|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 June 30, 2004.


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)       | (Zip
      code) | 

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

|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).o No ý

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                             | 
|---------------------------- | 
|Class                        | 
|Common Stock, $.01 par value | 

|
|

|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    June 30, 2004 and December 31, 2003   |  | 1       
|                               | Unaudited Condensed Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003 |  | 2       
|                               | Unaudited Condensed Consolidated Statement of Stockholders Equity                                              |  | 3       
|                               | Unaudited Condensed Consolidated Statements of Cash Flows                                                       |  | 4       
|                               | Notes to Unaudited Condensed Consolidated Financial Statements                                                  |  | 5       
|Item 2.                        | Managements Discussion and Analysis of Financial Condition and the
   Results of Operations                    |  | 10      
|                               | Cautionary Statements                                                                                           |  | 19      
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 25      
|Item 4.                        | Controls and Procedures                                                                                         |  | 25      
|                               |                                                                                                                 |  |         
|PART II - Other Information    |                                                                                                                 |  |         
|                               |                                                                                                                 |  |         
|Item 1.                        | Legal Proceedings                                                                                               |  | 25      
|Item 2.                        | Changes in Securities, Use of Proceeds and Issuer Purchases of Securities                                       |  | 26      
|Item 3.                        | Defaults Upon Senior Securities                                                                                 |  | 26      
|Item 4.                        | Submission of Matters to a Vote of Security Holders                                                             |  | 26      
|Item 5.                        | Other Information                                                                                               |  | 27      
|Item 6.                        | Exhibits and Reports on Form 8-K                                                                                |  | 27      
|SIGNATURES                     |                                                                                                                 |  | 29      

|i
|-

|
|

|
|

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

|                                                                             | June 30,
2004 | December 31,
2003
|---------------------------------------------------------------------------- | ------------- | -----------------
|Assets                                                                       |               |                  
|Current assets:                                                              |              
|Cash and cash equivalents                                                    |               | $   17,111,918   
|Accounts receivable, net of allowance of $979,392 and $862,114, respectively |               | 7,824,865        
|Inventories                                                                  |               | 4,141,907        
|Other current assets                                                         |               | 722,862          
|                                                                             |               |                  
|Total current assets                                                         |               | 29,801,552       
|                                                                             |               |                  
|Property and equipment, net                                                  |               | 909,627          
|                                                                             |               |                  
|Other assets                                                                 |               | 111,074          
|                                                                             |               |                  
|Total Assets                                                                 |               | $   30,822,253   
|                                                                             |               |                  
|Liabilities and Stockholders' Equity                                         |              
|Current liabilities:                                                         |              
|Accounts payable                                                             |               | $        812,327 
|Accrued liabilities                                                          |               | 6,457,549        
|Deferred income taxes                                                        |               | 1,100,000        
|Deferred revenue                                                             |               | 2,320,270        
|                                                                             |               |                  
|Total current liabilities                                                    |               | 10,690,146       
|                                                                             |               |                  
|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 -  15,826,558 and 14,554,407 shares, respectively                     |               | 158,266          
|Additional paid-in capital                                                   |               | 170,834,346      
|Accumulated deficit                                                          |               | (150,860,505     
|                                                                             |               |                  
|Total stockholders' equity                                                   |               | 20,132,107       
|                                                                             |               |                  
|Total liabilities and stockholders equity                                   |               | $   30,822,253   
|                                                                             |               |                  

|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
June 30, | Six Months Ended
June 30, |   |           
|---------------------------------------------- | --------------------------- | ------------------------- | - | ----------
|
|Revenues:                                      |                             |                           |   |           
|Product revenues                               |                             |                           | $ | 10,686,773
|Royalty revenues                               |                             |                           |   | 1,455,227 
|Funded product development revenues            |                             |                           |   | 1,088,172 
|                                               |                             |                           |   |           
|Total revenues                                 |                             |                           |   | 13,230,172
|                                               |                             |                           |   |           
|Costs and expenses:                            |                             |                          
|Cost of product revenues                       |                             |                           |   | 3,822,507 
|Cost of royalty revenues                       |                             |                           |   | 582,091   
|Research and development                       |                             |                           |   | 2,490,182 
|Selling and marketing                          |                             |                           |   | 3,124,608 
|General and administrative                     |                             |                           |   | 1,176,854 
|                                               |                             |                           |   |           
|Total costs and expenses                       |                             |                           |   | 11,196,242
|                                               |                             |                           |   |           
|Income from operations                         |                             |                           |   | 2,033,930 
|                                               |                             |                           |   |           
|Interest income                                |                             |                           |   | 38,794    
|Interest expense                               |                             |                           |   | (1,521    
|Other income                                   |                             |                           |   | 18,000    
|                                               |                             |                           |   |           
|Income from operations before income taxes     |                             |                           |   | 2,089,203 
|                                               |                             |                           |   |           
|Provision (benefit) from income taxes          |                             |                           |   | 59,114    
|                                               |                             |                           |   |           
|Net income                                     |                             |                           | $ | 2,030,089 
|                                               |                             |                           |   |           
|Net income per share:                          |                             |                          
|Basic                                          |                             |                           | $ | 0.13      
|                                               |                             |                           |   |           
|Diluted                                        |                             |                           | $ | 0.12      
|                                               |                             |                           |   |           
|Weighted average number of shares outstanding: |                             |                          
|Basic                                          |                             |                           |   | 15,697,135
|                                               |                             |                           |   |           
|Diluted                                        |                             |                           |   | 17,607,376
|                                               |                             |                           |   |           

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

|Palomar Medical
Technologies, Inc. and Subsidiaries


Condensed Consolidated
Statement of Stockholders' Equity (Unaudited)
|--------------------------------------------------------------------------------------------------------------------------

|                                                                 | Common Stock |  |  | Total      | 
|---------------------------------------------------------------- | ------------ |  |  | ---------- | 
|
|
|Balance, December 31, 2003                                       |              |  |  | 14,554,407 | 
|Net income                                                       |              |  |  | --         | 
|Issuance of stock for employee stock purchase plan               |              |  |  | 10,763     | 
|Issuance of stock for 2003 employer 401(k) matching contribution |              |  |  | 38,819     | 
|Costs incurred related to the issuance of common stock           |              |  |  | --         | 
|Tax benefit from the exercise of stock options                   |              |  |  | --         | 
|Exercise of stock options                                        |              |  |  | 1,184,569  | 
|Exercise of warrants                                             |              |  |  | 38,000     | 
|                                                                 |             
|Balance, June 30, 2004                                           |              |  |  | 15,826,558 | 
|                                                                 |             

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

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

|                                                                                              | Six Months Ended June 30, | 
|--------------------------------------------------------------------------------------------- | ------------------------- | 
|
|Cash flows from operating activities:                                                         |                           | 
|Net income                                                                                    |                           | 
|                                                                                              |                           | 
|Adjustments to reconcile net income  to net cash provided (used in)     operating activities: |                           | 
|Depreciation and amortization                                                                 |                           | 
|Increase in accounts receivable allowance                                                     |                           | 
|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 (used in) operating activities                                           |                           | 
|                                                                                              |                           | 
|Cash flows from investing activities:                                                         |                           | 
|Purchases of property and equipment                                                           |                           | 
|Decrease in other assets                                                                      |                           | 
|                                                                                              |                           | 
|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                                            |                           | 
|Proceeds from sale of common stock                                                            |                           | 
|                                                                                              |                           | 
|Net cash provided by financing activities                                                     |                           | 
|                                                                                              |                           | 
|                                                                                              |                           | 
|Net increase 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                                                                        |                           | 
|                                                                                              |                           | 
|                                                                                              |                           | 
|Supplemental disclosure of noncash financing and investing activities:                        |                           | 
|Issuance of stock for employer 401(k) matching contribution                                   |                           | 
|                                                                                              |                           | 
|Exchange of note payable for common stock                                                     |                           | 
|                                                                                              |                           | 

|The accompanying notes are
an integral part of these consolidated financial statements
-4-
|------------------------------------------------------------------------------------------

|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.  Accordingly, they 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, 2003.  Certain
prior-period amounts have been reclassified to conform with the current-period
presentation.


Note 2 - Stock based compensation


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


The
following table illustrates the effect on net income and earnings per share if Palomar
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 and six months ended
June 30, 2004 and 2003, respectively, 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 to
purchase common stock of Palomar would be as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                  | Three Months Ended
June 30, | Six Months Ended
June 30, |  |  | 
|--------------------------------- | --------------------------- | ------------------------- |  |  | 
|
|Net income as reported            |                             |                           |  |  | 
|                                  |                             |                           |  |  | 
|Less:  Total stock-based employee |                             |                          
|compensation expense determined   |                             |                          
|under fair value based method for |                             |                          
|all awards, net of tax            |                             |                           |  |  | 
|                                  |                             |                           |  |  | 
|Pro forma net income (loss)       |                             |                           |  |  | 
|                                  |                             |                           |  |  | 
|Net income (loss) per share:      |                             |                          
|Basic - as reported               |                             |                           |  |  | 
|                                  |                             |                           |  |  | 
|Basic - pro forma                 |                             |                           |  |  | 
|                                  |                             |                           |  |  | 
|Diluted - as reported             |                             |                           |  |  | 
|                                  |                             |                           |  |  | 
|Diluted - pro forma               |                             |                           |  |  | 
|                                  |                             |                           |  |  | 

|-5-
|---

|Palomar Medical
Technologies, Inc. and Subsidiaries                                     Notes to
Condensed Consolidated Financial Statements
Note 3 - Cash equivalents


Cash
equivalents consist of short-term, highly liquid investments which are readily
convertible into cash with maturities of three months or less when purchased.


Note 4 - Inventories


Inventories
are stated at lower of cost (first-in, first-out) or market.   At June 30, 2004 and December 31, 2003, inventories
consisted of the following:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                | June 30, 2004 | December 31, 2003
|--------------- | ------------- | -----------------
|Raw materials   |               | $2,603,788       
|Work-in-process |               | 369,282          
|Finished goods  |               | 1,168,837        
|                |               |                  
|                |               | $4,141,907       
|                |               |                  

|Note 5 - 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
the estimated useful lives. At June 30, 2004 and December 31, 2003, property and
equipment consisted of the following:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                  
|----------------------------------
|
|Machinery and equipment           
|Furniture and fixtures            
|Leasehold improvements            
|                                  
|                                  
|Less: accumulated depreciation and
|amortization                      
|                                  
|                                  
|                                  

|Note 6 - Warranty costs


Palomars
products generally carry a standard one-year warranty, with pulsed light handpieces
carrying a warranty of the earlier of the period of two-years or 100,000 shots fired.
 Palomar provides a reserve based on anticipated warranty claims at the time product
revenue is recognized.  In anticipation of actual warranty claims, Palomar amortizes the
reserve ratably over the life of the warranty thereby offsetting actual warranty claims
incurred.  Actual warranty claims incurred and charged to product costs of sale during an
interim period may be more or less than the amount of amortized warranty reserve
allocated against them. Factors that affect Palomars product warranty liability include
the number of installed units, the anticipated cost of warranty repairs and historical
and anticipated rates of warranty claims.


The
following table reflects the changes in Palomars accrued warranty during the six months
ended June 30, 2004:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                            | Total
(in thousands)
|------------------------------------------- | --------------------
|Warranty accrual as of December 31, 2003    |                     
|Plus accruals related to new sales          |                     
|Less: amortization of prior period accruals |                     
|                                            |                     
|Warranty accrual as of June 30, 2004        |                     

|-6-
|---

|Palomar Medical
Technologies, Inc. and Subsidiaries                                     Notes to
Condensed Consolidated Financial Statements
Note 7 - Segment information


Product
revenue from international sources were $3.4 million and $3.9 million for the three
months ended June 30, 2004 and 2003, respectively, and $7.7 million  for each of
the six months ended June 30, 2004 and 2003. The following table represents
the percentage of product revenue by geographic region from customers for the three and
six months ended June 30, 2004 and 2003:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                             | Three Months Ended
June 30, | Six Months Ended
June 30, |     |    
|---------------------------- | --------------------------- | ------------------------- | --- | ---
|
|United States                |                             | 68                        | .4% | 47 
|Asia / Pacific / Middle East |                             | 2                         | .0% | 4  
|Europe                       |                             | 4                         | .5% | 8  
|Canada                       |                             | 10                        | .1% | 5  
|Japan                        |                             | 9                         | .9% | 26 
|Australia                    |                             | 4                         | .0% | 4  
|South and Central America    |                             | 1                         | .1% | 3  
|                             |                             |                           |     |    
|Total                        |                             | 100                       | .0% | 100

|Note 8 - Net income per common
share


Basic
net income per share was determined by dividing net income attributable to common
stockholders by the weighted average common shares outstanding during the period.
 Diluted net income per share was determined by dividing net income attributable to
common stockholders 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 and the assumed conversion of all debt obligations and
convertible preferred stock and the elimination of related interest expense and preferred
stock dividends.


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

|                                   | Three Months Ended
June 30, | Six Months Ended
June 30, |  |           
|---------------------------------- | --------------------------- | ------------------------- |  | ----------
|
|Basic weighted average number of   |                             |                           |  |           
|shares outstanding                 |                             | 15,697,135                |  | 13,507,281
|Weighted average common equivalent |                            
|shares pursuant to options and     |                            
|warrants to purchase common stock  |                             | 1,910,241                 |  | 2,433,859 
|                                   |                             |                           |  |           
|Diluted weighted average number of |                             |                           |  |           
|shares outstanding                 |                             | 17,607,376                |  | 15,941,140

|Diluted
weighted average shares outstanding do not include options and warrants outstanding to
purchase 8,379 and 910,912 common equivalent shares for the three and six months ended
June 30, 2004, respectively, and 458,640 and 980,261 common equivalent shares for the
three and six months ended June 30, 2003, respectively, as their effect would have been
antidilutive.


Note 9 - Research and development
arrangement with Massachusetts General Hospital
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-7-
|---

|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 for hair removal/reduction developed at Wellman Laboratories of
Photomedicine. In July 1999, Palomar further amended this agreement to extend the
research agreement for an additional five years, with Palomar agreeing to pay
Massachusetts General Hospital $475,000 on an annual basis, and to expand the research
beyond photothermal hair removal into the fields of fat removal and acne treatment.
 Palomar has the right to exclusively license, on royalty terms to be negotiated,
Palomar-funded inventions in the relevant fields.  Palomar is in discussions with
Massachusetts General Hospital for an extension of this agreement for clinical research
beyond August 2004.


Note 10 - 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 provides for up to $7 million in support of
research and development to be paid by Gillette over approximately 30 months.


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.


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.


Note 11 - Research contract with
the 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.  Revenue is recognized under the contract as the costs are incurred and
the services are rendered.  This revenue is included in funded product development
revenue in the accompanying statements of operations.  Palomar has recognized $381,000 and $645,000
funded product development revenues from the Department of the Army during the three months
and six months ended June 30, 2004, respectively.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-8-
|---

|Palomar Medical
Technologies, Inc. and Subsidiaries                                     Notes to
Condensed Consolidated Financial Statements
Note 12 - Product upgrade rights


During
the quarter ended March 31, 2004, Palomar introduced the StarLux Pulsed Light and Laser
System. Palomar began commercially shipping StarLux products at the end of the second
quarter of 2004. In connection with this product introduction, Palomar offered certain
customers an upgrade option to trade-in existing products for a new StarLux system for an
upgrade fee. Palomar deferred approximately $863,000 of revenue during the three months
ended June 30, 2004 and $1.449 million of revenue during the six months ended June 30, 2004
in connection with the upgrade right in accordance with the Emerging Issues Task Force
issue No. 00-21 and SEC Staff Accounting Bulletin No. 104.



Note 13 - 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 will dismiss with prejudice both
the federal action in 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 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.  Lumenis made their first payment of $457,000 in
the second quarter for sales made in the first quarter of 2004.  The back-owed royalties of $1.3
million received in the second quarter of 2004 has been recorded as royalty revenue
together with the appropriate cost of revenue for the amounts due to the General Hospital
Corporation.


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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-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:
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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 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. Palomar undertakes 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 17, 2004. 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 2003.  There have been no material changes to our critical accounting
policies as of June 30, 2004.
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|-10-
|----

|Overview


We
are engaged in research, development, manufacturing and sale 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 own research and development as well as through research 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, fat reduction,
acne treatment, Pseudofolliculitis Barbae or PFB 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 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:
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| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenues. We derive revenues from products and services relating to our products, from royalty revenue
              and from funded product development.  Revenues from our products and services vary based on such factors as demand for
              our products, the number and size of transactions within the reporting period and the impact of changes in our sales
              prices. In addition to monitoring the amount of our 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.  Royalty revenues vary based on the amount of sales completed by our sublicensees.  Funded product development
              revenues from Gillette are at a fixed rate; however, funded product development revenues provided from the United Sates
              Army are on a reimbursement basis and fluctuate in accordance with work performed.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  | 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, overhead expenses and royalties collected.  With
              regard to the cost of royalty revenue, under our license agreement with Massachusetts General Hospital  (MGH), we pay
              MGH 40% of royalties we receive from third parties for sublicenses to United States Patents 5,595,568, 5,735,844 and
              foreign counterparts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  | 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 and
proceeds from the exercise of stock options.  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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

|-11-
|----

|Our
total revenues increased 53% for the second quarter of 2004 to $13.2 million, up from
$8.7 million in the second quarter of 2003. Gross margin from product sales increased to
$6.9 million (64 percent of product revenues), up from $4.5 million (58 percent of
product revenues) in the year-earlier quarter. We reported net income of $2.0 million, or
$0.12 per diluted share, for the second quarter of this year, versus net income of $1.1
million, or $0.07 per diluted share, for the second quarter of last year. These increases
in gross margins and net income are due to a higher margin product mix, improved manufacturing
efficiencies across all of our product lines and the effects of increased sales volumes.
Increases in Royalty revenues are attributed to Palomar and Lumenis reaching a settlement
resolving an on-going litigation concerning both patent infringement and contractual
matters.  As a result of this settlement, our royalty revenues increased by $1.2 million
or 525%.  We also strengthened our balance sheet since the end of last year, including
increasing our cash position by 62% and increasing stockholders' equity by 40%.


Over
the last two years, most of our product revenue has been from the Lux family of products with
their complementary handpieces, which offer 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
upgrade into a more powerful Lux system when ready.  Additionally, the Lux platform
enables Palomar 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.


Our
quarterly product revenue has increased as compared to the same period in 2003 as a
result of the increased product demand for our 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.


In
February 2004, we introduced the newest addition to the Lux family of products: the
StarLux Pulsed Light and Laser System.  In comparison to other Lux products, the StarLux
has increased power, a computer controlled touch screen, instant handpiece recognition,
integrated cooling, the ability to operate the Lux Y, LuxG, LuxR, LuxRs, LuxV and the
Lux1064 handpieces.  We began commercially shipping StarLux systems at the end of the
second quarter of 2004.


On
February 18, 2004, 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.  The project is scheduled to last for nineteen months.  As of June 30, 2004, we have
recognized approximately $645,000 to funded product development revenues.


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


Recent developments


On
June 28, 2004, Palomar and The Gillette Company announced that they completed the
initial phase of their agreement, and both parties will move into the next phase. Palomar
will now disclose additional proprietary information to assist the parties in completing
the development and commercialization of a patented home-use, light-based hair removal
device for women. In conjunction with entering this next phase, the parties amended
the agreement to provide for additional development funding to further technical
innovations. The original agreement provided for $7 million in development funding from
Gillette. Under the amendment, Gillette will provide $2.1 million in additional
development funding over a 9-month extension of the development phase, which is now
planned to be completed by August 31, 2006.


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. Palomar accused the LightSheer(TM) Diode Laser System, a product
initially developed by Palomar and   now marketed by Lumenis, and various Lumenis IPL
systems of infringing claims in two U.S. patents (5,595,568 and 5,735,844). Palomar has
an exclusive license to these patents from the General Hospital Corporation in Boston,
Massachusetts. Pursuant to the settlement, the parties will dismiss with prejudice both
the federal action in the Northern District of California as well as the state court
action in Massachusetts.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-12-
|----

|Under
the terms of the settlement, Lumenis paid $868,000 in the second quarter 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.  Lumenis made their first payment of $457,000 in the second
quarter  of 2004 for sales made in the first quarter of 2004.  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 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.


Results of operations


The
following tables contain selected statements of income information, which serves as
the basis of the discussion of our results of operations for the three and six months
ended June 30, 2004 and 2003, respectively (in thousands, except for percentages):
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                        | Three Months Ended
June 30, | Change |          |      |          |     
|--------------------------------------- | --------------------------- | ------ | -------- | ---- | -------- | ----
|
|
|Revenues:                               |                             |        |          |      |          |     
|Product revenues                        | $ 10,687                    | 81%    | $ 7,739  | 89%  | $ 2,948  | 38% 
|Royalty revenues                        | 1,455                       | 11%    | 233      | 3%   | 1,222    | 524%
|Funded product development revenues     | 1,088                       | 8%     | 700      | 8%   | 388      | 55% 
|                                        |                             |        |          |      |          |     
|Total revenues                          | $ 13,230                    | 100%   | $ 8,672  | 100% | $ 4,558  | 53% 
|                                        |                             |        |          |      |          |     
|Cost and expenses:                     
|Cost of product revenues                | $   3,823                   | 29%    | $ 3,228  | 37%  | $    595 | 18% 
|Cost of royalty revenues                | 582                         | 4%     | 93       | 1%   | 489      | 526%
|Research & development                  | 2,490                       | 19%    | 1,493    | 17%  | 997      | 67% 
|Selling & marketing                     | 3,124                       | 24%    | 2,127    | 25%  | 997      | 47% 
|General & administrative                | 1,177                       | 9%     | 1,110    | 13%  | 67       | 6%  
|                                        |                             |        |          |      |          |     
|Total costs & expenses                  | $ 11,196                    | 85%    | $ 8,051  | 93%  | $ 3,145  | 39% 
|                                        |                             |        |          |      |          |     
|Income from operations                  | $   2,034                   | 15%    | $    621 | 7%   | $ 1,413  | 228%
|Interest income                         | 39                          | -%     | 19       | -%   | 20       | 105%
|Interest expense                        | (2)                         | -%     | (1)      | -%   | (1)      | 100%
|Other income                            | 18                          | -%     | --       | -%   | 18       | *   
|                                        |                             |        |          |      |          |     
|Income before benefit from income taxes | $   2,089                   | 16%    | $    639 | 7%   | $ 1,450  | 227%
|(Provision) benefit  for income taxes   | (59)                        | -%     | 430      | 5%   | (489)    | 114%
|                                        |                             |        |          |      |          |     
|Net income                              | $   2,030                   | 15%    | $ 1,069  | 12%  | $    961 | 90% 
|                                        |                             |        |          |      |          |     

|__________________________________ *
 These percentages are not meaningful to the understanding of our financial condition and
results of operations.
|-----------------------------------------------------------------------------------------------------------------------------------------------------

|-13-
|----

|                                     | Six Months Ended
June 30, | Change |            |      |         |     
|------------------------------------ | ------------------------- | ------ | ---------- | ---- | ------- | ----
|
|
|Revenues:                            |                           |        |            |      |         |     
|Product revenues                     | $ 20,314                  | 84%    | $ 13,845   | 89%  | $ 6,469 | 47% 
|Royalty revenues                     | 1,649                     | 6%     | 469        | 3%   | 1,180   | 252%
|Funded product development revenues  | 2,101                     | 10%    | 1,200      | 8%   | 901     | 75% 
|                                     |                           |        |            |      |        
|Total revenues                       | $ 24,064                  | 100%   | $ 15,514   | 100% | $ 8,550 | 55% 
|                                     |                           |        |            |      |        
|Cost and expenses:                  
|Cost of product revenues             | $   7,241                 | 30%    | $   5,878  | 38%  | $ 1,363 | 23% 
|Cost of royalty revenues             | 659                       | 3%     | 188        | 1%   | 471     | 251%
|Research & development               | 5,030                     | 21%    | 2,894      | 19%  | 2,136   | 74% 
|Selling & marketing                  | 5,806                     | 24%    | 3,673      | 24%  | 2,133   | 58% 
|General & administrative             | 2,264                     | 9%     | 1,951      | 13%  | 313     | 16% 
|                                     |                           |        |            |      |        
|Total costs & expenses               | $ 21,000                  | 87%    | $ 14,584   | 94%  | $ 6,416 | 44% 
|                                     |                           |        |            |      |        
|Income from operations               | $   3,064                 | 13%    | $      929 | 6%   | $ 2,135 | 230%
|Interest income                      | 68                        | -%     | 35         | -%   | 33      | 94% 
|Interest expense                     | (3)                       | -%     | (25)       | -%   | (28)    | 88% 
|Other income                         | 161                       | -%     | 58         | -%   | 103     | 178%
|                                     |                           |        |            |      |        
|Income before income taxes           | $   3,290                 | 14%    | $      997 | 6%   | $ 2,293 | 230%
|(Provision) benefit for income taxes | (101)                     | -%     | 430        | 3%   | (531)   | 123%
|                                     |                           |        |            |      |        
|Net income                           | $   3,189                 | 13%    | $   1,427  | 9%   | $ 1,762 | 220%
|                                     |                           |        |            |      |        

|Product
revenues.  Increases in unit sales and the average selling prices of the Lux family of
products were the leading contributor to the increase in product revenues.  Sales from
the Lux family of products, consisting of the StarLux, MediLux, EsteLux, NeoLux and
related additional handpieces, increased by $2.7 million for both the second quarter ended and six months
ended June 30, 2004, respectively, in comparison to the same periods in 2003.  Product
revenues were unfavorably impacted by a decrease of $475,000 and $1.5 million of sales
related to our legacy products, the RD-1200 and SLP1000, during the second quarter and
six months ended, June 30, 2004, respectively, in comparison to the same periods in 2003.
 Market acceptance of the Lux family of products has been increasing since its
introduction in September 2001.


International
product revenue was 32% of total product revenue for the quarter ended June 30, 2004 in
comparison to 52% for the same period in 2003.  For the six months ended June 30, 2004,
international revenue was 38% versus 58% for the same period in 2003.  For the
quarter and six months ended June 30, 2004 and for the six months ended June 30, 2004, these decreases as
a percentage of revenues in international sales is directly attributed to the increase in
domestic product sales and a decrease in sales made in Japan in comparison to the same periods in 2003.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-14-
|----

|During
the quarter ended March 31, 2004, Palomar introduced the StarLux Pulsed Light and Laser
System. Palomar began commercially shipping StarLux products at the end of the second
quarter of 2004. In connection with this product introduction, Palomar offered certain
customers an upgrade option to trade-in existing products for a new StarLux system for an
upgrade fee.  Palomar deferred approximately $863,000 of revenue during the three months
ended June 30, 2004 and $1.449 million of revenue during the six months ended June 30, 2004
in connection with the upgrade right in accordance with the Emerging Issues Task Force
issue No.  00-21 and SEC Staff Accounting Bulletin No. 104.


Royalty
revenues.  The increase in royalty revenue for the quarter ended and six months ended
June 30, 2004, in comparison to the same period in 2003, is attributed to the settlement
agreement between Palomar and 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 Palomar a 5%
royalty on sales of the LightSheer and other professional laser hair removal devices and
modules.  Lumenis made their first payment of $457,000 in the second quarter of 2004 for
sales made in the first quarter of 2004.  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 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.


Funded
product development revenues.  We account for funded product development revenue
under the Gillette agreement ratably over the funding period as payments are received.
 For both the quarter ended and six months ended June 30, 2004, funded product
development revenues increased.  For the quarter ended June 30, 2004, we received from
Gillette $708,000 to fund development.  For the six months ended, we received from
Gillette approximately $1.5 million.  To date, we received from Gillette approximately
$4.9 million to fund development.  Any amounts received in advance are recorded as
deferred revenue. Payments are not refundable if the development is not successful.


For
the cost reimbursement contract with a fixed fee awarded by the Department of the Army,
we earn a fixed fee of 8% as costs are incurred or services are provided.  The total
value of the contract is $2.5 million.  For the second quarter ended June 30, 2004, we
billed the Department of the Army for approximately $352,000 plus a fixed fee of $29,000
totaling approximately $381,000. For the six months ended June 30, 2004, we billed the
Department of the Army for approximately $594,000 plus a fixed fee of $51,000 totaling
approximately $645,000.


Cost
of product revenues.  The cost of product revenues decreased as a percentage of
product revenue for both the quarter ended and six months ended June 30, 2004 from the
same periods in 2003.  These decreases as a percentage of product revenue are primarily
as a result of lower manufacturing costs associated with the Lux product lines.  In
addition, the increased sales volume and increased average selling prices of the Lux
family of products has improved the absorption of manufacturing overhead at our
manufacturing facility.


Cost
of royalty revenues.  As a percentage of royalty revenues, the cost of royalty
revenues was consistent at 40% in accordance with our license agreement with
Massachusetts General Hospital for each period in comparison to the same periods in 2003.
The increase in the cost of royalty revenues is attributed to the settlement agreement
between Palomar and Lumenis.


Research
and development expense. For the quarter and six months ended June 30, 2004,
research and development expenses increased in comparison to the same periods in 2003.
 These increases are a direct result of our spending related to the Gillette agreement,
other expenses related to the Department of the Army contract, legal costs related to our
increasing patent portfolio, our continued commitment to introducing new platforms and
enhancing our current family of products.


For
the second quarter ended June 30, 2004 expenses relating to the Gillette agreement
increased by approximately $100,000 as compared to the same period in 2003.  For the six
months ended June 30, 2004, expenses relating to the Gillette agreement increased by
approximately $485,000.  These increases in   expenses relating to the Gillette agreement
are directly attributed to Palomar incurring additional payroll and payroll related
expenses as well as additional development costs.
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--------------------------------------------------------

|-15-
|----

|Expenses
relating to the Army contract, which began in February of 2004, totaled approximately
$352,000 for the second quarter ended June 30, 2004 and $594,000 for the six months ended
June 30, 2004.  The project is scheduled to last for nineteen months from its inception.


For
the second quarter and six months ended June 30, 2004, legal expenses relating to
the prosecution of new patents increased by approximately $100,000 and $190,000,
respectively, in comparison to the same periods in 2003. We are committed to expanding
intellectual property rights necessary to protect discoveries made through our investment
in research and development.


Expenses
relating to the introduction of new products such as the StarLux, enhancements made to
the Companys current family of products and research and development overhead increased
by approximately $437,000 for the second quarter of 2004 and by $865,000 for the six
months ended June 30, 2004, in comparison to the same periods in 2003.


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 hair removal, pigmented and vascular lesion removal and acne
treatment are to design systems that: (1) permit effective treatment and more rapid
treatment of large areas, (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 fat reduction and skin
rejuvenation.


Selling
and marketing expense. For the quarter ended June 30, 2004, selling and marketing increased by $534,000 from payroll and payroll related expenses,
$481,000 related to tradeshow expenses and other overhead costs offset by a slight decrease in commission expense of $18,000 in
comparison to the same period in 2003. Domestic commission expense increased by approximately $430,000, European commissions
increased by approximately $13,000 while Far East commissions decreased by approximately $460,000 due to a change in our commission
structure with one of our Far East distributors.  This change in commission structure, which represents the Shonin regulatory
approval obtained by one of our distributors, allows us to sell certain products directly to our distributor at a transfer price.
Previously, we sold directly to the end customer and incurred higher commission costs. These increases directly correlate with our
increased revenues, upfront costs associated with both international and domestic sales force and distribution channel expansion as
well as the introduction of our newest product, the StarLux Pulsed Light and Laser System.



For the six months ended June 30, 2004, selling and marketing expenses increased by  $1.0 million from payroll and payroll
related expenses, approximately $887,000 relating to tradeshows, consultants and other sales and marketing infrastructure costs and
by approximately $197,000 relating to commission expense in comparison to the same period in 2003 Domestic commission increased by
approximately $750,000 correlating with our increased domestic product revenue, European commissions increased by $40,000, while Far
East commissions decreased by approximately $593,000 due to a change in our commission structure with one of our Far East
distributors.  This change in commission structure, which represents the Shonin regulatory approval obtained by one of our
distributors, allows us to sell certain products directly to our distributor at a transfer price.  Previously, we sold directly to the
end customer and incurred higher commission costs. These increases directly correlate with our
increased revenues, upfront costs associated with both international and domestic sales force and distribution channel expansion as
well as the introduction of our newest product, the StarLux Pulsed Light and Laser System.





General
and administrative expense.  For both the quarter and six months ended, June
30, 2004, general and administrative expenses increased.   For the quarter ended June 30,
2004, this increase is mainly attributed to increases to incentive compensation of
$190,000, related to our incentive compensation plan of 2004, offset by a reduction in
our corporate legal expenses of approximately $134,000 as compared to the same period in
2003.  For the six months ended, June 30, 2004, this increase is mainly attributed to
increases to incentive compensation of $360,000, related to our incentive compensation
plan of 2004, an increase in travel of $25,000 offset by a reduction in our corporate
legal expenses of approximately $199,000 as compared to the same period in 2003.


Interest
income. For the quarter and six months ended June 30, 2004, interest income
increased, respectively, in comparison to the same periods in 2003.  For both the quarter
and six months ended June 30, 2004, interest income increased due to higher levels
of excess cash on hand in comparison to the same periods in 2003.


Interest
expense. The interest expense decrease is attributable to our reduction of debt. On
March 14, 2003, a director surrendered a $1 million Promissory Note in exchange for
293,255 unregistered shares of our Common Stock at a price of $3.41 per share.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-16-
|----

|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 approximately a 3% effective tax rate for anticipated
federal alternative minimum taxes and minimum state income taxes due for 2004.
The benefit from income taxes for the three and six months ended, June 30, 2003 was $430,000
and reflected the filing of refund claims for $470,000 to carryback operating losses to recover taxes
paid in prior years pursuant to the Economic Stimulus package of 2002.
Offsetting the refund claims, Palomar provided a 4% effective tax rate for both the three and six
months ended June 30, 2003 for the anticipated alternative minimum taxes due for 2003.
Given our limited history of profitability, we have fully reserved our otherwise recognizable deferred
tax asset, as its realization is uncertain.


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):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                          | Six months ended
June 30, | Change
2004 to 2003 |   |      
|------------------------- | ------------------------- | ------------------- | - | -----
|
|Operating cash flows      |                           |                     | $ | 4,721
|Investing cash flows      |                           |                     |   | (467 
|Financing cash flows      |                           |                     |   | 2,300
|Capital expenditures, net |                           |                     |   | 467  

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

|                          | June 30,
2004 | December 31,
2003 | Change
Dollars | Change
%
|------------------------- | ------------- | ----------------- | -------------- | --------
|Cash and cash equivalents |               | $17,112           |                | $10,559 
|Accounts receivable, net  |               | 7,825             |                | 6,637   
|Inventories, net          |               | 4,142             |                | 3,385   
|Working capital           |               | 19,111            |                | 13,670  
|Current ratio             |               | 2.79              |                | 2.87    

|As
of June 30, 2004, we had $17.1 million in cash and cash equivalents.  The sales of our
current products and future products will be critical to our future liquidity.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-17-
|----

|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 June 30, 2004, we had no long-term debt.


Operating cash flows during the six months ended June 30, 2004 provided cash as compared to cash used in operating
activities for the same period in 2003.  This increase primarily reflects the increase of net profits, payables, liabilities and
deferred revenue offset by increases in accounts receivables, inventories and other current assets.  The primary changes in operating
cash flows are from increases in accounts receivable, which corresponds with the increase in our product revenues, an increase in
inventory versus year end levels, which is attributed to new product activities associated with the StarLux product line and
increases in deferred revenue, which is mainly made up of deferred revenue relating to our upgrade option to trade-in existing
products for a new StarLux system for an upgrade fee.  Net cash used in investing activities primarily reflect cash used for the
purchases of capital equipment.  Cash provided by financing activities were a result of sales of common stock, and exercises of stock
options and purchases of common stock pursuant to the employee stock purchase plan offset by costs related to the issuance of common
stock.


We
anticipate that capital expenditures for the remainder of 2004 will total approximately
$200,000, consisting primarily of machinery, equipment, computers and peripherals.  We
expect to finance these expenditures with cash on hand.



On
February 14, 2003, Palomar entered into a Development and License Agreement with Gillette
to complete development and commercialize a home-use, light-based, hair removal device
for women.  The agreement provides up to $7 million in initial development support
funding to be paid by Gillette to Palomar over approximately the first 30 months of the
agreement. On June 28, 2004, Palomar and The Gillette Company announced that they have
completed the initial phase of this agreement, and both parties will move into the next
phase.  The original agreement provided for $7 million in development funding from
Gillette. Under this amendment, 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.


For
the six months ended, we received from Gillette approximately $1.5 million.  To date, we
received from Gillette approximately $4.9 million to fund development.  Any amounts
received in advance are recorded as deferred revenue. Payments are not refundable if the
development is not successful.


In
the first quarter of 2004, we 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.  Revenue is recognized under the contract as the costs are incurred and
the services are rendered.  This revenue is included in funded product development
revenue in the accompanying statements of operations.  We recognized approximately
$645,000 to funded product development revenues during the six months ended June 30, 2004.


Contractual obligations


It
is not our usual business practice to enter into off-balance sheet arrangements, except
for off-balance sheet arrangements related to inventory purchase commitments and
operating lease commitments, as disclosed in the table of contractual obligations below.
 In addition, it is not our normal policy to issue guarantees to third parties.


In
August 1995, we entered into an agreement with Massachusetts General Hospital whereby
Massachusetts General Hospital agreed to conduct clinical trials on a laser treatment for
hair removal/reduction developed at Wellman Laboratories of Photomedicine. In July 1999,
we further amended this agreement to extend its exclusive research agreement for an
additional five years.  In addition to laser hair removal, the agreement has been
expanded to include research and development in the fields of fat removal and acne
treatment.  We have the right to exclusively license, on royalty terms to be negotiated,
the Palomar-funded inventions related to this research.  Under the terms of this
agreement, we have paid Massachusetts General Hospital $475,000 on an annual basis for
clinical research through August 2004.  Palomar is in discussions with Massachusetts
General Hospital for an extension of this agreement for clinical research beyond August
2004. We are a party to a license agreement, as amended, with Massachusetts General
Hospital whereby the Company is obligated to pay royalties to Massachusetts General
Hospital for sales of certain products as well as 40% of royalties received from third
parties.  Royalty expense in 2004 totaled approximately $659,000.


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 June 30,
2004, excluding royalty and employment obligations because they are variable and/or
subject to uncertain timing (000s omitted):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     | Remainder of
2004 | 2005  | 2006  | 2007  | 2008  | Thereafter
|-------------------- | ----------------- | ----- | ----- | ----- | ----- | ----------
|Purchase commitments | $3,208            | $  -- | $  -- | $  -- | $  -- | $  --     
|Operating leases     | 447               | 949   | 949   | 949   | 949   | 712       
|                     |                   |       |       |       |       |           
|Total                | $3,655            | $949  | $949  | $949  | $949  | $712      

|-18-
|----

|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 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 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 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
product 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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-19-
|----

|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 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 were 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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-20-
|----

|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 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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-21-
|----

|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.


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 management of us, 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 (Rights Plan).  The
Rights Plan is intended to protect shareholders from unfair or coercive takeover
practices.  In accordance with the 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.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-22-
|----

|In
past years and now again 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 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 150 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 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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-23-
|----

|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, 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 49% of total product revenue for the
year ended 2003, 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.  We believe that this represents a unique opportunity to bring light based devices
to the mass market.  Under the agreement, significant resources and the attention of key
technical personnel and management will be directed to the development of such a device
even though such device will not likely be commercialized for several years, if ever.  In
addition, we cannot be sure that Gillette will agree with our interpretation of the terms
of the agreement, that the agreement will provide us with marketable products in the
future or that we will receive payments for any of the products developed under the
agreement.  During the term of the agreement, Gillette has the ability to choose not to
continue and may terminate the agreement.  If Gillette terminates the agreement, the
price of our common stock could fall significantly, and we will not receive certain
payments.  We may proceed to develop and commercialize the device on our own or with a
third party.  However, there can be no assurance that we will be able to successfully
implement such a strategy.  In addition, after commercialization of such device, Gillette
is to pay us a percentage of net sales of such device. Certain of these percentages of
net sales are only owed if the device is covered by valid patents.  There can be no
assurance that valid patents will cover the device in any or all countries, in which the
device will be manufactured, used or sold.  This could have a material adverse effect on
our business, results of operations and financial condition.


Managing our contract with the
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 is scheduled to last for nineteen months, 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.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-24-
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|Item 3.  Quantitative and
qualitative disclosures about market risk


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



Item 4.  Controls and procedures


Our
management has evaluated the effectiveness of our disclosure controls and procedures as
of the end of the period covered by this report. Based upon that evaluation, our Chief
Executive Officer and our Chief Financial Officer concluded that our disclosure controls
and procedures were effective to provide reasonable assurance that we record, process,
summarize and report the information we must disclose in reports that we file or submit
under the Securities Exchange Act of 1934, as amended, within the time periods specified
in the SEC's rules and forms.


The
effectiveness of a system of disclosure controls and procedures is subject to various
inherent limitations, including cost limitations, judgments used in decision making,
assumptions about the likelihood of future events, the soundness of internal controls,
and the risk of fraud. Because of these limitations, there can be no assurance that any
system of disclosure controls and procedures will be successful in preventing all errors
or fraud or in making all material information known in a timely manner to the
appropriate levels of management.


During
the three months ended June 30, 2004, there were no changes in our internal control over
financial reporting that have affected, or are reasonably likely to affect, materially
our internal control over financial reporting.


PART II - Other information



Item 1.  Legal proceedings


On
June 22, 2004, Palomar and Lumenis, Ltd announced that they reached a settlement
resolving their on-going litigation concerning both patent infringement and contractual
matters.  Palomar accused the LightSheer Diode Laser System, a product initially
developed by Palomar and now marketed by Lumenis, and various Lumenis IPL systems of
infringing claims in two U.S. patents (5,595,568 and 5,735,844).  Palomar has an
exclusive license to these patents from the General Hospital Corporation in Boston,
Massachusetts. 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 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
professional laser hair removal devices and modules.  Lumenis made their first payment of
$457,000 in the second quarter for sales made in the first quarter of 2004.  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 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.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-25-
|----

|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 has been 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.  Fact discovery is on-going.
 A trial date has not yet been set. (See Cautionary Statements)


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


Not
applicable.


Item 3.  Defaults upon senior
securities


Not
applicable.


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


Palomars
Annual Meeting of Shareholders was held on May 12, 2004 (the Annual Meeting). At the
Annual Meeting, stockholders voted on three matters:  the election of directors for a
term of one year, the ratification of the appointment of Ernst & Young LLP as the Companys
registered public accounting firm and the approval of the 2004 Stock Incentive Plan.  The
stockholders elected managements nominees as directors in an uncontested election,
ratified the appointment of the registered public accounting firm and approved the 2004
Stock Incentive Plan by the following votes, respectively:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Matter                                 | Votes For  | Votes Against | Abstained
|-------------------------------------- | ---------- | ------------- | ---------
|Proposal #1: The Election of Directors |            |               |          
|                                       |            |               |          
|Joseph P. Caruso                       | 11,496,365 | 2,632,783     | -        
|Jeanne Cohane                          | 14,046,298 | 82,850        | -        
|Jay Delahanty                          | 14,034,169 | 94,979        | -        
|Nicolas P. Economou                    | 14,034,723 | 94,425        | -        
|James Martin                           | 14,047,730 | 81,418        | -        
|A. Neil Pappalardo                     | 14,063,978 | 65,170        | -        
|Louis (Dan) Valente                    | 11,495,813 | 2,633,335     | -        

|Matter                                                                       | Votes For  | Votes Against | Abstained
|---------------------------------------------------------------------------- | ---------- | ------------- | ---------
|Proposal #2: The Ratification of Ernst & Young LLP as the Companys Auditors |            |               |          
|Ernst & Young LLP                                                            | 14,070,685 | 46,270        | 12,194   
|                                                                             |            |               |          
|Proposal #3: Approval of the 2004 Stock Incentive Plan                      
|2004 Stock Incentive Plan                                                    | 5,358,934  | 3,696,902     | 150,279  

|-26-
|----

|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.                                                
| | 32.1 | 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.   
| | 32.1 | 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
|-----------------------

| | During
the three months ended June 30, 2004 we furnished the following Form 8-Ks.  Information
regarding each item reported on is listed below.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

|-27-
|----

|
|

|Date filed or
Furnished | Item No. | Description                                                                                                                                                                                                                                                                                                                           
|----------------------- | -------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|June 28, 2004           | 99.1     | Amendment dated June 24, 2004 to the Development and License
                               Agreement between Palomar Medical Technologies, Inc. and The
                               Gillette Company effective as of February 14, 2003.                                                                                           
|June 28, 2004           | 99.2     | Amendment dated October 2, 2003 to the Development and License
                               Agreement between Palomar Medical Technologies, Inc. and The
                               Gillette Company effective as of February 14, 2003.                                                                                         
|June 28, 2004           | 99.3     | Amendment dated February 14, 2003 to the Development and License
                               Agreement between Palomar Medical Technologies, Inc. and The
                               Gillette Company effective as of February 14, 2003.                                                                                       
|June 28, 2004           | 99.4     | Press Release dated June 28, 2004 entitled Palomar Medical and
                               Gillette Enter Into Next Phase of Their Agreement to Develop and
                               Commercialize a Home-Use, Light-Based Hair Removal Device for
                               Women.                                   
|June 22, 2004           | 99.1     | Settlement Agreement dated June 17, 2004 between Palomar Medical
                               Technologies, Inc., The General Hospital Corporation, Lumenis, Inc.
                               and Lumenis, Ltd.                                                                                                                  
|June 22, 2004           | 99.2*    | Patent License Agreement dated June 17, 2004 between Palomar
                               Medical Technologies, Inc. and Lumenis, Inc.                                                                                                                                                                                              
|June 22, 2004           | 99.3     | Press Release dated June 22, 2004 entitled Palomar and Lumenis
                               Settle Patent Infringement Lawsuit.                                                                                                                                                                                                   
|April 29, 2004          | 99.1     | Press Release dated April 29, 2004 entitled PALOMAR MEDICAL REPORTS
                               RECORD REVENUES AND PROFITABILITY FOR FIRST QUARTER 2004 Revenues
                               Increase by 58 Percent; Net Income More than Triples; Product Gross
                               Margins Improve to 64 Percent

|*    Filed under application for
confidential treatment
|-------------------------------------------------------

|-28-
|----

|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:  August 11, 2004 | By:/s/ Joseph P. Caruso
      Joseph P. Caruso
      President, Chief Executive Officer and Director
|                       |                                                                                                     

|                       |                                                                                            
|---------------------- | -------------------------------------------------------------------------------------------
|Date:  August 11, 2004 | By:/s/ Paul S. Weiner
      Paul S. Weiner
      Vice President and Chief Financial Officer
|                       |                                                                                            

|-29-
|----