FORM 10-Q

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

                                   (Mark one)

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

                    For quarterly period ended June 30, 1999

                                       OR

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

               For the transition period from ________ to ________

                         Commission file number: 0-22340

                       PALOMAR MEDICAL TECHNOLOGIES, INC.
               (Exact name of issuer as specified in its charter)
<TABLE>
<S>                                                                     <C>

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

               45 HARTWELL AVENUE, LEXINGTON, MASSACHUSETTS 02421
               --------------------------------------------------
                    (Address of principal executive offices)

                                 (781) 676-7300
                 -----------------------------------------------
                (Issuer's telephone number, including area code)

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

         As of July 31, 1999,  10,077,987 shares of common stock, $.01 par value
per share, were outstanding.

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

<PAGE>
               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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

PART I - FINANCIAL INFORMATION

         ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

                  Consolidated Condensed Balance Sheets                                                   1

                  Consolidated Statements of Operations                                                   2

                  Consolidated Statements of Stockholders' (Deficit) Equity                               3

                  Consolidated Statements of Cash Flows                                                   4

                  Notes to Consolidated Financial Statements                                              5

         ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                          12

         RISK FACTORS                                                                                    18

         ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES
                  ABOUT MARKET RISK                                                                      22

PART II - OTHER INFORMATION

         ITEM 1.  LEGAL PROCEEDINGS                                                                      23

         ITEM 2.  CHANGES IN SECURITIES                                                                  24

         ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                        24

         ITEM 4.  SUBMISSION OF MATTERS TO A VOTE
                  OF SECURITY HOLDERS                                                                    25

         ITEM 5.  OTHER INFORMATION                                                                      25

         ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                       26

SIGNATURES                                                                                               27
</TABLE>

                                      -i-
<PAGE>


ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED).

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

                                   (UNAUDITED)

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

                                                                         December 31,              June 30,
                                                                             1998                    1999
                                                                       ------------------     -------------------
ASSETS

CURRENT ASSETS:

       Cash and cash equivalents                                              $1,874,718             $17,518,734
       Available-for-sale investments, at market value                                 -              17,796,284
       Accounts receivable, net                                                9,938,121               2,355,955
       Inventories                                                             5,416,342               3,978,105
       Other current assets                                                    1,056,388               3,477,791
                                                                       ------------------     -------------------
                Total current assets                                          18,285,569              45,126,869
                                                                       ------------------     -------------------

PROPERTY AND EQUIPMENT, AT COST, NET                                           3,314,087               1,459,757
                                                                       ------------------     -------------------

OTHER ASSETS:

       Cost in excess of net assets acquired, net                              1,699,983                 757,236
       Deferred financing costs                                                   58,923                       -
       Other noncurrent assets                                                   167,352                 154,427
                                                                       ------------------     -------------------
                Total other assets                                             1,926,258                 911,663
                                                                       ------------------     -------------------

                                                                             $23,525,914             $47,498,289
                                                                       ==================     ===================
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY

CURRENT LIABILITIES:

       Current portion of long-term debt                                      $6,290,041              $2,974,907
       Accounts payable                                                        6,553,745                 581,222
       Accrued liabilities                                                    10,301,624              10,669,830
       Current portion of deferred revenue                                     1,143,796               1,214,082
       Other current liabilities                                                       -               3,239,556
                                                                       ------------------     -------------------
           Total current liabilities                                          24,289,206              18,679,597
                                                                       ------------------     -------------------

NET LIABILITIES OF DISCONTINUED OPERATIONS                                     1,680,171                       -
                                                                       ------------------     -------------------

LONG-TERM DEBT, NET OF CURRENT PORTION                                         3,150,000               2,844,242
                                                                       ------------------     -------------------

DEFERRED REVENUE, NET OF CURRENT PORTION                                         870,000                       -
                                                                       ------------------     -------------------

STOCKHOLDERS' (DEFICIT) EQUITY:
       Preferred stock, $.01 par value-

           Authorized - 1,500,000 shares
           Issued and outstanding -
           6,993 shares and 6,000 shares
           at December 31, 1998 and June 30, 1999, respectively                       69                      60
       Common stock, $.01 par value-
           Authorized - 45,000,000 shares
           Issued - 10,074,864 shares and 11,028,959 shares
           at December 31, 1998 and June 30, 1999, respectively                  100,747                 110,288
       Additional paid-in capital                                            161,337,926             162,447,380
       Accumulated deficit                                                 (166,263,346)           (133,208,381)
       Unrealized loss on available-for-sale investments                               -                (53,964)
       Less: Treasury stock - 49,285 and 894,846 shares at cost
       at December 31, 1998 and June 30, 1999, respectively                  (1,638,859)             (3,320,933)
                                                                       ------------------     -------------------
           Total stockholders' (deficit) equity                              (6,463,463)              25,974,450
                                                                       ------------------     -------------------
                                                                             $23,525,914             $47,498,289
                                                                       ==================     ===================
</TABLE>

                                      -1-
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>
                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

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

                                                        Three Months Ended                Six Months Ended
                                                             June 30,                         June 30,

                                                       1998           1999              1998            1999
                                                   -------------  --------------   ---------------  --------------

REVENUES                                             $9,090,396      $5,529,177       $16,157,801     $19,007,786

COST OF REVENUES                                      4,812,456       4,237,045        11,148,701       9,207,021
                                                   -------------  --------------   ---------------  --------------

     Gross Margin                                     4,277,940       1,292,132         5,009,100       9,800,765
                                                   -------------  --------------   ---------------  --------------

OPERATING EXPENSES

     Research and development                         1,943,523       2,504,746         4,108,523       4,630,729
     Sales and marketing                              3,526,770       1,618,800         6,029,885       5,717,222
     General and administrative                       2,359,142       1,485,378         5,203,001       3,157,632
     Costs incurred for proxy contest                         -         624,627                 -         624,627
     Settlement costs                                         -         750,000                 -         750,000
                                                   -------------  --------------   ---------------  --------------
        Total operating expenses                      7,829,435       6,983,551        15,341,409      14,880,210
                                                   -------------  --------------   ---------------  --------------

        Loss from operations                         (3,551,495)     (5,691,419)      (10,332,309)     (5,079,445)

GAIN FROM SALE OF SUBSIDIARY (NOTE 1)                         -      47,090,876                 -      47,090,876
SWISS FRANC REDEMPTION (NOTE 8)                               -      (6,167,369)                 -     (6,167,369)
INTEREST INCOME                                           1,065         401,937            29,544         407,634
INTEREST EXPENSE                                       (409,088)       (192,969)         (829,335)       (363,916)
OTHER INCOME (EXPENSE), NET                              (8,935)        257,291           324,965         279,637
                                                   -------------  --------------   ---------------  --------------

        (LOSS) INCOME FROM CONTINUING OPERATIONS
        BEFORE PROVISION FOR INCOME TAXES            (3,968,453)      35,698,347      (10,807,135)      36,167,417

PROVISION FOR INCOME TAXES                                    -        2,500,000                 -       2,500,000
                                                   -------------  --------------   ---------------  --------------
        (LOSS) INCOME FROM CONTINUING
        OPERATIONS                                   (3,968,453)      33,198,347      (10,807,135)      33,667,417

LOSS FROM DISCONTINUED OPERATIONS (NOTE 10)

        Loss from operations                         (1,090,885)        (435,000)      (1,090,885)        (435,000)
        Loss on disposal                             (1,533,295)               -       (1,533,295)               -
                                                   -------------  --------------   ---------------  --------------
        NET LOSS FROM DISCONTINUED OPERATIONS        (2,624,180)        (435,000)      (2,624,180)        (435,000)
                                                   =============  ==============   ===============  ==============
        NET (LOSS) INCOME                           $(6,592,633)     $32,763,347     $(13,431,315)     $33,232,417
                                                   =============  ==============   ===============  ==============

BASIC NET (LOSS) INCOME PER SHARE:

        Continuing operations                        $    (0.48)      $     3.22      $     (1.45)      $     3.27
        Discontinued operations                           (0.29)          (0.04)            (0.32)          (0.04)
                                                   -------------  --------------   ---------------  --------------
        TOTAL BASIC NET (LOSS) INCOME PER
             SHARE                                   $    (0.77)      $     3.18      $     (1.77)      $     3.23

BASIC WEIGHTED AVERAGE NUMBER OF SHARES               9,047,185      10,284,035         8,234,764      10,239,338
                                                   =============  ==============   ===============  ==============

DILUTED NET (LOSS) INCOME PER SHARE:

     Continuing operations                          $    (0.48)      $     3.02      $     (1.45)      $     3.03
     Discontinued operations                        $    (0.29)           (0.04)           (0.32)           (0.04)
                                                   -------------  --------------   ---------------  --------------
        TOTAL DILUTED NET (LOSS) INCOME PER
        SHARE                                       $    (0.77)      $     2.98      $     (1.77)      $     2.99

DILUTED WEIGHTED AVERAGE NUMBER OF SHARES             9,047,185      11,033,819         8,234,764      11,183,627
                                                   =============  ==============   ===============  ==============


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

<PAGE>


                       PALOMAR MEDICAL TECHNOLOGIES, INC.

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
                                   (UNAUDITED)

                                                         Preferred Stock               Common Stock               Treasury Stock
                                                        ---------------------------------------------------------------------------
                                                         Number    $0.01           Number      $0.01          Number
                                                          of       Par Value     of Shares  Par Value        of Shares    Cost
                                                         Shares
                                                        ---------------------------------------------------------------------------

BALANCE, DECEMBER 31, 1998                                 6,993       $69      10,074,864   $100,747      (49,285)    ($1,638,859)

     Issuance of common stock for 1998 employer 401(k)
          matching contribution                                -         -          32,561        326            -               -
     Conversion of preferred stock                          (340)       (3)         74,905        749            -               -
     Conversion of convertible debentures                      -         -         377,760      3,778            -               -
     Redemption of preferred stock                          (653)       (6)              -          -            -               -
     Redemption of common stock related to
          Swiss Franc convertible debentures                             -                          -     (130,576)       (575,348)
     Purchase of treasury stock                                          -                          -     (250,700)     (1,102,084)
     Issuance of common stock for  Employee Stock
          Purchase Plan                                        -         -           4,584         46            -               -
     Issuance of escrow shares to treasury                               -         464,285      4,642     (464,285)         (4,642)
     Costs incurred related to the issuance of common
          stock                                                -         -               -          -            -               -
     Unrealized loss on available-for-sale investments                   -               -          -            -               -
     Preferred stock dividends                                 -         -               -          -            -               -
     Net income                                                -         -               -          -            -               -
                                                        ===========================================================================
BALANCE, JUNE 30, 1999                                     6,000       $60      11,028,959   $110,288     (894,846)    ($3,320,933)
                                                        ===========================================================================
</TABLE>
<TABLE>
<S>                                                     <C>           <C>             <C>                   <C>

                                                        ---------------------------------------------------------------------------
                                                        Additional                        Unrealized Loss         Total
                                                         Paid-in         Accumulated           on              Stockholders'
                                                         Capital           Deficit       Available-for-Sale      (Deficit)
                                                                                            Investments            Equity
                                                        ---------------------------------------------------------------------------

BALANCE, DECEMBER 31, 1998                              $161,337,926  $ ($166,263,346)     $        -             $  (6,463,463)

     Issuance of common stock for 1998 employer 401(k)
          matching contribution                              206,333                -               -                   206,659
     Conversion of preferred stock                            62,665                -               -                    63,411
     Conversion of convertible debentures                  1,802,296                -               -                 1,806,074
     Redemption of preferred stock                          (781,381)               -               -                  (781,387)
     Redemption of common stock related to
        Swiss Franc convertible debentures                         -                -               -                  (575,348)
     Purchase of treasury stock                                    -                -               -                (1,102,084)
     Issuance of common stock for  Employee Stock
          Purchase Plan                                       18,041                -               -                    18,087
     Issuance of escrow shares to treasury                         -                -               -                         -
     Costs incurred related to the issuance of common
          stock                                             (198,500)               -               -                   (198,500)
     Unrealized loss on available-for-sale investments             -                -         (53,964)                   (53,964)
     Preferred stock dividends                                     -         (177,452)              -                   (177,452)
     Net income                                                    -       33,232,417               -                 33,232,417
                                                        ===========================================================================
BALANCE, JUNE 30, 1999                                  $162,447,380  $ ($133,208,381)       ($53,964)               $25,974,450
                                                        ===========================================================================
</TABLE>


                                       3
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<S>  <C>                                                                       <C>                  <C>

                                                                                       Six Months Ended June 30,
                                                                                      1998                 1999
                                                                               -------------------  -------------------
CASH FLOWS FROM OPERATING ACTIVITIES

     Net (Loss) Income                                                              $(13,431,315)           33,232,417
        Less: Net Loss from discontinued operations                                   (2,624,180)            (435,000)
                                                                               -------------------  -------------------
     Net (Loss) Income from continuing operations                                    (10,807,135)           33,667,417
                                                                               -------------------  -------------------

     Adjustments to reconcile net (loss) income from continuing operations
         to net cash used in operating activities-
        Depreciation and amortization                                                   1,372,120              873,603
        Non-cash interest expense related to debt                                         171,000                    -
        Unrealized gain on marketable securities                                        (332,965)                    -
        Gain from sale of subsidiary                                                           -           (47,090,876)
        Redemption of common stock held by Swiss Franc debenture holders                       -             6,167,369
        Changes in assets and liabilities, net of effects from sale of
          subsidiary
           Net sale of marketable trading securities                                    1,840,395                    -
           Accounts receivable                                                        (3,033,274)            2,367,166
           Inventories                                                                  1,785,358          (1,067,763)
           Other current assets                                                           604,470          (2,456,403)
           Accounts payable                                                             (649,765)          (4,119,523)
           Accrued expenses                                                               400,354            1,589,202
           Other current liabilities                                                            -            3,239,556
                                                                                                -             (799,714)
                                                                               -------------------  -------------------
                 Net cash used in operating activities                                 (8,649,442)          (7,629,966)
                                                                               -------------------  -------------------

CASH FLOWS FROM INVESTING ACTIVITIES

     Purchases of property and equipment                                                (233,069)            (249,691)
     Purchases of available-for-sale investments                                               -          (17,850,248)
     Proceeds from the sale of subsidiary, net of cash on hand $288,000                        -            49,448,023
     Increase in other assets                                                           (470,252)               10,925
     Increase in notes receivable                                                        (86,818)                    -
                                                                               -------------------  -------------------
                 Net cash used in investing activities                                  (790,139)           31,359,009
                                                                               -------------------  -------------------

CASH FLOWS FROM FINANCING ACTIVITIES

     Redemption of convertible debentures                                             (2,196,667)                   -
     Net proceeds from the issuance of notes payable and advances from                  3,394,070              750,000
     distributor
     Proceeds from issuance of common stock                                             6,874,482                   -
     Proceeds from exercise of warrants, stock options and Employee Stock
          Purchase Plan                                                                         -               18,087
     Costs incurred related to issuance of common stock                                  (100,000)            (198,500)
     Payments on line of credit                                                                 -           (1,000,000)
     Payment on Swiss Franc convertible debentures                                              -           (1,365,931)
     Purchase of treasury stock                                                                 -           (1,102,084)
     Payment on note payable                                                                    -           (2,290,041)
     Redemption of preferred stock                                                     (3,791,889)            (781,387)
                                                                               -------------------  -------------------
                 Net cash provided by financing activities                              4,179,996          (5,969,856)
                                                                               -------------------  -------------------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS                                           (5,259,585)           17,759,187
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS                                  3,462,141          (2,115,171)
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD                                      3,003,300            1,874,718
                                                                               ===================  ===================
CASH AND CASH EQUIVALENTS, END OF THE PERIOD                                           $1,205,856          $17,518,734
                                                                               ===================  ===================

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

     Cash paid for interest                                                            $1,022,863             $264,934
                                                                               ===================  ===================

SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
     Conversion of convertible debentures and related accrued

        interest, net of financing fees                                                $6,076,994           $1,806,074
                                                                               ===================  ===================

     Conversion of preferred stock                                                       $480,659              $63,411
                                                                               ===================  ===================

     Issuance of common stock for 1997 and 1998 employer 401(k)

        matching contribution                                                            $254,282             $206,659
                                                                               ===================  ===================

     Unrealized loss on available-for-sale investments                                   $      -              $53,964
                                                                               ===================  ===================
</TABLE>

                                        4
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>


                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       BASIS OF PRESENTATION

         The accompanying  unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
information.  Accordingly,  they  do not  include  all of  the  information  and
footnotes  required by generally  accepted  accounting  principles  for complete
financial statements. The results of operations for the interim periods shown in
this report are not  necessarily  indicative of expected  results for any future
interim period or for the entire fiscal year. Palomar Medical Technologies, Inc.
and its  subsidiaries  (the "Company" or "Palomar")  believes that the quarterly
information presented includes all adjustments (consisting of normal,  recurring
adjustments)  necessary for a fair  presentation  in accordance  with  generally
accepted accounting principles.  The accompanying financial statements and notes
should be read in conjunction with the Company's Form 10-K as amended, as of and
for the year ended December 31, 1998.

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization (the "Agreement") with Coherent, Inc. ("Coherent") to sell all of
the issued and outstanding common stock of Palomar's Star Medical  Technologies,
Inc.  subsidiary  ("Star").  This  sale  was  approved  by  a  majority  of  the
stockholders  of Palomar on April 21,  1999 and on April 27,  1999,  the Company
completed the sale of Star to Coherent.  The total purchase price for all of the
issued and outstanding capital stock of Star was $65 million,  paid in cash. The
purchase  price  was paid to the  shareholders  of Star in  proportion  to their
holdings of Star capital  stock.  On the date of sale,  Palomar  owned 82.46% of
Star. Palomar received net proceeds of $49,736,023, of which $3,254,908 is being
held in escrow for one year as security for any claims  which  Coherent may have
under the Agreement,  resulting in a gain of $47,090,876. In addition, under the
terms of the Agreement the Company will receive an ongoing  royalty of 7.5% from
Coherent  on the sale of any  products  by  Coherent  that  incorporate  certain
patented  technology or use certain patented methods  currently  licensed by the
Company on an exclusive basis from Massachusetts General Hospital.

         On April 21, 1999, a majority of the Company's  stockholders'  approved
an amendment to the Company's  Certificate of  Incorporation to effect a plan of
recapitalization that resulted in a one-for-seven reverse split of the Company's
common  stock  and  that  reduced  the  Company's  authorized  capital  stock to
45,000,000  shares of common stock and 1,500,000  shares of preferred stock. All
share and per share amounts of common stock for all periods  presented have been
retroactively adjusted to reflect the reverse stock split.

2.       CASH AND CASH EQUIVALENTS

         Cash  equivalents   consists   principally  of  corporate  notes,  U.S.
government-agency  securities,  commercial paper,  money market funds, and other
marketable  securities  purchased  with an original  maturity of three months or
less. These investments are carried at cost, which approximates market value.

3.       MARKETABLE SECURITIES

         The Company's marketable equity securities with maturities greater than
90  days  are  considered  available-for-sale  investments  in the  accompanying
balance sheet and are carried at market value, with the difference  between cost
and market value, net of related tax effects,  recorded as a separate  component
of shareholders'  (deficit) equity.  The aggregate market value, cost basis, and
gross unrealized losses of available-for-sale investments are as follows:
<TABLE>
<S>      <C>                                           <C>               <C>             <C>

                                                         Market             Cost              Gross
                                                          Value             Basis        Unrealized Loss
                                                       -----------       -----------     ---------------

         Available-for-sale securities:

         Corporate and municipal debt securities       $17,796,284       $17,850,248         $53,964
                                                       ===========       ===========     ===============
</TABLE>


                                       5
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>
                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Available-for-sale  investments  in the  accompanying  balance sheet at
June 30, 1999 include debt securities of $9,708,572 with contractual  maturities
of one year or less, $8,141,676 million with contractual maturities of more than
one year  through  five years.  Actual  maturities  may differ from  contractual
maturities as a result of the Company's intent to sell these securities prior to
maturity and as a result of call features of the  securities  that enable either
the Company,  the issuer, or both to redeem these securities at an earlier date.
Unrealized  holding  losses  totaling  $53,964  on such  debt  securities,  were
deducted from  stockholders'  (deficit)  equity during six months ended June 30,
1999.

4.       INVENTORIES

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

                                                                    December 31,           June 30,
                                                                        1998                 1999

                                                                  ------------------   ----------------
                           Raw materials                               $2,478,289          $1,520,703
                           Work-in-process                              1,330,822           1,341,205
                           Finished goods                             1,607,231            1,116,197
                                                                   ----------------    ----------------
                                                                   ================    ================
                                                                      $5,416,342           $3,978,105
                                                                   ================    ================
</TABLE>

5.       PROPERTY AND EQUIPMENT

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

                                                                      December 31,        June 30,
                                                                         1998               1999

                                                                   ------------------  ----------------
                            Machinery and equipment                      $6,022,320       $4,728,081
                            Furniture and fixtures                        1,120,450          941,790
                            Leasehold improvements                          567,216                0
                                                                   ------------------  ----------------
                                                                          7,709,986        5,669,871

                            Less:  Accumulated depreciation
                                    and amortization                      4,395,899        4,210,114
                                                                   ------------------  ----------------
                                                                         $3,314,087       $1,459,757
                                                                    =================  ================
</TABLE>


                                       6
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.       NET INCOME LOSS PER COMMON SHARE

         Basic net income (loss) per share was determined by dividing net income
(loss) by the weighted  average  common  shares  outstanding  during the period.
Diluted net income  (loss) 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  based on the
treasury  stock method and the assumed  conversion of all debt  obligations  and
convertible  preferred stock and the elimination of related interest expense and
preferred  stock  dividends.  The  calculations  of basic and  diluted  weighted
average shares outstanding are as follows:
<TABLE>
<S><C>                                                     <C>             <C>            <C>           <C>

                                                               Three Months Ended           Six Months Ended
                                                                    June 30,                    June 30,
                                                           ---------------------------- ---------------------------
                                                              1998          1999          1998           1999
                                                           ------------- -------------- ------------- -------------
  Basic weighted average common
    shares outstanding                                       9,047,185     10,284,035     8,234,764     10,239,338

  Potential common shares pursuant to:

    Stock options and warrants                                       -        110,086             -         83,514
    Convertible preferred stock                                      -        415,529             -        468,288
    Convertible debentures                                           -        224,169             -        392,487
                                                           ----------------------------------------- --------------
  Diluted weighted average common
    shares outstanding                                       9,047,185     11,033,819     8,234,764     11,183,627
                                                           ========================================= ==============
</TABLE>

         The Company's net income  (loss) per share from  continuing  operations
for the three and six months ended June 30, 1998 and 1999 is as follows:
<TABLE>
<CAPTION>

                                                        Three Months Ended                         Six Months Ended
                                                             June 30,                                  June 30,
<S><C>    <C>    <C>                          <C>                  <C>                  <C>                 <C>
                                              ---------------------------------------   ---------------------------------------
                                                    1998                 1999                 1998                 1999
                                              ------------------   ------------------   ------------------  -------------------
  Net (loss) income from                           $(3,968,453)          $33,198,347        $(10,807,135)          $33,667,417
       continuing operations
  Preferred stock dividends                           (401,614)             (80,226)          (1,146,435)            (177,452)
                                              ------------------   ------------------   ------------------  -------------------
  Adjusted net (loss) income                       $(4,370,067)          $33,118,121        $(11,953,570)          $33,489,965
                                              ==================   ==================   ==================  ===================

  Basic net (loss) income per common share
  from continuing operations                            $(0.48)                $3.22              $(1.45)                $3.27
                                              ==================   ==================   ==================  ===================

  Basic weighted average number of shares
  outstanding                                         9,047,185           10,284,035            8,234,764           10,239,338
                                              ==================   ==================   ==================  ===================
</TABLE>

         As of June 30, 1998 and 1999,  3,928,083 and 3,010,354 weighted average
common  equivalent  shares,  respectively,  were  not  included  in the  diluted
weighted average shares outstanding as they were antidilutive.


                                       7
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.      COMPREHENSIVE (LOSS) INCOME

         The Company adopted SFAS 130, Reporting Comprehensive Income, effective
January 1, 1998.  SFAS 130  established  standards  for reporting and display of
comprehensive (loss) income and its components in the financial statements.  The
Company's only item of other  comprehensive  income relates to unrealized losses
on its available-for-sale investments and is presented separately on the balance
sheet as  required.  A  reconciliation  of  comprehensive  (loss)  income  is as
follows:
<TABLE>
<CAPTION>

                                                        Three Months Ended                         Six Months Ended
                                                             June 30,                                  June 30,
<S>                                           <C>                  <C>                  <C>                 <C>
                                              ---------------------------------------   ---------------------------------------
                                                    1998                 1999                 1998                 1999
                                              ------------------   ------------------   ------------------  -------------------
                                              ------------------   ------------------   ------------------  -------------------
  Net (loss) income from continuing                $(3,968,453)          $33,198,347        $(10,807,135)          $33,667,417
       operations
  Unrealized loss on available-for-sale
       investments                                   ---                     (53,964)           ---                    (53,964)
                                              ------------------   ------------------   ------------------  -------------------
  Comprehensive (loss) income from
       continuing operations                       $(3,968,453)          $33,144,383        $(10,807,135)          $33,613,453
                                              ==================   ==================   ==================  ===================
</TABLE>

8.       NOTES PAYABLE

         Notes payable consist of the following:
<TABLE>
<S>                                                                                  <C>                  <C>
                                                                                       December 31,           June 30,
                                                                                           1998                 1999
                                                                                     -----------------    -----------------
  Dollar denominated convertible debentures                                              $2,150,000             $500,000
  Swiss Franc denominated convertible debentures                                                  -            5,319,149
  Note payable issued in connection with guaranty on behalf of

           discontinued subsidiary                                                        2,290,041                    -
  Revolving line of credit with a bank                                                    1,000,000                    -
  Short-term notes payable to Coherent                                                    4,000,000                    -
                                                                                     -----------------    -----------------
                                                                                          9,440,041            5,819,149
  Less - current maturities                                                               6,290,041            2,974,907
                                                                                     -----------------    -----------------
                                                                                         $3,150,000           $2,844,242
                                                                                     =================    =================
</TABLE>

(A)     DOLLAR DENOMINATED CONVERTIBLE DEBENTURES

        During the first six months of 1999, the Company converted $1,650,000 of
its 6%, 7% and 8% convertible  debentures due March 31, 2002, including $176,483
of accrued interest, into 377,760 shares of the Company's common stock.


                                       8
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(B)      SWISS FRANC DENOMINATED CONVERTIBLE DEBENTURES

        During the three  months  ended June 30,  1999,  the Company  recorded a
redemption expense of $6,167,369  million as a result of a compromise  agreement
between  Palomar  and  certain  European  banks that had held 4.5%  Swiss  Franc
subordinated  convertible  debentures  originally  totaling  approximately  $8.2
million  due in 2003.  Under the terms of this April 21, 1999  agreement,  which
resolved a lawsuit,  Palomar agreed to rescind its conversion  notices issued in
November  1997.  Through  these  conversion   notices,   Palomar  converted  the
subordinated debentures into 130,576 shares of the Company's common stock. Since
the  conversion  date,  the  Company  had  treated  these  shares as issued  and
outstanding.  Under the terms of the agreement the Company agreed to pay a total
of approximately  $6,741,867 to the European banks, of which $1,365,931 has been
paid as of June 30, 1999 and an additional $2,974,659 was paid during July 1999.
The remaining  amounts due under this  obligation are due in 2001.  Accordingly,
the Company  has  recorded a charge to  operations  of  $6,167,369.  This amount
represents the total amount due to the European banks less the fair market value
of the redemption of the common shares previously considered  outstanding by the
Company.

(C)      NOTE  PAYABLE   ISSUED  IN  CONNECTION   WITH  GUARANTY  ON  BEHALF  OF
         DISCONTINUED SUBSIDIARY

         In  connection  with  the  divestiture  of  one  of  its   discontinued
operations,  the Company entered into a Loan and  Subscription  Agreement with a
bank for  $3,233,000.  This promissory note represents the settlement of amounts
owed to the bank by Palomar's former Comtel,  Inc.  subsidiary and by Palomar in
connection  with a guarantee  from Palomar in favor of the bank.  Principal  and
interest payments were being made over 24 months,  beginning  December 31, 1997,
with interest accruing at the bank's prime rate plus 2.25%. This promissory note
was  collateralized  by 464,286 shares of the Company's common stock,  which was
held in escrow.  On May 3, 1999,  the Company  paid off the balance of this note
(totaling  $2,020,625),  and the  shares  of the  Company's  common  stock  were
released from escrow and returned to the Company.  The Company has accounted for
the return of the shares as an  increase  to its  treasury  stock.

(D)      REVOLVING LINE OF CREDIT

         The Company  had a  $10,000,000  revolving  line of credit with a bank.
This line of credit  was to mature on March 31,  2000 and bore  interest  at the
bank's  prime  rate.  Borrowings  under  this line of  credit  were  secured  by
substantially  all assets of the  Company and were  limited to 80% of  qualified
accounts receivable.  A director of Palomar personally guaranteed all borrowings
under this line of credit. The Company repaid all amounts outstanding under this
line of credit on April 27, 1999, and cancelled this line of credit.

(E)      SHORT-TERM NOTES PAYABLE

         Through March 31, 1999, the Company's Star subsidiary  borrowed a total
of $4,750,000  from Coherent in the form of notes  payable.  These notes accrued
interest at 8.5% per annum and were collateralized by Star's inventory. Coherent
assumed  this debt in  connection  with its  purchase  of all of the  issued and
outstanding common stock of Star on April 27, 1999. See Note 1.


                                       9
                   The accompanying notes are an integral part
                   of these consolidated financial statements.
<PAGE>

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.       STOCKHOLDERS' (DEFICIT) EQUITY

(A)      CONVERTIBLE PREFERRED STOCK

         During the first quarter of 1999,  the Company  converted 340 shares of
Series G Preferred  Stock and accrued  dividends  and  interest of $63,411  into
74,905 shares of the Company's common stock.

         During the second quarter of 1999,  the Company  redeemed 403 shares of
Series G Preferred Stock and 250 shares of Series H Preferred Stock for $902,396
including related accrued dividends and interest of $121,009.

(B)      OPTIONS TO PURCHASE COMMON STOCK

         During the six months ended June 30, 1999, the Company  granted options
to purchase  929,327  shares of the  Company's  common stock at exercise  prices
ranging from $3.1875 to $10.50 per share.  No options were exercised  during the
six months  ended June 30,  1999.  During  the six  months  ended June 30,  1999
options to purchase  37,238  shares of the  Company's  common  stock at exercise
prices ranging from $3.1875 to $10.50 per share expired.

(C)      WARRANTS TO PURCHASE COMMON STOCK

         During the six months ended June 30, 1999, the Company granted warrants
to purchase 113,000 shares of the Company's common stock at an exercise price of
$3.1875 per share.  No warrants were exercised  during the six months ended June
30, 1999. During the six months ended June 30, 1999, warrants to purchase 88,899
shares of the Company's  common stock at exercise  prices ranging from $14.00 to
$72.625 per share expired.

(D)      RESERVED SHARES

         As of June 30,  1999,  the  Company had  reserved  shares of its common
stock for the following:
<TABLE>
<S>            <C>                                             <C>

                                                                    June 30, 1999

                                                                ----------------------
               Convertible debentures                                      188,635
               Stock option plans                                        4,686,828
               Warrants                                                  2,821,119
               Employee 401(k) plan                                         46,697
               Employee Stock Purchase Plan                                126,764
               Convertible preferred stock                                  85,714
                                                                ======================
                              Total                                      7,955,757
                                                                ======================
</TABLE>

         Substantially   all  of  the  reserved   shares   reflected  above  are
exercisable  at prices in excess of the current  market  price of the  Company's
common stock.


                                       10

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

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.      DISCONTINUED OPERATIONS

         On December 31, 1997 the Company entered into an Exchange Agreement and
sold 500,000 shares of the common stock of Nexar Technologies, Inc. ("Nexar") to
GFL  Advantage  Fund  Limited  ("GFL")  for  $2,000,000.  Under the terms of the
Exchange  Agreement,  Palomar  guaranteed GFL a minimum selling price of $5.00 a
share with  respect to 400,000  shares of the Nexar common stock over a two year
time  period.  The Company  therefore  would have been  obligated  to pay GFL on
January 1, 2000 the difference between $5.00 and the price at which GFL sold the
shares of Nexar  common  stock.  As of March 31, 1999,  the  deferred  liability
related to this transaction  totaled $1,680,171 and represented the total amount
due to GFL after GFL sold all of its 400,000  shares of Nexar common stock.  The
Company paid this obligation on May 3, 1999.

         During the second  quarter of 1998,  the Company sold all of the issued
and outstanding  common stock of its subsidiary,  Dynaco Corp.  ("Dynaco").  The
Company  recognized  a  loss  from  discontinued   operations  of  approximately
$1,091,000  related  to  operations  of  Dynaco  through  disposition  that  was
previously not accrued.  During the second quarter of 1998, the Company recorded
a charge to discontinued  operations of $1,525,000 due to management's  decision
to write down the carrying value of its investment in Nexar.

         During  the second  quarter of 1999,  the  Company  paid and  settled a
lawsuit related to the operations of Dynaco for $435,000.

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

                                                    Three Months Ended                   Six Months Ended
                                                         June 30,                            June 30,

                                                    1998           1999                 1998          1999
                                              -------------------------------      -----------------------------
  Revenues                                         $2,125,580       $--               $5,745,750       $--
  Net loss from discontinued operations           $(2,624,180)    $(435,000)         $(2,624,180)    $(435,000)
</TABLE>

11.      COMMITMENTS

         On June 17, 1999,  the Company  entered into a 10 year lease  agreement
for its  operating  facilities.  Under  the  terms  of  this  lease  the  annual
commitment is  approximately  $890,000 for the first five years of the agreement
and $980,000 for the second five years of the agreement.

         In July 1999,  the  Company  entered  into an  amendment  to extend its
exclusive  research  agreement with  Massachusetts  General Hospital for another
five years.  In addition to laser hair removal,  the agreement has been expanded
to include  research and development in the use of laser to remove fat and treat
acne.  Under the terms of this  agreement,  the Company is  obligated to pay MGH
$475,000  for  clinical  research  on an annual  basis  during  the term of this
extension.

                                       11

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

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

(A)      OVERVIEW

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization  with Coherent to sell all of the issued and  outstanding  common
stock of Star. The total  purchase  price for all of the issued and  outstanding
capital stock of Star was $65 million, paid in cash. The purchase price was paid
to the  shareholders  of Star in  proportion  to their  holdings of Star capital
stock.  This sale was approved by a majority of the  stockholders  of Palomar on
April 21, 1999,  and on April 27, 1999,  Palomar  completed  the sale of Star to
Coherent.  On the date of the  sale,  Palomar  owned  82.46%  of  Star.  Palomar
received net proceeds of $49,736,023 of which $3,254,908 is being held in escrow
for one year as  security  for any  claims  which  Coherent  may have  under the
Agreement.  In  addition,  under the terms of the  Agreement,  the Company  will
receive an ongoing  royalty of 7.5% from Coherent on the sale of any products by
Coherent that incorporate  certain  patented  technology or use certain patented
methods   currently   licensed  by  the  Company  on  an  exclusive  basis  from
Massachusetts General Hospital.

         As a result of the consummation of the transaction discussed above, the
Company  revenues will decline  significantly  in the near term because  Palomar
will no longer be selling the  LightSheer(TM)  diode laser manufactured by Star.
For the six months ended June 30, 1999 and 1998 gross revenues  associated  with
Star's  LightSheer(TM)  diode laser  comprised  77.0% and 55.9% of the Company's
total  revenues,  respectively.  Accordingly,  the Company  expects to incur net
losses from operations over the next few quarters.  The successful  introduction
and  marketing  of new  products  will be  critical to the  Company's  long-term
success,  since a significant  portion of the Company's  revenue base previously
generated  from  Star's  LightSheer(TM)  laser  will  need to be  replaced  with
revenues from other laser  products,  including the Palomar E2000TM hair removal
laser  introduced in March of 1999 and other products  currently in development.
There can be no  assurance  that the  Palomar  E2000TM or the  Company's  future
products will achieve market acceptance or generate  sufficient  margins.  Broad
market  acceptance  of laser hair  removal  is also  critical  to the  Company's
success. The Company recognizes the need and intends to broaden its product line
by developing cosmetic laser products other than hair removal lasers.

(B)      RESULTS OF OPERATIONS.

         (i)      REVENUES AND GROSS  PROFIT:  THREE MONTHS ENDED JUNE 30, 1999,
                  COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1998

         For the three  months  ended  June 30,  1999,  the  Company's  revenues
decreased  to $5.5  million,  as compared to $9.1  million for the three  months
ended June 30, 1998. The decrease in the Company's revenues of $3.6 million,  or
39% from the three months ended June 30, 1998,  was mainly due to the  reduction
in sales volume of $4.8 million associated with the  LightSheer(TM)  diode laser
manufactured  by Star.  The  Company  sold Star to Coherent on April 27, 1999 as
discussed  above.  This  decrease  was offset by an increase of $1.2  million in
other cosmetic revenues and royalties received by the Company from Coherent. The
Company anticipates that sales volumes from its E2000 TM laser system introduced
during  the first  quarter  of 1999 will not  increase  substantially  until the
Company  manufactures this unit in high volume,  overcomes product  introduction
issues, and achieves further manufacturing efficiencies.

         Gross profit for the three months ended June 30, 1999 was approximately
$1.3 million (23% of  revenues)  compared to $4.3 million (47% of revenues)  for
the three  months  ended June 30,  1998.  The decrease in gross profit and gross
profit  percentage  was mainly due to the  reduction in sales volume  associated
with the LightSheer(TM) diode laser manufactured by Star and sold to Coherent on
April 27, 1999. The decrease in gross profit dollars was partially offset by the
gross margin  related to the sales of the Palomar  E2000TM  hair  removal  laser
system and royalties  earned from  Coherent.  The Company  anticipates  that its
gross profit  percentage from sales of the Palomar E2000TM will be significantly
less than the gross profit from its former  LightSheer(TM)  product,  unless and
until the Company achieves volume production and manufacturing efficiencies, and
overcomes product introduction issues related to the Palomar E2000 TM.


                                       12
<PAGE>

         (ii)     OPERATING  AND OTHER  EXPENSES:  THREE  MONTHS  ENDED JUNE 30,
                  1999, COMPARED TO THREE MONTHS ENDED JUNE 30, 1998

         Research and development  costs increased to $2.5 million for the three
months  ended June 30,  1999,  from $1.9 million for the three months ended June
30, 1998.  Research and development  expenses as a percentage of revenue totaled
45% for the three  months ended June 30, 1999 and 21% for the three months ended
June 30, 1998. The increase as a percentage of sales is directly attributable to
the reduction in sales volume  associated  with the  LightSheer(TM)  diode laser
manufactured  by Star  while the  Company  continued  to  increase  the  overall
spending on research and  development.  The  continued  spending on research and
development  reflects the Company's  commitment to research and  development for
devices and  delivery  systems for  cosmetic  and medical  applications  using a
variety of lasers, while continuing dermatology research utilizing the Company's
ruby and diode lasers.  Among the Company's  research and  development  goals in
hair  removal is to design  systems  permitting  more rapid  treatment  of large
areas, and to produce systems with high gross margins.  Management believes that
research and development expenditures will remain constant over the next year as
the Company  continues  product  development  and clinical trials for additional
applications   for  its  lasers  and  delivery   systems  in  the  cosmetic  and
dermatological  markets.  The Company has recently  entered into an amendment to
its existing  Clinical Trial  Agreement  with  Massachusetts  General  Hospital,
pursuant  to which it will fund a minimum of $475,000  per year for  research in
the   fields  of  photo   thermal   removal/reduction   of  hair,   non-invasive
electromagnetic targeting of subcutaneous fat, and treating sebaceous glands and
related skin disorders (e.g., acne) using infrared light (except when externally
applied  chromophores are used),  and obtain  exclusive  license rights in these
fields, over the next five years.

         Selling  and  marketing  expenses  decreased  to $1.6  million  (29% of
revenues)  for the three  months ended June 30, 1999,  from  approximately  $3.5
million (39% of revenues) for the three months ended June 30, 1998. The decrease
in selling and marketing  expenses is directly  attributable to the reduction in
sales volumes due to the sale of Star to Coherent and related  commissions  paid
to Coherent as the former  exclusive  distributor for the  LightSheer(TM)  diode
laser manufactured by Star.

         General and  administrative  expenses decreased to $1.5 million (27% of
revenues)  for the three months ended June 30, 1999, as compared to $2.4 million
(26% of revenues)  for the three months ended June 30, 1998.  This  decrease for
the  three  months  ended  June  30,  1999  is  attributable  to  the  Company's
restructuring  and  consolidation  of  administrative  functions  related to the
Company's Esthetica Partners, Inc. (formerly Cosmetic Technology  International,
Inc.) and Palomar Medical  Products,  Inc.  subsidiaries  and general  corporate
costs that resulted in respective reductions of approximately $300,000, $150,000
and  $475,000  compared  to the three  months  ended June 30,  1998 offset by an
additional  $25,000  incurred  for  general and  administrative  expenses at the
Company's Star subsidiary.  The Company  anticipates  general and administrative
expense  will  decrease  slightly  in the  future as a result of the Star  sale,
although it expects  such  expenses to increase as a  percentage  of revenues as
revenues decline in the near term as the result of the Star sale.

         Costs  related  to  solicitation  of  proxies  in  connection  with the
Company's 1999 Annual Meeting of Stockholders were $625,000 for the three months
ended June 30,1999 due to a proxy contest launched by a dissident shareholder.

         Settlement costs were $750,000 for the three months ended June 30, 1999
and are  attributable  to various  lawsuits  and other  claims made  against the
Company.

         Gain  from the sale of a  subsidiary  was $47.1  million  for the three
months ended June 30,  1999.  This amount  represents  the gain from the sale of
Star to Coherent, which was completed on April 27, 1999.

         Redemption expense was $6.2 million for the three months ended June 30,
1999. This amount reflects a redemption expense of $6.2 million as a result of a
settlement  agreement  between Palomar and certain  European banks that had held
4.5% Swiss Franc  denominated  subordinated  convertible  debentures  originally
totaling $8.2 million,  due in 2003.  Under the terms of this  agreement,  which
resolved a lawsuit,  Palomar agreed to rescind its conversion  notices issued in
November  1997.  Through  these  conversion   notices,   Palomar  converted  the
subordinated debentures into 130,576 shares of the Company's common stock. Since
the  conversion  date,  the  Company  had  treated  these  shares as issued  and
outstanding.  Under the terms of this  compromise,  the Company  agreed to pay a
total of approximately $6.7 million to the European banks, of which $1.4 million
was paid as of June

                                       13
<PAGE>

30, 1999 and an additional $3 million was paid during July 1999.  The balance of
$2.3  million is due 2001.  Accordingly  the  Company  has  recorded a charge to
operations of  approximately  $6.2  million.  This amount  represents  the total
amount due to the European banks less the fair market value of the redemption of
the common shares previously considered outstanding by the Company.

         Interest expense  decreased to $193,000 for the three months ended June
30, 1999,  from  $409,000  for the three  months  ended June 30, 1998.  This 53%
decrease  is  primarily  the  result  of a  decrease  in  convertible  debenture
financings  and the Company's  increased use of  conventional  financing.  Also,
operations  did not require as much  financing in 1999 as compared to 1998. As a
result of the sale of Star,  which  generated $49.7 million in cash, the Company
anticipates that interest expense will decline significantly because it utilized
a portion of these  proceeds to pay down  substantially  all of its  outstanding
debt during the second quarter of 1999.

         Interest  income  increased  to  approximately  $402,000  for the three
months  ended June 30,  1999.  This  amount  represents  interest  earned on the
balance  of the  funds  received  from the sale of Star  which are  invested  in
high-grade  corporate  and  government  notes and bonds and will be used to fund
future operations and research and development efforts.

         Other  income  (expense)  increased to  approximately  $257,000 for the
three months ended June 30, 1999. This amount compares to approximately $(9,000)
for the three  months  ended June 30,  1998.  Other  income for the three months
ended June 30, 1999 consisted of $134,000 of a foreign  currency gain related to
the Swiss  Franc  denominated  convertible  debentures  and other  non-operating
income of $123,000.

         The loss from  discontinued  operations for the three months ended June
30, 1999 was  $435,000,  compared to a loss of $2.6 million for the three months
ended June 30, 1998.  The $435,000 loss from  discontinued  operations  incurred
during 1999 was related to a settlement related to the operations of Dynaco.

         (iii)    REVENUES  AND GROSS  PROFIT:  SIX MONTHS  ENDED JUNE 30, 1999,
                  COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1998

         For  the six  months  ended  June  30,  1999,  the  Company's  revenues
increased  to $19.0  million,  as compared  to $16.2  million for the six months
ended June 30, 1998. The increase in the Company's revenues of $2.8 million,  or
18% from the six months ended June 30, 1998, was mainly due to additional  sales
volume of $5.5 million  associated with the  introduction of the  LightSheer(TM)
diode laser,  partially  offset by a decrease in revenue of  approximately  $2.7
million in other  cosmetic  laser  product  revenue.  The Company  obtained  FDA
clearance to market and sell its  LightSheer(TM)  laser for hair removal and leg
vein  treatment in the United  States at the end of 1997.  The decrease in sales
volume  associated with other cosmetic laser product revenue was principally due
to declining sales of the Company's  EpiLaser(R) ruby laser.  Palomar introduced
its  second  generation  long pulse ruby  laser for hair  removal,  the  Palomar
E2000TM,  during  the  first  quarter  of 1999.  In March of 1999,  the  Company
obtained FDA  clearance to market and sell its Palomar  E2000TM  laser system in
the United States for "permanent hair reduction." The Company generated revenues
of approximately $1.5 million on the Palomar E2000TM during the first six months
of 1999.

         Gross profit for the six months  ended June 30, 1999 was  approximately
$9.8 million (52% of  revenues)  compared to $5.0 million (31% of revenues)  for
the six months  ended June 30,  1998.  The  increase  in gross  profit and gross
profit  percentage  was due to sales of the  LightSheer(TM)  diode laser system.
This  laser  system  provided  a  significantly  higher  gross  profit  than the
Company's  EpiLaser(R)  hair removal  system and other  cosmetic  products.  The
Company  anticipates that its gross profit  percentage from sales of the Palomar
E2000TM  will be  significantly  less  than the  gross  profit  from its  former
LightSheer(TM)  product,  unless and until the Palomar  E2000TM  achieves volume
production  and  further  manufacturing  efficiencies,   and  overcomes  product
introduction issues.

                                       14
<PAGE>


         (iv)     OPERATING AND OTHER EXPENSES:  SIX MONTHS ENDED JUNE 30, 1999,
                  COMPARED TO SIX MONTHS ENDED JUNE 30, 1998

         Research and  development  costs  increased to $4.6 million for the six
months ended June 30, 1999,  from $4.1 million for the six months ended June 30,
1998.  Research and development  expenses as a percentage of revenue totaled 24%
for the six months ended June 30, 1999 and 25% for the six months ended June 30,
1998. The continued spending on research and development  reflects the Company's
commitment  to research and  development  for devices and  delivery  systems for
cosmetic and medical  applications  using a variety of lasers,  while continuing
dermatology  research  utilizing the Company's ruby and diode lasers.  Among the
Company's  research and  development  goals in hair removal is to design systems
permitting more rapid treatment of large areas, and to produce systems with high
gross margins.  Management  believes that research and development  expenditures
will  remain  constant  over  the next  year as the  Company  continues  product
development and clinical trials for additional  applications  for its lasers and
delivery  systems in the cosmetic and  dermatological  markets.  The Company has
recently entered into an amendment to its existing Clinical Trial Agreement with
Massachusetts  General  Hospital,  pursuant  to which it will fund a minimum  of
$475,000  per year for  research  in the  fields  of photo  thermal  removal  or
reduction of hair, non-invasive  electromagnetic  targeting of subcutaneous fat,
and treating  sebaceous  glands and related skin  disorders  (e.g.,  acne) using
infrared  light (except when  externally  applied  chromophores  are used),  and
obtain  exclusive  license  rights in these  fields  over the next  five  years.
However,  research and  development  as a percentage  of revenues  will increase
until the Company  achieves  higher sales  volume from its  recently  introduced
Palomar E2000TM laser system.

         Selling  and  marketing  expenses  decreased  to $5.7  million  (30% of
revenues)  for the six  months  ended June 30,  1999,  from  approximately  $6.0
million (37% of revenues)  for the six months ended June 30, 1998.  The decrease
in selling and marketing expenses as a percentage of revenues is a result of the
Company's  introduction  of its Palomar  E2000(TM) laser system during the first
quarter of 1999,  which is being sold through new distribution  channels.  These
new  distribution  channels include direct sales by the Company and distribution
though  Continuum  Biomedical,  a  distributor  of  medical  products,  and  the
associated  selling  and  marketing  expenses  have to date  been  less than the
commission earned by Coherent,  the Company's previous distributor.  The Company
also will consider  establishing  its own direct sales force to compliment these
sales channels.  The Company  anticipates  that, in comparison to the commission
previously paid to Coherent as a percentage of net revenues,  its future selling
and marketing  costs as a percentage of net revenues will decrease.  The Company
will also consider selling entire product lines and/or  technology to others, as
in the case of the sale of Star to Coherent.

         General and  administrative  expenses decreased to $3.2 million (17% of
revenues)  for the six months ended June 30,  1999,  as compared to $5.2 million
(32% of revenues) for the six months ended June 30, 1998.  This decrease for the
six months ended June 30, 1999 is  attributable  to the Company's  restructuring
and consolidation of administrative functions related to the Company's Esthetica
Partners,  Inc. (formerly Cosmetic Technology  International,  Inc.) and Palomar
Medical Products, Inc. subsidiaries and general corporate costs that resulted in
respective  reductions  of  approximately  $730,000,   $450,000  and  $2,300,000
compared to the three months ended June 30, 1998. An additional  $1,480,000  was
incurred  for  general  and  administrative   expenses  at  the  Company's  Star
subsidiary.  The Company  anticipates  general and  administrative  expense will
decrease  slightly  in the  future as a result  of the Star  sale,  although  it
expects such  expenses to increase as a percentage  of revenues as sales decline
in the near term as the result of the Star sale.

         Cost  related  to  solicitation  of  proxies  in  connection  with  the
Company's 1999 Annual Meeting of  Stockholders  were $625,000 for the six months
ended June 30,1999 due to a proxy contest launched by a dissident shareholder.

         Settlement  costs were  $750,000 for the six months ended June 30, 1999
and are attributable to various lawsuits and other claims against the Company.

         Gain from the sale of a subsidiary was $47.1 million for the six months
ended June 30, 1999 due to the Company  completing the sale of Star on April 27,
1999.

         Redemption  expense was $6.2  million for the six months ended June 30,
1999. This amount reflects a redemption expense of $6.2 million as a result of a
settlement  agreement  between Palomar and certain  European

                                       15
<PAGE>

banks  that had held  4.5%  Swiss  Franc  denominated  subordinated  convertible
debentures  originally  totaling $8.2 million,  due in 2003.  Under the terms of
this  agreement,  which  resolved  a  lawsuit,  Palomar  agreed to  rescind  its
conversion  notices issued in November 1997.  Through these conversion  notices,
Palomar  converted  the  subordinated  debentures  into  130,576  shares  of the
Company's common stock. Since the conversion date, the Company had treated these
shares as issued  and  outstanding.  Under  the  terms of this  compromise,  the
Company  agreed to pay a total of  approximately  $6.7  million to the  European
banks, of which $1.4 million has been paid as of June 30, 1999 and an additional
$3 million was paid during July 1999.  The balance of $2.3  million is due 2001.
Accordingly  the Company has recorded a charge to  operations  of  approximately
$6.2 million.  This amount represents the total amount due to the European banks
less the fair market value of the  redemption  of the common  shares  previously
considered outstanding by the Company.

         Interest  expense  decreased  to $364,000 for the six months ended June
30,  1999,  from  $829,000  for the six  months  ended June 30,  1998.  This 56%
decrease  is  primarily  the  result  of a  decrease  in  convertible  debenture
financings  and the Company's  increased use of  conventional  financing.  Also,
operations  did not require as much  financing in 1999 as compared to 1998. As a
result of the sale of Star,  which  generated $49.7 million in cash, the Company
anticipates that interest expense will decline significantly because it utilized
a portion of these  proceeds to pay down  substantially  all of its  outstanding
debt during the second quarter of 1999.

         Interest income increased to approximately  $407,000 for the six months
ended June 30, 1999.  This amount  represents  interest earned on the balance of
the funds  received  from the sale of Star  which  are  invested  in  high-grade
corporate  and  government  notes  and  bonds  and  will be used to fund  future
operations and research and development efforts.

         Other  income  decreased  to $280,000 for the six months ended June 30,
1999. This amount compares to $325,000 for the six months ended June 30, 1998.

         The loss from discontinued operations for the six months ended June 30,
1999 was  $435,000,  compared to a loss of $2.6 million for the six months ended
June 30, 1998. The $435,000 loss from  discontinued  operations  incurred during
1999 was related to a settlement related to the operations of Dynaco.

(C)      LIQUIDITY AND CAPITAL RESOURCES

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization  with Coherent to sell all of the issued and  outstanding  common
stock of Star. The total  purchase  price for all of the issued and  outstanding
capital stock of Star was $65 million, paid in cash. The purchase price was paid
to the  shareholders of Star in proportion to their holdings of capital stock of
Star.  This sale was  approved by a majority of the  stockholders  of Palomar on
April 21, 1999,  and on April 27, 1999,  Palomar  completed  the sale of Star to
Coherent.  On the date of the  sale,  Palomar  owned  82.46%  of  Star.  Palomar
received  net  proceeds of  $49,736,023,  of which  $3,254,908  is being held in
escrow for one year as security for any claims which Coherent may have under the
Agreement.  In  addition,  under the terms of the  Agreement,  the Company  will
receive an ongoing  royalty of 7.5% from Coherent on the sale of any products by
Coherent that incorporate  certain  patented  technology or use certain patented
methods   currently   licensed  by  the  Company  on  an  exclusive  basis  from
Massachusetts General Hospital.

         The Company  utilized a portion of the proceeds of the Star sale to pay
down  substantially  all of its debt  during  the second  quarter  of 1999.  The
balance of the funds will be invested in high-grade  corporate and  governmental
notes and bonds to fund future operations and research and development  efforts.
Accordingly,  the  Company  will  generate  additional  interest  income for the
foreseeable future.

         The  Company  is a  holding  company  with no  significant  operations.
Operations  are  carried  out at  the  subsidiary  level.  The  majority  of the
operations  are research  and  development.  To date,  the  Company's  operating
subsidiaries  have  required  cash  advances  from  the  Company  to fund  their
operations.  As of June 30, 1999,  the Company had $35.3  million in cash,  cash
equivalents and marketable securities. With the proceeds from the Star sale, the
Company  has  a  strong  financial  position  to  meet  its  ongoing  cash  flow
requirements and fund expected  operating losses at its subsidiaries in the near
term.

                                       16
<PAGE>

         During the three months ended June 30, 1999,  the Company agreed to pay
a total of  approximately  $6.7 million to the European banks that had held 4.5%
convertible  debentures  totaling  $8.2 million due in 2003,  under a settlement
agreement.  The Company paid $1.4  million a of June 30, 1999 and an  additional
$3.1 million was paid during July 1999. The balance of $2.2 million is due 2001.

         During the three months ended June 30, 1999, the Company entered into a
10 year lease  agreement for its  operating  facilities.  The annual  commitment
under this agreement is  approximately  $890,000 for the first five years of the
agreement and $980,000 thereafter.

         In July 1999,  the  Company  entered  into an  amendment  to extend its
exclusive  research  agreement with  Massachusetts  General Hospital for another
five years.  In addition to laser hair removal,  the agreement has been expanded
to include  research and development in the use of laser to remove fat and treat
acne.  Under the terms of this  agreement,  the Company is  obligated to pay MGH
$475,000  for  clinical  research  on an annual  basis  during  the term of this
extension.

         As of June 30, 1999,  the Company's  accounts  receivable  totaled $2.4
million, as compared to $9.9 million as of December 31, 1998. This reduction was
due principally to the sale of Star to Coherent on April 27, 1999. The Company's
allowance for doubtful  accounts totaled  approximately  $400,000 as of June 30,
1999, compared to $364,000 as of December 31, 1998.

         As of June 30, 1999, accounts payable totaled approximately $581,000 as
compared to $6.6 million as of December 31, 1998.  This decrease is  principally
due to paying down debt with money  received from the sale of Star and timing of
additional  purchases of inventory for the manufacture of the Palomar  E2000(TM)
laser systems.

         The Company anticipates that capital  expenditures for the remainder of
1999 will total  approximately  $500,000,  consisting  primarily  of  machinery,
equipment and computers and  peripherals.  The Company  expects to finance these
expenditures with cash on hand and equipment leasing lines.

         The Company had a $10,000,000  revolving  line of credit from a bank. A
director  of the  Company  personally  guaranteed  borrowings  under the line of
credit.  The Company  borrowed an additional  $500,000 during April of 1999. The
Company repaid all amounts outstanding under this line of credit ($1,500,000) on
April 27, 1999 and subsequently cancelled this line of credit.

         The Company  entered into a Loan  Agreement  with Coherent  pursuant to
which  Coherent  agreed to loan the Company  money to help finance the Company's
working  capital  requirements.   These  loans  were  collateralized  by  Star's
inventory.  Coherent  assumed the $4.8  million of debt in  connection  with its
purchase of all of the issued and outstanding  common stock of Star on April 27,
1999. See Note 8(e).

(D)     MATERIAL UNCERTAINTIES.

         (i)      YEAR 2000 ISSUES

        During 1998 and 1999 the Company has been actively engaged in addressing
Year 2000 (Y2K)  issues,  which  result from the use of  two-digit,  rather than
four-digit,  year dates in software, a practice which could cause date-sensitive
systems to  malfunction  or fail because they may not  recognize or process date
information correctly.

                  STATE OF READINESS:

         To manage its Y2K  program,  the Company  has divided its efforts  into
four program areas:

         o        Information Technology (computer hardware and software)

         o        Physical Plant (manufacturing equipment and facilities)

         o        Products (including product development)

                                       17
<PAGE>

         o        Extended Enterprise (suppliers and customers)

         For each of these  program  areas,  the  Company  is using a  four-step
approach:

         o        Ownership (creating awareness, assigning tasks)

         o        Inventory (listing items to be assessed for Y2K readiness)

         o        Assessment  (prioritizing  the  inventoried  items,  assessing
                  their Y2K readiness,  planning corrective actions,  developing
                  initial contingency plans)

         o        Corrective Action Deployment (implementing corrective actions,
                  verifying implementation, finalizing and executing contingency
                  plans)

         At June 30, 1999,  the Ownership,  Inventory and Assessment  steps were
essentially complete for all program areas.

                  COSTS TO ADDRESS Y2K ISSUES:

         The Company's  estimated  aggregate  costs for its Y2K activities  from
1998 through 2000 are expected to be less than  $100,000.  Through June 30, 1999
the Company has spent approximately $60,000.

                  RISKS OF Y2K ISSUES AND CONTINGENCY PLANS:

         The Company  continues  to assess the Year 2000 issues  relating to its
physical  plant,  products  and  suppliers.  The  Company  intends  to develop a
contingency planning process to mitigate worst-case business  disruptions,  such
as delays in product  delivery,  which  could  result from events such as supply
chain disruptions.

                                  RISK FACTORS

         In addition to the other  information in this Quarterly  Report on Form
10-Q,  the following  cautionary  statements  should be considered  carefully in
evaluating the Company and its business.  Statements contained in this Form 10-Q
that  are  not  historical  facts  (including,  without  limitation,  statements
concerning financial  projections,  the financing of future operations,  product
gross margins,  product developments and improvements,  research and development
plans and  expenditures  and Y2K issues) and other  information  provided by the
Company and its employees from time to time may contain certain  forward-looking
information,  as defined by (i) the Private Securities  Litigation Reform Act of
1995  (the  "Reform  Act")  and  (ii)  releases  by the SEC.  The  risk  factors
identified  below,  among other  factors,  could cause actual  results to differ
materially from those suggested in such forward-looking statements.  Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date  hereof.  The  Company  undertakes  no  obligation  to
release  publicly  the  results  of  any  revisions  to  these   forward-looking
statements  that may be made to reflect events or  circumstances  after the date
hereof or to reflect the  occurrence of  unanticipated  events.  The  cautionary
statements below are being made pursuant to the provisions of the Reform Act and
with the  intention of obtaining  the benefits of safe harbor  provisions of the
Reform Act.

OUR FUTURE REVENUE DEPENDS ON OUR DEVELOPING NEW PRODUCTS.

         We face rapidly  changing  technology  and continuing  improvements  in
cosmetic laser technology.  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,
to  enhance  existing  products,  and to  achieve  market  acceptance  for  such
products.  We have in the past experienced delays in developing new products and
enhancing  existing products.  As a result of the sale of Star to Coherent,  our
future revenue will be entirely dependent on sales of newly introduced products.
Although  we have  recently  introduced  a new hair  removal  laser,  it may not
achieve  market  acceptance or generate  sufficient  margins.  In addition,  the
market for this type of hair removal laser may already be saturated. At present,
broad market  acceptance  of laser hair

                                       18
<PAGE>

removal is critical to our success.  We intend to diversify  our product line by
developing cosmetic laser products other than hair removal lasers.

WE FACE INTENSE  COMPETITION FROM COMPANIES WITH SUPERIOR  FINANCIAL,  MARKETING
AND OTHER RESOURCES.

         The laser hair removal  industry is highly  competitive,  and companies
frequently introduce new products.  We compete in the development,  manufacture,
marketing and servicing of hair removal  lasers with numerous  other  companies,
many  of  which  have  substantially  greater  financial,  marketing  and  other
resources than we do. As a result, some of our competitors are able to sell hair
removal  lasers at prices  significantly  below the  prices at which we sell our
hair removal lasers. In addition,  as a result of the Star sale,  Coherent,  our
former  exclusive  distributor  and one of the largest and best  financed  laser
companies,  is now our competitor and we have to find new ways to distribute our
products.  Our laser products also face  competition  from  alternative  medical
products and 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 medical  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.

OUR QUARTERLY  OPERATING RESULTS WILL DECREASE AS A RESULT OF THE STAR SALE, AND
THAT MAY HURT THE PRICE OF OUR COMMON STOCK.

         Almost  all of our  revenues  in our  most  recent  two  quarters  were
attributable to sales of the  LightSheer(TM)  diode laser  manufactured by Star.
Therefore,   as  a  result  of  the  Star  sale,   our  revenues   will  decline
significantly. If our operating results fall below the expectations of investors
or  public  market   analysts,   the  price  of  our  common  stock  could  fall
dramatically.

WE COULD BE DELISTED FROM NASDAQ.

         For continued  listing on the Nasdaq  SmallCap  Market,  a company must
maintain a minimum bid price of $1.00 per share.  In March of this year,  Nasdaq
held a hearing  regarding our continued listing on The Nasdaq SmallCap Market in
light of the fact that our common stock had traded  below the $1.00  minimum bid
price  requirement  for longer than 30 trading  days. As a result of our reverse
stock  split,  we regained  compliance  with the  minimum bid price  requirement
before that date,  and are now in compliance  with all of Nasdaq's  requirements
for continued  listing on The Nasdaq SmallCap Market.  However,  there can be no
assurance that we will remain in compliance with Nasdaq's criteria for continued
listing or that we will remain  listed on Nasdaq.  The  delisting  of our common
stock would likely  reduce the  liquidity of our common stock and our ability to
raise capital.  If our common stock is delisted from The Nasdaq SmallCap Market,
it will  likely  be  quoted  on the "pink  sheets"  maintained  by the  National
Quotation Bureau,  Inc. or Nasdaq's OTC Bulletin Board.  These listings can make
trading more difficult for stockholders.

OUR LASERS ARE SUBJECT TO NUMEROUS FDA REGULATIONS.  COMPLIANCE IS EXPENSIVE AND
TIME-CONSUMING.  OUR NEW  PRODUCTS MAY NOT BE ABLE TO OBTAIN THE  NECESSARY  FDA
CLEARANCES BEFORE WE CAN SELL THEM.

         All of our products are laser medical  devices.  Laser medical  devices
are  subject to FDA  regulations  regulating  clinical  testing,  manufacturing,
labeling,  sale,  distribution  and promotion of medical  devices.  Before a new
device can be introduced into the market, we must obtain clearance from the FDA.
Compliance with the FDA clearance process is expensive and  time-consuming,  and
we may not be able to obtain such clearances in a timely fashion or at all.

WE ARE DEPENDENT ON THIRD PARTY RESEARCHERS.

         We are substantially dependent upon third party researchers,  over whom
we do not have absolute control, to satisfactorily conduct and complete research
on our behalf and to grant us favorable  licensing terms for products which they
may  develop.  At  present,  our  principal  research  partner  is  the  Wellman
Laboratories of  Photomedicine  at Massachusetts  General  Hospital.  We provide
research  funding,  laser technology and optics know-how in return for licensing
agreements  with  respect to specific  medical  applications  and  patents.  Our
success will be highly dependent upon the results of this research. We cannot be
sure that such research  agreements will provide us with

                                       19
<PAGE>

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  AS THE  RESULT  OF  OUTSTANDING
CONVERTIBLE SECURITIES, WARRANTS AND OPTIONS.

         In the past, we have issued convertible securities,  such as debentures
and preferred  stock,  and warrants in order to raise money. We have also issued
options and warrants as compensation for services and incentive compensation for
our employees and  directors.  We have a substantial  number of shares of common
stock   reserved  for  issuance  upon  the  conversion  and  exercise  of  these
securities. These outstanding convertible securities, options and warrants could
affect the rights of our  stockholders,  and could  adversely  affect the market
price of our common stock.

OUR PROPRIETARY TECHNOLOGY HAS ONLY LIMITED PROTECTIONS.

         Our business could be materially  and adversely  affected if we are not
able to protect adequately our proprietary intellectual property rights. We rely
on a  combination  of patent,  trademark  and trade  secret  laws,  license  and
confidentiality agreements to protect our proprietary rights. We generally enter
into  non-disclosure  agreements  with our  employees and customers and restrict
access to, and distribution of, our proprietary  information.  Nevertheless,  we
may be unable  to deter  misappropriation  of our  proprietary  information,  to
detect   unauthorized  use  and  to  take  appropriate   steps  to  enforce  our
intellectual  property rights.  Our competitors also may  independently  develop
technologies  that are  substantially  equivalent or superior to our technology.
Although  we believe  that our  services  and  products  do not  infringe on the
intellectual  property  rights of others,  we cannot  prevent  someone else from
asserting  a claim  against us in the future for  violating  their  intellectual
property  rights.  In  addition,  costly  and  time  consuming  lawsuits  may be
necessary to enforce  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.

         The medical  laser  industry is  characterized  by frequent  litigation
regarding  patent  and  other  intellectual  property  rights.   Because  patent
applications  are  maintained in secrecy in the United States until such patents
are issued and are maintained in secrecy for a period of time outside the United
States, we can conduct only limited searches to determine whether our technology
infringes any patents or patent applications. Any claims for patent infringement
could be time-consuming, result in costly litigation, diversion of technical and
management   personnel,   cause   shipment   delays,   require   us  to  develop
non-infringing  technology  or to enter into  royalty or  licensing  agreements.
Although patent and  intellectual  property  disputes in the laser 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.

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 the Secretary of the Company advance
notice of  business  to be  brought  by such  stockholder  before  any annual or
special meeting of stockholders  as well as certain  information  regarding such
business,  the  stockholder  and others known to support  such  proposal and any
material interest they may have in the proposed business. These provisions could
delay any  stockholder  actions that are favored by the holders of a majority of
the outstanding stock of the Company until the next  stockholders'  meeting.  In
addition,  the Board of Directors is  authorized to issue shares of common stock
and preferred stock which, 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 the Company.

         The Company is also subject to the anti-takeover  provisions of Section
203 of the Delaware  General  Corporation  Law, which prohibits the Company from
engaging in a "business  combination"  with an  "interested

                                       20
<PAGE>

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 management of the Company, including transactions in which
stockholders  might  otherwise  receive a premium for their shares over the then
current market prices.

AS WITH ANY NEW PRODUCTS, THERE IS SUBSTANTIAL RISK THAT THE MARKETPLACE MAY NOT
ACCEPT OR BE RECEPTIVE TO THE POTENTIAL BENEFITS OF OUR PRODUCTS.

         Market  acceptance of our current and proposed products will depend, in
large part,  upon our or any marketing  partner's  ability to demonstrate to the
marketplace  the advantages of our products over other types of products.  There
can be no assurance that the  marketplace  will accept  applications or uses for
our  current  and  proposed  products  or that any of our  current  or  proposed
products will be able to compete effectively.

WE FACE RISKS ASSOCIATED WITH PENDING LITIGATION.

         We are involved in disputes  with third  parties.  Such  disputes  have
resulted in litigation  with such  parties.  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. An
adverse  result in the MEHL patent  litigation  or the VARLJEN  litigation  (all
described in detail in Part II, Item 1) could have a material  adverse effect on
our business,  financial  condition and results of operations.  We are unable to
determine  the total expense or possible  loss,  if any, that may  ultimately be
incurred in the  resolution  of these  proceedings.  These matters may result in
diversion of management time and effort from the operations of the business.

WE MAY NOT BE ABLE TO RETAIN OUR KEY  EXECUTIVES  AND RESEARCH  AND  DEVELOPMENT
PERSONNEL.

         As a small company with less than 100 employees  after the sale of Star
to Coherent,  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 us.

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 with numerous  safety
features, but it is possible that patients could be adversely affected by use of
one of our products.  Further, in the event that any of our products prove to be
defective, we may be required to recall and redesign such products.  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 in the amount of $1,000,000 per
occurrence and $2,000,000 in the aggregate and maintain umbrella coverage in the
aggregate  amount of $25,000,000;  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  medical  personnel  with  respect to the proper use of our
products,  misuse of our products by medical personnel over whom we cannot exert
control  may  result in the filing of product  liability  claims or  significant
adverse publicity against us.

                                       21
<PAGE>

COMPUTER  SYSTEMS ON WHICH WE RELY MAY NOT  PROPERLY  RECOGNIZE  DATE  SENSITIVE
INFORMATION WHEN THE YEAR CHANGES TO 2000.

         Systems that do not properly  recognize such information could generate
erroneous data or cause a system to fail. We are at this time utilizing internal
resources to identify,  correct or reprogram, and test our systems for year 2000
compliance.  However,  there  can be no  assurance  that  the  systems  of other
companies on which our systems rely will also be converted in a timely manner or
that any such  failure to convert by another  company  would not have an adverse
effect on our systems.  Management  is in the process of assessing the year 2000
compliance costs; however,  based on information to date (excluding the possible
impact of  vendor  systems),  management  does not  believe  that it will have a
material effect on our earnings.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         Not applicable.

                                       22
<PAGE>


PART II

ITEM 1.  LEGAL PROCEEDINGS.

         On March 7, 1997, Selvac Acquisition Corp. ("Selvac"),  a subsidiary of
Mehl Biophile  International,  Inc.  ("Mehl"),  filed a complaint for injunctive
relief and damages for patent  infringement  and for unfair  competition  in the
United States District Court for the District of New Jersey against the Company,
two of its  subsidiaries  and a New  Jersey  dermatologist.  Selvac's  complaint
alleged that the Company's  EpiLaser(R) ruby laser hair removal system infringed
a patent licensed to Selvac (the "Selvac  Patent") and that the Company unfairly
competed by promoting the  EpiLaser(R)  ruby laser hair removal  system for hair
removal before it had received FDA clearance for that specific  application.  On
May 18, 1998 the court granted the Company's motion for partial summary judgment
on the ground that the Selvac patent is invalid  because  prior art  anticipated
it. The court later denied  Selvac's motion for  reconsideration  of the summary
judgment  ruling.  On September 25, 1998, the court denied  Selvac's  motion for
reconsideration  of its  prior  order  dismissing  so  much of  Selvac's  unfair
competition  claim as relied on interpreting the Food, Drug and Cosmetics Act or
FDA  regulations,  and  dismissed  without  prejudice the state law remainder of
Selvac's unfair  competition claim. On October 26, 1998, Selvac filed its notice
of appeal with the Court of Appeals for the Federal Circuit. Selvac subsequently
filed its opening brief on appeal;  the Company filed its  opposition and Selvac
its reply.  The  Federal  Circuit  heard oral  argument  on August 5, 1999.  The
Company is unable to express  an  opinion as to the likely  outcome of  Selvac's
appeal. The Federal Circuit will probably issue its opinion this year.

         On October 16, 1997, the Company brought a declaratory  judgment action
in U.S. District Court for the District of Massachusetts against the holders and
the indenture trustee of the Company's 4.5% Subordinated  Convertible Debentures
due 2003,  denominated  in Swiss  francs (the  "Swiss  Franc  Debentures").  The
defendants in this action were Banque SCS Alliance SA,  Arbuthnot Fund Managers,
Ltd.,  Banca  Commerciale  Lugano,  Privatinvest  Bank AG (these four defendants
being referred to  collectively as the "Asserting  Holders"),  CUF Finance S.A.,
Fibi Bank  (Schweiz) AG,  Teawood  Nominees,  Ltd.,  JS Gadd & CIE SA,  Swedbank
(Luxembourg)  SA,  Christiana  Bank  Luxembourg SA (now know as Credit  Agricole
Indosuez),  Landatina  Financiera SA and American Stock Transfer & Trust Co., as
trustee ("Trustee").  Just prior to this suit, the Asserting Holders had alleged
that the  Company  was in  breach  of  certain  protective  covenants  under the
indenture,  and on  October  22,  1997  they  sued  the  Company  and all of its
principal  subsidiaries  in the same court;  the October 16 and October 22 cases
were assigned to the same judge,  and the dispute between the Asserting  Holders
and the Company was proceeding under the October 22 case. The Asserting  Holders
claimed that the Company had breached certain protective indenture covenants and
that  the  Asserting   Holders  are  entitled  to  immediate  payment  of  their
indebtedness under the Swiss Franc Debentures.  (The total disputed indebtedness
is approximately  $6.2 million at current exchange rates; the Asserting Holders'
portion of the total is  approximately  $5.6  million.) As of November 13, 1997,
acting under  applicable  provisions of the indenture,  the Company notified the
holders of the Swiss Franc  Debentures that it was causing the conversion of all
of the  Swiss  Franc  Debentures  into an  aggregate  of  135,575  shares of the
Company's common stock.  Palomar filed a motion for summary judgment,  asserting
that its  conversion of the  debentures  into Palomar  common stock deprived the
plaintiffs  of  standing  to bring a  claim.  That  motion  was  denied  without
prejudice,  and the  court  also  denied  the  plaintiffs'  motion  for  summary
judgment.  By mutual  agreement,  the  Asserting  Holders and the  Company  have
dismissed the case. The parties have resolved the dispute by  restructuring  the
debentures  (whereby  Palomar  prepays  approximately  two-thirds  of the  total
indebtedness, or about $4.2 million, withdraws its forced conversion, and repays
on a  modified  schedule  the  original  debt).  (See  Note  8(b)  of  Notes  to
Consolidated Financial Statements.)

         On March 11, 1999,  the United States  District  Court for the Southern
District of New York granted  plaintiffs  leave to amend their  complaint in the
action styled VARLJEN V. H.J.  MEYERS,  INC.,  ET. AL. to join the Company,  its
former  chief  executive   officer  and  current  chief  financial   officer  as
defendants.  On March 17,  1999,  the  Second  Amended  Class  Action  Complaint
("Complaint")  in VARLJEN was served  upon the  Company  and its  current  chief
financial  officer.  The  Complaint  alleges that the Company and the former and
current  officer  violated  the  federal   securities  laws  in  various  public
disclosures that the Company made directly and indirectly during the period from
February 1, 1996 to March 26, 1997. In  particular,  the Complaint  alleges that
Palomar and the former and current officer  misrepresented  the Company's future
prospects,  including  earnings  projections  and expected  shares  outstanding,
through  their direct  disclosures  and through  disclosures  made by securities
analysts and other third parties. The Company and the former and current officer
filed a motion to dismiss the complaint,  asserting all

                                       23
<PAGE>

claims are barred by the statute of  limitations,  that the  complaint  does not
meet  federal  pleading  requirements,  and that it fails to state a  securities
claim.  The Company and the former and current  officer have also filed a motion
to transfer the case to the District of  Massachusetts.  On August 6, 1999,  the
District  Court denied the  Company's  motion to dismiss,  and  scheduled a case
conference  for April 28,  2000.  The case is in its  earliest  stages,  and the
Company cannot predict its outcome.

         On July 20 1999, The Monterey Stockholders Group LLC ("Monterey") filed
a  complaint  for  declaratory  judgment  and for  damages in the United  States
District Court for the District of Delaware  against the Company.  The complaint
alleges that the Company and its directors  violated the federal securities laws
in various public  disclosures  that the Company made in the spring of 1999. The
complaint  alleges  Palomar  failed to disclose that it intended to include 3.25
million  escrowed shares in the vote at its annual meeting when such shares were
allegedly  non-voting and not outstanding.  Monterey seeks, among other forms of
relief,  a  declaration  that no quorum was present in person or by proxy at the
Company's annual meeting. Palomar's answer to the complaint is at present due on
September 8, 1999.  The case is in its earliest  stages,  and the Company cannot
predict its outcome.

         The Company is involved in other legal and  administrative  proceedings
and  claims of  various  types.  While any  litigation  contains  an  element of
uncertainty,  management, in consultation with the Company's general counsel, at
present  believes that the outcome of each such other  proceeding or claim which
is pending or known to be threatened,  or all of them combined,  will not have a
material adverse effect on the Company.

ITEM 2.  CHANGES IN SECURITIES.

         During the quarter ended June 30, 1999, the following  securities  were
redeemed by the Company for the dollar amount indicated:
<TABLE>
<S> <C>                                        <C>                                 <C>

                                                                                   Redemption
    Type of Security                           Number of Shares                       Amount
    ----------------                           ----------------                    -----------

    Preferred Stock Series G                         403                             $557,635
    Preferred Stock Series H                         250                             $344,761
</TABLE>

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

         Not applicable.

                                       24
<PAGE>

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

         The following table sets forth a brief description of each matter voted
upon and the  number  of votes  cast for or  against,  as well as the  number of
abstentions,  as to each  such  matter,  at the  Company's  Special  Meeting  of
Stockholders held on April 21, 1999.
<TABLE>
<S>      <C>                                                 <C>            <C>            <C>
                                                                 Votes          Votes
                               Matter                             For          Against      Abstentions
         --------------------------------------------------- -------------- -------------- ---------------
         Agreement and Plan of Reorganization providing       42,098,052      1,378,650       399,505
         for sale of Palomar's Star subsidiary to Coherent
         --------------------------------------------------- -------------- -------------- ---------------
         Plan of recapitalization resulting in                58,323,039      4,810,396       609,002
         one-for-seven reverse split of Palomar's common
         stock
         --------------------------------------------------- -------------- -------------- ---------------
</TABLE>

         The following table sets forth a brief description of each matter voted
upon and the  number  of votes  cast for or  against,  as well as the  number of
abstentions  and broker  non-votes,  as to each such  matter,  at the  Company's
Annual Meeting of Stockholders held on June 23, 1999, at which Messrs.  Valente,
Martin, Pappalardo, and Economou were elected as directors..
<TABLE>
<S>      <C>                                                 <C>            <C>            <C>
                                                                 Votes          Votes
                               Matter                             For          Against      Abstentions
         --------------------------------------------------- -------------- -------------- ---------------

         Ratification of selection of Arthur Andersen LLP       38,235,369        456,309         243,563
         as the Company's auditors
         --------------------------------------------------- -------------- -------------- ---------------
         Election of Directors:

         MANAGEMENT NOMINEES:
         --------------------------------------------------- -------------- -------------- ---------------
                  Louis P. Valente                              28,386,054        822,362               -
         --------------------------------------------------- -------------- -------------- ---------------
                  James G. Martin                               28,403,209        805,207               -
         --------------------------------------------------- -------------- -------------- ---------------
                  A. Neil Pappalardo                            28,402,059        806,357               -
         --------------------------------------------------- -------------- -------------- ---------------
                  Nicholas P. Economou                          28,396,609        811,807               -
         --------------------------------------------------- -------------- -------------- ---------------
         OPPOSITION NOMINEES:
         --------------------------------------------------- -------------- -------------- ---------------
                  Mark T. Smith                                  9,553,994        172,831               -
         --------------------------------------------------- -------------- -------------- ---------------
                  George F. Murphy                               9,546,294        180,531               -
         --------------------------------------------------- -------------- -------------- ---------------
                  Jay Delahanty                                  9,546,294        180,531               -
         --------------------------------------------------- -------------- -------------- ---------------
                  Michel D. Marks                                9,546,294        180,531               -
         --------------------------------------------------- -------------- -------------- ---------------
</TABLE>

ITEM 5.  OTHER INFORMATION.

         Not applicable.

                                       25
<PAGE>


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

(A)      EXHIBITS

         2.1*     By-laws, as amended.

         4.1      Second Amended 1991 Stock Option Plan.

         4.2      Second Amended 1993 Stock Option Plan.

         4.3      Second Amended 1995 Stock Option Plan.

         4.4      Second Amended 1996 Stock Option Plan.

         4.5      Third Amended 1996 Employee Stock Purchase Plan.

         4.6**    Rights  Agreement dated as of April 20, 1999,  between Palomar
                  Medical  Technologies,  Inc. and American  Stock  Transfer and
                  Trust Company, as Rights Agent.

         4.7**    Form of Certificate  of Designation of Series A  Participating
                  Cumulative  Preferred Stock of Palomar  Medical  Technologies,
                  Inc. (which is attached as Exhibit A to the Rights  Agreement,
                  Exhibit 4.6 hereto).

         4.8**    Form of Rights  Certificate (which is attached as Exhibit B to
                  the Rights Agreement, Exhibit 4.6 hereto).

         10.1     Amendment  No.  1 to  Key  Employment  Agreement  between  the
                  Company and Louis P. Valente dated May 15, 1999.

         10.2     Amendment  No. 1 to Employment  Agreement  between the Company
                  and Michael Smotrich dated May 15, 1999.

         10.3     Amended and Restated Employment  Agreement between the Company
                  and Joseph P. Caruso dated June 30, 1999.

         10.4     Commercial  Lease  between the  Company  and CRES  Development
                  Company, Inc., dated June 17, 1999.

         27.1     Financial Data Statement for the period ended June 30, 1999.

*        Previously  filed  as an  exhibit  to Form  10-K for the  period  ended
         December 31, 1996, and incorporated herein by reference.

**       Previously filed as an exhibit to Form 8-K, filed on April 21, 1999 and
         incorporated herein by reference. (B) REPORTS ON FORM 8-K.

                  Form 8-K filed on April 21, 1999.

                  Form 8-K filed on May 10, 1999.


                  Form 8-K filed on June 29, 1999.

                  Form 8-K filed on July 1, 1999.


<PAGE>


                                   SIGNATURES

         Pursuant  to the  requirements  of the  Securities  Act  of  1934,  the
Registrant  certifies  that it has caused this Report to be signed on its behalf
by the undersigned,  thereunto duly authorized,  in the Town of Lexington in the
Commonwealth of Massachusetts on August 16, 1999.

                                              PALOMAR MEDICAL TECHNOLOGIES, INC.
                                                         (Registrant)

DATE:  August 16, 1999                        By:  /s/ Louis P. Valente
                                                 -------------------------------
                                                    Louis P. Valente
                                                    Chief Executive Officer
                                                   (Principal Executive Officer)



DATE:  August 16, 1999                        By:  /s/ Joseph P. Caruso
                                                 -------------------------------
                                                  Joseph P. Caruso
                                                  Chief Financial Officer and
                                                  Treasurer
                                                  (Principal Financial Officer
                                                  and Principal
                                                  Accounting Officer)