated to make a development completion payment to Palomar of $2.5 million. If Gillette
decides not to continue, Palomar may proceed to develop and commercialize the device on
its own or with a different party.




7



Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements


After
Gillette makes the development completion payment to Palomar of $2.5 million, Gillette
will conduct approximately 12 months of commercial assessment tests with respect to the
device. Based on the commercial assessment tests, Gillette will then decide whether or not
to continue with the project. Upon deciding to continue, Gillette will be obligated to
make a development completion payment to Palomar of $10 million. If Gillette decides not
to continue to commercialize the device, Palomar may proceed to commercialize the device
on its own or with a different party.


Commencing
12 months after the $10 million development completion payment, Gillette will be obligated
to pay Palomar annual collaboration payments of $10 million for as long as Gillette elects
to have Palomar work exclusively with Gillette.


After
launch of the first device for females, Gillette will pay Palomar a percentage of net
sales of the device, subject in certain instances to various reductions and offsets.
Again, for as long as Gillette elects to have Palomar work exclusively with Gillette,
Gillette will continue to be obligated to pay Palomar annual collaboration payments of $10
million, which will be offset against the net sales percentage payments.


In
addition to the amounts to be paid by Gillette to Palomar in connection with jointly
developed products, Gillette is required to make certain lump sum and net sales based
payments to Palomar in the event that Gillette launches independent light based female
hair removal products. Gillette also receives the right to enter into a separate agreement
with Palomar for the development and commercialization of home-use, light based hair
removal devices for men.


For
the three months ended September 30, 2005 and 2004, Palomar recognized $700,000 and
approximately $796,000 of funded product development revenues from Gillette, respectively.
For the nine months ended September 30, 2005 and 2004, Palomar recognized approximately
$2.1 million and approximately $2.3 million of funded product development revenues from
Gillette, respectively.


Note 10  Joint Development
and License agreement with Johnson & Johnson Consumer Companies (JJCC), a
Johnson & Johnson company


Effective
as of September 1, 2004, Palomar entered into a Joint Development and License Agreement
with Johnson & Johnson Consumer Companies, Inc. (JJCC), a Johnson &
Johnson company, to develop and commercialize home-use, light based devices in the fields
of (i) reducing or reshaping body fat including cellulite; (ii) reducing appearance of
skin aging; and (iii) reducing or preventing acne. The agreement provides for JJCC to
fund Palomars research and clinical studies during an initial proof-of-principle
phase. At the end of the proof-of-principle phase, JJCC will decide whether or not to
continue with one or more of the devices in one or more of the fields into a development
phase. Upon JJCC deciding to continue, JJCC will be obligated to fund the development of
the selected devices.  If JJCC decides not to continue, Palomar may proceed in fields
not selected by JJCC to develop and commercialize these and other devices on its own or
with a different party.


At
the end of the development phase, JJCC will decide whether or not to commercialize one or
more of the devices in one or more fields. Upon JJCC deciding to commercialize one or more
of the devices, JJCC will make payments to Palomar for each selected field. Upon
commercial launch of the first device in each selected field, JJCC will make a payment to
Palomar, and for all devices sold for use in each selected field, JJCC shall pay Palomar a
percentage of sales of such devices and certain topical compounds. If JJCC decides not to
commercialize or fails to launch a device, Palomar may proceed in fields not selected by
JJCC to develop and commercialize these and other devices on its own or with a different
party.


For
the three and nine months ended September 30, 2005, Palomar recognized approximately
$375,000 and $1.1 million of funded product development revenues from JJCC, respectively
and deferred $375,000 of advance payments received from JJCC for which services were not
yet provided.


Note 11  Research
contract with the United States Department of the Army


8


Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements


In
the first quarter of 2004, Palomar began providing services under a $2.5 million research
contract with the United States Department of the Army to develop a light based
self-treatment device for Pseudofolliculitis Barbae or PFB. The contract is a cost plus
fee arrangement whereby Palomar is reimbursed for the expenses incurred in connection with
PFB research plus an 8% fee. This revenue is included in funded product development
revenue in the accompanying statements of income. Palomar has recognized $1.9 million of
funded product development revenues from the United States Department of the Army from the
inception of the contract through September 30, 2005. Palomars revenue from the
contract may be subject to government audit. Palomar is unaware of any specific
adjustments or open items that could result from any such audit.


For
the three months ended September 30, 2005 and 2004, Palomar recognized approximately
$266,000 and approximately $296,000, respectively, of funded product development revenues
under this agreement, respectively. For the nine months ended September 30, 2005 and 2004,
Palomar recognized approximately $789,000 and approximately $938,000, respectively, of
funded product development revenues under this agreement, respectively.


On
October 25, 2005, Palomar was awarded additional funding and contract extension from the
United States Department of Army. This additional funding of $888,000 and a 12 month
contract extension from the Department of the Army is to continue the development of a
light-based self-treatment device for Pseudofolliculitis Barbae. Palomar estimates that
this extension funds the program through October 2006.


Note 12 
Settlement of Litigation


On
June 22, 2004, Palomar and Lumenis Ltd. announced that both parties reached a settlement
resolving their on-going litigation concerning both patent infringement and contractual
matters. Pursuant to the settlement, the parties dismissed with prejudice both the federal
action in the Northern District of California as well as the state court action in
Massachusetts.


Under
the terms of the settlement, Lumenis paid $868,000 in the second quarter of 2004 for
back-owed royalties from sales of the LightSheer made prior to July 1, 2002 and agreed to
pay $3.225 million over the next six quarters, or $537,500 per quarter, for back-owed
royalties due on sales of the LightSheer made between July 1, 2002 and December 31, 2003.
Beginning on January 1, 2004, Lumenis agreed to pay Palomar a 5% royalty on sales of the
LightSheer and other professional laser hair removal devices and modules.


In
addition, Lumenis granted Palomar a paid up license to a variety of Lumenis patents
for Palomars light based devices. Palomar granted Lumenis a paid up license to the
568 and 844 patents for Lumenis lamp based devices. Both parties have
agreed to the validity and enforceability of each others patents and not to challenge such
validity and enforceability in the future.


For
the three and nine months ended September 30, 2005, Lumenis made payments of approximately
$519,000 and $1.7 million, respectively, relating to the 5% royalty. For the three and
nine months ended September 30, 2004, Lumenis made payments of approximately $523,000 and
$980,000 relating to the 5% royalty.


For
the three and nine months ended September 30, 2005, Lumenis made payments of $537,500 and
approximately $1.6 million, respectively, for back-owed royalties recorded as royalty
revenue. For the three and nine months ended September 30, 2004, Lumeniss payments
totaled $537,500 and approximately $1.4 million, respectively, for back-owed royalties
which Palomar recorded as royalty revenue. The final payment for back-owed royalties is
due from Lumenis in the fourth quarter of 2005.


Note 13  Litigation

9


Palomar Medical
Technologies, Inc. and Subsidiaries  Notes to Condensed
Consolidated Financial Statements


On
February 15, 2002, Palomar commenced an action for patent infringement in the United
States District Court for the District of Massachusetts against Altus Medical, Inc., now
known as Cutera, Inc., seeking both monetary damages and injunctive relief. The complaint
alleges Cuteras CoolGlide and CoolGlide Excel laser systems willfully infringe U.S.
patent No. 5,735,844, which is exclusively licensed to Palomar by the Massachusetts
General Hospital. The Massachusetts General Hospital was added as a plaintiff in this
lawsuit. Cutera answered the complaint denying that its products infringe the asserted
patent and filed a counterclaim seeking a declaratory judgment that the asserted patent is
invalid and not infringed. Palomar and the Massachusetts General Hospital filed a reply
denying the material allegations of the counterclaims. Palomar and the Massachusetts
General Hospital have further alleged that Cuteras CoolGlide Vantage and CoolGlide
XEO laser systems also willfully infringe the asserted patent. On June 4, 2003, Cutera
amended their answer and asserted a counter claim alleging that the patent is
unenforceable due to inequitable conduct. Palomar and the Massachusetts General Hospital
believe that this claim is without merit and filed a reply denying the material
allegations of this counterclaim. A claim construction hearing (often referred to as a
Markman hearing) was held on June 12, 2003, and on February 27, 2004 the Judge issued her
ruling. Palomar believes the ruling largely embraced Palomars position and will have
a considerable impact on the case as it proceeds toward trial. On January 14, 2005, Cutera
filed a Motion for Summary Judgment that the patent claims being asserted are invalid and
not infringed.  Palomar and the Massachusetts General Hospital believe that this
Motion is without merit and filed a response defending both the validity of the
patent claims and the infringement of those claims by Cuteras CoolGlide
products.  A hearing was held March 17, 2005, and the parties are waiting for the
Judge to issue her ruling.  On October 6, 2005, Cutera filed a Motion to Modify
Construction of the Claim Term Applicator. Palomar and the Massachusetts
General Hospital believing this motion is also without merit filed a response in
opposition, and the parties are waiting for the Judge to issue her ruling. A trial date
has not yet been set.


On
April 7, 2005, Palomar and the Massachusetts General Hospital commenced a second action
for patent infringement in the United States District Court for the District of
Massachusetts against Cutera, Inc. seeking both monetary damages and injunctive relief.
The complaint alleges Cuteras products using pulsed light technology for hair
removal willfully infringe U.S. patent Nos. 5,595,568 and 5,735,844, which are exclusively
licensed to Palomar by the Massachusetts General Hospital.  Cuteras products
include the Solera Opus product in the Solera Platform and other products using pulsed
light and light-based technology in Cuteras XEO platform.  Cuteras PW 770
handpiece is utilized in the Solera and XEO Platforms.  Instead of answering the
complaint, Cutera filed a motion to dismiss for lack of personal jurisdiction in
Massachusetts, and Cutera then filed identical lawsuits in California and Delaware seeking
a declaratory judgment that the 5,595,568 and 5,735,844 patents are not infringed, are
invalid, and that the patents are unenforceable due to inequitable conduct.  Palomar
and MGH believe Cutera is subject to personal jurisdiction in Massachusetts and have filed
a response opposing their motion.  The parties are waiting for the Judge
to issue her ruling.

10



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

Forward-looking
statements


This
Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements other than historical or
current facts, including, without limitation, statements about our business strategy,
plans and objectives of management and our future prospects, are forward-looking
statements. Although we believe that the expectations reflected in such forward-looking
statements are reasonable, such forward-looking statements are subject to risks and
uncertainties that could cause actual results to differ materially from these
expectations. Such risks and uncertainties include, without limitation, the following:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | financing of future operations, manufacturing risks, variations in our quarterly results,
the occurrence of unanticipated events and circumstances and general economic
conditions, including stock market volatility, results of future operations,
technological difficulties in developing or introducing new products, the results of
future research, lack of product demand and market acceptance for current and
future products, challenges in managing joint ventures, government contracts and
research with third parties, the impact of competitive products and pricing, governmental
regulations with respect to medical devices, including whether FDA clearance will
be obtained for future products, the results of litigation, difficulties in
collecting royalties, potential infringement of third-party intellectual property
rights;
| |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | we
expect to face increased competition that could result in price reductions and reduced
margins, as well as loss of market share; and
| |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | other risks indicated below under the caption Cautionary Statements.
| |  | - |  | ----------------------------------------------------------------------

|These
risks and uncertainties are beyond our control and, in many cases; we cannot predict the
risks and uncertainties that could cause our actual results to differ materially from
those indicated by the forward-looking statements. When used in this document, the words
assumptions, believes, plans, expects,
anticipates, intends, continue, may,
will, could, should, future,
potential, estimate, or the negative of such terms and similar
expressions as they relate to us or our management are intended to identify
forward-looking statements. We undertake no obligation to release publicly the
result of any revisions to these forward-looking statements that may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.



The
following discussion should be read in conjunction with, and is qualified in its entirety
by, the condensed consolidated financial statements and notes thereto included in Item 1
of this Quarterly Report and the condensed consolidated financial statements and notes
thereto and Managements Discussion and Analysis of Financial Condition and Results
of Operations in our Form 10-K filed with the SEC on March 11, 2005. Historical results
and percentage relationships among any amounts in the financial statements are not
necessarily indicative of trends in operating results for any future periods.


Critical accounting policies


The
discussion and analysis of the Companys financial condition and results of
operations are based upon the Companys consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires the Company to make
estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an on-going
basis, the Company evaluates its estimates, including those related to revenue
recognition, bad debts, inventories, warranty obligations, contingencies and income taxes.
The Company bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions. A discussion of the
Companys critical accounting policies and the related judgments and estimates
affecting the preparation of the Companys consolidated financial statements is
included in the Annual Report on Form 10-K of the Company for fiscal year 2004 There have
been no material changes to our critical accounting policies as of September 30, 2005.


11







Overview


We
are engaged in research, development, manufacturing and distribution of proprietary light
based systems for hair removal and other cosmetic treatments. Since our inception, we have
been able to develop a differentiated product mix of light based systems for cosmetic
treatments through our research and development as well as with our partnerships with
Massachusetts General Hospitals Wellman Laboratories and other centers throughout
the world. We are continually developing and testing new indications to further the
advancement of cosmetic light based treatments.


This
Managements Discussion and Analysis of Financial Condition and Results of Operations
provide information that our management believes to be necessary to achieve a clear
understanding of our financial statements and results of our operations.



Our
management monitors and analyzes a number of key performance indicators in order to manage
our business and evaluate our financial and operating performance.  Those indicators
include but are not limited to the following:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Revenues.  We derive revenues from products and services relating to our
products, royalties and from funded product development.  These revenues vary based
on such factors as demand for products, the number and size of transactions within the
reporting period and the impact of changes in sales prices.  In addition to
monitoring the amount of product and service revenues and total revenues, we also consider
revenue concentration by customer and by geographic region to be possible indicators of
current and future trends in our business.
| |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Cost of revenues and gross margins. We strive to control our cost of
revenues.  The major items impacting cost of product revenues are material costs,
personnel and overhead expenses.
| |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Operating expenses.  Operating expenses are substantially driven by personnel,
commissions and overhead expenses. Other significant operating expenses that we monitor
include research and development, travel and entertainment, professional fees and
facilities and other sales and marketing expenses.
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Liquidity and cash flows. In recent periods, the primary source of our
liquidity is our net income.  From period to period, we see fluctuations in various
items, including our working capital accounts, capital expenditures, purchases of property
and equipment and proceeds from the exercise of employee stock options.
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Balance sheet.  We view cash, cash equivalents, available-for-sale of
investments, working capital, inventory, inventory turns, accounts receivable balances and
days sales outstanding as important indicators of our financial health.
| |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|We
improved gross profit from product sales by 51% in the third quarter of 2005 due to a
higher margin product mix and the effects of increased sales volume as compared to the
same period in 2004. We strengthened our balance sheet since the end of last year,
including increasing our cash, cash equivalents and available-for-sale investments by 58%
and increasing stockholders equity by 52%. The current ratio is 4.2x, up from 3.7x
at the end of 2004, and we have no debt.

12

Our
total revenues for the quarter ended September 30, 2005 were $19.3 million, up from $13.9
million in the third quarter of 2004. Product revenues increased to $16.7 million from
$11.6 million in the third quarter of 2005 as compared to the third quarter of 2004. Gross
profit from product sales increased to $11.5 million (69 percent of product revenues), up
from $7.6 million (66 percent of product revenues) in the year-earlier quarter. We
reported net income of $4.6 million, or $0.24 per diluted share, for the third quarter of
this year, versus net income of $2.1 million, or $0.12 per diluted share, for the third
quarter of last year.


Over
the last three years, most of our product revenue were derived from the Lux family of
products with their complementary handpieces, offering a suite of applications to the end
user. Customers can invest in their first Lux system with one handpiece then purchase
additional handpieces as their practice grows and, if they prefer, upgrade into more
powerful Lux systems when ready. Additionally, the Lux platform enables us to custom
tailor products to fit almost any professional medical office or spa location and provides
our customers with the comfort that the system can grow with their practice. We have kept
a commitment to continually provide value to customers who invest in our Lux system
platform.


Our
quarterly product revenue has increased as compared to the same period in 2004 as a result
of the increased product demand for the Lux family of products. Looking forward, we would
expect as our installed base of Lux family of products continues to increase that the
demand for replacement handpieces will increase resulting in additional product revenue.


We
continue to focus on delivering innovative light based systems and products to our
customers in order to drive revenue and earnings growth.


Recent developments


On
October 25, 2005, we were awarded additional funding and contract extension from the
United States Department of Army. This additional funding of $888,000 and a 12 month
contract extension from the Department of the Army is to continue the development of a
light-based self-treatment device for Pseudofolliculitis Barbae. Initially, we were
awarded a $2.5 million research contract in February 2004 that was scheduled to last for
nineteen months. This program extension will allow us to evaluate new technology beyond
the current research phase of the program and incorporate those elements in the subsequent
development of a self use device. We believe that this extension funds the program through
October 2006.


Results of operations


The
following table contains selected income statement information, which serves as the basis
of the discussion of our results of operations for the three and nine months ended
September 30, 2005 and 2004, respectively (in thousands, except for percentages):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                    | Three Months Ended
September 30, |  |   |        |  | 
|----------------------------------- | -------------------------------- |  | - | ------ |  | 
|
|
|Revenues:                           |                                  |  |   |        |  | 
|Product revenues                    |                                  |  | $ | 16,726 |  | 
|Royalty revenues                    |                                  |  |   | 1,212  |  | 
|Funded product development revenues |                                  |  |   | 1,341  |  | 
|                                    |                                  | 
|Total revenues                      |                                  |  |   | 19,279 |  | 
|                                    |                                  | 
|Cost and expenses:                  |                                  | 
|Cost of product revenues            |                                  |  |   | 5,220  |  | 
|Cost of royalty revenues            |                                  |  |   | 485    |  | 
|Research & development              |                                  |  |   | 3,162  |  | 
|Selling & marketing                 |                                  |  |   | 4,335  |  | 
|General & administrative            |                                  |  |   | 1,713  |  | 
|                                    |                                  | 
|Total costs & expenses              |                                  |  |   | 14,915 |  | 
|                                    |                                  | 
|                                    |                                  |  |   |        |  | 
|Income from operations              |                                  |  |   | 4,364  |  | 
|Interest income                     |                                  |  |   | 312    |  | 
|Other income (expense), net         |                                  |  |   | 3      |  | 
|                                    |                                  | 
|                                    |                                  |  |   |        |  | 
|Income before income taxes          |                                  |  |   | 4,679  |  | 
|Provision for income taxes          |                                  |  |   | 91     |  | 
|                                    |                                  | 
|Net income                          |                                  |  | $ | 4,588  |  | 
|                                    |                                  | 

|13
|--

|                                    | Nine Months Ended
September 30, |  |   |        |  | 
|----------------------------------- | ------------------------------- |  | - | ------ |  | 
|
|
|Revenues:                           |                                 |  |   |        |  | 
|Product revenues                    |                                 |  | $ | 46,790 |  | 
|Royalty revenues                    |                                 |  |   | 3,724  |  | 
|Funded product development revenues |                                 |  |   | 4,033  |  | 
|                                    |                                
|Total revenues                      |                                 |  |   | 54,547 |  | 
|                                    |                                
|Cost and expenses:                  |                                 | 
|Cost of product revenues            |                                 |  |   | 14,977 |  | 
|Cost of royalty revenues            |                                 |  |   | 1,490  |  | 
|Research & development              |                                 |  |   | 9,219  |  | 
|Selling & marketing                 |                                 |  |   | 12,512 |  | 
|General & administrative            |                                 |  |   | 4,733  |  | 
|                                    |                                
|Total costs & expenses              |                                 |  |   | 42,931 |  | 
|                                    |                                
|                                    |                                 |  |   |        |  | 
|Income from operations              |                                 |  |   | 11,616 |  | 
|Interest income                     |                                 |  |   | 728    |  | 
|Other income (expense), net         |                                 |  |   | 13     |  | 
|                                    |                                
|Income before income taxes          |                                 |  |   | 12,357 |  | 
|Provision for income taxes          |                                 |  |   | 244    |  | 
|                                    |                                
|Net income                          |                                 |  | $ | 12,113 |  | 
|                                    |                                

|Product
revenues. Sales of the StarLux Pulsed Light and Laser System coupled with
its additional handpieces were the leading contributor to our increase in product revenues
for both the three and nine months ended, September 30, 2005 in comparison to the same
periods in 2004. Favorably impacting product revenues for the three months ended September
30, 2005, was an increase of 55% in sales related to the Lux family of
products, which includes the StarLux, MediLux, EsteLux, NeoLux and their additional
handpieces and an increase of 18% in customer service revenue. Offsetting these increases
was a reduction in sales of 19% relating to the Q-Yag 5 product line. For the nine months
ended September 30, 2005, favorably impacting product revenues was an increase of 45% in
sales related to the Lux family of products, a 31% increase in sales relating
to customer service offset by a decrease of 18% from sales related to the Q-Yag 5 product
line in comparison to the same period in 2004.


Product
revenue for the three and nine months ended September 30, 2005 comprised of 78% and 76%,
respectively, to North American customers where we sell through a direct sales force and
22% and 24%, respectively, outside of North America where we sell through distributors. In
comparison to the same three and nine month periods in 2004, product revenue consisted of
67% and 69%, respectively, to North American customers, and 33% and 31%, respectively,
outside of North America.


Royalty
revenues. Royalty revenue remained consistent for the three months ended
September 30, 2005, as compared to the same period in 2004. For the nine months ended
September 30, 2005, the increase in royalty revenue as compared to the same period in 2004
is attributed to the installments made by Lumenis for back-owed royalties and additional
payments in relation to the 5% royalty on sales of the LightSheer and other professional
laser hair removal devices and modules (See Note: 12 Settlement of
Litigation).
14






Funded
product development revenues. Funded product development revenue is
generated from the development agreements with Gillette and Johnson & Johnson Consumer
Companies, Inc. (JJCC) as well as the United States Department of the Army.
For both Gillette and JJCC, Palomar receives payments quarterly in accordance with the
work plans that were developed with both Gillette and JJCC. Revenue is recognized under
the contracts as costs are incurred and services are rendered. Any amounts received in
advance of costs incurred and services rendered from Gillette or JJCC are recorded as
deferred revenue. Payments are not refundable if the development is not
successful. For the three and nine months ended September 30, 2005, funded product
development revenue increased due to the payments received from Gillette and JJCC as
compared to the same period in 2004. JJCC development agreement commenced during the
fourth quarter of 2004.


We
provide services under a $3.4 million research contract with the United States Department
of the Army to develop a light based self-treatment device for Pseudofolliculitis Barbae
or PFB. The contract is a cost plus fee arrangement whereby Palomar is reimbursed for the
expenses incurred in connection with PFB research plus an 8% fee. Revenue is recognized
under the contract as the costs are incurred and the services are rendered. For the three
and nine months ended September 30, 2005, funded product development revenues from the
Department of the Army decreased as compared to the same periods in 2004.


Cost of product revenues. The increase in absolute dollars is directly
attributable to increased variable costs associated with increased product sales. The cost
of product revenues increased in absolute dollars, but decreased as a percentage of total
revenue. The decrease in cost of product revenues as a percentage of total revenue for the
three and nine months ended September 30, 2005 as compared to the same period in 2004 was
primarily due to a shift in sales mix to the higher priced StarLux Pulsed Light and Laser
System. In addition, increased sales volume has improved the absorption of fixed
manufacturing overhead at our manufacturing facility as approximately 70% of our
manufacturing overhead cost is fixed in nature and is spread over higher sales volumes.


Cost
of royalty revenues. As a percentage of royalty revenues, the cost of
royalty revenues was consistent at 40% in accordance with our license agreement with
Massachusetts General Hospital for each period in comparison to the same periods in 2004.
The cost of royalty revenues for the three months ended September 30, 2005, in comparison
to the same period in 2004, remained consistent. For the nine months ended September 30,
2005, the cost of royalty revenues increased due to the installments made by Lumenis for
back-owed royalties and additional payments in relation to the 5% royalty on sales of the
LightSheer and other professional laser hair removal devices and modules.


Research
and development expense. The increase in research and development expense
is a direct result of our spending related to the Gillette agreement, the JJCC agreement
and the research contract with the United States Department of the Army and our continued
commitment to introducing new technology and enhancing our current family of products.


For
both the three and nine months ended September 30, 2005, expenses relating to Gillette
decreased by approximately $80,000 in comparison to the same periods in 2004.


Expenses
relating to the JJCC agreement, which began in October 2004, increased by $539,000 and
$1.1 million, respectively, for the three and nine months ended September 30, 2005.


For
the three and nine months ended September 30, 2005, expenses relating to the United States
Department of the Army decreased by approximately $28,000 and $133,000, respectively, in
comparison to the same periods in 2004.

15

For
the three and nine months ended September 30, 2005, legal expenses relating to the
prosecution of new patents increased by approximately $225,000 and $624,000, respectively,
in comparison to the same periods in 2004. We are committed to expanding intellectual
property rights necessary to protect discoveries made through our investment in research
and development.


Expenses
relating to the introduction of new products, enhancements made to the current family of
products and research and development overhead decreased by approximately $27,000 for the
third quarter of 2005 and increased by $136,000 for the nine months ended September 30,
2005, in comparison to the same periods in 2004.


The
spending on research and development reflects our commitment to continuing dermatology
research for a better understanding of various cosmetic and medical conditions and to
continuing research and development of devices and delivery systems to better treat those
various cosmetic and medical conditions. The research and development goals in the fields
of light based dermatology are to design systems that: (1) permit safe and effective
treatment and more rapid and painless treatment, (2) have high gross margins, and (3) are
manufactured at lower costs, to expand our current markets.


Selling
and marketing expense. For the quarter ended September 30, 2005, selling
and marketing increased by $402,000 from payroll and payroll related expenses, $641,000
related to tradeshow expenses and other costs and $258,000 related to commission expense
in comparison to the same period in 2004. For the nine months ended September 30, 2005,
selling and marketing expenses increased by $1.2 million from payroll and payroll related
expenses, approximately $1.9 million related to tradeshow expenses and other costs and by
approximately $514,000 relating to commission expense in comparison to the same period in
2004. These increases directly correlate with our increased revenues, upfront costs
associated with both international and domestic sales force and distribution channel
expansion.


General
and administrative expense. For the quarter ended September 30, 2005, the
increase in general and administrative expenses is mainly attributed to payroll and
payroll related expenses of $902,000, offset by a reduction in our corporate legal
expenses of approximately $332,000 and an offset in other overhead expenses of $306,000 as
compared to the same period in 2004. For the nine months ended, September 30, 2005, the
increase is mainly attributed to payroll and payroll related expenses of $1.6 million,
offset by a reduction in our corporate legal expenses of approximately $243,000 and a
reduction in other overhead expenses of $335,000 as compared to the same period in 2004.


Interest
income.Interest income increased due to higher levels of excess cash on
hand and an increase in interest rates for the three and nine months ended September 30,
2005 in comparison to the same period in 2004.


Other
income (expense), net. For the three and nine months ended September 30, 2005, other
income (expense), net increased in comparison to the same period in 2004. During the three and nine
months ended, September 30, 2005, payments were received from a previously written-off
note receivable. During the three and nine months ended September 2004, we incurred costs
of $380,000 related to a non-recurring expense from the settlement of a previously owned
subsidiarys facility lease offset by payments received from a previously written-off
note receivable and equity investment.


Provision
for income taxes.  We provided income taxes at a 2% effective rate in
2005 and a 3% effective rate in 2004.  The primary components of this provision, in
both 2005 and 2004, were minimum federal and state taxes.  However, our cash tax
liabilities were partially offset with the tax benefit from the exercise of stock options.
 Given our limited history of profitability we have fully reserved our otherwise
recognizable deferred tax asset which is principally comprised of our net operating loss
carryforwards, as its realization is uncertain.  We will continue to revisit this analysis on a quarterly basis and record adjustments as necessary.



16


Liquidity and capital
resources


The
following table sets forth, for the periods indicated, a year-over year comparison of key
components of our liquidity and capital resources (000s omitted):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     | Nine months ended
September 30, | Change |   |        
|-------------------- | ------------------------------- | ------ | - | -------
|
|Operating cash flows |                                 |        | $ | 11,791 
|Investing cash flows |                                 |        |   | (12,602
|Financing cash flows |                                 |        |   | 2,943  
|                     |                                 |        |  
|Capital expenditures |                                 |        | $ | 229    

|Additionally,
our cash, cash equivalents, available-for-sale investments, accounts receivable,
inventories and working capital are shown below for the periods indicated.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                |  |  |   |       
|------------------------------- |  |  | - | ------
|
|Cash and cash equivalents       |  |  | $ | 9,641 
|Available-for-sale investments, |  | 
|at market value                 |  |  |   | 30,023
|Accounts receivable, net        |  |  |   | 9,645 
|Inventories, net                |  |  |   | 6,900 
|Working capital                 |  |  |   | 43,386

|We
believe that our current cash balances and expected future cash flows will be sufficient
to meet our anticipated cash needs for working capital, capital expenditures and other
activities for at least the next 12 months. As of September 30, 2005, we had no borrowings
or debt.


Operating
cash flows for the nine months ended September 30, 2005 increased compared to the same
period in 2004. This increase reflects the effects of an increase in net profit and a
decrease in working capital requirements. Cash used in investing activities decreased for
the nine months ended September 30, 2005, compared to the same period in 2004. These
amounts primarily reflect cash used for purchases of property and equipment, purchases of
available-for-sale investments offset by proceeds from the sale of available-for-sale
investments. Cash provided by financing activities increased for the nine month period
ended September 30, 2005 compared to the same period in 2004. This increase was
primarily due to an increase in exercises of stock options.


We
anticipate that capital expenditures for the remainder of 2005 will total approximately
$150,000, consisting primarily of machinery, equipment, computers and peripherals. We
expect to finance these expenditures with cash on hand.


Contractual obligations


On
August 1, 2004, we entered into a new agreement with Massachusetts General Hospital
whereby it agreed to conduct clinical and non-clinical research in the field of photo
thermal removal or reduction of hair, using light. The agreement has a term of three
years, until August 2007, and we will provide Massachusetts General Hospital at least
$230,000 on an annual basis to cover the direct and indirect costs of the research. We
have the right to exclusively license, on royalty terms to be negotiated, the inventions
we fund that are discovered during this research.



17


We
are a party to a license agreement, as amended, with Massachusetts General Hospital
whereby we are obligated to pay royalties to Massachusetts General Hospital for sales of
certain products as well as 40% of royalties received from third parties.


We
are obligated to make future payments under various contracts, including non-cancelable
inventory purchase commitments and our operating lease relating to our Burlington,
Massachusetts manufacturing, research and development and administrative offices.


The
following table summarizes our estimated contractual cash obligations as of September 30,
2005, excluding amounts due Massachusetts General Hospital, royalty and employment
obligations because they are variable and/or subject to uncertain timing (000s
omitted):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   |        | Payments due by period |        |         |         
|---------------------------------- | ------ | ---------------------- | ------ | ------- | --------
|
|Operating lease                    | $3,797 | $   949                | $1,899 | $   949 | $     --
|Purchase commitments               | 4,213  | 4,213                  | --     | --      | --      
|                                   |       
|Total contractual cash obligations | $8,010 | $5,162                 | $1,899 | $   949 | $     --
|                                   |       

|Recent Accounting
Pronouncements


In
December 2004, the FASB issued SFAS 123(R), Share-Based Payment. SFAS No.
123(R) revises SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation
guidance. SFAS 123(R) will require compensation costs related to share-based payment
transactions to be recognized in the financial statements (with limited exceptions). The
amount of compensation cost will be measured based on the grant-date fair value of the
equity or liability instruments issued. Compensation cost will be recognized over the
period that an employee provides service in exchange for the award. On April 14, 2005,
SFAS No. 123(R) was amended to allow companies to adopt the standard at the beginning of the
fiscal year that begins after June 15, 2005. We will adopt the standard as of the
effective date.


Cautionary statements


The
risks and uncertainties described below together with all of the other information
included in this filing, including the financial statements and related notes should be
carefully considered. If any of the following risks actually occurs, our business,
prospects, financial condition and results of operations may be materially harmed. In
this event, the market price of our common stock could decline and you could lose part or
all of your investment.


Our future revenue may decrease if
we are unable to successfully develop and market new products.


Light
based technology is rapidly changing and improving.  In order to be successful, we
must continue to make significant investments in research and development in order to
develop in a timely and cost-effective manner, new products that meet changing market
demands, enhance existing products, and achieve market acceptance for such products. We
have in the past experienced delays in developing and marketing new products and enhancing
existing products. Furthermore, some of our new products under development are based on
unproven technology and/or technology with which we have no previous experience. In
addition, the market for professional hair removal light based devices may already be
saturated. At present, broader market acceptance of light based hair removal is critical
to our success and we intend to continue our goals of bringing light based hair removal
devices to the mass consumer market. We also intend to continue to diversify our product
line by developing cosmetic light based products for uses other than hair and tattoo
removal, treatment of acne and wrinkles, and treatment of pigmented and vascular lesions. There can be no
assurance that we will be able to successfully implement such strategy in a timely fashion
or at all and our failure to do so could decrease our future revenue.

18
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Our failure to respond to rapid
changes in technology could make our products obsolete and we may be unable to compete
with companies having superior financial, marketing and other resources.


The
light based cosmetic and dermatology industry is highly competitive and companies
frequently introduce new products. We compete in the development, manufacture, marketing,
sales and servicing of light based devices with numerous other companies, some of which
have substantially greater financial, marketing and other resources than us, as well as
direct worldwide sales capabilities. Our products also face competition from medical
products, prescription drugs and cosmetic procedures, such as electrolysis and waxing,
among others. We may not be able to differentiate our products from the products of our
competitors, and customers may not consider our products to be superior to competing
products or procedures, especially if competitive products and procedures are offered at
lower prices. Our competitors may develop products or new technologies that make our
products obsolete or less competitive.  If forecasted demand decreases, we could have
excess inventories which may result in a write-off of some or all of our inventory. As a
result of competition with these companies, products, and procedures, we could experience
loss of market share and decreased revenue as well as reduced prices and profit margins,
any of which would harm our business and operating results.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Our
ability to compete effectively depends upon our ability to distinguish our company and our
products from our competitors and their products. Factors affecting our competitive
position include:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | product performance and design;
| |  | - |  | -------------------------------

| |  |  |  | ability to sell products tailored
to meet the applications needs of clients and patients;
| |  | - |  | -----------------------------------------------------------------------------------------

| |  |  |  | quality of customer support;
| |  | - |  | ----------------------------

| |  |  |  | product pricing;
| |  | - |  | ----------------

| |  |  |  | product safety;
| |  | - |  | ---------------

| |  |  |  | sales, marketing and distribution capabilities;
| |  | - |  | -----------------------------------------------

| |  |  |  | success and timing of new product development and introductions; and
| |  | - |  | --------------------------------------------------------------------

| |  |  |  | intellectual property protection.
| |  | - |  | ---------------------------------

|We may need to secure additional
financing and without such additional financing we may be unable to fund ongoing
operations or grow the business.


Although
we have generated a profit in recent years, we have a history of losses. We may not be
able to sustain or increase profitability on a quarterly or annual basis. If our
operating results fall below the expectations of investors or public market analysts, the
price of our common stock could decline.


We
may determine, depending upon the opportunities available, to seek additional debt or
equity financing to fund the costs of operations or expansion.  Additionally, if we
incur indebtedness to fund increased levels of accounts receivable, finance the
acquisition of capital equipment, or if we issue debt securities in connection with any
acquisition we will be subject to risks associated with incurring substantial additional
indebtedness.


If we do not continue to develop
and commercialize new products and identify new markets for our products and technology,
we may not remain competitive, and our revenues and operating results could suffer.


The
aesthetic laser and light-based treatment system industry is subject to continuous
technological development and product innovation. If we do not continue to be innovative
in the development of new products and applications, our competitive position will likely
deteriorate as other companies successfully design and commercialize new products and
applications. Accordingly, our success depends in part on developing new and innovative
applications of laser and other light-based technology and identifying new markets for and
applications of existing products and technology. If we are unable to develop and
commercialize new products and identify new markets for our products and technology, our products and technology could become
obsolete and our revenues and operating results could be adversely affected. To remain
competitive, we must:



19
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | develop or acquire new technologies that either add to or significantly improve our current products;
| |  | - |  | -----------------------------------------------------------------------------------------------------

| |  |  |  | convince our target customers that our new products or product upgrades would be attractive revenue-generating additions to
their practices;
| |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | sell our products to non-traditional customers, including primary care physicians, gynecologists and other specialists;
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------

| |  |  |  | identify new markets and emerging technological trends in our target markets and react effectively to technological changes;
and
| |  | - |  | --------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | maintain effective sales and marketing strategies.
| |  | - |  | --------------------------------------------------

|If our new products do not gain
market acceptance, our revenues and operating results could suffer.


The
commercial success of the products and technology we develop will depend upon the
acceptance of these products by providers of aesthetic procedures and their patients and
clients. It is difficult for us to predict how successful recently introduced products, or
products we are currently developing, will be over the long term. If the products we
develop do not gain market acceptance, our revenues and operating results could suffer.


We
expect that many of the products we develop will be based upon new technologies or new
applications of existing technologies. It may be difficult for us to achieve market
acceptance of some of our products, particularly the first products that we introduce to
the market based on new technologies or new applications of existing technologies.


If demand for our aesthetic
treatment systems by non-traditional physician customers and spas does not develop as we
expect, our revenues will suffer and our business will be harmed.


Our
revenues from non-traditional physician customers and spa purchasers of our products
continue to increase. We believe, and our growth expectations assume, that we and other
companies selling lasers and other light-based aesthetic treatment systems have only begun
to penetrate these markets and that our revenues from selling to these markets will
continue to increase. If our expectations as to the size of these markets and our ability
to sell our products to participants in these markets are not correct, our revenues will
suffer and our business will be harmed.


If there is not sufficient demand
for the procedures performed with our products, practitioner demand for our products could
decline, which would adversely affect our operating results.


Most
procedures performed using our aesthetic treatment systems are elective procedures that
are not reimbursable through government or private health insurance. The cost of these
elective procedures must be borne by the client. As a result, the decision to undergo a
procedure that utilizes our products may be influenced by a number of factors, including:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | consumer awareness of procedures and treatments;
| |  | - |  | ------------------------------------------------

| |  |  |  | the cost, safety and effectiveness of the procedure and of alternative treatments;
| |  | - |  | ----------------------------------------------------------------------------------

| |  |  |  | the success of our and our customers' sales and marketing efforts to purchasers of these procedures; and
| |  | - |  | --------------------------------------------------------------------------------------------------------

| |  |  |  | consumer confidence, which may be affected by economic and other conditions.
| |  | - |  | ----------------------------------------------------------------------------

|If
there is not sufficient demand for the procedures performed with our products,
practitioner demand for our products would be reduced, which would adversely affect our
operating results.


The expense and potential
unavailability of liability insurance coverage for our customers could adversely affect
our ability to sell our products and our financial condition.

20

Some
of our customers and prospective customers have had difficulty in procuring or maintaining
liability insurance to cover their operation and use of our products. Medical malpractice
carriers are withdrawing coverage in some states or substantially increasing premiums. If
this trend continues or worsens, our customers may discontinue using our products, and
potential customers may elect not to purchase laser and other light-based products.


Our business and operations are
experiencing rapid growth. If we fail to effectively manage our growth, our business and
operating results could be harmed.


We
have experienced significant growth in the scope of our operations and the number of our
employees. This growth has placed significant demands on our management, as well as our
financial and operational resources. If we do not effectively manage our growth, the
efficiency of our operations and the quality of our products could suffer, which could
adversely affect our business and operating results. To effectively manage this growth,
we will need to continue to:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | implement appropriate operational, financial and management controls, systems and procedures;
| |  | - |  | ---------------------------------------------------------------------------------------------

| |  |  |  | expand our manufacturing capacity and scale of production;
| |  | - |  | ----------------------------------------------------------

| |  |  |  | expand our sales, marketing and distribution infrastructure and capabilities; and
| |  | - |  | ---------------------------------------------------------------------------------

| |  |  |  | provide adequate training and supervision to maintain high quality standards.
| |  | - |  | -----------------------------------------------------------------------------

|Failure to receive shipments of
critical components could reduce revenues and reduced reliability of critical components
could increase expenses.


We
develop light based systems that incorporate third-party components. Some of these items
are custom made or otherwise not readily available on the market. We purchase some of
these components from small, specialized vendors that are not well capitalized. We do not
have long-term contracts with some of these third parties for the supply of parts. A
disruption in the delivery of these key components, or our inability to obtain substitute
components or subassemblies from alternate sources at acceptable prices in a timely
manner, or our inability to obtain assembly or testing services could prevent us from
manufacturing products and result in a decrease in revenue.  We depend on an
acceptable level of reliability for purchased components.  Reliability below
expectations for key components could have an adverse affect on inventory and inventory
reserves. Any extended interruption in our supplies of third party components could
materially harm our business.


Our products are subject to
numerous medical device regulations. Compliance is expensive and time-consuming. Without
necessary clearances, we may be unable to sell products and compete effectively.


All
of our current products are light based devices, which are subject to FDA regulations for
clinical testing, manufacturing, labeling, sale, distribution and promotion. Before a new
product or a new use of or claim for an existing product can be marketed in the United
States, we must obtain clearance from the FDA.  The types of medical devices that we
seek to market in the U.S. generally must receive either 510(k) clearance or
PMA approval in advance from the U.S. Food and Drug Administration (FDA)
pursuant to the Federal Food, Drug, and Cosmetic Act. The FDAs 510(k) clearance
process can be expensive and usually takes from four to twelve months, but it can last
longer. The process of obtaining PMA approval is much more costly and uncertain and
generally takes from one to three years or even longer from the time the pre-market
approval application is submitted to the FDA until an approval is obtained.


In
order to obtain pre-market approval and, in some cases, a 510(k) clearance, a product
sponsor must conduct well controlled clinical trials designed to test the safety and
effectiveness of the product. Conducting clinical trials generally entails a long,
expensive and uncertain process that is subject to delays and failure at any stage. The
data obtained from clinical trials may be inadequate to support approval or clearance of a
submission. In addition, the occurrence of unexpected findings in connection with clinical
trials may prevent or delay obtaining approval or clearance. If we conduct clinical
trials, they may be delayed or halted, or be inadequate to support approval or clearance,
for numerous reasons, including:

21
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | FDA, other regulatory authorities or an institutional review board may place a clinical trial on hold;
| |  | - |  | ------------------------------------------------------------------------------------------------------

| |  |  |  | patients may not enroll in clinical trials, or patient follow-up may not occur, at the rate we expect;
| |  | - |  | ------------------------------------------------------------------------------------------------------

| |  |  |  | patients may not comply with trial protocols;
| |  | - |  | ---------------------------------------------

| |  |  |  | institutional review boards and third party clinical investigators may delay or reject our trial protocol;
| |  | - |  | ----------------------------------------------------------------------------------------------------------

| |  |  |  | third party clinical investigators may decline to participate in a trial or may not perform a trial on our anticipated
              schedule or consistent with the clinical trial protocol, good clinical practices, or other FDA requirements;
| |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | third party organizations may not perform data collection and analysis in a timely or accurate manner;
| |  | - |  | ------------------------------------------------------------------------------------------------------

| |  |  |  | regulatory inspections of our clinical trials or manufacturing facilities may, among other things, require us to undertake
              corrective action or suspend or terminate our clinical trials, or invalidate our clinical trials;
| |  | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | changes in governmental regulations or administrative actions; and
| |  | - |  | ------------------------------------------------------------------

| |  |  |  | the interim or final results of the clinical trials may be inconclusive or unfavorable as to safety or effectiveness.
| |  | - |  | ---------------------------------------------------------------------------------------------------------------------

|Medical devices may be marketed
only for the indications for which they are approved or cleared. The FDA may not approve
or clear indications that are necessary or desirable for successful commercialization.
Indeed, the FDA may refuse our requests for 510(k) clearance or pre-market approval of new
products, new intended uses or modifications to existing products. Our clearances can be
revoked if safety or effectiveness problems develop.


To
date, the FDA has deemed our products eligible for the 510(k) clearance process. We
believe that our products in development will receive similar treatment. However, we
cannot be sure that the FDA will not impose the more burdensome PMA approval process upon
one or more of our future products, nor can we be sure that 510(k) clearance or PMA
approval will ever be obtained for any product we propose to market and our failure to do
so could adversely affect our ability to sell our products.


Our
products are subject to similar regulations in many international markets. Complying with
these regulations is necessary for our strategy of expanding the markets for sales of our
products into these countries. Compliance with the regulatory clearance process in any
country is expensive and time consuming.  Regulatory clearances may necessitate
clinical testing, limitations on the number of sales and limitations on the type of end
user, among other things.  In certain instances, these constraints can delay planned
shipment schedules as design and engineering modifications are made in response to
regulatory concerns and requests.  We may not be able to obtain clearances in each
country in a timely fashion or at all, and our failure to do so could adversely affect our
ability to sell our products in those countries.


After clearance or approval of our
products, we are subject to continuing regulation by the FDA, and if we fail to comply
with FDA regulations, our business could suffer.


Even
after clearance or approval of a product, we are subject to continuing regulation by the
FDA, including the requirements that our facility be registered and our devices listed
with the agency. We are subject to Medical Device Reporting regulations, which require us
to report to the FDA if our products may have caused or contributed to a death or serious
injury or malfunction in a way that would likely cause or contribute to a death or serious
injury if the malfunction were to recur. We must report corrections and removals to the
FDA where the correction or removal was initiated to reduce a risk to health posed by the
device or to remedy a violation of the Federal Food, Drug, and Cosmetic Act caused by the
device that may present a risk to health, and maintain records of other corrections or
removals. The FDA closely regulates promotion and advertising and our promotional and
advertising activities could come under scrutiny. If the FDA objects to our promotional
and advertising activities or finds that we failed to submit reports under the Medical
Device Reporting regulations, for example, the FDA may allege our activities resulted in
violations.

22

The
FDA and state authorities have broad enforcement powers. Our failure to comply with
applicable regulatory requirements could result in enforcement action by the FDA or state
agencies, which may include any of the following sanctions:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;
| |  | - |  | -------------------------------------------------------------------------------------------

| |  |  |  | repair, replacement, refunds, recall or seizure of our products;
| |  | - |  | ----------------------------------------------------------------

| |  |  |  | operating restrictions or partial suspension or total shutdown of production;
| |  | - |  | -----------------------------------------------------------------------------

| |  |  |  | refusing or delaying our requests for 510(k) clearance or pre-market approval of new products or new intended uses; and
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------

| |  |  |  | criminal prosecution.
| |  | - |  | ---------------------

|If any of these events were to occur,
they could harm our business.


We have modified some of our
products and sold them under prior 510(k) clearances. The FDA could retroactively decide
the modifications required new 510(k) clearances and require us to cease marketing and/or
recall the modified products.


Any
modification to one of our 510(k) cleared devices that could significantly affect its
safety or effectiveness, or that would constitute a major change in its intended use,
requires a new 510(k) clearance. We may be required to submit pre-clinical and clinical
data depending on the nature of the changes. We may not be able to obtain additional
510(k) clearances or pre-market approvals for modifications to, or additional indications
for, our existing products in a timely fashion, or at all. Delays in obtaining future
clearances or approvals would adversely affect our ability to introduce new or enhanced
products in a timely manner, which in turn would harm our revenue and operating results.
The FDA requires every manufacturer to make this determination in the first instance, but
the FDA can review any such decision. We have modified some of our marketed devices, but
we believe that new 510(k) clearances are not required. We cannot be certain that the FDA
would agree with any of our decisions not to seek 510(k) clearance. If the FDA requires us
to seek 510(k) clearance for any modification, we also may be required to cease marketing
and/or recall the modified device until we obtain a new 510(k) clearance.


Federal regulatory reforms may
adversely affect our ability to sell our products profitably.


From
time to time, legislation is drafted and introduced in Congress that could significantly
change the statutory provisions governing the clearance or approval, manufacture and
marketing of a device. In addition, FDA regulations and guidance are often revised or
reinterpreted by the agency in ways that may significantly affect our business and our
products. It is impossible to predict whether legislative changes will be enacted or FDA
regulations, guidance or interpretations changed, and what the impact of such changes, if
any, may be.


We may also be subject to state
regulations.   State regulations, and changes to state regulations, may prevent
sales to particular end users which may decrease revenues or prevent growth of revenues.


Our
products may also be subject to state regulations.   Federal regulation allows
our products to be sold to and used by licensed practitioners as determined on a
state-by-state basis which complicates monitoring compliance. In addition, these
regulations are in many instances in flux.  As a result, in some states
non-physicians may purchase and operate our product. However, a state could disagree with
our decision to sell to a particular type of end user or change regulations preventing
sales to particular types of end users.  Thus, state regulations and changes to
state regulations may decrease revenues or prevent growth of revenues.


Because we do not require training
for all users of our products, and sell our products to non-physicians, there exists an
increased potential for misuse of our products, which could harm our reputation and our
business.






23


Federal
regulations allow us to sell our products to or on the order of practitioners licensed by
law to use or order the use of a prescription device. The definition of licensed
practitioners varies from state to state. As a result, our products may be purchased
or operated by physicians with varying levels of training and, in many states, by
non-physicians, including nurse practitioners, chiropractors and technicians. Outside the
United States, many jurisdictions do not require specific qualifications or training for
purchasers or operators of our products. We do not supervise the procedures performed with
our products, nor do we require that direct medical supervision occur. We and our
distributors offer product training sessions, but neither we nor our distributors require
purchasers or operators of our products to attend training sessions. The lack of required
training and the purchase and use of our products by non-physicians may result in product
misuse and adverse treatment outcomes, which could harm our reputation and expose us to
costly product liability litigation.


Achieving complete compliance with
FDA regulations is difficult, and if we fail to comply, we could be subject to FDA
enforcement action or our business could suffer.


We
are subject to inspection and market surveillance by the FDA to determine compliance with
regulatory requirements. The FDAs regulatory scheme is complex, especially the
Quality System Regulation (QSR), which requires manufacturers to follow
elaborate design, testing, control, documentation, and other quality assurance procedures.
Because some of our products involve the use of lasers, those products also are covered by
a performance standard for lasers set forth in FDA regulations. The laser performance
standard imposes specific record keeping, reporting, product testing and product labeling
requirements. These requirements include affixing warning labels to laser products as well
as incorporating certain safety features in the design of laser products. The FDA enforces
the QSR and laser performance standards through periodic unannounced inspections. We have
been, and anticipate in the future being, subject to such inspections. The complexity of
the QSR makes complete compliance difficult to achieve. Also, the determination as to
whether a QSR violation has occurred is often subjective. If the FDA finds that we have
failed to comply with the QSR or other applicable requirements or take satisfactory
corrective action in response to an adverse QSR inspection or comply with applicable laser
performance standards, the agency can institute a wide variety of enforcement actions,
including a public warning letter or other stronger remedies, such as fines, injunctions,
criminal and civil penalties, recall or seizure of our products, operating 
restrictions, partial suspension, or total shutdown of our production, refusing to permit
the import or export of our products, delaying or refusing our requests for 510(k)
clearance or PMA approval of new products, withdrawing product approvals already granted
or criminal prosecution, any of which could cause our businesses an operating results to
suffer.


Failure to manage our
relationships with third party researchers effectively may limit our access to new
technology, increase the cost of licensing new technology, and divert management attention
from our core business.


We
are dependent upon third-party researchers over whom we do not have absolute control to
satisfactorily conduct and complete research on our behalf.  We are also dependent
upon third-party researchers to grant us licensing terms, which may or may not be
favorable for products and technology which they may develop. At present, our principal
research partner is the Wellman Laboratories of Photomedicine at Massachusetts General
Hospital. We provide research funding, light technology and optics know-how in return for
licensing rights with respect to specific dermatologic and cosmetic applications and
patents. In return for certain exclusive license rights, we are subject to due diligence
obligations in order to maintain such exclusivity.  Our success will be dependent
upon the results of research with our partners and meeting due diligence obligations. We
cannot be sure that third-party researchers will agree with our interpretation of the
terms of our agreements, that we will meet our due diligence obligations, or that such
research agreements will provide us with marketable products in the future or that any of
the products developed under these agreements will be profitable for us.


Our common stock could be further
diluted by the conversion of outstanding options and warrants.



24


In
the past, we have issued and still have outstanding convertible securities in the form of
options and warrants.  We have and may continue to issue options and warrants as
compensation for services and incentive compensation for our employees, directors and
consultants or others who provide services to us. We have a substantial number of shares
of common stock reserved for issuance upon the conversion and exercise of these securities. Such a
conversion would dilute our stockholders and could adversely affect the market price of
our common stock.


Our proprietary technology has
only limited protections which may not prevent competitors from copying our new
developments.  This may impair our ability to compete effectively, and we may expend
significant resources enforcing our intellectual property rights to prevent such copying.


Our
business could be materially and adversely affected if we are not able to adequately
protect our intellectual property rights. We rely on a combination of patent, copyright,
trademark and trade secret laws, licenses and confidentiality agreements to protect our
proprietary rights. We own and license a variety of patents and patent applications in the
United States and corresponding patents and patent applications in many foreign
jurisdictions. To date, however, our patent estate has not stopped other companies from
competing against us, and though we have licensed certain competitors to certain patents
and are enforcing those same patents against Cutera, Inc. (See Legal Proceedings) and
intend to enforce against others, we do not know how successful we will be in asserting
our patents against suspected infringers. Our pending and future patent applications may
not issue as patents or, if issued, may not issue in a form that will be advantageous to
us. Even if issued, patents may be challenged, narrowed, invalidated or circumvented,
which could limit our ability to stop competitors from marketing similar products or limit
the length of term of patent protection we may have for our products. Changes in either
patent laws or in interpretations of patent laws in the United States and other countries
may diminish the value of our intellectual property or narrow the scope of our patent
protection. In addition to patented technology, we rely upon unpatented proprietary
technology, processes and know-how. We generally enter into non-disclosure agreements with
our employees and third parties with whom we work, including but not limited to
consultants and vendors, to restrict access to, and distribution of, our proprietary
information. Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy or otherwise obtain and use our technology, proprietary information
and know-how and we may not have adequate remedies for any such breach. Monitoring
unauthorized use of our technology is difficult and we cannot be certain that the steps we
have taken will prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in the United
States. If competitors are able to use our technology, our ability to compete effectively
could be harmed and the value of our technology and products could be adversely
affected.  Costly and time consuming lawsuits may be necessary to enforce and defend
patents issued or licensed exclusively to us,, to protect our trade secrets and/or
know-how or to determine the enforceability, scope and validity of others
intellectual property rights. Such lawsuits may result in patents issued or licensed
exclusively to us to be found invalid and unenforceable.  In addition, our trade
secrets may otherwise become known or our competitors also may independently develop
technologies that are substantially equivalent or superior to our technology and which do
not infringe our patents.


Claims by others that our products
infringe their patents or other intellectual property rights could prevent us from
manufacturing and selling some of our products or require us to pay royalties or incur
substantial costs from litigation or development of non-infringing technology.


In
recent years, there has been significant litigation in the United States involving
patents and other intellectual property rights.  The light based cosmetic and
dermatology industry in particular is characterized by a large number of patents and
related litigation regarding patents and other intellectual property rights. Because our
resources are limited and patent applications are maintained in secrecy for a period of
time, we can conduct only limited searches to determine whether our technology infringes
any patents or patent applications. Any claims for patent infringement, regardless of
merit, could be time-consuming, result in costly litigation and diversion of technical
and management personnel, cause shipment delays, require us to develop non-infringing
technology or to enter into royalty or licensing agreements. Uncertainties resulting from
the initiation and continuation of patent litigation or other proceedings could have a
material adverse effect on our ability to compete in the marketplace. Although patent and
intellectual property disputes in the light based industry have often been settled
through licensing or similar arrangements, costs associated with such arrangements may be
substantial and often require the payment of ongoing royalties, which could have a
negative impact on gross margins. There can be no assurance that necessary licenses would
be available to us on satisfactory terms, or that we could redesign our products or
processes to avoid infringement, if necessary. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain necessary licenses could
prevent us from manufacturing and selling some of our products. This could have a
material adverse effect on our business, results of operations and financial condition.



25


Our charter documents and Delaware
law may discourage potential takeover attempts.


Our
Second Restated Certificate of Incorporation and our By-laws contain provisions that
could discourage takeover attempts or make more difficult the acquisition of a
substantial block of our common stock. Our By-laws require a stockholder to provide to
our Secretary advance notice of director nominations and business to be brought by such
stockholder before any annual or special meeting of stockholders, as well as certain
information regarding such nomination and/or business, the stockholder and others known
to support such proposal and any material interest they may have in the proposed
business. They also provide that a special meeting of stockholders may be called only by
the affirmative vote of a majority of the board of directors. These provisions could
delay any stockholder actions that are favored by the holders of a majority of our
outstanding stock until the next stockholders meeting. In addition, the board of
directors is authorized to issue shares of our common stock and preferred stock that, if
issued, could dilute and adversely affect various rights of the holders of common stock
and, in addition, could be used to discourage an unsolicited attempt to acquire control
of us.


We
are also subject to the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law, which prohibits us from engaging in a business combination
with an interested stockholder for a period of three years after the date of
the transaction in which the person becomes an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203 may limit
the ability of stockholders to approve a transaction that they may deem to be in their
best interests. These provisions of our Second Restated Certificate of Incorporation,
By-laws and the Delaware General Corporation Law could deter certain takeovers or tender
offers or could delay or prevent certain changes in control or our management, including
transactions in which stockholders might otherwise receive a premium for their shares over
the then current market price. In April 1999, we adopted a shareholder rights plan. This
is intended to protect shareholders from unfair or coercive takeover practices.  In
accordance with the shareholder rights plan, the Board of Directors declared a dividend
distribution of Series A right for each share of common stock outstanding until the rights
become exercisable.


We may not be able to
successfully collect licensing royalties.


In
past years and following the settlement with Lumenis, material portions of our revenues
consist of royalties from sub-licensing patents licensed to us on an exclusive basis by
Massachusetts General Hospital.


We
have sued Cutera, Inc. (formerly Altus Medical Inc., See Legal Proceedings) for patent
infringement, and we are involved in patent disputes with other third parties. Such other
disputes may also result in litigation. We have 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 us. Any adverse result in litigation
could weaken the strength of the patents involved, and have a material adverse effect on
our business, financial condition and results of operations.


We may be unable to attract and
retain key executives and research and development personnel that we need to succeed.


As
a small company with less than 200 employees, our success depends on the services of key
employees in executive and research and development positions. The loss of the services
of one or more of these employees could have a material adverse effect on our business.  Our
future success will depend in large part upon our ability to attract, retain, and
motivate highly skilled employees. We cannot be certain that we will be able to do so.

26

We face a risk of financial
exposure to product liability claims in the event that the use of our products results in
personal injury.


Our
products are and will continue to be designed and manufactured with numerous safety
features, but it is possible that consumers could be adversely affected by use of one of
our products. Furthermore, in the event that any of our products prove to be defectively
designed and manufactured, we may be required to recall and redesign such products.
Product liability claims could divert managements attention from our core business,
be expensive to defend and result in sizable damage awards against us. Although we have
not experienced any material losses due to product liability claims to date, there can be
no assurance that we will not experience such losses in the future. We maintain general
liability insurance and umbrella coverage; however, there can be no assurance that such
coverage will continue to be available on terms acceptable to us or that such coverage
will be adequate for liabilities actually incurred. In the event we are found liable for
damages in excess of the limits of our insurance coverage or if any claim or product
recall results in significant adverse publicity against us, our business, financial
condition and results of operations could be materially and adversely affected. In
addition, although our products have been and will continue to be designed to operate in
a safe manner, and although we attempt to educate customers with respect to the proper
use of our products, misuse of our products by personnel over whom we cannot exert
control may result in the filing of product liability claims or significant adverse
publicity against us. Any product liability claims brought against us, with or without
merit, could increase our product liability insurance rates or prevent us from securing
continuing coverage, could harm our reputation in the industry and reduce product sales.
We would need to pay any product losses in excess of our insurance coverage out of cash
reserves, harming our financial condition and adversely affecting our operating results.


Disappointing quarterly revenue or
operating results could cause the price of our common stock to fall.


Our
quarterly revenue and operating results are difficult to predict and may swing sharply
from quarter to quarter.  If our quarterly revenue or operating results fall
below the expectations of investors or public market analysts, the price of our common
stock could fall substantially. Our quarterly revenue is difficult to forecast for many
reasons, some of which are outside of our control.  For example, many factors are
related to market supply and demand, including potential increases in the level and
intensity of price competition between our competitors and us, potential decrease in
demand for our products and possible delays in market acceptance of our new products.  Other
factors are related to our customers and include changes in or extensions of our customers budgeting
and purchasing cycles and changes in the timing of product sales in anticipation of new
product introductions or enhancements by us or our competitors.   Factors
related to our operations may also cause quarterly revenue or operating results to fall
below expectations, including absence of significant product backlogs, our effectiveness
in our manufacturing process, unsatisfactory performance of our distribution channels,
service providers, or customer support organizations, and timing of any acquisitions and
related costs. These factors and each of the risk factors listed in this Cautionary
Statements section may adversely affect our financial results.


We face risks associated with
product warranties.


We
could incur substantial costs as a result of product failures for which we are responsible
under warranty obligations.


Because we derive a significant
amount of our revenue from international sales, we are susceptible to currency
fluctuations, long payment cycles, credit risks and other risks associated with conducting
business overseas.

27


We
sell a significant amount of our products and services outside the U.S. International
product revenue, consisting of sales from our distributors in Japan, Europe, Australia,
Asia\Pacific Rim and South and Central America and sales shipped directly to
international locations from the United States, and we expect that international sales
will continue to be significant.  As a result, a major part of our revenues and
operating results could be adversely affected by risks associated with international
sales, including but not limited to political and economic instability and difficulties
in managing our foreign operations.  In particular, longer payment cycles common in
foreign markets, credit risk and delays in obtaining necessary import or foreign
certification or regulatory approvals for products may occur.  In addition,
significant fluctuations in the exchange rates between the U.S. dollar and foreign
currencies could cause us to lower our prices and thus reduce our profitability, or could
cause prospective customers to push out orders to later dates because of the increased
relative cost of our products in the aftermath of a currency devaluation or currency
fluctuation.





We rely on third party
distributors to market and sell a large portion of our products. If these distributors do
not commit the necessary resources to effectively market and sell our products or if our
relationships with these distributors are disrupted, our business and operating results
may be harmed.


In
the United States, we sell our products through our internal sales organization. Outside
of this market, we sell our products through third party distributors. Our sales and
marketing success in these other markets depends on these distributors, in particular
their sales and service expertise and relationships with the customers in the marketplace.
We do not control these distributors, and they may not be successful in marketing our
products. Third party distributors may terminate their relationships with us, or fail to
commit the necessary resources to market and sell our products to the level of our
expectations. If current or future third party distributors do not perform adequately, or
if we fail to maintain our existing relationships with these distributors or fail to
recruit and retain distributors in particular geographic areas, our revenue from
international sales may be adversely affected and our operating results could suffer.


Managing our relationship with
Gillette effectively may divert the attention of key technical personnel and management
from the core business.   If Gillette ends the relationship our stock price
could fall, and we may be unable to bring a home use hair removal device for women to the
market.


On
February 14, 2003, we entered into a Development and License Agreement with Gillette to
complete development and commercialize a home-use, light based hair removal device for
women.  On June 28, 2004 Palomar and Gillette announced that they completed the
initial phase of their agreement and that both parties would move into the next phase. In
conjunction with entering this next phase, the parties amended the agreement to provide
for additional development funding to further technical innovations. We believe that this
represents a unique opportunity to bring light based devices to the mass market. 
Under the agreement, significant resources and the attention of key technical personnel
and management will be directed to the development of such a device even though such
device will not likely be commercialized for several years, if ever.  In addition, we
cannot be sure that Gillette will agree with our interpretation of the terms of the
agreement, that the agreement will provide us with marketable products in the future or
that we will receive payments for any of the products developed under the agreement. 
During the term of the agreement, Gillette has the ability to choose not to continue and
may terminate the agreement.  If Gillette terminates the agreement, the price of our
common stock could fall significantly, and we will not receive certain payments.  We
may proceed to develop and commercialize the device on our own or with a third
party.  However, there can be no assurance that we will be able to successfully
implement such a strategy.  In addition, after commercialization of such device,
Gillette is to pay us a percentage of net sales of such device. Certain of these
percentages of net sales are only owed if the device is covered by valid patents. 
There can be no assurance that valid patents will cover the device in any or all
countries, in which the device will be manufactured, used or sold.  This could have a
material adverse effect on our business, results of operations and financial
condition.


Managing our contract with the
United States Department of the Army effectively may divert the attention of key technical
personnel and management from the core business.   We may be unable to complete
the project within the time period which may impact our ability to receive future
government contracts.



28


On
February 18, 2004, we announced that we were awarded a $2.5 million research contract by
the Department of the Army to develop a light based self-treatment device for
Pseudofolliculitis Barbae or PFB. This represents a unique opportunity to address
PFB.  On October 25, 2005, we announced that we had received additional funding of
$888,000 and a twelve month extension of this contract.  We believe we can complete
the project within the extension. However, there can be no assurance that we will be able
to complete the project within that time period which may impact our ability to receive
future government contracts.  Under the agreement, significant resources and the
attention of key technical personnel and management will be directed to the development of
such a device even though such device will not likely be ready for military use for
several years, if ever.


Managing our relationship with
Johnson & Johnson Consumer Companies (JJCC) effectively may divert the
attention of key technical personnel and management from the core business.   If
JJCC ends the relationship our stock price could fall, and we may be unable to bring to
market home-use, light based devices for (i) reducing or reshaping body fat including
cellulite; (ii) reducing appearance of skin aging; and (iii) reducing or preventing acne.


On
September 1, 2004, we entered into a Development and License Agreement with Johnson &
Johnson Consumer Companies, Inc. (JJCC), a Johnson & Johnson company, to
develop and commercialize home-use, light based devices in the fields of (i) reducing or
reshaping body fat including cellulite; (ii) reducing appearance of skin aging; and (iii)
reducing or preventing acne.  We believe that this represents a unique opportunity to
bring light based devices to the mass market.  Under the agreement, significant
resources and the attention of key technical personnel and management will be directed to
the development of such devices even though such devices will not likely be commercialized
for several years, if ever.  In addition, we cannot be sure that JJCC will agree with
our interpretation of the terms of the agreement, that the agreement will provide us with
marketable products in the future or that we will receive payments for any of the products
developed under the agreement.During the term of the agreement, JJCC has the
ability to choose not to continue and may terminate the agreement.  If JJCC
terminates the agreement, the price of our common stock could fall significantly, and we
will not receive certain payments.  We may proceed to develop and commercialize the
devices on our own or with a third party.  However, there can be no assurance that we
will be able to successfully implement such a strategy.In addition, after
commercialization of such device, JJCC is to pay us a percentage of net sales of such
device. Certain of these percentages of net sales are only owed if the device is covered
by valid patents. There can be no assurance that valid patents will cover these devices in
any or all countries, in which the devices will be manufactured, used or sold.  This
could have a material adverse effect on our business, results of operations and financial
condition.


Failure to maintain effective
internal controls over financial reporting could have a material adverse effect on our
business, operating results and stock price.



Beginning
with our annual report for our fiscal year ending on December 31, 2004, Section 404 of the
Sarbanes-Oxley Act of 2002 required us to include a report by our management on our
internal controls over financial reporting. Such report must contain an assessment by
management of the effectiveness of our internal controls over financial reporting as of
the end of our fiscal year and a statement as to whether or not such internal controls are
effective. Such report must also contain a statement that our independent auditors have
issued an attestation report on managements assessment of such internal controls.



Our
efforts to comply with Section 404 have resulted in, and are likely to continue to result
in, significant costs, the commitment of time and operational resources and the diversion
of managements attention. If our management identifies one or more material
weaknesses in our internal controls over financial reporting, we will be unable to assert
that such internal controls are effective. If we are unable to assert that our internal
controls over financial reporting are effective our business may be harmed.


We have not paid dividends in the
past and do not expect to pay dividends in the future, and any return on investment may be
limited to the value of our stock.


We
have never paid cash dividends on our common stock and do not anticipate paying cash
dividends on our common stock in the foreseeable future. The payment of dividends on our
common stock will depend on our earnings, financial condition and other business and
economic factors affecting us at such time as our board of directors
may consider relevant. If we do not pay dividends, our stock may be less valuable because
a return on your investment will only occur if our stock price appreciates.

29









Item 3.  Quantitative
and qualitative disclosures about market risk


Our
primary market risk exposures are in the areas of interest rate risk. Our investment
portfolio of cash equivalents and debt securities is subject to interest rate
fluctuations, but we believe this risk is immaterial because of the short-term nature of
these investments.



Item 4. Controls and
procedures


Under
the direction of the principal executive officer and principal financial officer, the
Company has evaluated the effectiveness of its disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2005. Based on
that evaluation, the Company has concluded that its disclosure controls and procedures
were effective in providing reasonable assurance that material information required to be
disclosed is included on a timely basis in the reports filed with the Securities and
Exchange Commission.


There
were no significant changes in the Companys internal controls over financial
reporting or in other factors that could significantly affect these controls during the
quarter ended September 30, 2005, including any corrective actions with regard to
significant deficiencies and material weaknesses.


PART II  Other
information


Item
1.    Legal proceedings


On
February 15, 2002, Palomar commenced an action for patent infringement in the United
States District Court for the District of Massachusetts against Altus Medical, Inc., now
known as Cutera, Inc., seeking both monetary damages and injunctive relief. The complaint
alleges Cuteras CoolGlide and CoolGlide Excel laser systems willfully infringe U.S.
patent No. 5,735,844, which is exclusively licensed to Palomar by the Massachusetts
General Hospital. The Massachusetts General Hospital was added as a plaintiff in this
lawsuit. Cutera answered the complaint denying that its products infringe the asserted
patent and filed a counterclaim seeking a declaratory judgment that the asserted patent is
invalid and not infringed. Palomar and the Massachusetts General Hospital filed a reply
denying the material allegations of the counterclaims. Palomar and the Massachusetts
General Hospital have further alleged that Cuteras CoolGlide Vantage and CoolGlide
XEO laser systems also willfully infringe the asserted patent. On June 4, 2003, Cutera
amended their answer and asserted a counter claim alleging that the patent is
unenforceable due to inequitable conduct. Palomar and the Massachusetts General Hospital
believe that this claim is without merit and filed a reply denying the material
allegations of this counterclaim. A claim construction hearing (often referred to as a
Markman hearing) was held on June 12, 2003, and on February 27, 2004 the Judge issued her
ruling. Palomar believes the ruling largely embraced Palomars position and will have
a considerable impact on the case as it proceeds toward trial. On January 14, 2005, Cutera
filed a Motion for Summary Judgment that the patent claims being asserted are invalid and
not infringed.  Palomar and the Massachusetts General Hospital believe that this
Motion is without merit and filed a response defending both the validity of the
patent claims and the infringement of those claims by Cuteras CoolGlide
products.  A hearing was held March 17, 2005, and the parties are waiting for the
Judge to issue her ruling.  On October 6, 2005, Cutera filed a Motion to Modify
Construction of the Claim Term Applicator. Palomar and the Massachusetts
General Hospital believing this motion is also without merit filed a response in
opposition, and the parties are waiting for the Judge to issue her ruling. A trial date
has not yet been set. (See Cautionary Statements)


30




On
April 7, 2005, Palomar and the Massachusetts General Hospital commenced a second action
for patent infringement in the United States District Court for the District of
Massachusetts against Cutera, Inc.
          seeking both monetary damages and injunctive relief. The complaint alleges
          Cuteras products using pulsed light technology for hair removal willfully
          infringe U.S. patent Nos. 5,595,568 and 5,735,844, which are exclusively
          licensed to Palomar by the Massachusetts General Hospital.  Cuteras
          products include the Solera Opus product in the Solera Platform and other
          products using pulsed light and light-based technology in Cuteras XEO
          platform.  Cuteras PW 770 handpiece is utilized in the Solera and XEO
          Platforms.  Instead of answering the complaint, Cutera filed a motion to
          dismiss for lack of personal jurisdiction in Massachusetts, and Cutera then
          filed identical lawsuits in California and Delaware seeking a declaratory
          judgment that the 5,595,568 and 5,735,844 patents are not infringed, are
          invalid, and that the patents are unenforceable due to inequitable
          conduct.  Palomar and MGH believe Cutera is subject to personal
          jurisdiction in Massachusetts and have filed a response opposing
          their motion. The parties are waiting for the Judge to issue her ruling. 
          (See Cautionary Statements)


Item 2. Changes in
securities, use of proceeds and issuer purchases of securities.


Not
applicable.


Item 3. Defaults upon
senior securities


Not
applicable.

Item 4.  Submission of matters to a vote of security holders


Not applicable.


Item 5. Other
information.


Not
Applicable.


Item 6.  Exhibits and reports on Form 8-K


(a)
 Exhibits
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------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| |      |                                                                                                                                                                                                                         
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 31.1 | Certification of Joseph P. Caruso, President and Chief Executive Officer of
                             the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                             2002.

| |      |                                                                                                                                                                  
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 31.2 | Certification of Paul S. Weiner, Vice President and Chief Financial Officer of the
Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

| |    |                                                                                                                                                                                                               
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 32 | Certification of Joseph P. Caruso, President and Chief Executive Officer of the
Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

| |    |                                                                                                                                                                                                                  
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 32 | Certification of Paul S. Weiner, Vice President and Chief Financial Officer of the
Company, pursuant to 18 United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

|(b)
  Reports on Form 8-K


On
July 28, 2005, we filed a current report on Form 8-K, which reported our financial results
for the three months ending June 30, 2005.

31





Signatures


Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant certifies that
it has caused this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Palomar Medical
Technologies, Inc.(Registrant)
| |  | ----------------------------------------------

|                        |                                                                                                     
|----------------------- | ----------------------------------------------------------------------------------------------------
|Date:  November 4, 2005 | By:/s/ Joseph P. Caruso
      Joseph P. Caruso
      President, Chief Executive Officer and Director
|                        |                                                                                                     

|                        |                                                                                            
|----------------------- | -------------------------------------------------------------------------------------------
|Date:  November 4, 2005 | By:/s/ Paul S. Weiner
      Paul S. Weiner
      Vice President and Chief Financial Officer
|                        |                                                                                            

|32
|--