-i-

                                   FORM 10-KSB

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
(Mark one)
            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                     For fiscal year ended December 31, 1996
                                       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 small business issuer as specified in its charter)

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

                     66 Cherry Hill Drive, Beverly, MA 01915
                     ---------------------------------------
                    (Address of principal executive offices)
                                 (508) 921-9300
                                 --------------
                (Issuer's telephone number, including area code)

Securities registered pursuant to Section 12 (b) of the Act:
------------------------------------------------------------   
                                                        Name of each exchange on
         Title of each class                               which registered
         -------------------                            ------------------------
         Not Applicable                                     Not Applicable  

          SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:
          ------------------------------------------------------------
                          Common Stock , $.01 par value

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such report(s), and (2) has been subject to such
filing  requirements  for the  past 90  days.  Yes     X    No  
                                                     ----

     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of  Regulation  S-B  contained  in  this  form,  and no  disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

     The  issuer's  revenues  for its fiscal year ended  December  31, 1996 were
$70,098,443.

     As of March 20, 1997, 30,945,824 shares of Common Stock, $.01 par value per
share,  and  16,000  shares of  Preferred  Stock  $.01 par value per share  were
outstanding.  The aggregate market value, held by  non-affiliates,  of shares of
the  Common  Stock,  based  upon the  average of the bid and ask prices for such
stock on that date was approximately $195,345,514.

        Transitional Small Business Disclosure Format:  Yes          No     X
                                                            ----         -------

                       DOCUMENTS INCORPORATED BY REFERENCE


Documents                                                  Form 10-KSB Reference
---------                                                  ---------------------
Proxy Statement for the Annual Meeting of  Shareholders           Part III
to be held June 18, 1997



<PAGE>
                                      -1-

                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL

     Palomar Medical Technologies,  Inc., a Delaware corporation, (the "Company"
or "Palomar")  was organized in 1987 to design,  manufacture  and market lasers,
delivery systems and related disposable products for use in cosmetic and medical
procedures.  The Company currently  operates in two business  segments:  medical
products and services and electronic products.  In the medical products segment,
the Company  manufactures and markets U.S. Food and Drug Administration  ("FDA")
approved  ruby and CO2 lasers for hair  removal,  skin  resurfacing  and wrinkle
treatment,  among other  things.  The Company has and continues to develop ruby,
pulse dye and diode medical lasers for use in clinical  trials and is engaged in
the research and  development  of  additional  laser  products.  The Company has
expanded  its  efforts in the  cosmetic  laser area  through a series of product
development activities, acquisitions and strategic alliances that target patient
self-pay procedures  performed in doctors' offices and clinics.  Principal among
these are the  development of the  EpiLaserTM,  a ruby laser system for removing
unwanted hair. The laser hair removal,  skin  resurfacing and wrinkle  treatment
products are  significant  to the Company's  strategic plan and are discussed in
further  detail  below.  The  Company  has  entered  into a number  of  research
agreements with recognized  research  hospitals and clinical  laboratories.  The
Company  provides  research  funding,  laser  technology and optics expertise in
return for licensing  agreements to specific medical applications and patents as
more fully described below. See "Patents and Licenses." Management believes that
this method of conducting  research and  development  provides a higher level of
technical and clinical expertise than it could provide on its own, and in a more
cost-efficient manner.

     In  February  1997,  Palomar  Medical  Products,   Inc.  ("Palomar  Medical
Products")  was formed  with the purpose of  consolidating  the  management  and
operations of the medical products companies. In January 1997, the Company named
an outside party as the President and CEO of Palomar Medical Products to oversee
and  manage the  operations.  Included  in the  Medical  Products  Group are the
following companies;  Spectrum Medical Technologies,  Inc., Tissue Technologies,
Inc., Star Medical Technologies, Inc., Dermascan, Inc. and Palomar Technologies,
Ltd. (see "Formation of Palomar  Technologies,  Ltd.").  Included as part of the
medical business segment but excluded from the Medical Products Group is a newly
formed,   wholly  owned   subsidiary   of  the  Company,   Cosmetic   Technology
International,  Inc., which intends to establish a worldwide network of cosmetic
and dermatological  laser sites with medical service partners (see "Formation of
Cosmetic Technology International, Inc.").

     In September 1995, the Company established Palomar Electronics  Corporation
as a wholly-owned subsidiary of Palomar Medical Technologies,  Inc. as part of a
plan to separate the electronics and computer  segments of the business from the
medical laser segments of the business.

     In the electronic products segment, the Company's Nexar Technologies,  Inc.
subsidiary  manufactures,  markets and sells  personal  computers  with a unique
circuit  board design that  enables end users to easily  upgrade and replace the
microprocessor, memory and hard drive components, which management believes will
decrease  the level of  technical  obsolescence  associated  with  most  desktop
personal  computers  in the market.  Dynaco  Corp.  manufactures  high  density,
flexible  electronic  circuitry  for use in  industrial,  military  and  medical
devices and is also  introducing a number of  proprietary  products  targeted to
service the personal computer  industry,  including high density memory modules.
These new  proprietary  computer  memory modules  double the memory  capacity of
traditional  memory modules using the same  interface.  Comtel  Electronics is a
contract  manufacturer which provides turnkey manufacturing and test services of
electronic assemblies.

THE COMPANY'S STRATEGIC PLAN

     The  Company's  near-term  strategy is to increase its focus on the medical
segment  portion of the  business.  The  company  believes  that it can spin out
companies in the  non-core  electronics  segment in the form of publicly  traded
companies.  The Company  believes that with the  attainment of FDA clearance for
marketing  and sales of its  lasers  for the  treatment  of hair  removal,  skin
resurfacing,  and  wrinkle  treatment,  the medical  segment of its  business is
positioned for success. The Company will continue to develop, acquire or license
technologies  that can be integrated  into its current and proposed  products in
the medical business segment. Through its Cosmetic Technology International Inc.
subsidiary, the Company will also focus on the services segment of the business.
The Company intends to address very large


<PAGE>
                                      -2-

markets incorporating its core technology with proprietary products and services
and structure its operations to strive to be the low-cost  producer and provider
of these  products  and  services.  The Company  intends to seek  agreements  or
arrangements with other medical products and high technology  companies in order
to acquire technical and financial assistance in the research and development of
such  products  and in the  extensive  experimentation  and testing  required to
obtain regulatory approvals in the United States and elsewhere. The Company will
continue  to  seek  marketing  and  distribution   agreements  with  established
companies  to  enable  it to  market  some  of its  products  quickly  and  more
efficiently and will also utilize and enhance a direct sales force.

     The Company  has already  begun to spin out  Companies  in its  electronics
segment. Management is currently evaluating various alternatives and methods for
Dynaco  Corp.  and its  subsidiaries,  as well as CD Titles,  Inc.  Although the
Company  cannot  guarantee  successful   completion  of  these  publicly  traded
spinouts,  the  intention is to complete  these  transactions  during  1997.  In
addition,  the Company's subsidiary Nexar Technologies,  Inc. (See "Formation of
Nexar Technologies,  Inc.") is in the process of completing its proposed initial
public offering.  Management  anticipates that this initial public offering will
be completed by mid-April 1997. However, the Company can in no way guarantee nor
ensure successful completion of the initial public offering.

     The Company  believes  that the  expansion  and success of its  business is
significantly  influenced by key employees at its  operating  subsidiaries.  The
Company  has and intends to continue  to create  incentive  programs  that allow
management  as well as key members of senior  management of the Company at these
operating  subsidiaries  to  participate  in  the  success  of  these  operating
subsidiaries by participating in the equity of each subsidiary or profit sharing
plans.

     The Company also makes early stage  investments  in core  technologies  and
companies that management feels are strategic to the Company's  business or will
yield a higher  than  average  financial  return to support the  Company's  core
business.  Some of these investments are with companies that are related to some
of the directors and officers of the Company. See "Related Party Investments and
Transactions."

RECENT FINANCING OF OPERATIONS AND INVESTMENTS

     The Company has  financed  current  operations  and  expansion  of its core
business  with  short-term  financial  borrowings  and  investments  through the
private sale of debt and equity securities of the Company.  The Company raised a
total of $56,112,391 and  $31,083,892 in such financings  during the years ended
December 31, 1996, and December 31, 1995, respectively.  The Company anticipates
that  it  will  require  substantial   additional   financing  during  the  next
twelve-month  period.  The  Company  may from time to time be  required to raise
additional  funds through  additional  private  sales of the  Company's  debt or
equity  securities.  Sales of  securities  to  private  investors  are sold at a
discount to the current or future public market for similar  securities.  It has
been the Company's  experience that private  investors  require that the Company
make its best effort to register  their  securities  for resale to the public at
some future time. The Company  increased its authorized  shares on July 19, 1996
from  40,000,000  shares of common stock to 100,000,000  shares of common stock.
There  can be no  assurance  that the  Company  will be  successful  in  raising
additional  capital  on  favorable  terms.  See Notes 5 and 15 in the  "Notes to
Consolidated Financial Statements."

INCREASE IN OUTSTANDING SHARES

     As a result of financing  activities,  business  developments,  mergers and
acquisitions,  issuance of  incentive  stock  options  and  warrants to purchase
common  stock to attract  and retain key  employees,  the  Company's  issued and
outstanding  shares of common stock have increased to 30,596,812 at December 31,
1996.  The Company also had  additional  reserved but unissued  shares of common
stock of  20,467,819  shares at December  31,  1996.  The  Company's  issued and
outstanding shares of common stock increased  subsequent to December 31, 1996 to
30,996,283  shares with additional  reserved but unissued shares of common stock
of  20,061,274  shares as of February  21,  1997.  A  substantial  number of the
Company's  reserved  shares are  registered  and could be resold into the public
market.

RELATED PARTY INVESTMENTS AND TRANSACTIONS

     The Company has entered into a number of transactions with related parties.
To date,  the Company has an aggregate of  $5,076,751  of notes  receivable  and
investments with related parties.  Included in the aggregate amount are loans to
certain officers,  directors and key employees of $995,331;  notes receivable to
related parties of $464,153; a loan of

<PAGE>
                                      -3-

$1,100,000  to a public  company of which a former  director is the director and
chief  financial  officer;  an  unsecured  note  of  $604,653  to the  Company's
underwriter;  and trading  securities of $1,912,614 in a publicly traded company
in which the chief executive  officer is an approximately 13% owner. See Note 11
in the "Notes to Consolidated Financial Statements."

MEDICAL PRODUCTS SEGMENT
------------------------

BUSINESS DEVELOPMENTS

ACQUISITION OF STAR MEDICAL TECHNOLOGIES, INC.

     On July 1, 1993,  the  Company  acquired  80% of the  common  stock of Star
Medical Technologies, Inc. ("Star"), a development stage company formed on April
1, 1993.  Star develops  medical and commercial  products using high power laser
diodes.  To date, Star has developed a number of medical diode laser  prototypes
under clinical  investigation.  The  acquisition  price was $600,000 in cash and
five-year  nonqualified  stock  options  granted to certain  officers of Star to
purchase up to an aggregate of 100,000  shares of the Company's  common stock at
an exercise price of $1.78 (50% of the fair market value of the Company's common
stock on July 1, 1993).  In  addition,  during  1994,  the  Company  acquired an
additional 5% of the common stock of Star for cash payments of $970,000.

     In April 1996, the Company  purchased the remaining 15% of the  outstanding
common  stock of Star from its  founders,  bringing its  ownership  to 100%,  in
exchange for 217,943 shares of Palomar's common stock valued at $7.85 per share.
This  agreement  restricts  for a period of two years the sale of the  Company's
common stock issued in connection  with this  agreement.  The purchase price has
been recorded as  additional  goodwill and is being  amortized  over a period of
five years. In connection with this agreement the original founders of Star have
agreed to rescind all royalties due to them under a Rights  Agreement dated July
1, 1993. To date, revenue from the Star subsidiary has not been significant.

ACQUISITION OF SPECTRUM MEDICAL TECHNOLOGIES, INC.

     On April 5, 1995, the Company acquired all of the outstanding  common stock
of  Spectrum  Medical  Technologies,   Inc.  ("Spectrum").  The  purchase  price
consisted  of $300,000 in cash, a $700,000  two-year  promissory  note,  364,178
shares of the  Company's  common  stock with an  aggregate  fair market value of
$1,000,000,  acquisition  costs of  $161,138  and assumed  liabilities  totaling
$1,128,139.  In  addition,  the  purchase  price  consists of a 20%  contingency
payment,  payable in the Company's common stock,  based upon the future earnings
performance  of Spectrum over a three to five-year  period.  Spectrum  develops,
manufactures,   sells  and  services  ruby  lasers   throughout  the  world  for
dermatological applications.

FORMATION OF SPECTRUM FINANCIAL SERVICES LLC

     On June 30, 1995,  Spectrum  Financial  Services  LLC ("SFS"),  a financial
services  leasing company and a minority- owned  subsidiary of the Company,  was
formed.  As of December  31, 1996 and 1995,  the Company had funded the minority
subsidiary with cash in the amount of $1,680,919 and $856,300 respectively.  SFS
arranges for  financing of medical  products  sold by the Company.  In addition,
during 1996 as part of its business  strategy,  the Company  aligned itself with
Copelco  Capital,  one of the  world's  largest  and  most  established  leasing
companies,  to become the  exclusive  label  leasing  company for the  Company's
complete line of cosmetic lasers.

LICENSE AND RESEARCH  AGREEMENT WITH  MASSACHUSETTS  GENERAL  HOSPITAL FOR LASER
HAIR REMOVAL

     In August 1995, the Company entered into an exclusive, worldwide, perpetual
license for certain  technology  that applies to a patented method of delivering
laser energy to treat  unwanted  hair. The Company also entered into a four-year
agreement with the Massachusetts General Hospital ("MGH"), whereby MGH agreed to
conduct clinical trials on a laser treatment for hair removal/reduction invented
by Dr. R. Rox Anderson,  Wellman Laboratories of Photomedicine,  MGH. As part of
the agreement, MGH provided the Company with prior data already generated by Dr.
Anderson with respect to the ruby laser device at MGH. This  information was the
basis for an application  filed on December 8, 1995 with the FDA for approval of
the Company's  EpiLaser(TM) for treating unwanted hair. The Company is obligated
to fund the clinical research in the aggregate amount of approximately  $917,000
over the term of the contract. On August 18, 1995, the Company also entered into
a worldwide  exclusive  license  agreement with MGH. Upon  completion of a valid
product or service,  or new uses (not related  solely to hair removal)  based on
the findings of the clinical studies, the Company shall be given the first

<PAGE>
                                      -4-

right of refusal to negotiate an exclusive or non-exclusive  license  agreement.
As consideration for this license, the Company is obligated to pay MGH royalties
of 5% of net revenue from product/services  covered by valid patents licensed to
the Company exclusively;  2.5% of net revenues of  products/services  covered by
valid patents licensed to the Company non-exclusively;  1.25% of net revenues of
products developed and exploited, not covered above and no less than 2.5% on the
sale of any other laser using  other  technology  as defined for the use of hair
removal.

ACQUISITION OF TISSUE TECHNOLOGIES, INC.

     On May 3,  1996 the  Company  acquired  100% of Tissue  Technologies,  Inc.
("Tissue  Technologies"),  an  Albuquerque,  New Mexico  based  manufacturer  of
dermatology  laser products,  in exchange for 3,200,000  shares of the Company's
common   stock.   The  Company  has  accounted   for  this   acquisition   as  a
pooling-of-interest  in  accordance  with  Accounting  Principles  Board Opinion
No.16. Tissue Technologies is engaged in the manufacture, marketing and sales of
C02 laser systems used in skin resurfacing and treatment of wrinkles.

ACQUISITION OF DERMASCAN, INC.

     On July 18, 1996 the Company  purchased  80 shares of common  stock (80% of
total issued and  outstanding  capital stock) of Dermascan,  Inc.  ("Dermascan")
from a Dermascan  stockholder  in exchange for 35,000  shares of common stock of
the  Company.  The  Company  included  these  35,000  shares  in a  registration
statement that became effective February 28, 1997. In addition,  the Company has
agreed  to pay the  Dermascan  stockholder  an  amount  equal to the  difference
between  $14.00 and $7.8125,  the closing bid price on February  28,  1997.  The
agreement  also  includes  a put  right  by the  remaining  20%  stockholder  of
Dermascan,  which  provides that, at any time after three years from the date of
the agreement,  the Company will be required to purchase the  stockholders'  20%
interest for $130,000 in cash. In  connection  with the  agreement,  the Company
entered into a five year  employment  agreement  with the President of Dermascan
which guarantees annual payments of up to $125,000. Dermascan's operations prior
to acquisition  were not material.  The Company has recorded the  acquisition at
the  guaranteed  stock price of $490,000 in total.  Dermascan  markets and sells
electrology  equipment  and supplies to the  electrology  market.  To date,  the
operations of Dermascan have not been significant.

FORMATION OF PALOMAR TECHNOLOGIES, LTD.

     On November 13, 1996, the Company formed Palomar Technologies, Ltd. located
in Hull,  England.  This company was formed to establish a European  resource to
manufacture,  sell and service laser  products  throughout  Europe and provide a
low-cost sourcing alternative for specialty components.  Operations have not yet
begun and will not begin until mid-1997.  Through February 28, 1997, the Company
has funded this  subsidiary  with  $1,592,180  for the purchase and lease of its
manufacturing facilities and the hiring of certain key employees.

FORMATION OF PALOMAR MEDICAL PRODUCTS, INC.

     On February 18, 1997, the Company formed Palomar Medical Products, Inc. for
the  purpose of  consolidating  the  management  and  operations  of the medical
products  companies.  Included in the Medical  Products  Group are the following
companies:  Spectrum,  Tissue, Star Medical, Dermascan and Palomar Technologies,
Ltd.

MEDICAL SERVICES SEGMENT
------------------------

FORMATION OF COSMETIC TECHNOLOGY INTERNATIONAL, INC.

     On December 20, 1996, Cosmetic Technology  International,  Inc. ("CTI") was
formed as a 100%-owned  subsidiary  of the Company.  As of December 31, 1996 the
Company had funded CTI with cash of  approximately  $650,000.  CTI is a services
company   which   intends  to   establish  a   worldwide   network  of  cosmetic
dermatological  laser and medical  device sites with medical  services  partners
(both fixed and mobile) in key geographic locations.  Each site will be provided
a turnkey package of laser and medical device  technology,  equipment,  training
and service, operations personnel, strategic advertising and marketing programs,
patient  financial credit programs and management  assistance.  In early 1997, a
binding letter of intent was completed with Columbia/HCA,  a $20 billion company
and one of the world's  largest owners and operators of medical  facilities,  to
establish revenue sharing sites throughout the country in existing  Columbia/HCA
facilities. During 1996 the operations of CTI were not significant.

<PAGE>
                                      -5-

MEDICAL PRODUCTS AND LASERS IN MEDICINE

     EPILASER PRODUCT FOR LASER HAIR REMOVAL

     In recent years,  scientists and clinicians have developed a concept called
TISSUE OPTICS to describe how the unique  properties of the laser can be used to
treat human tissue selectively and more precisely. By careful selection of laser
parameters,  such as wavelength (color), energy and pulse width (exposure time),
and with a detailed  understanding of the physical and optical properties of the
target  tissue,  the  clinician  can  selectively  treat the target tissue while
minimizing or  eliminating  damage to surrounding  tissue.  The concept of color
selectivity  has been useful in developing a number of  successful  dermatologic
applications.  With the appropriate selection of energy and pulse width to allow
for the preferential  absorption by the melanin present in the target area or by
the  hemoglobin  in blood  there is  negligible  absorption  by the  surrounding
tissue.  This  concept  of tissue  optics  applies to all of the  medical  laser
products under development by the Company.

     Spectrum has  developed a long pulse ruby laser,  using its core ruby laser
technology  developed  for  tattoo  removal  and  pigmented  lesions,   that  is
specifically  configured to allow the appropriate  wavelength,  energy level and
pulse  duration to  effectively  be absorbed by the hair follicle  without being
absorbed  by the  surrounding  tissue.  In  March  1997  Spectrum  received  FDA
clearance to sell and market the EpiLaser in the U.S. for hair removal.  In July
1996 the Company received clearance from the FDA to sell and market the EpiLaser
for a wide range of  dermatological  applications,  not including  hair removal.
During April of 1996, clearance was given to market the laser-based hair removal
system in Canada.  This method of hair removal allows for selective  destruction
of the target follicle without harming the surrounding  skin. The laser operates
in the 20-25 J energy range, delivering fluences in the range of 10-50J/cm2 in a
3-ms  pulse.  The beam  delivering  system  produces  a round beam with a nearly
flat-top energy distribution, thereby avoiding local hot spots. The hair-removal
technology  utilized by Palomar  targets the pigment in a hair  follicle and was
developed  by Dr. Rox  Anderson at MGH.  The laser  incorporates  a  proprietary
handpiece  delivery  system that  enables the laser  light to  penetrate  to the
correct  depth  while  at the  same  time  limiting  the  amount  of  discomfort
associated  with the  procedure.  The  laser  light is  pulsed  at a rapid  rate
covering approximately one half square inch at each pulse. This treatment method
allows for a large area of treatment over a short period of time.

     In an effort to find a way to allow the  laser  light to pass  through  top
skin  layers  and be  deeply  absorbed  in the hair  follicle  below,  a contact
handpiece  applicator  was  developed  by MGH and  licensed  to  Spectrum  on an
exclusive  world-wide perpetual basis. This unique delivery device is the key to
the success and  selectivity  of the ruby based laser hair removal  system.  The
Company  believes  this  unique  delivery  system  enables the user to address a
potentially larger market than electrolysis  currently does by offering to treat
large  areas of the body  such as back,  chest,  abdomen,  legs,  arms and other
areas. See "License and Research Agreement with  Massachusetts  General Hospital
for Laser Hair Removal".

     THE HAIR-REMOVAL MARKET

     The market for  laser-based  hair  removal is in its early  stages  and, as
such,  market  segment  information  is  only  now  being  formulated.  However,
management  believes that the current  electrolysis market is a good model. Last
year, more than one million women in the United States underwent treatment using
electrolysis,  spending on average more than $1,000 each,  representing a market
of approximately $1 billion annually.  In addition,  surveys indicate as many as
15% of men would  also like to remove  unwanted  hair  especially  from back and
chest areas.  Electrolysis is the only proven commercially  available method for
the  long-term  removal of body hair.  Other  methods  of hair  removal  include
waxing,  depilators,  tweezing,  depilatory creams and shaving, all resulting in
only short-term hair removal.

         Electrolysis  is a process in which an  electrologist  inserts a needle
directly into a hair  follicle and activates an electric  current in the needle,
which disables the hair  follicle.  The tiny blood vessels in each hair follicle
are heated and coagulated,  presumably  cutting off the blood supply to the hair
matrix or are destroyed by chemical  action  depending  upon modality  used. The
success  rate for  electrolysis  is  variable  depending  upon the  skill of the
electrologist  and  always  requires  a series of  treatments.  Electrolysis  is
time-consuming, expensive and sometimes painful. There is also some risk of skin
blemishes and a rising concern relating to needle infection.  Since electrolysis
only  treats  one  hair  follicle  at a time  and can only  treat  visible  hair
follicles,  the  treatment  of an area as  small  as an  upper  lip may  require
numerous  visits  at an  aggregate  cost of up to  $1,000.  Although  70% of all
electrolysis  treatments are for facial hair, the neck,  breasts and bikini line
are  also  treated.   

<PAGE>
                                       -6-

Because hair follicles are disabled one at a time,  electrolysis  is rarely used
to remove hair from large areas such as the back, chest, abdomen and legs.

     Market  surveys  report  that more than 70% of women in the  United  States
employ one or more  techniques  for temporary hair removal from various parts of
the body.  Pulling  hair from the follicle  produces the longest term  temporary
results,  but is painful and may cause skin  irritation.  A number of techniques
are used to pull  hair  from  the  follicle  including  waxing,  depilators  and
tweezing. In the waxing process, a lotion, generally beeswax-based, is spread on
the area to be treated and allowed to harden,  thereby  trapping the hairs.  The
hardened  film is then  rapidly  peeled off,  pulling out the  entrapped  hairs.
Depilators employ rotating spring coils or slotted rubber rolls to trap and pull
out the  hairs.  Tweezing  involves  removing  individual  hairs  with a pair of
tweezers.  Depilatory creams,  which contain chemicals to separate hair from the
follicle, frequently leave a temporary,  unpleasant odor and may also cause skin
irritation.  Shaving is the most widely used method of hair removal,  especially
for legs and underarms, but produces the shortest term results. Hair bleaches do
not  remove  hair,  but  instead  lighten  the  color of hair so that it is less
visible.  A  principle  drawback  of all of these  methods is that they  require
frequent treatment.

     Preliminary   studies   using   Spectrum's   laser  hair  removal   process
demonstrated  significant  prolonged  hair growth delay ranging from six to nine
months  to in  excess of two years in some  cases.  In some  cases,  the hair is
permanently removed following treatment with the EpiLaser. Potential benefits of
laser hair removal include: treatment of larger areas in each treatment session,
relatively painless procedure, reduced risk of scarring, non-invasive procedure,
carries  no risk of  cross-contamination,  and  higher  success  rates than with
previous methods.

     COMPETITION

     Currently,  there are three other companies (ThermoLase (Division of Thermo
Electron Corp.),  Laser Industries,  Ltd. and MEHL/Biophile  International) that
have FDA clearance for a laser-based  hair removal  system in the United States.
ThermoLase, a publicly traded company,  received clearance from the FDA in April
1995 to commercially  market services using its laser-based hair removal system.
The ThermoLase system uses a low-energy, dermatology laser in combination with a
carbon based lotion that absorbs the laser's  energy to disable hair  follicles.
ThermoLase opened up spas in California, Texas, Florida and Colorado. ThermoLase
is also opening or plans to open additional spas, including in suburban Detroit,
Michigan; Greenwich, Connecticut;  Manhasset, New York; Minneapolis,  Minnesota;
and Palm Beach, Florida. As part of its commercialization  strategy,  ThermoLase
plans to establish a network of  ThermoLase-owned  centers in major metropolitan
areas in the U.S.,  third-party  licensees in selected  smaller U.S. markets and
joint  ventures  in  foreign  markets.  Laser  Industries,  Ltd.,  received  FDA
clearance in March 1997 to market its  EpiTouchTM  ruby laser for hair  removal.
The EpiTouchTM  will be sold in the U.S.  through  Sharplan 2000,  Inc., a joint
venture  of  Laser  Industries,   Ltd.  and  MEHL/Biophile  International  Corp.
MEHL/Biophile's wholly owned subsidiary, Selvec Acquisitions Corp., received FDA
clearance  in March 1997 to market its SLS CHROMOS 694 (R) long pulse ruby laser
hair removal system.

     Several other companies have also indicated  interest in developing  and/or
introducing  hair  removal  devices in 1997,  making laser hair removal the most
competitive application within the cosmetic laser marketplace.

     As more companies complete  development of cosmetic/medical  laser products
and/or  receive FDA clearance it is expected that there will be a  consolidation
of companies within the industry via  acquisitions,  partnering  arrangements or
joint  ventures.  In February 1997, ESC Medical  Systems  announced a definitive
stock swap agreement under which it would acquire Luxar Corporation, a privately
held manufacturer of surgical lasers.

     MARKETING, DISTRIBUTION AND SERVICE FOR THE EPILASER

     Spectrum sells and markets the EpiLaser  through an established  network of
distributors  in the U.S.  and  worldwide  and will also  enhance  and develop a
direct sales force during 1997.  Management feels that this  combination  allows
for a level of  coverage  that is more than  adequate  to service  all its major
market  segments.  As part of  Spectrum's  marketing  efforts,  the sales  force
provides  the  doctors  a level  of local  market  support  including  in-office
marketing brochures,  advertising copy and clinical data in a marketing kit that
the doctor uses to educate  the  doctors'  patient  base.  Using this  marketing
approach,  Spectrum  is able to  establish  long  term  relationships  with  its
customers  providing Spectrum with an installed base of customers.  This base of
customers is an important factor in introducing new products to the market.

<PAGE>
                                       -7-

Spectrum  provides for service in the U.S. through its own service  organization
with regional representation. Spectrum's international sales are serviced by its
distributor network. All service technicians are trained by Spectrum. Spectrum's
recommended  preventive maintenance schedule provided by these trained technical
representatives provides for a high level of product reliability.

     MANUFACTURING AND SUPPLIERS FOR THE EPILASER

     Spectrum's  manufacturing operations consist of the assembly and testing of
components purchased from outside suppliers and contract manufacturers. Spectrum
maintains  control and  manufactures key components  in-house.  The entire fully
assembled  system is  subjected  to a rigorous set of tests prior to shipment to
the customer or distributors.

     Spectrum  depends and will depend  upon a number of outside  suppliers  for
components used in its manufacturing  process. Most of Spectrum's components and
raw materials are available from a number of qualified  suppliers.  One critical
component that is available through only one supplier is ruby rods. To date, the
Company has not experienced,  nor does it expect to experience,  any significant
delays in obtaining component parts or raw materials.  Spectrum has expanded its
manufacturing  capabilities in the United States to satisfy projected demand and
allow for manufacturing  capacity for additional products.  Spectrum is pursuing
both CE mark and ISO 9001 Registrations to meet  international  standards needed
to pursue European markets.

     TRU-PULSE(R) C02 LASER FOR SKIN RESURFACING AND TREATMENT OF WRINKLES

     Tissue  Technologies  manufactures  and sells the Tru-Pulse  Laser. In late
1995,  Tissue  Technologies  received  FDA  clearance  to sell  and  market  its
Tru-Pulse laser in the U.S. for skin resurfacing.  To date, Tissue  Technologies
has shipped  approximately 250 laser systems to dermatologists and other medical
specialists  worldwide.  In October of 1996 Tissue Technologies received both CE
Mark and ISO 9001 registrations,  meeting the international standards that allow
products to be sold and shipped primarily to European countries. On February 18,
1997, Tissue Technologies received additional clearance from the FDA to sell and
market its Tru-Pulse Laser for the treatment of wrinkles, scar revision and burn
debridement.

     The Tru-Pulse  laser offers skin ablation as a means of reducing  wrinkles.
The laser uses certain  patented C02  technology  designed  especially  for skin
ablation.  The Tru-Pulse  operates at 10,000 watts of peak power  delivering 500
millijoules per pulse in a 65 microsecond  pulse.  The Tru-Pulse has the ability
to deliver the required amount of energy in a relatively short pulse as compared
to competitors'  systems. The Tru-Pulse also has a unique beam profile. Most C02
lasers have a gaussion beam with a central hot spot. In contrast,  the Tru-Pulse
has a  non-gaussion  beam with power  evenly  distributed  throughout  its cross
section.  Clinical data suggests that the  combination of these unique C02 laser
properties  may  account  for the  shorter  healing  time and  reduced  erythema
reported by doctors who use the Tru-Pulse.

     The Tru-Pulse is currently  being sold through  distributors  in the United
States  as  well as  internationally.  Tissue  Technologies  utilizes  the  same
distributors as Spectrum Medical and is in the process of  enhancing/utilizing a
joint direct sales force within the Palomar Medical  Products Group.  The system
is also sold to dermatologists,  plastic surgeons and other medical  specialists
directly.

     MANUFACTURING AND SUPPLIERS FOR TRU-PULSE LASER

     Tissue Technologies'  manufacturing  operations consist of the assembly and
testing  of   components   purchased   from  outside   suppliers   and  contract
manufacturers.  Tissue  Technologies  depends upon a number of outside suppliers
for components used in its assembly process. To date Tissue Technologies has not
experienced any significant  delays or other  difficulties in obtaining parts or
components.  The Tissue  Technology CO2 technology is based on recent technology
advances  and as such  is yet to be  optimized.  Currently,  the  most  critical
component is manufactured by one supplier that has experienced  problems in tube
reliability.  The Company is currently  seeking other alternative tube suppliers
as well as considering manufacturing and producing the CO2 tubes themselves, and
believes that this reliability issue will be rectified during 1997.

<PAGE>
                                      -8-

     COMPETITION FOR TISSUE'S TRU-PULSE LASER

     Currently,  there are three main competitors to the Tru-Pulse Laser:  Laser
Industries  (Sharplan),  Coherent,  Inc.  and Luxar  (recently  acquired  by ESC
Medical  Systems.)  Laser  Industries  and  Coherent,   combined,   account  for
approximately  50% of the world market.  The  estimated  U.S.  patient  services
market for skin resurfacing and treatment of wrinkles is $500-plus million.  The
annual worlwide  cosmetic skin resurfacing  product laser market is estimated to
be approximately  $115 million.  These numbers are expected to increase as "baby
boomers" age into their 50's. Coherent had been pricing its UltraPulse System at
the high end of the market with a high power laser that lists for $120,000,  but
recently introduced new models which are priced from $75,000 to $90,000.  Tissue
Technologies, Sharplan and Luxar average list price is $40,000 - $70,000.

     RUBY LASER FOR TATTOO REMOVAL

     In April 1995, the Company acquired all of the outstanding  common stock of
Spectrum.  This  acquisition  provided the Company with an operating  subsidiary
concentrating  on sales and  marketing  to the cosmetic  laser market  including
dermatologists  and plastic  surgeons.  The majority of Spectrum's  sales in the
past have been Q-Switched Ruby Lasers for tattoo removal and treating  pigmented
lesions,  but in 1996  more than half of  Spectrum's  sales  were from the newly
developed  EpiLaser.  The EpiLaser  will  clearly be the focus in 1997,  but the
RD-1200 ruby laser for tattoo  removal will  continue to be marketed and sold as
it is already approved for sale in the U.S., Japan and in certain other parts of
the world. The basic ruby laser  technology  includes core laser technology that
the Company believes is applicable to other lasers for additional  applications.
Spectrum  sells and  markets  the  RD-1200  through  an  established  network of
distributors  and  direct  sales  force in the  U.S.  and  through  distributors
worldwide.  Spectrum  provides  for service in the U.S.  through its own service
organization with regional  representation.  Spectrum's  international sales are
serviced by its distributor network.

     COMPETITION FOR SPECTRUM'S RUBY LASER FOR TATTOO REMOVAL

     Competition  in the  medical  device  industry  is intense  and  technology
developments  are  expected to continue at the rapid pace  experienced  over the
past few  decades.  Spectrum  relies  on  proprietary  technology,  performance,
product features, price, reputation in the marketplace and its installed base as
leverage to keep its competitive edge in the marketplace. Spectrum competes with
other  manufacturers,  some with similar  technology  and others with  competing
technology.   Some  of  these  competitive  companies  have  greater  financial,
marketing and technical resources than that of Spectrum. The Company anticipates
competition for its tattoo removal laser will continue.

FUTURE PRODUCTS

     RELATIONSHIP WITH WELLMAN LABORATORIES

     Wellman Laboratories ("Wellman Labs"), the world's largest biomedical laser
research  facility  and  part  of  the  MGH  Laser  Center  located  in  Boston,
Massachusetts,  was  created to oversee and speed the flow of  biomedical  laser
research from the laboratory to patient care. Funded in part by a grant from the
Department of Energy, the Laser Center brings together two strengths of MGH: its
clinical  departments and Wellman Labs. The MGH Laser Center works together with
industry,  academia,  and  the  Department  of  Energy  Laboratories  to  access
information  and  technology  across  a broad  spectrum  of  laser  and  medical
capabilities.

     The  principals  at Wellman Labs study the  fundamental  photophysical  and
photochemical  properties and processes of biomolecules  excited by ultraviolet,
visible, and near infrared radiation.  The labs are staffed by engineers,  laser
physicists and physicians familiar with all aspects of biomolecules,  cells, and
tissue IN  VITRO.  The  scientists  work  side by side  with the  clinicians  to
understand the basic  principles  involved in the complex  interactions of light
and tissue.

     In 1994, the Company began a number of studies for the treatment of certain
dermatologic  conditions  using its diode laser at Wellman Labs. In 1995,  these
studies  were  expanded  to include  the  Company's  ruby  lasers  for  cosmetic
procedures.  The data  associated  with  these  treatments  is  currently  being
evaluated by Wellman Labs and the Company. The Company works closely with Dr. R.
Rox Anderson,  a recognized expert in laser tissue  interaction and the inventor
of a number of laser procedures in use today. The Company feels that these types
of relationships  are critical in developing  effective  products for widespread
use in the market on a timely basis.

<PAGE>
                                      -9-

     DIODE LASER PRODUCT DEVELOPMENT

     BURN DIAGNOSIS SYSTEM - U.S. AIR FORCE CONTRACT

     In March 1994,  the  Company's  Star  subsidiary  was  notified  that their
proposal entitled "High Energy Diode Laser for Burn Diagnosis," submitted to the
Phillips  Laboratory  Kirkland Air Force Base, New Mexico under DOD Solicitation
94.1 Topic  AF94-110,  had been selected for funding.  The initial  contract,  a
phase I Small Business  Innovation  Research  Grant  ("SBIR") for  approximately
$60,000, was completed.

     On June 21, 1994, Star was granted an exclusive  worldwide  license for the
measurement  of the Burn Depth in Skin from the Office of Technology  Affairs at
MGH.

     In March 1995, Star was granted a follow-on phase II SBIR contract with the
U.S. Air Force,  Phillips  Laboratory,  for the research and  development of the
burn diagnosis system.  The aggregate  contract value is approximately  $743,000
over a two-year  performance period.  During the fiscal years ended December 31,
1996 and 1995,  the Company  recognized  $281,991  and  $307,000  of  government
contract revenue, respectively.

     In January 1996, Star began initial  clinical testing of the burn diagnosis
system at the Shriner  Burn Center in Boston,  Massachusetts  and at the Augusta
Medical  Center in Augusta,  Georgia in November 1996. The system is designed to
illuminate  the burn site with near  infrared  light  from a diode  laser and to
image the blood flow using fluorescence from an FDA cleared dye as an aid to the
doctor in determining the burn depth.  The treatment of the burn differs greatly
depending  on the  degree  of burn.  This  technique  has been  licensed  by MGH
exclusively to Star. To date the system has been tested on five burn victims and
has  demonstrated  the  ability to detect the  absence or presence of blood flow
deep in the dermis.  The Company expects that it may take several years before a
commercial product for the measurement of burn depth is available.

     LASER TONSILLECTOMY  RESEARCH AGREEMENT WITH THE NEW ENGLAND MEDICAL CENTER
     ("NEMC")

     In June 1994, the Company signed an agreement (the "NEMC  Agreement")  with
the Otolaryngology  Research Center for Advanced Endoscopic  Applications at New
England Medical Center, Boston,  Massachusetts,  to provide a research grant and
to  sponsor  investigations  and  development  of laser  applications,  advanced
delivery  systems  and  disposable  products  in the area of dye and diode laser
applications in  otolaryngology  and related  specialties.  As defined under the
NEMC  Agreement,  the Company will  provide a total of $150,000  over a one-year
period,  of which  $50,000  has been paid in the form of laser  hardware  and an
additional  $100,000 has been incurred  through  December 31, 1995.  The parties
have reached an  understanding  that the Company will obtain ownership rights or
the right of first  refusal to exclusive  worldwide  licenses to sell and market
any  inventions  developed  with the grant  funding.  In August  1994,  the NEMC
Agreement was amended to support animal testing with one of the Company's  diode
lasers in connection with performing  tonsillectomies.  The Company has provided
funding of $54,813 and $36,534  for the years ended  December  31, 1995 and 1996
respectively.  The Company  intends to fund human clinical  studies in this area
over the next twelve-month  period. The Company expects that it may take several
years before a commercial product for tonsillectomy is available.

     DYE LASER PRODUCT DEVELOPMENT

     SOLID-STATE DYE LASER SYSTEM DEVELOPMENT

     In response  to an  increasing  demand  within the  medical  community  for
reliability,  compactness and lower cost, the Company has completed  preliminary
work on the development of a solid-state laser that the Company believes will be
substantially  smaller in size,  less  expensive and easier to maintain than the
current medical pulsed dye lasers. By using a solid-state lasing medium in place
of fluid,  the need for pumps,  plumbing,  valves,  filters and fluid reservoirs
found in a liquid dye laser can be eliminated.  In addition,  since  solid-state
lasers do not  require  regular  dye and filter  changes  and have fewer  moving
parts,  they  may  prove  to  be  more  reliable.  Research  has  indicated  the
feasibility  of a  solid-state  laser  device and the  Company  has  developed a
working prototype.  The development of the Company's solid-state laser is in the
very  preliminary  stages,  however,  and the Company  does not  anticipate  the
inclusion of this technology into its products within the next few years.

<PAGE>
                                      -10-

     U.S. ARMY CONTRACT

     During  1995,  the  Company  entered  into a  two-year  cost plus fixed fee
contract  with  the  U.S.  Army.  The  contract  provides  for  the  Company  to
investigate Compact,  Wavelength Diverse, High Efficiency Solid-State Dye Lasers
and is valued at $3,555,223.  Revenue on the contract is recognized as costs are
incurred. During the fiscal years ended December 31, 1995, and December 31, 1996
the Company  recognized  $1,305,542  and $190,694,  respectively,  of government
contract revenue. The Company does not anticipate this research will result in a
commercial  product within the next few years.  The Company has submitted to the
U.S.  Army a draft  Novation  Agreement in which it seeks to have this  contract
novated to Physical Sciences,  Inc. ("PSI").  If the contract is novated to PSI,
upon completion of the contract,  PSI has agreed to offer the Company a right of
first refusal for a commercial license to sell, manufacture or otherwise dispose
of solid-state  dye laser  technology as developed by PSI under the contract for
use in medical products.

     THROMBOLYSIS AGREEMENT

     On September 10, 1993, the Company  entered into the Baxter  Agreement with
the  Edwards  LIS  Division  of  Baxter.  Under the  Baxter  Agreement,  the two
companies  intend to develop,  market,  and sell an integrated  system utilizing
lasers and catheters for the removal of blood clots.  Baxter is responsible  for
sales and  marketing  of the  product  after FDA  clearance  and the  Company is
responsible for the  development  and manufacture of the product.  Following FDA
clearance the Company will receive 80% of the net sales for laser  equipment and
50% of the net  sales  for  catheter  and  disposable  components.  Prior to FDA
clearance,  the Company will receive 100% of the revenue received from the laser
and the catheter.  Under the Baxter  Agreement,  Baxter licensed its proprietary
technology  to the Company,  and the Company  cross-licensed  its  technology to
Baxter. The Company also granted to Baxter a license to sell and market products
incorporating  such  technology.  Baxter  agreed to transfer its interest in the
agreement to ACS, a division of Eli Lilly, as part of a purchase by Eli Lilly of
the Baxter LIS  division.  Eli Lilly  subsequently  sold ACS to Guidant Corp. In
January  1997,  Palomar  became  an equity  partner  in the  formation  of a new
company,  LaTIS, Inc., created to use Palomar's Laser Thrombolysis technology to
develop a pulsed-dye  laser system for treating  stroke.  With the  formation of
this new venture,  Laser  Thrombolysis is no longer part of Palomar's  strategic
agenda,  although the Company can still derive the benefits from its research by
potentially being the laser supplier for this large market.

     PATENTS AND LICENSES

     On February 24, 1993,  the  principals  of the  Company's  Star  subsidiary
applied for a patent.  This application was subsequently  transferred to Star in
connection with the technology  underlying the use of a high powered diode laser
for the treatment of psoriasis and other derma vascular malformation. The patent
was  issued on June 18,  1996.  On June 22,  1995,  the NEMC  filed a patent for
Coagulation Laser Tonsillectomy. The patent was issued on May 28, 1996. Star has
applied for  additional  patents  regarding  the design and use of high  powered
diode lasers. The Company has exclusive rights to the NEMC patent. MGH has filed
a number of patents  surrounding  technology  involving laser hair removal.  The
first patent was issued on January 21, 1997. The Company has licensed this laser
hair  removal  technology  from MGH in  accordance  with a certain  license  and
research agreement as previously discussed.

     The Company intends to pursue certain  applications of laser  technologies,
and  is  aware  of  patents  relating  to  laser   technologies  used  in  those
applications.  If those patents are valid and enforceable, they may be infringed
by the  Company.  If the  Company's  current or  proposed  products  are, in the
opinion of patent  counsel,  infringing  on any of these  patents,  the  Company
intends to seek non-exclusive, royalty-bearing licenses to such patents.

     The  Company  has  obtained  opinions  of counsel  that the  Company is not
infringing  on patents held by others;  however,  these  opinions  have not been
challenged in court.

         In March 1997, Selvac  Acquisitions Corp.  ("Selvac") filed a complaint
in the United  States  District  Court for the District of New Jersey  alleging,
among other  things,  that the EpiLaser  infringes a patent held by Selvac.  The
Company filed an action  against  Selvac's  parent  MEHL/Biophile  in the United
States District Court for the District of Massachusetts in October 1996 seeking,
among other things,  a declaration  that the Company does not infringe  Selvac's
patent and that Selvac's patent is invalid, void and unenforceable. See "Item 3.
Legal  Proceedings."  Other than the Selvac  action,  the  Company  has not been
notified  that it is  currently  infringing  on any  patents nor has it been the
subject of any patent 

<PAGE>
                                      -11-

infringement action. Defense of a claim of infringement is costly and could have
a material adverse effect on the Company's business, even if the Company were to
prevail.

     The United States Patent and Trademark  Office has granted  certain patents
covering  basic  laser  technology  to  Dr.  Gordon  Gould,  an  individual  not
affiliated with the Company. In October 1988, Dymed, the Company's  predecessor,
entered into a License  Agreement  with Patlex  Corporation  ("Patlex")  whereby
Dymed was granted a worldwide  non-exclusive  license to several  laser  related
patents  developed by Dr. Gould and assigned to Patlex ("Dymed  Agreement").  In
exchange  for  payment  of  royalties,  Patlex  granted  to Dymed  the  right to
manufacture  lasers using its patented  technologies until the expiration of its
patents  and  agreed  not to sue  the  Company  or  any  of  its  customers  for
infringement of the licensed patents.  In January 1992, the Company entered into
a new Patent  License  Agreement  with  Patlex  (the  "Patlex  Agreement")  that
superseded the Dymed  Agreement.  Under the terms of the Patlex  Agreement,  the
Company is required to pay,  during the term of the applicable  licenses  (which
are for the life of the patents  covered),  royalties  of 5% of the "net selling
price" (as defined  therein) of lasers which are  manufactured,  used or sold by
the Company,  and incorporate  Patlex's  patent rights.  These patents expire on
various dates through May 4, 2005.  During the years ended December 31, 1996 and
1995,  the Company  recorded  $167,000 and  $620,000,  respectively,  of royalty
expense relating to this agreement.

GOVERNMENT REGULATION

     All medical devices are subject to FDA regulation  under the Medical Device
Amendments  of the United  States Food,  Drug and Cosmetics Act (the "FDA Act").
The Company's  business,  financial  condition  and  operations  are  critically
dependent upon timely receipt of FDA regulatory clearances.

     FDA CLEARANCE STATUS FOR COSMETIC LASER PRODUCTS

     The FDA clearance  process in  dermatology  may be  accomplished  through a
pre-market  approval  ("PMA") or under Section 510(k) of the FDA Act. Based upon
discussions  with  several  experts  familiar  with the FDA  clearance  process,
management  believes  that  the  appropriate  FDA  clearance  process  for  most
dermatology  laser  systems is via the 510(k)  process  which  historically  has
required  less  clearance  time than the PMA clearance  process.  The Company is
subject to FDA regulation governing the use and marketing of medical devices.

     In December 1995,  the Company filed an application  for clearance with the
FDA to  commercially  market the  EpiLaser  system  pursuant to the FDA's 510(k)
process.  The data  submitted  in the filing was based on  clinical  information
obtained at Wellman Laboratories under the direction of Dr. R. Rox Anderson. The
purpose of the data was to illustrate  the safety and  effectiveness  of using a
ruby laser for removing  unwanted  hair. In March 1997 the Company  received FDA
clearance to sell and market the EpiLaser in the U.S. for hair removal.  In July
1996 the Company received clearance from the FDA to sell and market the EpiLaser
for a wide range of dermatological applications, not including hair removal. The
Company's  other FDA cleared lasers  include the Tru-Pulse for skin  resurfacing
and  treatment  of  wrinkles  and the  RD-1200(TM)  Q-switched  ruby  laser  for
treatment  of age spots and  tattoos.  In the event the  Company  changes  laser
specifications  of its  lasers,  it may be  required  to  obtain  FDA  clearance
pursuant to a new 510(k) application.

     OTHER GOVERNMENT APPROVALS FOR MEDICAL PRODUCTS

     In order to be sold outside the United States,  the Company's  products are
subject to FDA permit  requirements  that are conditioned  upon clearance by the
importing  country's  appropriate  regulatory  authorities.  Many countries also
require that imported products comply with their own or international electrical
and safety standards. In November 1992, the Company obtained approval certifying
compliance  with  certain   international   electrical  and  safety  regulations
applicable  to its pulsed dye laser.  Additional  approvals  may be  required in
other countries. The Company has yet to apply for international approval for its
diode  laser for use in  cosmetics  and  dermatology.  In October  1996,  Tissue
Technologies  received  both  CE  Mark  and  ISO  9001  registrations,   meeting
international  standards that allow the Tru-Pulse  laser to be sold and marketed
in certain European  countries.  Another  significant  certification the Company
will pursue will be Shonin,  which allows sales and  marketing of the  Company's
lasers in Japan.

         The Company is subject to the laser radiation safety regulations of the
FDA Act administered by the National Center for Devices and Radiological  Health
("CDRH") of the FDA. These regulations  require a laser manufacturer to file new
product and annual reports,  to maintain  quality  control,  product testing and
sales  records,  to distribute  appropriate  operation  

<PAGE>
                                      -12-

manuals,  to incorporate certain design and operating features in lasers sold to
end-users  and to certify and label each laser sold to  end-users as one of four
classes of lasers (based on the level of radiation from the laser). In addition,
various  warning  labels must be affixed to the  product and certain  protective
devices must be installed,  depending  upon the class of product.  Under the FDA
Act, the Company is also required to register  with the FDA as a medical  device
manufacturer  and is subject  to  inspection  on a routine  basis by the FDA for
compliance  with  Good  Manufacturing  Practice  ("GMP")  regulations.  The  GMP
regulations  impose certain  procedural and documentation  requirements upon the
Company relevant to its manufacturing,  testing and quality control  activities.
The CDRH is empowered to seek fines and other  remedies for  violations of these
regulatory requirements. The Company believes that it is currently in compliance
with these regulations.

ELECTRONIC PRODUCTS SEGMENT
---------------------------

BUSINESS DEVELOPMENTS

     ACQUISITION OF DYNACO CORPORATION

     On February 9, 1994, the Company acquired  substantially  all of the assets
and business of Dynaco Corp.  ("Dynaco"),  Tempe, AZ, for $1,300,000 in cash and
the assumption of  approximately  $6 million in liabilities.  At the time of the
acquisition,  Dynaco had been operating under Chapter 11 of the U.S.  Bankruptcy
Code.  Dynaco now operates as a wholly-owned  subsidiary of the Company and is a
manufacturer of high density flexible  electronic  circuitry with commercial and
government  applications.  The flexible  circuit  technology  utilized by Dynaco
offers  advantages  over  traditional  circuit board  technology in applications
where space constraints and performance  specifications demand compact packaging
and a high  level of  reliability.  Dynaco  has  developed  a number  of  unique
products using the flexcircuit  core technology that it plans to market over the
next twelve months.

     FORMATION OF NEXAR TECHNOLOGIES, INC.

     On March 7, 1995, the Company formed Nexar Technologies,  Inc. ("Nexar),  a
wholly-owned  subsidiary.  Nexar is an early stage company  which  manufactures,
markets,  and sells  personal  computers with a unique circuit board design that
enables end users to upgrade and  replace  the  microprocessor,  memory and hard
drive  components.  Nexar markets its products using various  proprietary  brand
names through multiple channels of distribution, including the wholesale, retail
and direct response channels. Revenue recognized during 1996 was $18,695,364.

     On December 20, 1996,  Nexar filed a  registration  statement  with the SEC
relating to an initial public  offering of 2,500,000  shares of its common stock
for its own account, as well as shares held by Nexar shareholders. The estimated
price per share of the  proposed  offering  is $9.00 to $11.00.  Following  the
offering,  Palomar will  beneficially  own  approximately  67% of Nexar's common
stock subject to a contingent repurchase right of the Company at a nominal price
per  share  in the  event  that  Nexar  does  not  achieve  certain  performance
milestones  set forth in an agreement  between Nexar and Palomar,  and shares of
Nexar common stock which Palomar may acquire upon  conversion of shares of Nexar
Convertible  Preferred Stock. The Company  anticipates that the offering will be
completed by mid-April  1997.  However,  the Company can in no way guarantee nor
ensure successful completion of the initial public offering.

     FORMATION OF DYNAMEM, INC.

     On September 29, 1995,  Dynaco formed a new company  called  Dynamem,  Inc.
("Dynamem") with an outside party who is a joint owner of the patent  underlying
certain  FRAMM  technology  (a  technology  utilized to package  two  rigid-flex
printed circuit boards in the same slot arrangement  that  customarily  houses a
single  board).  The joint  owner  became  an  employee  of the new  subsidiary,
Dynamem.  Dynamem issued 80% of its authorized and outstanding  capital stock to
Dynaco and the remaining 20% to the joint owner. The joint owner granted Dynamem
a non-exclusive  license to  manufacture,  use, sell and sublicense the patented
FRAMM  technology in exchange for certain  royalty  payments.  The royalties are
guaranteed  by  Dynaco.   Dynaco  and  the  joint  owner  also  entered  into  a
stockholders' agreement which grants the joint owner the right, upon the earlier
of December 29, 2000 or the  termination  of his  employment  with  Dynamem,  to
require Dynaco to purchase a total of 75% of the  securities  owned by the joint
owner in Dynamem.  In  addition,  if the  Company  purchases  the joint  owner's
shares,  the  joint  owner  may  elect to  receive  between  35% and 100% of the
purchase price in the form of common stock of the Company.

<PAGE>
                                      -13-

     LICENSE AGREEMENT WITH TECHNOVATION COMPUTER LAB, INC.

     Nexar's  current  PCs are shipped  with  motherboards  based on  technology
licensed  from  Technovation  Computer  Lab,  Inc.  ("Technovation"),  a  Nevada
corporation which, to the best of the Company's knowledge,  is owned by Babar I.
Hamirani, a former executive officer of Nexar whose employment was terminated on
November 29, 1996.  The Company has agreed to acquire all such  technology and a
patent application  related thereto,  and settle all claims between Mr. Hamirani
and Nexar, no later than the closing of Nexar's initial public offering pursuant
to the Asset  Purchase  and  Settlement  Agreement  by and  among Mr.  Hamirani,
Technovation,  Nexar and the Company  dated as of February  28, 1997 (the "Asset
Purchase  and  Settlement  Agreement").  Pursuant  to  the  Asset  Purchase  and
Settlement Agreement and a separate asset purchase agreement between the Company
and Nexar, the Company will first acquire the subject technology and then convey
such technology to Nexar.

     FORMATION OF PALOMAR ELECTRONICS CORPORATION

     On September 15, 1995, the Company formed Palomar  Electronics  Corporation
("PEC"), a wholly-owned subsidiary,  as part of a reorganization to separate the
electronics  and computer  operations of the  Company's  business from the laser
segments of its business. On September 29, 1995, as part of this reorganization,
the Company contributed all of its outstanding capital stock of Dynaco and Nexar
to PEC in exchange for all of the outstanding common stock of PEC.

     ACQUISITION OF CD TITLES, INC.

     On July 13, 1995, CD Titles,  Inc. ("CD Titles") was incorporated  with the
Company owning  substantially  all of CD Titles' common stock.  Certain minority
stockholders  of CD Titles  loaned CD  Titles a total of  $600,000.  On July 31,
1995, CD Titles  purchased  certain  assets and assumed  certain  liabilities of
CDRP,  Inc. The purchase price consisted of $625,000 in cash and a $600,000 note
due  September  30, 1995,  which was  guaranteed  by the  Company.  The notes to
minority  stockholders  and CDRP, Inc. were repaid in December 1995 with 386,144
shares of the Company's  common stock. CD Titles is a CD ROM publishing  company
which  distributes  various  materials  on  CD  ROM  through  personal  computer
wholesale channels in the United States.

     ACQUISITION OF COMTEL ELECTRONICS, INC.

     During 1996, Dynaco acquired 80.32% of Comtel Electronics,  Inc. ("Comtel")
by  converting  a  $100,000  note  receivable  into  equity of Comtel and paying
$27,500 in cash.  Effective December 31, 1996, as part of a recapitalization  of
Comtel,  Dynaco  exchanged  $2,200,000 in intercompany  receivables  from Comtel
issued by Comtel to fund its  operations for an additional  16.98%  ownership in
Comtel, resulting in Dynaco owning 97.3% of Comtel. The remaining 2.7% ownership
is held  by two  individuals.  This  acquisition  has  been  accounted  for as a
purchase in accordance  with Accounting  Principles  Board (APB) Opinion No. 16.
Accordingly,  the Company has  allocated  the  purchase  price based on the fair
market value of assets acquired and liabilities  assumed.  The results of Comtel
have been included with those of the Company since March 20, 1996.

     Comtel has entered into a five-year  agreement  with New Media,  Inc. ("New
Media") whereby New Media  subcontracted to Comtel all of its  manufacturing and
assembly  business over the contract  term. On April 5, 1996,  Palomar  invested
$2,690,000 in New Media Series E Preferred Stock and common stock and loaned New
Media an  additional  $1,000,000.  Palomar  also  received a warrant to purchase
200,000  shares of common  stock in New Media at $1.20 per  share.  Palomar  has
accounted for this investment under the cost method.

     On  February  14,  1997  Palomar  invested  an  additional  $1,200,000  and
converted its $1,000,000 note plus accrued  interest  totaling  $76,931 into New
Media  Series F Preferred  Stock.  In  addition,  Palomar  also  entered  into a
settlement  agreement  together with Lucent  Technologies  and New Media whereby
Palomar agreed to purchase 33,000 LapTalk(TM)  speaker/microphone  products from
Lucent Technologies and New Media for $1,200,000, which was paid March 1997.

     During the twelve  months  ended  December 31, 1996 Comtel had sales to New
Media of $15,664,967.  At December 31, 1996,  $4,896,632 of accounts  receivable
was due from New Media,  of which  $2,475,929  was  collected  through March 20,
1997.

<PAGE>
                                      -14-

GENERAL

     Through  its   wholly-owned   subsidiary   Nexar,   PEC  is  marketing  and
manufacturing a new family of personal computers that incorporates user-oriented
printed  circuit boards and computer  chassis  designs that allow an end-user to
conveniently  alter or upgrade the computer's  processor,  memory and hard drive
capacity,  thereby reducing the rate of obsolescence in the rapidly changing and
technology-driven arena of personal computers. Nexar offers PCs to its resellers
without  the CPU,  RAM,  cache and hard drive  pre-installed,  allowing  them to
configure  the PC with  their  customers'  choice of  components.  Unlike  other
upgradeable  or  modular  computers,  Nexar PCs are not  based on a  proprietary
architecture.  Industry standard  components can be used. The customer,  not the
manufacturer's  technicians,  is in control of enhancements  to the system.  The
removable hard drive is a feature that is particularly  desirable where security
is an issue or when a user wants portable data to go. It also makes possible the
use of  multiple  operating  systems  on a single PC.  See  "Formation  of Nexar
Corporation".

     PEC,  through its wholly-owned  subsidiary  Dynaco,  designs,  develops and
manufactures   interconnect   products,   principally  flexible  circuits,   for
electronic systems. Dynaco currently designs flexible interconnect solutions for
complex military and commercial  applications where high reliability,  precision
tolerances  and  multilayer   packaging  are  important.   Dynaco's  traditional
customers serve diverse markets, including the defense,  aerospace,  electronics
and  telecommunications  industries.  Dynaco  has  recently  developed  two new,
lower-cost flexible circuit products which it believes will enable it to develop
more cost-effective interconnect solutions for commercial applications.  Comtel,
which is a majority owned subsidiary of Dynaco, is a contract  manufacturer that
specializes  in thin core and high  density  surface  mount  assemblies  for the
computer and telecommunication  industries.  Dynaco,  through its majority-owned
subsidiary  Dynamem,  has developed,  and plans to manufacture and market to the
personal  computer  industry,  foldable rigid  assembly  memory modules which it
believes  will have  between 50% and 100% more memory  capacity  than  currently
available memory modules.

     PERSONAL COMPUTER INDUSTRY BACKGROUND

     In 1991,  there were over 100 vendors  competing in the  personal  computer
marketplace  with intense  competition in both price and product  specification.
Nexar believes that, over the past five years,  the personal  computer  industry
has become  oversaturated  with  manufacturers  of varying  degrees of financial
stability  and  marketing   expertise.   Since  1995,  many  personal   computer
manufacturers  have exited the industry for a variety of reasons,  and many more
have reported significant losses.

     Nexar believes that aggressive  channel  expansion played an important role
in the demise of many  second and third tier  personal  computer  manufacturers.
Since  1995,  many first tier  manufacturers  have  expanded  their  channels of
distribution  to  include  national  distributors,   mass  merchants,   computer
superstores,  office  superstores,  end-user direct sellers and wholesale buying
clubs.  Prior to 1992, these channels were almost  exclusively the domain of the
second and third  tier  manufacturers.  The  channel  expansion  of the top tier
manufacturers reduced the available retail shelf space for second and third tier
manufactures through these once alternative channels.  Consequently,  second and
third  tier  suppliers,  which  compete  primarily  on the  basis of  price  and
availability, are facing ever-increasing competition.

     NEXAR STRATEGY

     The Nexar  strategy is to provide  products  that benefit  wholesalers  and
resellers  by  reducing  their   commitment  to  inventory  with  specific  unit
configuration  and  permitting  them to satisfy  customers  with systems  easily
configured  to their needs,  and that benefit  end-users by  permitting  them to
upgrade  components  from time to time  without  incurring  the expense of a new
system.

<PAGE>
                                      -15-

     LEVERAGE NEXAR'S XPA(TM) (CROSS-PROCESSOR ARCHITECTURE) TECHNOLOGY.

     Nexar    develops,     manufactures    and    markets     high-performance,
competitively-priced  desktop personal  computers (PCs) based on  patent-pending
technologies.  Unlike  conventional  PCs,  Nexar  systems  permit an end user to
easily upgrade or switch important  components of the PC to accommodate emerging
and future technologies  resulting in a significant  extension of the computer's
useful life. Nexar sells a high-performance system which is typically shipped to
resellers without the key system defining components (microprocessor, memory and
hard drive), but which is otherwise fully configured. This approach:

          Enables the end-user, whether corporate or individual, to buy a system
          configured   exactly  to  that  customer's   technical  and  budgetary
          requirements  and,  later,  to easily  upgrade the PC's key components
          with industry-standard products;

          Enables  Nexar's  channel   resellers  to  reduce  their  exposure  to
          inventory  depreciation  caused by rapid  advances in  technology  and
          frequent  price  reductions  of  the  key  system  components,   which
          typically account for more than 50% of the cost of a PC;

          Enables Nexar's  resellers to compete with direct  marketers,  such as
          Dell Computer and Gateway 2000,  because a Nexar PC provides resellers
          with  the  ability  to  promptly  deliver  a  custom-configured,  high
          performance PC at a competitive price;

          Enables Nexar to maintain profit margins unaffected by the forecasting
          risks borne by  conventional  PC  manufacturers  who operate  within a
          several-month-long  cycle from  component  procurement  to assembly to
          date-of-sale,  all conducted in an environment of rapid  technological
          advances and frequent price reductions.

     Nexar's current PCs are based on an industry  standard,  open  architecture
design,  co-engineered  by HCL Hewlett  Packard  LTD.,  which allows the central
processing  unit (CPU),  random  access  memory  (RAM),  and cashe  memory to be
replaced by  end-users  without  technical  assistance  and without  opening the
entire chassis.  Nexar's current model accepts Intel  Corporation's  Pentium and
compatible  CPUs,  including the recently  released  Pentium  processor with MMX
multimedia extension technology.  Nexar PCs also include, as a standard feature,
a removable hard drive, permitting its replacement and the further advantages of
increased  data  portability  and  security,  and the use of multiple  operating
systems  in a  single  PC.  The  Nexar  PC  is  configured  with  the  following
components:   system  chassis  with  removable  side  panels,   custom  designed
motherboard,  power supply, video controller,  input/output  controller,  floppy
disk  drive,  caddy for  removable  hard disk,  keyboard,  mouse,  and  hardware
manuals.  Nexar occasionally includes additional  components,  including the key
system defining  components (CPU, memory and hard drive) and peripherals such as
monitors and modems at the customer's request. Nexar PCs sold by resellers fully
configured have list prices generally  ranging from $1,200 to $2,500,  depending
upon the components included.

     Nexar's  objective  is to  become  the  industry  leader in  designing  and
marketing PCs with technology that enables  resellers and end-users,  in an easy
and  cost-effective  manner, to upgrade and transition the CPU and the other key
system defining components in accordance with the known and anticipated roadmaps
of various makers of fundamental and  leading-edge  PC technology.  Accordingly,
Nexar has developed  and will soon market a new  generation of PCs featuring the
Company's patent-pending  Cross-Processor ArchitectureTM (Nexar XPATM ) in which
any one of the several  state-of-the-art CPUs can be initially included or later
installed,  including  Intel's Pentium or Pentium Pro and Compatible  CPU's. The
Nexar XPATM  technology  will also  accommodate  microprocessors  based on other
technologies, such as the Alpha CPU made by Digital Equipment Corporation or the
PowerPC processor offered jointly by IBM, Motorola, and Apple Computer.

     ENGAGE IN PRIVATE LABELING.

     Nexar believes that as personal computer users become increasingly computer
literate, they will tend to shift away from branded products and towards private
label  products.  Nexar  anticipates  that  contemporary  technology and design,
upgradability,  value,  reliability and system  flexibility  will continue to be
essential requirements,  but the method of presentation and product distribution
will adapt to satisfy the  requirements  of resellers and users alike. A primary
component of Nexar's overall  channel  strategy is to bypass the OEM and provide
custom,  private  label  systems  directly  to major  channel  resellers.  Nexar
believes that there will be a proliferation of private label personal  computers
by channel resellers, and that

<PAGE>
                                      -16-

private label branding will become an increasingly  standard practice in various
reseller  channels.  Nexar  intends  to be  one of the  first  manufacturers  to
capitalize upon this opportunity.

     EXPLOIT SPECIALIZED GOVERNMENT MARKETS.

     Nexar believes  that, in addition to the other  advantages of Nexar PCs and
the  increased  security  and other  benefits of the  removable  hard disk drive
described  herein,  the Nexar PC is  particularly  appealing to many  government
buyers  because the time  required  for  ordering  entirely new systems is often
prohibitive  under  government  regulations,  while  component parts can be more
timely requisitioned, thereby allowing a government office to more easily remain
technologically  current.  In 1996,  Nexar recognized  approximately  66% of its
total year revenue from Government  Technology Services,  Inc. (GTSI), a leading
supplier of desktop systems to the U.S. government.

     COMPETITION

     The desktop PC industry is intensely  competitive and may become more so as
the  result  of,  among  other  things,  the  introduction  of  new  competitors
(including large multi-national,  diversified  companies) and possibly weakening
demand. Nexar currently competes in the desktop PC market principally with Acer,
Apple Computer,  Compaq Computer, Dell Computer,  Gateway 2000,  Hewlet-Packard,
IBM and  Packard  Bell NEC. In  addition,  Nexar plans to compete in the network
server market by late 1997 with established companies such as ALR, Compaq, Dell,
Hewlett-Packard and IBM. All of these companies have stronger brand recognition,
significantly  greater financial,  marketing,  manufacturing,  technological and
distribution  resources,  broader  product lines and larger  installed  customer
bases than  Nexar.  Principal  competitive  factors  include  product  features,
product performance,  quality and reliability, the ability to deliver product to
customers  in a timely  fashion,  customer  service and support,  marketing  and
distribution   capabilities   and  price.   The  ability  of  Nexar  to  compete
successfully  will depend on factors  within and outside its control,  including
the  acceptance  of its Nexar  XPA(TM)  system and general  market and  economic
conditions.

     MANUFACTURING AND SUPPLIERS

     Nexar's  manufacturing process requires a high volume of quality components
that are  procured  from third party  suppliers.  Most of these  components  are
generally available from multiple sources;  however, Nexar relies on two outside
contractors to manufacture  motherboards used in PCs and plans to rely on a sole
outside  contractor to manufacture  the  motherboards  to be used in its planned
server  product.  In addition,  Nexar relies on a single supplier to produce its
customized chassis and has several other single supplier  relationships for less
critical  components.  In some  cases,  alternative  sources  of supply  are not
readily  available  for  some  of  Nexar's  single  sourced  components.   Nexar
occasionally  experiences delays in receiving certain components,  which can and
has caused delays in shipment of products.

     ENVIRONMENTAL CONTROLS AND GOVERNMENT CERTIFICATIONS

     Although Nexar conducts certain manufacturing operations,  those operations
consist  primarily  of product  assembly  and do not involve the use of material
quantities of hazardous or other  regulated  substances.  Nexar believes that it
has substantially complied with existing environmental laws and regulations, but
has not  conducted  any  environmental  studies of its  operations  to determine
whether contamination has occurred at its facilities.  Nexar's computer products
are subject to certain FCC  guidelines.  Nexar  believes  they are in compliance
with these FCC guidelines.

     INTELLECTUAL PROPERTY

     Nexar has rights to two pending patent applications  covering the essential
technology which enables the easy  installation,  removal and replacement of key
components  in the  Nexar  PC.  Nexar  filed a patent  application  in late 1996
covering its proprietary Nexar XPATM technology, which is expected to be used in
Nexar's PCs by  mid-1997.  Also Nexar has agreed to  acquire,  no later than the
closing of its initial public offering, a patent application originally filed in
March 1995 together with the related  technology which is currently  included in
Nexar's PCs under an exclusive license agreement.

<PAGE>
                                      -17-

DYNACO CORP. BUSINESS INTRODUCTION

     DYNACO CORP. ("DYNACO")

     Dynaco is a leading U.S.  supplier of  high-density,  multilayer,  flexible
printed  circuit  products  for  original  equipment   manufacturers   ("OEMs"),
value-added  resellers and contract  manufacturers of sophisticated  electronics
equipment. Specifically, Dynaco designs, develops and manufactures products that
provide  electrical   connections  between  components  in  electronic  systems.
Dynaco's  interconnect  solutions  use  3-dimensional  packaging  techniques  to
enhance  space  utilization  and  increase  signal  speed via  thin,  multilayer
substrates.  Dynaco's  principal  products are flexible  circuits and rigid-flex
circuits.  Dynaco's flexible circuits are flexible,  multilayer  printed circuit
boards  that can be bent or  folded  to fit into  spaces  too small or too oddly
shaped  for  traditional  rigid  printed  circuit  boards.  Dynaco's  rigid-flex
circuits  consist  of one or  more  rigid,  multilayer  printed  circuit  boards
combined with flexible  circuitry.  The multiple layers of circuitry in Dynaco's
products  increase  reliability and reduce the overall size of its  interconnect
systems by reducing the number of circuit boards,  connectors and wires.  Dynaco
also  manufactures  specialty  interconnect  cable  harnesses that are sold with
Dynaco's traditional flexible circuit products and that are sold independently.

     Dynaco  currently  designs  flexible  interconnect  solutions  for  complex
military  and  commercial   applications   where  high  reliability,   precision
tolerances  and  multilayer   packaging  are  important.   Dynaco's  traditional
customers serve diverse  markets,  including  defense,  aerospace,  electronics,
telecommunications,  global positioning systems navigation, medical electronics,
interactive displays and semiconductor wafer fabrication equipment. For example,
Dynaco's products have been used in guidance systems for the Tomahawk and AMRAAM
missiles,  and  Dynaco has  developed  applications  for  lasers,  night  vision
systems, digital imaging and engine monitoring controls.

     FLEXIBLE INTERCONNECT SUBSTRATE INDUSTRY BACKGROUND

     Generally,  interconnect  substrates  are printed  circuits,  consisting of
copper traces  (circuitry)  and an insulating  (dielectric)  base,  that provide
electrical  connections  between electronic  components such as microprocessors,
resistor networks and capacitors.  Interconnect substrates include rigid printed
circuit  boards,  ceramic hybrid  circuits and flexible  circuits.  Each type of
substrate  has  specific  performance  and price  ratios  which affect usage and
demand in the marketplace.

     Dynaco believes that its multilayer  flexible  circuits offer the following
advantages  over  rigid  printed  circuit  boards  and  ceramic  substrates  for
sophisticated, compact electronic equipment:

          Flexible  circuits  are  thinner and better able to conform to smaller
          volumes and unusual container shapes;

          Flexible   circuits   allow   3-dimensional   interconnect   packaging
          techniques;

          Flexible  circuits are lighter and more  space-efficient  because they
          eliminate the need for connectors and wires;

          Film-based   flexible   substrates   cost   significantly   less   per
          input/output connection than ceramic-based interconnect systems; and

          The  use  of  multiple  layers  can  provide  significant  performance
          enhancements over single-sided and double-sided interconnect packages.

     The  3-dimensional  packaging  and flexure  characteristics  of  multilayer
flexible circuits and multilayer  rigid-flex circuits have made them the fastest
growing  segment of the U.S.  printed  circuit  market.  According to a May 1996
report by TechSearch International,  Inc., a technology licensing and consulting
firm, the world market for flexible printed  circuits in 1995 was  approximately
$1.8 billion to $2.0 billion,  of which the U.S. market was  approximately  $550
million,  an  increase  of  nearly  18% from  $470  million  in  1994.  Japanese
manufacturers  and their affiliated  offshore  operations had  approximately 60%
share of the world  market.  According  to  Flexible  Circuits  Engineering,  an
industry  publication,  sales of flexible  circuits in North  America have grown
from $300 million in 1985 to an estimated $650 million in 1995. The  publication
points out that the market has grown  erratically,  growing  principally  in the
periods from 1985  through 1987 and from 1993 through the present.  According to
Flexible  Circuits  Engineering,  the first growth phase reflected a short-lived
increase in the use of flexible  circuits in missiles,  "black  boxes" and other
defense-related products shortly before the end of 

<PAGE>
                                      -18-

the Cold War,  and the  current  growth  phase  reflects  the  increased  use of
flexible  circuits in  commercial  markets,  including  the  personal  computer,
automotive, consumer and instrument markets. As a result of these market trends,
Dynaco believes there is a significant market opportunity for manufacturers that
can timely  deliver  complex  multilayer  flexible  and  rigid-flex  circuits to
leading suppliers of electronic equipment.

     DYNACO STRATEGY

     Dynaco's objective is to be the preferred  supplier of multilayer  flexible
circuits and rigid-flex  circuits in the electronics  industry and to expand its
business  to include  high  density  memory  modules.  Dynaco's  strategy  is to
capitalize on its significant investment in flexible circuit technology,  modern
facilities  and  multilayer  packaging  expertise in order to participate in the
growth of the worldwide  electronics  market.  In order to achieve its objective
and benefit  from the trends in the  industry,  Dynaco's  strategy  includes the
following:

     MAINTAIN AND IMPROVE THE COMPANY'S MARKET POSITION IN THE DEFENSE/AEROSPACE
     MARKETS

     Dynaco  seeks  to  capitalize   on  a  growing   trend  among   electronics
manufacturers  in the  defense  and  aerospace  markets  to reduce the number of
suppliers  with which they do business  and to increase  their  out-sourcing  of
higher level assemblies.  Dynaco is currently a preferred  supplier with leading
prime contractors such as Hughes Aircraft Company,  Lockheed Martin Corporation,
Loral  Corporation,  McDonnell  Douglas  Corporation  and  Raytheon  Company.  A
preferred  supplier is one of a select  number of suppliers  whose  products and
facilities have been determined by the customer to meet certain  performance and
quality  specifications.  Because  customers  frequently  contact only preferred
suppliers for  particular  products,  Dynaco  intends to obtain and maintain the
status of preferred supplier with its current and prospective customers.

     In January 1997,  Raytheon announced a tentative agreement to purchased the
defense  operations of Texas  Instruments,  Inc. and GM Hughes Electronics Corp.
for $2.95 billion and $9.5 billion respectively.  These three companies combined
accounted for approximately one third of Dynaco's 1996 revenue.  It is too early
to determine how this proposed consolidation will affect Dynaco.

     Another market trend is the growth occurring in defense  electronics due to
electronic upgrades,  re-packaging for lower cost, and the  commercialization of
defense  hardware.  Dynaco is  currently  developing  new  flat-panel  displays,
night-vision  systems,  digital electronic  upgrades,  global positioning system
navigation  products  and  enhanced  communication  systems  that  use  flexible
circuits as the principal electronic interconnect.  Dynaco also plans to utilize
its  packaging  expertise  to convert  wire  bundles  and cable  harnesses  into
flexible  circuits to reduce  weight,  space and cost.  Dynaco has  designed and
currently   expects  to  convert  at  least  five  wire  and  cable   electronic
interconnect systems.

     COMMERCIALIZE THE DYNAFLEX PRODUCTS

     Dynaco  believes  that the  demand for  smaller  electronic  products  will
increasingly  cause  commercial  designers to consider  high-density  multilayer
flexible packaging.  Historically,  Dynaco's flexible circuit products have been
too costly to make most commercial  applications  feasible.  Dynaco has recently
developed,  and in June, 1995,  submitted patent  applications  for,  Dynaflex-D
(Dynamic)  and  Dynaflex-S  (Static),  two new flexible  circuit  products  that
utilize less expensive,  commercial-grade substrates. Dynaco believes that these
proposed  products  will permit it to expand  into  commercial  markets.  Dynaco
believes that its proposed Dynaflex-D and Dynaflex-S products will ultimately be
used in commercial  applications such as automotive engine monitoring  controls,
disk  drives,  personal  computers,  workstations,  and  cellular  communication
systems.

     EXPLOIT MANUFACTURING AND MARKETING CAPABILITIES

         Dynaco   believes  there  are  few  domestic  or  foreign   high-volume
multilayer  flexible  and  rigid-flex  circuit   manufacturers  with  comparable
expertise and know-how.  As the manufacture of multilayer  flexible circuits for
commercial   applications   proliferates,   Dynaco   intends  to   license   its
manufacturing and marketing expertise to high volume, highly capitalized printed
circuit board  manufacturers  throughout  the world.  Dynaco  recently  signed a
license agreement with Wong Circuits International,  a Hong Kong corporation, to
manufacture  certain  flexible  circuit  products  in Hong  Kong and  China.  In
addition,   the  Company  is  currently   conducting   negotiations  with  other
manufacturers   in  the  United  States  and  

<PAGE>
                                      -19-

Europe. By working with these manufacturers, Dynaco hopes to expand the customer
base for its flexible circuits technology.

     ACQUIRE, DEVELOP AND MARKET FLEXIBLE CIRCUIT PRODUCTS

     Dynaco   through  its  Dynamem   subsidiary   and  internal   research  and
development, intends to produce and market additional flexible circuit products.
Dynaco has recently  obtained  certain rights to the patented FRAMM  technology.
See "Acquisition of Dynamem."

     COMTEL ELECTRONICS, INC. BUSINESS INTRODUCTION

     COMTEL ELECTRONICS, INC. ("COMTEL")

     Comtel,    which   was   acquired   in   1996,   is   an   electronic   and
electro-mechanical,  contract  manufacturer.  Comtel's  business is to provide a
lower cost alternative  (outsourcing) to OEM in-house, or captive manufacturing.
Comtel's  primary  product is  turnkey,  build-to-print  (versus its own design)
circuit card assemblies.  These circuit card assemblies range in complexity from
very high volume,  relatively  simple (few components)  assemblies in support of
the consumer electronics  industry,  to very complex, full "black and white box"
builds for high technology industry.

     CONTRACT MANUFACTURING INDUSTRY BACKGROUND

     Contract  electronics   manufacturers  (CEMs)  are  playing  an  even  more
important  role  in the  electronics  market.  The  world  market  for  contract
manufacturing  services  exceeded  $30 billion in 1996,  and  industry  analysts
recently  estimated the U.S.  contract  manufacturing  market will grow from $11
billion in 1994 to over $36 billion by the year 2001, a compound  average annual
growth rate of 20%. Based on industry  data, the Company  believes that OEMs are
increasingly  relying  upon  independent  manufacturers  of complex,  electronic
interconnect  products,   such  as  Comtel,  rather  than  on  internal  captive
production.  Factors which Comtel  believes  will lead OEMs to utilize  contract
manufacturers include:

          LIMITED  RESOURCES  USED ON CORE  COMPETENCIES:  In  recent  years the
     electronics  industry has  experienced  greater levels of  competition  and
     technical changes forcing OEMs to focus their resources on critical product
     activities.  By offering comprehensive turnkey manufacturing services, CEMs
     afford  OEMs the  resources  to focus on core  activities  such as  product
     development, marketing and product distribution.

          IMPROVED PURCHASING POWER AND MATERIAL MANAGEMENT: OEMs are faced with
     increasing difficulties planning,  procuring and managing their inventories
     efficiently  due to frequent  design  changes,  short product  life-cycles,
     component price fluctuations, and the need to achieve economies of scale in
     material  procurement.  By using the CEMs'  combined  purchasing  power and
     required  expertise  in  inventory  management,  OEMs  can  reduce  capital
     required for production and inventory.

          REDUCED  CAPITAL  INVESTMENT:   As  electronic  products  become  more
     technologically  advanced,  including the transition  from  through-hole to
     surface  mount  assembly,  the  manufacturing  operation  has  become  more
     sophisticated   and  automated,   requiring  a  greater  level  of  capital
     investment  in  equipment.  By  outsourcing,  OEMs can reduce their overall
     capital  equipment  investment,  maintain  access  to the  latest  advanced
     manufacturing technology,  and enjoy the lower costs associated with higher
     capacity utilization experienced by CEMs.

          DESIGN/PACKAGING  EXPERTISE:  The  customer  benefits  from  the  ever
     accumulating design and packaging capabilities of CEMs. For example, Comtel
     works on  hundreds of  different  designs  each year and certain  packaging
     solutions  can be  applied to a  multitude  of new  applications.  OEMs are
     motivated  to work  with a CEM in  order  to gain  access  to this  process
     expertise and manufacturing know-how.

     Comtel  Electronics  believes  they can exploit this market with the latest
manufacturing  capabilities  in  surface  mount  assembly  and thin core PC card
assembly.

<PAGE>
                                      -20-

     COMTEL STRATEGY

     Comtel is a CEM who provides  turnkey  manufacturing  and test  services of
electronic assemblies.  Comtel specializes in thin core and high density surface
mount   assemblies.   Comtel's   services   consist  of   design,   procurement,
manufacturing and test.

          DESIGN: Working closely with customers and the substrate manufacturer,
     Comtel designs a specific packaging configuration to satisfy the customer's
     requirements for reliability and lowest cost of ownership.  In selection of
     substrate  materials,  Comtel  advises its customers with respect to issues
     such as size, power consumption and package configuration.

          PROCUREMENT:  Early involvement in the design process allows Comtel to
     assist in the  selection of  suppliers  and  components  to enhance time to
     market,  manufacturability  and logistical  support of volume ramp-ups.  As
     part of the  procurement  process,  Comtel  offers its  customers  material
     planning and  procurement,  inventory  management,  and  material  handling
     services.  From time to time,  material suppliers must allocate  components
     among  their  customers  in  response  to  supply  shortages.  By  assuming
     responsibility  for procurement,  Comtel and the Company may be required to
     bear the risks of price fluctuations and availability.  However, in certain
     cases,  Comtel can pool its purchasing power and leverage its position as a
     manufacturing   partner  to  receive  more  favorable  pricing  and  volume
     allocations.

          ASSEMBLY:   Substrate   assembly  involves  the  exact  placement  and
     soldering of a wide size range of electronic  components.  Comtel's current
     assembly  techniques range from manual assembly of through-hole  connectors
     to highly  automated  screen  printing and  placement of  miniaturized  SMT
     components.  SMT is a method of affixing electronic  components,  including
     integrated circuits, onto the surface of a substrate. Components mounted in
     SMT  assemblies  can be of  relatively  small  size  due to the use of fine
     lead-to-lead spacing (called "pitch") which currently can be as small as 12
     Mils. Comtel's SMT assembly process has become increasingly complex because
     of these smaller dimensions and tight tolerances,  and accordingly requires
     the use of expensive automated assembly and test equipment.

          TEST:  Using  sophisticated  in-circuit and  functional  test systems,
     Comtel  tests  complex   assemblies  in  order  to  determine  whether  the
     electronic  assembly  is  performing  to customer  satisfactions.  Comtel's
     current and planned  investment in  manufacturing  defect analyzer  testers
     enables customers to specify a wide range of test options.

     DYNAMEM, INC. BUSINESS INTRODUCTION

     DYNAMEM, INC. ("DYNAMEM")

     Dynamem spent most of 1996 developing the 64MB, 128MB, and 256MB FRAMM high
density memory  modules.  These memory modules are currently  being  technically
evaluated by a number of potential OEM users. A memory module  usually  consists
of various  configurations  of memory chips or other memory devices mounted on a
printed circuit board inserted into a slot on a computer's  motherboard.  Memory
modules  currently in use include single  in-line  memory modules  ("SIMMs") and
double  in-line memory  modules  ("DIMMs"),  both of which utilize rigid printed
circuit boards.  Industry standards limit the number of memory chips that can be
mounted on a rigid  printed  circuit  board  within a given  length and  height.
Consequently,  a traditional  memory module that has reached the maximum  length
and height has also  reached  maximum  memory  capacity.  Dynamem  believes  its
proposed  memory  modules will  overcome this  limitation of memory  capacity by
utilizing the FRAMM  technology to fit two rigid printed  circuit  boards in the
same slot arrangement that customarily houses SIMMs and DIMMs. Dynaco's proposed
memory  modules will mount thin,  small  outline  package  memory chips onto two
rigid printed circuit boards,  connected by flexible  circuits,  that are folded
for insertion into the motherboard.

     HIGH-DENSITY MEMORY MODULES

     A memory  module  usually  consists  of  various  configurations  of memory
devices or chips mounted on a printed  circuit  board  inserted into a slot on a
computer's  motherboard.  Dynamem's memory modules consists of two rigid printed
circuit boards connected by flexible circuits that are folded for insertion.  In
recent  years,  the  overall  size of  computers,  especially  that of  portable
computers, has shrunk while the newest program applications, such as Windows 95,
continue to use increasing  amount of random-access  memory ("RAM").  Meanwhile,
computer manufacturers are shipping an increasing number of systems with limited
RAM in order to  maintain  price  competitiveness.  As a result,  end-users  who
desire to run

<PAGE>
                                      -21-

the latest  applications must add memory modules or buy new systems with greater
memory capacity.  Dynaco believes that these trends will favor  manufacturers of
high density memory modules as requirements  for RAM increase from 16MB to 32MB,
64MB, 128MB and beyond.

     DYNAMEM STRATEGY

     Dynaco has  introduced  high density  memory  modules based on the patented
FRAMM technology. These memory modules overcome the current limitation on memory
capacity by utilizing  the FRAMM  technology  to fit two rigid  printed  circuit
boards in the same slot  arrangement  that  customarily  houses SIMMs and DIMMs.
Dynaco's memory modules will mount thin, small outline package memory chips onto
two rigid  printed  circuit  boards,  connected by flexible  circuits,  that are
folded for insertion into the motherboard.  This  combination  produces a module
that is no wider or taller than  conventional  rigid boards but that offers four
substrate surface areas, twice the area offered by rigid boards. Dynaco believes
that FRAMM represents a novel and innovative  packaging approach which will have
between  50% and 100% more  memory  capacity  than  currently  available  memory
modules.

     This is in  comparison  to a  traditional  memory  module that  consists of
various  configurations  of memory  chips or other memory  devices  mounted on a
printed circuit board inserted into a slot on a computer's motherboard. Industry
standards  limit the  number  of memory  chips  that can be  mounted  on a rigid
printed  circuit  board  within  a given  length  and  height.  Consequently,  a
traditional  memory  module that has  reached the maximum  length and height has
also reached maximum memory capacity.  Dynaco is designing a full memory product
line   around  the  FRAMM   technology.   Initial   products   are  planned  for
IBM-compatible  personal,   portable,  laptop  and  notebook  computers,   Apple
Computer's Macintosh computers and Sun Microsystems'  workstations.  Dynaco also
plans to design custom  modules for certain  special needs and is  investigating
other applications.

     SALES AND DISTRIBUTION

     Dynaco  markets  its  products  through a direct  sales force and through a
network of four independent sales representatives and distributors  specializing
in electronics equipment.  Dynaco principally targets large OEM corporations and
government prime contractors. These and other customers often employ competitive
bidding techniques with respect to large, multi-year contracts, for which Dynaco
competes with other qualified suppliers of flexible circuits.

     Comtel  presently  utilizes a combination of direct factory and independent
manufacturers  representatives  sales  personnel and is moving towards  complete
direct selling.  Comtel relocated its manufacturing facility in November 1996 to
a much larger  (65,000 square feet) facility to increase its capacity to fulfill
the expected increase in demand.

     Dynaco's  Dynamem  subsidiary  markets its FRAMM  products  through  both a
separate  sales  organization  and  through  Nexar.  Dynaco  believes  that this
approach  will  enable the  Dynamem  sales  force to develop  specific  industry
contacts and a focused knowledge base of the high-density memory market.

     Dynaco has generally utilized selected sources to obtain volume discounts.

     CUSTOMERS

          DYNACO

     Dynaco's traditional customers include OEMs, prime contractors and contract
manufacturers   of  defense  and   aerospace   electronics,   telecommunications
equipment,  navigational  systems and medical  products.  Dynaco's  new Dynaflex
products  have  attracted  prototype  orders from  customers in the  automotive,
computer and data storage markets.

     For the year  ended  December  31,  1996,  sales to Hughes,  Raytheon,  and
Lockheed Martin accounted for approximately  20%, 10% and 5%,  respectively,  of
Dynaco's net sales.  For the year ended  December 31, 1995,  sales to Raytheon ,
Hughes  Electronics  and Loral  accounted for 15%, 9% and 6%,  respectively,  of
Dynaco's  net  sales.   Sales  to  Dynaco's  top  10  customers   accounted  for
approximately  55% of Dynaco's  net sales for the year ended  December 31, 1996.
Approximately  100 other  customers  accounted for the remainder of Dynaco's net
sales for the year ended December 31, 1996.

<PAGE>
                                      -22-

     COMTEL

     Comtel  entered  into a five year  agreement  New Media,  whereby New Media
subcontracted to Comtel all of its  manufacturing and assembly business over the
contract term. Comtel recognized approximately $17.1 million of total revenue of
which 91% was from New Media.  Comtel's  intention  in 1997 is to  increase  and
diversify  its  overall  revenue  base and  reduce the  percentage  of New Media
concentration.  The Company has received  orders in 1997 from  customers such as
MCI,  MGE UPS  Systems  and  others,  thereby  reducing  the New Media  customer
concentration.   However,   the  Company   cannot  ensure  that  the  New  Media
concentration will significantly decrease in 1997.

COMPETITION

     The flexible  circuit  industry is  characterized  by intense  competition.
Dynaco and its competitors  have developed  various  technologies to serve niche
packaging  requirements.  Dynaco has  focused  its  development  efforts on more
complex  multilayer  circuit technology rather than single sided or double sided
circuit technology.  Among others,  Dynaco's competitors include  Packard-Hughes
Interconnect  Co.,  Parlex  Corporation  and Teledyne,  Inc.  Dynaco believes it
competes  principally  on the  basis of  design,  quality,  price  and  customer
service.  Some of  Dynaco's  competitors  include  larger  companies  that  have
substantially greater managerial,  financial,  technical and marketing resources
than Dynaco.

     Other flexible circuit companies such as Adflex Solutions,  Inc., Sheldahl,
Inc., MFlex and Smartflex primarily market single sided and double sided circuit
technology.  Although Dynaco does not currently compete with such companies with
respect to those products, Dynaco believes that the customers of these companies
have begun to demand  multilayer  flexible circuits and that such companies will
become competitors in the near future.

     The  contract  manufacturing  market is  estimated  to be $30 billion  plus
worldwide made up of many  competitors.  Comtel primarily  competes with smaller
sized regional competitors. The same is true for Dynamem which competes in a $20
plus billion computer memory market.

ENVIRONMENTAL CONTROLS AND GOVERNMENT CERTIFICATIONS

     The  manufacture  of  substrate  interconnect  products  involves  numerous
chemical solvents and other solid,  chemical and hazardous wastes and materials.
Dynaco incurs  approximately  $200,000 per year in waste treatment costs. Dynaco
is  subject to a variety  of  environmental  laws  relating  to the  generation,
storage,  handling,  use, emission,  discharge and disposal of these substances.
Dynaco  believes that it operates its facilities in substantial  compliance with
existing environmental laws and regulations. In June 1989 and April 1994, Dynaco
conducted  environmental  studies of its Tempe, Arizona substrate  manufacturing
facility and did not discover any contamination requiring remediation.

     Certain  sales  of  flexcircuits   are  subject  to  certain  military  and
government   certifications.   Dynaco  maintains  military   certifications  for
Mil-P-50884,  Mil-P-55110, Mil-I-45208 and Mil-Std. 2000, and various subsets of
such  certifications.  In January 1996, Dynaco obtained ISO 9001  certification.
Dynaco is  further  subject  to  various  federal,  state and local  regulations
regarding environmental protection and hazardous substance controls.  Management
believes  that  its  Dynaco  operations  are  in  compliance  with  governmental
environmental regulations.

MANUFACTURING AND SUPPLIERS

         Dynaco  relies  upon a  number  of  outside  suppliers  for  all of its
manufacturing  supplies,  parts and components and, to date, has not experienced
any significant  delays in obtaining parts and components.  Although most of the
supplies,  parts and components are available from multiple sources,  Dynaco has
generally  utilized selected sources to obtain volume discounts.  Pyralux(R),  a
substrate  material used in substantially  all of the products sold by Dynaco in
1994, is available only from DuPont. In addition,  certain customers issue, from
time to time,  narrow  product  specifications  that can be fulfilled  only by a
single  component  available from a single source.  Because such  specifications
vary from product to product,  Dynaco is unable to  anticipate  its future needs
for such  components  and  therefore  cannot make advance  arrangements  for the
supply of such  components.  Dynaco believes that it will continue to be able to
obtain  most of the  required  components  and parts from a number of  different
suppliers. Dynaco may subcontract production of certain subsystems, such as heat
exchangers,  power 

<PAGE>
                                      -23-

supplies  and  electronic  control  modules,  in  order to  minimize  production
overhead and to avoid rapid  fluctuations in capacity  utilization as the demand
for Dynaco's product changes.

PATENTS IN THE ELECTRONIC BUSINESS SEGMENT

     The  Company's  Nexar  subsidiary  has filed a patent for the  construction
method  facilitating  replacement  of CPU memory and other modules in a personal
computer.  This technology allows the end user a simple, quick and easy platform
for upgrading the most volatile components in a personal computer.

     The Company,  through its Dynaco subsidiary has filed a patent for flexible
circuit boards and method for their manufacture. This technology covers a unique
method  of   manufacturing,   using   proprietary   materials  that  enable  the
manufacturer to be cost  competitive with rigid board  manufacturers.  Dynaco is
awaiting  first  office  action  from the  U.S.  Patent  Office.  As part of the
formation  of Dynamem  discussed  previously,  Dynamem  became joint owner of an
issued patent surrounding  technology that uses two rigid printed circuit boards
attached by flex  circuitry  that can be folded with low  profile  memory  chips
attached to be inserted into the motherboard of a computer.  This design,  while
no larger  than  conventional  rigid  board  designs,  doubles  the  capacity of
conventional memory modules.

RESEARCH AND DEVELOPMENT

     For the fiscal year ended  December  31, 1996,  and December 31, 1995,  the
Company incurred  $7,977,085 and $4,419,487,  respectively,  in product research
and development  costs. Due to the intense  competition and rapid  technological
changes in the medical device and electronic industry, the Company believes that
it must continue to improve and refine its existing  products and services,  and
develop new applications for its technology.  The Company also intends to obtain
additional   technology   and  expand  its  product   line   through   strategic
partnerships, joint ventures, licensing and acquisitions.

EMPLOYEES

     As of December 31, 1996 the Company and its  subsidiaries had 522 full-time
employees and 64 temporary employees. When necessary, the Company also relies on
consultants  with  particular  expertise  for specific  research and  consulting
assignments.  The  Company's  ability to  develop,  manufacture,  and market its
products and to establish  and maintain a  competitive  position in the industry
will  depend,  in large part,  upon its ability to attract and retain  qualified
technical,  marketing and managerial  personnel.  The Company  believes that its
relations  with its  employees  are good.  None of the  Company's  employees are
represented by a union.

ITEM 2. DESCRIPTION OF PROPERTY

     The Company currently leases  approximately  11,500 square feet of research
and  development and office space in Beverly,  Massachusetts  under a seven year
lease, expiring in June 2000, for laser research and as corporate  headquarters.
The  Company's  Dynaco  subsidiary  leases  approximately  55,000 square feet in
Tempe,  Arizona  under a lease from a partnership  consisting of Dynaco's  Chief
Executive  Officer and Chief  Operating  Officer which expires in July 1997. The
Company's  Comtel  subsidiary  leases 65,000 square feet in Tustin,  California,
which is used as a  manufacturing  facility under a lease that expires in August
2002. The Company's Star  subsidiary  leases an office and research  facility of
approximately  6,200  square  feet in  Pleasanton,  California  for diode  laser
research and  manufacturing  under a lease expiring in April 1999. The Company's
Spectrum  subsidiary  leases an office,  manufacturing  and research facility of
approximately  25,000  square  feet in  Lexington,  Massachusetts  under a lease
expiring in June 2000. The Company's Tissue  Technologies  subsidiary  leases an
office and  manufacturing  facility of 17,000  square feet in  Albuquerque,  New
Mexico under a lease  expiring in October 1999. The Company's  Nexar  subsidiary
leases an office and telemarketing  facility of approximately  7,000 square feet
in  Westboro,  Massachusetts  under a  lease  expiring  in  August  1998,  and a
manufacturing   facility  of  approximately  100,000  square  feet  in  Haywood,
California  under a  lease  expiring  in  August  2001.  The  Company's  Palomar
Technologies, Ltd. subsidiary owns an office and leases a manufacturing facility
in Hull,  England.  In the opinion of management,  the properties  leased by the
Company and its  subsidiaries  are  currently  suitable  and  adequate for their
intended purposes.

<PAGE>
                                      -24-

ITEM 3. LEGAL PROCEEDINGS

     On October 7, 1996 the Company filed a declaratory  judgment action against
MEHL/Biophile  ("MEHL")  seeking (i) a declaration that MEHL is without right or
authority to threaten or maintain  suit against the Company or its customers for
alleged infringement of the patent held by MEHL's subsidiary Selvac Acquisitions
Corp.  ("Selvac"  and the "Selvac  Patent"),  that the Selvac Patent is invalid,
void and  unenforceable,  and that the  Company  does not  infringe  the  Selvac
patent;  (ii)  a  preliminary  and  permanent  injunction  enjoining  MEHL  from
threatening  the  Company  or its  customers  with  infringement  litigation  or
infringement;  and  (iii)  an  award  to the  Company  of  damages  suffered  in
connection with MEHL's conduct.  On March 7, 1997,  Selvac filed a complaint for
injunctive relief and damages for patent infringement and for unfair competition
against the Company,  its Spectrum Medical  Technologies and Spectrum  Financial
Services  subsidiaries,  and a New Jersey  dermatologist,  in the United  States
District Court for the District of New Jersey.  Selvac's  complaint alleges that
the Company's EpiLaser infringes the Selvac Patent and that the Company unfairly
competed by promoting  the  EpiLaser or hair removal  before it had received FDA
approval for that specific  application.  The Company intends to assert defenses
vigorously which it believes to be meritorious. Both suits are in their infancy,
and, as of March 17, 1997, discovery has not yet commenced in either action. The
extent of exposure of the Company cannot be determined at this time.

     The Company is a defendant in a lawsuit  filed by  Commonwealth  Associates
("Commonwealth") on March 14, 1996. In its suit,  Commonwealth  alleges that the
Company  breached a contract  with  Commonwealth  in which  Commonwealth  was to
provide certain investment banking services in return for certain  compensation.
In January  1997,  Commonwealth's  motion for summary  judgment on its breach of
contract claim was granted.  A trial on Commonwealth's  damages is scheduled for
April 14, 1997.  Commonwealth  has alleged that it suffered up to  $3,381,250 in
damages on its breach of contract  claim,  exclusive  of  interest.  The Company
intends to appeal the matter after  damages have been  determined,  and believes
its grounds for appeal are meritorious.

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

     The Company's Annual Meeting of Stockholders was held on November 14, 1996.
Holders of record of the  Company's  common  stock at the close of  business  on
October 7, 1996 were entitled to vote at the meeting.  On that date, the Company
had 28,409,007  shares of its common stock  outstanding.  Each  stockholder  was
entitled  to one  vote per  share on all  matters  voted  on at the  meeting.  A
majority  of the  outstanding  shares  constituted  a  quorum  at  the  meeting.
Abstentions  and broker  non-votes were counted for purposes of determining  the
presence or absence of a quorum for the  transaction  of  business.  Abstentions
were  counted  in  tabulations  of the  votes  cast on  proposals  presented  to
stockholders,  whereas  broker  non-votes  were  not  counted  for  purposes  of
determining  whether a proposal had been approved.  At the Annual  Meeting,  the
stockholders elected four (4) Directors.

The  tabulation  of votes with respect to the  election of such  Directors is as
follows:

                                            Total Votes        Total Votes
                                                For              Withheld

         Steven Georgiev                     25,014,274         348,728

         Michael H. Smotrich                 25,014,274         348,728

         Joseph E. Levangie                  25,014,274         348,728

         Buster Glossen                      25,014,274         348,728


     The  stockholders  also  ratified  and  approved  the  selection  of Arthur
Andersen, LLP as the Company's independent auditor for the 1996 fiscal year by a
vote of 25,106,794  shares in favor,  155,717  shares against and 100,491 shares
abstaining.

<PAGE>
                                      -25-

                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The company's Common Stock is currently traded on the National  Association
of Securities Dealers Automated Quotation System (NASDAQ) under the symbol PMTI.
The following  table sets forth the high and low bid prices quoted on NASDAQ for
the Common Stock for the periods indicated. Such quotations reflect inter-dealer
prices,  without retail mark-up,  mark-down or commission and do not necessarily
represent actual transactions.

                                                     Fiscal Year Ended
                                                     December 31, 1995
                                                     -------------------
                                                     High        Low
                                                     -------------------
                Quarter Ended March 31, 1995         3 5/8       2 1/2
                Quarter Ended June 30, 1995          2 5/8       1 15/16
                Quarter Ended Sept. 30, 1995         6 11/16     1 7/8
                Quarter Ended Dec. 31, 1995          7 1/8       4 7/16

                                                     Fiscal Year Ended
                                                     December 31, 1996
                                                     -------------------
                                                     High        Low
                                                     -------------------
                Quarter Ended March 31, 1996         13 1/8      5
                Quarter Ended June 30, 1996          16 3/8      9 1/8
                Quarter Ended Sept. 30, 1996         14 5/8      7 7/8
                Quarter Ended Dec. 31, 1996          9 1/8       6

     As of March 24,  1997,  the  Company  had 600  holders  of record of common
stock. This does not include holdings in street or nominee names.

     The Company has not paid  dividends  to its common  stockholders  since its
inception and does not plan to pay dividends to its common  stockholders  in the
foreseeable  future.  The Company  intends to retain any earnings to finance the
growth of the Company.

     PRIVATE PLACEMENT OF COMMON STOCK

     Pursuant to Regulation S under the Act, the Company sold  1,176,205  shares
of common stock and 182,765  warrants to purchase  common stock to a total of 22
overseas  individuals  and  corporations  on February  1, 1996 for an  aggregate
purchase price of  $1,683,800.  The warrants were issued at a price of $5.00 per
share, are immediately exercisable and expire on February 1, 1999.

     Pursuant to  Regulation  D and Section  4(2) of the Act, the Company sold a
total of  1,176,205  shares of common  stock on March 29, 1996 for an  aggregate
purchase  price of  $1,364,842.  1,176,205  shares of common  stock were sold to
Arista High-Tech Growth Fund, Ltd. for an aggregate  purchase price of $936,442;
45,000 shares of common stock were sold to Histon Financial  Services,  Inc. for
an  aggregate  purchase  price of $378,000 and 6,000 shares of common stock were
sold to  Berkshire  International  Finance,  Inc.  Pension Plan for an aggregate
purchase price of $50,400.

     Pursuant to  Regulation  D and Section  4(2) of the Act, the Company sold a
total of  1,176,205  shares of common stock on April 15, 1996 to Egger & Co. for
an aggregate purchase price of $416,250.

         Pursuant to Section 4(2) of the Act, the Company sold 1,176,205  shares
of common  stock on December  27, 1996 to  Finmanagment,  Inc.  for an aggregate
purchase  price of  $3,150,000.  In addition to the common  stock,  Finmanagment
received  420,000  net  warrants to  purchase  common  stock at $7.50 per share,
300,000 net warrants to purchase common stock at $9.50 per share and 180,000 net
warrants to purchase  common  stock at $11.50 per share.  The net  warrants  are
subject to a cashless exercise for common stock in which the number of shares of
common  stock  issuable  upon such  cashless  exercise  

<PAGE>
                                      -26-

shall be determined by multiplying  (1) the  difference  between (a) the closing
bid  price of the  common  stock on the day  prior  to the  date  exercised,  as
reported by NASDAQ, and (b) the exercise price, by (2) the number of net warrant
shares; divided by the closing bid price of the common stock on the day prior to
the date exercised.  The net warrants are exercisable  immediately and expire on
February 28, 1997.

     CONVERTIBLE DEBENTURES

     Pursuant to  Regulation  S under the Act,  the Company  sold 9,675 units of
convertible debentures to a total of 11 overseas individuals on July 3, 1996 for
an aggregate  purchase price of $7,669,441.  Each unit consists of a convertible
debenture  due July 3, 2003  denominated  in 1,000 Swiss Francs and a warrant to
purchase  24 shares of the  Company's  common  stock at $16.50  per  share.  The
warrants are immediately exercisable and expire on June 27, 2003.

     Pursuant to Section 4(2) of the Act, the Company sold a total of $5,000,000
4.5% Convertible Debentures on October 17, 1996 to Cameron Capital Ltd. and Wood
Gundy London Limited. The debentures,  due October 17, 2001, may be converted at
any time after 75 days from  issuance at the option of the holder into shares of
the Company's  common stock at a price equal to 85% of the average trailing five
day bid price from the date of conversion.

     Pursuant to Section 4(2) of the Act, the Company sold a total of $6,000,000
5% Convertible Debentures as follows:  $3,000,000 to High Risk Opportunities Hub
Fund Ltd. on December 31, 1996;  $2,000,000 to Berckeley  Investment Group, Ltd.
on January 13, 1997; and $1,000,000 to High Risk  Opportunities Hub Fund Ltd. on
January 13, 1997. The  debentures,  due December 31, 2001,  January 13, 2002 and
January 13, 2002, respectively, are convertible into shares of common stock at a
conversion  price equal to 85% of the average trailing 10 day bid price from the
date of  conversion,  provided  that in any 30 day  period  the  holder of these
debentures  may  convert  no more  than  33% (or 34% in the  last 30 day  period
available for conversion) of the debentures.

     PREFERRED STOCK

     Pursuant  to Section  4(2) of the Act,  the  Company  sold 6,000  shares of
Series D  Convertible  Preferred  Stock on February  14,  1996 to the  Travelers
Insurance  Company for an aggregate  purchase  price of  $6,000,000.  All of the
Series D Convertible  Preferred  Stock was converted  into  1,116,918  shares of
common stock  (including  accrued  dividends of $342,092 and accrued interest of
$9,183) as of December 31,  1996.  In  connection  with the issuance of Series D
Convertible  Preferred  Stock the Company  issued  600,000  warrants to purchase
common  stock at a price of $7.50 per share,  and  200,000  warrants to purchase
common stock at a price of $8.00 per share, both of which expire on February 14,
2001 and are immediately exercisable.

     Pursuant  to Section  4(2) of the Act,  the Company  sold 10,000  shares of
Series E Convertible  Preferred  Stock on April 17, 1996 to GFL  Advantage  Fund
Limited for an  aggregate  purchase  price of  $10,000,000.  All of the Series E
Preferred Stock was converted into 1,381,435  shares of common stock  (including
accrued  dividends of $326,174 and accrued interest of $7,536) as of January 28,
1997. In connection with the issuance of Series E Convertible  Preferred  Stock,
the Company issued 304,259  warrants to purchase  common stock at a price of $15
per share, which expire on April 17, 2001 and are immediately exercisable.

     Pursuant  to Section  4(2) of the Act,  the  Company  sold 6,000  shares of
Series F Convertible Preferred Stock on July 12, 1996 to the Travelers Insurance
Company for an aggregate purchase price of $10,000,000. The Series F Convertible

<PAGE>
                                      -27-

Preferred  Stock,  together  with  any  accrued  but  unpaid  dividends,  may be
converted  into common stock at 80% of the daily  average  closing  price of the
common stock on the ten trading days preceding such conversion,  but in no event
less than $7.00 or more than $16.00. Series F Preferred stock may be redeemed at
any time,  with no less than 10 days and no more than 30 days notice or when the
stock  price  exceeds  $16.50  per  share,  at an amount  equal to the amount of
liquidation  preference  determined  as of the  applicable  redemption  date. In
connection  with the  issuance  of Series F  Convertible  Preferred  Stock,  the
Company issued 500,000  warrants to purchase  common stock at a price of $11 per
share, which expire on July 12, 2001 and are immediately exercisable.

     Pursuant  to Section  4(2) of the Act,  the Company  sold 10,000  shares of
Series G  Convertible  Preferred  Stock to Genesee Fund Limited on September 26,
1996 for an  aggregate  purchase  price of  $10,000,000.  Genesee  Fund  Limited
subsequently  transferred 5,000 of its shares of Series G Convertible  Preferred
Stock to GFL Advantage  Fund and the remaining  5,000 shares to GFL  Performance
Fund. The Series G Convertible  Preferred  Stock,  together with any accrued but
unpaid  dividends,  may be  converted  into  common  stock at 85% of the average
closing  bid  price  for  the  three  trading  days  immediately  preceding  the
conversion  date, but in no event at less than $6.00 or more than $11.50 for the
5,000 shares of Series G Convertible  Preferred Stock held by GFL Advantage Fund
and no less  than  $6.00 or more than  $8.00  for the  5,000  shares of Series G
Convertible  Preferred  Stock held by GFL  Performance  Fund.  The  warrants are
immediately  exercisable  and expire on December 31, 2001.  Series G Convertible
Preferred  Stock may be redeemed  at any time,  with no less than 10 days and no
more than 20 days  notice,  at an amount  equal to the sum of (a) the  amount of
liquidation  preference determined as of the applicable redemption date plus (b)
$176.50.  In  connection  with the  issuance of Series G  Convertible  Preferred
Stock,  the Company issued 323,799  warrants to purchase common stock at a price
of $12 per share,  which expire on September  27, 2001,  and 50,000  warrants to
purchase common stock at a price of $6.5625 per share,  which expire on December
31, 2001 and are immediately exercisable.

     STOCKHOLDER SERVICES

     Stockholders  of the Company who desire  information  about the Company are
invited to contact  John  Ingoldsby,  Director  of Investor  Relations,  Palomar
Medical Technologies,  Inc., 66 Cherry Hill Drive, Beverly, Massachusetts 01915,
508-921-9300,  e-mail at jingoldsby@palmed.com.  A mailing list is maintained to
enable  stockholders  whose stock is held in street name,  and other  interested
individuals,  to receive quarterly reports, annual reports and press releases as
quickly as possible.  (Quarterly  reports and press  releases are also available
through  the  Internet  at the  Company's  home  page  on  the  World  Wide  Web
(http://www.palmed.com)).

ITEM 6. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995

     For the  year  ended  December  31,  1996,  the  Company  had  revenues  of
$70,098,443 as compared to $21,906,504 for the year ended December 31, 1995. The
220%  increase  in  revenues  from  1995 to  1996 is  primarily  the  result  of
acquisitions,   additional   product   lines  and  the   transition  of  certain
subsidiaries from the development stage to commercialization in both the medical
and  electronic  business  segments.  Net  revenues  by the  Company's  business
segments are as follows:

                                             Year ended
                                            December 31,
                               ------------------------------------
                                    1995                    1996
                               -------------           ------------
     Medical                   $   5,610,280           $ 17,824,158
     Electronic                   16,296,224             52,274,285
                               -------------           ------------
    Total                       $ 21,906,504           $ 70,098,443
                                ============           ============

     The increase in revenues for the Company's  medical segment was principally
attributable  to $10.1 million of revenues  generated from the Company's  Tissue
Technologies  subsidiary  during the year ended December 31, 1996 as compared to
only $114,000 for the year ended December 31, 1995.  Tissue  Technologies  began
commercial shipment of its product in the fourth quarter of 1995.  Approximately
$6.1  million of medical  revenues  were  generated  by the  Company's  Spectrum
subsidiary during the year ended December 31, 1996, as compared to approximately
$3.8 million of revenues for the year ended December 31, 1995.  This increase in
revenues at Spectrum was due to the introduction and initial shipments

<PAGE>
                                      -28-

of its  EpiLaser  during  the third and fourth  quarters  of 1996.  The  Company
expects  its  revenue  from the  medical  segment to continue to increase as the
Company further  penetrates the domestic and international  medical markets with
its  Tru-Pulse  CO2 laser for  treatment  of wrinkles and skin  resurfacing  and
begins  marketing  and shipping its EpiLaser for hair removal which was approved
by the FDA in March of 1997.

     The  increase  in  revenues  for  the  Company's  electronics  segment  was
attributable  to  approximately  $18.6  million of revenues  generated  from the
Company's Nexar subsidiary  which  introduced its proprietary  upgradeable PC in
April of 1996, as compared to only approximately  $620,000 of revenues generated
from the sale of  non-proprietary  PCs during the year ended  December 31, 1995.
The remaining increase in 1996 in the electronics segment was principally due to
$17.1  million of sales by  Dynaco's  Comtel  subsidiary  acquired  in the first
quarter of 1996. The Company believes that the revenue in the electronic segment
will continue to increase as Nexar further expands its production  capabilities,
marketing  and   distribution   efforts  and  as  Comtel  expands  its  contract
manufacturing  operations.  However,  the Company intends to divest a portion of
its interest in  companies  in the  electronics  segment,  and such  increase in
revenue may not be reflected in the  consolidated  results of the Company to the
extent it is successful in its divesture.

     Gross margin for the year ended December 31, 1996 was  $6,920,888  (9.9% of
revenues) versus  $4,714,034 (21.5% of revenues) for the year ended December 31,
1995. Gross margin by the Company's business segments are as follows:

                                                Year ended
                                                December 31,
                                   -----------------------------------
                                       1995                    1996
                                   -----------------------------------
             Medical               $ 2,145,808             $ 3,437,399
             Electronic              2,568,226               3,483,489
                                   -----------             -----------
             Total                 $ 4,714,034             $ 6,920,888
                                   ===========             ===========


     The  increase  in  gross  profit  dollars  was a result  of the  additional
revenues  generated from new products  introduced during the year ended December
31,1996 as discussed  above. In the medical segment the principal reason for the
decrease in the gross profit percent was the phase-out of the Company's research
and   development   contract  with  the  U.S.  Army  in   anticipation   of  the
commercialization  of its  medical  products.  The  gross  profit  percent  also
decreased due to underutilization  of increased  production capacity at Spectrum
in preparation for the anticipated  increase in demand of its EpiLaser in fiscal
1997. A portion of this  decrease in gross  margins was offset by an increase in
gross  margins  attributed  to the  acquisition  of Tissue  Technologies,  which
introduced  its Tru-Pulse CO2 laser to the  commercial  marketplace in the first
quarter of 1996.

     In the  electronic  segment,  the principal  reason for the decrease in the
gross  profit  percent  was a decrease in yields at Dynaco due to an increase in
production  costs  attributable  to a  change  in  Dynaco's  product  mix and an
inventory  valuation  write-off of $643,000 at Dynaco's Comtel subsidiary offset
by an  increase  in the gross  margin as a result of  Nexar's  introduction  and
initial volume shipments of its proprietary upgradeable PC in 1996.

     Research and  development  costs  increased to $7,977,085 (11% of revenues)
for the year ended December 31, 1996,  from $4,419,487 (20% of revenues) for the
year ended December 31, 1995.  This 80.5%  increase in research and  development
reflects the Company's  continuing  commitment to research and  development  for
both its medical and  electronic  business  segments.  In the Company's  medical
segment the Company  focused its efforts during 1996 to obtain FDA clearance for
hair removal  using the  EpiLaser.  The Company  received FDA clearance for hair
removal in March of 1997.  The Company  also  continued  to  concentrate  on the
development  of  additional  products  for medical  laser  applications.  In the
electronics  segment,  the Company's Nexar  subsidiary  continues to enhance and
further develop its current proprietary  upgradeable PC product in order to stay
competitive in a rapidly changing high technology industry. In addition,  Dynaco
began funding a new process engineering and materials  development  program, and
has filed several  patents.  Management  believes that research and  development
expenditures  will  increase  over the next few years as the  Company  continues
clinical trials of its medical products and develops additional applications for
its lasers and delivery systems.  However,  management anticipates that research
and  development  expenditures  as a percentage  of revenue will decrease as its
revenues increase with commercialization of its products.

     General  and  Administrative  expenses  increased  to  $21,569,054  (31% of
revenues)  for the  year  ended  December  31,  1996,  from  $7,879,694  (36% of
revenues)  for the year  ended  December  31,  1995.  This  173.7%  increase  is
primarily due to

<PAGE>
                                      -29-

acquisitions  and the transition of certain  subsidiaries  from the  development
stage to commercialization  combined with the increased administrative resources
required  at the  Company's  corporate  offices  to  oversee  the  growth of the
Company's medical and electronic business segments.  In the medical segment, the
Company acquired Tissue Technologies and expanded its general and administrative
support staff at Spectrum to  accommodate  the  forecasted  growth in the fourth
quarter of 1996 and in 1997. In the electronics  segment,  the Company's  Dynaco
subsidiary acquired Comtel and formed Dynamem. Additionally, the Company's Nexar
subsidiary  has expanded its  executive,  administrative  and finance  staffs to
support  Nexar's growing  operations.  The Company has continued to increase its
support staffs in anticipation of several new product introductions in 1996. All
the Company's subsidiaries maintain their own general and administrative support
staffs.  The  increase  in general  and  administrative  expenses is also due to
write-downs and valuation allowances totaling  approximately  $3,100,000 related
to accounts receivable, intangibles and the accrual of severance costs.

     Selling and Marketing  expenses  increased to $11,420,943 (16% of revenues)
for the year ended December 31, 1996,  from $2,768,541 (13% of revenues) for the
year ended December 31, 1995. This 312.5% increase reflects the Company's effort
to increase its marketing and  distribution as a result of its new product lines
developed  internally within the medical segment.  This increase is attributable
to the Company's Spectrum subsidiary and the acquisition of Tissue Technologies,
both  increasing  its sales and  marketing  expenditures  to  coincide  with the
addition of two new product lines.  In the  electronics  segment,  this increase
reflects  the change in focus of the  Company's  Nexar  subsidiary  from product
development to selling and marketing its proprietary upgradeable PC. During 1996
Nexar began its efforts to increase  its  selling,  marketing  and  distribution
which  resulted in additional  costs of $4.8 million in 1996 as compared to $0.6
million in 1995.

     Business  Development  and Financing  Costs  increased to $2,879,603 (4% of
revenues) for the year ended December 31, 1996, from $1,409,303 (6% of revenues)
for the year ended December 31, 1995.  This 104.3%  increase is  attributable to
the Company's  continuing  acquisitions  and financing  activities.  The Company
anticipates that it will continue to expend funds to raise additional sources of
financing and to focus its efforts to acquire other  technologies to broaden its
scope of product  applications  and services in both the medical and  electronic
business segments.

     Settlement and litigation  costs increased to $2,255,000 for the year ended
December  31, 1996 from  $700,000 for the year ended  December  31,  1995.  This
increase is a result of a settlement of potential claims with a former executive
of Nexar for  approximately  $1,400,000  and  under  which  Nexar is  purchasing
previously-licensed  core technology and eliminated  future royalty  payments on
the use of Nexar's core technology,  a settlement of  approximately  $525,000 in
connection  with a suit  brought  against the  Company  and the chief  executive
officer  of Nexar  upon  Nexar's  organization,  and other  claims  against  the
Company, combined with the associated legal costs.

     Merger expenses  totaled  $443,780 for the year ended December 31, 1996 and
are  comprised  of  professional  fees  associated  with the  merger  of  Tissue
Technologies and the Company.

     Interest  expense  increased to $1,443,564  for the year ended December 31,
1996,  from $1,374,199 for the year ended December 31, 1995. This 5% increase is
primarily  the  result of the  issuance  of  acquisition  debt in April  1995 to
purchase  Spectrum,  and  the  issuance  of the  4.5%  Swiss  Franc  convertible
debentures in July 1996.

     Interest  income  increased to $1,586,620  for the year ended  December 31,
1996,  from  $913,050 for the year ended  December 31,  1995.  This  increase is
primarily the result of interest  received  from  subscriptions  receivable  and
other loans and  investments  made as a result of the  Company's  improved  cash
position.

     Net gain on trading securities  represents  realized and unrealized trading
gains and losses of $2,033,371 for the year ended December 31, 1996. Included in
this amount is an unrealized gain totaling  approximately  $1,547,000 related to
the  Company's  investment in a publicly  traded  company in which the Company's
chief  executive  officer owns  approximately  13% and a realized  gain totaling
approximately  $827,000 related to the Company's  investment in another publicly
traded company offset by various  unrealized  losses  aggregating  approximately
$340,000.  The Company had a net realized  trading gain of $201,067 for the year
ended December 31, 1995. It is the Company's  intention to continue to invest in
trading  securities,  which may result in  additional  realized  and  unrealized
trading gains or losses in the future

     Gain on the  sale of  stock  of a  subsidiary  stock  represents  a gain of
$3,830,000 related to the private placement sale by the Company of 400,000 Nexar
common  shares.  See  Note  10  of  the  Notes  to  the  Consolidated  Financial
Statements.

<PAGE>
                                      -30-

     Other income and expense  totaled  $4,245,642 of expense for the year ended
December 31, 1996 as compared to $102,305 income for the year ended December 31,
1995.  Significant  amounts  included  in this  amount  for 1996 is a charge  to
operations of  $3,690,000  related to the  Company's  New Media  investment  and
additional  reserves  totaling  $1,306,038  required  for  other  loans to joint
ventures.  Offsetting  these  losses  is a  foreign  currency  exchange  gain of
$446,596. See Note 9 of the Notes to the Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

     As of  December  31,  1996,  the  Company  had  $19,066,523  in cash,  cash
equivalents and trading securities. During the year ended December 31, 1996, the
Company  generated  the  following  net cash  proceeds  from its  financing  and
investing activities to fund operations, acquisitions and the development of its
products:

                                                            YEAR ENDED
                                                        DECEMBER 31, 1996
                                                        -----------------
          Sale of common stock                               $ 6,061,380
          Sale of preferred stock                             30,823,147
          Issuance of convertible debentures                  14,169,441
          Sale of Stock of a subsidiary                        2,000,000
          Exercise of stock options and warrants               7,653,907
                                                         ---------------
                  Total                                      $60,707,875
                                                         ---------------

     The Company's net loss for the year ended  December 31, 1996,  included the
following  noncash items:  $3,916,221 of depreciation and amortization  expense;
$70,130 of interest expense relating to the amortization of the discounts on the
convertible debentures; and $741,982 related to common stock and warrants issued
to non-employees  and consultants of which  approximately  $532,758 results from
the issuance of warrants for services in accordance with SFAS No. 123.

     The  Company  anticipates  that  capital  expenditures  for 1997 will total
approximately $16 million,  with nearly 60% of this amount funding lasers needed
for CTI laser  centers.  The Company  intends to finance the majority of the CTI
expenditures  under  equipment  leasing   arrangements  with  various  financing
institutions.  However,  there can be no assurance that the Company will be able
to obtain the necessary financing.

     Dynaco has a  three-year  revolving  credit and security  agreement  with a
financial  institution.  The  agreement  provides  for  the  revolving  sale  of
acceptable accounts  receivable,  as defined in the agreement,  with recourse at
85% of face value, up to a maximum commitment of $3,000,000.  As of December 31,
1996, the amount of accounts  receivable sold that remained  uncollected totaled
$1,787,057 net of related  reserves and fees, as defined in the agreement.  This
amount  is  classified  as a  revolving  line  of  credit  in  the  accompanying
consolidated  balance  sheet as of December 31, 1996.  The interest rate on such
outstanding  amounts is the bank's  prime rate (8.25% at December 31, 1996) plus
1.5%,   and  interest  is  payable   monthly  in  arrears.   The   financing  is
collateralized  by the purchased  accounts  receivable and  substantially all of
Dynaco's assets. Borrowings under this line are guaranteed by the Company.

     On December  5, 1996,  Comtel  entered  into a loan  agreement  with a loan
association  which  provided  for  borrowings  up to  $4,500,000  in the form of
revolving  receivable and inventory  loans.  Borrowings under the loan agreement
are limited by a borrowing base calculation on eligible accounts  receivable and
inventory, and are collateralized by accounts receivable,  inventory and certain
other assets. Borrowings bear interest at the lender's prime rate plus 2.25% and
amounted to $2,770,375 as of December 31, 1996. The loan agreement terminates on
November 30, 1998.  Borrowings  under this loan  agreement are guaranteed by the
Company.

     Some  of  the  Company's  medical  products  businesses  are  still  in the
development   stage,  with  significant   research  and  development  costs  and
regulatory constraints that currently limit sales of its medical products. These
activities  are an important  part of the Company's  business  plan.  Due to the
nature of clinical  trials and research and  development  activities,  it is not
possible to predict with any certainty  the  timetable  for  completion of these
research  activities  or the total amount of funding  required to  commercialize
products  developed as a result of such  research and  development.  The rate of
research  and the number of research  projects  underway  are  dependent to some
extent upon external funding. While the Company is regularly reviewing potential
funding  sources in relation to these  ongoing and proposed  research  projects,
there can be no

<PAGE>
                                      -31-

assurance  that the  current  levels of funding or  additional  funding  will be
available, or, if available, on terms satisfactory to the Company.

     The Company also makes early stage  investments  in core  technologies  and
companies that management feels are strategic to the Company's  business or will
yield a higher  than  average  financial  return to support the  Company's  core
business.  Some of these investments are with companies that are related to some
of the directors and officers of the Company. In addition,  the Company has made
loans to various  affiliated  parties.  See  "Related  Party  Transactions".  At
December 31, 1996, the Company had $1,564,153 of such related party  investments
and loans.

     The Company has had significant  losses to date and expects these losses to
continue for the near  future.  Therefore,  the Company must  continue to secure
additional  financing  to complete  its  research  and  development  activities,
commercialize  its current and proposed medical products  segment,  spin-off its
electronic  products  segment,  execute its  acquisition  business plan and fund
ongoing  operations.  The Company  believes that the cash generated to date from
its financing  activities and amounts  available under its credit agreement will
be sufficient to satisfy its working capital  requirements  through at least the
next twelve months. However, there can be no assurance that events in the future
will not require the Company to seek additional  financing  sooner.  The Company
continues to investigate several financing alternatives, strategic partnerships,
additional bank financing,  private debt and equity financing and other sources.
The Company believes that it has adequate cash reserves or will be successful in
obtaining  additional  financing in order to fund current operations in the near
future.

FACTORS THAT MAY AFFECT FUTURE RESULTS

     In addition to the other  information  in this Annual Report on Form 10-KSB
the following cautionary statements should be considered carefully in evaluating
the Company and its business.  Statements contained in this Form 10-KSB that are
not historical  facts  (including,  without  limitation,  statements  concerning
anticipated  operational  and capital  expense  levels and such  expense  levels
relative to the Company's total revenues) and other information  provided by the
Company   and  its   employees   from   time  to  time   may   contain   certain
"forward-looking"  information,  as that  term  is  defined  by (i) the  Private
Securities Litigation Reform Act of 1995 (the "Reform Act") and (ii) in releases
by the SEC. The factors  identified in the cautionary  statements  below,  among
other  factors,  could  cause  actual  results to differ  materially  from those
suggested in such forward-looking  statements.  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.

     SUBSTANTIAL  AND  CONTINUING   LOSSES.  The  Company  and  certain  of  its
subsidiaries  have a history of losses,  and the  Company  expects its losses to
continue.  The Company must secure additional financing to complete its research
and  development  activities,  commercialize  its current and  proposed  medical
products,  spin-off its non-medical  business,  execute its acquisition business
plan and fund ongoing operations.  To the extent that the Company is not able to
successfully execute its plan to spin-off its non-medical business,  the Company
may be  required  either to fund or to shut down those  operations,  potentially
incurring substantial losses.

     LIMITED  OPERATING  HISTORY;  RECENT  ACQUISITIONS.  Many of the  Company's
subsidiaries have limited operating  histories and are in the development stage,
and the Company is subject to all of the risks inherent in the  establishment of
a new  business  enterprise.  The  likelihood  of success of the Company must be
considered in light of the problems, expenses,  difficulties,  complications and
delays  frequently  encountered in connection  with the  establishment  of a new
business and development of new  technologies in the cosmetic laser products and
electronic  products  industries.   These  include,  but  are  not  limited  to,
government   regulation,   competition,   the  need  to   expand   manufacturing
capabilities  and  market  expertise,   and  setbacks  in  production,   product
development,  market acceptance and sales and marketing. The Company's prospects
could be  significantly  affected  by its  ability  to  subsequently  manage and
integrate the operations of several distinct  businesses with diverse  products,
services and customer bases in order to achieve cost efficiencies.  There can be
no assurance that the Company will be able to successfully  manage and integrate
the  operations of newly  acquired  businesses  into its  operations or that the
failure to do so will not increase the costs  inherent in the  establishment  of
new business enterprises.

     HOLDING COMPANY STRUCTURE.  The Company has no significant operations other
than those incidental to its ownership of the capital stock of its subsidiaries.
As  a  holding  company,   the  Company  is  dependent  on  dividends  or  other
intercompany transfers of funds from its subsidiaries to meet the Company's debt
service and other obligations. Claims of creditors of the

<PAGE>
                                      -32-

Company's subsidiaries,  including trade creditors, will generally have priority
as to the assets of such  subsidiaries  over the claims of the  Company  and the
holders of the Company's indebtedness.

     RISKS ASSOCIATED WITH ACQUISITIONS.  In the normal course of business,  the
Company   evaluates   potential   acquisitions   of  businesses,   products  and
technologies that would complement or expand the Company's  business.  Promising
acquisitions  are  difficult  to identify  and complete for a number of reasons,
including  competition  among  prospective  buyers  and the need for  regulatory
approvals.  Acquisitions  may result in the  incurrence of additional  debt, the
write-off of in-process  research and development or technology  acquisition and
development costs and the amortization of expenses related to goodwill and other
intangible  assets,  any of which  could have a material  adverse  effect on the
Company's business,  financial  condition,  results of operations and cash flow.
Acquisitions  involve numerous additional risks,  including  difficulties in the
assimilation of the operations, services, products and personnel of the acquired
company,  the diversion of management's  attention from other business concerns,
entering  markets in which the Company has little or no direct prior  experience
and the  potential  loss of key employees of the acquired  company.  In order to
finance  acquisitions,  it may be necessary for the Company to raise  additional
funds through public or private  financings.  Any equity or debt  financing,  if
available at all, may be on terms which are not favorable to the Company and, in
the  case  of  equity  financing,  may  result  in  dilution  to  the  Company's
stockholders.

     NEW VENTURES. The Company's CTI subsidiary has entered into agreements with
medical service  partners to provide cosmetic  dermatological  laser services at
laser  treatment  centers,  and plans to enter into more such  agreements in the
future.  While the Company  believes these new  partnerships  are  strategically
important,  there are substantial  uncertainties associated with the development
of new products,  technologies and services for evolving markets. The success of
these ventures will be determined not only by the Company's efforts, but also by
those of its partners.  Initial  timetables for the development and introduction
of  new   technologies,   products  or  services  may  not  be   achieved,   and
price/performance targets may not prove feasible.  External factors, such as the
development of competitive alternatives or government regulation,  may cause new
markets  to  evolve  in  unanticipated  directions.   (See  "Highly  Competitive
Industries.")

     INVESTMENTS  IN  UNRELATED  BUSINESSES.  The  Company  has  investments  in
marketable  and  non-marketable  securities  and loans to related and  unrelated
parties.  The  amount  that  the  Company  may  ultimately  realize  from  these
investments could differ materially from the value of these investments recorded
in the Company's financial statements.

     MANAGEMENT OF GROWTH.  In light of management's  views of the potential for
future growth,  the Company has adopted an aggressive  growth plan that includes
substantial  investments in its sales,  marketing,  production and  distribution
organizations,  the  creation  of new  research  and  development  programs  and
increased   funding  of  existing   programs,   and   investments  in  corporate
infrastructure  that will be required to support  significant  growth. This plan
carries  with it a  number  of  risks,  including  a higher  level of  operating
expenses,  the difficulty of attracting  and  assimilating a large number of new
employees,  and the  complexities  associated  with managing a larger and faster
growing organization.  Depending on the extent of future growth, the Company may
experience a significant  strain on its management,  operational,  manufacturing
and  financial  resources.  The  failure  of the  Company's  management  team to
effectively  manage growth,  should it continue to occur,  could have a material
adverse effect on the Company's financial condition and results of operations

     HIGHLY   COMPETITIVE   INDUSTRIES.   The  cosmetic  laser  and  electronics
industries are characterized by intense competition. The cosmetic laser industry
is highly  competitive and is characterized by the frequent  introduction of new
products.  The Company competes in the development,  manufacture,  marketing and
servicing of laser technology products with numerous other companies, certain of
which have substantially  greater financial,  marketing and other resources than
the Company. In addition, the Company's cosmetic laser products face competition
from alternative medical products and procedures, such as dermabrasion, chemical
peels, pharmaceutical treatment, electrolysis, waxing and surgery, among others.
There can be no  assurance  that the Company will be able to  differentiate  its
products  from the  products of its  competitors  or that the  marketplace  will
consider the Company's  products to be superior to competing products or medical
procedures. There can be no assurance that competitors will not develop products
or that new  technologies  will  not be  developed  that  render  the  Company's
products  obsolete or less  competitive.  See  "Technological  Obsolescence." In
addition, in entering areas of business in which it has little or no experience,
such as the opening of laser treatment  centers,  the Company may not be able to
compete  successfully  with competitors that are more established in such areas.
See "New Ventures."

     FLUCTUATIONS IN QUARTERLY PERFORMANCE.  The Company's results of operations
have  fluctuated   substantially  and  can  be  expected  to  continue  to  vary
significantly.  The Company's  quarterly operating results depend on a number of
factors,  including the timing of the introduction or acceptance of new products
offered by the Company or its competitors, changes in the mix of

<PAGE>
                                      -33-

products  sold by the Company,  changes in  regulations  affecting  the cosmetic
laser  products or  electronics  industry,  changes in the  Company's  operating
expenses, personnel changes and general economic conditions.

     The Company's  stock price,  like that of other  technology  companies,  is
subject to significant  volatility.  If revenues or earnings in any quarter fail
to meet the  investment  community's  expectations,  there could be an immediate
impact on the price of the Shares.  The price of the Shares may also be affected
by  broader  market  trends  unrelated  to  the  Company's   performance.   (See
"Volatility of Share Price.")

     VOLATILITY OF SHARE PRICE.  Factors such as  announcements  of developments
related to the  Company's  business,  announcements  by  competitors,  quarterly
fluctuations  in the Company's  financial  results and other factors have caused
the price of the Company's stock to fluctuate, in some cases substantially,  and
could  continue  to do so in the  future.  In  addition,  the stock  market  has
experienced  extreme  price  and  volume  fluctuations  that  have  particularly
affected the market price for many technology companies and that have often been
unrelated to the operating  performance of these  companies.  These broad market
fluctuations  may adversely  affect the market price of the Shares.  The trading
prices of many  technology  companies'  stocks are at or near  their  historical
highs, and reflect  price/earnings  ratios substantially above historical norms.
There can be no assurance that the trading price of the Shares will remain at or
near its current level.

     GOVERNMENT REGULATION. The Company's laser product business segment and, to
a lesser degree,  its electronics  business segment are subject to regulation in
the United  States and  abroad.  Failure to comply  with  applicable  regulatory
requirements can result in fines, denial or suspension of approvals, seizures or
recall of products, operating restrictions and criminal prosecutions, any or all
of which  could  have a material  adverse  effect on the  Company.  Furthermore,
changes in existing regulations or adoption of new regulations could prevent the
Company  from  obtaining,  or could  affect  the timing  of,  future  regulatory
approvals.

     LASER PRODUCT SEGMENT.  All laser product devices,  including those sold by
the  Company,  are subject to  regulation  by the FDA under the  Medical  Device
Amendments  of the United  States Food,  Drug and Cosmetics Act (the "FDA Act").
The Company's  business,  financial  condition  and  operations  are  critically
dependent upon timely receipt of FDA regulatory clearance.

          FDA  CLEARANCE  STATUS  FOR  COSMETIC  LASER  PRODUCTS.  Three  of the
     Company's  lasers  have  received   clearance  from  the  FDA  for  certain
     dermatological  applications:  the Q-pulse ruby laser,  the Tru-Pulse laser
     and the EpiLaser system.

     The Company is also investigating other applications in dermatology for its
laser systems.  It will be required to obtain FDA clearance before  commercially
marketing any other  application.  The Company  believes that it will be able to
seek such clearance under the 510(k) application process;  however, no assurance
can be given  that the FDA will not  require  the  Company  to  follow  the more
extensive and time-consuming  Pre-Market Approval ("PMA") process. FDA review of
a 510(k)  application  currently  averages  about  seven to  twelve  months  and
requires limited  clinical data based on "substantial  equivalence" to a product
marketed  prior to 1976,  while a PMA  review  can last for  several  years  and
require substantially more clinical data.

     The FDA also imposes various  requirements on manufacturers  and sellers of
products under its jurisdiction, such as labeling, good manufacturing practices,
record keeping and reporting requirements.  The FDA also may require post-market
testing and surveillance  programs to monitor a product's effects.  There can be
no assurance that the appropriate  clearances from the FDA will be granted, that
the process to obtain  such  clearances  will not be  excessively  expensive  or
lengthy  or  that  the  Company  will  have  sufficient  funds  to  pursue  such
clearances.

     No  assurance  can be given that FDA  clearance  will be  obtained  for the
Company's  current or proposed laser products on a timely basis,  if at all. The
laser products segment of the Company's  business,  is, and will continue to be,
critically  dependent  upon FDA  clearance of its current and proposed  cosmetic
laser products. Delays or failure to obtain such clearance would have a material
adverse effect on the Company.

     OTHER  GOVERNMENT   CLEARANCES  FOR  LASER  PRODUCTS;   GOOD  MANUFACTURING
PRACTICES. In order to be sold outside the United States, the Company's products
are subject to FDA permit  requirements  that are conditioned  upon clearance by
the importing country's appropriate regulatory authorities.  Many countries also
require that imported products comply with their own or international electrical
and safety standards. In November 1992, the Company obtained approval certifying
compliance  with  certain   international   electrical  and  safety  regulations
applicable to its pulsed dye laser. Additional approvals may be

<PAGE>
                                      -34-

required in other  countries.  The  Company  has yet to apply for  international
approval for its diode laser for use in cosmetic surgery and dermatology.

     The Company is subject to the laser radiation safety regulations of the FDA
Act  administered  by the National  Center for Devices and  Radiological  Health
("CDRH") of the FDA. These regulations  require a laser manufacturer to file new
product and annual reports,  to maintain  quality  control,  product testing and
sales  records,  to distribute  appropriate  operation  manuals,  to incorporate
certain design and operating features in lasers sold to end-users and to certify
and label each laser sold to end-users  as one of four classes of lasers  (based
on the level of radiation from the laser).  In addition,  various warning labels
must be affixed on the product and certain  protective devices must be installed
depending  upon the class of  product.  Under the FDA Act,  the  Company is also
required  to  register  with the FDA as a  medical  device  manufacturer  and is
subject to  inspection on a routine  basis by the FDA for  compliance  with Good
Manufacturing  Practice ("GMP") regulations.  The GMP regulations impose certain
procedural  and  documentation  requirements  upon the  Company  relevant to its
manufacturing,  testing and quality control activities. The CDRH is empowered to
seek fines and other remedies for violations of these  regulatory  requirements.
The Company believes that it is currently in compliance with these regulations.

     ELECTRONIC  SEGMENT.  A  significant  percentage  of the total sales of the
flexible  circuit  board  component  business of the  Company,  which  presently
accounts for a significant amount of the sales of the Company, are the result of
either a subcontract or a direct contract for government  programs funded by the
U.S. military.  Generally,  government contracts and subcontracts are terminable
at the convenience of the government.  Cutbacks in military spending for certain
programs or lack of military  spending in general could have a material  adverse
effect on the Company.  There can be no assurance that termination of contracts,
cessation of purchase orders,  or a failure to appropriate  funds will not occur
in the future. Any termination,  cessation, or failure to appropriate funds with
respect to contracts or  subcontracts  having a  significant  dollar value would
have a material adverse effect on the Company's  business,  financial  condition
and results of operation. The unpredictable nature of the government procurement
process  also  may  contribute  to  fluctuations  in  the  Company's   quarterly
performance. (See "Fluctuations in Quarterly Performance.")

     UNCERTAINTY  OF MARKET  ACCEPTANCE.  The Company  continually  develops new
products  intended  for  use in the  cosmetic  laser  products  segment  and the
electronic products segment. As with any new products, there is substantial risk
that the marketplace may not accept or be receptive to the potential benefits of
such products.  Market acceptance of the Company's current and proposed products
will  depend,  in large part,  upon the ability of the Company or any  marketing
partners to  demonstrate  to the  marketplace  the  advantages  of the Company's
products  over  other  types  of  products.  There  can  be  no  assurance  that
applications  or uses for the  Company's  current and proposed  products will be
accepted by the  marketplace  or that any of the  Company's  current or proposed
products will be able to compete effectively.

     UNCERTAINTY OF HEALTHCARE REIMBURSEMENT AND REFORM. The healthcare industry
is subject to changing  political,  economic and regulatory  influences that may
affect  the  procurement   practices  and  operations  of  healthcare   industry
participants.  During  the past  several  years,  state and  federal  government
regulation of reimbursement rates and capital  expenditures in the United States
healthcare  industry has increased.  Lawmakers  continue to propose  programs to
reform the United  States  healthcare  system,  which may  contain  programs  to
increase  governmental  involvement in  healthcare,  lower Medicare and Medicaid
reimbursement  rates or  otherwise  change  the  operating  environment  for the
Company's  customers.  Healthcare  industry  participants  may  react  to  these
proposals by curtailing or deferring  investments,  including investments in the
Company's products.

     DEPENDENCE  ON  THIRD  PARTY  RESEARCHERS.  The  Company  is  substantially
dependent upon third party  researchers and others,  over which the Company will
not have absolute control,  to  satisfactorily  conduct and complete research on
behalf of the Company and to grant to the Company favorable  licensing terms for
products  which may be  developed.  The  Company  has  entered  into a number of
research   agreements   with   recognized   research   hospitals   and  clinical
laboratories.  These  research  institutions  include the Oregon  Medical  Laser
Center at the Heart  Institute of St.  Vincent  Hospital  and Medical  Center in
Portland, Oregon, the Wellman Labs at MGH and the Otolaryngology Research Center
for Advanced Endoscopic Applications at NEMC, Boston, Massachusetts. The Company
provides  research  funding,  laser technology and optics know-how in return for
licensing  agreements with respect to specific medical applications and patents.
The Company's success will be highly dependent upon the results of the research,
and there can be no assurance  that these research  agreements  will provide the
Company  with  marketable  products  in the  future or that any of the  products
developed under these agreements will be profitable for the Company.

<PAGE>
                                      -35-

     TECHNOLOGICAL  OBSOLESCENCE.  The markets for the  Company's  products  are
characterized by rapid and significant  technological change,  evolving industry
standards and frequent new product  introductions and enhancements.  Many of the
Company's   products  and  products  under   development   are   technologically
innovative, and require significant planning, design, development and testing at
the technological,  product and manufacturing  process levels.  These activities
require  significant  capital  commitments  and  investment by the Company.  The
Company's  failure to develop products in a timely manner in response to changes
in the industry,  whether for financial,  technological  or other reasons,  will
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

     Development   by  others  of  new  or  improved   products,   processes  or
technologies may make the Company's  products or proposed  products  obsolete or
less  competitive.  The Company will be required to devote continued efforts and
financial  resources to enhancement of its existing  products and development of
new products. There can be no assurance that the Company will have the financial
resources or the  technological  capability  necessary to carry out such product
enhancement  and  development.  Nor can there be any  assurance  that any of the
products  currently being developed by the Company,  or those to be developed in
the future,  will be  technologically  feasible or accepted by the  marketplace,
that any such  development  will be completed in any particular  time frame,  or
that  the  Company's  products  or  proprietary  technologies  will  not  become
uncompetitive or obsolete.

     LACK OF PATENT PROTECTION.  The Company currently holds several patents and
intends  to pursue  various  additional  avenues  that it deems  appropriate  to
protect its  technology.  There can be no assurance,  however,  that the Company
will file any additional  patent  applications  or that any patent  applications
that have been,  or may be,  filed will  result in issued  patents,  or that any
patent, patent application,  know-how,  license or cross-license will afford any
protection or benefit to the Company.

     The cosmetic  laser device  market has been  characterized  by  substantial
litigation  regarding patent and other intellectual  property rights. One of the
company's  competitors  has filed  suit  against  the  Company  alleging  patent
infringement,  among other things. See "Item 3. Legal  Proceedings." In both the
cosmetic laser products and the electronic products segments,  litigation, which
could result in substantial cost to and diversion of effort by the Company,  may
be necessary to protect  trade  secrets or know-how  owned by or licensed to the
Company  or  to  determine  the  enforceability,   scope  and  validity  of  the
proprietary   rights  of  others.   Adverse   determination   in  litigation  or
interference proceedings could subject the Company to significant liabilities to
third parties, require the Company to seek licenses from third parties and could
prevent the Company from  manufacturing  and selling its products,  all of which
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations.

     POSSIBLE PATENT INFRINGEMENTS. In the medical products segment, the Company
is aware of patents relating to laser technologies used in certain  applications
that the Company  intends to pursue,  which,  if valid and  enforceable,  may be
infringed by the Company.  The Company has obtained opinions of counsel that the
Company is not  infringing  currently  on patents held by others;  however,  the
validity  of such  opinions  have not yet  been  judicially  determined.  If the
Company's  current or proposed  products are, in the opinion of patent  counsel,
infringing on any of these patents,  the Company intends to seek  non-exclusive,
royalty-bearing  licenses to such patents but there can be no assurance that any
such license would be available on favorable terms, if at all. In the electronic
products  segment,  the  Company  has not  been  notified  that it is  currently
infringing on any patents nor has it been the subject of any patent infringement
action. No assurance can be given that  infringement  claims will not be made or
that the Company would prevail in any legal action with respect thereto. Defense
of a claim of infringement is costly and could have a material adverse effect on
the Company's business, even if the Company were to prevail.

     DEPENDENCE ON PROPRIETARY  RIGHTS.  The Company relies on trade secrets and
proprietary  know-how  which it seeks to protect,  in part,  by  confidentiality
agreements with its  collaborators,  employees and consultants.  There can be no
assurance  that these  agreements  will not be breached,  that the Company would
have adequate  remedies for any breach, or that the Company's trade secrets will
not otherwise become known or be independently developed by competitors.

     NEED FOR ADDITIONAL QUALIFIED  PERSONNEL/DEPENDENCE  ON KEY PERSONNEL.  The
Company's ability to develop, manufacture and market all of its products, and to
attain  a  competitive  position  within  the  laser  products  and  electronics
industries,  will  depend,  in large part,  on its ability to attract and retain
qualified personnel.  Competition for qualified personnel in these industries is
intense and the Company  will be  required  to compete for such  personnel  with
companies which may have greater financial and other resources;  there can be no
assurance  that the Company will be successful in attracting,  assimilating  and
retaining  the  personnel  it  requires  to grow  and  operate  profitably.  The
Company's  inability to attract and retain such personnel  could have a material
adverse effect upon its business. (See "Management of Growth.")

<PAGE>
                                      -36-

     The  Company's  future  success  depends  to a  significant  extent  on its
executive  officers and certain technical,  managerial and marketing  personnel.
The loss of the  services of any of these  individuals  or group of  individuals
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations.

     The Company is dependent on various sales  representatives and distributors
to market  and sell its  medical  products.  The  Company  is in the  process of
expanding its direct sales force to ensure that it  satisfactorily  monitors and
controls the expected growth of its medical product sales.

     ISSUANCE OF PREFERRED  STOCK AND  DEBENTURES  COULD AFFECT RIGHTS OF COMMON
SHAREHOLDERS.  The  Company  is  authorized  to issue up to 5 million  shares of
Preferred  Stock,  $.01 par value.  The Preferred  Stock may be issued in one or
more series, the terms of which may be determined at the time of issuance by the
Board of Directors,  without  further  action by  shareholders,  and may include
voting rights  (including the right to vote as a series on particular  matters),
preferences as to dividends and  liquidation,  conversion and redemption  rights
and sinking fund provisions. The issuance of any such additional Preferred Stock
or Debentures could affect the rights of the holders of Shares, and could reduce
the market price of the Shares. In particular, specific rights granted to future
holders of Preferred Stock or Debentures could be used to restrict the Company's
ability to merge with or sell its assets to a third  party,  thereby  preserving
control of the Company by the existing  control  group.  See "Item 5. Market for
Common Equity and Related Stockholder Matters."

     PRODUCT  LIABILITY  EXPOSURE.  Cosmetic  laser  product  companies  face an
inherent business risk of financial  exposure to product liability claims in the
event that the use of their products results in personal  injury.  The Company's
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 the
Company's products or that deaths could occur. Further, in the event that any of
the Company's  products  prove to be  defective,  the Company may be required to
recall and redesign such products.  Although the Company has not experienced any
material  losses  due to  product  liability  claims  to date,  there  can be no
assurance  that it will not  experience  such losses in the future.  The Company
maintains general liability insurance in the amount of $1,000,000 per occurrence
and $2,000,000 in the aggregate and maintains 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 the Company or that such
coverage will be adequate for liabilities  actually  incurred.  In the event the
Company  is found  liable for  damages in excess of the limits of its  insurance
coverage,  or if any claim or  product  recall  results in  significant  adverse
publicity against the Company,  the Company's business,  financial condition and
results of operations could be materially and adversely  affected.  In addition,
although the  Company's  products  have been and will continue to be designed to
operate in a safe manner,  and although the Company  attempts to educate medical
personnel  with  respect  to  the  proper  use of its  products,  misuse  of the
Company's  products  by medical  personnel  over whom the Company  cannot  exert
control  may  result in the filing of product  liability  claims or  significant
adverse publicity against the Company.

     RISKS  ASSOCIATED WITH  INTERNATIONAL  OPERATIONS.  As part of its business
strategy,  the Company intends to seek  opportunities  to expand its product and
service  offerings  into  international  markets.  In marketing its products and
services  internationally,  the Company will likely face new competitors.  There
can be no  assurance  that  the  Company  will be  successful  in  marketing  or
distributing  products and services in these  markets or that its  international
revenue will be adequate to offset the expense of  establishing  and maintaining
international operations.  The Company's international business may be adversely
affected by changing economic  conditions in foreign countries.  The majority of
the Company's sales are currently  denominated in U.S. dollars, but there can be
no  assurance  that a  significantly  higher  level of future  sales will not be
denominated  in  foreign  currencies.  To the  extent the  Company  makes  sales
denominated  in  currencies  other  than U.S.  dollars,  gains and losses on the
conversion of those sales to U.S.  dollars may contribute to fluctuations in the
Company's business,  financial condition and results of operations. In addition,
fluctuations  in exchange  rates could affect demand for the Company's  products
and services.  Conducting an international business inherently involves a number
of other  difficulties and risks, such as export  restrictions,  export controls
relating  to  technology,  compliance  with  existing  and  changing  regulatory
requirements,  tariffs and other trade  barriers,  difficulties  in staffing and
managing international operations, longer payment cycles, problems in collecting
accounts  receivable,  political  instability,  seasonal  reductions in business
activity  in Europe  and  certain  other  parts of the world  during  the summer
months, and potentially adverse tax consequences. There can be no assurance that
one or more of these  factors  will not have a  material  adverse  effect on any
international  operations established by the Company and,  consequently,  on the
Company's business, financial condition and results of operations.

<PAGE>
                                      -37-

     The Company plans to expand its business into international markets and has
set up a manufacturing and distribution  center in Hull,  England.  To date, the
Company has minimal  experience  in  marketing  and  distributing  its  products
internationally  and plans to  establish  alliances  with  sales  representative
organizations and resellers with particular experience in international markets.
Accordingly,   the   Company's   success  in   international   markets  will  be
substantially  dependent  upon the skill  and  expertise  of such  international
participants in marketing the Company's products. There can be no assurance that
the Company will be able to successfully  market,  sell and deliver its products
in these  markets.  In  addition,  there are  certain  risks  inherent  in doing
business in  international  markets,  such as  unexpected  changes in regulatory
requirements,   export   restrictions,   tariffs  and  other   trade   barriers,
difficulties in staffing and managing foreign  operations,  management's lack of
international  expertise,  political  instability  and  fluctuations in currency
exchange rates and potentially  adverse tax consequences,  which could adversely
impact the success of the Company's  international  operations.  There can be no
assurance  that one or more of such  factors  will not have a  material  adverse
effect on the Company's future international  operations and,  consequently,  on
the Company's business, financial condition or operating results.

     HAZARDOUS  SUBSTANCE  AND  ENVIRONMENTAL   CONCERNS.   The  manufacture  of
substrate  interconnect  products  involves numerous chemical solvents and other
solid,  chemical  and  hazardous  wastes and  materials.  Dynaco is subject to a
variety of  environmental  laws relating to the generation,  storage,  handling,
use,  emission,  discharge  and  disposal of these  substances  and  potentially
significant risks of statutory and common law liability for environmental damage
and personal injury. The Company,  and in certain  circumstances,  its officers,
directors  and  employees,  may be subject to claims  arising from the Company's
manufacturing  activities,  including the improper release,  spillage, misuse or
mishandling of hazardous or  non-hazardous  substances or material.  The Company
may be strictly liable for damages,  regardless of whether it exercised due care
and  complied  with all  relevant  laws and  regulations.  The Company  does not
currently maintain environmental impairment insurance. There can be no assurance
that the Company will not face claims  resulting in  substantial  liability  for
which the Company is uninsured or that hazardous  substances are not or will not
be present at the Company's facilities.  Failure to comply with proper hazardous
substance handling procedures or violation of environmental laws and regulations
would have a material adverse effect on the Company.

     SIGNIFICANT  OUTSTANDING  INDEBTEDNESS;  SUBORDINATION  OF DEBENTURES.  The
Company has incurred substantial  indebtedness in relation to its equity capital
and will be subject to all of the risks  associated with  substantial  leverage,
including  the risk that  available  cash may not be adequate  to make  required
payments to the holders of the Debentures.  The Company's ability to satisfy its
obligations  under the  Debentures  from cash  flow will be  dependent  upon the
Company's  future  performance  and will be subject to  financial,  business and
other  factors  affecting  the  operation of the  Company,  many of which may be
beyond the Company's control.  In the event the Company does not have sufficient
cash resources to satisfy quarterly  interest or other repayment  obligations to
the  holders  of the  Debentures,  the  Company  will be in  default  under  the
Debentures,  which would have a material  adverse effect on the Company.  To the
extent that the Company is required to use cash  resources  to satisfy  interest
payments to the holders of the Debentures, it will have less resources available
for other  purposes.  Inability  of the  Company  to repay the  Debentures  upon
maturity would have a material adverse effect on the Company, which could result
in a reduction of the price of the Company's Shares.

     The Debentures will be unsecured and subordinate in right of payment to all
Senior Indebtedness of the Company. The Debentures do not restrict the Company's
ability to incur additional Senior Indebtedness and most other indebtedness. The
terms of Senior Indebtedness now existing or incurred in the future could affect
the  Company's  ability to make  payments of  principal  and/or  interest to the
holders  of  Debentures.  See "Item 5.  Market for  Common  Equity  and  Related
Stockholder Matters."

         POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS. The Company is subject to
the anti-takeover  provisions of Section 203 of the Delaware General Corporation
Law, which prohibit 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 could have the effect of delaying or  preventing a change of control
of the Company.  The  Company's  stock option  grants  generally  provide for an
exercise of some or all of the optioned stock, including non-vested shares, upon
a change of control or similar  event.  The Board of Directors  has authority to
issue  up to  5,000,000  shares  of  Preferred  Stock  and  to fix  the  rights,
preference,  privileges and  restrictions,  including  voting  rights,  of these
shares without any further vote or action by the stockholders. The rights of the
holders of the Common  Stock will be subject to, and may be  adversely  affected
by, the rights of the holders of any  Preferred  Stock that may be issued in the
future. The issuance of Preferred Stock, while providing  desirable  flexibility
in connection with possible  acquisitions  and other corporate  purposes,  could
have the  effect of  making it more  difficult  for a third  party to  acquire a
majority of the  outstanding  voting  stock of the  Company,  thereby  delaying,

<PAGE>
                                      -38-

deferring or  preventing a change in control of the Company.  Furthermore,  such
Preferred Stock may have other rights,  including  economic rights senior to the
Common Stock, and, as a result,  the issuance of such Preferred Stock could have
a  material  adverse  effect  on the  market  value of the  Common  Stock.  (See
"Issuance  of  Preferred  Stock and  Debentures  Could  Affect  Rights of Common
Shareholders.")

<PAGE>
                                      F-1

ITEM 7. FINANCIAL STATEMENTS


                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS




Report of Independent Public Accountants                                     F-2

Consolidated Balance Sheets as of December 31, 1995 and 1996                 F-3

Consolidated Statements of Operations for the years ended
December 31, 1995 and 1996                                                   F-4

Consolidated Statements of Stockholders' Equity for the years ended
 December 31, 1995 and 1996                                                  F-5

Consolidated Statements of Cash Flows for the years ended
 December 31, 1995 and 1996                                                  F-7

Notes to Consolidated Financial Statements                                  F-10

<PAGE>
                                      F-2

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Palomar Medical Technologies, Inc. and Subsidiaries:

     We have audited the  accompanying  consolidated  balance  sheets of Palomar
Medical  Technologies,  Inc. (a Delaware  corporation) and  subsidiaries,  as of
December  31,  1995  and  1996,  and  the  related  consolidated  statements  of
operations,  stockholders' equity and cash flows for the years then ended. These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management as well as evaluating the overall financial  statement  presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion,  the financial statements referred to above present fairly,
in  all  material   respects,   the  financial   position  of  Palomar   Medical
Technologies,  Inc. and  subsidiaries  as of December 31, 1995 and 1996, and the
results  of their  operations  and their  cash flows for the years then ended in
conformity with generally accepted accounting principles.





                                                             ARTHUR ANDERSEN LLP



Boston, Massachusetts,
March 7, 1997 (Except with respect
to the matter discussed
in Note 15(a) as to which
the date is March 31, 1997)
<PAGE>
                                      F-3

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<C>                                                                             <C>                   <C>
                                                                                 December 31,         December 31,
                                                                                     1995                  1996
ASSETS

Current Assets:
    Cash and cash equivalents                                                   $17,138,178          $16,172,731
    Marketable securities                                                           749,410            2,893,792
    Accounts receivable, net of allowance for doubtful accounts of                4,737,766           18,308,077
       approximately $445,000 and $3,113,000, respectively
    Inventories                                                                   3,649,884           18,790,484
    Loans to officers                                                               948,198              995,331
    Notes receivable related parties                                              3,161,375              464,153
    Other notes receivable                                                              ---              899,937
    Other current assets                                                            352,130            7,623,161
                                                                                -----------           ----------
       Total current assets                                                      30,736,941           66,147,666
                                                                                -----------           ----------

Property and Equipment, at Cost, Net                                              3,165,015            8,404,605

Other Assets:
    Cost in excess of net assets acquired, net of accumulated                     3,729,508            5,024,299
       amortization of approximately  $673,000 and $1,480,000,
       respectively
    Intangible assets, net of accumulated amortization of approximately           1,597,745            2,286,058
       and $1,025,000, respectively
    Deferred costs                                                                  809,120            2,895,803
    Long-term investments                                                           500,000            3,179,554
    Loan to related party                                                           700,000            1,100,000
    Other assets                                                                    631,831            1,719,211
                                                                                -----------          -----------
       Total other assets                                                         7,968,204           16,204,925
                                                                                -----------          -----------
                                                                                $41,870,160          $90,757,196
                                                                                ===========          ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:

    Revolving lines of credit                                                     $1,296,462           $4,558,052
    Current portion of long-term debt                                              2,574,265            2,783,683
    Contingent note payable                                                          500,000                  ---
    Accounts payable                                                               4,246,950           14,304,285
    Accrued expenses                                                               4,633,557           14,669,893
                                                                                ------------           ----------
       Total current liabilities                                                  13,251,234           36,315,913
                                                                                ------------           ----------

Long-Term Debt, Net of Current Portion                                             3,330,172           16,204,692
                                                                                ------------           ----------
Minority Interest in Subsidiary                                                          ---              160,000
                                                                                ------------           ----------

Commitments and Contingencies (Note 13)

Stockholders' Equity:
    Preferred stock, $.01 par value-                                                     139                  182
       Authorized - 5,000,000  shares 
       Issued and outstanding - 
       13,860 shares and 18,151 shares 
       at December 31, 1995 and 1996
       (Liquidation preference of $18,645,956 as of December 31,
       1996)
    Common stock, $.01 par value-                                                    201,353              305,968
       Authorized  -  100,000,000  shares  
       Issued and outstanding  - 20,135,406 shares 
       and 30,596,812 shares at December 31, 1995 and 1996
    Additional paid-in capital                                                    54,152,385          104,900,551
    Accumulated deficit                                                          (25,864,657)         (64,971,200)
    Unrealized loss on marketable securities                                             ---             (342,500)
    Subscriptions receivable from related party                                   (1,988,709)            (604,653)
    Less: Treasury Stock (200,000 shares at cost)                                 (1,211,757)          (1,211,757)
                                                                                ------------          ------------
       Total stockholders' equity                                                 25,288,754           38,076,591
                                                                                ------------          ------------
                                                                                 $41,870,160          $90,757,196
                                                                                ============          ============

</TABLE>


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

<PAGE>
                                      F-4

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS


                                                    Year ended December 31,
                                                        1995            1996
                                                    -----------     ------------

Revenues                                            $21,906,504     $70,098,443

Cost of revenues                                     17,192,470      63,177,555
                                                    -----------     ------------

      Gross profit                                    4,714,034       6,920,888
                                                    -----------     ------------

Operating Expenses

      Research and development                        4,419,487       7,977,085
      Sales and marketing                             2,768,541      11,420,943
      General and administrative                      7,879,694      21,569,054
      Business development
           and other financing costs                  1,409,303       2,879,603
      Settlement and Litigation Costs                   700,000       2,255,000
      Merger expenses                                        --         443,780
                                                    -----------     ------------
            Total operating expenses                 17,177,025      46,545,465
                                                    -----------     ------------

            Loss from operations                    (12,462,991)    (39,624,577)

Interest Expense                                     (1,374,199)     (1,443,564)

Interest Income                                         913,050       1,586,620

Net Gain on Trading Securities                          201,067       2,033,371

Gain On Sale of Stock of a Subsidiary                        --       3,830,000

Other Income (Expense)                                  102,305      (4,245,642)
                                                    -----------     ------------

      Net loss                                     $(12,620,768)   $(37,863,792)
                                                   ============    =============

Net Loss Per Common Share                                $(0.89)         $(1.49)
                                                   ============    =============
Weighted Average Number of
    Common Shares Outstanding                        14,164,901      26,166,538
                                                   ============    =============


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

<PAGE>
                                      F-5

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<C>                                                         <C>        <C>       <C>        <C>      <C>           <C>    
                                                             Preferred Stock     Common Stock        Treasury Stock
                                                            --------------------------------------------------------------
                                                               Number    $0.01     Number    $0.01     Number
                                                             of Shares Par Value of Shares Par Value of Shares      Cost  
                                                            -------------------- ------------------- ---------------------
Balance, December 31, 1994                                       --       $--     9,464,963  $94,649     --         $--

   Sale of common stock pursuant to warrants and options         --        --     2,925,093   29,251     --          --
   Sale of common stock                                          --        --     1,622,245   16,223     --          --
   Payments received on subscriptions receivable                 --        --        --        --        --          --
   Issuance of preferred stock, including common stock issued as
             as a placement fee, net of issuance costs          21,295       213    300,000    3,000     --          --
   Purchase of treasury stock                                    --        --        --        --     (200,000)  (1,211,757)
   Issuance of common stock in lieu of payment of notes payab    --        --       632,144    6,321     --          --
   Repayment of convertible debentures                           --        --        --        --        --          --
   Conversion of convertible debentures                          --        --     1,943,870   19,438     --          --
   Value ascribed to convertible debentures                      --        --        --        --        --          --
   Value ascribed to warrant in exchange for license technolo    --        --        --        --        --          --
   Issuance of common stock for technology                       --        --       739,546    7,395     --          --
   Conversion of preferred stock                                (7,435)      (74) 1,775,691   17,757     --          --
   Exercise of underwriter's warrants                            --        --       200,000    2,000     --          --
   Issuance of common stock for Spectrum Medical Tech., Inc.     --        --       364,178    3,642     --          --
   Issuance of common stock for investment banking and merger
             and acquisition consulting services                 --        --       167,676    1,677     --          --
   Amortization of deferred financing costs                      --        --        --        --        --          --
   Compensation expense related to warrants issued to
             consultants and investment bankers                  --        --        --        --        --          --
   Preferred stock dividends                                     --        --        --        --        --          --
   Net loss                                                      --        --        --        --        --          --
                                                            --------------------------------------------------------------

Balance, December 31, 1995                                      13,860      $139 20,135,406 $201,353  (200,000) $(1,211,757)
                                                            ===============================================================

</TABLE>

<TABLE>

<C>                                                  <C>         <C>               <C>           <C>            <C>          
                                                       Additional                  Unrealized                       Total
                                                        Paid-in    Accumulated       Loss On     Subscription    Stockholders
                                                        Capital      Deficit       Marketable      Receivable      Equity
                                                                                   Securities
Balance, December 31, 1994                           $15,773,109 $(13,119,279)       $--            $--          $2,748,479

   Sale of common stock pursuant to 
     warrants and options                              7,588,888      --              --          (4,633,975)     2,984,164
   Sale of common stock                                2,935,921      --              --              --          2,952,144
   Payments received on subscriptions receivable          --          --              --           3,694,840      3,694,840
   Issuance of preferred stock,
      including common stock issued as
      as a placement fee, net of issuance costs       19,382,750      --              --              --         19,385,963
   Purchase of treasury stock                             --          --              --              --         (1,211,757)
   Issuance of common stock in lieu of 
     payment of notes payable                          1,873,611      --              --              --          1,879,932
   Repayment of convertible debentures                  (321,533)     --              --              --           (321,533)
   Conversion of convertible debentures                3,071,302      --              --              --          3,090,740
   Value ascribed to convertible debentures              899,813      --              --              --            899,813
   Value ascribed to warrant in exchange 
     for license technology                              100,000      --              --              --            100,000
   Issuance of common stock for technology               292,605      --              --              --            300,000
   Conversion of preferred stock                          68,377      --              --              --             86,060
   Exercise of underwriter's warrants                  1,049,574      --              --          (1,049,574)         2,000
   Issuance of common stock for 
     Spectrum Medical Tech., Inc.                        996,358      --              --              --          1,000,000
   Issuance of common stock for 
     investment banking and merger
     and acquisition consulting services                 416,823      --              --              --            418,500
   Amortization of deferred financing costs              (70,583)     --              --              --            (70,583)
   Compensation expense related to 
     warrants issued to
     consultants and investment bankers                   95,370      --              --              --             95,370
   Preferred stock dividends                              --         (124,610)        --              --           (124,610)
   Net loss                                               --      (12,620,768)        --              --        (12,620,768)
                                                    ------------------------------------------------------------------------

Balance, December 31, 1995                           $54,152,385 $(25,864,657)       $--         $(1,988,709)   $25,288,754
                                                    ========================================================================
</TABLE>


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


<PAGE>
                                      F-6


              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES


                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                  (continued)

<TABLE>


<C>                                                           <C>       <C>         <C>        <C>          <C>       <C>
                                                              Preferred Stock         Common Stock              Treasury Stock
                                                              Number    $0.01        Number     $0.01       Number
                                                              of Shares Par Value    of Shares  Par Value   of Shares    Cost

Balance, December 31, 1995                                      13,860       $139   20,135,406   $201,353   (200,000) $(1,211,757)

    Sale of common stock pursuant to warrants and options           --        --     2,967,996     29,681         --          --
    Sale of common stock                                            --        --     1,176,205     11,762         --          --
    Payments received on subscriptions receivable                   --        --            --         --         --          --
    Issuance of preferred stock, including common stock 
          issued as a placement fee, net of issuance costs      32,000       320      115,000       1,150         --          --
    Issuance of common stock for 1995 employer 401(k) 
          matching contribution                                     --        --       45,885         459         --          --
    Conversion of preferred stock, including accrued 
          dividends and interest of $782,602                   (25,209)     (252)   4,481,518      44,815         --          --
    Conversion of convertible debentures                            --        --       34,615         346         --          --
    Redemption of convertible debentures                            --        --          --           --         --          --
    Value ascribed to convertible debentures                        --        --          --           --         --          --
    Redemption of preferred stock                               (2,500)      (25)         --           --         --          --
    Exercise of underwriter's warrants                              --        --     500,000        5,000         --          --
    Exercise of stock options in majority controlled 
          subsidiary                                                --        --         --            --         --          --
    Issuance of common stock for conversion of 
          debentures at Tissue Technologies, Inc.                   --        --    813,431         8,134         --          --
    Issuance of common stock for minority interest 
          in Star Medical subsidiary                                --        --    224,054         2,241         --          --
    Issuance of common stock in exchange for license
          rights                                                    --        --     56,900           569         --          --
    Issuance of common stock for acquisition of 
          Dermascan, Inc.                                           --        --     35,000           350         --          --
    Issuance of common stock for investment banking 
          and merger and acquisition consulting services            --        --     56,802           568         --          --
    Compensation expense related to warrants issued to 
          non-employees under SFAS No. 123                          --        --        --             --         --          --
    Return of escrowed shares                                       --        --   (46,000)          (460)        --          --
    Amortization of deferred financing costs                        --        --        --             --         --          --
    Unrealized loss on marketable securities                        --        --        --             --         --          --
    Preferred stock dividends                                       --        --        --             --         --          --
    Net loss                                                        --        --        --             --         --          --
                                                            ----------------------------------------------------------------------
Balance, December 31, 1996                                      18,151      $182 30,596,812      $305,968   (200,000) $(1,211,757)
                                                            ======================================================================

</TABLE>


<TABLE>
<C>                                                       <C>          <C>          <C>             <C>              <C>
                                                            Additional                Unrealize                          Total
                                                             Paid-in    Accumulated    Loss  on      Subscriptions   Stockholders'
                                                             Capital    Deficit     Marketable        Receivable        Equity
                                                                                      Securities 
                                                            ----------------------------------------------------------------------

Balance, December 31, 1995                                 $54,152,385 $(25,864,657)        $--        $(1,988,709)    $25,288,754

    Sale of common stock pursuant to warrants 
          and options                                        7,569,226           --          --                 --       7,598,907
    Sale of common stock                                     6,049,618           --          --                 --       6,061,380
    Payments received on subscriptions receivable                   --           --          --          2,441,556       2,441,556
    Issuance of preferred stock, including common 
          stock issued as a placement fee, net 
          of issuance costs                                 30,821,677           --          --                 --      30,823,147
    Issuance of common stock for 1995 employer 401(k) 
          matching contribution                                160,139           --          --                 --         160,598
    Conversion of preferred stock, including accrued 
          dividends and interest of $782,602                   744,124           --          --                 --         788,687
    Conversion of convertible debentures                       145,260           --          --                 --         145,606
    Redemption of convertible debentures                       (41,530)          --          --                 --         (41,530)
    Value ascribed to convertible debentures                 2,757,860           --          --                 --       2,757,860
    Redemption of preferred stock                           (3,123,127)          --          --                 --      (3,123,152)
    Exercise of underwriter's warrants                       1,057,500           --          --         (1,057,500)          5,000
    Exercise of stock options in majority 
          controlled subsidiary                                 50,000           --          --                 --          50,000
    Issuance of common stock for conversion 
          of debentures at Tissue Technologies, Inc.         1,019,022           --          --                 --       1,027,156
    Issuance of common stock for minority interest
           in Star Medical subsidiary                        1,747,482           --          --                 --       1,749,723
    Issuance of common stock in exchange for 
          license rights                                       369,574           --          --                 --         370,143
    Issuance of common stock for acquisition 
          of Dermascan, Inc.                                  489,650            --          --                 --         490,000
    Issuance of common stock for investment 
          banking and merger and acquisition 
          consulting services                                 476,156            --          --                 --         476,724
    Compensation expense related to warrants 
          issued to non-employees under SFAS No. 123          532,758            --          --                 --         532,758
    Return of escrowed shares                                     460            --          --                 --              --
    Amortization of deferred financing costs                  (77,683)           --          --                 --         (77,683)
    Unrealized loss on marketable securities                       --            --    (342,500)                --        (342,500)
    Preferred stock dividends                                      --    (1,242,751)         --                 --      (1,242,751)
    Net loss                                                       --   (37,863,792)         --                 --     (37,863,792)
                                                          -------------------------------------------------------------------------
Balance, December 31, 1996                                $104,900,551 $(64,971,200)  $(342,500)         $(604,653)    $38,076,591
                                                          =========================================================================

</TABLE>


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

<PAGE>
                                      F-7


PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS

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

                                                                Year ended December 31,
                                                                  1995           1996
                                                              -------------  -------------
Cash Flows from Operating Activities
   Net loss                                                   $(12,620,768)  $(37,863,792)
   Adjustments to reconcile net loss to net cash
      used in operating activities-
      Depreciation and amortization                              1,825,673      3,916,221
      Settlement and litigation costs                              700,000      2,255,000
      Gain on sale of stock of a subsidiary                        --          (3,830,000)
      Write-off of in-process research and development             --              57,212
      Write-off of intangible assets                               --             631,702
      Write-off of deferred financing costs associated with
         redemption of convertible debentures                      --             201,500
      Valuation allowances for notes and investments               --           4,996,038
      Minority interest in loss of subsidiary                     (102,305)       --
      Accrued interest receivable on note
          and subscription receivable                              --            (568,917)
      Foreign currency exchange gain                               --            (446,596)
      Noncash interest expense related to debt                     220,280        163,680
      Noncash compensation related to common stock and warrant      95,370        836,982
      Realized gain on marketable securities                       --            (835,197)
      Unrealized gain on marketable securities                    (133,568)    (1,198,174)
      Changes in assets and liabilities, net of effects
         from business combinations;
         Purchases of marketable securities                       (615,842)   (10,355,055)
         Sale of marketable securities and
               interest received on marketable securities           50,000     10,244,044
         Accounts receivable, net                               (1,479,532)   (13,806,643)
         Inventories                                            (1,419,030)   (14,975,426)
         Other current assets and loans to officers               (658,012)    (1,809,381)
         Accounts payable                                        1,770,100      9,902,024
         Accrued expenses                                        2,159,702      6,251,560
                                                              ------------   -------------
               Net cash used in operating activities           (10,207,932)   (46,233,218)
                                                              ------------   -------------

Cash Flows from Investing Activities
   Cash paid for purchase of Comtel Electronics, Inc., net of      --            (146,586)
   Cash acquired from purchase of Spectrum Medical 
          Technologies, Inc., and CD Titles, Inc.                  101,207        --
   Cash paid for purchase of  Inter-connecting Products, Inc.     (397,199)       --
   Proceeds from sale of subsidiary stock                          --           2,000,000
   Purchases of property and equipment                          (1,147,945)    (5,142,128)
   Increase in intangible assets                                   --            (410,647)
   Increase in other assets                                       (695,673)    (1,125,333)
   Loans to related parties                                     (3,861,375)    (7,338,625)
   Loans to non-related parties                                    --          (2,236,531)
   Payments received on loans to related parties                   --           9,322,284
   Investment in nonmarketable securities                         (500,000)    (5,767,054)
   Increase in organizational costs                               (500,000)       --
                                                              ------------   -------------
               Net cash used in investing activities            (7,000,985)   (10,844,620)
</TABLE>


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

<PAGE>
                                      F-8

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (continued)

<TABLE>
<C>                                                              <C>           <C>
                                                                 Year ended December 31,
                                                                    1995          1996
                                                                 ---------     ---------- 
Cash Flows from Financing Activities
   Proceeds from issuance of convertible debentures              4,150,000     14,169,441
   Proceeds from notes payable                                   2,630,000        --
   Deferred financing costs incurred related to 
          convertible debemtures                                  (182,000)    (1,365,217)
   Redemption of convertible debentures                         (1,048,967)      (930,000)
   Payments of notes payable and capital lease obligations      (1,653,957)      (944,413)
   Net (payments) proceeds from revolving lines of credit         (616,538)     3,261,590
   Proceeds from sale of common stock                            2,952,144      6,061,380
   Exercise of warrants                                          6,194,955      7,111,684
   Issuance of preferred stock                                  19,385,963     30,823,147
   Purchase of treasury stock                                   (1,211,757)       --
   Payment of contingent note payable                              --            (500,000)
   Redemption of preferred stock, including accrued dividends      --          (3,194,375)
   Payments received on subscriptions receivable                   --           2,009,592
   Deferred costs                                                  --            (932,661)
   Proceeds from exercise of stock options                         484,049        542,223
                                                               -----------     ----------
               Net cash provided by financing activities        31,083,892     56,112,391
                                                               -----------     ----------
Net increase (decrease) in cash and cash equivalents            13,874,975       (965,447)
Cash and cash equivalents, beginning of year                     3,263,203     17,138,178
                                                               -----------     ----------
Cash and cash equivalents, end of year                         $17,138,178    $16,172,731
                                                               ===========    ===========

Supplemental Disclosure of Cash Flow Information
   Cash paid for interest                                         $542,294       $599,011
                                                               ===========    ===========

Supplemental Disclosure of Noncash Financing and Investing Activities:
   Conversion of convertible debentures and related accrued
      interest, net of financing fees                           $3,190,740     $1,172,762
                                                               ===========    ===========

   Subscriptions received in connection with warrant
      exercises                                                 $1,988,709     $1,057,500
                                                               ===========    ===========

   Issuance of common stock in lieu of payment of 
          notes payable                                         $1,879,932        $--
                                                               ===========    ===========

   Conversion of preferred stock                                   $86,060       $788,687
                                                               ===========    ===========

   Property acquired under capital leases                         $196,321     $1,135,189
                                                               ===========    ===========

   Issuance of common stock in exchange for license rights        $300,000       $370,143
                                                               ===========    ===========

   Purchase of technology                                         $---         $1,375,000
                                                               ===========    ===========

   Investment banking and consulting fees for services
      related to the issuance of common stock and
      convertible debentures                                      $120,000       $709,224
                                                               ===========    ===========
</TABLE>

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

<PAGE>
                                      F-9

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (continued)


<TABLE>

<C>                                                              <C>           <C>
                                                                 Year ended December 31,
                                                                  1995           1996
                                                                 ---------     -----------

Supplemental Disclosure of Noncash Financing and Investing Activities

   Value ascribed to warrants in exchange for
      license technology                                          $100,000        $--
                                                                 =========     ===========

   Issuance of common stock for 1995 employer 401(k)
      matching contribution                                        $--           $160,598
                                                                 =========     ===========

   Issuance of common stock for minority interest
   in Star Medical subsidiary                                      $--         $1,749,723
                                                                 =========     ===========

Acquisition of Comtel Electronics, Inc.
   Liabilities assumed                                             $--          $(258,144)
   Fair value of assets acquired                                    --             72,661
   Cash paid, net of cash acquired                                  --           (146,586)
                                                                 ---------     -----------
Cost In Excess of Net Assets Acquired                              $--          $(332,069)
                                                                 =========     ===========

Acquisition of Dermascan, Inc.
   Liabilities assumed                                             $--           $(39,980)
   Fair value of assets acquired                                   --              28,126
   Fair value of  common stock issued                              --            (490,000)
                                                                 ---------     -----------
Cost In Excess of Net Assets Acquired                              $--          $(501,854)
                                                                 =========     ===========

Acquisition of Spectrum Medical Technologies, Inc.
   Liabilities assumed                                         $(1,128,139)       $--
   Fair value of assets acquired                                 1,456,920         --
   Fair value of 364,178 shares of common stock issued          (1,000,000)        --
   Promissory note issued                                         (700,000)        --
   Cash paid                                                      (300,000)        --
   Acquisition costs incurred                                     (161,138)
                                                               ------------    -----------
Cost in Excess of Net Assets Acquired                          $(1,832,357)       $--
                                                               ============    ===========

Acquisition of CD Titles, Inc.
   Liabilities assumed                                         $(1,271,345)       $--
   Fair value of assets acquired                                 1,271,345         --
                                                               ------------    -----------
Cost In Excess of Net Assets Acquired                              $--            $--
                                                               ============    ===========

Acquisition of Inter-connecting Products, Inc.
   Liabilities assumed                                           $(201,761)       $--
   Fair value of assets acquired                                   598,960         --
   Cash Paid                                                      (397,199)        --
                                                               ------------    -----------
Cost In Excess of Net Assets Acquired                              $--            $--
                                                               ============    ===========
</TABLE>

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

<PAGE>
                                      F-10

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)  ORGANIZATION AND OPERATIONS

     Palomar  Medical  Technologies,  Inc. and  subsidiaries  ("Palomar"  or the
"Company")  is engaged in two business  segments:  medical  device  products and
services and  electronic  products and  services.  The medical  device  products
segment consists of the commercial sales and development of cosmetic and medical
laser systems and services.  The electronics  products  segment  consists of the
manufacture and sale of personal  computers,  high density flexible  electronics
circuitry and memory modules.

     The Company also makes early stage  investments  in core  technologies  and
companies that management feels are strategic to the Company's  business or will
yield a higher  than  average  financial  return to support the  Company's  core
business.  Some of these investments are with companies  associated with some of
the directors and officers of the Company (See Note 11).

     Some of the Company's medical laser and electronic  products are in various
stages of development,  and, as such, success of future operations is subject to
a number of risks  similar  to those of other  companies  in  similar  stages of
development.  Principal  among these risks are the  successful  development  and
marketing  of its  products,  proper  regulatory  approval,  the need to achieve
profitable   operations,   competition  from  substitute   products  and  larger
companies,  the need to obtain adequate  financing to fund future operations and
dependence on key individuals.

     The Company has incurred  significant  losses since inception.  The Company
continues to seek  additional  financing  from  issuances of common stock and/or
other prospective  sources in order to fund future  operations.  The Company has
financed  current  operations,  expansion  of  its  core  business  and  outside
short-term financial  investments primarily through the private sale of debt and
equity securities of the Company.  The Company raised a total of $56,112,391 and
$31,083,892  in such  financings  during the years ended  December  31, 1996 and
1995,  respectively.  The Company  anticipates  that it will require  additional
financing during the next twelve-month period to continue to fund operations and
growth.  The Company may from time to time be required to raise additional funds
through  additional  private sales of the Company's  debt or equity  securities.
Sales of  securities  to private  investors are sold at a discount to the public
market for similar securities. It has been the Company's experience that private
investors  require  that the  Company  make its best  effort to  register  these
securities for resale to the public at some future time.

MEDICAL SEGMENT BUSINESS DEVELOPMENTS

STAR MEDICAL TECHNOLOGIES, INC.

     On April  22,  1996,  the  Company  purchased  the  remaining  14.5% of the
outstanding  common stock of Star Medical  Technologies,  Inc. ("Star") which it
did not already own in exchange  for 224,054  shares of  Palomar's  common stock
valued between $6 and $8 per share.  This agreement  restricts,  for a period of
two years, the sale of the Company's common stock issued in connection with this
agreement.  The purchase  price has been recorded as additional  goodwill and is
being  amortized over a period of five years.  In connection with this agreement
the original  founders of Star have agreed to rescind all  royalties due to them
under a Rights  Agreement  dated July 1, 1993. To date,  revenues from Star have
not been significant.

SPECTRUM MEDICAL TECHNOLOGIES, INC.

         On April 5, 1995, the Company  acquired all of the  outstanding  common
stock of Spectrum Medical Technologies,  Inc.  ("Spectrum").  The purchase price
consisted  of $300,000 in cash, a $700,000  two-year  promissory  note,  364,178
shares of the  Company's  common  stock with an  aggregate  fair market value of
$1,000,000,  acquisition  costs of  $161,138  and assumed  liabilities  totaling
$1,128,139.  In addition, the purchase price includes a 20% contingency payment,
payable  in  the  Company's  common  stock,   based  upon  the  future  earnings
performance of Spectrum over a three to five-year period, which will be recorded
as additional  goodwill if earned.  Spectrum develops,  manufactures,  sells and
services  ruby  lasers  

<PAGE>
                                      F-11

throughout  the world for  dermatological  applications  including  the recently
(March 1997) FDA approved EpiLaser.  The acquisition has been accounted for as a
purchase in accordance with Accounting Principles Board ("APB") Opinion No. 16.

SPECTRUM FINANCIAL SERVICES LLC

     On June 30,  1995,  the Company  formed  Spectrum  Financial  Services  LLC
("SFS"),  a Limited Liability  Company.  SFS provides financial leasing services
for medical and  electronic  manufacturers  both  related and  unrelated  to the
Company.  The Company has majority control over the operating activities of this
entity. Accordingly,  the Company has consolidated the results of operations and
financial  position of SFS since the date of formation.  To date, the operations
of SFS have not been a significant.

TISSUE TECHNOLOGIES, INC.

     On May 3, 1996,  the Company  acquired  100% of Tissue  Technologies,  Inc.
("Tissue  Technologies"),  a manufacturer of a dermatology laser product for the
treatment of wrinkles,  in exchange for 3,200,000 shares of the Company's common
stock. The Company has accounted for this  acquisition as a  pooling-of-interest
in  accordance  with  APB  No.  16.  Tissue   Technologies  is  engaged  in  the
manufacturing,  marketing  and sales of the  Tru-Pulse  C02 laser system used in
skin resurfacing and treatment of wrinkles.

DERMASCAN, INC.

     On July 18, 1996 the Company  purchased  80 shares of common  stock (80% of
total issued and  outstanding  capital stock) of Dermascan,  Inc.  ("Dermascan")
from a Dermascan  stockholder  in exchange  for 35,000  shares of the  Company's
common  stock.  The  Company  included  these  35,000  shares in a  registration
statement  that became  effective  February 28, 1997.  In addition,  the Company
agreed  to pay the  Dermascan  stockholder  an  amount  equal to the  difference
between $14.00 and the $7.8125,  the closing bid price on February 28, 1997. The
Company has recorded the acquisition at a price of $490,000 in total.  Dermascan
markets and sells electrology  equipment and supplies to the electrology market.
To date, the operations of Dermascan have not been significant.

PALOMAR TECHNOLOGIES, LTD.

     On November 13, 1996, the Company formed Palomar Technologies, Ltd. located
in Hull, England.  The purpose of the formation of this company was to establish
a European  entity to  manufacture,  sell and service laser products  throughout
Europe and provide a low-cost  sourcing  alternative  for specialty  components.
Operations are expected to begin in mid-1997. Through March 7, 1997, the Company
has funded this  subsidiary  with  approximately  $1,600,000 for the purchase of
office  building  and lease of its  manufacturing  facilities  and the hiring of
certain key employees, and is committed to fund this subsidiary an additional $1
million.  Subsequent  to  year  end,  Palomar  Technologies  Ltd.  entered  into
employment  agreements  with several  individuals  and issued  stock  options to
purchase up to 49% of the outstanding common shares of Palomar Technologies Ltd.
Under the terms of the employment  agreements,  the optionholders have the right
to require  the  Company to  purchase  all or a portion of these  common  shares
exercised pursuant to such stock option at a purchase price based on an earnings
formula as defined.

COSMETIC TECHNOLOGY INTERNATIONAL, INC.

     On December 20, 1996, the Company formed Cosmetic Technology International,
Inc.  ("CTI").  CTI is a service  company which intends to establish a worldwide
network of cosmetic,  dermatological laser and medical device sites with medical
service partners (both fixed and mobile) in key geographic locations.  Each site
will be  provided a turnkey  package  of laser and  medical  device  technology,
equipment  and  services.   To  date,  the  operations  of  CTI  have  not  been
significant.

<PAGE>
                                      F-12

ELECTRONICS SEGMENT BUSINESS DEVELOPMENTS

NEXAR TECHNOLOGIES, INC.

     On March 7, 1995, the Company formed Nexar  Technologies,  Inc.  ("Nexar").
Nexar is an early-stage  company that  manufactures,  markets and sells personal
computers  with a unique  circuit  board  design  that will  enable end users to
upgrade and replace the microprocessor,  memory and hard drive components. Nexar
markets its products  using various  proprietary  brand names  through  multiple
channels of  distribution,  including the wholesale,  retail and direct response
channels.

     On December 20, 1996, Nexar filed a registration statement on Form S-1 with
the SEC in connection with an initial public offering of 2,500,000 shares of its
common stock for its own account,  as well as shares held by Nexar shareholders.
The  estimated  price  per share  range of the  proposed  offering  is $11.00 to
$13.00. Following the offering,  Palomar will beneficially own approximately 67%
of the common  stock  subject  to a  contingent  repurchase  right of Nexar at a
nominal  price per share in the event that Nexar  achieves  certain  performance
milestones  set forth in an agreement  between Nexar and Palomar,  and shares of
Nexar common stock which Palomar may acquire upon  conversion of shares of Nexar
convertible  preferred  stock.  The Company  anticipates  that the offering will
close in early April 1997. Upon completion of the offering, Nexar will repay the
Company  approximately  $8,200,000  from the net  proceeds  received  from  this
offering.  However, the Company can in no way guarantee, nor ensure,  successful
completion of the initial public offering.

     In December 1996 the Company sold 400,000  shares of Nexar common stock for
$4,000,000,  of which  $2,000,000 was collected prior to year end and $2,000,000
is in  other  current  assets  in the  consolidated  balance  sheet.  One of the
purchasers  of 200,000  shares is a  shareholder  of the  Company.  The  Company
recognized a gain on this sale of  $3,830,000 in the  consolidated  statement of
operations.  Subsequent  to year end,  the Company  sold an  additional  200,000
shares of Nexar common stock for $2,000,000 to another Company shareholder.  The
subsequent  to  year  end  sale  of  Nexar  common  stock   includes  an  option
arrangement,  whereby the  purchaser  has the option to  exchange  the shares of
Nexar common stock,  as defined,  for  $2,000,000 of the Company's  common stock
based on a discounted  value as defined,  if an option  exercise  event  occurs,
based on the value of the  Company's  stock on the  exchange  date.  The  option
exercise terminates upon the completion of Nexar's initial public offering.

CD TITLES, INC.

     On July 13, 1995,  CD Titles,  Inc.  ("CD  Titles") was  incorporated.  The
Company owns substantially all of CD Titles'  outstanding  common stock.  During
July 1995,  certain minority  stockholders of CD Titles loaned CD Titles a total
of $600,000.  On July 31, 1995, CD Titles  purchased  certain assets and assumed
certain  liabilities  of CD  Titles  totaling  $1,271,345.  The  purchase  price
consisted  of $625,000 in cash and a $600,000  note  payable due  September  30,
1995,  which was  guaranteed  by the Company.  CD Titles is a CD ROM  publishing
company that distributes  various  materials on CD ROM through personal computer
wholesale  channels in the United States. The acquisition has been accounted for
as a purchase in accordance with the APB No. 16.

     CD Titles  defaulted  on its  loans to the  minority  stockholders,  and on
October  30,  1995  the  Company  negotiated  a  settlement  with  the  minority
stockholders  by agreeing to issue 257,144 shares of the Company's  common stock
in lieu of the then outstanding  principal and accrued  interest  (approximately
$794,000 at October 30, 1995).  The common stock was issued at a 35% discount of
the closing bid price of the stock on October 30, 1995. The discount represented
the  Company's  cost of  acquiring  capital and was  consistent  with  discounts
offered in similar financings during 1995.

     In addition to the  settlement  of the minority  stockholders'  notes,  the
Company  entered  into a  settlement  agreement  with the  former  stockholders.
Pursuant to the settlement  agreement,  the Company registered 175,000 shares of
its authorized, but unissued common stock (the "pledged shares") which were then
issued to the  former  shareholders  of CD  Titles  for  resale.  As part of the
agreement,  the former  shareholders  of CD Titles would sell only the amount of
pledged  shares to  receive  proceeds  equal to the  outstanding  principal  and
accrued interest on the note payable,  which totaled $628,531,  due on September
30,  1995,  as part  of the  acquisition  of CD  Titles.  In  1996,  the  former
shareholders  of  CD  Titles  returned  46,000  of  the  pledged  shares,  which
represents  the unused  portion.  The Company has retired the  returned  shares.


<PAGE>
                                      F-13

DYNAMEM, INC.

     On September 28, 1995, Dynaco Corp.  ("Dynaco") formed Dynamem  Corporation
("Dynamem") (a Delaware Corporation) and contributed $8,000 for a majority (80%)
ownership  in this  subsidiary.  The  remaining  20%  ownership  is owned by the
president of Dynamem (the "Joint Owner").  Dynamem was formed to manufacture and
distribute a patented, high-density memory packaging technology. The Joint Owner
granted Dynamem a non-exclusive license to manufacture, use, sell and sublicense
certain patented FRAMM technology in exchange for certain royalty payments.  The
royalities  are  guaranteed  by Dynaco.  Dynaco and the Joint Owner also entered
into a stockholders'  agreement which grants the Joint Owner the right, upon the
earlier of December 29, 2000, or the termination of his employment with Dynamem,
to  require  Dynaco to  purchase a total of 75% of the  securities  owned by the
Joint Owner in Dynamem. In addition,  if the Company purchases the Joint Owner's
shares,  the  Joint  Owner  may  elect to  receive  between  35% and 100% of the
purchase price in the form of common stock of the Company.

PALOMAR ELECTRONICS CORPORATION

     On September 15, 1995, the Company formed Palomar  Electronics  Corporation
("PEC"),  as part of a  reorganization  to separate the electronics and computer
operations  of the Company's  business  from the medical  laser  segments of its
business.  On September  29, 1995, as part of this  reorganization,  the Company
contributed all of its outstanding  capital stock of Dynaco and Nexar,  together
with certain intercompany indebtedness,  to PEC in exchange for 4,500,000 shares
of common  stock of PEC.  On  December  21,  1995,  PEC issued 10% bridge  notes
payable to certain  investors for an aggregate  consideration of $1,350,000 (see
Note 4). In connection with these notes, PEC issued to the noteholders  warrants
to  purchase  up to 240,000  shares of its common  stock.  During the year ended
December 31, 1995, the Company started, but did not complete,  an initial public
offering of PEC and incurred  costs of  approximately  $438,000.  This amount is
included in business  development and other financing costs in the  accompanying
consolidated statement of operations for the year ended December 31, 1995.

COMTEL ELECTRONICS, INC.

     During 1996,  Dynaco acquired 80.23%  ownership  Comtel  Electronics,  Inc.
("Comtel") by converting a $100,000  note  receivable  into equity of Comtel and
paying   $27,500  in  cash.   Effective   December  31,  1996,   as  part  of  a
recapitalization  of  Comtel,   Dynaco  exchanged   $2,200,000  in  intercompany
receivables  due from  Comtel and used by Comtel to fund its  operations  for an
additional  11.98%  ownership  in Comtel.  This  transaction  resulted in Dynaco
owning 97.3% of Comtel. The remaining 2.7% ownership is held by two individuals.
The  acquisition has been accounted for as a purchase in accordance with APB No.
16. Accordingly,  the Company has allocated the purchase price based on the fair
market value of assets acquired and liabilities  assumed.  The results of Comtel
have been included with those of the Company since March 20, 1996.

PRO FORMA INFORMATION

     The results of operations related to Spectrum have been included with those
     of the Company since April 5, 1995.

     The  results  of  operations  related  to CD  Titles,  Inc./CDRP  have been
     included with those of the Company since July 31, 1995.

     The results of  operations  related to Comtel have been included with those
     of the Company since March 20, 1996.

     The results of  operations  related to Dermascan  have been  included  with
     those of the Company since July 18, 1996

<PAGE>
                                      F-14

     Unaudited  pro  forma  operating  results  for the  Company,  assuming  the
acquisitions  of Spectrum and Comtel had been made as of January 1, 1995, are as
follows  (operations  of CD  Titles  and  Dermascan  prior to  acquisition  were
insignificant):


                                                       Year Ended
                                               1995                  1996
                                           -----------          -----------
      Revenue                              $31,051,600          $70,483,048
      Net loss                             (16,827,709)         (37,901,990)
      Net loss per common share                 $(1.20)              $(1.49)

     Separate  and  combined  results of the  Company  and  Tissue  Technologies
preceding the merger were as follows:

                                 Tissue            Palomar          Combined
                            ------------        -----------        -------------
     Four Months Ended 
          May 3, 1996 
          (unaudited)
     Net Revenues             $3,093,804        $10,255,380         $13,349,184
     Net Loss                $(1,731,775)       $(8,259,386)       $ (9,991,161)

     Year Ended 
          December 31, 1995
     Net Revenues               $114,425        $21,792,079         $21,906,504
     Net Loss                $(1,969,793)      $(10,650,975)       $(12,620,768)

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     The accompanying  consolidated financial statements reflect the application
of certain  accounting  policies  described  below and elsewhere in the Notes to
Consolidated Financial Statements.

(a) PRINCIPLES OF CONSOLIDATION

     The accompanying consolidated financial statements reflect the consolidated
financial position,  results of operations and cash flows of the Company and all
wholly-owned  and  majority-owned   subsidiaries.   All  other  investments  are
accounted  for using the cost  method as the  Company  owns less than 20% of the
common stock outstanding for these  investments.  All intercompany  transactions
have been eliminated in consolidation.

(b) MANAGEMENT ESTIMATES

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting  period.  Actual  results  could  differ from those  estimates.  As of
December  31,  1996,  the  Company  also  has   investments  in  marketable  and
nonmarketable  securities and loans to related parties totaling $8,632,830.  The
amount that the Company may  ultimately  realize  from these  investments  could
differ  materially  from  the  value  of  these  investments   recorded  in  the
accompanying consolidated financial statements as of December 31, 1996.

(c) INVESTMENTS

         The fair values for the Company's  marketable  securities  are based on
quoted market prices.  The fair values of nonmarketable  equity securities which
totaled  $2,400,000 at December 31, 1996 represent  equity  investments in early
stage technology companies,  and are based on the financial information provided
by these ventures.  The Company  periodically  performs a financial  analysis to
evaluate  whether a  permanent  impairment  has  occurred.  The amount  that the
Company  

<PAGE>
                                      F-15

realizes  from these  investments  may  differ  significantly  from the  amounts
recorded in the accompanying consolidated financial statements.

     The Company accounts for marketable  securities in accordance with SFAS No.
115,  ACCOUNTING FOR CERTAIN  INVESTMENTS IN DEBT AND EQUITY  SECURITIES.  Under
SFAS No. 115, securities that the Company has the positive intent and ability to
hold  to  maturity   are   reported  at  amortized   cost  are   classified   as
held-to-maturity.  There were no held-to-maturity  securities as of December 31,
1995 and 1996.  Securities  purchased to be held for indefinite  periods of time
and  not  intended  at the  time  of  purchase  to be held  until  maturity  are
classified  as  available-for-sale  securities.   Unrealized  gains  and  losses
relating to  available-for-sale  securities are included as a separate component
of stockholders' equity. Securities that are bought and held principally for the
purpose of selling them in the near term are  classified as trading  securities.
Realized and  unrealized  gains and losses  relating to trading  securities  are
included in the accompanying consolidated statements of operations.  The Company
has  deemed  its  portfolios  at  December  31,  1995  and  1996 to  consist  of
available-for-sale and trading securities summarized as follows:

                                             December 31, 1995
                          ------------------------------------------------------

                                          Gross         Gross
                          Amortized    Unrealized     Unrealized        Fair
                            Costs         Gain           Loss          Value
                         -----------  ------------  -------------  -------------
Trading Securities:
Investments in publicly
traded companies          $615,842      $137,170        $3,602        $749,410
                        ============  ============  =============  =============


                                             December 31, 1996
                         ------------------------------------------------------

Trading Securities:
Investments in  publicly
traded companies          $1,695,618    $1,537,614      $339,440      $2,893,792

Available-for-Sale (long-term):
Investments in  publicly
traded companies           1,000,000        ---         342,500        657,500

                        ------------  ------------  -------------  -------------
                          $2,695,618    $1,537,614      $681,940      $3,551,292
                        ============  ============  =============  =============

(d) INVENTORIES

     Inventories  are  stated  at the  lower of cost  (first-in,  first-out)  or
market.  Work-in-process  and finished  goods  inventories  consist of material,
labor and  manufacturing  overhead.  At December 31, 1995 and 1996,  inventories
consist of the following:

                                                   December 31,
                                             1995                1996
                                       ----------------    ----------------
   Raw materials                           $1,949,288         $13,266,204
   Work-in-process and finished goods       1,700,596           5,524,280
                                       ----------------    ----------------
                                           $3,649,884         $18,790,484
                                       ================    ================

<PAGE>
                                      F-16

(e) DEPRECIATION AND AMORTIZATION

     The Company  provides for  depreciation  and  amortization  on property and
equipment using the straight-line method, by charging to operations amounts that
allocate the cost of assets over their estimated useful lives as follows:

                                                                  Estimated
                   Asset Classification                          Useful Life
          ------------------------------------            ----------------------
          Equipment under capital leases                      Term of Lease
          Machinery and Equipment                               5-8 Years
          Furniture and Fixtures                                 5 Years
          Leasehold improvements                              Term of Lease

     Property and Equipment consist of the following:

                                                         December 31,
                                                   1995               1996
                                            ----------------   -----------------
     Equipment under capital leases               $1,214,950          $2,261,339
     Machinery and equipment                       1,992,157           5,429,764
     Furniture and fixtures                          806,252           1,926,948
     Leasehold improvements                          308,158           1,160,814
                                            ----------------   -----------------
                                                   4,321,517          10,778,865
     Less:  Accumulated depreciation
                and amortization                   1,156,502           2,374,260
                                            ----------------   -----------------
                                                  $3,165,015          $8,404,605
                                            ================   =================

(f) COST IN EXCESS OF NET ASSETS ACQUIRED AND INTANGIBLE ASSETS

     The costs in excess of net assets acquired for Dynaco,  Spectrum,  Star and
Comtel are being amortized on a straight-line  basis over periods ranging from 5
to 10 years, and are as follows:


                                                           December 31,
                                                     1995               1996
                                             ----------------   ----------------
     Dynaco                                        $2,570,318         $2,570,318
     Spectrum                                       1,832,357          1,832,357
     Star                                              ---             1,749,722
     Comtel                                            ---               352,220
                                             ----------------   ----------------
                                                    4,402,675          6,504,617
     Less:  accumulated amortization                  673,167          1,480,318
                                             ================   ================
                                                   $3,729,508         $5,024,299
                                             ================   ================

     Amortization  expense  for the years ended  December  31,  1995,  and 1996,
amounted to approximately $445,000 and $807,000,  respectively,  and is included
in  general  and  administrative  expenses  in  the  accompanying   consolidated
statements of operations.

     The  Financial  Accounting  Standards  Board issued  Statement of Financial
Accounting  Standards  ("SFAS")  No.  121,  ACCOUNTING  FOR  THE  IMPAIRMENT  OF
LONG-LIVED  ASSETS AND FOR  LONG-LIVED  ASSETS TO BE DISPOSED OF, in March 1995.
Under SFAS No.  121,  the Company is  required  to assess the  valuation  of its
long-lived assets, including cost in excess of net assets acquired, based on the
estimated  future cash flows to be  generated  by such  assets.  The Company had
write-offs totaling  

<PAGE>
                                      F-17

approximately  $1,032,000  associated with the realizability of certain licenses
and goodwill.  This amount is included in general and administrative expenses in
the  accompanying  consolidated  statement  of  operations  for the  year  ended
December 31, 1996.

     Other  intangibles  include the cost of licenses and technologies  acquired
through the purchase of product rights and licenses during 1995 and 1996.  These
intangibles  are  being  amortized  over a period  of five  years.  Amortization
expense  for the years  ended  December  31,  1995 and 1996  were  approximately
$149,000   and   $876,000   respectively,   and  is   recorded  in  general  and
administrative   expenses  in  the  accompanying   consolidated   statements  of
operations.

     On February 28, 1995, Tissue Technologies  entered into a license agreement
to license a patent on a low pressure  discharge  apparatus (a key instrument in
Tissue Technologies' product) with a corporation.  As consideration for entering
into the agreement,  the corporation  received  $50,000 in cash and a warrant to
purchase  160,000  shares of common  stock at a price of $.01 per share.  Tissue
Technologies  ascribed a value to the warrant of $100,000.  The former  majority
stockholder  and  officer  of Tissue  Technologies  also  assigned  his right to
license the  technology  to Tissue  Technologies,  on an  exclusive  basis,  and
exchanged   his  note  payable  of  $100,000   for  600,000   shares  of  Tissue
Technologies'  common  stock,  which was  subsequently  exchanged  in the merger
discussed  in  Note  1.  Tissue  Technologies  has  capitalized  $450,000  which
represents  the cash paid plus the value  ascribed  to the equity  consideration
given in exchange for the license.

     As part of the formation  and  organization  of PEC and Nexar,  the Company
agreed to settle a complaint brought against the Company and the chief executive
officer of Nexar.  As part of the  settlement,  the Company was  required to pay
$525,000  and  agreed  to issue  warrants  to  purchase  108,000  shares  of the
Company's  common stock at $5.00 per share.  The Company has fully expensed this
amount in 1996 which is  included  in  settlement  and  litigation  costs in the
accompanying consolidated statement of operations.

(g) DEFERRED COSTS

     Deferred costs consisted of the following at December 31, 1995 and 1996:

                                                          December 31,
                                                     1995              1996
                                                ---------------   --------------
     Prepaid Investment banking fees                 $290,816         $      ---
     Deferred initial public offering costs               ---            952,383
     Deferred financing costs, net                    518,304          1,943,420
                                                ===============   ==============
                                                     $809,120         $2,895,803
                                                ===============   ==============

     On August  19,  1994,  the  Company  entered  into an  investment  services
agreement  whereby an  investment  banker would provide  merger and  acquisition
consulting  services  over a two-year  period  ending  August 1996.  The Company
expensed  approximately  $436,000 and $291,000 of these  prepaid fees during the
years ended December 31, 1995 and 1996, respectively.

     As of December 31, 1996,  the Company has incurred  costs of  approximately
$952,383 in  connection  with the proposed  initial  public  offering of Nexar's
common  stock.  These costs have been  deferred as of December 31, 1996 and upon
the consummation of the proposed  initial public offering the deferred  offering
costs  will be  charged  to  stockholder's  equity  as  reduction  of the  gross
proceeds.

     During the years ended  December  31, 1995 and 1996,  the Company  incurred
financing costs related to several issuances of convertible debentures (see Note
4). Deferred financing costs related to convertible debentures totalled $238,333
and $1,943,420 at December 31, 1995 and 1996, respectively.

<PAGE>
                                      F-18

(h) REVENUE RECOGNITION

     The Company  recognizes  product revenue upon shipment.  Design and tooling
revenue  is  recognized  upon  customer  acceptance.  Occasionally,  revenue  is
recognized by the Company's Dynaco  subsidiary upon completion of a phase of the
order when  contractually  accepted by the customer.  Provisions are made at the
time of revenue  recognition  for any  applicable  warranty costs expected to be
incurred.

     Nexar  recognizes  product  revenue upon  shipment.  Nexar has  established
programs which,  under  specified  conditions,  provide price  protection and or
enable customers to return products. The effects of these programs are estimated
and current period revenue and cost of revenue are reduced accordingly.  This is
standard industry practice,  and no other  contingencies exist relating to these
programs.  Provisions are made at the time of sale for any  applicable  warranty
costs expected to be incurred.

     During the year ended December 31, 1996, Nexar recognized  revenue totaling
approximately  $2,500,000  for  products  whose  title  passed to a  significant
customer  (see Note 2(i)) and such customer  instructed  the Company to hold the
product at its manufacturing  facility on the customer's  behalf.  Subsequent to
December  31,  1996,  all of this  product  had been  shipped to this  customer.
Included in accounts  receivable at December 31, 1996 is approximately  $160,000
due from this customer related to this  transaction.  The Company has recognized
this revenue in  accordance  with the SEC  Accounting  and Auditing  Enforcement
Release No. 108.

(i) SIGNIFICANT CUSTOMERS

     For the year ended  December 31, 1995 one customer  accounted  for 10.3% of
revenues and 11.2% of accounts receivable.  For the year ended December 31, 1996
one customer  accounted for 22.3% of revenues and 26.7% of accounts  receivable.
The two largest customers in 1996 accounted for 39.9% of revenue and represented
49.9%  of  the  December  31,  1996   accounts   receivable   balance  of  which
approximately   $5,056,000  was  collected  subsequent  to  year  end.  Accounts
receivable  included $4,896,632 from a customer of Comtel's in which the Company
has approximately 14% equity ownership as of December 31, 1996. (See Note 11.)

(j) RESEARCH AND DEVELOPMENT EXPENSES

     The Company  charges  research and  development  expenses to  operations as
incurred.

(k) NET LOSS PER COMMON SHARE

     For the years  ended  December  31,  1995 and 1996 the net loss per  common
share has been computed by dividing net loss,  as adjusted for  preferred  stock
dividends,  by the weighted average number of shares of common stock outstanding
during the period.  Common stock  equivalents are not considered as outstanding,
as the result would be antidilutive.

     The net loss was adjusted by the  aggregate  amount of  dividends  totaling
$124,610 and $1,242,751 on the Company's  preferred stock during the years ended
December 31, 1995 and 1996, respectively. In March of 1997, SFAS No.128 EARNINGS
PER SHARE was  issued  which  established  new  standards  for  calculating  and
presenting  earnings  per share.  The Company will be required to adopt this new
standard in the 1997 consolidated financial statements.  In accordance with this
new  standard,  basic and  diluted  loss per  share  for 1995 and 1996  would be
$(0.89) and $(1.49).

(l) CONCENTRATION OF CREDIT RISK

     SFAS No. 105,  DISCLOSURE OF INFORMATION  ABOUT FINANCIAL  INSTRUMENTS WITH
OFF-BALANCE-SHEET  RISK AND FINANCIAL  INSTRUMENTS WITH  CONCENTRATION OF CREDIT
RISK, requires disclosures of any significant  off-balance-sheet and credit risk
concentrations.  Financial  instruments  that subject the company to credit risk
consist primarily of cash and trade accounts receivable.  The Company places its
cash in highly rated  financial  institutions.  The Company also has convertible
debentures  denominated  in Swiss francs of $7,222,846 at December 31, 1996 (see
Note  4(c)).  The Company  currently  does not have a 

<PAGE>
                                      F-19

foreign currency hedging arrangement and plans to hedge this amount in 1997. The
Company has no other significant off-balance-sheet  concentration of credit risk
such as foreign exchange  contracts,  options contracts or other foreign hedging
arrangements.  To reduce its accounts  receivable  risk,  the Company  routinely
assesses the financial strength of its customers and, as a consequence, believes
that its  accounts  receivable  credit risk  exposure  is  limited.  The Company
maintains an allowance  for potential  credit  losses.  The  Company's  accounts
receivable credit risk is not within any geographic area. The Company has issued
notes and made investments to various related parties  totaling  $5,076,751as of
December 31, 1996 (see Note 11).  Included in this amount are unsecured loans of
$604,653 to and for the benefit of a director of the Company's  underwriter.  As
of  December  31,  1996,  the Company  also made  strategic  equity  investments
totaling $2,587,500 in four technology  companies.  Subsequent to year-end,  the
Company loaned money to, prepaid fees for, purchased  inventory on behalf of and
made investments in certain related entities totaling $3,060,000.

(m) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

     SFAS No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS requires
disclosure  of an estimate of the fair value of certain  financial  instruments.
The fair value of financial  instruments  pursuant to SFAS No. 107  approximated
their  carrying  values at  December  31,  1995 and 1996.  Fair values have been
determined  through  information  obtained  from market  sources and  management
estimates.

(n) RECLASSIFICATIONS

     Certain reclassifications have been made to the 1995 consolidated financial
statements to conform with the current year's presentation.

(3) INCOME TAXES

     The  Company  provides  for  income  taxes  under the  liability  method in
accordance with the provisions of SFAS No. 109,  ACCOUNTING FOR INCOME TAXES. At
December 31,  1996,  the Company had  available,  subject to review and possible
adjustment  by the  Internal  Revenue  Service,  a federal  net  operating  loss
carryforward  of  approximately  $45,917,000 to be used to offset future taxable
income,  if any. This net operating  loss  carryforward  will begin to expire in
2002. The Internal Revenue Code contains provisions that limit the net operating
loss  carryforwards  due to changes  in  ownership,  as defined by the  Internal
Revenue Code.  The Company  believes that its net operating  loss  carryforwards
will  be  limited  due  to its  reorganization  in  1991  and  subsequent  stock
offerings.  The  Company  has not  recorded  a  deferred  tax  asset for the net
operating  losses,  due to  uncertainty  relating  to the  Company's  ability to
utilize such  carryovers.  In connection  with Nexar's  proposed  initial public
offering it is  contemplated  that the  Company's  ownership  of Nexar will fall
below 80%. Accordingly, $6,375,000 of net operating losses generated by Nexar as
of December 31, 1996 will not be  available  for to Company to utilize in future
periods.

<PAGE>
                                      F-20

(4) LONG-TERM DEBT

(a) NOTES PAYABLE

<TABLE>
<C>                                                                             <C>       <C>       <C>     
                                                                                          December 31,
                                                                                     1995             1996
                                                                                 --------------  ---------------
Dollar denominated convertible debentures                                          $   819,359       $7,288,063
Swiss franc denominated convertible debentures                                              --        7,222,846
7% Note payable                                                                        244,782          244,782
7.4% to 21% Capital lease obligations, maturities ranging from August 1997 to
   May 2001                                                                          1,393,612        2,290,847
Present value of notes payable, discounted at 8%, maturities ranging from
February 1996  to February 1998                                                        468,012          337,606
Note payable in connection with the Spectrum acquisition, interest at the prime
   rate (8.25% at Dec. 31, 1996) plus 1%, due April 1997                               500,000          150,000
Bridge notes payable, interest at 10% until March 1996, then prime (8.25% at
   December 31, 1996) plus 2%                                                        1,350,000        1,200,000
8% Convertible debentures                                                              950,000               --
Other notes payable                                                                    178,672          254,231
                                                                                 --------------  ---------------
                                                                                     5,904,437       18,988,375
Less - current maturities                                                            2,574,265        2,783,683
                                                                                 --------------  ---------------
                                                                                    $3,330,172      $16,204,692
                                                                                 ==============  ===============
</TABLE>

     On  December  21,  1995,  PEC issued  $1,350,000  face value  bridge  notes
payable.  The  notes  will be due 18 months  after  their  inception  or 10 days
following  the closing of a public  offering of PEC.  Payment of  principal  and
accrued  interest is  guaranteed by the Company.  In connection  with the bridge
financing,  PEC issued to the  noteholders at nominal value warrants to purchase
up to  240,000  shares of PEC's  common  stock at $1.20 per  share.  In 1996 the
Company  paid back one bridge  noteholder  a principal  amount of $120,000  plus
accrued  interest.  As of  December  31,  1995,  the  Company  had  $950,000  of
convertible  debentures  that were  issued by the  Company's  subsidiary  Tissue
Technologies.  These notes were  converted  into 813,431 shares of the Company's
common stock on May 3, 1996 in connection with the merger of Tissue Technologies
with Palomar.

(b) DOLLAR DENOMINATED CONVERTIBLE DEBENTURES

     During the years  ended  December  31, 1995 and 1996,  the  Company  issued
several  series of  convertible  debentures.  The  interest  on certain of these
convertible  debentures  is  forgiven if the  debentures  are  converted  before
specified dates;  otherwise,  interest is payable on their respective due dates.
During 1995 and 1996,  approximately  $152,000  and  $10,500,  respectively,  of
accrued interest was forgiven and is included in additional paid-in capital. The
convertible  debentures outstanding on December 31, 1996 have a conversion price
which  represents a discount of 15% of the Company's common stock at the time of
conversion.  It has been the  Company's  policy to  discount  those  convertible
debentures using an assumed implicit rate ranging from 12% to 15% as a result of
the  discount  conversion  feature of the  convertible  debentures.  The Company
believes that the intent of the  debentureholders  is to convert the  debentures
into common stock at their discounted conversion price. Accordingly, the Company
has credited this ascribed value to additional paid-in-capital,  and this amount
is  being  amortized  to  interest  expense  over the  terms of the  convertible
debentures.  During the years  ended  December  31,  1995 and 1996,  the Company
recorded  $168,393 and $76,721,  respectively,  of additional  interest  expense
relating  to the  amortization  of the  discounts  relating  to the  convertible
debentures.

     In  addition,  the Company has  incurred  financing  costs of $380,000  and
$1,055,400  during the years ended  December  31,  1995 and 1996,  respectively,
relating to these  debentures.  Given the  debentureholders'  intent to convert,
these  costs  have  been  reflected  in  deferred  costs  in  the   accompanying
consolidated  balance sheet as of December 31, 1995 and 

<PAGE>
                                      F-21

1996,  and are  amortized  to  additional  paid-in  capital over the term of the
related convertible  debentures.  Any remaining  unamortized  deferred financing
costs are also recorded to  additional  paid-in-capital  upon  conversion of the
debentures.  During the years  ended  December  31,  1995 and 1996,  the Company
amortized  deferred financing costs of $70,583 and $77,683 to additional paid-in
capital,  respectively.  Also,  as  a  result  of  the  conversions  of  certain
convertible  debentures  during  1995 and 1996,  the Company  amortized  another
$253,158 and $40,658, respectively, to additional paid-in capital.

     The  following  table   summarizes  the  issuance  and  conversion  of  the
convertible debentures for the years ended December 31, 1995 and 1996.

<TABLE>
  <C>                                               <C>            <C>             <C>             <C>          <C>
                                                                       Value                                       Common
                                                                    Ascribed to                                    Shares
                                                                     Additional          Outstanding at            Issued
                                                        Face          Paid-In             December 31,              Upon
                                                                                   ---------------------------
   Series                                              Value          Capital          1995          1996        Conversion
   -----------------------------------------------  -------------   -------------  -------------  ------------  -------------
   3% Series due September 30, 1996                  $   750,000     $   150,000       $     --       $    --        370,189
   6% Series due November 21, 1997                     2,000,000         400,000             --            --      1,172,132
   7% Series due March 31, 2000                        1,100,000         350,000             --            --             --
   7% Series due July 1, 2000                          1,200,000         350,000             --            --        401,549
   8% Series due October 26, 1997                      1,000,000         199,813        819,359            --         34,615
   4.5% Series due October 21, 1999, 2000, 2001        5,000,000       1,284,705             --     3,761,038             --
   5% Series due December 31, 2001                     5,000,000       1,472,975             --     3,527,025             --
                                                    -------------   -------------  -------------  ------------  -------------
                                                     $16,050,000      $4,207,493       $819,359    $7,288,063      1,978,485
                                                    =============   =============  =============  ============  =============
</TABLE>

     During  the  years  ended  December  31,  1995  and  1996,  all  of  the 7%
convertible  debentures  due on March 31, 2000 and $775,000 face value of the 8%
convertible debentures, respectively, were redeemed by the Company together with
accrued interest. Accordingly, $321,533 and $41,530 for the years ended December
31 1995 and 1996,  respectively,  representing the unamortized amount previously
credited to additional  paid-in  capital for the ascribed value of the discount,
was reversed.

     During  1995,  the  debentureholders  converted  the 3%,  6% and 7%  series
convertible  debenture due September  30, 1996,  November 21, 1997,  and July 1,
2000, respectively. During 1996, the debentureholders converted $225,000 in face
value of the 8% convertible debentures.  Upon their conversion, in 1995 and 1996
these  convertible  debentures  totaled  $2,964,209  and  $191,139  with related
accrued  interest  of  $126,531  and  $10,500,  respectively,  on the  dates  of
conversion.

     In connection with the 6% convertible  debentures,  each holder is entitled
to receive one  warrant to purchase  common  stock of the Company  (expiring  no
later than three  years from the date of  conversion)  for every five  shares of
common stock of the Company issued, at 150% of the market price, as defined,  at
the time of conversion.  As a result,  the Company  issued  242,655  warrants to
purchase  common shares of the Company  during 1995 at stock prices ranging from
$3.09 to $3.75. These warrants expire through July 28, 1998.

(c) SWISS FRANC DENOMINATED CONVERTIBLE DEBENTURES

     On July 3, 1996,  the Company  raised  $7,669,442  through the  issuance of
9,675 units in convertible  debenture  financing.  These units are traded on the
Luxembourg  Stock  Exchange.  Each  unit  consists  of a  convertible  debenture
denominated  in 1,000  Swiss  Francs and a warrant to  purchase 24 shares of the
Company's common stock at $16.50 per share and is due July 3, 2003. The warrants
are  non-detachable  and may be  exercised  only if the related  debentures  are
simultaneously  converted,  redeemed or purchased.  Interest on the  convertible
debentures accrues at a rate of 4.5% per annum and is payable quarterly in Swiss
Francs. The convertible debentures may be converted by the holder or the Company
commencing  October 1, 1996 at a conversion  price equal to 100% to 77.5% of the
price per share of the  Company's  common  stock,  calculated  as defined.  This
conversion price decreases from the third anniversary to the seventh 

<PAGE>
                                      F-22

anniversary  of the  convertible  debentures but in no event is less than $12.00
per share. Because of this decreasing  conversion feature and the non-detachable
nature  of  the  debentures,  the  Company  believes  that  the  intent  of  the
debentureholder  is to hold the  debenture  through  the life of the debt and no
discount has been ascribed to this debt. In addition, the Company has the option
to redeem these  debentures  after the third  anniversary  of the issuance.  The
Company is required to set up a mandatory sinking fund beginning on July 3, 2000
through  July  3,  2003,  for  25%  of the  aggregate  principal  amount  of the
convertible debentures. The debenture is payable in Swiss Francs and the Company
adjusts the debt based on  fluctuations  in the exchange  rate.  The  translated
value of these convertible debentures as of December 31, 1996 was $7,222,846 and
the  difference  of  $446,596  was  recognized  as a foreign  exchange  gain and
included  in  other  income  (see  Note  9) in  the  consolidated  statement  of
operations for the year ended December 31, 1996. The Company incurred  financing
costs of $982,365 relating to these debentures and is amortizing this asset over
the life of the debentures.

(d) FUTURE MATURITIES OF LONG-TERM DEBT OBLIGATIONS

     Future   maturities  of  notes  payable,   capital  lease  obligations  and
convertible  debentures  reflected  at face value as of December 31, 1996 are as
follows:

                         1997                               $ 2,783,683
                         1998                                 1,359,208
                         1999                                 1,881,242
                         2000                                 1,732,169
                         2001                                 6,721,163
                   Thereafter                                 7,222,846
                                                          =============
                                                            $21,700,311
                                                          =============

(5) STOCKHOLDERS' EQUITY

(a) COMMON STOCK OUTSTANDING

     During 1995, the Company  pledged  2,860,000  shares of its common stock as
collateral for an anticipated  $5,000,000 debt financing with Whetstone Ventures
Corporation,  Inc.  ("Whetstone").  The  Company  received  only  $400,000  from
Whetstone,  and the debt  financing was canceled  before being  consummated.  On
March 13, 1996,  the Company  filed a complaint  against the third party to whom
Whetstone had pledged the shares,  demanding return of the shares and obtained a
restraining  order  prohibiting  transfer of the shares.  On March 22, 1996, the
third party agreed to return the shares in exchange for the $400,000  previously
received by the  Company and an  additional  $700,000.  The Company  charged the
additional  $700,000 to  settlement  and  litigation  cost during the year ended
December 31,  1995.  Accordingly,  the Company did not consider  these shares as
outstanding in the accompanying consolidated financial statements as of December
31, 1995.

     On February 1, 1996,  the Company issued 365,533 shares of common stock and
warrants  to  purchase  182,765  shares of common  stock at $5.00 per share in a
private placement for net proceeds of $1,530,776. Under the terms of the private
placement  agreement,  the  Company  can only use the  proceeds  to finance  the
development and premarketing activities of certain products.

<PAGE>
                                      F-23

(b)  PREFERRED STOCK

     The  Company is  authorized  to issue up to 5 million  shares of  preferred
stock, $.01 par value.

     As of December 31, 1995 and 1996,  preferred stock  authorized,  issued and
outstanding consists of the following:

<TABLE>
       <C>                                                                                       <C>     <C>          <C> 
                                                                                                          Par Value
                                                                                                         December 31,
                                                                                                    ----------------------
                                                                                                    1995              1996
                                                                                                    ----              ----
       Redeemable convertible  preferred stock, Series I Class A, $.01 par value
         Authorized - 7,000 shares
         Issued and outstanding - 1,960 shares in 1995, liquidation preference of $1,989,500      $   20                --
       Redeemable convertible preferred stock, Series II Class A, $.01 par value
         Authorized - 9,000 shares
         Issued and outstanding - 4,400 shares in 1995, liquidation preference of $4,456,415          44                --
       Redeemable convertible preferred stock, Series A, $.01 par value
         Authorized - 2,500 shares
         Issued and outstanding - 2,500 shares in 1995, liquidation preference of $2,512,329          25                --
       Redeemable convertible preferred stock, Series B, $.01 par value
         Authorized - 2,500 shares
         Issued and outstanding - 2,500 shares in 1995, liquidation preference of $2,512,329          25                --
       Redeemable convertible preferred stock, Series C, $.01 par value
         Authorized - 2,500 shares
         Issued and outstanding - 2,500 shares in 1995, liquidation preference of $2,512,329          25                --
       Redeemable convertible preferred stock, Series E, $.01 par value
         Authorized - 10,000 shares
         Issued and outstanding - 2,151 shares in 1996, liquidation preference of $2,235,615          --                22
         Redeemable  convertible  preferred  stock,  Series  F,  $.01 par  value
         Authorized - 6,000 shares
         Issued and outstanding - 6,000 shares in 1996, liquidation preference of $6,229,333          --                60
       Redeemable convertible preferred stock, Series G, $.01 par value
         Authorized - 10,000 shares
         Issued and outstanding - 10,000 shares in 1996, liquidation preference of $10,181,008        --               100

           Total preferred stock                                                                    $139              $182
                                                                                                    ====              ====
</TABLE>

     During  1996,  all of the  outstanding  Series  I and II  preferred  shares
(including  accrued  dividends of $110,689) were converted into 1,527,242 shares
of the Company's common stock. In addition,  all of the 5,000 shares of Series A
and B redeemable  convertible  preferred stock (including dividends of $125,625)
were converted into 788,711  shares of the Company's  common stock.  The Company
also redeemed all the 2,500 shares of Series C convertible  redeemable preferred
stock (including accrued dividends of $71,223) on March 20, 1996 for $3,194,375.

     In February  1996,  the Company  issued 6,000 shares of Series D redeemable
convertible  preferred  stock, all of which were converted into 1,116,918 shares
of common  stock  (including  accrued  dividends of $342,092) as of December 31,
1996.  In April 1996,  the Company  issued  10,000 shares of Series E redeemable
preferred  stock,  7,849 shares of which were converted into 1,048,647 shares of
common stock (including  accrued dividends of $204,196) as of December 31, 1996,
and the remaining were converted after year end as discussed in Note 15.

         In July 1996,  the Company  issued  6,000 shares of Series F redeemable
convertible  preferred  stock at a price  of  $1,000  per  share.  The  Series F
redeemable  convertible  preferred  stock,  together with any accrued but unpaid
dividends,  may be  converted  into shares at 80% of the daily  average  closing
price of the shares on the ten trading days preceding such conversion, 

<PAGE>
                                      F-24

but in no event less than  $7.00 or more than  $16.00.  The Series F  redeemable
convertible  preferred  stock may be redeemed  as defined,  with no less than 10
days and no more than 30 days notice or when the stock price exceeds  $16.80 per
share for sixty  consecutive  trading  days, at an amount equal to the amount of
liquidation   preference  determined  as  of  the  applicable  redemption  date.
Dividends are payable quarterly at 8% per annum in arrears on March 31, June 30,
September 30 and December 31. Dividends not paid on the payment date, whether or
not such dividends have been declared, will bear interest at the rate of 10% per
annum until paid.

     On  September  26,  1996,  the  Company  issued  10,000  shares of Series G
redeemable  convertible  preferred  stock at a price of $1,000  per share to two
investors.  The Series G redeemable  convertible  preferred stock, together with
any accrued but unpaid  dividends,  may be converted into common stock at 85% of
the average closing bid price for the three trading days  immediately  preceding
the conversion  date, but in no event at less than $6.00 or more than $11.50 for
5,000 shares of Series G redeemable convertible preferred stock or $8.00 for the
other 5,000  shares of Series G  redeemable  convertible  preferred  stock.  The
Series G  redeemable  convertible  preferred  stock may be redeemed at any time,
with no less than 15 days and no more than 20 days notice, at an amount equal to
the  sum of (a)  the  amount  of  liquidation  preference  determined  as of the
applicable redemption date plus (b) $176.50.  Dividends are payable quarterly at
7% per annum in arrears on January 1, April 1, July 1 and  October 1.  Dividends
not paid on the payment date,  whether or not such dividends have been declared,
will bear interest at the rate of 12% per annum until paid.

     The conversion  price for Series F and G redeemable  convertible  preferred
stock is adjustable for certain dilutive events, as defined.  The Series F and G
redeemable  convertible  preferred stock have a liquidation  preference equal to
$1,000 per share of redeemable  convertible  preferred  stock,  plus accrued but
unpaid dividends, and accrued but unpaid interest. The Series F and G redeemable
convertible  preferred  stockholders  do not have any  voting  rights  except on
matters effecting the Series F and G redeemable convertible preferred stock. The
Company  has  registered   2,100,000  shares  of  common  stock  underlying  the
conversion  of the Series F and G redeemable  convertible  preferred  stock into
common shares.

(c) STOCK OPTION PLANS AND WARRANTS

     (i) STOCK OPTIONS

     The Company has 1991,  1993, 1995 and 1996 Stock Option Plans (the "Plans")
that provide for the issuance of a maximum of 350,000,  500,000,  1,000,000  and
2,500,000 shares of common stock, respectively, which may be issued as incentive
stock options (ISOs) or nonqualified options. Under the terms of the Plans, ISOs
may not be granted at less than the fair market  value on the date of grant (and
in no event less than par value),  provided that ISO grants to holders of 10% of
the combined  voting power of all classes of Company stock must be granted at an
exercise  price of not less  than 110% of the fair  market  value at the date of
grant.  Pursuant to the plans,  options are  exercisable  at varying  dates,  as
determined  by the  Board of  Directors,  and have  terms not to exceed 10 years
(five years for 10% or greater  stockholders).  The Board of  Directors,  at the
request of the optionee,  may, in its  discretion,  convert the optionee's  ISOs
into nonqualified options at any time prior to the expiration of such ISOs.

     During 1995, Tissue Technologies granted options to purchase 224,235 shares
of the Company's  common stock at prices  ranging from $0.40 to $0.81 per share.
These  options were not granted  pursuant to the above  mentioned  plans.  These
options were  exercised on May 3, 1996 in connection  with the Company's  merger
with Tissue Technologies as discussed in Note 1.

<PAGE>
                                      F-25

     The following table summarizes all stock option activity for the Company:
<TABLE>
<C>                                                             <C>              <C>                <C>                 
                                                                 Number of          Exercise            Weighted Average
                                                                   Shares             Price              Exercise Price
                                                                -------------    ----------------    ----------------------
Outstanding, December 31, 1994                                     1,047,500          $1.00-3.50             $2.25
            Granted                                                  820,235           0.40-3.00             1.75
            Exercised                                              (285,000)           1.00-3.50             1.76
            Canceled                                                (75,000)               2.375             2.375
                                                                -------------    ----------------    ----------------------
Outstanding, December 31, 1995                                     1,507,735         $0.40-$3.50             $2.06
            Granted                                                1,520,000          6.00-10.50             7.08
            Exercised                                              (366,735)           0.40-3.50             1.28
            Canceled                                                 (5,000)                3.00             3.00
                                                                -------------    ----------------    ----------------------
Outstanding, December 31, 1996                                     2,656,000        $2.00-$10.50             $5.03
                                                                =============    ================    ======================
Exercisable as of December 31, 1996                                1,600,998        $2.00-$10.50             $3.79
                                                                =============    ================    ======================
Available for future issuances under the plans
            as of December 31, 1996                                1,266,500
                                                                =============
</TABLE>

     The  range  of  exercise   prices  for  options   outstanding  and  options
exercisable at December 31, 1996 are as follows:
<TABLE>

<C>                  <C>       <C>      <C>                  <C>                        <C>     <C>     <C>                   
                               Options Outstanding                                              Options Exercisable
------------------------------------------------------------------------------------    --------------------------------------

                                        Weighted Average
     Range of            Options            Remaining           Weighted Average           Options        Weighted Average
  Exercise Prices      Outstanding      Contractual Life         Exercise Price          Exercisable       Exercise Price
-------------------- ---------------- ---------------------- -----------------------    -------------- -----------------------

        $2.00-$3.50        1,136,000                   3.04                   $2.29         1,136,000                   $2.29
         6.00-10.50        1,520,000                   4.75                    7.08           464,998                    7.46
                     ================ ---------------------- -----------------------    ============== =======================
                           2,656,000                   4.01                   $5.03         1,600,998                   $3.79
                     ================ ====================== =======================    ============== =======================

</TABLE>

     In August 1995,  Nexar  established  its 1995 Stock Option Plan (the "Nexar
Plan"),  which  provides for the  issuance of a maximum of  4,800,000  shares of
common  stock,  which  may be  issued  as  incentive  stock  options  (ISOs)  or
nonqualified stock options.  Subsequent to December 31, 1996, the Nexar Board of
Directors  increased  the  number of  shares  issuable  under the Nexar  Plan to
5,300,000.

     On January  30, 1996 and July 19,  1996 Nexar  granted  options to purchase
3,234,480 and 83,000  respective  shares of Nexar's  common stock at an exercise
price of $0.0025 and $4.25 per share.  The price per share was based on the fair
market value of Nexar's  Common Stock as determined by the Board of Directors of
Nexar on the date of grant.

     Nexar has also agreed to issue, upon consummation of Nexar's initial public
offering,  options to purchase  50,000 and 50,000 shares of Nexar's common stock
at 85% and 50% of the initial  public  offering  price,  respectively.  Upon the
granting of these options, the Company will record deferred compensation expense
for the  difference  between  the  exercise  price and the price of the  initial
public offering,  if any. In addition,  the Board of Directors of Nexar approved
the issuance of stock  options to purchase  1,050,000  shares of Nexar's  common
stock at the initial  public  offering price upon the  effectiveness  of Nexar's
proposed  initial  public  offering  price to certain  employees,  directors and
officers of the Company and Nexar.  These stock  options  will vest over periods
ranging from four to five years,  except for stock  options to purchase  800,000
shares of Nexar's common stock, which may vest earlier,  upon the achievement of
certain  revenue,  net income and stock price  milestones,  as defined,  through
December 31, 2000.

<PAGE>
                                      F-26

     In December  1996,  the Director Plan was adopted by the Board of Directors
of Nexar.  The  Director  Plan will  become  effective  upon the  closing of the
proposed initial public offering.  Under the terms of the Director Plan, initial
options (the "Initial  Options") to purchase  15,000 shares of common stock will
be granted to each person who becomes a non-employee director of Nexar after the
closing date of the proposed  initial  public  offering and who is not otherwise
affiliated  with  Nexar,  effective  as of the date of  election to the Board of
Directors. The Initial Options will vest in equal annual installments over three
years after the date of grant.  In addition,  each  non-employee  director  will
receive annually options to purchase 10,000 shares (the "Annual Options") on the
date of each annual  meeting of Nexar's  stockholders  held after the closing of
Nexar's initial public offering.  The Annual Options will vest one year from the
date of grant.  A total of 100,000 shares of common stock may be issued upon the
exercise  of stock  options  granted  under the  Director  Plan.  Unless  sooner
terminated  pursuant to its terms,  the Director Plan will terminate in December
2006.

     Subsequent to December 31, 1996, the Board of Directors of Nexar authorized
amendments to employment agreements  accelerating the vesting of certain options
to purchase  451,950  shares of Nexar's common stock upon the closing of Nexar's
initial public offering contemplated herein. In addition, the Board of Directors
of Nexar approved amendments to employment  agreements  accelerating the vesting
of options to purchase  903,900  shares of Nexar's common stock to vest one year
from the closing of Nexar's initial public offering contemplated.

     The following table summarizes stock option activity for Nexar:

<TABLE>
<C>                                                         <C>                        <C>          
                                                                   Number of               Exercise
                                                                    Shares                  Price
                                                            ------------------------   -----------------
Inception, March 7, 1995                                                          -                   $
                                                                                                      -
            Granted                                                          20,640                .001
                                                            ------------------------   -----------------
Outstanding, December 31, 1995                                               20,640                .001
            Granted                                                       3,396,840         .0025-10.00
            Canceled                                                      (361,560)               .0025
                                                            ------------------------   -----------------
Outstanding, December 31, 1996                                            3,055,920        $.001-$10.00
                                                            ========================   =================
Exercisable as of December 31, 1996                                       1,063,973        $.001-$.0025
                                                            ========================   =================

</TABLE>

     Star also has  established  a stock  option  plan  which  provides  for the
issuance of both  nonqualified and ISOs. As of December 31, 1994, Star granted a
total of  97,000  options  to  purchase  Star's  common  stock to  officers  and
employees  ranging  from $2.50 to $6.00 per share.  In the  fiscal  year  ending
December 31, 1996,  Star granted a total of 140,000  options to purchase  Star's
common stock to officers and employees ranging from $2.50 to $9.50 per share. In
the fiscal year ending December 31, 1996,  20,000 shares at $2.50 per share were
exercised by an individual;  in addition,  12,000 shares at $6.00 per share were
canceled. As of December 31, 1996, 205,000 ranging from $2.50 to $9.50 per share
are outstanding, of these, 105,000 are exercisable.

     PEC has also  established  a stock  option  plan,  which  provides  for the
issuance of both nonqualified and incentive stock options.  On December 1, 1995,
PEC granted stock options to purchase  1,590,000  shares of PEC common stock for
$.30 per share,  the fair value of PEC's common  stock,  as  determined by PEC's
Board of  Directors.  Of the  total  stock  options  granted,  1,230,000  vested
immediately,  and the balance vest over a four-year period. In 1996,  options to
purchase  870,000 shares of PEC common stock were canceled.  No additional stock
options were granted by PEC during 1996.

     Comtel has  established a stock option plan which provides for the issuance
of both  nonqualified  and incentive stock options.  During 1996,  Comtel issued
423,675  options to purchase  Comtel  common stock for $.55 per share,  the fair
market value as determined by Comtel's Board of Directors.

     CTI has  established a stock option plan which provides for the issuance of
both  nonqualified  and inventive  stock options.  During 1996, CTI issued 1,750
options to purchase CTI common  stock for $.01 per share,  the fair market value
at the date of grant as determined by CTI's Board of Directors.

<PAGE>
                                      F-27

     The  Company  accounts  for its  stock-based  compensation  plans under APB
Opinion No. 25,  ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.  In October 1995, the
Financial  Accounting  Standards  Board  issued  SFAS No.  123,  ACCOUNTING  FOR
STOCK-BASED  COMPENSATION,  which is effective for fiscal years  beginning after
December  15,  1995.  SFAS No.  123  established  a  fair-value-based  method of
accounting  for  stock-based  compensation  plans.  The  Company has adopted the
disclosure-only  alternative under SFAS No. 123 which requires disclosure of the
pro forma effects on earnings per share as if SFAS No. 123 had been adopted,  as
well as certain other information.

     The Company has computed the pro forma disclosures  required under SFAS No.
123 for all stock  options and warrants  granted to employees of the Company and
its Nexar subsidiary in fiscal years ending December 31, 1995 and 1996 using the
Black Scholes  option  pricing  model  prescribed by SFAS No. 123. The pro forma
disclosure for the Company's results of operations related to stock option plans
at its Dynaco,  Star, PEC, Comtel and CTI  subsidiaries  were immaterial for the
years ended December 31, 1995 and 1996.

     The assumptions used to calculate the SFAS 123 pro forma disclosure and the
weighted  average  information for the fiscal years ending December 31, 1995 and
1996 for Palomar are as follows:

<TABLE>
<C>                                                     <C>                          <C>
                                                                 1995                         1996
                                                        ------------------------     -----------------------

Risk-free interest rate                                          6.08%                       6.37%
Expected dividend yield                                            -                           -
Expected lives                                                 3.2 years                   4.4 years
Expected volatility                                               55%                         79%
Weighted-average grant date fair value of
     options granted during the period                           $3.92                       $4.57

</TABLE>

     The weighted  fair-value and weighted exercise price of options granted for
the Company in fiscal years ending December 31, 1995 and 1996 are as follows:

<TABLE>
<C>                                                                       <C>                     <C>
                                                                                 1995                    1996
                                                                          --------------------    -------------------

Weighted Average Exercise Price for options:
     whose  exercise price exceeded fair market value at the                    $3.00                  $10.00
      date of grant
     whose  exercise price was equal to fair market value at                    $1.614                  $6.875
      the date of grant
Weighted Average Fair Market Value for options:
     whose  exercise price exceeded fair market value at the                    $2.125                  $8.875
      date of grant
     whose  exercise price was equal to fair market value at                    $5.265                  $6.875
      the date of grant

</TABLE>

<PAGE>
                                      F-28

     The assumptions used to calculate the SFAS No. 123 pro forma disclosure and
the weighted  average  information for the fiscal years ending December 31, 1995
and 1996 for Nexar are as follows:

<TABLE>
<C>                                                     <C>                          <C>            
                                                                 1995                         1996
                                                        ------------------------     -----------------------

Risk-free interest rate                                          6.11%                       5.87%
Expected dividend yield                                            -                           -
Expected lives                                                 4.5 years                   4.5 years
Expected volatility                                               51%                         51%
Weighted-average grant date fair value of
     options granted during the period                          $0.001                       $0.28
Weighted-average  exercise  price of  options  granted
during the period                                               $0.001                       $0.45
Weighted-average remaining contractual life of
     options outstanding                                      4.58 years                   4.13 years
Weighted-average exercise price of  5,733 and
     1,063,973 options exercisable at December
     31, 1995 and 1996, respectively.                           $0.001                      $0.0025
</TABLE>

     (ii) WARRANTS

     In  connection  with the Company's  initial  public  offering,  the Company
issued  2,442,621  warrants to purchase one share of common stock per warrant as
adjusted in certain antidilution provisions in the warrant agreement. In January
1995,  the Company  announced  its  intention  to redeem the  warrants.  Through
February  10,  1995,  the date the warrant  call ended,  certain  warrantholders
exercised such warrants to purchase a total of 1,852,012 shares of common stock.
The remaining  unexercised  warrants to purchase 590,609 shares were redeemed by
the Company for $29,530.  As a result of these  warrant  exercises,  the Company
received cash proceeds totaling  $1,286,931 and received demand promissory notes
in the total principal amount of $4,633,975 with interest at 7.75% per annum. In
September 1995, $3,694,840 of the notes were repaid.

     The remaining balance of $939,135 from the demand promissory note discussed
above relates to warrants exercised by a director of the Company's  underwriter.
In addition,  on May 12, 1995,  this director  exercised  warrants to purchase a
total of 200,000  shares of the  Company's  common stock.  The Company  received
another  demand  promissory  note in the  principal  amount of  $1,049,574  with
interest at 7.75% per annum.  These promissory notes are unsecured and there are
no  restrictions  on transfer or sale of the shares of common stock  received in
connection with the exercise of these warrants. In 1996, the Company loaned this
underwriter  $1,057,500 in connection  with the exercise of warrants for a total
of 500,000 shares of the Company's  common stock. In 1996, the underwriter  paid
off loans totaling $2,509,591 in connection with the exercise of stock warrants.
Of this  amount  $2,009,591  was paid in cash  and  $500,000  was  paid  through
investment  banking  services in connection  with the 5% convertible  debentures
issued on December 31, 1996.

     In the years  ending  December  31, 1995 and 1996,  the  Company  issued to
certain  investment  bankers,  consultants  (including  related  parties  to the
Company  - see Note  11),  directors,  noteholders  and  officers,  warrants  to
purchase common stock.  In 1995, the Company issued warrants  totaling 82,500 at
an  exercise  price of $1.25 to certain  investment  bankers.  The  warrants  to
purchase  82,500 shares were issued below the fair market value of the Company's
common stock at the date of grant.  Accordingly,  the Company charged $95,370 to
business development and other financing costs in the accompanying  consolidated
statement of operations for the year ended December 31, 1995.

         The Company issued 182,765  warrants during 1996 in connection with the
private  placement of common stock for a total Black  Scholes value of $599,465;
these  amounts  are  exclusive  of  900,000  shares  of net  warrants  issued in
connection with the sale of 600,000 shares of common stock to  Finmanagement  on
December 27, 1996. The Company issued 232,200 warrants during 1996 in connection
with convertible  debentures for a total Black Scholes value of $2,468,286.  The
Company issued 1,978,058 warrants during 1996 in connection with preferred stock
for a total  Black  Scholes  value of  

<PAGE>
                                      F-29

$13,325,477.  The Company  issued  36,553  warrants  during  1996 in  investment
banking fees in connection  with  financings  for a total Black Scholes value of
$119,894. The Company has not reflected the value attributable to these warrants
in the consolidated  statement of stockholders'  equity due to the fact that the
issuance  of these  warrants  were  directly  associated  with the  issuance  of
convertible  debentures,  common and preferred stock and the Company believes it
is the intent of the debenture  holders to convert their  debentures into common
stock on a short-term basis. Accordingly, the value of those warrants would both
increase and decrease additional paid-in capital.

     In January 1995, the Company issued a warrant to purchase 160,000 shares of
the  Company's  common  stock at $0.01  per share in  connection  with a license
agreement.  See  Note  2(f).  This  warrant  was  exercised  on May 3,  1996  in
connection with the Company's merger with Tissue  Technologies,  as discussed in
Note 1.

     From  January  1,  1997  through  March  7,  1997,  certain  warrantholders
exercised  warrants to  purchase  155,532  shares of common  stock at a price of
$2.25 per share. The total proceeds received by the Company were $349,947.

         The following table summarizes all warrant activity for the Company:

<TABLE>
<C>                                                      <C>               <C>               <C>
                                                                                                  Average
                                                           Number of          Exercise           Weighted
                                                             Shares             Price         Exercise Price
                                                         ----------------  ----------------  ------------------
Outstanding, December 31, 1994                                 4,554,862    $0.60 - $15.00         $5.39
              Granted                                          4,835,155     0.01 -   7.50          2.36
                                                                                      
              Exercised                                      (2,840,093)     0.60 -   5.00          3.86
                                                         ----------------  ----------------  ------------------
Outstanding, December 31, 1995                                 6,549,924     0.01 -  15.00          3.82
                                                         ================  ================  ==================
Exercisable as of December 31, 1995                            6,549,924     0.60 -  15.00          3.82
                                                         ================  ================  ==================
              Granted                                          6,527,576     4.88 -  16.50          8.16
              Exercised                                       (3,101,261)    0.01 -   7.69          2.66
                                                         ----------------  ----------------  ------------------
Outstanding, December 31, 1996                                 9,976,239    $0.60 - $16.50         $7.02
                                                         ================  ================  ==================
Exercisable, December 31, 1996                                 8,161,237    $0.60 - $16.50         $5.80
                                                         ================  ================  ==================
</TABLE>

     The range of exercise  prices for warrants  outstanding  and exercisable at
December 31, 1996 are as follows:
<TABLE>
<C>                  <C>       <C>     <C>                  <C>                         <C>            <C>                      
                               Warrants Outstanding                                             Warrants Exercisable
------------------------------------------------------------------------------------    --------------------------------------

                                        Weighted Average
     Range of           Warrants            Remaining           Weighted Average          Warrants       Weighted Average
  Exercise Prices      Outstanding      Contractual Life         Exercise Price          Exercisable      Exercise Price
-------------------- ---------------- ---------------------- -----------------------    -------------- ----------------------

        $0.60-$1.00           98,660                    .39                 $   .67            98,660               $    .67
          2.00-4.88        2,343,579                   2.43                    2.30         2,343,579                   2.30
          5.00-7.69        4,773,742                   4.58                    6.57         3,375,407                   4.80
         8.00-16.50        2,760,258                   4.45                   12.03         2,343,591                  10.68
                     ================ ====================== =======================    ============== ======================
                           9,976,239                   4.00                  $ 7.02         8,161,237                 $ 5.80
                     ================ ====================== =======================    ============== ======================
</TABLE>

     The Company has computed the pro forma disclosures  required under SFAS No.
123 for all warrants  granted in fiscal years ending  December 31, 1995 and 1996
using the Black Scholes option pricing model prescribed by SFAS No. 123.

<PAGE>
                                      F-30

     The assumptions used to calculate the SFAS No. 123 pro forma disclosure and
the weighted  average  information for the fiscal years ending December 31, 1995
and 1996 for the Company are as follows:

<TABLE>
<C>                                                    <C>                           <C>                    
                                                                 1995                         1996
                                                        ------------------------     -----------------------
Risk-free interest rate                                           6.01%                      5.93%
Expected dividend yield                                            -                           -
Expected lives                                                     4.8 years               5.9 years
Expected volatility                                               56%                         80%
Weighted-average grant date fair value of
     warrants granted during the period                          $1.81                       $5.39
Weighted-average exercise price of  warrants
     granted during the period                                   $2.36                       $8.16

</TABLE>

     The weighted fair-value and weighted exercise price of warrants granted for
the Company in fiscal years ending December 31, 1995 and 1996 are as follows:

<TABLE>
<C>                                                           <C>                     <C>                
                                                                     1995                    1996
                                                              --------------------    -------------------

Weighted Average Exercise Price for warrants:
     whose  exercise  price  exceeded  fair market  value at         $2.72                  $11.76
       date of grant
     whose  exercise  price was less than fair market  value         3.17                    7.07
       at date of grant
     whose  exercise price was equal to fair market value at         1.98                    6.67
       date of grant
Weighted Average Fair Market Value for warrants:
     whose  exercise  price  exceeded  fair market  value at         2.18                    9.34
       date of grant
     whose  exercise  price was less than fair market  value         4.96                    8.82
       at date of grant
     whose  exercise price was equal to fair market value at         $2.86                  $6.67
       date of grant

</TABLE>

     During 1996, the Company issued 300,000  warrants to purchase  common stock
at $7.69 per share to three  non-employees  who  provided  consulting  services.
These  warrants  vest over a period of two to three  years.  The Company  valued
these  warrants in  accordance  with SFAS No. 123 at  $1,598,298 to be amortized
over the  vesting  period.  The  Company  recorded  $266,375  of this  amount as
business development and other financing costs in the accompanying  consolidated
statement of  operations  and $266,383 as  capitalized  deferred  Nexar  initial
public offering costs in 1996 in the accompanying consolidated balance sheet.

     (iii) PRO FORMA DISCLOSURE

     The pro forma effect of applying  SFAS No. 123 for all options and warrants
to purchase  common stock for the Company and its Nexar  subsidiary  would be as
follows:

                                            Year Ended December 31,
                                       1995                        1996
                            -------------------------    -----------------------
Pro forma net loss                 $(22,730,970)               $(65,358,314)
Pro forma net loss per share         $(1.60)                     $(2.50)

<PAGE>
                                      F-31

(d) RESERVED SHARES

     At December 31, 1996,  the Company has reserved  shares of its common stock
for the following:


        Warrants                                                       9,976,239
        Stock option plans                                             3,922,500
        Convertible debentures                                         2,617,800
        Preferred stock                                                2,697,165
        Employee Stock Purchase Plan                                   1,000,000
        Employee 401(k) Plan                                             254,115
                                                                 ---------------
                         Total                                        20,467,819
                                                                 ===============

     From January 1, 1997 through  March 7, 1997 740,826  shares of common stock
were issued in connection with certain of the items above.

(e) COMMON STOCK ISSUED IN LIEU OF PAYMENT

     In August  1995,  the  Company  issued to an  officer  of Dynaco a total of
200,000 shares of common stock in lieu of two demand  promissory  notes totaling
$355,000 (see Note 11).

     In  connection  with the  organization  and purchase of CD Titles and CDRP,
Inc. (see Note 1),  certain  related  parties of the officers of the Company and
Dynaco loaned CD Titles  $300,000.  On October 27, 1995,  the Company  agreed to
issue common stock at a 35% discount to these individual  noteholders,  (as well
as the remaining  noteholders  in CD Titles),  in lieu of payment on the related
promissory  notes.  The related parties received 128,572 shares of the Company's
common stock in satisfaction of the notes payable and accrued interest  totaling
approximately $397,000. In 1996 the Company issued 56,900 shares of common stock
to purchase the license rights to product line on behalf of CD Titles.

     During the year ended  December 31, 1995, the Company issued 167,676 shares
of its common stock for investment  banking,  merger and  acquisition  services,
with a fair market  value of  $421,500.  The Company  included  $398,250 of this
amount in  deferred  costs,  as the shares were  issued in  connection  with the
convertible  debenture  financings and other prepaid investment banking services
(See Note 2(g)).  The remaining  amount was expensed to and included in business
development and other financing costs in the accompanying consolidated statement
of  operations.  In 1996,  the Company  issued 36,802 shares of common stock for
investment  banking services in connection with the sale of common stock and the
issuance of convertible  debentures for a value of $209,224.  The Company issued
20,000 shares of common stock for acquisition  services of $267,500  relating to
the  Tissue  Technologies   acquisition  and  recognized  this  expense  in  the
accompanying consolidated statement of operations.

(f) EMPLOYEE STOCK PURCHASE PLAN

     In June  1996,  the Board of  Directors  established  the  Palomar  Medical
Technologies,  Inc. 1996 Employee  Stock  Purchase Plan (the  "Purchase  Plan").
Under the Purchase Plan, all employees, as defined, are eligible to purchase the
Company's  common  stock at an  exercise  price  equal to 95% of the fair market
value of the common stock. The Purchase Plan provides for up to 1,000,000 shares
for  issuance  under the  Purchase  Plan.  As of December  31,  1996,  rights to
purchase 580 shares were outstanding.

(6) RESEARCH & PRODUCT DEVELOPMENT AGREEMENTS

     The Company has an agreement with the New England  Medical Center  ("NEMC")
and Dr.  Stanley  M.  Shapshay  to  provide  a  research  grant  and to  sponsor
investigations and development of laser applications,  advanced delivery systems
and

<PAGE>
                                      F-32

disposable  products in the agreed-upon medical  applications.  The Company also
agreed to provide a total of $150,000 over a one-year  period,  of which $50,000
was  paid  in  the  form  of  laser  hardware.   The  parties  have  reached  an
understanding  that the  Company  will obtain  ownership  rights or the right of
first  refusal to exclusive  worldwide  licenses to sell and market any products
developed with the grant funding.  In August 1994, this agreement was amended to
support animal testing with one of the Company's diode lasers in connection with
performing  tonsillectomies.  The  Company  recorded  approximately  $95,000 and
$37,000 of research and  development  expenses for the years ended  December 31,
1995 and 1996 related to this agreement.

     The Company entered into a multiyear  agreement with Massachusetts  General
Hospital  ("MGH")  effective  August  18,  1995,  whereby  MGH agreed to conduct
clinical trials on a laser treatment for hair removal/reduction  invented by Dr.
R. Rox Anderson,  Wellman  Laboratories of Photomedicine,  MGH. MGH will provide
the Company with data previously  generated by Dr.  Anderson,  further  clinical
research on the ruby laser device at MGH and other sites, and remit ownership of
all case  report  forms  and data  resulting  from the  study.  The  Company  is
obligated to fund the clinical research obligation of $917,000 and pay a license
fee of $250,000 over the term of the contract,  until  completion of the studies
which is  anticipated  to be two years from the effective date unless amended or
terminated.   During  1995,   the  Company   expensed   approximately   $177,000
representing the cost of research and development and capitalized  approximately
$50,000 as a license fee, which is being amortized over five years. In 1996, the
Company paid the  remaining  $200,000 for the license fee and in early 1997 made
payments  of $54,417 per the terms of the  agreement.  The Company has agreed to
enter into a worldwide exclusive license agreement with MGH upon completion of a
valid product or service, or new uses (not related solely to hair removal) based
on the findings of the clinical studies.

     Effective  February  14,1997,  the  Company  amended  the August  18,  1995
agreement  with MGH. The Company  agrees to provide MGH with a grant of $203,757
to perform  research and  evaluation in the field of hair  removal.  The Company
immediately paid $50,090 upon execution of this agreement, and the Company shall
pay a  license  fee  of  $10,000  within  thirty  days  of  this  amendment.  As
consideration  for this amended license,  the Company is obligated to pay to MGH
royalties of 5.5% of net revenues of  products/services  covered by valid patent
licensed to the Company  exclusively;  2.5% of net revenues of products/services
covered by valid  patent  licensed  to the Company  nonexclusively;  1.5% of net
revenues of products developed and exploited, not covered above and no less than
3% on the sale of any other laser using other  technology as defined for the use
of hair  removal.  In  March  of 1997 the  U.S.  Patent  Office  issued a patent
protecting the laser-based hair removal technology developed by Dr. Rox Anderson
at MGH,  for which  Palomar is the  exclusive  worldwide  licensee.  The Company
incurred $175,000 of royalties under this license in 1996.

     On March  11,  1996 the  Company  entered  in an  agreement  with Dr.  R.G.
Geronemus, M.D., P.C ("Geronemus") a New York State professional corporation, to
conduct clinical studies using the ruby laser for hair removal with longer pulse
duration   than  in  previous   studies.   The  studies  will  be  performed  on
approximately 70 patients.  The total contract is for $178,750, of which $44,688
was recorded as research expense for the year ended December 31, 1996.

<PAGE>
                                      F-33

(7) SEGMENT INFORMATION

     The  Company  has two  operating  business  groups,  medical  products  and
electronics products. All of the operations of Dynaco, Nexar, CD Titles, PEC and
their  subsidiaries  are reported below as the Electronics  Products Group.  All
other operations are focused in the areas of cosmetology and dermatology,  which
are included in the Medical Products Group. Information with respect to industry
segments is set forth as follows:

<TABLE>
                    <C>                              <C>  <C>                <C>                  <C>           
                                                           As of and for the year ended December 31, 1995
                                                          Electronic          Medical
                                                           Products          Products             Total
                                                      ----------------------------------------------------------
                    Revenues                                $16,296,224        $5,610,280          $21,906,504
                    Loss from Operations                     (3,668,083)       (8,794,908)         (12,462,991)
                    Identifiable Assets                       17,048,106        24,822,054           41,870,160
                    Depreciation and Amortization                881,530           944,143            1,825,673
                    Capital Expenditures                        $540,725          $908,062           $1,448,787

                                                           As of and for the year ended December 31, 1996
                                                          Electronic          Medical
                                                           Products          Products             Total
                                                      ----------------------------------------------------------
                    Revenues                                $52,274,285       $17,824,158          $70,098,443
                    Loss from Operations                    (17,189,563)      (22,435,014)         (39,624,577)
                    Identifiable Assets                       43,501,440        47,255,756           90,757,196
                    Depreciation and Amortization              1,243,666         2,672,555            3,916,221
                    Capital Expenditures                      $3,066,056        $3,257,632           $6,323,688

</TABLE>

(8) ACCRUED EXPENSES

     Accrued expenses consist of the following:

<TABLE>
                    <C>                                      <C>                   <C>
                                                                  December 31,         December 31,
                                                                      1995                 1996
                                                              ----------------      ---------------
                    Payroll and consulting costs                     $852,793           $3,456,311
                    Professional fees                                 914,935              961,815
                    Settlement costs                                  700,000            1,755,000
                    Warranty                                          295,962            2,854,401
                    Other                                           1,869,867            5,642,365
                                                              ----------------      ---------------
                        Total                                      $4,633,557          $14,669,892
                                                              ================      ===============
</TABLE>

(9) OTHER INCOME (EXPENSE)

     Other Income (Expense) consist of the following:

<TABLE>
                    <C>                                       <C>                 <C>
                                                                  December 31,        December 31,
                                                                     1995                1996
                                                              ----------------    ----------------
                    Foreign Currency Gain                            $     --        $   446,596
                    Write-down of notes and
                        investments                                        --         (4,996,038)
                    Other                                             102,305             303,800
                                                              ================    ================
                        Total                                        $102,305        $(4,245,642)
                                                              ================    ================
</TABLE>
<PAGE>
                                      F-34

(10) REVOLVING LINES OF CREDIT

     On May 31,  1995,  Dynaco  entered into a three year  revolving  credit and
security  agreement  with  a  financial  institution,  which  provides  for  the
revolving sale of acceptable  trade accounts  receivable with recourse at 85% of
face value, up to a maximum  commitment of $3 million.  The outstanding  balance
under the line bears  interest at the lender's  prime rate (8.25% as of December
31, 1996) plus 1.5%, payable monthly,  and amounted to $1,296,462 and $1,787,057
as of December 31, 1995 and 1996,  respectively.  Borrowings under this line are
collateralized  by the purchased  receivables and  substantially all of Dynaco's
assets and are guaranteed by the Company.

     On December  5, 1996,  Comtel  entered  into a loan  agreement  with a loan
association  which  provided  for  borrowings  up to  $4,500,000  in the form of
revolving  receivable and inventory  loans.  Borrowings under the loan agreement
are limited by a borrowing base calculation on eligible accounts  receivable and
inventory, and are collateralized by accounts receivable, inventory, and certain
other assets. Borrowings bear interest at the lender's prime rate plus 2.25% and
amounted to $2,770,375 as of December 31, 1996. The loan agreement terminates on
November 30, 1998.

(11) RELATED PARTY TRANSACTIONS

     Included in current assets at December 31, 1995 and 1996 are $4,109,573 and
$1,459,484 of notes  receivable from various  officers and related  entities and
investments in related entities. Also included in trading securities at December
31,  1996 is a  $1,912,614  investment  in a related  entity.  It is  reasonably
possible that the Company's  estimate that it will collect these  receivables or
realize its investment within one year will change in the near term.

     Dynaco leases its Tempe, Arizona, facility from a partnership consisting of
the Chief Executive Officer and Chief Operating  Officer of Dynaco.  The Company
also has certain capital leases which are personally guaranteed by an officer.

     The Board of Directors have established a corporate loan policy under which
loans may be granted to certain  officers/stockholders/directors  of the Company
for  amounts  up to an  aggregate  of  $800,000.  All  of  such  loans  must  be
collateralized by certain  stockholdings of these  individuals,  as defined.  At
December 31, 1995 and 1996, $383,198 and $578,680,  respectively,  with interest
at   the   rate   of   7%   per    annum,    was    outstanding    to    certain
officers/stockholders/directors under the corporate loan policy.

     At December  31,  1996,  the Company had loans  receivable  of $134,000 and
$151,363 from two officers of Dynaco,  which are  evidenced by promissory  notes
due upon  demand,  respectively,  with  interest at the rate of 8% and the prime
rate per annum,  respectively.  The $151,363 loan  receivable is  collateralized
with a certain  amount of  vested  stock  options  in the  Company  owned by the
officer  with a market price in excess of the  exercise  price.  At December 31,
1996, the Company had an additional  loan receivable for $75,000 from an officer
of Dynaco,  which is evidenced by a demand promissory note and bears interest at
7%. The total accrued interest  relating to all of the Company loans to officers
of the Company and Dynaco was $56,288 as of December 31, 1996.

     At December 31, 1995, the Company had notes  receivable for $3,150,000 from
an  affiliated   company.   The  Company's  chairman  and  CEO  personally  owns
approximately  13% of the affiliated  company as of December 31, 1996. The notes
receivable  were repaid during 1996,  upon the affiliated  company's  successful
completion  of an initial  public  offering.  In  connection  with the notes the
Company  received  173,874  shares of common  stock and two warrants to purchase
289,790 shares of common stock at $1.29 from the affiliated company. The Company
fully  exercised  these  warrants and at December  31, 1996 still owned  463,664
shares.  The shares are registered and the Company plans to sell these shares in
1997.  The  Company   recognized  an  unrealized   gain  of  $1,537,614  in  the
accompanying  consolidated  statement of  operations  in  connection  with these
shares.  The Company also has a demand note of $500,000 from a manufacturer that
is collateralized by a portion of the Chairman's common stock in this affiliated
company.

     A former  director  of  Palomar is also a  director  of a  publicly  traded
company.  The Company  loaned  $1,700,000  during 1996 to this  publicly  traded
company,  of which $500,000 was paid back as of December 31, 1996. The remaining

<PAGE>
                                      F-35

balance  outstanding of $1,200,000 is a note receivable which is  collateralized
by a security agreement for manufacturing equipment owned by the publicly traded
company.  The note is also  convertible to common stock at the discretion of the
Company at a  conversion  price of $1.00 per share,  subject  to  adjustment  as
defined.  The  Company  also has three  warrants  to purchase a total of 300,000
shares of common stock at a price of $1.13.

     On  September  30,  1996  the  Company   purchased  two  limited  liability
partnership  units  for  $500,000  in a  full  service  investment  banking  and
securities brokerage firm. A director of the partnership is a former director of
the Company and a current director of Nexar.

     The Company has a $500,000 equity investment in a privately held technology
company.  A  director  of the  Company's  underwriter,  H.J.  Meyers,  is also a
director of the investee company. In addition, at December 31, 1996, the Company
had unsecured notes receivable from this director totaling $1,059,548,  of which
$604,653 was in connection  with the exercise of stock warrants (see Note 5). In
1996 the Company loaned $500,000 to an affiliate of the underwriter. This amount
was paid back in full as of year end. Subsequent to year end, the Company made a
deposit of $450,000  towards the purchase of a publicly traded  affiliate of the
underwriter and prepaid the underwriter  $200,000  relating to future investment
banking  services.  Both the  deposit and the  prepayment  are  refundable  upon
demand.  Also  subsequent  to year  end,  the  Company  loaned  $500,000  to the
underwriter which has been paid back in full.

     During the year ended  December  31,  1996 the  Company  made a  $1,000,000
equity  investment in a publicly traded technology  company.  In connection with
this  investment,  a director of Palomar  joined the Board of  Directors of this
publicly  traded  company.  In  1996,  the  Company  loaned  $5,800,000and  paid
$109,000in  consulting  fees to a company owned by this director.  This loan has
been paid back as of December 31, 1996.

     During the year ended  December  31, 1996 the Company  purchased  2,325,581
shares of Series E  preferred  stock and  1,000,000  shares of common  stock for
$2,690,000  in the  privately  held former  parent of Comtel.  The Company  also
loaned the privately held company  $1,000,000 in the form of a subordinated note
and  sold  500,000  shares  of the  privately  held  company's  common  stock to
employees of the company for non-recourse  promissory  notes totaling  $345,000.
Both the notes and the investments  were written off by the Company at year end,
as the Company believes there has been an impairment in the net realizable value
of this  investment.  The privately  held company was a significant  customer as
disclosed  in Note  2(i).  Subsequent  to year  end,  the  Company  invested  an
additional  $1,200,000  and  converted  the  $1,000,000  subordinated  note into
764,665 shares of Series F preferred stock. The Company also purchased  $960,000
of inventory  and is committed to purchase an  additional  $240,000 of inventory
from a major supplier on behalf of the privately  held company.  The Company has
entered into an agreement to resell this  inventory  back to this privately held
company in 1997 at an estimated loss of $210,000.

     On October 11, 1996 the Company paid  $500,000 to a privately  held medical
and cosmetic services company.  An officer of CTI is a director of the privately
held company.  In return the Company received 500,000 shares of common stock and
a promissory  note for $499,500 due on October 11, 1997 accruing  interest at 8%
per annum.  Subsequent to year end, the Company paid $250,000 for 100,000 shares
of common stock and a promissory note of $249,900  accruing  interest at 12% per
annum and was due February 28, 1997.  For every thirty day period this note goes
unpaid,  the Company will receive  50,000 shares of the privately held company's
common stock, to a maximum of 250,000 shares. The privately held company intends
to file an initial  public  offering  in 1997 and will  register  the  Company's
shares subsequent to the filing.

     During  the year  ended  December  31,  1996,  the  Company  granted to its
officers and directors  warrants to purchase  1,700,000  shares of the Company's
common stock, at prices ranging from $6.00 - $8.00, and expiring five years from
the date of grant.  These  warrants  were issued at the fair market value on the
date of grant. In addition,  the Company issued to these individuals  options to
purchase  500,000 shares of the Company's  common stock, at a price of $8.00 and
expiring five years from the date of grant.

<PAGE>
                                      F-36

(12) 401(K) PROFIT SHARING PLAN

     The Company has a 401(k)  profit  sharing  plan (the  "Plan")  which covers
substantially all employees who have satisfied a six-month service  requirement,
have  attained  the  age of 18 and  are  employed  at  year-end.  Employees  may
contribute  up to 15% of their  salary,  as  defined,  subject  to  restrictions
defined by the  Internal  Revenue  Service.  The Company is  obligated to make a
matching contribution,  in the form of the Company's common stock, of 50% of all
employee contributions effective January 1, 1995. The Company contributions vest
over a three-year period.

     On March 25, 1996,  the Company issued 45,885 shares of its common stock to
the Plan in  satisfaction  of its $160,595  employer  match of the 1995 employee
contributions.  For the year ended  December  31,  1996 the  Company has accrued
$225,000 for the 1996 match which will be made in common stock in April 1997.

(13) COMMITMENTS AND CONTINGENCIES

(a) OPERATING LEASES

     The Company has entered into  various  operating  leases for its  corporate
office,  research  facilities and  manufacturing  operations.  These leases have
monthly rents ranging from  approximately  $2,000 to $49,000,  adjusted annually
for  certain  other  costs such as  inflation,  taxes and  utilities  and expire
through August 2002. The Company also leases certain automobiles under operating
leases   expiring   through  January  2000.  The  Company   guarantees   certain
subsidiaries' operating leases.

Future minimum payments under all leases at December 31, 1996 are  approximately
as follows:

          December 31,

               1997                                            $2,151,000
               1998                                             1,983,000
               1999                                             1,692,000
               2000                                             1,350,000
               2001                                               940,000
               Thereafter                                       1,002,000
                                                             -------------
                                                                $9,118,000
                                                             =============


     Rental expense related to all operating leases was  approximately  $695,000
and $1,383,000 for years ended December 31, 1995 and 1996, respectively.


(b) ROYALTIES

     The Company is required to pay a royalty of up to 5% of "net laser  sales",
as defined, under a royalty agreement with MGH (see Note 6). For the years ended
December  31, 1995 and 1996,  approximately  $167,000  and $620,000 was incurred
under this agreement.

     As discussed in Note 2(f),  Tissue  Technologies has a license agreement to
license a patent on a low pressure discharge apparatus.  Under the terms of this
license,  Tissue  Technologies  is  required to pay a 3% royalty on net sales of
product as defined.  During 1996, the Company  incurred  approximately  $301,000
under this license agreement.

     In  connection  with the formation of Dynamem,  the Company  entered into a
license  agreement  with the 20%  minority  shareholder  of Dynamem to license a
patent on a foldable  electronic  assembly  module on an  exclusive  basis.  The
license  agreement  gives  Dynamem  the right to  manufacture,  sell and use the
foldable  electronic  assembly  module  for a royalty,  payable to the  minority
shareholder  of Dynamem,  equal to 2% of net sales  proceeds,  as defined in the
license

<PAGE>
                                      F-37

agreement.  The license  agreement  expires upon  expiration of the patent,  and
royalties are  guaranteed by Dynaco.  For the years ended  December 31, 1995 and
1996, amounts incurred under this agreement were immaterial.

     On August 1, 1995, Nexar entered into a license agreement with Technovation
Computer Lab Inc.  (the  "licensor").  The licensor is controlled by one current
and one former officer of Nexar. The license  agreement gives Nexar the right to
manufacture,  sell  and use a  system  designed  by the  licensor  which  allows
external  replacement of certain  component parts. In exchange for these rights,
Nexar  will  pay a  royalty  on each  unit  sold,  as  defined.  The term of the
agreement is for five years (three years on an exclusive  basis),  renewable for
an  additional  five-year  period at the option of Nexar.  For the  period  from
inception  of Nexar  (March 7, 1995) to December 31, 1995 and for the year ended
December 31, 1996,  royalties charged to operations were immaterial.  Subsequent
to  December  31,  1996,  the  Company and the  Licensor  entered  into an Asset
Purchase and Settlement Agreement, see Note 15(b).

(c) CONSULTING AGREEMENTS

     The Company has entered into various  consulting  agreements  with a former
treasurer and director of the Company.  During the years ended December 31, 1995
and  1996,  the  Company   incurred  an  aggregate  of  $124,300  and  $258,891,
respectively, in consulting expenses relating to these agreements. On January 1,
1997, a new three year  consulting  agreement  was executed  which  replaced the
existing  two year  agreement.  From  January 1, 1997 to  December  31, 1997 the
Company shall pay the consultant at a rate of $15,000 per month for  performance
of services,  which rate shall be increased by 10% per annum  therafter  for the
term of the  agreement.  This  agreement  can be  terminated by the Company upon
twelve months written notice to the former director and upon other circumstances
as defined.

     On August 1, 1995, the Company entered into a consulting  agreement with an
individual   pursuant  to  which  the  individual   provides   certain  business
development  and consulting  services for a monthly fee of $10,000 which expired
on July 31, 1996.  During the year ended December 31, 1995, the Company incurred
an aggregate of $50,000 in consulting  expenses  relating to this agreement,  of
which $10,000  remained  unpaid at December 31, 1995.  In addition,  the Company
issued  warrants to purchase  1,500,000  common shares of the  Company's  common
stock at $2.25,  the fair market value on the date of issuance.  These  warrants
were fully vested on July 31, 1996. On August 1, 1996, the consulting  agreement
was renewed for a period of one year for a monthly fee of $10,000.  During 1996,
$120,000 of consulting finances were incurred relating to this agreement.

     On January 1, 1996, the Company entered into a consulting  agreement with a
strategic investment banking and financial services company.  Under the terms of
this agreement,  the Company is required to pay $5,000 monthly. In addition,  on
February 7, 1996, the Company granted two individuals, who are employees of this
investment banking and financial services company,  150,000 warrants to purchase
shares of common stock at $7.69,  the fair market value on the date of issuance.
These stock  options  vest based on  milestones  defined in the  agreement.  The
company incurred  expenses of $143,830 for consulting  services  received during
the year ended December 31, 1996.

     On  February 7, 1996,  the  Company  entered  into a  consulting  agreement
whereby the consultant would provide investment banking services for one year to
the  Company  in  exchange  for a  warrant  to  purchase  150,000  shares of the
Company's common stock at $7.69.

(d) GOVERNMENT CONTRACTS

     The Company,  like other companies doing business with the U.S. government,
is subject to routine audit and, in certain  circumstances,  inquiry,  review or
investigation  by U.S.  government  agencies for its compliance  with government
procurement policies and practices. Based on government procurement regulations,
under  certain  circumstances,  a  contractor  violating or not  complying  with
procurement  regulations can be subject to legal or administrative  proceedings,
including  fines  and  penalties,  as  well as be  suspensed  or  debarred  from
contracting with the government. The Company's policy has been, and continues to
be, to conduct  its  activities  in  compliance  with all  applicable  rules and
regulations.

<PAGE>
                                      F-38

(e) CONTINGENCIES

     On December 19, 1996 the Company  signed a price  quotation with a vascular
laser  manufacturer  for the  purchase of up to 120 vascular  lasers.  The price
quotation requires the Company to place a deposit of $1,200,000 for the purchase
of 120 vascular lasers.  After a minimum of 40 units are purchased at a per unit
average  price of $147,250,  the remaining  down-payment  will be refunded if no
additional  purchases  are made.  The Company also paid $400,000 for tooling and
other costs to ensure the vascular laser is manufactured  with the Palomar name.
The  Company  plans to use  this  vascular  laser  in the CTI  sites in order to
provide a full suite of lasers.

     On October 17, 1996 the Company entered into an option  purchase  agreement
with  Enviro-Invest  Oy  ("Enviro"),  a  privately  held  Finnish  company  with
technology related to the detection of nuclear and chemical compounds. Under the
option purchase agreement the Company has the right to acquire all of the issued
and  outstanding  shares of Enviro at any time  through  October  1,  1997.  The
purchase  price is $400,000 in cash, a range of  $3,750,000 to $5,250,000 in the
Company's  common stock based on certain  milestones,  and other contingent cash
payments  not to exceed  $325,000.  The  purchase  agreement  also calls for the
Company to fund Enviro with a $400,000 loan. As of December 31, 1996 the Company
has paid $300,000 and has  recognized a liability  for the  remaining  $100,000,
payable on March 31, 1997. The Company  intends to exercise the purchase  option
in 1997 and has accounted for the $400,000 loan as a long term investment.

     Enviro  has  a  distribution   agreement  with  Sensor   Applications  Inc.
("Sensor"),  a Delaware  corporation.  On November 14, 1996 the Company  entered
into a option purchase  agreement with Sensor.  The purchase agreement calls for
the Company to pay $150,000 in cash and issue  150,000  shares of Palomar  stock
for all the issued and  outstanding  shares of Sensor and extends to November 1,
1997. The purchase agreement calls for the Company to make payments of $200,000,
payable in four  installments  for  consulting  services.  During the year ended
December 31, 1996,  the Company  incurred  $50,000  related to these  consulting
services.  The Company is also committed to make payments to Sensor of $15,000 a
month to cover 50% of monthly operating  expenses which the Company has expenses
as  incurred.  The  Company  intends to  exercise  this  purchase  agreement  in
conjunction with the option for Enviro.

(f) LETTERS OF CREDIT

     Dynaco  has a three  irrevocable  letters  of credit  outstanding  totaling
$295,000 with a bank to secure payment to a vendor.

(g) CORPORATE GUARANTEES

     The Company has issued guarantees for payment of various vendor liabilities
for several subsidiaries.  Outstanding guarantees totaled approximately $975,000
as of December 31, 1996.

(h) LITIGATION

     The Company is a defendant in a lawsuit filed by a former consultant to the
Company on March 14, 1996. In the suit, the former  consultant  alleges that the
Company  breached a contract with the  consultant in which the consultant was to
provide certain investment banking services in return for certain  compensation.
In January 1997, this  consultant's  motion for summary  judgment on a breach of
contract  claim was granted.  The  consultant has alleged that he suffered up to
$3,381,250 in damages on a breach of contract claim,  exclusive of interest. The
Company has not accrued for the full cost of the alleged  damages and intends to
vigorously  defend this action and appeal this matter  after  damages  have been
determined. The Company believes its grounds for appeal are meritorious.

     The Company is also involved in legal and  administrative  proceedings  and
claims of various types,  including a patent infringement and unfair competition
claim by a competitor of the Company.  While any litigation  contains an element
of  uncertainty,  management,  based upon the opinion of the  Company's  general
counsel,  presently  believes that the outcome of each such  proceeding or claim
which is pending or known to be  threatened  (including  the  actions  described
above), or all of them combined,  will not have a material adverse effect on the
Company.

<PAGE>
                                      F-39

(14) EMPLOYMENT AGREEMENTS

     The Company and its  subsidiaries  have employment  agreements with certain
executive officers that provide for annual bonuses to the officers and expire on
various  dates  through  2001.  Each of these  agreements  provide for 12 months
severance upon  termination of employment.  One of the officers at the Company's
Spectrum  subsidiary  receives a bonus equal to .75% of Spectrum's net sales, as
defined.

     Dynamem  entered into an employment  agreement on September 29, 1995,  with
its minority  shareholder  to serve as  President  and director of Dynamem for a
period of five years. At the end of five years from the date of employment,  the
minority  shareholder will have the option to sell 75% of his outstanding shares
of Dynamem to PEC at a price equal to 10 times the average net income of Dynamem
for the preceding  48-month  period. A portion (35%) of the payment will be made
in the Company's common stock, with the balance to be paid in cash. The minority
shareholder  also has the option to increase the percentage of the payment to be
paid  in  common  shares  of  the  Company.   Dynaco  has  also  guaranteed  the
compensation  due its President under this agreement.  The Company is accounting
for the option related to the  restricted  stock in the subsidiary in accordance
with Financial  Accounting Standard Board  Interpretation No. 28, ACCOUNTING FOR
STOCK  APPRECIATION  RIGHTS  AND OTHER  VARIABLE  STOCK  OPTION OR AWARD  PLANS.
Accordingly, compensation is measured annually based on the increase in value of
the subsidiary.  Total compensation has been insignificant to date. In the event
of a public offering of Dynamem,  the minority  shareholder/officer  has certain
registration rights as defined in the employment agreement.

     Nexar has an employment  agreement with its Chief  Executive  Officer (CEO)
expiring in March 2002,  unless  extended.  The  agreement  provides  for annual
salary  and bonus for the CEO and a  commission  of $2.00 per  computer  sold by
Nexar.  Upon  termination of employment with Nexar,  the CEO will be entitled to
amounts  ranging from  $1,000,000  to  $3,000,000  in cash,  three to five years
salary,  bonus and participation in Nexar's benefit plans,  immediate vesting of
unvested  stock  options and an income tax "gross up" for all the above items in
the event of a change of control.  This termination payment is guaranteed by the
Company for as long as the Company owns greater than 50% of Nexar.

     Nexar also has an  employment  agreement  with  another  executive  officer
expiring in March 2002,  unless  extended.  The  agreement  provides  for annual
salary  and bonus for the  officer  and a  commission  of $2.00 per unit sold by
Nexar.  Upon  termination of employment with Nexar, the officer will be entitled
to up to  $750,000  in cash,  one year of  salary,  bonus and  participation  in
Nexar's benefit plans, immediate vesting of unvested stock options and an income
tax "gross up" for all the above items in the event of a change of control. This
termination payment is guaranteed by the Company for as long as the Company owns
greater than 50% of Nexar.

(15) SUBSEQUENT EVENTS

(a) EQUITY AND FINANCING TRANSACTIONS

     On January 13, 1997 the Company raised  $1,000,000  through the issuance of
5% series  convertible  debentures  due January 13, 2002.  The Company  incurred
financing  costs of  $100,000  relating  to  investment  banking  services.  The
financing  costs were offset  against a note  receivable  from a director of the
investment  bank.  This  debenture  has been  accounted for similar to the other
dollar denominated convertible debentures as discussed in Note 4(b).

     Subsequent to year-end, all of the outstanding shares of Series E preferred
stock  (including  accrued  dividends of $121,978)  were  converted into 332,859
shares of the Company's common stock. In addition,  as of February 28, 1997, 680
shares of Series G convertible  preferred stock (including  accrued dividends of
$19,833) were converted into 102,508 shares of the Company's common stock.

     On February 28,  1997,  the Company  redeemed 300 units of the  outstanding
Swiss franc denominated convertible debentures for $196,000.


<PAGE>
                                      F-40

     Subsequent  to year end, the Company  raised an additional  $12,000,000  to
help  sustain  1997  operations.  The  Company  raised  $6,000,000  through the
issuance of Series H redeemable  convertible preferred stock. The Company raised
$5,500,000  through  the  issuance of 5%  convertible  debentures  and  $500,000
through the issuance of 6% convertible debentures.  The Company will account for
these financings  similar to the 1996 preferred stock and convertible  debenture
issuances as discussed in Notes 5 and 4, respectively.

(b) LEGAL SETTLEMENTS

     In 1996, a former  executive  officer of Nexar threatened to file a lawsuit
or seek arbitration  proceedings  against Nexar regarding Nexar's termination of
his employment and Nexar's license agreement with the Licensor.

     On February 28, 1997,  Nexar entered into an Asset  Purchase and Settlement
Agreement with this former  executive and the Licensor.  Under the terms of this
agreement,  the Company has agreed to pay this former  executive  and certain of
his affiliates  $1,250,000 in cash and deliver $1,500,000 worth of the Company's
common  stock in exchange  for all right,  title and  interest in and to all the
technology  licensed  under Nexar's  license  agreement  with the Licensor and a
patent  application  thereto and a complete release and settlement of all claims
between this former  executive  and Nexar.  The Company  will first  acquire the
subject  technology and then convey such technology to Nexar.  Accordingly,  the
Company paid $75,000 upon  execution of this  agreement.  The Company will issue
its common shares and remit $475,000 to this former  executive on the earlier of
April 30,  1997 or the  closing of the initial  public  offering  of Nexar.  The
$700,000 balance of the cash  consideration  will be held in escrow,  subject to
release to the former  executive and/or Licensor in the absence of a breach of a
representation, warranty or covenant within one year after closing.

     The  Company  has  agreed to assign to Nexar all of its rights and title in
the technology to be received under the Asset Purchase and Settlement  Agreement
immediately  upon  the  receipt  thereof,  and has  charged  to  Nexar  the cost
associated  with  this  claim  and the  purchase  of the  technology.  Nexar has
allocated  $1,375,000 of the  consideration to settle this claim and the Company
has reflected this amount in settlement and litigation costs in its accompanying
statement of  operations  for the year ended  December 31, 1996.  The  remaining
consideration  totaling  $1,375,000  has been  allocated  to the purchase of the
technology as of December 31, 1996 and will be amortized  over the  technology's
estimated  useful life. The allocation of the purchased  technology was based on
the value of anticipated  royalty  payments to the Licensor over the three years
ended December 31, 1999.

     On March 14, 1997,  CTI entered into an  agreement  with a medical  service
company in settlement of CTI's claims of breach of the contract.  The settlement
calls  for the  medical  service  company  to  reimburse  CTI  for all  expenses
incurred,  not to  exceed  $900,000,  and an  additional  lump  sum  payment  of
$400,000.  In  addition,  the  medical  service  company is required to purchase
lasers from CTI under certain circumstances. The medical service company also is
not to compete with CTI, as defined, for a period of six months.

(c) COMMITMENTS AND CONTINGENCIES

     Subsequent to year end, the Company entered into an exclusive  relationship
with a private  label  leasing  company.  CTI then  entered  into a master lease
agreement with this private label leasing  company.  This master lease agreement
is guaranteed by the Company.

<PAGE>
                                      -40-

ITEM  8.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
          FINANCIAL DISCLOSURE

     There has been no change in the Company's  accountants during the Company's
two most recent fiscal years, nor were there any  disagreements on any matter of
accounting  principle or practice of financial statement  disclosure which would
be required to be reported on a Form 8-K.

<PAGE>
                                      -41-

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(A) OF THE EXCHANGE ACT.

     See the sections entitled "Election of Directors" and "Executive  Officers"
appearing in the Company's Proxy Statement in connection with its Annual Meeting
of  Shareholders  to be held on June 18,  1997,  which  section is  incorporated
herein by reference.

ITEM 10. EXECUTIVE COMPENSATION.

     See the section  entitled  "Executive  Compensation  and Other  Information
Concerning Officers and Directors" appearing in the Company's Proxy Statement in
connection  with its Annual Meeting of Shareholders to be held on June 18, 1997,
which section is incorporated herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     See the section entitled  "Security  Ownership of Certain Beneficial Owners
and  Management"  appearing in the Company's  Proxy Statement in connection with
its Annual Meeting of Shareholders to be held on June 18, 1997, which section is
incorporated herein by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     See the section entitled "Certain Transactions"  appearing in the Company's
Proxy Statement in connection with its Annual Meeting of Shareholders to be held
on June 18, 1997, which section is incorporated herein by reference.

<PAGE>
                                      -42-

                                     PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)  EXHIBITS

     The following  exhibits  required to be filed herewith are  incorporated by
reference  to the  filings  previously  made by the Company  where so  indicated
below.

<TABLE>
<C>               <C>
Exhibit
   No.                                                    Title

*****2.1          Stock Purchase Agreement, dated July 1, 1993, by and between the Company and Star Medical Technologies,
                  Inc.

+++2.2            Agreement, dated December 30, 1993, by and between the Company, Dynaco Corporation and Dynaco West
                  Corporation.

+++2.3            First Amendment to Purchase and Sale Agreement, by and between the Company, Dynaco Corporation and
                  Dynaco West Corporation, dated January 24, 1994.

-2.4              Purchase  and Sale  Agreement  dated  March 14,  1995,  by and
                  between  the  Company  and SPMT  Acquisition  Corp.,  Spectrum
                  Medical   Technologies,   Inc.,   Sanford   R.  Lane  and  CSF
                  Investments Ltd.

--2.5             Purchase and Sale Agreement dated June 5, 1995, by and between Dynaco Acquisition Corporation and
                  Inter-Connecting Products, Inc.

&&&&2.6           Agreement and Plan of Reorganization dated March 9, 1996 by and among the Company, TTI Acquisition
                  Corp., Tissue Technologies, Inc. and Mario Barton

&&&&2.7           Amendment to the Merger Agreement dated April 29, 1996 by and among the Company,  TTI Acquisition Corp.,
                  Tissue Technologies, Inc. and Mario Barton.

&&&&2.8           Letter from the Company to Tissue Technologies, Inc. waiving the Company's right to receive
                  indemnification under Section 6 of the Merger Agreement in certain circumstances.

&&&&2.9           Plan of Merger dated May 3, 1996 by and between the Company, TTI Acquisition Corp. and Tissue
                  Technologies, Inc.

&&&&2.10          List of exhibits and schedules omitted from the Tissue Technologies, Inc. Merger Agreement.
                  (The Company hereby undertakes and agrees to furnish copies of the exhibits and schedules set forth in
                  exhibit 2f above to the Commission upon its request.)

2.11              Stock Purchase Agreement dated March 19, 1996, by and between Dynaco Acquisition Corp., Comtel
                  Electronics, Inc., Mikel C. Green, Peter Rogal and Palomar Electronics Corp.

2.12              Agreement for Purchase of Stock dated July 12, 1996, by and between the Company, Eleanor Roberts Weisman
                  and Wallace Roberts.

----3.1           Restated Certificate of Incorporation, as amended.


&&3.2             Certificate of Amendment to Certificate of Incorporation, as filed with the Delaware Secretary of State
                  on December 16, 1996.

<PAGE>
                                      -43-

&3.3              Certificate of  Designation of Series G Convertible  Preferred
                  Stock  as  filed  with  the  Delaware  Secretary  of  State on
                  September 26, 1996.

*3.4              Bylaws, as amended.

***4.1            Form of Common Stock Certificate.

*10.1             Patent License Agreement by and between the Company and Patlex Corporation, effective as of January 1,
                  1992.

**10.2            1991 Stock Option Plan, as amended.

#10.3             1993 Stock Option Plan.

####10.4          1995 Stock Option Plan.

----10.5          1996 Stock Option Plan

----10.6          1996 Employee Stock Purchase Plan

**10.7            Form of  Stock Option Grant under the 1991, 1993 and 1995 Stock Option Plans.

10.8              Form of  Stock Option Agreement under the 1996 Stock Option Plan.

##10.9            Form of  Company Warrant to Purchase Common Stock.

****10.10         Lease for premises at 66 Cherry Hill Drive,  Beverly,  Massachusetts,
                  dated May 25, 1993.

---10.11          The Company's 401(k) Plan.

&10.12            Securities Purchase Agreement between the Company and The Travelers Insurance Company dated July 12,
                  1996.

&10.13            Warrant to purchase Common Stock of the Company, dated July 12, 1996.

&10.14            Subscription Agreement between the Company and Genesee Fund Limited, dated September 26, 1996.

&10.15            Registration Rights Agreement between the Company and Genesee Fund Limited, dated September 26, 1996.

&10.16            Warrant to purchase Common Stock of the Company, dated September 27, 1996.

&10.17            Warrant Agreement between the Company and American Stock Transfer & Trust Co. as warrant agent, dated
                  June 24, 1996.

&10.18            Palomar Medical Technologies, Inc. and American Stock Transfer & Trust Company as trustee, Indenture
                  dated as of June 24, 1996, SF 25,000,000, 4.5% Convertible Subordinated Debentures due 2003.

&&&10.19          Form of Offshore Securities Subscription Agreement, dated July 3, 1996.

&&&10.20          Palomar Medical Technologies, Inc. and American Stock Transfer & Trust Company as trustee, Indenture
                  dated as of June 24, 1996, SF 25,000,000 4.5% Convertible Subordinated Debentures due 2003.

&&&10.21          Warrant Agreement between the Company and American Stock Transfer & Trust Company as warrant agent,
                  dated June 24, 1996.

<PAGE>
                                      -44-

&&&10.22          Form of Registration Rights Agreement, dated July 3, 1996.

&&&10.23          Form of Debenture, dated July 3 1996.

&&&10.24          Form of Warrant, dated July 3, 1996.

&&&10.25          Berckeley Subscription Agreement, dated December 31, 1996 and Amendment thereto dated January 10, 1997.

&&&10.26          Berckeley Debenture, dated December 31, 1996.

&&&10.27          High Risk Opportunities Hub Fund, Ltd. Subscription Agreement, dated January 14, 1997.

&&&10.28          High Risk Opportunities Hub Fund, Ltd. Debenture, dated January 13, 1997.

10.29             Securities Purchase Agreement between Palomar Electronics Corporation and Clearwater Fund IV, LLC, dated
                  December 31, 1996.

10.30             Securities Purchase Agreement between Palomar Electronics Corporation, the Company and The Travelers
                  Insurance Company, dated as of December 18, 1996.

10.31             Securities Purchase Agreement between Palomar Electronics Corporation and GFL Advantage Fund Limited
                  dated December 31, 1996.

10.32             Option Agreement between the Company and GFL Advantage Fund Limited dated December 31, 1996.

10.33             Common Stock Purchase Warrant dated December 31, 1996.

10.34             Form of Net Warrant to Purchase Common Stock.

10.35             Subscription Agreement between the Company and Finmanagement, Inc. dated December 27, 1996.

10.36             Subscription Agreement dated as of April 12, 1996, between the Company and GFL Advantage Fund Limited.

10.37             Registration Rights Agreement dated as of April 17, 1996 by and between the Company and GFL Advantage
                  Fund Limited.

10.38             Warrant dated as of April 16, 1996.

10.39             Form of Warrant to Purchase Common Stock dated February 1, 1996.

10.40             Form of Offshore Stock Subscription Agreement dated February 1, 1996.

10.41             Form of Subscription Agreement dated as of  March 10, 1997.

10.42             Form Registration Rights Agreement dated as of  March 10, 1997.

10.43             Form of 5% Convertible Debenture due March 10, 2002.

10.44             Subscription Agreement between the Company and Soginvest Bank dated as of March 13, 1997.

10.45             6% Convertible Debenture due March 13, 2002.

<PAGE>
                                      -45-

10.46             Asset Purchase and Settlement Agreement by and among the Company, Nexar Technologies, Inc., Technovation
                  Computer Labs, Inc. and Babar I. Hamirani, dated February 28, 1997.

10.47             List of exhibits omitted from the Asset Purchase and Settlement Agreement.
                  (The Company hereby undertakes and agrees to furnish copies of
                  the exhibits and schedules set forth in exhibit 10(dddd) above
                  to the Commission upon its request.)

10.48             Employment Agreement dated as of  January 1, 1997, between the Company and Steven Georgiev.

10.49             Employment Agreement dated as of January 1, 1997, between the Company and Michael H. Smotrich.

10.50             Employment Agreement dated as of January 1, 1997, between the Company and Joseph P. Caruso.

10.51             Employment Agreement dated as of January 1, 1997, between the Company and Anthony Fiorillo.

10.52             Securities and Purchase Agreement between the Company and RGC International Investors, LDC,
                  dated March 27, 1997

10.53             Registration Rights Agreement between the Company and RGC International Investors, LDC, 
                  dated March 27, 1997

23                Consent of Arthur Andersen LLP.

*                 Previously filed as an exhibit to Registration Statement No. 33-47479 filed on April 27, 1992, and
                  incorporated herein by reference.

**                Previously filed as and exhibit to Amendment No. 4 to Form S-1 Registration Statement No. 33-47479 filed
                  on October 5, 1992.

***               Previously filed as an exhibit to Amendment No. 8 Registration Statement on Form S-1, No. 33-37379,
                  filed on December 17, 1992.

****              Previously filed as an exhibit to the Company's Annual Report on Form 10-KSB date March 31, 1993, and
                  incorporated herein by reference.

*****             Previously filed as an exhibit to the Current Report on Form 8-K date July 1, 1993, and incorporated
                  herein by reference.

#                 Previously  filed as an exhibit to the Company's Annual Report
                  on  Form  10-KSB  for the  year  ended  March  31,  1994,  and
                  incorporated herein by reference.

##                Previously  filed as an exhibit to the Company's Annual Report
                  on Form  10-KSB  for the year ended  December  31,  1995,  and
                  incorporated herein by reference.

-                 Previously filed as an exhibit to the Current Report on Form 8-k dated April 20, 1995, and incorporated
                  herein by reference.

--                Previously filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended
                  June 30, 1995, and incorporated herein by reference.

---               Previously filed as an exhibit to Form S-8 Registration Statement No. 33-97710 filed on October 4, 1995,
                  and incorporated herein by reference.

----              Previously filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended
                  June 30, 1996, and incorporated herein by reference.

&                 Previously filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended
                  September 30, 1996, and incorporated herein by reference.

&&                Previously filed as an exhibit to Form S-3 Registration Statement No. 333-18003 filed on December 16,
                  1996, and incorporated herein by reference.

<PAGE>
                                      -46

&&&               Previously filed as an exhibit to Form S-3 Registration Statement No. 333-22725 filed on March 4, 1997,
                  and incorporated herein by reference

&&&&              Previously filed as an exhibit to the Current Report on Form 8-K dated May 16, 1996, and incorporated
                  herein by reference

+                 Previously filed as an exhibit to the Current Report on Form 8-K dated September 10, 1993, and
                  incorporated herein by reference.

++                Previously filed as an exhibit to the Current Report on Form 8-K dated February 7, 1994, and
                  incorporated herein by reference.

+++               Previously filed as an exhibit to the Current Report on Form 8-K dated February 9, 1994, and
                  incorporated herein by reference.

++++              Previously filed as an exhibit to the Current Report on Form 8-K dated February 14, 1994, and
                  incorporated herein by reference.
</TABLE>

(b)  REPORTS ON FORM 8-K

            None

<PAGE>
                                      -47-

                                   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  Beverly  in  the
Commonwealth of Massachusetts on March 30, 1997.


                                          PALOMAR MEDICAL TECHNOLOGIES, INC.





                                          By:     /s/ Stevem Georgiev
                                              ------------------------------
                                              Steven Georgiev
                                              Chairman of the Board of Directors
                                              Chief Executive Officer

     Pursuant to the requirements of the Securities Act of 1934, this Report has
been  signed  by the  following  persons  on  behalf  of the  Registrant  in the
capacities and on the dates indicated.

<TABLE>
            <C>                                  <C>                                             <C>           
                          Name                                   Capacity                             Date

            /s/ Steven Georgiev                  President, Chief Executive                      April __, 1997
            ---------------------------------
            Steven Georgiev                      Officer and Chairman of the Board

            /s/ Dr. Michael H. Smotrich          President, Chief Operating Officer,             April __, 1997
            ---------------------------------
            Dr. Michael H. Smotrich              Secretary and Director

            /s/ Joseph P. Caruso                 Chief Financial Officer and Treasurer           April __, 1997
            ---------------------------------
            Joseph P. Caruso                     ( Principal Financial Officer and
                                                 Principal Accounting Officer)

            /s/ Buster C. Glosson                Director                                        April __, 1997
            ---------------------------------
            Buster C. Glosson

            /s/ Louis P. Valente                 Director                                        April __, 1997
            ---------------------------------
            Louis P. Valente

            /s/ John M. Deutch                   Director                                        April __, 1997
            ---------------------------------
            John M. Deutch

</TABLE>