FORM 10-Q

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   (Mark one)

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

                  For quarterly period ended September 30, 1999

                                       OR

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

               For the transition period from ________ to ________

                         Commission file number: 0-22340

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

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


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

                                 (781) 993-2300
                ------------------------------------------------
                (Issuer's telephone number, including area code)

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

         As of October 31, 1999,  10,081,978  shares of common  stock,  $.01 par
value per share, were outstanding.

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

<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                                      INDEX

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

PART I  - FINANCIAL INFORMATION

         ITEM 1.    CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

                           Consolidated Condensed Balance Sheets                                                1

                           Consolidated Statements of Operations                                                2

                           Consolidated Statements of Stockholders' (Deficit) Equity                            3

                           Consolidated Statements of Cash Flows                                                4

                           Notes to Consolidated Financial Statements                                           5

         ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                  CONDITION AND RESULTS OF OPERATIONS                                                          13

                  RISK FACTORS                                                                                 19

         ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES
                  ABOUT MARKET RISK                                                                            22

PART II - OTHER INFORMATION                                                                                    23

         ITEM 1.  LEGAL PROCEEDINGS                                                                            23

         ITEM 2.  CHANGES IN SECURITIES                                                                        23

         ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                              24

         ITEM 4.  SUBMISSION OF MATTERS TO A VOTE                                                              24
                  OF SECURITY HOLDERS

         ITEM 5.  OTHER INFORMATION                                                                            24

         ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                             25

SIGNATURES                                                                                                     26
</TABLE>




                                       -i-


<PAGE>

PART I - FINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements (Unaudited).
         ---------------------------------------------

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                            CONDENSED BALANCE SHEETS
                                   (Unaudited)


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

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

Current Assets:
        Cash and cash equivalents                                                         $1,874,718           $8,557,690
        Available-for-sale investments, at market value                                            -           20,517,171
        Accounts receivable, net                                                           9,938,121            2,231,757
        Inventories                                                                        5,416,342            4,131,854
        Other current assets                                                               1,056,388            4,268,168
                                                                                    -----------------    -----------------
             Total current assets                                                         18,285,569           39,706,640
                                                                                    -----------------    -----------------

Property and Equipment, at Cost, Net                                                       3,314,087            1,311,569
                                                                                    -----------------    -----------------

Other Assets:
        Cost in excess of net assets acquired, net                                         1,699,983              694,131
        Deferred financing costs                                                              58,923                    -
        Other non-current assets                                                             167,352              198,155
                                                                                    -----------------    -----------------
             Total other assets                                                            1,926,258              892,286
                                                                                    -----------------    -----------------
                                                                                         $23,525,914          $41,910,495
                                                                                    =================    =================
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY

Current Liabilities:
        Current portion of long-term debt                                                 $6,290,041             $      -
        Accounts payable                                                                   6,553,745            1,442,742
        Accrued liabilities                                                               10,301,624           10,401,160
        Current portion of deferred revenue                                                1,143,796            1,249,668
        Deferred gain                                                                              -            3,139,556
                                                                                    -----------------    -----------------
             Total current liabilities                                                    24,289,206           16,233,126
                                                                                    -----------------    -----------------

Net Liabilities of Discontinued Operations                                                 1,680,171                    -
                                                                                    -----------------    -----------------

Long-Term Debt, Net of Current Portion                                                     3,150,000            2,744,016
                                                                                    -----------------    -----------------

Deferred Revenue, Net of Current Portion                                                     870,000                    -
                                                                                    -----------------    -----------------

Stockholders' (Deficit) Equity:
        Preferred stock, $.01 par value-
             Authorized - 1,500,000 shares
             Issued and outstanding -
                     6,993 shares and 6,000 shares
                     at December 31, 1998 and September 30, 1999, respectively                    69                   60
        Common stock, $.01 par value-
             Authorized - 45,000,000 shares
             Issued - 10,074,864 shares and 11,034,493 shares
                      at December 31, 1998 and September 30, 1999, respectively              100,747              110,345
        Additional paid-in capital                                                       161,337,926          162,374,263
        Accumulated deficit                                                             (166,263,346)        (135,893,496)
        Unrealized loss on available-for-sale investments                                          -             (56,768)

        Less: Treasury stock - 49,285 and 956,596 shares at cost
             at December 31, 1998 and September 30, 1999, respectively                    (1,638,859)          (3,601,051)
                                                                                    -----------------    -----------------
             Total stockholders' (deficit) equity                                         (6,463,463)          22,933,353
                                                                                    -----------------    -----------------

                                                                                         $23,525,914          $41,910,495
                                                                                    =================    =================

</TABLE>

                                       1

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


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                            STATEMENTS OF OPERATIONS
                                   (Unaudited)
<TABLE>
<S>     <C>    <C>    <C>    <C>    <C>    <C>

                                                              Three Months Ended                   Nine Months Ended
                                                                 September 30,                       September 30,
                                                            1998             1999               1998               1999
                                                       ---------------  ----------------   ----------------   ---------------

Product revenues                                         $ 13,810,307      $  1,716,517      $  29,968,108      $ 20,074,303
Royalty revenues                                                    -         1,206,823                  -         1,856,823
                                                       ---------------  ----------------   ----------------   ---------------
        TOTAL REVENUES                                     13,810,307         2,923,340         29,968,108        21,931,126

Cost of product revenues                                    5,721,860         2,044,485         16,870,561        10,991,486
Cost of royalty revenues                                            -           482,729                  -           742,749
                                                       ---------------  ----------------   ----------------   ---------------
        TOTAL COST OF REVENUES                              5,721,860         2,527,214         16,870,561        11,734,235
                                                       ---------------  ----------------   ----------------   ---------------

        Gross margin                                        8,088,447           396,126         13,097,547        10,196,891
                                                       ---------------  ----------------   ----------------   ---------------

OPERATING EXPENSES (INCOME)
        Research and development                            1,544,543         1,642,140          5,653,066         6,272,869
        Sales and marketing                                 4,438,962           590,188         10,468,847         6,307,410
        General and administrative                          1,777,036         1,041,677          6,980,037         4,199,309
        Costs incurred for proxy contest                            -                 -                  -           624,627
        Settlement costs                                            -                 -                  -           750,000
        Gain from sale of subsidiary (Note 1)                       -                 -                  -       (47,090,876)
                                                       ---------------  ----------------   ----------------   ---------------
              Total operating expenses (income)             7,760,541         3,274,005         23,101,950       (28,936,661)
                                                       ---------------  ----------------   ----------------   ---------------
              (Loss) Income from operations                   327,906        (2,877,879)       (10,004,403)       39,133,552

Swiss Franc Redemption (Note 8)                                     -                 -                  -        (6,167,369)
Interest Income                                                     -           469,984             29,544           877,618
Interest Expense                                             (184,295)         (182,257)        (1,013,630)         (546,173)
Other Income (Expense), net                                   396,272            (8,148)           721,237           271,489
                                                       ---------------  ----------------   ----------------   ---------------
              (Loss) Income from Continuing
              Operations Before Provision for
              Income Taxes                                    539,883        (2,598,300)       (10,267,252)        33,569,117

Provision for Income Taxes                                          -                 -                  -          2,500,000
                                                       ---------------  ----------------   ----------------   ---------------
              (Loss) Income from Continuing Operations        539,883        (2,598,300)       (10,267,252)        31,069,117

Loss from Discontinued Operations (Note 10)

              Loss from operations                                  -                 -         (1,090,885)         (435,000)
              Loss on disposal                                      -                 -         (1,533,295)                -
                                                       ---------------  ----------------   ----------------   ---------------
              Net Loss from Discontinued Operations                 -                 -         (2,624,180)         (435,000)
                                                       ---------------  ----------------   ----------------   ---------------
              Net (Loss) Income                              $539,883       $(2,598,300)      $(12,891,432)      $30,634,117
                                                       ===============  ================   ================   ===============
Basic Net (Loss) Income Per Share:
        Continuing operations                              $     0.07      $      (0.27)      $      (1.33)       $     3.02
        Discontinued operations                                     -                 -              (0.28)            (0.04)
                                                       ---------------  ----------------   ----------------   ---------------
              Total Basic Net (Loss) Income Per Share      $     0.07      $      (0.27)       $     (1.61)       $     2.98
                                                       ===============  ================   ================   ===============

Basic Weighted Average Number of Shares                     9,606,956        10,087,905          8,697,187        10,188,306
                                                       ===============  ================   ================   ===============

Diluted Net (Loss) Income Per Share:
        Continuing operations                              $     0.07      $      (0.27)       $     (1.33)        $    2.85
        Discontinued operations                                     -                 -              (0.28)            (0.04)
                                                       ---------------  ----------------   ----------------   ---------------
              Total Diluted Net (Loss) Income Per
              Share                                        $     0.07      $      (0.27)       $     (1.61)        $    2.81
                                                       ===============  ================   ================   ===============

Diluted Weighted Average Number of Shares                   9,606,956        10,087,905          8,697,187        10,957,857
                                                       ===============  ================   ================   ===============
</TABLE>



                                       2

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



               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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

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

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

Balance, December 31, 1998
                                                          6,993           $69      10,074,864    $100,747    (49,285)  ($1,638,859)
     Issuance of common stock for 1998 employer 401(k)
          matching contribution                               -             -          32,561         326          -             -
     Conversion of preferred stock                         (340)           (3)         74,905         749          -             -
     Conversion of convertible debentures                     -             -         377,760       3,778          -             -
     Redemption of preferred stock                         (653)           (6)              -           -          -             -
     Redemption of common stock related to Swiss Franc
          denominated convertible debentures                  -             -               -           -   (130,576)     (575,348)
     Purchase of treasury stock                               -             -               -           -   (312,450)   (1,382,202)
     Issuance of common stock for  Employee Stock
          Purchase Plan                                       -             -          10,118         103          -             -
     Issuance of escrow shares to treasury                    -             -         464,285       4,642   (464,285)       (4,642)
     Costs incurred related to the issuance of common
          stock                                               -             -               -           -          -             -
     Unrealized loss on available-for-sale investments        -             -               -           -          -             -
     Preferred stock dividends                                -             -               -           -          -             -
     Net  income                                              -             -               -           -          -             -
                                                        ===========================================================================
Balance, September 30, 1999                               6,000           $60      11,034,493    $110,345   (956,596)  ($3,601,051)
                                                        ===========================================================================



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

Balance, December 31, 1998                              $161,337,926 $ ($166,263,346)    $              -           $   (6,463,463)

     Issuance of common stock for 1998 employer 401(k)
          matching contribution                              206,333                -                   -                  206,659
     Conversion of preferred stock                            62,665                -                   -                   63,411
     Conversion of convertible debentures                  1,802,296                -                   -                1,806,074
     Redemption of preferred stock                          (781,381)               -                   -                 (781,387)
     Redemption of common stock related to Swiss Franc
          denominated convertible debentures                       -                -                   -                 (575,348)
     Purchase of treasury stock                                    -                -                   -               (1,382,202)
     Issuance of common stock for  Employee Stock
          Purchase Plan                                       37,424                -                   -                   37,527
     Issuance of escrow shares to treasury                         -                -                   -                        -
     Costs incurred related to the issuance of common
          stock                                             (291,000)               -                   -                 (291,000)
     Unrealized loss on available-for-sale investments             -                -             (56,768)                 (56,768)
     Preferred stock dividends                                     -         (264,267)                  -                 (264,267)
     Net  income                                                   -       30,634,117                   -               30,634,117
                                                        ---------------------------------------------------------------------------
Balance, September 30, 1999                             $162,374,263  $ ($135,893,496)           ($56,768)             $22,933,353
                                                        ===========================================================================
</TABLE>

                                       3

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

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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

                                                                                           Nine Months Ended September 30,
                                                                                           1998                     1999
                                                                                    ----------------------   ---------------------
Cash Flows from Operating Activities
     Net (loss) income                                                                 $(12,891,432)            $ 30,634,117
        Less: net loss from discontinued operations                                      (2,624,180)                (435,000)
                                                                                    ----------------------   ---------------------
     Net (loss) from continuing operations                                              (10,267,252)              31,069,117
                                                                                    ----------------------   ---------------------

     Adjustments to reconcile net (loss) income from continuing operations to
           net cash used in operating activities -
        Depreciation and amortization                                                     2,189,013                  979,546
        Noncash interest expense related to debt                                            171,000                        -
        Unrealized gain on marketable securities                                           (703,211)                       -
        Unrealized foreign currency exchange loss on foreign debt                                 -                    8,988
        Gain from sale of subsidiary                                                              -              (47,090,876)
        Redemption of common stock held by Swiss Franc debenture holders                          -                6,167,369
        Changes in assets and liabilities, net of effects from sale of subsidiary
           Net sale of marketable trading securities                                      2,484,572                        -
           Accounts receivable                                                           (3,608,624)               2,491,364
           Inventories                                                                      434,925               (1,221,512)
           Other current assets                                                             654,227               (3,033,952)
           Accounts payable                                                                (840,022)              (3,258,003)
           Accrued expenses                                                                 124,140                1,224,728
           Other current liabilities                                                              -                3,139,556
                                                                                                  -                 (764,128)
                                                                                    ----------------------   ---------------------
                 Net cash used in operating activities                                   (9,361,232)             (10,287,803)
                                                                                    ----------------------   ---------------------

Cash Flows from Investing Activities
     Purchases of property and equipment                                                   (308,896)                (144,341)
     Purchases of available-for-sale investments                                                  -              (20,786,767)
     Proceeds from the sale of subsidiary, net of cash on hand                                    -               49,448,023
     Increase in other assets                                                              (470,252)                 (32,803)
     Increase in notes receivable                                                           (86,818)                       -
                                                                                    ----------------------   ---------------------
                 Net cash (used in) provided by investing activities                       (865,966)               28,484,112
                                                                                    ----------------------   ---------------------

Cash Flows from Financing Activities
     Redemption of convertible debentures                                                (2,196,667)                        -
     Net proceeds from the issuance of notes payable and advances from distributor        3,138,439                   750,000
          Proceeds from issuance of common stock                                          9,840,000                         -
     Proceeds from exercise of warrants, stock options
          and Employee Stock Purchase Plan                                                   34,482                    37,527
     Costs incurred related to issuance of common stock                                    (190,000)                 (291,000)
     Payments on line of credit                                                                   -                (1,000,000)
     Payment on Swiss Franc denominated convertible debentures                                    -                (4,441,064)
     Purchase of treasury stock                                                                   -                (1,382,202)
     Payment on note payable                                                                      -                (2,290,041)
     Redemption of preferred stock                                                       (4,120,673)                 (781,387)
                                                                                    ----------------------   ---------------------
                 Net cash (used in) provided by financing activities                       6,505,581               (9,398,167)
                                                                                    ----------------------   ---------------------
Net increase (decrease) in cash and cash equivalents                                      (3,721,617)               8,798,142
Net cash (used in) provided by discontinued operations                                     3,384,003               (2,115,171)
Cash and cash equivalents, beginning of the period                                         3,003,300                1,874,718
                                                                                    ----------------------   ---------------------
Cash and cash equivalents, end of the period                                              $2,665,686               $8,557,689
                                                                                    ======================   =====================

Supplemental Disclosure of Cash Flow Information
      Cash paid for interest                                                            $  1,094,759             $    357,829
                                                                                    ======================   =====================

 Supplemental Disclosure of Noncash Financing and Investing Activities:
      Conversion of convertible debentures and related accrued
         interest, net of financing fees                                                $  6,076,994             $  1,806,074
                                                                                    ======================   =====================

      Conversion of preferred stock                                                     $   598,111              $     63,411
                                                                                    ======================   =====================

      Issuance of common stock for 1998 and 1999 employer 401(k)
         matching contribution                                                          $   254,281              $    206,659
                                                                                    ======================   =====================

      Unrealized loss on available-for-sale investments                                 $         -              $     56,768
                                                                                    ======================   =====================
</TABLE>


                                       4

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


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       BASIS OF PRESENTATION
         ---------------------

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

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization (the "Agreement") with Coherent, Inc. ("Coherent") to sell all of
the issued  and  outstanding  common  stock of  Palomar's  former  Star  Medical
Technologies,  Inc. subsidiary ("Star").  The Company completed the sale of Star
to Coherent on April 27, 1999.  The total  purchase  price for all of the issued
and  outstanding  capital  stock of Star  was $65  million,  paid in  cash.  The
purchase  price  was paid to the  shareholders  of Star in  proportion  to their
holdings of Star capital  stock.  On the date of sale,  Palomar  owned 82.46% of
Star. Palomar received net proceeds of $49,736,023, of which $3,254,908 is being
held in escrow until April 27, 2000 as security  for any claims  which  Coherent
may have  under  the  Agreement,  resulting  in a gain of  $47,090,876  or $4.29
diluted  earnings per share for the nine months ended  September  30, 1999.  The
Company has  deferred  gain  recognition  of  approximately  $3.1 million of the
proceeds from this sale pending the  resolution  in 2000 of certain  commitments
and contingencies related to the sale.

         Under the terms of the  Agreement  the Company  will receive an ongoing
royalty of 7.5% from  Coherent  on the sale of any  products  by  Coherent  that
incorporate   certain  patented  technology  or  use  certain  patented  methods
currently  licensed  by the  Company on an  exclusive  basis from  Massachusetts
General  Hospital.   A  portion  of  these  royalty  proceeds  are  remitted  to
Massachusetts General Hospital.

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

2.       CASH AND CASH EQUIVALENTS
         -------------------------

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

3.       MARKETABLE SECURITIES
         ---------------------

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

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

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

         Corporate and municipal debt securities       $20,517,171       $20,573,939         $56,768
                                                       ===========       ===========         =======
</TABLE>


                                       5

<PAGE>
              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


         Available-for-sale  investments  in the  accompanying  balance sheet at
September  30, 1999 include debt  securities  of  $20,517,171  with  contractual
maturities of one year or less.  Actual  maturities may differ from  contractual
maturities as a result of the Company's intent to sell these securities prior to
maturity and as a result of call features of the  securities  that enable either
the Company,  the issuer, or both to redeem these securities at an earlier date.
Unrealized holding losses totaling $56,768 on such debt securities were deducted
from stockholders' (deficit) equity during nine months ended September 30, 1999.

4.       INVENTORIES
         -----------

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

                                             December 31,        September 30,
                                                1998                 1999
                                          ------------------   ----------------
           Raw materials                     $2,478,289           $2,227,123
           Work-in-process                    1,330,822            1,200,999
           Finished goods                     1,607,231              703,732
                                          ------------------    ----------------
                                             $5,416,342           $4,131,854
                                          ==================    ================

5.       PROPERTY AND EQUIPMENT
         ----------------------

         Property and equipment consist of the following:

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

                                                        December 31,      September 30,
                                                           1998               1999
                                                    ------------------  ----------------
           Machinery and equipment                      $6,022,320       $4,430,480
           Furniture and fixtures                        1,120,450          999,984
           Leasehold improvements                          567,216          134,056
                                                    ------------------  ----------------
                                                         7,709,986        5,564,520
           Less:  Accumulated depreciation
                  and amortization                       4,395,899        4,252,951
                                                    ------------------  ----------------
                                                        $3,314,087       $1,311,569
                                                     =================  ================
</TABLE>


                                       6


<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.       NET INCOME LOSS PER COMMON SHARE
         --------------------------------

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

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

                                                               Three Months Ended           Nine Months Ended
                                                                 September 30,                September 30,
                                                           --------------------------  -----------------------------
                                                              1998          1999          1998           1999
                                                           ------------ -------------  -------------- --------------
  Basic weighted average common
    shares outstanding                                      9,606,956     10,087,905     8,697,187     10,188,306

  Potential common shares pursuant to:
    Stock options and warrants                                      -              -             -        167,135
    Convertible preferred stock                                     -              -             -        423,979
    Convertible debentures                                          -              -             -        178,437
                                                           ------------ -------------  -------------- --------------
  Diluted weighted average common
    shares outstanding                                       9,606,956     10,087,905     8,697,187     10,957,857
                                                           ============ =============  ============== ==============
</TABLE>


         The Company's net income  (loss) per share from  continuing  operations
for the three and nine months ended September 30, 1998 and 1999 is as follows:

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

                                                        Three Months Ended                        Nine Months Ended
                                                          September 30,                             September 30,
                                              ---------------------------------------   ---------------------------------------
                                                    1998                 1999                 1998                 1999
                                              ------------------   ------------------   ------------------  -------------------
  Net (loss) income from                               $539,883         $(2,598,300)        $(10,267,252)          $31,069,118
       continuing operations
  Preferred stock dividends                            (195,000)            (86,815)           (1,341,435)             (264,267)
                                              ------------------   ------------------   ------------------  -------------------
  Adjusted net (loss) income                           $344,883         $(2,685,115)        $(11,608,687)          $30,804,851
                                              ==================   ==================   ==================  ===================
  Basic net (loss) income per common share
  from continuing operations                              $0.07              $(0.27)              $(1.33)                $3.02
                                              ==================   ==================   ==================  ===================
  Basic weighted average number of shares
  outstanding                                         9,606,956          10,087,905            8,697,187            10,188,306
                                              ==================   ==================   ==================  ===================
</TABLE>


         For the three  months  ended  September  30,  1998 and 1999,  potential
common shares related to,  respectively,  4,199,274 and 4,420,021 of outstanding
stock options,  stock warrants and  convertible  securities were not included in
the diluted weighted average shares outstanding as they were  antidilutive.  For
the nine months  ended  September  30, 1998 and 1999,  potential  common  shares
related to, respectively,  4,199,274 and 3,650,470 of outstanding stock options,
stock  warrants  and  convertible  securities  were not  included in the diluted
weighted average shares outstanding as they were antidilutive.



                                       7

<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TOCONSOLIDATED FINANCIAL STATEMENTS


7.      COMPREHENSIVE (LOSS) INCOME
        ---------------------------

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

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

                                                Three Months Ended                         Nine Months Ended
                                                   September 30,                             September 30,
                                       --------------------------------------    --------------------------------------
                                             1998                 1999                 1998                1999
                                       -----------------    -----------------    -----------------  -------------------
Net (loss) income from continuing              $539,883         $(2,598,300)        $(10,267,252)          $31,069,117
     operations
Unrealized loss on available-for-sale
     investments                                      -              (2,804)                   -               (56,768)
                                       -----------------    -----------------    -----------------  -------------------
Comprehensive (loss) income from
     continuing operations                     $539,883         $(2,601,104)        $(10,267,252)          $31,012,349
                                       =================    =================    =================  ===================
</TABLE>

8.       NOTES PAYABLE
         -------------

         Notes payable consist of the following:
<TABLE>
<S>                                                                              <C>                 <C>

                                                                                   December 31,        September 30,
                                                                                       1998                1999
                                                                                 -----------------   ------------------
  Dollar denominated convertible debentures                                          $2,150,000             $500,000
  Swiss Franc denominated convertible debentures                                              -            2,244,016
  Note payable issued in connection with guaranty on behalf of
       discontinued subsidiary                                                        2,290,041                    -
  Revolving line of credit with a bank                                                1,000,000                    -
  Short-term notes payable to Coherent                                                4,000,000                    -
                                                                                 -----------------   ------------------
                                                                                      9,440,041            2,744,016
  Less - current maturities                                                           6,290,041                    -
                                                                                 -----------------   ------------------
                                                                                     $3,150,000           $2,744,016
                                                                                 =================   ==================
</TABLE>

(a)     Dollar Denominated Convertible Debentures

        During the nine months ended  September 30, 1999, the Company  converted
$1,650,000  of its 6%, 7% and 8%  convertible  debentures  due  March 31,  2002,
including  $176,483 of accrued  interest,  into 377,760  shares of the Company's
common stock.


                                       8

<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(b)     Swiss Franc Denominated Convertible Debentures

        During the three  months  ended June 30,  1999,  the Company  recorded a
redemption  expense of $6,167,369 as a result of a compromise  agreement between
Palomar and certain  European  banks that had held 4.5% Swiss Franc  denominated
subordinated  convertible  debentures  originally  totaling  approximately  $8.2
million  due in 2003.  Under the terms of this April 21, 1999  agreement,  which
resolved a lawsuit,  Palomar agreed to rescind its conversion  notices issued in
November  1997.  Through  these  conversion   notices,   Palomar  converted  the
subordinated debentures into 130,576 shares of the Company's common stock. Since
the  conversion  date,  the  Company  had  treated  these  shares as issued  and
outstanding.  Under the terms of the agreement the Company agreed to pay a total
of approximately  $6,742,717 to the European banks, of which $4,441,064 has been
paid as of September 30, 1999. The remaining  amounts due under this  obligation
are due in 2001. Accordingly, the Company has recorded a charge to operations of
$6,167,369.  This amount  represents  the total amount due to the European banks
less the fair market value of the  redemption  of the common  shares  ($575,348)
previously considered outstanding by the Company.

(c)      Note  Payable   Issued  In  Connection   With  Guaranty  On  Behalf  Of
         Discontinued Subsidiary

         In  connection  with  the  divestiture  of  one  of  its   discontinued
operations,  the Company entered into a Loan and  Subscription  Agreement with a
bank for  $3,233,000.  This promissory note represents the settlement of amounts
owed to the bank by Palomar's former Comtel,  Inc.  subsidiary and by Palomar in
connection  with a guarantee  from Palomar in favor of the bank.  Principal  and
interest payments were being made over 24 months,  beginning  December 31, 1997,
with interest accruing at the bank's prime rate plus 2.25%. This promissory note
was  collateralized  by 464,285 shares of the Company's common stock,  which was
held in escrow.  On May 3, 1999,  the Company  paid off the balance of this note
(totaling  $2,020,625),  and the  shares  of the  Company's  common  stock  were
released from escrow and returned to the Company.  The Company has accounted for
the return of the shares as an increase to its treasury stock.

(d)      Revolving Line of Credit

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

(e)      Short-Term Notes Payable

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


                                       9

<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. ND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.       STOCKHOLDERS' (DEFICIT) EQUITY
         ------------------------------

(a)      Convertible Preferred Stock

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

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

(b)      Options to Purchase Common Stock

         During the nine months ended  September 30, 1999,  the Company  granted
options to purchase  954,327  shares of the  Company's  common stock at exercise
prices  ranging  from  $3.1875 to $10.50 per share.  No options  were  exercised
during the nine months ended  September  30, 1999.  During the nine months ended
September 30, 1999,  options to purchase  84,087 shares of the Company's  common
stock at exercise prices ranging from $3.1875 to $10.50 per share expired.

(c)      Warrants to Purchase Common Stock

         During the nine months ended  September 30, 1999,  the Company  granted
warrants to purchase 113,000 shares of the Company's common stock at an exercise
price of $3.1875 per share to various directors of the Company. No warrants were
exercised  during the nine months  ended  September  30,  1999.  During the nine
months ended  September  30, 1999,  warrants to purchase  117,470  shares of the
Company's  common  stock at exercise  prices  ranging from $14.00 to $72.625 per
share expired.

(d)      Reserved Shares

         As of September 30, 1999, the Company had reserved shares of its common
stock for the following:

                                                      September 30, 1999
                                                    -----------------------
         Convertible debentures                               188,635
         Stock option plans                                 4,686,828
         Warrants                                           2,792,548
         Employee 401(k) plan                                  46,697
         Employee Stock Purchase Plan                         121,230
         Convertible preferred stock                           85,714
                                                    =======================
                          Total                             7,921,652
                                                    =======================

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


                                       10

<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


10.      DISCONTINUED OPERATIONS
         -----------------------

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

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

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

         Summarized financial information for the discontinued  operations is as
follows:

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

                                                    Three Months Ended                  Nine Months Ended
                                                      September 30,                       September 30,
                                                    1998           1999                 1998          1999
                                              -------------------------------      -----------------------------
  Revenues                                          $--             $--               $5,745,750           $--
  Net loss from discontinued operations             $--       $(435,000)             $(2,624,180)    $(435,000)
</TABLE>

11.      COMMITMENTS
         -----------

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

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

                                       11

<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12.      SEGMENT AND GEOGRAPHIC INFORMATION
         ----------------------------------

         Product  revenue  from  international  sources was  approximately  $6.3
million and $0.6 million for the three months ended September 30, 1998 and 1999,
respectively,  and  approximately  $10.3  million and $7.9  million for the nine
months  ended   September  30,  1998  and  1999.  The  Company's   revenue  from
international   sources  was  primarily  generated  from  customers  located  in
Europe/Middle East, Asia/Pacific, Latin America, Canada and Australia/Africa.

         The following  table  represents the  percentage of product  revenue by
geographic  region from  customers  for the three  month and nine month  periods
ended September 30, 1998 and 1999:

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

                                              Three Months Ended                       Nine Months Ended
                                                 September 30,                           September 30,
                                            1998               1999                 1998               1999
                                     --------------------------------------  --------------------------------------

         United States                       54.5%              59.1%                65.5%              57.9%
         Europe/Middle East                  17.6%               0.0%                11.5%              19.4%
         Asia/Pacific                        12.9%              34.1%                14.7%              19.2%
         Latin America                        5.9%               0.0%                 3.1%               1.5%
         Canada                               5.8%               6.7%                 3.1%               1.3%
         Australia/Africa                     3.3%               0.1%                 2.1%               0.7%

                                     --------------------------------------  --------------------------------------
         Total                              100.0%             100.0%               100.0%             100.0%
                                     ======================================  ======================================
</TABLE>

13.      LITIGATION

         On March 17,  1999,  the Company and a former and current  officer were
added as defendants in the class action of VARLJEN V. H.J.  MEYERS,  INC. ET AL.
pending in the United  States  District  Court of the  Southern  District of New
York. The plaintiffs may be seeking  monetary damages in excess of the Company's
ability to pay.  Management is vigorously  defending  this class action suit and
believes that it has meritorious defenses; however, the ultimate results of this
matter cannot be determined  at this time.  Management  believes that an adverse
result in the VARLJEN  action  could have a materially  adverse  effect upon the
financial condition and operations of the Company.



                                       12

<PAGE>

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

(a)      Overview

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization  with Coherent to sell all of the issued and  outstanding  common
stock of Star. The total  purchase  price for all of the issued and  outstanding
capital stock of Star was $65 million, paid in cash. The purchase price was paid
to the  shareholders  of Star in  proportion  to their  holdings of Star capital
stock.  This sale was approved by a majority of the  stockholders  of Palomar on
April 21, 1999,  and on April 27, 1999,  Palomar  completed  the sale of Star to
Coherent.  On the date of the  sale,  Palomar  owned  82.46%  of  Star.  Palomar
received  net  proceeds of  $49,736,023,  of which  $3,254,908  is being held in
escrow until April 27, 2000 as security  for any claims which  Coherent may have
under the Agreement. In addition,  under the terms of the Agreement, the Company
receives an ongoing royalty of 7.5% from Coherent on the sale of any products by
Coherent that incorporate  certain  patented  technology or use certain patented
methods   currently   licensed  by  the  Company  on  an  exclusive  basis  from
Massachusetts General Hospital. A portion of these royalty proceeds are remitted
to Massachusetts General Hospital.

         As a result of the consummation of the transaction discussed above, the
Company's  revenues will decline  significantly in the near term because Palomar
no longer sells the  LightSheer(TM)  diode laser  manufactured  by Star. For the
nine months ended  September 30, 1999 and 1998,  gross revenues  associated with
Star's  LightSheer(TM)  diode laser  comprised  77.0% and 66.2% of the Company's
total  revenues,  respectively.  Accordingly,  the Company  expects to incur net
losses from operations over the next few quarters.  The successful  introduction
and  marketing  of new  products  will be  critical to the  Company's  long-term
success,  since a significant  portion of the Company's  revenue base previously
generated  from  Star's  LightSheer(TM)  laser  will  need to be  replaced  with
revenues from other laser  products,  including the Palomar E2000TM hair removal
laser  introduced in March of 1999 and other products  currently in development.
There can be no  assurance  that the  Palomar  E2000TM or the  Company's  future
products will achieve market acceptance or generate  sufficient  margins.  Broad
market  acceptance  of laser hair  removal  is also  critical  to the  Company's
success. The Company recognizes the need and intends to broaden its product line
by developing cosmetic laser products other than hair removal lasers.

(b)      Results of Operations.

         (i)      REVENUES AND GROSS  PROFIT:  Three Months Ended  September 30,
                  1999, Compared to Three Months Ended September 30, 1998

         For the three months ended  September 30, 1999, the Company's  revenues
decreased  to $2.9  million,  as compared to $13.8  million for the three months
ended  September  30,  1998.  The  decrease in the  Company's  revenues of $10.9
million,  or 79% from the three months ended  September 30, 1998, was mainly due
to  the  reduction  in  sales  volume  of  $13.0  million  associated  with  the
LightSheer(TM)  diode  laser  manufactured  by Star.  The  Company  sold Star to
Coherent on April 27, 1999, as discussed  above.  This decrease was offset by an
increase of $2.1 million in other  cosmetic  revenues and royalties  received by
the Company from Coherent.  The Company  anticipates that sales volumes from its
E2000 TM laser  system  introduced  during  the first  quarter  of 1999 will not
increase  substantially until the Company manufactures this unit in high volume,
overcomes  product  introduction  issues  and  achieves  further   manufacturing
efficiencies.

         Gross  profit  for the  three  months  ended  September  30,  1999  was
approximately  $396,000  (14% of  revenues)  compared  to $8.1  million  (59% of
revenues) for the three months ended  September 30, 1998.  The decrease in gross
profit and gross  profit  percentage  was mainly due to the  reduction  in sales
volume associated with the  LightSheer(TM)  diode laser manufactured by Star and
sold to Coherent on April 27, 1999.  The  decrease in gross  profit  dollars was
partially offset by the gross margin related to the sales of the Palomar E2000TM
hair  removal  laser  system and  royalties  earned from  Coherent.  The Company
anticipates  that its gross profit  percentage from sales of the Palomar E2000TM
will be significantly less than the gross profit from its former  LightSheer(TM)
product,   unless  and  until  the  Company   achieves  volume   production  and
manufacturing  efficiencies and overcomes product introduction issues related to
the Palomar E2000(TM).


                                       13
<PAGE>


         (ii)     OPERATING AND OTHER EXPENSES: Three Months Ended September 30,
                  1999, Compared to Three Months Ended September 30, 1998

         Research and development  costs increased to $1.6 million for the three
months ended  September  30, 1999,  from $1.5 million for the three months ended
September 30, 1998. Research and development expenses as a percentage of revenue
totaled 56% for the three months ended  September 30, 1999 and 11% for the three
months  ended  September  30, 1998.  The  increase as a  percentage  of sales is
directly  attributable  to the  reduction  in sales volume  associated  with the
LightSheer(TM)  diode laser  manufactured by Star while the Company continued to
increase  the overall  spending  on  research  and  development.  The  continued
spending on research  and  development  reflects  the  Company's  commitment  to
research  and  development  for devices and  delivery  systems for  cosmetic and
medical  applications  using a variety of lasers,  while continuing  dermatology
research  utilizing  the Company's  ruby and diode  lasers.  Among the Company's
research and development  goals in hair removal is to design systems  permitting
more rapid  treatment  of large  areas,  and to produce  systems with high gross
margins.  Management  believes that research and development  expenditures  will
remain constant over the next year as the Company continues product  development
and  clinical  trials for  additional  applications  for its lasers and delivery
systems in the cosmetic  and  dermatological  markets.  The Company has recently
entered  into  an  amendment  to its  existing  Clinical  Trial  Agreement  with
Massachusetts  General  Hospital,  pursuant  to which it will fund a minimum  of
$475,000  per year over the next five years for  research in the fields of photo
thermal  removal/reduction of hair,  non-invasive  electromagnetic  targeting of
subcutaneous  fat, and treatment of sebaceous  glands and related skin disorders
(e.g., acne) using infrared light (except when externally  applied  chromophores
are used), and obtain exclusive license rights in these fields.

         Selling and marketing expenses decreased to approximately $590,000 (20%
of revenues) for the three months ended September 30, 1999,  from  approximately
$4.4 million (32% of revenues)  for the three months ended  September  30, 1998.
The decrease in selling and marketing  expenses is directly  attributable to the
reduction  in sales  volumes  due to the sale of Star to  Coherent  and  related
commissions  paid  to  Coherent  as the  former  exclusive  distributor  for the
LightSheer(TM) diode laser manufactured by Star.

         General and  administrative  expenses decreased to $1.0 million (36% of
revenues)  for the three months ended  September  30, 1999,  as compared to $1.8
million (13% of revenues) for the three months ended  September  30, 1998.  This
decrease for the three months ended  September 30, 1999 is  attributable  to the
Company's restructuring and consolidation of administrative functions related to
the  Company's   Esthetica   Partners,   Inc.  (formerly   Cosmetic   Technology
International, Inc.) and Palomar Medical Products, Inc. subsidiaries and general
corporate costs that resulted in respective reductions of approximately $250,000
and $100,000  compared to the three months ended September 30, 1998,  along with
an additional  $450,000 reduction for general and  administrative  expenses as a
result of the Company's sale of the Star subsidiary.

         Interest  expense  remained  constant at $182,000  for the three months
ended  September  30,  1999,  compared to $184,000  for the three  months  ended
September  30,  1998.  As a result of the sale of Star,  which  generated  $49.7
million in cash,  the Company  anticipates  that  interest  expense will decline
significantly  because  it  utilized  a portion  of these  proceeds  to pay down
substantially all of its outstanding debt.

         Interest  income  increased  to  approximately  $470,000  for the three
months ended September 30, 1999. This amount  represents  interest earned on the
balance  of the  funds  received  from the sale of Star  which are  invested  in
high-grade  corporate  and  government  notes and bonds and will be used to fund
future ongoing operations and research and development efforts.

         Other  income  (expense)  decreased to  approximately  ($8,000) for the
three months ended  September 30, 1999.  This amount  compares to  approximately
$396,000 for the three months ended September 30, 1998.


         (iii)    REVENUES AND GROSS  PROFIT:  Nine Months Ended  September  30,
                  1999, Compared to Nine Months Ended September 30, 1998

         For the nine months ended  September 30, 1999,  the Company's  revenues
decreased  to $21.9  million,  as compared to $30.0  million for the nine months
ended  September  30,  1998.  The  decrease  in the  Company's  revenues

                                       14
<PAGE>

of $8.1  million,  or 27% from the nine months ended  September  30,  1998,  was
mainly due to the reduction in sales volume of $7.5 million  associated with the
LightSheer(TM)  diode  laser  manufactured  by Star.  The  Company  sold Star to
Coherent on April 27, 1999, as discussed above. There was an additional decrease
of $2.4 million due to declining  sales of other cosmetic  lasers,  offset by an
increase of $1.8  million  increase in  royalties  received by the Company  from
Coherent.  The Company  anticipates  that sales  volumes from its E2000 TM laser
system   introduced   during  the  first  quarter  of  1999  will  not  increase
substantially until the Company manufactures this unit in high volume, overcomes
product introduction issues and achieves further manufacturing efficiencies. The
decrease in sales volume  associated  with other cosmetic laser product  revenue
was principally due to declining sales of the Company's  EpiLaser(R) ruby laser.
Palomar introduced its second generation long pulse ruby laser for hair removal,
the Palomar  E2000TM,  during the first quarter of 1999.  In March of 1999,  the
Company  obtained  FDA  clearance to market and sell its Palomar  E2000TM  laser
system  in the  United  States  for  "permanent  hair  reduction."  The  Company
generated  revenues of approximately  $2.2 million on the Palomar E2000TM during
the first nine months of 1999.

         Gross  profit  for  the  nine  months  ended  September  30,  1999  was
approximately  $10.2 million (46% of revenues) compared to $13.1 million (44% of
revenues) for the nine months ended June 30, 1998.  The increase in gross profit
and gross profit percentage was due to sales of the  LightSheer(TM)  diode laser
system. This laser system provided a significantly  higher gross profit than the
Company's  EpiLaser(R)  hair removal  system and other  cosmetic  products.  The
Company  anticipates that its gross profit  percentage from sales of the Palomar
E2000TM  will be  significantly  less  than the  gross  profit  from its  former
LightSheer(TM)  product,  unless and until the Palomar  E2000TM  achieves volume
production  and  further   manufacturing   efficiencies  and  overcomes  product
introduction issues.

         (iv)     OPERATING AND OTHER EXPENSES:  Nine Months Ended September 30,
                  1999, Compared to Nine Months Ended September 30, 1998

         Research and  development  costs increased to $6.3 million for the nine
months ended  September  30,  1999,  from $5.7 million for the nine months ended
September 30, 1998. Research and development expenses as a percentage of revenue
totaled 29% for the nine months  ended  September  30, 1999 and 19% for the nine
months ended June 30, 1998. The continued  spending on research and  development
reflects the Company's  commitment to research and  development  for devices and
delivery  systems  for  cosmetic  and  medical  applications  using a variety of
lasers,  while continuing  dermatology research utilizing the Company's ruby and
diode lasers. Among the Company's research and development goals in hair removal
is to design  systems  permitting  more rapid  treatment of large areas,  and to
produce systems with high gross margins.  Management  believes that research and
development  expenditures will remain constant over the next year as the Company
continues  product  development and clinical trials for additional  applications
for its lasers and delivery systems in the cosmetic and dermatological  markets.
The Company has recently  entered  into an  amendment  to its existing  Clinical
Trial Agreement with Massachusetts  General Hospital,  pursuant to which it will
fund a minimum of $475,000 per year over the next five years for research in the
fields  of  photo   thermal   removal  or   reduction   of  hair,   non-invasive
electromagnetic targeting of subcutaneous fat, and treatment of sebaceous glands
and related  skin  disorders  (e.g.,  acne) using  infrared  light  (except when
externally  applied  chromophores are used), and obtain exclusive license rights
in these fields.  However,  research and development as a percentage of revenues
will increase until the Company  achieves  higher sales volume from its recently
introduced  Palomar E2000TM laser system and introduces other products currently
in development.

         Selling  and  marketing  expenses  decreased  to $6.3  million  (29% of
revenues) for the nine months ended  September 30, 1999, from $10.5 million (35%
of revenues)  for the nine months  ended  September  30,  1998.  The decrease in
selling and  marketing  expenses as a percentage  of revenues is a result of the
Company's  introduction  of its Palomar  E2000(TM) laser system during the first
quarter of 1999,  which is being sold through new distribution  channels.  These
new  distribution  channels  include  direct  sales  by the  Company  and  other
distribution channels, and the associated selling and marketing expenses have to
date been less than the commission  earned by Coherent,  the Company's  previous
distributor.  The Company also will consider  establishing  its own direct sales
force to  complement  these sales  channels.  The Company  anticipates  that, in
comparison to the commission  previously paid to Coherent as a percentage of net
revenues, its future selling and marketing costs as a percentage of net revenues
will  decrease.  The Company will also  consider  selling  entire  product lines
and/or technology to others, as in the case of the sale of Star to Coherent.

                                       15
<PAGE>

         General and  administrative  expenses decreased to $4.2 million (19% of
revenues)  for the nine months ended  September  30,  1999,  as compared to $7.0
million (23% of revenues)  for the nine months ended  September  30, 1998.  This
decrease for the nine months ended  September  30, 1999 is  attributable  to the
Company's restructuring and consolidation of administrative functions related to
the  Company's   Esthetica   Partners,   Inc.  (formerly   Cosmetic   Technology
International, Inc.) and Palomar Medical Products, Inc. subsidiaries and general
corporate  costs  that  resulted  in  respective   reductions  of  approximately
$1,000,000,  $400,000 and $2,400,000 compared to the nine months ended September
30, 1998. An additional  $1,000,000 was incurred for general and  administrative
expenses at the Company's Star subsidiary during the nine months ended September
30, 1998 as compared to the nine months ended  September  30, 1999.  The Company
anticipates  general and  administrative  expense will decrease  slightly in the
future as a result of the Star  sale,  although  it  expects  such  expenses  to
increase as a  percentage  of revenues as sales  decline in the near term as the
result of the Star sale.

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

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

         Gain  from the sale of a  subsidiary  was  $47.1  million  for the nine
months ended  September 30, 1999 due to the Company  completing the sale of Star
on April 27, 1999. The Company has deferred gain  recognition  of  approximately
$3.1 million of the proceeds  from this sale pending the  resolution  in 2000 of
certain commitments and contingencies related to the sale.

         Redemption expense was $6.2 million for the nine months ended September
30, 1999. This amount reflects a redemption  expense of $6.2 million as a result
of a settlement  agreement  between Palomar and certain  European banks that had
held 4.5% Swiss Franc denominated subordinated convertible debentures originally
totaling $8.2 million and due in 2003. Under the terms of this agreement,  which
resolved a lawsuit,  Palomar agreed to rescind its conversion  notices issued in
November  1997.  Through  these  conversion   notices,   Palomar  converted  the
subordinated debentures into 130,576 shares of the Company's common stock. Since
the  conversion  date,  the  Company  had  treated  these  shares as issued  and
outstanding.  Under the terms of this  compromise,  the Company  agreed to pay a
total of approximately $6.7 million to the European banks, of which $4.4 million
has been paid as of September 30, 1999. The balance of $2.3 million is due 2001.
Accordingly, the Company has recorded a charge to  operations  of  approximately
$6.2 million.  This amount represents the total amount due to the European banks
less the fair market value of the  redemption  of the common  shares  previously
considered outstanding by the Company.

         Interest  expense  decreased  to  $546,000  for the nine  months  ended
September  30, 1999,  from $1.0 million for the nine months ended  September 30,
1998.  This 46%  decrease is primarily  the result of a decrease in  convertible
debenture financings and the Company's increased use of conventional  financing.
Also,  operations did not require as much financing in 1999 as compared to 1998.
As a result of the sale of Star,  which  generated  $49.7  million in cash,  the
Company anticipates that interest expense will decline  significantly because it
utilized  a  portion  of these  proceeds  to pay down  substantially  all of its
outstanding debt during the second quarter of 1999.

         Interest income increased to approximately $878,000 for the nine months
ended September 30, 1999. This amount represents  interest earned on the balance
of the funds  received  from the sale of Star which are  invested in  high-grade
corporate  and  government  notes  and  bonds  and  will be used to fund  future
operations and research and development efforts.

         Other income  decreased to $271,000 for the nine months ended September
30, 1999.  This amount  compares to $721,000 for the nine months ended September
30, 1998.

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



                                       16
<PAGE>

(c)      Liquidity and Capital Resources

         On April 27, 1999,  Palomar  completed the sale of Star to Coherent for
$65 million.  On the date of the sale,  Palomar  owned  82.46% of Star.  Palomar
received  net  proceeds of  $49,736,023,  of which  $3,254,908  is being held in
escrow until April 27, 2000 as security  for any claims which  Coherent may have
under the Agreement. In addition,  under the terms of the Agreement, the Company
receives an ongoing royalty of 7.5% from Coherent on the sale of any products by
Coherent that incorporate  certain  patented  technology or use certain patented
methods   currently   licensed  by  the  Company  on  an  exclusive  basis  from
Massachusetts General Hospital. A portion of these royalty proceeds are remitted
to Massachusetts  General  Hospital.  From April 27, 1999 through  September 30,
1999, the Company received  approximately  $1.9 million in royalty revenues from
Coherent.

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

         The  Company  is a  holding  company  with no  significant  operations.
Operations are carried out at the  subsidiary  level,  and consist  primarily of
research and development.  To date, the Company's  operating  subsidiaries  have
required  cash  advances  from  the  Company  to fund  their  operations.  As of
September 30, 1999, the Company had $29.1 million in cash, cash  equivalents and
available-for-sale  investments.  With the  proceeds  from the  Star  sale,  the
Company  believes  that its  financial  position will meet its ongoing cash flow
requirements and fund expected  operating losses at its subsidiaries in the near
term. The successful  introduction and marketing of new products currently under
development will be critical to future liquidity.

         During the nine months ended  September  30,  1999,  under a settlement
agreement,  the Company agreed to pay a total of  approximately  $6.7 million to
the  European  banks that had held 4.5%  convertible  debentures  totaling  $8.2
million due in 2003.  The Company has paid $4.4  million to these banks  through
September 30, 1999. The balance of $2.3 million is due 2001.

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

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

         As of September 30, 1999,  the Company's  accounts  receivable  totaled
$2.2  million,  as  compared  to $9.9  million as of  December  31,  1998.  This
reduction was due principally to the sale of Star to Coherent on April 27, 1999.
The Company's allowance for doubtful accounts totaled approximately  $650,000 as
of September 30, 1999, compared to $364,000 as of December 31, 1998.

         As of September 30, 1999,  accounts payable totaled  approximately $1.4
million as compared to $6.6 million as of December 31,  1998.  This  decrease is
principally  due to paying down debt with money  received  from the sale of Star
and timing of  additional  purchases of  inventory  for the  manufacture  of the
Palomar E2000(TM) laser systems.

         The Company anticipates that capital  expenditures for the remainder of
1999 will total  approximately  $200,000,  consisting  primarily  of  machinery,
equipment and computers and  peripherals.  The Company  expects to finance these
expenditures with cash on hand and equipment leasing lines, if available.

                                       17
<PAGE>

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

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

(d)     Material Uncertainties.

        (i)      Year 2000 Issues

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

                 State of Readiness:

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

         o        Information Technology (computer hardware and software)

         o        Physical Plant (manufacturing equipment and facilities)

         o        Products (including product development)

         o        Extended Enterprise (suppliers and customers)

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

         o        Ownership (creating awareness, assigning tasks)

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

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

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

         At September 30, 1999,  the ownership,  inventory and assessment  steps
were essentially complete for all program areas.

                 Costs to Address Y2K Issues:

         The Company's  estimated  aggregate  costs for its Y2K activities  from
1998 through 2000 are expected to be less than $100,000.  Through  September 30,
1999, the Company has spent approximately $70,000.

                 Risks of Y2K Issues and Contingency Plans:

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

                                       18
<PAGE>

                                  RISK FACTORS

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

OUR FUTURE REVENUE DEPENDS ON OUR DEVELOPING NEW PRODUCTS.

         We face rapidly  changing  technology  and continuing  improvements  in
cosmetic laser technology.  In order to be successful,  we must continue to make
significant  investments  in research and  development  in order to develop in a
timely and cost-effective manner new products that meet changing market demands,
enhance existing products,  and achieve market acceptance for such products.  We
have in the past  experienced  delays in  developing  new products and enhancing
existing products.  Furthermore,  some of our new products under development are
based on unproven  technology  and/or  technology  with which the Company has no
previous  experience.  As a result of the sale of Star to  Coherent,  our future
revenue  will be  entirely  dependent  on sales of  newly  introduced  products.
Although we have  recently  introduced a new hair removal  laser,  sales to date
have been  minimal and this new product may not  achieve  market  acceptance  or
generate  sufficient  margins.  In  addition,  the  market for this type of hair
removal laser may already be saturated.  At present,  broad market acceptance of
laser hair  removal is  critical  to our  success.  We intend to  diversify  our
product  line by  developing  cosmetic  laser  products  other than hair removal
lasers.

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

         The laser hair removal  industry is highly  competitive,  and companies
frequently introduce new products.  We compete in the development,  manufacture,
marketing and servicing of hair removal  lasers with numerous  other  companies,
many  of  which  have  substantially  greater  financial,  marketing  and  other
resources than we do. As a result, some of our competitors are able to sell hair
removal  lasers at prices  significantly  below the  prices at which we sell our
hair removal lasers. In addition,  as a result of the Star sale,  Coherent,  our
former  exclusive  distributor  and one of the largest and best  financed  laser
companies,  is now our competitor and we have to find new ways to distribute our
products.  We currently  have no sales force in place for our new products under
development.  Our laser products also face competition from alternative  medical
products and procedures,  such as electrolysis and waxing,  among others. We may
not be able to differentiate  our products from the products of our competitors,
and customers may not consider our products to be superior to competing products
or medical  procedures,  especially if  competitive  products and procedures are
offered  at  lower  prices.   Our  competitors  may  develop   products  or  new
technologies that make our products obsolete or less competitive.

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

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

                                       19
<PAGE>

WE COULD BE DELISTED FROM NASDAQ.

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


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

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

WE ARE DEPENDENT ON THIRD PARTY RESEARCHERS.

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

OUR  COMMON  STOCK  COULD  BE  FURTHER  DILUTED  AS THE  RESULT  OF  OUTSTANDING
CONVERTIBLE SECURITIES, WARRANTS AND OPTIONS.

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

OUR PROPRIETARY TECHNOLOGY HAS ONLY LIMITED PROTECTIONS.

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

                                       20
<PAGE>

consuming  lawsuits  may be  necessary  to enforce  patents  issued or  licensed
exclusively to us, to protect our trade secrets and/or  know-how or to determine
the enforceability, scope and validity of others' intellectual property rights.

         The medical  laser  industry is  characterized  by frequent  litigation
regarding  patent  and  other  intellectual  property  rights.   Because  patent
applications  are  maintained in secrecy in the United States until such patents
are issued and are maintained in secrecy for a period of time outside the United
States, we can conduct only limited searches to determine whether our technology
infringes any patents or patent applications. Any claims for patent infringement
could be time-consuming,  result in costly litigation 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 laser industry have
often been settled through licensing or similar  arrangements,  costs associated
with such  arrangements  may be  substantial  and often  require  the payment of
ongoing  royalties,  which could have a negative impact on gross margins.  There
can  be no  assurance  that  necessary  licenses  would  be  available  to us on
satisfactory terms, or that we could redesign our products or processes to avoid
infringement, if necessary.  Accordingly, an adverse determination in a judicial
or  administrative  proceeding  or failure to obtain  necessary  licenses  could
prevent us from manufacturing and selling some of our products.  This could have
a material  adverse effect on our business,  results of operations and financial
condition.

OUR  CHARTER  DOCUMENTS  AND  DELAWARE  LAW MAY  DISCOURAGE  POTENTIAL  TAKEOVER
ATTEMPTS.

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

         The Company is also subject to the anti-takeover  provisions of Section
203 of the Delaware  General  Corporation  Law, which prohibits the Company from
engaging in a "business  combination"  with an  "interested  stockholder"  for a
period of three  years  after the date of the  transaction  in which the  person
becomes an interested  stockholder,  unless the business combination is approved
in a prescribed  manner. The application of Section 203 may limit the ability of
stockholders  to  approve a  transaction  that they may deem to be in their best
interests. These provisions of our Second Restated Certificate of Incorporation,
By-laws and the Delaware General  Corporation Law could deter certain  takeovers
or tender  offers or could  delay or  prevent  certain  changes  in  control  or
management of the Company,  including  transactions in which  stockholders might
otherwise  receive  a premium  for their  shares  over the then  current  market
prices.

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

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

WE MAY NOT BE ABLE SUCCESSFULLY TO COLLECT LICENSING ROYALTIES.

         We hope that a material  portion of our future revenues will consist of
royalties from  licensing both our own patents and patents  licensed to us on an
exclusive basis by  Massachusetts  General  Hospital.  However,  there can be no
assurance that we will be able to obtain valuable patent rights. Moreover, there
can be no assurance  that,  even if we do obtain such patent rights and are able
to license them to third  parties,  we will derive a significant  revenue stream
from such licenses.

                                       21
<PAGE>

WE FACE RISKS ASSOCIATED WITH PENDING LITIGATION.

         We are involved in disputes  with third  parties.  Such  disputes  have
resulted in litigation  with such  parties.  We have  incurred,  and likely will
continue to incur, legal expenses in connection with such matters.  There can be
no assurance that such litigation  will result in favorable  outcomes for us. An
adverse result in the Varljen  litigation  (described in detail in Part II, Item
1) could have a material adverse effect on our business, financial condition and
results of operations.  We are unable to determine the total expense or possible
loss,  if any,  that  may  ultimately  be  incurred  in the  resolution  of this
proceeding.  However,  an  adverse  result  at  trial  could  be  in  an  amount
substantially greater than any existing insurance,  even assuming coverage. This
matter may also  result in  diversion  of  management  time and effort  from the
operations of the business.

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

         As a small company with less than 100 employees, 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.

WE FACE A RISK OF FINANCIAL  EXPOSURE TO PRODUCT  LIABILITY  CLAIMS IN THE EVENT
THAT THE USE OF OUR PRODUCTS RESULTS IN PERSONAL INJURY.

         Our products are and will continue to be designed with numerous  safety
features, but it is possible that patients could be adversely affected by use of
one of our products.  Further, in the event that any of our products prove to be
defective, we may be required to recall and redesign such products.  Although we
have not  experienced  any material  losses due to product  liability  claims to
date,  there can be no assurance that we will not experience  such losses in the
future. We maintain general liability  insurance in the amount of $1,000,000 per
occurrence and $2,000,000 in the aggregate and maintain umbrella coverage in the
aggregate  amount of $25,000,000;  however,  there can be no assurance that such
coverage  will  continue to be available on terms  acceptable to us or that such
coverage will be adequate for liabilities actually incurred. In the event we are
found liable for damages in excess of the limits of our insurance  coverage,  or
if any claim or product recall results in significant  adverse publicity against
us,  our  business,  financial  condition  and  results of  operations  could be
materially and adversely affected. In addition,  although our products have been
and will  continue to be designed to operate in a safe  manner,  and although we
attempt  to  educate  medical  personnel  with  respect to the proper use of our
products,  misuse of our products by medical personnel over whom we cannot exert
control  may  result in the filing of product  liability  claims or  significant
adverse publicity against us.

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

         Systems that do not properly  recognize such information could generate
erroneous data or cause a system to fail. We are at this time utilizing internal
resources to identify,  correct or reprogram  and test our systems for year 2000
compliance.  However,  there  can be no  assurance  that  the  systems  of other
companies on which our systems rely will also be converted in a timely manner or
that any such  failure to convert by another  company  would not have an adverse
effect on our systems.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.
         ----------------------------------------------------------

         Not applicable.

                                       22
<PAGE>

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings.
         -----------------

         On March 7, 1997, Selvac Acquisition Corp. ("Selvac"),  a subsidiary of
Mehl Biophile  International,  Inc.  ("Mehl"),  filed a complaint for injunctive
relief and damages for patent  infringement  and for unfair  competition  in the
United States District Court for the District of New Jersey against the Company,
two of its  subsidiaries  and a New  Jersey  dermatologist.  Selvac's  complaint
alleged that the Company's  EpiLaser(R) ruby laser hair removal system infringed
a patent licensed to Selvac (the "Selvac  Patent") and that the Company unfairly
competed by promoting the  EpiLaser(R)  ruby laser hair removal  system for hair
removal before it had received FDA clearance for that specific  application.  On
May 18, 1998 the court granted the Company's motion for partial summary judgment
on the ground that the Selvac patent is invalid  because  prior art  anticipated
it. The court later denied  Selvac's motion for  reconsideration  of the summary
judgment  ruling.  On September 25, 1998, the court denied  Selvac's  motion for
reconsideration  of its  prior  order  dismissing  so  much of  Selvac's  unfair
competition  claim as relied on interpreting the Food, Drug and Cosmetics Act or
FDA  regulations,  and  dismissed  without  prejudice the state law remainder of
Selvac's unfair  competition claim. On October 26, 1998, Selvac filed its notice
of appeal with the Court of Appeals for the Federal Circuit. The Federal Circuit
heard oral argument on August 5, 1999, and on September 30 affirmed the district
court's  summary  judgment of  invalidity of the Selvac  Patent.  On October 14,
1999, Selvac filed a petition for rehearing, which the Federal Circuit denied on
October 27, 1999.

         On March 11, 1999,  the United States  District  Court for the Southern
District of New York granted  plaintiffs  leave to amend their  complaint in the
action styled Varljen v. H.J.  Meyers,  Inc.,  et. al. to join the Company,  its
former  chief  executive   officer  and  current  chief  financial   officer  as
defendants.  On March 17,  1999,  the  Second  Amended  Class  Action  Complaint
("Complaint")  in Varljen was served  upon the  Company  and its  current  chief
financial  officer.  The  Complaint  alleges that the Company and the former and
current  officer  violated  the  federal   securities  laws  in  various  public
disclosures that the Company made directly and indirectly during the period from
February  1, 1996 to March 26,  1997.  The  Company  and the former and  current
officer filed a motion to dismiss the complaint, asserting all claims are barred
by the statute of limitations, that the complaint does not meet federal pleading
requirements, and that it fails to state a securities claim. The Company and the
former and current  officer have also filed a motion to transfer the case to the
District of  Massachusetts.  On August 6, 1999,  the  District  Court denied the
Company's motion to dismiss, and scheduled a case conference for April 28, 2000.

         On July 20, 1999,  The  Monterey  Stockholders  Group LLC  ("Monterey")
filed a complaint for declaratory  judgment and for damages in the United States
District Court for the District of Delaware  against the Company.  The complaint
alleged that the Company and its directors  violated the federal securities laws
in various public  disclosures  that the Company made in the spring of 1999. The
complaint  alleged  Palomar  failed to disclose that it intended to include 3.25
million  escrowed shares in the vote at its annual meeting when such shares were
allegedly non-voting and not outstanding.  Monterey sought, among other forms of
relief,  a  declaration  that no quorum was present in person or by proxy at the
Company's  annual  meeting.  On September 3, 1999, the Company and its directors
filed an answer and counterclaim  against Monterey,  Mark Smith, Thomas O'Brien,
The Rockside Foundation,  Logg Investment  Research,  and the R. Templeton Smith
Foundation,  alleging,  among other things, that Monterey filed fraudulent proxy
statements,  and  requesting  a  declaration  that a quorum  was  present at the
Company's annual meeting and that the Palomar nominees were properly elected. On
October 19, 1999, all parties filed a stipulation of dismissal with prejudice of
the lawsuit, including all claims and counterclaims.

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

Item 2.  Changes in Securities.
         ---------------------

         Not applicable.

                                       23
<PAGE>



Item 3.  Defaults upon Senior Securities.
         -------------------------------

         Not applicable.


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

         Not applicable.


Item 5.  Other Information.
         -----------------

         Not applicable.

                                       24
<PAGE>



Item 6.  Exhibits and Reports on Form 8-K.
         --------------------------------

(a)      Exhibits

   2.1*           By-laws, as amended.

   2.2**          Second Restated Certificate of Incorporation of the Company

   4.1***         Second Amended 1991 Stock Option Plan.

   4.2***         Second Amended 1993 Stock Option Plan.

   4.3***         Second Amended 1995 Stock Option Plan.

   4.4***         Second Amended 1996 Stock Option Plan.

   4.5***         Third Amended 1996 Employee Stock Purchase Plan.

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

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

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

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

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

   **             Previously  filed as an exhibit to  Registration  Statement on
                  Form S-3, No. 333-70391, and incorporated herein by reference.

   ***            Previously  filed as an  exhibit  to Form 10-Q for the  period
                  ended June 30, 1999, and incorporated herein by reference.

   ****           Previously filed as an exhibit to Form 8-K, filed on April 21,
                  1999 and incorporated herein by reference.

(b)      Reports on Form 8-K.

                  Form 8-K filed on July 1, 1999 (announcing  Palomar victory in
                  proxy contest).


                                       25
<PAGE>


                                   SIGNATURES

         Pursuant  to the  requirements  of the  Securities  Act  of  1934,  the
Registrant  certifies  that it has caused this Report to be signed on its behalf
by the undersigned,  thereunto duly authorized, in the Town of Burlington in the
Commonwealth of Massachusetts on November 12, 1999.

                                              PALOMAR MEDICAL TECHNOLOGIES, INC.
                                                        (Registrant)



DATE:  November 12, 1999                       By:     /S/ LOUIS P. VALENTE
                                                  ------------------------------
                                                   Louis P. Valente
                                                   Chief Executive Officer
                                                   (Principal Executive Officer)




DATE:  November 12, 1999                       By:     /S/ JOSEPH P. CARUSO
                                                  ------------------------------
                                                   Joseph P. Caruso
                                                   Chief Financial Officer and
                                                   Treasurer
                                                   (Principal Financial Officer
                                                   and
                                                   Principal Accounting Officer)

                                       26
<PAGE>