|UNITED STATES
                                                  SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549


FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the quarterly period ended March 31, 2005.





Commission file number 0-22340

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

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

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

|
|

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

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

As of April 28, 2005, 16,871,867 shares of common stock were issued and outstanding.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|Palomar Medical
Technologies, Inc. and Subsidiaries

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

|                               |                                                                                                                |  | Page No.
|------------------------------ | -------------------------------------------------------------------------------------------------------------- |  | --------
|PART I - Financial Information |                                                                                                                |  |         
|                               |                                                                                                                |  |         
|Item 1.                        | Financial Statements                                                                                           |  |         
|                               | Unaudited Condensed Consolidated Balance Sheets for the periods ending March 31, 2005 and December 31, 2004    |  | 1       
|                               | Unaudited Condensed Consolidated Statements of Income for the periods ending March 31, 2005 and March 31, 2004 |  | 2       
|                               | Unaudited Condensed Consolidated Statements of Cash Flows                                                      |  | 3       
|                               | Notes to Unaudited Condensed Consolidated Financial Statements                                                 |  | 4       
|Item 2.                        | Managements Discussion and Analysis of Financial Condition and the
   Results of Operations                   |  | 10      
|                               | Cautionary Statements                                                                                          |  | 16      
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                                                     |  | 22      
|Item 4.                        | Controls and Procedures                                                                                        |  | 23      
|                               |                                                                                                                |  |         
|PART II - Other Information    |                                                                                                                |  |         
|                               |                                                                                                                |  |         
|Item 1.                        | Legal Proceedings                                                                                              |  | 23      
|Item 2.                        | Changes in Securities, Use of Proceeds and Issuer Purchases of Securities                                      |  | 23      
|Item 3.                        | Defaults Upon Senior Securities                                                                                |  | 23      
|Item 4.                        | Submission of Matters to a Vote of Security Holders                                                            |  | 24      
|Item 5.                        | Other Information                                                                                              |  | 24      
|Item 6.                        | Exhibits and Reports on Form 8-K                                                                               |  | 24      
|SIGNATURES                     |                                                                                                                |  | 25      

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

|                                                         | March 31,
2005  | December 31,
2004
|-------------------------------------------------------- | --------------- | -----------------
|Assets                                                   |                 |                  
|Current assets:                                         
|Cash and cash equivalents                                | $     5,072,826 | $     7,508,856  
|Available-for-sale investments, at market value          | 24,100,000      | 17,650,000       
|Accounts receivable, net                                 | 7,358,935       | 7,122,745        
|Inventories                                              | 5,973,043       | 5,866,494        
|Other current assets                                     | 742,203         | 440,254          
|                                                         |                
|Total current assets                                     | 43,247,007      | 38,588,349       
|                                                         |                
|Property and equipment, net                              | 903,407         | 899,368          
|                                                         |                 |                  
|Other assets                                             | 111,074         | 111,074          
|                                                         |                
|Total Assets                                             | $   44,261,488  | $   39,598,791   
|                                                         |                
|Liabilities and Stockholders' Equity                    
|Current liabilities:                                    
|Accounts payable                                         | $     1,174,583 | $        971,030 
|Accrued liabilities                                      | 6,989,912       | 8,014,207        
|Deferred revenue                                         | 1,436,500       | 1,439,639        
|                                                         |                
|Total current liabilities                                | 9,600,995       | 10,424,876       
|                                                         |                
|Commitments and Contingencies                           
|                                                         |                 |                  
|Stockholders' equity:                                   
|Preferred stock, $.01 par value-                        
|Authorized - 1,500,000 shares                           
|Issued -  none                                           | --              | --               
|Common stock, $.01 par value-                           
|Authorized - 45,000,000 shares                          
|Issued -  16,799,034 and 16,231,502 shares, respectively | 167,991         | 162,315          
|Additional paid-in capital                               | 174,392,623     | 172,428,102      
|Accumulated deficit                                      | (139,900,121)   | (143,416,502)    
|                                                         |                
|Total stockholders' equity                               | 34,660,493      | 29,173,915       
|                                                         |                
|Total liabilities and stockholders equity               | $   44,261,488  | $   39,598,791   
|                                                         |                

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


1
|------------------------------------------------------------------------------------------

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

|                                               | Three Months Ended
March 31, |                 
|---------------------------------------------- | ---------------------------- | ----------------
|
|Revenues:                                      |                              |                 
|Product revenues                               | $14,283,416                  | $  9,627,115    
|Royalty revenues                               | 1,382,284                    | 193,278         
|Funded product development revenues            | 1,379,604                    | 1,013,464       
|                                               |                             
|Total revenues                                 | 17,045,304                   | 10,833,857      
|                                               |                             
|Costs and expenses:                           
|Cost of product revenues                       | 4,520,796                    | 3,418,513       
|Cost of royalty revenues                       | 552,914                      | 77,311          
|Research and development                       | 3,186,164                    | 2,539,163       
|Selling and marketing                          | 3,824,642                    | 2,681,110       
|General and administrative                     | 1,550,712                    | 1,087,329       
|                                               |                             
|Total costs and expenses                       | 13,635,228                   | 9,803,426       
|                                               |                             
|Income from operations                         | 3,410,076                    | 1,030,431       
|                                               |                              |                 
|Interest income                                | 172,068                      | 27,238          
|Other income (expense), net                    | 6,000                        | 143,067         
|                                               |                             
|Income before income taxes                     | 3,588,144                    | 1,200,736       
|                                               |                              |                 
|Provision for income taxes                     | 71,763                       | 41,515          
|                                               |                             
|Net income                                     | $  3,516,381                 | $  1,159,221    
|                                               |                             
|Net income per share:                         
|Basic                                          | $           0.21             | $           0.08
|                                               |                             
|Diluted                                        | $           0.19             | $           0.07
|                                               |                             
|Weighted average number of shares outstanding:
|Basic                                          | 16,477,815                   | 15,063,754      
|                                               |                             
|Diluted                                        | 18,982,746                   | 17,352,236      
|                                               |                             

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


2
|------------------------------------------------------------------------------------------

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

|                                                                         | Three Months Ended March 31, | 
|------------------------------------------------------------------------ | ---------------------------- | 
|
|Cash flows from operating activities:                                    |                              | 
|Net income                                                               |                              | 
|                                                                         |                              | 
|Adjustments to reconcile net income  to net cash provided (used in)      |                              | 
|operating activities:                                                    |                              | 
|Depreciation and amortization                                            |                              | 
|Provision for bad debt                                                   |                              | 
|Tax benefit from the exercise of stock options                           |                              | 
|Changes in assets and liabilities,                                       |                              | 
|Accounts receivable                                                      |                              | 
|Inventories                                                              |                              | 
|Other current assets                                                     |                              | 
|Accounts payable                                                         |                              | 
|Accrued liabilities                                                      |                              | 
|Deferred revenue                                                         |                              | 
|                                                                         |                              | 
|Net cash provided by operating activities                                |                              | 
|                                                                         |                              | 
|Cash flows from investing activities:                                    |                              | 
|Purchases of property and equipment                                      |                              | 
|Purchases of available-for-sale investments                              |                              | 
|Proceeds from sale of available-for-sale investments                     |                              | 
|                                                                         |                              | 
|Net cash used in investing activities                                    |                              | 
|                                                                         |                              | 
|Cash flows from financing activities:                                    |                              | 
|Proceeds from the exercise of stock options, warrants and employee stock |                              | 
|purchase plan                                                            |                              | 
|Costs incurred related to issuance of common stock                       |                              | 
|                                                                         |                              | 
|Net cash provided by financing activities                                |                              | 
|                                                                         |                              | 
|Net decrease in cash and cash equivalents                                |                              | 
|Cash and cash equivalents, beginning of the period                       |                              | 
|                                                                         |                              | 
|Cash and cash equivalents, end of the period                             |                              | 
|                                                                         |                              | 
|Supplemental disclosure of cash flow information:                        |                              | 
|Cash paid for interest                                                   |                              | 
|                                                                         |                              | 
|Cash paid for income taxes                                               |                              | 
|                                                                         |                              | 
|Supplemental disclosure of noncash financing and investing activities:   |                              | 
|Issuance of stock for employer 401(k) matching contribution              |                              | 
|                                                                         |                              | 

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


3
|------------------------------------------------------------------------------------------

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



Note 1           Basis
of presentation


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


Note 2  Stock
based compensation


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


The
following tables illustrate the assumptions used and the effect on net income and earnings
per share if Palomar had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation. Palomar has computed the pro forma disclosures required
under SFAS No. 123 for all stock options granted to employees of Palomar for the three
months ended March 31, 2005 and 2004, using the Black-Scholes option-pricing model
prescribed by SFAS No. 123.


Pro forma disclosure


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

|                                                             | Three Months Ended
March 31, |                     
|------------------------------------------------------------ | ---------------------------- | --------------------
|
|Net income, as reported                                      | $      3,516,381             | $      1,159,221    
|Less: Total stock-based employee compensation expense       
|determined under fair value based method for all awards, net
|of tax                                                       | (186,216)                    | (300,273)           
|                                                             |                             
|Pro forma net income                                         | $      3,330,165             | $          858,948  
|                                                             |                             
|Net income per share:                                       
|                                                             |                              |                     
|Basic - as reported                                          | $               0.21         | $               0.08
|                                                             |                             
|Basic - pro forma                                            | $               0.20         | $               0.06
|                                                             |                             
|Diluted - as reported                                        | $               0.19         | $               0.07
|                                                             |                             
|Diluted - pro forma                                          | $               0.18         | $               0.05
|                                                             |                             

|4
|-

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



Recent Accounting
Pronouncement


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


Note 3  Inventories


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

|                | March 31,
2005 | December 31,
2004
|--------------- | -------------- | -----------------
|Raw materials   | $  2,860,110   | $  3,613,032     
|Work in process | 1,030,709      | 840,795          
|Finished goods  | 2,082,224      | 1,412,667        
|                |               
|                | $  5,973,043   | $  5,866,494     
|                |               

|Note 4  Property
and equipment


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

|                               | March 31,
2005 | December 31,
2004 | Estimated
useful life                            
|------------------------------ | -------------- | ----------------- | -------------------------------------------------
|Machinery and equipment        | $1,390,258     | $1,376,668        | 3-8 years                                        
|Furniture and fixtures         | 2,009,262      | 1,936,779         | 5 years                                          
|Leasehold improvements         | 293,555        | 293,555           | Shorter of estimated useful life or term of lease
|                               |                |                  
|                               | 3,693,075      | 3,607,002        
|Less: accumulated depreciation | 2,789,668      | 2,707,634        
|                               |                |                  
|Total                          | $   903,407    | $   899,368      
|                               |                |                  

|Note 5  Warranty
costs


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


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

|5

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

|                                                     | March 31,
2005 | December 31,
2004
|---------------------------------------------------- | -------------- | -----------------
|Warranty accrual, beginning of period                | $ 722,040      | $    584,929     
|Charged to costs and expenses  relating to new sales | 353,000        | 1,260,695        
|Costs incurred / write-offs                          | (355,827)      | (1,123,584)      
|                                                     |               
|Warranty accrual, end of period                      | $ 719,213      | $    722,040     
|                                                     |               

|Note 6  Segment
information


Product
revenue from international sources was $4.3 million and $3.1 million for the three months
ended March 31, 2005 and 2004, respectively. The following table represents the percentage
of product revenue by geographic region from customers for the three months ended March
31, 2005 and 2004:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                             | Three Months Ended
March 31, |    
|---------------------------- | ---------------------------- | ---
|
|United States                |                              | 70 
|Asia / Pacific / Middle East |                              | 3  
|Europe                       |                              | 4  
|Canada                       |                              | 9  
|Japan                        |                              | 8  
|Australia                    |                              | 2  
|South and Central America    |                              | 1  
|                             |                              |    
|Total                        |                              | 100
|                             |                              |    

|Note 7  Net income
per common share


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


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

|                                                               | Three Months Ended
March 31, |           
|-------------------------------------------------------------- | ---------------------------- | ----------
|
|Basic weighted average number of shares outstanding            | 16,477,815                   | 15,063,754
|Potential common shares pursuant to stock options and warrants | 2,504,931                    | 2,288,482 
|                                                               |                             
|Diluted weighted average number of shares outstanding          | 18,982,746                   | 17,352,236
|                                                               |                             

|Diluted
weighted average shares outstanding do not include options and warrants outstanding to
purchase 4,758 common equivalent shares for the three months ended March 31, 2004, as their
effect would have been antidilutive.


Note 8  Research
and development arrangement with Massachusetts General Hospital

6
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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


Note 9 
Development and license agreement with Gillette


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


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


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


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


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


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


For
the periods ended March 31, 2005 and 2004, Palomar recognized approximately $712,000 and
approximately $752,000 of funded product development revenues from Gillette, respectively.


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


7
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



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


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


For
the period ended March 31, 2005, Palomar recognized approximately $375,000 of funded
product development revenues from JJCC and deferred $375,000 of advance payments received
from JJCC for which services were not yet provided.


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


In
the first quarter of 2004, Palomar began providing services under a $2.5 million research
contract with the Department of the Army to develop a light based self-treatment device
for Pseudofolliculitis Barbae or PFB. The contract is a cost plus fee arrangement whereby
Palomar is reimbursed for the expenses incurred in connection with PFB research plus an 8%
fee. This revenue is included in funded product development revenue in the accompanying
statements of operations. Palomar has recognized $1.4 million of funded product
development revenues from the United States Department of the Army from the inception of
the contract through March 31, 2005. Palomars revenue from the contract may be
subject to government audit. Palomar is unaware of any specific adjustments or open items
that could result from any such audit.


For
the periods ended March 31, 2005 and 2004, Palomar recognized approximately $289,000 and
approximately $261,000 of funded product development revenues under this agreement,
respectively.


Note 12 
Settlement of Litigation


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


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


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


8
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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


For
the three months ended March 31, 2005, Lumenis made payments of approximately $656,000
relating to the 5% royalty and approximately $537,500 for back-owed royalties recorded as
royalty revenue.


Note 13  Litigation


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


On
April 7, 2005, Palomar and the Massachusetts General Hospital commenced a second action
for patent infringement in the United States District Court for the District of
Massachusetts against Cutera, Inc. seeking both monetary damages and injunctive relief.
The complaint alleges Cuteras products using pulsed light technology for hair
removal willfully infringe U.S. patent Nos. 5,595,568 and 5,735,844, which are exclusively
licensed to Palomar by the Massachusetts General Hospital. Cuteras products include
the Solera Opus product in the Solera Platform and other products using pulsed light and
light-based technology in Cuteras XEO platform. Cuteras PW 770 handpiece is
utilized in the Solera and XEO Platforms.
9
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Forward-looking
statements


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

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

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

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

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


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


Critical accounting policies


The
discussion and analysis of the Companys financial condition and results of
operations are based upon the Companys consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires the Company to make
estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an on-going
basis, the Company evaluates its estimates, including those related to revenue
recognition, bad debts, inventories, warranty obligations, contingencies, restructurings
and income taxes. The Company bases its estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions. A discussion of the
Companys critical accounting policies and the related judgments and estimates
affecting the preparation of the Companys consolidated financial statements is
included in the Annual Report on Form 10-K of the Company for fiscal year 2004.


10
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Overview


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


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



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

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

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

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

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

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

|We
improved product gross margins by 57% due to a higher margin product mix and the effects
of increased sales volume as compared to the same period in 2004. We also strengthened our
balance sheet since the end of last year, including increasing our cash and cash
equivalents and available-for-sale investments by 16% and increasing stockholders
equity by 19%. The current ratio is now 4.5x, up from 3.7x at the end of 2004, and we have
no debt.


11
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Our
reported total revenues for the three months ended March 31, 2005, were $17.0 million, up
from $10.8 million for the same period in 2004. Gross profit from product sales increased
to $9.8 million (68% of product revenues), up from $6.2 million (65% of product revenues)
for the same period in 2004. We also reported net income of $3.5 million, or $0.19 per
diluted share, for the three months ended March 31, 2005, versus net income of $1.2
million, or $0.07 per diluted share, for the same period in 2004.


Over
the last three years, most of our revenue has included the Lux family of products with
their complementary handpieces, offering a suite of applications to the end user at a
lower cost than other competing systems. Customers can invest in their first Lux system
with one handpiece then purchase additional handpieces as their practice grows and if they
prefer upgrade into more powerful Lux systems when ready. Additionally, the Lux platform
enables us to custom tailor products to fit almost any professional medical office or spa
location and provides our customers with the comfort that the system can grow with their
practice. We have kept a commitment to continually provide value to customers who invest
in our Lux system platform. We believe the Lux family of products are the most affordable
and versatile cosmetic light based systems on the market.


The
StarLux, with its suite of handpieces, can be used for permanent hair reduction, the
treatment of pigmented lesions, vascular lesions, leg veins, acne, wrinkles and other
cosmetic applications. The StarLux can operate the LuxY, LuxG, LuxR,
LuxRs, and LuxV lamp handpieces as well as the Lux1064 Nd: YAG laser
handpiece. Incorporated into the StarLux is active contact cooling for safety, smooth
pulse technology for comfort, AccuSpectrum technology for versatility, photon
recycling for efficacy and a full-color touch screen for ease of use.


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


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


Results of operations


The
following table contains selected income statement information, which serves as the basis
of the discussion of our results of operations for the three months ended March 31, 2005
and 2004, respectively (in thousands, except for percentages):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                    | Three Months Ended
March 31, | Change |           |      |         |       | 
|----------------------------------- | ---------------------------- | ------ | --------- | ---- | ------- | ----- | 
|
|
|Revenues:                           |                              |        |           |      |         |       | 
|Product revenues                    | $ 14,283                     | 84%    | $   9,627 | 89%  | $ 4,656 | 48%  
|Royalty revenues                    | 1,382                        | 8%     | 193       | 2%   | 1,189   | 616% 
|Funded product development revenues | 1,380                        | 8%     | 1,014     | 9%   | 366     | 36%  
|                                    |                              |        |          
|Total revenues                      | 17,045                       | 100%   | 10,834    | 100% | 6,211   | 57%  
|                                    |                              |        |          
|Cost and expenses:                 
|Cost of product revenues            | 4,521                        | 27%    | 3,419     | 32%  | 1,102   | 32%  
|Cost of royalty revenues            | 553                          | 3%     | 77        | 1%   | 476     | 618% 
|Research & development              | 3,186                        | 19%    | 2,539     | 23%  | 647     | 25%  
|Selling & marketing                 | 3,825                        | 22%    | 2,681     | 25%  | 1,144   | 43%  
|General & administrative            | 1,550                        | 9%     | 1,087     | 10%  | 463     | 43%  
|                                    |                              |        |          
|Total costs & expenses              | 13,635                       | 80%    | 9,803     | 91%  | 3,832   | 39%  
|                                    |                              |        |          
|Income from operations              | 3,410                        | 20%    | 1,031     | 9%   | 2,379   | 231% 
|Interest income                     | 172                          | 1%     | 27        | -%   | 145     | 537% 
|Other income                        | 6                            | -%     | 143       | 1%   | (137)   | (96%)
|                                    |                              |        |          
|Income before income taxes          | 3,588                        | 21%    | 1,201     | 11%  | 2,387   | 199% 
|Provision for income taxes          | (72)                         | -%     | (42)      | -%   | 30      | 71%  
|                                    |                              |        |          
|Net income                          | $   3,516                    | 21%    | $   1,159 | 11%  | $ 2,357 | 203% 
|                                    |                              |        |          

|12
|--

|Product
revenues. Sales of the StarLux Pulsed Light and Laser System coupled with
its additional handpieces were the leading contributor to our increase in product
revenues. Product revenues were favorably impacted by an increase of 46% in sales related
to the Lux family of products, which includes the StarLux, MediLux, EsteLux,
NeoLux and their additional handpieces. In addition, product revenues were favorably
impacted with an increase of 68% customer service revenues offset by a decrease of 16%
from sales related to the Q-Yag 5 product line as compared to the same period in 2004.


International
product revenue, consisting of sales by our distributors in Japan, Europe, Australia,
Asia\Pacific Rim and South and Central America and our sales shipped directly to
international customers was 30% of total product revenue for the three months ended March
31, 2005 in comparison to 32% for the same period in 2004. This decrease as a percentage
of revenues in international sales is directly attributed to the increase in domestic
product sales.


Royalty
revenues. The increase in royalty revenue for the three months ended March
31, 2005, in comparison to the same period in 2004, is attributed to our settlement
agreement with Lumenis. Under the terms of the settlement, Lumenis paid $868,000 in the
second quarter of 2004 for back-owed royalties from sales of the LightSheer made prior to
July 1, 2002 and agreed to pay $3.225 million over the next six quarters, or $537,500 per
quarter, for back-owed royalties due on sales of the LightSheer made between July 1, 2002
and December 31, 2003. Beginning on January 1, 2004, Lumenis agreed to pay us a 5% royalty
on sales of the LightSheer and other professional laser hair removal devices and modules.
We record royalty revenue from Lumenis when received. In addition, Lumenis granted us a
paid up license to a variety of Lumenis patents for our light based devices. We
granted Lumenis a paid up license to the 568 and 844 patents for Lumenis
professional lamp based devices. Both parties have agreed to the validity and
enforceability of each others patents and not to challenge such validity and
enforceability in the future. For the three months ended March 31, 2005, Lumenis made
payments of approximately $656,000 relating to the 5% royalty and $537,500 for back-owed
royalties recorded as royalty revenue.


Funded
product development revenues.Funded product development revenue increased
for the three months ended March 31, 2005, in comparison to the same period in 2004.
Funded product development revenue is generated from the development agreements with
Gillette and Johnson & Johnson Consumer Companies, Inc. (JJCC) as well as
the United States Department of the Army. For both Gillette and JJCC, Palomar receives
payments quarterly in accordance with the work plan that were developed with both Gillette
and JJCC. Revenue is recognized under the contracts as costs are incurred and services are
rendered. Any amounts received in advance of costs incurred and services rendered from
Gillette or JJCC are recorded as deferred revenue. Payments are not refundable if
the development is not successful. For the three months ended March 31, 2005, we
recognized approximately $712,000 and $375,000 of funded product development revenue from
Gillette and JJCC, respectively as compared to approximately $752,000 from Gillette during
the same period in 2004.


We
provide services under a $2.5 million research contract with the United States Department
of the Army to develop a light based self-treatment device for Pseudofolliculitis Barbae
or PFB. The contract is a cost plus fee arrangement whereby Palomar is reimbursed for the
expenses incurred in connection with PFB research plus an 8% fee. Revenue is recognized
under the contract as the costs are incurred and the services are rendered. For the three
months ended March 31, 2005, we recognized approximately $289,000 of funded product
development revenues from the Department of the Army as compared to approximately $261,000
for the same period in 2004.


Cost of product revenues. The cost of product revenues increased in
absolute dollars, but decreased as a percentage of total revenue for the three months
ended March 31, 2005 as compared to the same period in 2004. The increase in absolute
dollars is directly attributable to increased variable costs associated with increased
product sales. This cost decreased as a percentage of total revenue primarily due to a shift in sales mix to the higher
priced StarLux Pulsed Light and Laser System. In addition, increased sales volume has
improved the absorption of fixed manufacturing overhead at our manufacturing facility as
approximately 70% of our manufacturing overhead cost is fixed in nature and is spread over
much higher sales volumes.

13
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Cost
of royalty revenues. As a percentage of royalty revenues, the cost of
royalty revenues was consistent at 40% in accordance with our license agreement with
Massachusetts General Hospital for each period in comparison to the same period in 2004.
The increase in the cost of royalty revenues in absolute dollars is attributed to our
settlement agreement with Lumenis.


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


For
our research and development agreement with Gillette, costs related to payroll and payroll
related expenses increased by $45,000, material costs increased by $44,000 and other
clinical, consulting and overhead expenses decreased by approximately $64,000 as compared
to the same period in 2004.


Expenses
relating to the JJCC agreement, which began in October 2004, increased by $265,000 for the
three months ended March 31, 2005.


Expenses
relating to the United States Department of the Army costs related to payroll and payroll
related expenses increased by $124,000 and materials, other clinical, consulting and
overhead expenses decreased by approximately $96,000 as compared to the same period in
2004. This increase is attributed to an additional month of costs in 2005 associated with
payroll and payroll related expenses, material costs and other overhead expenses due to
the project starting in February of 2004. Though the project was scheduled to last for
nineteen months, we believe we will need several more months to complete the work.


For
the three months ended March 31, 2005, legal expenses relating to the prosecution of
patent applications increased by approximately $223,000 in comparison to the same period
in 2004. We are committed to expanding our intellectual property rights to protect
discoveries made through our investment in research and development.


Expenses
relating to the introduction of new products, enhancements made to our current family of
products and research and development overhead increased by approximately $187,000 for the
three months ended March 31, 2005, in comparison to the same period in 2004.


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


Selling
and marketing expense. The increase in selling and marketing expenses is directly
associated with an increase in commissions of approximately $87,000, an increase of
$332,000 in costs related to our domestic sales force, which includes salaries and wages,
travel, demonstration materials and insurance increases, an increase in overhead expenses
of approximately $637,000 and an increase in costs relating to tradeshows of approximately
$88,000. These increases directly correlate with our increased revenues, upfront costs
associated with both international and domestic sales force and distribution channel
expansion.


General and administrative expense. The increase in general and
administrative expense is mainly attributed to increases to incentive compensation of
$150,000, related to our incentive compensation plan of 2005, increases in payroll and
payroll related expenses of approximately $68,000, increases in other infrastructure costs
of approximately $60,000 and increases in legal expenses of approximately $185,000 in
comparison to the same period in 2004.

14
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Interest
income.Interest income increased due to higher levels of excess cash on
hand and an increase in interest rates for the three months ended March 31, 2005 in
comparison to the same period in 2004.


Other
income. Other income is attributable to payments received from a previously
written-off note receivable and equity investment.


Provision
for income taxes.  We provided income taxes at a 2% effective rate in
2005 and a 4% effective tax in 2004.  The primary components of this provision, in
both 2005 and 2004, were minimum federal and state taxes.  However, we were able to
fully offset our cash tax liabilities with the tax benefit from the exercise of stock
options.  Given our limited history of profitability we have fully reserved our
otherwise recognizable deferred tax asset which is principally comprised of our net
operating loss carryforwards, as its realization is uncertain.  We will continue to
revisit this analysis on a quarterly basis and record adjustments as necessary.


Liquidity and capital
resources


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

|                          | Three months ended
March 31, | Change    |   |         
|------------------------- | ---------------------------- | --------- | - | --------
|
|Operating cash flows      |                              | $ 2,202   |   | $    829
|Investing cash flows      |                              | (6,536    | ) | (6,330  
|Financing cash flows      |                              | 1,898     |   | 1,702   
|                          |                              |           |   |         
|Capital expenditures, net |                              | $      86 |   | $    130

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

|                                   | March 31, | December 31, | Change    |      
|---------------------------------- | --------- | ------------ | --------- | -----
|
|Cash and cash equivalents          | $  5,073  | $  7,509     | $ (2,436) | (32%)
|Available-for-sale investments, at
|market value                       | 24,100    | 17,650       | 6,450     | 37%  
|Accounts receivable, net           | 7,359     | 7,123        | 236       | 3%   
|Inventories, net                   | 5,973     | 5,866        | 107       | 2%   
|Working capital                    | 33,646    | 28,163       | 5,483     | 19%  

|As
of March 31, 2005, we had $29.2 million in cash and cash equivalents and
available-for-sale investments. We believe that our current cash balances and expected
future cash flows will be sufficient to meet our anticipated cash needs for working
capital, capital expenditures and other activities for at least the next 12 months. As of
March 31, 2005, we had no borrowings or debt.


Operating
cash flows for the three months ended March 31, 2005, increased compared to the same
period in 2004. This increase reflects the effects of an increase in net profit and a
increase in working capital requirements primarily from the reduction in accrued
liabilities. Cash used in investing activities decreased for the three months ended March
31, 2005, compared to the same period in 2004. These amounts primarily reflect cash used
for purchases of property and equipment, purchases of available-for-sale investments
offset by proceeds from the sale of available-for-sale investments. Cash provided by
financing activities increased for the three month period ended March 31, 2005 compared to
the same period in 2004. This increase was primarily due to an increase in exercises
of stock options offset partially by costs incurred related to the issuance of common
stock.

15
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|We
anticipate that capital expenditures for the remainder of 2005 will total approximately
$300,000, consisting primarily of machinery, equipment, computers and peripherals. We
expect to finance these expenditures with cash on hand.


Contractual obligations


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


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


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


The
following table summarizes our estimated contractual cash obligations as of March 31,
2005, excluding amounts due Massachusetts General Hospital, royalty and employment
obligations because they are variable and/or subject to uncertain timing (000s
omitted):
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   | Payments due by period |         |         |        |      
|---------------------------------- | ---------------------- | ------- | ------- | ------ | -----
|
|Operating lease                    | $ 3,560                | $   712 | $ 2,136 | $  712 | $  --
|Purchase commitments               | 3,696                  | 3,696   | --      | --     | --   
|                                   |                       
|Total contractual cash obligations | $ 7,256                | $ 4,408 | $ 2,136 | $ 712  | $  --
|                                   |                       

|Recent Accounting
Pronouncements


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


Cautionary statements


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


Light
based technology is rapidly changing and improving. In order to be successful, we must
continue to make significant investments in research and development in order to develop
in a timely and cost-effective manner, new products that meet changing market demands,
enhance existing products, and achieve market acceptance for such products. We have in the
past experienced delays in developing and marketing new products and enhancing existing
products. Furthermore, some of our new products under development are based on unproven
technology and/or technology with which we have no previous experience. In addition, the
market for professional hair removal light based devices may already be saturated. At
present, broader market acceptance of light based hair removal is critical to our success
and


16
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|we intend to continue our goals of
bringing light based hair removal devices to the mass consumer market. We also intend to
continue to diversify our product line by developing cosmetic light based products for
uses other than hair and tattoo removal, treatment of acne and wrinkles, and treatment of
pigmented and vascular lesions. There can be no assurance that we will be able to
successfully implement such strategy in a timely fashion or at all and our failure to do
so could decrease our future revenue.


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


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


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


Although
we have generated a profit in recent years, we have a history of losses. We may have to
secure additional financing to complete our research and development activities,
commercialize our current and proposed light based products, and fund ongoing operations.
However, there can be no assurance that such financing will be obtained. We may also
determine, depending upon the opportunities available, to seek additional debt or equity
financing to fund the costs of operations or expansion. Additionally, if we incur
indebtedness to fund increased levels of accounts receivable, finance the acquisition of
capital equipment, or if we issue debt securities in connection with any acquisition we
will be subject to risks associated with incurring substantial additional indebtedness.
Our quarterly operating results are and may continue to be volatile, and that may hurt the
price of our common stock. If our operating results fall below the expectations of
investors or public market analysts, the price of our common stock could decline.


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


We
develop light based systems that incorporate third-party components. Some of these items
are custom made or otherwise not readily available on the market. We purchase some of
these components from small, specialized vendors that are not well capitalized. A
disruption in the delivery of these key components could prevent us from manufacturing
products and result in a decrease in revenue. We depend on an acceptable level of
reliability for purchased components. Reliability below expectations for key components
could have an adverse affect on inventory and inventory reserves.


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


All
of our current products are light based devices, which are subject to FDA regulations for
clinical testing, manufacturing, labeling, sale, distribution and promotion. Before a new
product or a new use of or claim for an existing product can be marketed in the United
States, we must obtain clearance from the FDA. The types of medical devices that we seek
to market in the U.S. generally must receive either 510(k) clearance or
PMA approval in advance from the U.S. Food and Drug Administration (FDA)
pursuant to the Federal Food, Drug, and Cosmetic Act. The FDAs 510(k) clearance
process usually takes from four to twelve months, but it can last longer. The process of
obtaining PMA approval is much more costly and uncertain and generally takes from one to
three years or even longer. To date, the FDA has deemed our products eligible for the
510(k) clearance process. We believe that our products in development will receive similar
treatment. However, we cannot be sure that the FDA will not impose the more burdensome PMA
approval process upon one or more of our future products, nor can we be sure that

17
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|510(k)
          clearance or PMA approval will ever be obtained for any product we propose to
          market and our failure to do so could adversely affect our ability to sell our
          products.


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


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


Any
modification to one of our 510(k) cleared devices that could significantly affect its
safety or effectiveness, or that would constitute a major change in its intended use,
requires a new 510(k) clearance. The FDA requires every manufacturer to make this
determination in the first instance, but the FDA can review any such decision. We have
modified some of our marketed devices, but we believe that new 510(k) clearances are not
required. We cannot be certain that the FDA would agree with any of our decisions not to
seek 510(k) clearance. If the FDA requires us to seek 510(k) clearance for any
modification, we also may be required to cease marketing and/or recall the modified device
until we obtain a new 510(k) clearance.


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


Our
products may also be subject to state regulations. Federal regulation allows our products
to be sold to and used by licensed practitioners as determined on a state-by-state basis.
As a result, in some states non-physicians may purchase and operate our product. However,
a state could disagree with our decision to sell to a particular type of end user or
change regulations preventing sales to particular types of end users. Thus, state
regulations and changes to state regulations may decrease revenues or prevent growth of
revenues. The purchase and use of our products by non-physicians may result in their
misuse, which could harm our reputation and expose us to costly product liability
litigation.


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


We
are subject to inspection and market surveillance by the FDA to determine compliance with
regulatory requirements. The FDAs regulatory scheme is complex, especially the
Quality System Regulation (QSR), which requires manufacturers to follow
elaborate design, testing, control, documentation, and other quality assurance procedures.
This complexity makes complete compliance difficult to achieve. Also, the determination as
to whether a QSR violation has occurred is often subjective. If the FDA finds that we have
failed to comply with the QSR or other applicable requirements, the agency can institute a
wide variety of enforcement actions, including a public warning letter or other stronger
remedies, such as fines, injunctions, and civil penalties, recall or seizure of our
products, operating restrictions, partial suspension, or total shutdown of our production,
refusing our requests for 510(k) clearance or PMA approval of new products, withdrawing
product approvals already granted or criminal prosecution.


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


We
are dependent upon third-party researchers over whom we do not have absolute control to
satisfactorily conduct and complete research on our behalf. We are also dependent upon
third-party researchers to grant us licensing terms, which may or may not be favorable for
products and technology which they may develop. At present, our principal research partner
is the Wellman Laboratories of Photomedicine at Massachusetts General Hospital. We provide
research funding, light technology and

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

|optics know-how in return for
licensing rights with respect to specific dermatologic and cosmetic applications and
patents. In return for certain exclusive license rights, we are subject to due diligence
obligations in order to maintain such exclusivity. Our success will be dependent upon the
results of research with our partners and meeting due diligence obligations. We cannot be
sure that third-party researchers will agree with our interpretation of the terms of our
agreements, that we will meet our due diligence obligations, or that such research
agreements will provide us with marketable products in the future or that any of the
products developed under these agreements will be profitable for us.


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


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


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


Our
business could be materially and adversely affected if we are not able to adequately
protect our intellectual property rights. We rely on a combination of patent, copyright,
trademark and trade secret laws, licenses and confidentiality agreements to protect our
proprietary rights. We generally enter into non-disclosure agreements with our employees
and third parties with whom we work, including but not limited to consultants and vendors,
to restrict access to, and distribution of, our proprietary information. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise obtain and use our technology. Monitoring unauthorized use of our technology is
difficult and we cannot be certain that the steps we have taken will prevent unauthorized
use of our technology, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States. If competitors are able to use
our technology, our ability to compete effectively could be harmed. Costly and time
consuming lawsuits may be necessary to enforce and defend patents issued or licensed
exclusively to us, to protect our trade secrets and/or know-how or to determine the
enforceability, scope and validity of others intellectual property rights. Such
lawsuits may result in patents issued or licensed exclusively to us to be found invalid
and unenforceable. Our competitors also may independently develop technologies that are
substantially equivalent or superior to our technology and which do not infringe our
patents.


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


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


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


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

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


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


We may not be able to
successfully collect licensing royalties.


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


We
have sued Cutera, Inc. (formerly Altus Medical Inc., See Legal Proceedings) for patent
infringement, and we are involved in patent disputes with other third parties. Such other
disputes may also result in litigation. We have incurred, and likely will continue to
incur, legal expenses in connection with such matters. There can be no assurance that such
litigation will result in favorable outcomes for us. Any adverse result in litigation
could weaken the strength of the patents involved, and have a material adverse effect on
our business, financial condition and results of operations.


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


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


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


Our
products are and will continue to be designed and manufactured with numerous safety
features, but it is possible that consumers could be adversely affected by use of one of
our products. Furthermore, in the event that any of our products prove to be defectively
designed and manufactured, we may be required to recall and redesign such products.
Although we have not experienced any material losses due to product liability claims to
date, there can be no assurance that we will not experience such losses in the future. We
maintain general liability insurance and umbrella coverage; however, there can be no
assurance that such coverage will continue to be available on terms acceptable to us or
that such coverage will be adequate for liabilities actually incurred. In the event we are
found liable for damages in

20
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|excess of the limits of our insurance
coverage or if any claim or product recall results in significant adverse publicity
against us, our business, financial condition and results of operations could be
materially and adversely affected. In addition, although our products have been and will
continue to be designed to operate in a safe manner, and although we attempt to educate
customers with respect to the proper use of our products, misuse of our products by
personnel over whom we cannot exert control may result in the filing of product liability
claims or significant adverse publicity against us.


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


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


We face risks associated
with product warranties.


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


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


We
sell a significant amount of our products and services outside the U.S. International
product revenue, consisting of sales from our distributors in Japan, Europe, Australia,
Asia\Pacific Rim and South and Central America and sales shipped directly to international
locations from the United States was 30% of total product revenue for the three months
ended March 31, 2005, and we expect that international sales will continue to be
significant. As a result, a major part of our revenues and operating results could be
adversely affected by risks associated with international sales. In particular, longer
payment cycles common in foreign markets, credit risk and delays in obtaining necessary
import or foreign regulatory approvals for products may occur. In addition, significant
fluctuations in the exchange rates between the U.S. dollar and foreign currencies could
cause us to lower our prices and thus reduce our profitability, or could cause prospective
customers to push out orders to later dates because of the increased relative cost of our
products in the aftermath of a currency devaluation or currency fluctuation.


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


On
February 14, 2003, we entered into a Development and License Agreement with Gillette to
complete development and commercialize a home-use, light based hair removal device for
women. On June 28, 2004 Palomar and Gillette announced that they completed the initial
phase of their agreement and that both parties would move into the next phase. In
conjunction with entering this next phase, the parties amended the agreement to provide
for additional development funding to further technical innovations. We believe that this
represents a unique opportunity to bring light based devices to the mass market. Under the
agreement, significant resources and the attention of key technical personnel and
management will be directed to the development of such a device even though such device
will not likely be commercialized for several years, if ever. In addition, we cannot be
sure that Gillette will agree with our interpretation of the terms of the agreement, that
the agreement will provide us with marketable products in the future or that we will
receive payments for any of the products developed under the agreement. During the term of
the


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

|agreement, Gillette has the ability
to choose not to continue and may terminate the agreement. If Gillette terminates the
agreement, the price of our common stock could fall significantly, and we will not receive
certain payments. We may proceed to develop and commercialize the device on our own or
with a third party. However, there can be no assurance that we will be able to
successfully implement such a strategy. In addition, after commercialization of such
device, Gillette is to pay us a percentage of net sales of such device. Certain of these
percentages of net sales are only owed if the device is covered by valid patents. There
can be no assurance that valid patents will cover the device in any or all countries, in
which the device will be manufactured, used or sold. This could have a material adverse
effect on our business, results of operations and financial condition.


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


On
February 18, 2004, we announced that we were awarded a $2.5 million research contract by
the Department of the Army to develop a light based self-treatment device for
Pseudofolliculitis Barbae or PFB. We believe this represents a unique opportunity to
address PFB. Although the project was scheduled to last for nineteen months, we now
believe it will take several additional months to complete the work. There can be no
assurance that we will be able to complete the project within that time period which may
impact our ability to receive future government contracts. Under the agreement,
significant resources and the attention of key technical personnel and management will be
directed to the development of such a device even though such device will not likely be
ready for military use for several years, if ever.


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


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

Item 3.  Quantitative and qualitative disclosures about market risk

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

22
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Item 4. Controls and
procedures


Under
the direction of the principal executive officer and principal financial officer, the
Company has evaluated the effectiveness of its disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2005. Based on that
evaluation, the Company has concluded that its disclosure controls and procedures were
effective in providing reasonable assurance that material information required to be
disclosed is included on a timely basis in the reports filed with the Securities and
Exchange Commission.


There
were no significant changes in the Companys internal controls over financial
reporting or in other factors that could significantly affect these controls during the
quarter ended March 31, 2005, including any corrective actions with regard to significant
deficiencies and material weaknesses.


PART II  Other
information


Item 1. Legal proceedings


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


On
April 7, 2005, Palomar and the Massachusetts General Hospital commenced a second action
for patent infringement in the United States District Court for the District of
Massachusetts against Cutera, Inc. seeking both monetary damages and injunctive relief.
The complaint alleges Cuteras products using pulsed light technology for hair
removal willfully infringe U.S. patent Nos. 5,595,568 and 5,735,844, which are exclusively
licensed to Palomar by the Massachusetts General Hospital. Cuteras products include
the Solera Opus product in the Solera Platform and other products using pulsed light and
light-based technology in Cuteras XEO platform. Cuteras PW 770 handpiece is
utilized in the Solera and XEO Platforms. (See Cautionary Statements)


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


Not
applicable.


Item 3. Defaults upon
senior securities


Not
applicable.

23
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Not Applicable.


Item 5. Other
information.


Not
Applicable.


Item 6. Exhibits and
reports on Form 8-K

(a)
 Exhibits
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |      |                                                                                                                                                                                                                                                                            
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 31.1 | Certification of Joseph P. Caruso, President and Chief Executive Officer of
                             the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                             2002.                                                   
| | 31.2 | Certification of Paul S. Weiner, Vice President and Chief Financial Officer
                             of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
                             of 2002.                                                
| | 32   | Certification of Joseph P. Caruso, President and Chief Executive Officer of
                             the Company, pursuant to 18 United States Code Section 1350, as adopted
                             pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.   
| | 32   | Certification of Paul S. Weiner, Vice President and Chief Financial Officer
                             of the Company, pursuant to 18 United States Code Section 1350, as adopted
                             pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

|(b)
  Reports on Form 8-K






On
February 8, 2005, the Board of Directors of Palomar Medical Technologies, Inc. (the
"Company") adopted a 2005 Incentive Compensation Program - Executive Level (the
"Program") for fiscal year 2005. Under the Program, if the Company meets a certain base
level profit milestone, these officers would receive a cash bonus of up to 45% of such
officer's annual base salary for meeting both corporate and individual objectives. In
addition, if the Company meets a certain second level profit milestone above base level,
these officers would receive an additional cash bonus of up to 25% of such officer's
annual base salary. Also, these officers would receive an additional cash bonus of up to
3% of such officer's annual base salary for each certain additional level above the
second profit milestone.


Also on February 8, 2005, the Board of Directors of the Company increased the Board meeting
fees provided to non-employee directors to $32,000 per Director per year.



On February 10, 2005, we filed a current report on Form 8-K, which reported our financial
results for our fiscal year end, 2004.

24
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Signatures


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

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

|                   |                                                                                                     
|------------------ | ----------------------------------------------------------------------------------------------------
|Date:  May 5, 2005 | By:/s/ Joseph P. Caruso
      Joseph P. Caruso
      President, Chief Executive Officer and Director
|                   |                                                                                                     

|                   |                                                                                            
|------------------ | -------------------------------------------------------------------------------------------
|Date:  May 5, 2005 | By:/s/ Paul S. Weiner
      Paul S. Weiner
      Vice President and Chief Financial Officer
|                   |                                                                                            

|-25-
|----