FORM 10-K


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

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

                     For fiscal year ended December 31, 1999
                                 Commission file
                                 number: 0-22340

                        PALOMAR MEDICAL TECHNOLOGIES, INC
                        ---------------------------------
             (Exact name of registrant as specified in its charter)
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<S>             <C>                                                                              <C>

                Delaware                                                                         04-3128178
                --------                                                                         ----------
(State or other jurisdiction of incorporation or organization)                      (I.R.S. Employer Identification No.)
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              82 Cambridge Street, Burlington, Massachusetts 01803
              ----------------------------------------------------
                    (Address of principal executive offices)

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

Securities registered pursuant to Section 12 (b) of the Act:
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<S>      <C>                                                                               <C>
                                                                                           Name of each exchange on
         Title of each class                                                                    which registered
         -------------------                                                               -------------------------
         Not Applicable                                                                          Not Applicable
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          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-K 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-K
or any amendment to this Form 10-K.  X
                                    ---

         As  of  March  1,  2000,   10,034,550   shares  of  common  stock  were
outstanding.  The  aggregate  market value of the voting  shares (based upon the
closing  price  reported  by  Nasdaq  on  March  1,  2000)  of  Palomar  Medical
Technologies,  Inc., held by nonaffiliates was $42,356,444. For purposes of this
disclosure,  shares of common stock held by entities and  individuals who own 5%
or more of the  outstanding  common  stock,  as reported in Amendment No. 6 to a
Schedule 13D/A filed on January 10, 2000 and Amendment No. 5 to a Schedule 13G/A
filed on February  14, 2000 and shares of common  stock held by each officer and
director  have  been  excluded  in  that  such  persons  may  be  deemed  to  be
"affiliates"  as that term is  defined  under the Rules and  Regulations  of the
Securities  Exchange Act of 1934. This  determination of affiliate status is not
necessarily conclusive.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the definitive  proxy  statement to be filed prior to April
30, 2000,  pursuant to Regulation 14A of the Securities Exchange Act of 1934 are
incorporated by reference into Part III of this Form 10-K

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

<PAGE>

                                      INDEX
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<S>      <C>                                                                                              <C>

Item                                                                                                      Page No.
----                                                                                                      --------

PART I.........................................................................................................1

     Item 1.  Business.........................................................................................1

         (a)  Introduction.....................................................................................1
         (b)  Financial Information About Industry Segments....................................................1
         (c)  Description of Business..........................................................................1
         (d)  Financial Information About Exports by Domestic Operations.......................................5

     Item 2.  Properties.......................................................................................5

     Item 3.  Legal Proceedings................................................................................5

     Item 4.  Submission of Matters to a Vote of Security Holders..............................................6

PART II  7

     Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters............................7

     Item 6.  Selected Financial Data..........................................................................8

     Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations............9

         (a)  Overview.........................................................................................9
         (b)  Results..........................................................................................9
(c)      Liquidity and Capital Resources......................................................................13
(c)      Year 2000 Impact.....................................................................................14
(e)      Recently Issued Accounting Standard..................................................................14

     Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.....................................14

     Statement Under the Private Securities Litigation Reform Act.............................................14

     Risk Factors.............................................................................................15

     Item 8.  Financial Statements............................................................................19

         Reports of Independent Public Accountants............................................................20
         Consolidated Balance Sheets as of December 31, 1998 and 1999.........................................22
         Consolidated Statements of Operations for the years ended December 31, 1997, 1998 and 1999...........23
         Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
              December 31, 1997, 1998 and 1999................................................................24
         Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999...........27
         Notes to Consolidated Financial Statements...........................................................29

     Item 9.  Changes and Disagreements with Accountants on Accounting and Financial Disclosures..............54

                                      -i-

<PAGE>

PART III......................................................................................................55

     Item 10.  Directors and Executive Officers of the Registrant.............................................55

     Item 11.  Executive Compensation.........................................................................55

     Item 12.  Security Ownership of Certain Beneficial Owners and Management.................................55

     Item 13.  Certain Relationships and Related Transactions.................................................55

PART IV  56

     Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K................................56

         (a)  Index to Consolidated Financial Statements and Schedules........................................56
         (b)  Reports on Form 8-K.............................................................................56
(c)      Exhibits.............................................................................................57

SIGNATURES....................................................................................................62
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                                      -ii-

<PAGE>
                                     PART I

ITEM 1.  BUSINESS.
         ---------

(a)      Introduction

         Palomar  Medical  Technologies,  Inc. was  organized in 1987 to design,
manufacture and market lasers,  delivery systems and related disposable products
for use in medical  procedures.  In  December  1992,  the Company  went  public.
Subsequently,  the Company pursued an aggressive acquisition program,  acquiring
companies  in its core  laser  business  as well as others,  principally  in the
electronics  industry,  in order to spread  risk and bolster  operating  assets,
among other reasons. By the beginning of 1997, the Company had more than a dozen
subsidiaries.  At the same time,  having  obtained  FDA  clearance to market its
EpiLaser(R)  ruby laser hair removal laser system in March 1997, the Company was
well positioned to focus on what it believed was at that time the most promising
product in its core laser  business.  Hence,  under the direction of a new Board
and  management  team,  the  Company  undertook  an  ambitious  program in 1997,
completed in May of 1998, of exiting all non-core businesses and investments and
focusing only on those  businesses  which it believes hold the greatest  promise
for maximizing  stockholder value. The Company's  exclusive focus is now the use
of lasers in dermatology and cosmetic procedures, with an emphasis on laser hair
removal and research and  development  relating to that and other cosmetic laser
products. On December 7, 1998, the Company entered into an Agreement and Plan of
Reorganization  (the "Agreement") with Coherent,  Inc. to sell all of the issued
and  outstanding  common stock of  Palomar's  Star  Medical  Technologies,  Inc.
subsidiary.  The  Company  completed  the sale of Star to  Coherent on April 27,
1999.  Currently,  the Company has two operating  subsidiaries,  Palomar Medical
Products,   Inc.  ("PMP")  and  Esthetica  Partners,   Inc.  (formerly  Cosmetic
Technology International, Inc). In early 2000, the Company opened a research and
development division in Livermore,  California ("Palomar West"). PMP, located at
the  Company's   headquarters   in  Burlington,   Massachusetts,   oversees  the
manufacture  and sale of the Company's  laser  systems  currently on the market.
Esthetica, also based in Burlington,  Massachusetts, places the Company's lasers
in  clinical  and  cosmetic  settings  and  shares in a portion  of the  revenue
generated thereby. Palomar West was established to expand product development in
dermatology,  including laser treatment of tattoos,  pigmented lesions,  and leg
veins. (See Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Overview.")

(b)      Financial Information About Industry Segments

         The Company conducts business in one industry segment, medical products
and services.  In 1998,  the Company  completed  the program,  begun in 1997, of
divesting  all  of  its  non-core   electronics   subsidiaries.   (See  Item  7.
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Overview" and Note 12 to Financial Statements.)

(c)      Description of Business

         (i)      Principal Products

                           Hair Removal Lasers

         Using its core ruby laser technology,  originally  developed for tattoo
removal and pigmented  lesions,  Palomar  developed a long pulse ruby laser, the
EpiLaser(R),   that  is   specifically   configured  to  allow  the  appropriate
wavelength,  energy level and pulse  duration to be absorbed  effectively by the
hair follicle without being absorbed by the surrounding  tissue.  That, combined
with the patented cooling handpiece, allows for safe and effective hair removal.
In March 1997,  Palomar was the first  company to receive FDA  clearance to sell
and market a ruby laser (the EpiLaser(R) system) in the U.S. for hair removal.

         In December  1997 and January 1998  respectively,  Palomar was also the
first  company to receive FDA  clearance  for a diode laser for hair removal and
for leg vein treatment,  the LightSheer(TM)  diode laser system  manufactured by
Star. The  LightSheer(TM)  was the first generation of high powered diode lasers
designed  for hair  removal.  These diode lasers also  incorporate  the patented
contact-cooling system licensed exclusively to Palomar. High-powered diode laser
systems are compact, solid-state lasers that are significantly smaller than most
current systems, and relatively easy to install and service.

         During 1998,  Palomar  introduced its second generation ruby laser, the
Palomar  E2000(TM) hair removal laser system, a product that is superior to hair
removal lasers currently available in a number of respects,  including speed and
efficacy.  The  Palomar  E2000(TM)  has also  received  FDA  clearance  for hair
removal.

                                       1
<PAGE>

         Studies  using  Palomar's  laser  hair  removal  process   demonstrated
significant permanent reduction of hair following treatment with the EpiLaser(R)
and the  Palomar  E2000(TM).  The first  treatment  causes a portion of the hair
(typically  the hair in the growth  mode) to be reduced  in size,  color  and/or
quantity  (based  on  studies  followed  for  up  to  three  years)  and  causes
significant  growth delay (three to six months) of most of the rest of the hair.
Since the partial re-growth tends to occur in synchrony, the follow-up treatment
is often  more  effective  than the first  treatment.  The  EpiLaser(R)  and the
Palomar  E2000(TM)  were the first hair  removal  lasers on the market that were
cleared by the FDA for "permanent hair reduction" labeling.

         During 1999,  Palomar  completed its early clinical  studies using high
powered  diode  lasers that deliver  energy over a  relatively  long time period
("Super Long Pulse  Technology").  This new generation of lasers  promises to be
much  gentler to the skin,  capable of treating a wide range of skin types,  and
cheaper to produce than current  systems on the market.  We plan on  introducing
products in 2000 that use this Super Long Pulse Technology.  The key to this new
technology is the  specialized  delivery  systems  attached to the laser.  These
proprietary  delivery  systems are  essential  to providing  safe and  effective
treatment.

         Market  surveys  report that the great  majority of women in the United
States employ one or more  techniques  for  temporary  hair removal from various
parts of the  body,  including  waxing,  depilatories,  tweezing,  shaving,  and
electrolysis.  The market for  laser-based  hair removal is in its early stages.
Benefits of  Palomar's  laser hair  removal  process,  as compared to other hair
removal methods  currently  available,  include  significant  long term cosmetic
improvement,  treatment of larger areas in each treatment  session,  a procedure
that is relatively painless and non-invasive,  reduced risk of scarring, no risk
of cross-contamination, and higher success rates.

                           Tattoo Removal/Pigmented Lesion Laser

         The Company also sells a Q-switched  ruby laser for tattoo  removal and
treating  pigmented  lesions,  the RD-1200(TM).  The RD-1200(TM) has been on the
market for ten years.  Intense  competition in the medical  device  industry and
market saturation for this type of laser have reduced RD-1200(TM) sales over the
last five years.  In addition,  there are less expensive  products now available
for this purpose. Palomar expects sales of this product to continue in 2000 at a
low  volume to  foreign  countries  where the  advantages  of the ruby laser for
treatment  of  pigmented  lesions  is  especially  important.  Palomar  West  is
developing technology for this market that is expected to be less expensive than
current products on the market.

                           Marketing, Distribution and Service

         Palomar has changed its distribution  method over the past few years to
address  changes in the market  conditions and  composition of its product line.
Pursuant  to an  agreement  executed  in November  1997,  Coherent  acted as the
exclusive  distributor for Palomar's hair removal lasers.  Under that agreement,
Coherent was responsible for sales, marketing,  service, training and education.
However,  Coherent and Palomar agreed that,  beginning January 1, 1999,  Palomar
would take over all service for Palomar's  ruby hair removal lasers and act as a
nonexclusive  distributor for Palomar's hair removal laser. Since December 1998,
Continuum  Biomedical,  Inc., a medical  division of the scientific  laser-based
company Continuum  Electro-Optics (which is in turn a wholly-owned subsidiary of
Hoya  Corp.  of  Japan),   has  been  distributing   Palomar's   products  on  a
non-exclusive  basis.  Recently,  the Company has hired a number of direct sales
representatives  in anticipation  of new products to be introduced  during 2000.
The  Company  further  intends  to  tailor  distribution  methods  to  different
geographic  regions and may include a combination of exclusive and non-exclusive
distributors,  independent  representatives  and additional direct  salespeople.
Palomar sells and services the RD-1200(TM) through distributors internationally.
In  the  United  States,  Palomar  provides  service  through  its  own  service
organization.

(ii)     Products Under Development

         The Company is engaged in developing  products for the  dermatology and
cosmetic market.  Products under development include hair removal lasers, tattoo
and pigmented  lesion lasers,  leg vein lasers,  acne  treatment  lasers and fat
reduction lasers.  The core research,  including in vitro, in vivo, and clinical
research,  is a joint effort between  scientists and  researchers at the Company
and at our research  partner  Massachusetts  General Hospital  ("MGH").  Product
development   is  performed  by  scientists   and  engineers  at  the  Company's
headquarters and in our Livermore,  California facility.  The Company splits its
efforts between new products for existing markets such as hair removal, leg vein
treatment  and tattoo  removal,  and new products for new markets,  such as acne
treatment and fat reduction. We feel that focusing our efforts among these types
of projects gives us the best chance for increasing stockholder value.

                                       2
<PAGE>

         (iii)    Production and Sources and Availability of Materials

         Palomar's manufacturing operations are currently located in Burlington,
Massachusetts.  Manufacturing consists of the assembly and testing of components
purchased from outside suppliers and contract  manufacturers.  Palomar maintains
control of and  manufactures  most key  components  in-house.  The entire  fully
assembled  system is  subjected  to a rigorous set of tests prior to shipment to
the customer or distributor.

         Palomar depends and will depend upon a number of outside  suppliers for
components used in its manufacturing process. Palomar has also contracted with a
key overseas  supplier of a major component of the Super Long Pulse  Technology.
The component is matched with a specific  delivery  system  developed by Palomar
and is  incorporated  into a full system.  Most of Palomar's  components and raw
materials are available from a number of qualified suppliers.  Ruby rods for the
ruby lasers are available  through only one  qualified  supplier.  To date,  the
Company has not experienced,  nor does it expect to experience,  any significant
delays in obtaining  component parts or raw materials.  Palomar has expanded its
manufacturing capabilities to satisfy projected demand. Palomar has the approval
for the CE  Mark  for the  EpiLaser(R)  and  E2000(TM)  laser  systems,  and has
obtained ISO 9001 registration.

         (iv)     Patents and Licenses

         Certain  products  of the  Company  and  methods  for  the  use of such
products are largely proprietary. The Company believes that patent protection of
its  technology  and  products  that  result  from the  Company's  research  and
development  efforts  is  important  to the  possible  commercialization  of the
Company's   technology.   The  Company  continually   attempts  to  protect  its
proprietary  technology  by  obtaining  patent  protection  and relying on trade
secret laws and non-disclosure and confidentiality agreements with its employees
and persons that have access to its proprietary technology.

         The  Company  believes  it owns,  or has the  right to use,  the  basic
patents covering its products. However, each year there are many patents granted
worldwide related to lasers and their applications. In the past, the Company has
been able to obtain  patent  licenses  for  patents  related to its  products on
commercially reasonable terms. The failure to obtain a key patent license from a
third party could cause the Company to incur liabilities for patent infringement
and, in the extreme case, to  discontinue  manufacturing  products that infringe
upon the patent. Management believes that none of the Company's current products
infringe  upon a valid claim of any patents  owned by third  parties,  where the
failure to license the patent  would have a material  and adverse  effect on the
Company's financial position or results of operations.

         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.
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. (See Item
3. "Legal Proceedings" and Item 7. "Risk Factors.")

         In August 1995, the Company  entered into an agreement with MGH whereby
MGH  agreed  to  conduct   clinical   trials  on  a  laser  treatment  for  hair
removal/reduction  developed at MGH's Wellman Laboratories of Photomedicine.  In
July 1999, the Company  amended this agreement to extend its exclusive  research
relationship  for an additional five years. In addition to photo thermal removal
or reduction of hair,  the agreement  has been expanded to include  research and
development  in  the  fields  of  non-invasive   electromagnetic   targeting  of
subcutaneous  fat, and treatment of sebaceous  glands and related skin disorders
(e.g., acne) using infrared light  (hereinafter  referred to,  respectively,  as
"hair removal," "fat removal," and "acne treatment," for simplicity).

         MGH has  filed a number of  patents  surrounding  technology  involving
laser hair removal. These patents expire on February 1, 2015. MGH licenses these
patents  exclusively to Palomar.  Palomar,  in turn, has the right to sublicense
these patents to others.  Palomar also has the right to  exclusively  license in
the fields of hair removal,  fat removal,  and acne  treatment any other patents
arising out of MGH's  Palomar-funded  clinical trials. As consideration for this
license,  the Company is obligated to pay MGH royalties on products and services
covered by valid patents  licensed to the Company.  Palomar has  sublicensed  to
competitors these two MGH hair removal patents.

         (v)      Seasonal Influences

         There is no significant seasonal influence on the Company's sales.

                                       3
<PAGE>

         (vi)     Working Capital

         There are no special inventory  requirements,  return rights, or credit
terms  extended to customers  that would have a material  adverse  effect on the
Company's working capital.

         (vii)    Dependence on a Single Sales Agent

         Sales pursuant to the Company's  Sales Agency,  Development and License
Agreement with Coherent  accounted for  approximately 60% of the Company's total
revenues  in fiscal  1999 and 89% in fiscal  1998.  The Sales  Agency  Agreement
terminated upon the closing of the sale of Star in April 1999.

         (viii)   Backlog

         The Company's  backlog of firm orders for its continuing  operations at
December 31, 1999,  and December 31, 1998, was  approximately  $885,000 and $3.4
million,  respectively.  The backlog in 1998 consisted almost entirely of orders
for Star's LightSheer(TM) diode laser.

         (ix)     Government Contracts

         Not applicable.

         (x)      Competition

         The  markets  in which the  Company  is  engaged  are  subject  to keen
competition and rapid technological change. To Palomar's knowledge,  eight other
companies have received market clearance from the FDA for laser hair removal and
another  company has received FDA clearance to market a laser-like  system using
filtered  intense light to remove hair. The Company's former  subsidiary,  Star,
was sold to Coherent on April 27, 1999 and now competes with Palomar in the hair
removal market as well. The Company expects that other hair removal devices will
be developed and/or  introduced in 2000, making laser hair removal a competitive
application within the cosmetic laser marketplace. The Company also expects that
there may be further  consolidation  of companies  within the laser hair removal
industry  via  acquisitions,  partnering  arrangements  or joint  ventures.  The
Company's  products  will also  compete  with other hair  removal  products  and
methods.  The Company  competes  primarily on the basis of  technology,  product
performance, price, quality, reliability,  distribution and customer service and
support.  To remain  competitive,  the  Company  will be required to continue to
develop new  products,  periodically  enhance its existing  products and compete
effectively in the areas described above. (See Item 7. "Risk Factors.")

         (xi)     Research and Development

         Palomar's  research  and  development  goals in the field of laser hair
removal  are to design  systems  that (1) permit more rapid  treatment  of large
areas,  (2) have high gross margins,  and (3) are  manufactured at a lower cost,
thus addressing broader markets.  Further,  Palomar aims to address  dermatology
and cosmetic  procedure  markets  other than hair,  including the fields of acne
treatment  and fat  removal  covered in its  expanded  research  agreement  with
Massachusetts General Hospital.

         During fiscal 1999, 1998 and 1997, the Company  incurred  approximately
$8,022,000,  $7,029,000 and $11,990,000,  respectively,  of internally sponsored
research and  development  programs.  Due to the intense  competition  and rapid
technological  changes in the laser industry,  the Company believes that it must
continue to improve and refine its existing  products and services,  and develop
new applications for its technology.

(See Item 7.  "Risk Factors" and Note 4 to Financial Statements.)

         (xii)    Environmental Protection Regulations

         The Company  believes that  compliance  with  federal,  state and local
environmental regulations will not have a material adverse effect on its capital
expenditures, earnings or competitive position.

                                       4
<PAGE>

         (xiii)   Number of Employees

         As of December 31, 1999, the Company and its divisions and subsidiaries
employed 81 people, 5 independent contractors and 5 temporary employees.

(d)      Financial Information About Exports by Domestic Operations

         Aggregate  export sales for the Company's  continuing  operations  were
approximately $5,030,000 for 1997, $17,360,000 for 1998 and $8,440,000 for 1999.
The 1997 export sales consisted  primarily of the EpiLaser(R),  and the 1998 and
1999 export sales consisted primarily of the LightSheer(TM). (See Notes 2(i) and
3 to Financial Statements.)

ITEM 2.  PROPERTIES.
         -----------

         The  Company  occupies  approximately  44,000  square  feet of  office,
manufacturing  and research  space in  Burlington,  Massachusetts  under a lease
expiring in August 2009. The Company occupies approximately 4,000 square feet of
research space in Livermore, California under a lease expiring in December 2001.
The  Company  believes  that  these  facilities  are in good  condition  and are
suitable and adequate for its current operations.

ITEM 3.  LEGAL PROCEEDINGS.
         ------------------

         On March 7, 1997, Selvac Acquisition Corp. ("Selvac"),  a subsidiary of
Mehl Biophile  International,  Inc.  ("Mehl"),  filed a complaint for injunctive
relief and damages for patent  infringement  and for unfair  competition  in the
United States District Court for the District of New Jersey against the Company,
two of its  subsidiaries  and a New  Jersey  dermatologist.  Selvac's  complaint
alleged,  among other  things,  that the Company's  EpiLaser(R)  ruby laser hair
removal system infringed a patent licensed to Selvac (the "Selvac  Patent").  On
May 18,  1998,  the court  granted  the  Company's  motion for  partial  summary
judgment  on the ground  that the Selvac  patent is  invalid  because  prior art
anticipated it. The court later denied Selvac's  motion for  reconsideration  of
the summary judgment ruling. On September 30, 1999, the Court of Appeals for the
Federal Circuit  affirmed the district court's summary judgment of invalidity of
the Selvac Patent.  On October 14, 1999,  Selvac filed a petition for rehearing,
which the Federal Circuit denied on October 27, 1999.

         On March 11, 1999,  the United States  District  Court for the Southern
District of New York granted  plaintiffs  leave to amend their  complaint in the
action styled Varljen v. H.J.  Meyers,  Inc.,  et. al. to join the Company,  its
former  chief  executive   officer  and  current  chief  financial   officer  as
defendants.  On March 17, 1999,  the Second  Amended  Class Action  Complaint in
Varljen was served upon the Company  and its current  chief  financial  officer,
alleging  that the  Company  and the former and  current  officer  violated  the
federal  securities  laws in various  public  disclosures  that the Company made
directly  and  indirectly  during the period from  February 1, 1996 to March 26,
1997.  Palomar and the Varljen plaintiffs have reached an agreement in principle
pursuant to which  Palomar and its  insurance  carrier  would pay  plaintiffs $5
million  in  settlement  of all their  claims.  Of this  amount,  Palomar  would
contribute  up to $1  million  in stock  and  $1.375  million  in cash,  and its
insurance  carrier  the  remaining  $2.625  million  in  cash.  This  settlement
agreement must be approved by the court. There can be no assurance of such court
approval;  however,  management believes that the court approval is probable and
has accrued for its estimated loss at December 31, 1999.

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

     The Company is involved in other legal and  administrative  proceedings and
claims  of  various  types.   While  any  litigation   contains  an  element  of
uncertainty,  management, in consultation with the Company's general counsel, at
present  believes that

                                       5
<PAGE>

the outcome of each such other  proceeding or claim which is pending or known to
be threatened,  or all of them combined, will not have a material adverse effect
on the Company.

         (See Item 7. "Risk Factors.")

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

         Not applicable.

                                       6
<PAGE>


                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S 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 markup,  markdown or commission and
do not necessarily represent actual transactions.

                                                           Fiscal Year Ended
                                                           December 31, 1998
                                                           High          Low
                                                           -------       ------
              Quarter Ended March 31, 1998                 2 11/32       5/8
              Quarter Ended June 30, 1998                  1 9/16        31/32
              Quarter Ended September 30, 1998             1 7/32        3/4
              Quarter Ended December 31, 1998              1 3/32        19/32

                                                           Fiscal Year Ended
                                                           December 31, 1999
                                                           High          Low
                                                           ------        -------
              Quarter Ended March 31, 1999                 1 3/32        17/32
              Quarter Ended June 30, 1999                  5 3/16        15/32
              Quarter Ended September 30, 1999             4 15/16       1 25/32
              Quarter Ended December 31, 1999              2 5/32        15/16

         As of March 1, 2000,  the Company had 1,682 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  substantially all earnings to
finance the  operations  of the Company.  The Company may buy back shares of its
common stock on the open market from time to time.

         Conversions of Preferred Stock and Debentures

         During the year ended December 31, 1999, the following  securities were
converted by the accredited  investor  unaffiliated  third-party holders for the
number of shares of common stock indicated:
<TABLE>
<S>           <C>                                                <C>                      <C>

                                                                                           Number of Shares
              Type of Security                                   Number of Shares         Common Stock Issued
              ----------------                                   ----------------         -------------------

              Preferred Stock Series G                                  340                        74,905
              Debenture 6%,7%,8% Due September 30, 2002                 N/A                       377,760
</TABLE>

         The  Company  received  no  proceeds  in  connection  with any of these
conversions.

                                       7
<PAGE>



ITEM 6.       SELECTED FINANCIAL DATA.
              -----------------------

        The following table sets forth selected consolidated financial and other
information  (in thousands  except per share data) on a consolidated  historical
basis for the  Company  and its  subsidiaries  as of and for each of the  fiscal
years in the five year period ended  December 31, 1999.  Pursuant to  Accounting
Principles  Board Opinion ("APB") No. 30,  Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and  Infrequently  Occurring Events and  Transactions,  the consolidated
financial  statements  of the  Company  have been  reclassified  to reflect  the
dispositions of its  subsidiaries  that comprise the electronics  segment.  This
table should be read in conjunction with the Consolidated  Financial  Statements
of the Company and the Notes thereto included elsewhere in this Annual Report on
Form 10-K.

                             Selected Financial Data
                      (in thousands, except per share data)


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

                                                        Nine months
                                                           ended                            Year ended December 31,
                                                         December 31,    ----------------------------------------------------------
Statement of Operations Data                                1995              1996           1997            1998            1999
                                                       --------------    -----------    ------------    ------------    -----------

Revenues                                                     $ 5,610       $ 17,607        $ 20,995        $ 44,514        $24,251
Gross Profit                                                   2,146          3,437             939          21,463          8,741
Operating Expenses (Income)                                   10,985         26,548          42,867          30,897        (24,297)
Income (Loss) from Operations                                 (8,839)       (23,110)        (41,929)         (9,434)        33,038
Net Income (Loss)  from Continuing Operations                 (8,390)       (20,798)        (58,369)         (9,967)        25,501
Net Loss from Discontinued Operations                         (4,231)       (17,066)        (27,435)         (2,624)          (435)
Net Income (Loss)                                            (12,621)       (37,864)        (85,804)        (12,591)        25,066
Basic Net  Income (Loss) Per Common Share:
             Continuing Operations                           $ (4.20)       $ (5.88)        $(12.52)        $ (1.26)         $2.48
             Discontinued Operations                           (2.10)         (4.55)          (5.47)          (0.29)         (0.04)
                                                        --------------    -----------    ------------    ------------    ----------
             Total Basic Income (Loss) Per Common
                  Share                                      $ (6.30)      $ (10.43)       $ (17.99)        $ (1.55)         $2.44
Basic Weighted Average Number of
    Common Shares Outstanding                                  2,024          3,738           5,015           8,981         10,153
                                                        ==============    ===========    ============    ============    ==========
Diluted Net Income (Loss) Per Common Share:
             Continuing Operations                           $ (4.20)        $(5.88)        $(12.52)         $(1.26)         $2.39
             Discontinued Operations                           (2.10)         (4.55)          (5.47)          (0.29)         (0.04)
                                                        --------------    -----------    ------------    ------------    ----------
             Total Diluted Income (Loss) Per Common
                  Share                                      $ (6.30)       $(10.43)        $(17.99)         $(1.55)         $2.35
Diluted Weighted Average Number of
    Common Shares Outstanding                                  2,024          3,738           5,015           8,981         10,776
                                                        ==============    ===========    ============    ============    ==========
Balance Sheet Data:

Working Capital                                             $ 12,998       $ 15,203        $ (7,269)       $ (6,004)      $ 18,347
Total Assets                                                  33,656         67,533          28,968          23,526         34,843
Long-term  Debt                                                1,765         14,665          12,446           3,150          1,622
Stockholder's Equity (Deficit)                                25,289         38,077          (6,184)         (6,463)        17,093
</TABLE>


                                       8
<PAGE>



ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS.
         -----------------------------------------------------------

(a)      Overview

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization  (the  "Agreement")  with  Coherent to sell all of the issued and
outstanding   common  stock  of  Palomar's  Star  Medical   Technologies,   Inc.
subsidiary.  The  Company  completed  the sale of Star to  Coherent on April 27,
1999.  The total purchase  price for all of the issued and  outstanding  capital
stock of Star was $65 million,  paid in cash. The purchase price was paid to the
stockholders  of Star in proportion to their holdings of Star capital stock.  On
the date of sale, Palomar owned 82.46% of Star. Palomar received net proceeds of
$49,736,023, of which $3,254,907 is being held in escrow until April 27, 2000 as
security for any claims which Coherent may have under the  Agreement,  resulting
in a gain of $47,090,877 or $3.98 diluted earnings per share, net of tax effect.
The Company has deferred gain recognition of  approximately  $3.1 million of the
proceeds from this sale pending the  resolution  in 2000 of certain  commitments
and contingencies related to the sale.

         As a result of the above  transaction,  the Company is able to fund its
operations  for the short term.  However,  revenues have declined  significantly
over the last two quarters, and will continue to remain low in the near term and
the successful  introduction  and marketing of new products will become critical
to the Company's  long-term  success.  For the years ended December 31, 1998 and
1999, gross revenues associated with Star's  LightSheer(TM) system comprised 80%
and 60%, respectively,  of the Company's total revenues.  This revenue base will
need to be replaced with  revenues  from  products  that the Company  intends to
introduce  in 2000.  There can be no assurance  that the Palomar  E2000TM or the
Company's future products will achieve market acceptance or generate  sufficient
margins.  Broad  market  acceptance  of laser hair  removal is  critical  to the
Company's  success.  The Company  recognizes the need and intends to broaden its
product  line by  developing  cosmetic  laser  products  other than hair removal
lasers.

         In the third  and  fourth  quarters  of 1997,  the  Board of  Directors
authorized  management  to focus the  Company  on its core  laser  products  and
services  business,  principally  related to laser hair removal,  and to proceed
with a  restructuring  plan to reorganize  the Company and divest its electronic
subsidiaries,  Dynaco Corp., Dynamem, Inc., Comtel Electronics,  Inc., and Nexar
Technologies,  Inc.  (collectively,  the "Electronic  Subsidiaries"),  and other
non-core  businesses.  As a result,  the Company has simplified its organization
and now conducts business in only two locations,  Burlington,  Massachusetts and
Livermore,  California.  Prior  to  the  restructuring,  the  Company  conducted
business in over a dozen different locations.

         Pursuant  to  Accounting   Principles   Board  Opinion  (APB)  No.  30,
"Reporting  the Results of  Operations -- Reporting the Effects of Disposal of a
Segment of a Business,  and  Extraordinary,  Unusual and Infrequently  Occurring
Events and Transactions," the consolidated  financial  statements of the Company
have been presented to reflect the dispositions of the Electronic  Subsidiaries.
Accordingly,  the revenues,  cost and expenses,  assets and liabilities and cash
flows  of the  Electronics  Subsidiaries  have  been  reported  as  discontinued
operations  in  these  consolidated  financial  statements  (see  Note 12 to the
Financial Statements).

(b)     Results

        (i)      REVENUES  AND GROSS  PROFIT:  Year  Ended  December  31,  1999
                 Compared to Year Ended December 31, 1998

         For the year ended December 31, 1999, the Company's  revenues decreased
to $24.3  million as compared to $44.5  million for the year ended  December 31,
1998. The decrease in the Company's  revenues of $20.2 million,  or 45% from the
year ended December 31, 1998, was mainly due to the reduction in sales volume of
$21.1  million  associated  with  the  elimination  of  LightSheer(TM)  sales in
connection  with the sale of Star to Coherent on April 27,  1999,  as  discussed
above.  There was an additional  decrease of $2.1 million due to declining sales
of other cosmetic  lasers,  offset by an increase of $3.0 million  consisting of
royalties  received by the Company from Coherent.  The Company  anticipates that
sales volumes from its E2000 TM hair removal laser system  introduced during the
first quarter of 1999 will not be substantial,  and will need to be supplemented
with additional new products. The decrease in sales volume associated with other
cosmetic laser product  revenue was  principally  due to declining  sales of the
Company's  EpiLaser(R)  ruby laser hair removal system.  Palomar  introduced its
second  generation long pulse ruby laser for hair removal,  the Palomar E2000TM,
during the first  quarter of 1999.  In March of 1999,  the Company  obtained FDA
clearance  to market  and sell its  Palomar  E2000TM  in the  United  States for
"permanent hair reduction."

                                       9
<PAGE>

         Gross profit for the year ended December 31, 1999 was $8.7 million (36%
of revenues)  compared to $21.5  million  (48% of  revenues)  for the year ended
December 31, 1998. The decrease in gross profit and gross profit  percentage was
due the fact that the Company sold Star and its  LightSheer(TM)  laser system to
Coherent on April 27,  1999,  as  discussed  above.  The  LightSheer  provided a
significantly  higher  gross  profit than the  Company's  EpiLaser(R)  and other
cosmetic products. The Company anticipates that its gross profit percentage from
sales of the Palomar  E2000TM will be  significantly  less than the gross profit
from its former  LightSheer(TM)  product,  unless and until the Palomar  E2000TM
achieves volume production and further manufacturing  efficiencies and overcomes
product introduction issues.

         (ii)     OPERATING  AND OTHER  EXPENSES:  Year Ended  December 31, 1999
                  Compared to Year Ended December 31, 1998

         Research and  development  costs increased to $8.0 million for the year
ended  December 31, 1999 from $7.0 million for the year ended December 31, 1998.
Research and  development  expenses as a percentage of revenues  totaled 33% for
the year ended  December 31, 1999 and 16% for the year ended  December 31, 1998.
The  continued  spending on research  and  development  reflects  the  Company's
commitment  to research  and  development  of devices and  delivery  systems for
cosmetic and medical  applications  using a variety of lasers,  while continuing
dermatology  research  utilizing the Company's ruby and diode lasers.  Palomar's
research and development  goals in the field of laser hair removal are to design
systems that (1) permit more rapid treatment of large areas, (2) have high gross
margins,  and (3) are  manufactured  at a lower cost,  thus  addressing  broader
markets.  Management  believes that research and development  expenditures  will
remain constant over the next year as the Company continues product  development
and  clinical  trials for  additional  applications  for its lasers and delivery
systems in the cosmetic and dermatological markets. The Company recently entered
into an amendment to its existing  Clinical Trial  Agreement with  Massachusetts
General Hospital,  pursuant to which it will fund a minimum of $475,000 per year
over the next five  years for  research.  The  funding  will be in the fields of
photo  thermal  removal  or  reduction  of  hair,  non-invasive  electromagnetic
targeting of  subcutaneous  fat, and  treatment of sebaceous  glands and related
skin disorders  (e.g.,  acne) using infrared light. In return,  the Company will
obtain exclusive  license rights to patents arising from Palomar funded research
in these fields  (referred to,  respectively,  as "hair removal," "fat removal,"
and "acne treatment," for simplicity).  Research and development as a percentage
of revenues is expected to increase until the Company  introduces other products
currently in development.

         Sales  and  marketing  expenses  decreased  to  $6.6  million  (27%  of
revenues)  for the year  ended  December  31,  1999 from $15.1  million  (34% of
revenues)  for the year ended  December  31,  1998.  The  decrease  in sales and
marketing expenses as a percentage of revenues is a result of the Company's sale
of  Star  to  Coherent,  which  incurred  significant  commission  expense.  New
distribution channels include direct sales by the Company and other distribution
channels,  and the associated sales and marketing expenses for the E2000(TM) are
less than the commission earned by Coherent, the Company's previous distributor.
The Company  will  continue to expand its own direct  sales force to  complement
these sales  channels.  The  Company  anticipates  that,  in  comparison  to the
commission  previously paid to Coherent as a percentage of revenues,  its future
sales and marketing costs as a percentage of revenues will decrease.

         General and  administrative  expenses decreased to $5.1 million (21% of
revenues) for the year ended  December 31, 1999 as compared to $8.9 million (20%
of revenues)  for the year ended  December 31, 1998.  This decrease for the year
ended December 31, 1999 is attributable  to a $3.5 million  reduction due to the
sale of the Company's Star subsidiary and due to the Company's restructuring and
consolidation of administrative functions.

         Costs  related  to  solicitation  of  proxies  in  connection  with the
Company's 1999 Annual Meeting of  Stockholders  were $625,000 for the year ended
December  31,  1999 as a  result  of a proxy  contest  launched  by a  dissident
stockholder group.

         Settlement costs were $2.5 million for the year ended December 31, 1999
and are attributable to lawsuits and claims against the Company. (See Note 10(c)
to Financial Statements.)

         Gain from the sale of a subsidiary was $47.1 million for the year ended
December  31, 1999 due to the Company  completing  the sale of Star on April 27,
1999. The Company has deferred gain  recognition of $3.1 million of the proceeds
from this  sale  pending  the  resolution  in 2000 of  certain  commitments  and
contingencies related to the sale.

         Redemption  expense was $6.2  million for the year ended  December  31,
1999.  This amount  reflects a  redemption  expense as a result of a  settlement
agreement  between  Palomar and certain  European banks that had held 4.5% Swiss
franc denominated  subordinated  convertible debentures originally totaling $7.7
million and due in 2003.  Under the terms of this

                                       10
<PAGE>

agreement,  which  resolved a lawsuit,  Palomar agreed to rescind its conversion
notices  issued in November  1997.  Through these  conversion  notices,  Palomar
converted  the  subordinated  debentures  into 130,576  shares of the  Company's
common stock. Since the conversion date, the Company had treated these shares as
issued and outstanding.  Under the terms of this compromise,  the Company agreed
to pay a total of $6.7 million to the European  banks, of which $4.5 million has
been paid as of December  31,  1999.  The balance of $2.2 million is due through
2001.  Accordingly,  the Company  has  recorded a charge to  operations  of $6.2
million.  This amount represents the total amount due to the European banks less
the  fair  market  value  of the  redemption  of the  common  shares  previously
considered outstanding by the Company.

         Interest expense  decreased to $597,000 for the year ended December 31,
1999 from $1.3 million for the year ended  December 31, 1998.  This 54% decrease
is primarily the result of the use of  conventional  financing and a decrease in
convertible  debenture  financings.  Also,  operations  did not  require as much
financing  in 1999 as  compared  to 1998 as a result  of lower  working  capital
needs.  As a result of the sale of Star,  which generated $49.7 million in cash,
the Company anticipates that interest expense will decline  significantly due to
use of a portion of these proceeds to pay down certain of its  outstanding  debt
during the second quarter of 1999.

         Net  gain  on  trading   securities   represents  a  realized  gain  of
approximately  $703,000  for the year ended  December  31,  1998  related to the
Company's investment in a publicly traded company that was sold during 1998. The
Company did not have any marketable trading securities as of December 31, 1999.

         Interest  income  increased to $1.3 million for the year ended December
31,  1999 as  compared to $33,000 for the year ended  December  31,  1998.  This
amount represents  interest earned on the balance of the funds received from the
sale of Star,  which are invested in high-grade  corporate and government  notes
and  bonds  and  will be  used  to  fund  future  operations  and  research  and
development efforts.

         Other  income  increased  to $411,000  for the year ended  December 31,
1999.  This amount compares to $21,000 for the year ended December 31, 1998. The
increase is primarily  due to $231,000 of foreign  currency  gain from the Swiss
franc convertible debentures.

         The Company  provided  income taxes of $2.5 million in 1999 as a result
of the sale of Star.  The Company was not able to fully offset the gain with the
net operating loss carryforwards.

         The loss from  discontinued  operations for the year ended December 31,
1999 was $435,000 compared to a loss of $2.6 million for the year ended December
31, 1998. The $435,000 loss from  discontinued  operations  incurred during 1999
was related to a settlement related to the operations of Dynaco.

         (iii)    REVENUES  AND GROSS  PROFIT:  Year  Ended  December  31,  1998
                  Compared to Year Ended December 31, 1997

         For the year ended December 31, 1998, the Company's  revenues increased
to $44.5  million as compared to $21.0  million for the year ended  December 31,
1997.  The increase in the Company's  revenues of $23.5 million or 112% from the
year ended December 31, 1997 was mainly due to additional  sales volume of $35.6
million associated with the introduction of the LightSheer(TM), partially offset
by a decrease  in  revenue of $12.1  million  in other  cosmetic  laser  product
revenue.   The  Company   obtained   FDA   clearance  to  market  and  sell  the
LightSheer(TM)  for hair removal and leg vein  treatment in the United States at
the end of 1997.  The decrease in sales volume  associated  with other  cosmetic
laser product  revenue was  principally  due to declining sales of the Company's
EpiLaser(R)  ruby laser. The Company focused on bringing the  LightSheer(TM)  to
market while further  developing a new  generation  of ruby hair removal  lasers
during 1998.

         Gross  margin for the year ended  December  31, 1998 was $21.5  million
(48% of  revenues)  compared to  $939,000  (4% of  revenues)  for the year ended
December 31, 1997. The increase in gross margin and gross margin  percentage was
due to sales of the  LightSheer(TM),  which  had a  significantly  higher  gross
margin than the Company's EpiLaser(R) and other cosmetic products.

                                       11
<PAGE>



         (iv)     OPERATING  AND OTHER  EXPENSES:  Year Ended  December 31, 1998
                  Compared to Year Ended December 31, 1997

         Research and  development  costs decreased to $7.0 million for the year
ended December 31, 1998 from $12.0 million for the year ended December 31, 1997.
Research and development expenses as a percentage of revenue totaled 16% for the
year ended  December 31, 1998 and 57% for the year ended  December 31, 1997. The
decline in spending was  primarily  the result of the  Company's  receipt of FDA
approval for the LightSheer(TM) at the end of 1997.

         Sales  and  marketing  expenses  increased  to  $15.1  million  (34% of
revenues)  for the year ended  December  31,  1998,  from $7.0  million  (33% of
revenues)  for the year ended  December  31,  1997.  The  increase  in sales and
marketing  expenses was  attributable to the costs associated with the Company's
distribution  agreement with Coherent,  which increased in direct  proportion to
sales volume  because  Coherent  received a commission for each of the Company's
products that it sold, to compensate it for its sales and marketing efforts. The
amounts  received by Coherent (as a percentage of the Company's  revenues)  were
greater than the Company's sales and marketing  expenses when it performed these
functions internally during 1997.

         General and  administrative  expenses decreased to $8.9 million (20% of
revenues)  for the year ended  December 31, 1998,  as compared to $15.3  million
(73% of  revenues)  for the year ended  December  31,  1997.  This  decrease  is
attributable to the Company's  restructuring and consolidation of administrative
functions  in the third and fourth  quarters of 1997,  including a reduction  in
costs  attributable to Palomar  Technologies,  Ltd.,  Esthetica  Partners,  Inc.
(formerly Cosmetic Technology  International,  Inc.),  Palomar Medical Products,
Inc. and corporate costs totaling $1.0 million,  $2.4 million,  $1.9 million and
$2.0 million, respectively. This reduction was offset by an increase of $900,000
for  general  and  administrative   expenses  incurred  at  the  Company's  Star
subsidiary to support the introduction of the LightSheer(TM). In previous years,
the  Company  used  management's  time and  allocated  resources  to  developing
businesses  outside of the medical and cosmetic laser industry and financing the
non-core  businesses.  Beginning  in the  fourth  quarter of 1997,  the  Company
focused its efforts on its core business.

         The Company incurred no business development and financing costs during
the year ended  December 31, 1998, as compared to $2.1 million (10% of revenues)
for the year ended  December  31, 1997.  This  decrease is  attributable  to the
Company's restructuring efforts to focus on its core medical business.

         Restructuring and asset write-off costs were $13.0 million for the year
ended December 31, 1997. These charges reflect restructuring and asset write-off
costs for certain operating and  non-operating  assets that the Company believes
were not fully  realizable  for both the  Company's  medical  business and other
non-medical  investments.  Included in this charge is a $2.7 million reserve for
severance   costs   associated   with   consolidating   selling,   general   and
administrative functions,  including the closing of certain facilities.  Through
December 31, 1998, the Company paid out $2.3 million of severance  costs and had
a remaining  liability of $279,000  related to two individuals that was paid out
in 1999,  resulting  in actual  restructuring  costs  incurred of $2.6  million.
Accordingly,  the Company reversed the balance of this restructuring  accrual of
$131,000 in its consolidated  statement of operations  during the fourth quarter
of fiscal 1998.

         For the year  ended  December  31,  1998,  the  Company  did not  incur
settlement costs. Settlement costs of $3.2 million were incurred during the year
ended December 31, 1997. These costs consisted mainly of a legal accrual related
to a legal settlement with an investment bank.

         Interest expense  decreased to $1.3 million for the year ended December
31, 1998 from $7.0 million for the year ended  December 31, 1997. The amount for
1997 includes  $5.5 million of non-cash  interest  expense  related to the value
ascribed to the discount  features of the convertible  debentures  issued by the
Company  during 1996 and 1997.  This 82% decrease is  primarily  the result of a
decrease in convertible  debenture financings and the Company's increased use of
conventional  financing.  Also,  operations did not require as much financing in
1998 as compared to 1997.

         Interest  income  decreased to $33,000 for the year ended  December 31,
1998 from  $457,000  for the year ended  December  31,  1997.  This  decrease is
primarily  the result of a reduction  in interest  received due to a decrease in
other  loans and  investments  and a  decrease  in the  Company's  average  cash
position during 1998.

                                       12
<PAGE>

         Net gain on trading  securities  represents a realized gain of $703,000
for the year ended  December 31, 1998 related to the  Company's  investment in a
publicly  traded company that was sold during 1998. The Company did not have any
marketable trading securities as of December 31, 1998.

         The loss from  discontinued  operations for the year ended December 31,
1998 was $2.6  million  compared  to a loss of $27.4  million for the year ended
December 31, 1997.  The loss from  discontinued  operations in 1998 was due to a
delay in the  disposition  of Dynaco  resulting  in  operating  expenses of $1.1
million above the estimated  operating  expenses accrued at December 31, 1997. A
loss on  disposition  of  discontinued  entities for the year ended December 31,
1998 of $1.5 million was  incurred.  The majority of this charge  relates to the
write off of the Company's  carrying value of its investment in Nexar during the
second quarter of 1998.

(c)      Liquidity and Capital Resources

         On April 27, 1999,  Palomar  completed the sale of Star to Coherent for
$65 million.  On the date of the sale,  Palomar  owned  82.46% of Star.  Palomar
received  net  proceeds of  $49,736,023,  of which  $3,254,907  is being held in
escrow until April 27, 2000 as security  for any claims  Coherent may have under
the Agreement.

         In addition,  the Company receives an ongoing royalty from Coherent for
all  licensed  products  sold by  Coherent  that  incorporate  certain  patented
technology or use certain patented methods currently  licensed by the Company on
an exclusive basis from MGH. Palomar has also  sublicensed  these patents to two
additional competitors. Portions of these royalty proceeds are remitted to MGH.

         The Company used a portion of the proceeds of the Star sale to pay down
certain of its  outstanding  debt during 1999. The balance of the funds has been
invested in high-grade  corporate  and municipal  notes and bonds to fund future
operations and research and development efforts.  Accordingly,  the Company will
generate additional interest income for the near future.

         The  Company  is a  holding  company  with no  significant  operations.
Operations are carried out at the  subsidiary  level,  and consist  primarily of
research and development.  To date, the Company's  operating  subsidiaries  have
required cash advances from the Company to fund their operations. As of December
31,  1999,  the  Company  had  $25.2  million  in  cash,  cash  equivalents  and
available-for-sale  investments.  With the  proceeds  from the  Star  sale,  the
Company  believes  that its  financial  position will meet its ongoing cash flow
requirements  and can fund operating losses at its subsidiaries for at least the
next 12 months.  The  successful  introduction  and  marketing  of new  products
currently under development will be critical to funding future operations.

         During the year ended December 31, 1999, under a settlement  agreement,
the Company agreed to pay a total of $6.7 million to the European banks that had
held 4.5% convertible  debentures  originally totaling $7.7 million due in 2003.
The Company has paid $4.5 million to these banks through  December 31, 1999. The
balance of $2.2 million is due through 2001.

         During 1999, the Company entered into a 10-year lease agreement for its
operating  facility in Burlington,  Massachusetts.  The annual  commitment under
this  agreement  is  $860,000  for the first  five  years of the  agreement  and
$950,000 thereafter.

         In July 1999,  the  Company  entered  into an  amendment  to extend its
exclusive  research agreement with MGH for an additional five years. In addition
to laser hair removal,  the agreement has been expanded to include  research and
development in the fields of fat removal and acne treatment.  Under the terms of
this agreement,  the Company is obligated to pay MGH $475,000 on an annual basis
for clinical research through August 1, 2004.

         The Company  anticipates that capital  expenditures for 2000 will total
$700,000,   consisting   primarily  of  machinery,   equipment,   computers  and
peripherals. The Company expects to finance these expenditures with cash on hand
and equipment leasing lines, if available.

         The Company had a $10 million  revolving  line of credit from a bank. A
director  of the  Company  personally  guaranteed  borrowings  under the line of
credit.  On April 27, 1999, the Company repaid all the amounts  outstanding  and
subsequently cancelled the line of credit.

                                       13
<PAGE>

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

(d)      Year 2000 Impact

         We have not yet  experienced  any problems  with our  computer  systems
relating to  distinguishing  twenty-first  century dates from twentieth  century
dates,  which  generally are referred to as Year 2000 problems.  We are also not
aware  of  any  material  Year  2000  problems  with  our  clients  or  vendors.
Accordingly,  we do not anticipate  incurring  material expenses or experiencing
any material operational disruptions as a result of any Year 2000 problems.

(e)      Recently Issued Accounting Standard

         In February 1997,  Financial Accounting Standards Board ("FASB") issued
Statement of Financial  Accounting  Standards  ("SFAS")  No.133,  Accounting for
Derivative  Instruments  and  Hedging  Activities.   SFAS  No.  133  establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts  (collectively referred to as
derivatives)  and for hedging  activities.  SFAS No. 133 is effective for fiscal
years beginning  after June 15, 1999. The Company  believes that the adoption of
this new  accounting  standard will not have a material  impact on the Company's
financial statements.

ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
         -----------------------------------------------------------

         (i)      Derivative Financial Instruments, Other Financial Instruments,
                  and Derivative Commodity Instruments.

         As of  December  31,  1999,  the  Company  did not  participate  in any
derivative  financial  instruments or other financial and commodity  instruments
for which fair value disclosure would be required under SFAS No. 107. All of the
Company's  investments are considered cash equivalent  money market accounts and
debt  securities  which are considered  available-for-sale  investments  and are
carried at market value, with the difference  between cost and market value, net
of related  tax  effects,  recorded  as a separate  component  of  stockholders'
(deficit)  equity.  Accordingly,  the  Company has no  quantitative  information
concerning the market risk of participating in such investments.

         (ii)     Primary Market Risk Exposures.

         The  Company's  primary  market  risk  exposures  are in the  areas  of
interest  rate risk and  foreign  currency  exchange  rate risk.  The  Company's
investment  portfolio  of cash  equivalents  and debt  securities  is subject to
interest  rate  fluctuations,  but the Company  believes this risk is immaterial
because of the short-term nature of these investments.

         The   Company's   significant   exposure  to  currency   exchange  rate
fluctuations is specifically related to its Swiss franc convertible  debentures.
The impact of exchange rate movements on these debentures was immaterial for the
year ended December 31, 1999. The Company's other exposure to currency  exchange
rate  fluctuations  has been and is expected  to continue to be modest  since it
sells its products in United  States  dollars.  Currently,  the Company does not
engage in foreign currency hedging activities.

          STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
          ------------------------------------------------------------

         In addition  to the other  information  in this  Annual  Report on Form
10-K,  the following  cautionary  statements  should be considered  carefully in
evaluating the Company and its business.  Statements contained in this Form 10-K
that  are  not  historical  facts  (including,  without  limitation,  statements
concerning products under development,  the timing of new product introductions,
financing of future operations, and the Company's research partnership with MGH)
and other  information  provided by the Company and its  employees  from time to
time may  contain  certain  forward-looking  information,  as defined by (i) the
Private  Securities  Litigation  Reform Act of 1995 (the "Reform  Act") and (ii)
releases by the SEC. The risk factors  identified  below,  among other  factors,
could cause actual  results to differ  materially  from those  suggested in such
forward-looking statements. Readers are cautioned not to place undue reliance on
these  forward-looking  statements,  which speak only as of the date hereof. The
Company  undertakes  no  obligation  to  release  publicly  the  results  of any
revisions to these forward-looking

                                       14
<PAGE>

statements  that may be made to reflect events or  circumstances  after the date
hereof or to reflect the  occurrence of  unanticipated  events.  The  cautionary
statements below are being made pursuant to the provisions of the Reform Act and
with the  intention of obtaining  the benefits of safe harbor  provisions of the
Reform Act.

                                  RISK FACTORS
                                  ------------

OUR FUTURE REVENUE DEPENDS ON OUR DEVELOPING NEW PRODUCTS.

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

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

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

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

         Almost all of our  revenues in 1999 were  attributable  to sales of the
LightSheer(TM) diode laser system manufactured by Star.  Therefore,  as a result
of the Star sale,  our revenues  have declined  significantly.  If our operating
results fall below the expectations of investors or public market analysts,  the
price of our common stock could fall.

WE COULD BE DELISTED FROM NASDAQ.

         For continued  listing on The Nasdaq  SmallCap  Market,  a company must
maintain a minimum bid price of $1.00 per share.  In March  1999,  Nasdaq held a
hearing  regarding our continued  listing on The Nasdaq SmallCap Market in light
of the fact that our common stock had traded  below the $1.00  minimum bid price
requirement  for longer than 30 trading  days.  As a result of our reverse stock
split, we regained compliance with the minimum bid price requirement before that
date, and are now in compliance with all of Nasdaq's  requirements for continued
listing on The Nasdaq SmallCap Market.  However,  there can be no assurance that
we will remain in  compliance  with Nasdaq's  criteria for continued  listing or
that we will remain  listed on Nasdaq.  The  delisting of our common stock would
likely  reduce  the  liquidity  of our  common  stock and our  ability  to raise
capital.  If our common stock is delisted from The Nasdaq  SmallCap  Market,  it
will likely be quoted on the "pink sheets"  maintained by the National Quotation
Bureau,  Inc. or Nasdaq's OTC Bulletin  Board.  These  listings can make trading
more difficult for stockholders.

                                       15
<PAGE>

WE DEPEND ON A NUMBER OF VENDORS  FOR  CRITICAL  COMPONENTS  IN OUR  CURRENT AND
FUTURE PRODUCTS.

         We develop laser  systems that  incorporate  third-party  components as
part of the overall  systems.  Some of these items are custom made or  otherwise
not readily  available on the market.  We purchase some of these components from
small  specialized  vendors that are not well  capitalized.  A disruption in the
delivery of these key  components  could have an adverse effect on our business.
In 2000, we anticipate  that we will be  substantially  dependent on an overseas
third-party manufacturer over whom we do not have absolute control to provide us
with critical components for a new Super Long Pulse hair removal laser we intend
to introduce in 2000.

OUR LASERS ARE SUBJECT TO NUMEROUS  MEDICAL  DEVICE  REGULATIONS.  COMPLIANCE IS
EXPENSIVE  AND  TIME-CONSUMING.  OUR NEW  PRODUCTS MAY NOT BE ABLE TO OBTAIN THE
NECESSARY CLEARANCES IN ORDER TO SELL THEM.

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

         Our  products  are  subject  to  similar   regulations   in  our  major
international  markets.  Complying  with these  regulations is necessary for our
strategy  of  expanding  the markets  for and sales of our  products  into these
countries. These approvals may necessitate clinical testing,  limitations on the
number of sales and controls of end user purchase price,  among other things. In
certain  instances,  these  constraints can delay planned shipment  schedules as
design and engineering modifications are made in response to regulatory concerns
an requests.

WE ARE DEPENDENT ON THIRD-PARTY RESEARCHERS.

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

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

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

OUR PROPRIETARY TECHNOLOGY HAS ONLY LIMITED PROTECTIONS.

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

                                       16
<PAGE>

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

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

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

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

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

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

WE MAY NOT BE ABLE TO SUCCESSFULLY COLLECT LICENSING ROYALTIES.

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

                                       17
<PAGE>

WE FACE RISKS ASSOCIATED WITH PENDING LITIGATION.

         We are involved in disputes  with third  parties.  Such  disputes  have
resulted in litigation  with such  parties.  We have  incurred,  and likely will
continue to incur, legal expenses in connection with such matters.  There can be
no assurance  that such  litigation  will result in  favorable  outcomes for us.
Although we have  reached a  settlement  agreement  with the  plaintiffs  in the
Varljen  litigation  (described  in Part I,  Item  3),  the  settlement  must be
approved by the court,  and there can be no assurance  that it will be approved.
An  adverse  result in that suit could  have a  material  adverse  effect on our
business, financial condition and results of operations.

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

         As a small company with less than 100 employees, our success depends on
the  services  of key  employees  in  executive  and  research  and  development
positions. The loss of the services of one or more of these employees could have
a material adverse effect on our business.

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

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

                                       18
<PAGE>

ITEM 8.        FINANCIAL STATEMENTS.
               ---------------------

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S>                                                                                                           <C>

Reports of Independent Public Accountants                                                                     20

Consolidated Balance Sheets as December 31, 1998 and 1999                                                     22

Consolidated Statements of Operations for the Years Ended December 31, 1997,
     1998 and 1999                                                                                            23

Consolidated Statement of Stockholders' Equity (Deficit) for the Years Ended December 31, 1997,
     1998 and 1999                                                                                            24

Consolidated Statements of Cash Flows for the Years Ended December 31, 1997,
     1998 and 1999                                                                                            27

Notes to Consolidated Financial Statements                                                                    29
</TABLE>


                                       19
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Palomar Medical Technologies, Inc:

         We have audited the accompanying consolidated balance sheets of Palomar
Medical  Technologies,  Inc. (a Delaware  corporation)  and  subsidiaries  as of
December  31,  1998  and  1999  and  the  related  consolidated   statements  of
operations,  stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1999. 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.  The  summarized
financial data for Nexar Technologies, Inc. for the year ended December 31, 1997
contained  in  Note  12  are  based  on  the   financial   statements  of  Nexar
Technologies,  Inc., which were audited by other auditors. Their report has been
furnished to us and our  opinion,  insofar as it relates to the data in Note 12,
is based solely on the report of the other auditors.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States.  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,  based on our audits and the report of other  auditors,
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,  1998  and  1999  and the  results  of  their
operations  and their cash flows for each of the three years in the period ended
December 31, 1999 in conformity with accounting principles generally accepted in
the United States.

                                                             ARTHUR ANDERSEN LLP



Boston, Massachusetts
February 1, 2000

                                       20
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders
of Nexar Technologies, Inc.
Southborough, Massachusetts

We  have  audited  the   accompanying   consolidated   balance  sheet  of  Nexar
Technologies,  Inc. and  subsidiary  as of December  31,  1997,  and the related
consolidated  statements of operations,  stockholders' equity (deficit) and cash
flows for the year then ended.  These financial  statements (which are not shown
separately  herein) are the  responsibility  of the  Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audit. The consolidated financial statements of Nexar Technologies, Inc. and
subsidiary as of December 31, 1996 and for the periods  ended  December 31, 1995
and 1996 (not shown  separately  herein),  were audited by other  auditors whose
report dated January 24, 1997 (except with respect to the  purchased  technology
matter  discussed  in Note  12 as to  which  the  date is  February  28,  1997),
expressed an unqualified opinion on those statements.

We conducted our audit 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 audit provides a reasonable basis for our opinion.

In our opinion,  the 1997 financial statements referred to above present fairly,
in all material respects, the financial position of Nexar Technologies, Inc. and
subsidiary as of December 31, 1997 and the results of their operations and their
cash  flows  for the year  then  ended in  conformity  with  generally  accepted
accounting principles.

                                                                BDO Seidman, LLP

February 13, 1998 (except for Note 10 which
is as of March 20, 1998)

                                       21
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<S>                                                                                  <C>                        <C>

                                                                                     December 31,               December 31,
                                                                                         1998                       1999
                                                                                     ------------               ------------
                                                           ASSETS

Current Assets:
         Cash and cash equivalents                                                     $1,874,718                 $2,712,466
         Available-for-sale investments, at market value                                        -                 22,505,996
         Accounts receivable, net of allowance for doubtful accounts of
               approximately $364,000 and $207,000 in 1998 and 1999,                    9,938,121                  1,879,612
               respectively
         Inventories                                                                    5,416,342                  1,899,591
         Receivable from sale of subsidiary (Note 1)                                            -                  3,330,976
         Other current assets                                                           1,056,388                    729,301
                                                                                     ------------               ------------
               Total current assets                                                    18,285,569                 33,057,942
                                                                                     ------------               ------------

Property and Equipment, Net                                                             3,314,087                    991,432
                                                                                     ------------               ------------

Other Assets:
         Cost in excess of net assets acquired, net of accumulated
           amortization of
               approximately $1,882,000 and $1,201,000 in 1998 and 1999,
               respectively                                                             1,699,983                    631,026
         Deferred financing costs                                                          58,923                          -
         Other non-current assets                                                         167,352                    162,468
                                                                                     ------------               ------------
               Total other assets                                                       1,926,258                    793,494
                                                                                     ------------               ------------

                                                                                      $23,525,914                $34,842,868
                                                                                     ============               ============

                                       LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current Liabilities:
         Current portion of long-term debt                                             $6,290,041               $  1,122,008
         Accounts payable                                                               6,553,745                    659,280
         Accrued liabilities                                                            9,049,238                  6,371,553
         Accrued income taxes                                                                   -                  2,500,000
         Current portion deferred revenue                                               1,143,796                    918,642
         Deferred gain from sale of subsidiary of (Note 1)                                      -                  3,139,556
                                                                                     ------------               ------------
               Total current liabilities                                               23,036,820                 14,711,039
                                                                                     ------------               ------------

Liabilities of Discontinued Operations                                                  1,680,171                          -
                                                                                     ------------               ------------
Long-Term Debt, Net of Current Portion                                                  3,150,000                  1,622,008
                                                                                     ------------               ------------

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

Accrued Dividends and Interest on Preferred Stock                                       1,252,386                  1,417,184
                                                                                     ------------               ------------
Commitments and Contingencies (Note 10)

Stockholders' Equity (Deficit):
         Preferred stock, $.01 par value-
               Authorized - 1,500,000 shares
               Issued and outstanding -
               6,993 shares and 6,000 shares
               at December 31, 1998 and 1999, respectively
               (Liquidation preference of $7,417,183 as of December 31, 1999)                  69                         60

         Common stock, $.01 par value-
               Authorized - 45,000,000 shares
               Issued - 10,074,864 shares and 11,034,493 shares
               at December 31, 1998 and 1999, respectively                                100,747                    110,345
         Additional paid-in capital                                                   161,337,926                162,275,613
         Accumulated deficit                                                         (166,263,346)              (141,550,040)
         Unrealized loss on available-for-sale investments                                      -                    (67,943)
         Less: Treasury stock - 49,285 and 1,002,615 shares at cost
               at December 31, 1998 and 1999, respectively                             (1,638,859)                (3,675,398)
                                                                                     ------------               ------------
                        Total stockholders' equity (deficit)                          (6,463,463)                 17,092,637
                                                                                     ------------               ------------
                                                                                      $23,525,914                $34,842,868
                                                                                     ============               ============
</TABLE>


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

                                       22
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

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

                                                                                   Years Ended December 31,
                                                                      1997                  1998                  1999
                                                                ------------------    ------------------    -----------------

Product revenues                                                    $  20,994,546         $  44,514,057        $  21,279,168
Royalty revenues                                                                -                     -            2,972,279
                                                                ------------------    ------------------    -----------------
           Total Revenues                                              20,994,546            44,514,057           24,251,447
                                                                ------------------    ------------------    -----------------

Cost of product revenues                                               20,055,963            23,050,834           14,321,615
Cost of royalty revenues                                                        -                     -            1,188,912
                                                                ------------------    ------------------    -----------------
           Total Cost of Revenues                                      20,055,963            23,050,834           15,510,527
                                                                ------------------    ------------------    -----------------

           Gross profit                                                   938,583            21,463,223            8,740,920
                                                                ------------------    ------------------    -----------------

Operating Expenses (Income)

           Research and development                                    11,990,332             7,029,348            8,022,294
           Sales and marketing                                          6,959,750            15,132,595            6,586,959
           General and administrative                                  15,332,241             8,866,530            5,059,884
           Costs incurred for proxy contest                                     -                     -              624,627
           Business development
                and other financing costs                               2,060,852                     -                    -
           Restructuring and asset write-off (Note 13)                  3,325,000              (131,310)                   -
           Settlement and litigation costs                              3,199,000                     -            2,500,000
           Gain from sale of subsidiary (Note 1)                                -                     -          (47,090,877)
                                                                ------------------    ------------------    -----------------
                    Total operating expenses (income)                  42,867,175            30,897,163          (24,297,113)
                                                                ------------------    ------------------    -----------------

                    Income (loss) from operations
                                                                      (41,928,592)           (9,433,940)          33,038,033

Interest Expense                                                       (6,993,898)           (1,290,905)            (597,352)

Interest Income                                                           456,945                33,080            1,316,158

Net Gain (Loss) on Trading Securities                                     (52,272)              703,211                    -

Asset Write-off (Note 13)                                              (9,658,000)                    -                    -

Swiss Franc Redemption (Note 9)                                                 -                     -           (6,167,369)

Other Income (Expense), Net                                              (193,262)               21,311              411,420
                                                                ------------------    ------------------    -----------------
           Income (Loss) from  Continuing Operations
           Before Provision from Income Taxes                         (58,369,079)           (9,967,243)          28,000,890

Provision for Income Taxes                                                      -                     -            2,500,000
                                                                ------------------    ------------------    -----------------
           Net Income (Loss) from Continuing Operations               (58,369,079)           (9,967,243)          25,500,890
                                                                ------------------    ------------------    -----------------

Loss from Discontinued Operations (Note 12)
           Loss from operations                                       (29,508,755)           (1,090,885)            (435,000)
           Gain (Loss) on dispositions, net                             2,073,943            (1,533,295)                   -
                                                                ------------------    ------------------    -----------------

           Net Loss from Discontinued Operations                      (27,434,812)           (2,624,180)            (435,000)
                                                                ------------------    ------------------    -----------------

                    Net Income (Loss)                               $ (85,803,891)        $ (12,591,423)        $  25,065,890
                                                                ==================    ==================    =================

Basic Net Income (Loss) Per Share:
           Continuing operations                                      $    (12.52)          $     (1.26)           $     2.48
           Discontinued operations                                          (5.47)                (0.29)                (0.04)
                                                                ------------------    ------------------    -----------------
                    Total Basic Net Income (Loss) Per Share           $    (17.99)          $     (1.55)           $     2.44
                                                                ==================    ==================    =================

Basic Weighted Average Number of Shares Outstanding                     5,015,039             8,981,242           10,152,763
                                                                ==================    ==================    =================

Diluted Net Income (Loss) Per Share:
           Continuing operations                                      $    (12.52)          $     (1.26)           $     2.39
           Discontinued operations                                          (5.47)                (0.29)                (0.04)
                                                                ------------------    ------------------    -----------------
                    Total Diluted Net Income (Loss)  Per Share        $    (17.99)          $     (1.55)           $     2.35
                                                                ==================    ==================    =================
Diluted Weighted Average Number of Shares Outstanding                   5,015,039             8,981,242            10,775,672
                                                                ==================    ==================    =================
</TABLE>


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


                                       23
<PAGE>




               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<S>     <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, 1996                    18,151       $182         4,370,975       $43,708         (28,571)       $(1,211,757)

        Sale of common stock pursuant to
           warrants, options and Employee
           Stock Purchase Plan                     -          -           116,443         1,164               -                  -
        Reduction in subscriptions
           receivable                              -          -                 -             -               -                  -
           issuance costs of
           approximately $1,000,000           16,000        160                 -             -               -                  -
           1996 employer 401(k)
           matching contribution                   -          -            12,492           125               -                  -
        Conversion and redemption of
           preferred stock                   (17,754)      (178)          877,120         8,771               -                  -
        Conversion of convertible
           debentures and issuance of
           common stock to an
           investor                                -          -         1,066,423        10,664               -                  -
        Issuance of common stock for
           investment banking,
           merger and acquisition
           and consulting services                 -          -             2,857            29               -                  -
           feature of convertible
           debentures issued                       -          -            59,016           590               -                  -
        Unrealized gain on
           available-for-sale
           investments                             -          -                 -             -               -                  -
        Preferred stock dividends                  -          -                 -             -               -                  -
           associated with Dermascan
           acquisition                             -          -                 -             -               -                  -
        Issuance of common stock for
           technology                              -          -            36,474           365               -                  -
        Purchase of stock for treasury             -          -                 -             -         (20,714)          (427,102)
        Gain related to the issuance of
           common stock by Nexar
           Technologies, Inc.                      -          -                 -             -               -                 -
        Value ascribed to warrant to
           purchase common stock
           issued to Coherent, Inc.                -          -                 -             -               -                 -
        Net loss                                   -          -                 -             -               -                 -
                                             --------------------------------------------------------------------------------------
Balance, December 31, 1997                    16,397       $164         6,541,800       $65,416         (49,285)      $(1,638,859
                                             ======================================================================================
</TABLE>

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

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

Balance, December 31, 1996                    $105,162,811  $(64,971,200)       $(342,500)          $(604,653)       $38,076,591

        Sale of common stock pursuant to
           warrants, options and Employee
           Stock Purchase Plan                   1,613,070             -                -                   -          1,614,234
        Reduction in subscriptions
           receivable                                    -             -                -             604,653            604,653
        Sale of preferred stock, net of
           issuance costs of
           approximately $1,000,000             14,999,840             -                -                   -         15,000,000
        Issuance of common stock for
           1996 employer 401(k)
           matching contribution                   318,029             -                -                   -            318,154
        Conversion and redemption of
           preferred stock                      (3,873,689)            -                -                   -         (3,865,096)
        Conversion of convertible
           debentures and issuance of
           common stock to an
           investor                             16,999,699             -                -                   -         17,010,363
        Issuance of common stock for
           investment banking,
           merger and acquisition
           and consulting services                  53,096             -                -                   -             53,125
        Value ascribed to the discount
           feature of convertible
           debentures issued                     3,754,353             -                -                   -          3,754,943
        Unrealized gain on
           available-for-sale
           investments                                   -             -          342,500                   -            342,500
        Preferred stock dividends                        -    (1,584,406)               -                   -         (1,584,406)
        Guaranteed value of common stock
           associated with Dermascan
           acquisition                            (216,562)            -                -                   -           (216,562)
        Issuance of common stock for
           technology                            1,148,576             -                -                   -          1,148,941
        Purchase of stock for treasury                   -             -                -                   -           (427,102)
        Gain related to the issuance of
           common stock by Nexar
           Technologies, Inc.                    7,409,866             -                -                   -          7,409,866
        Value ascribed to warrant to
           purchase common stock
           issued to Coherent, Inc.                380,000             -                -                   -            380,000
        Net loss                                         -   (85,803,891)               -                   -         (85,803,891)
                                             -------------------------------------------------------------------------------------
Balance, December 31, 1997                    $147,749,089 $(152,359,497)         $     -             $     -     $    (6,183,687)
</TABLE>



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


                                       24
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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


<TABLE>
<S>    <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, 1997                                   16,397       $164       6,541,800      $65,416   (49,285) $(1,638,859)

       Sale of common stock pursuant to warrants,
          options and Employee Stock Purchase Plan               -           -          27,459          275         -            -
       Issuance of common stock for 1997 employer
          401(k) matching contribution                           -           -          44,555          446         -            -
       Conversion of preferred stock                        (5,888)        (59)        984,526        9,845         -            -
       Conversion of convertible debentures                      -           -       1,005,095       10,051         -            -
       Issuance of common stock, net of investment
          banking fees                                           -           -       1,457,143       14,571         -            -
       Redemption of preferred stock                        (3,516)        (36)              -            -         -            -
       Value ascribed to warrants issued to
          investment banker                                      -           -               -            -         -            -
       Common stock issued for advisory services                 -           -          14,286          143         -            -
       Costs incurred related to the issuance of
          common stock                                           -           -               -            -         -            -
       Preferred stock dividends and penalties                   -           -               -            -         -            -
       Net loss                                                  -           -               -            -         -            -
                                                       ---------------------------------------------------------------------------
Balance, December 31, 1998                                   6,993         $69      10,074,864     $100,747   (49,285) $(1,638,859)
                                                       ===========================================================================
</TABLE>



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

                                                              Additional                                Total
                                                               Paid-in          Accumulated          Stockholders'
                                                               Capital            Deficit           Equity  (Deficit)
                                                           ----------------------------------------------------------------

Balance, December 31, 1997                                   $147,749,089     $(152,359,497)          $(6,183,687)
       Sale of common stock pursuant to warrants,
          options and Employee Stock Purchase Plan                 65,856                 -                66,131
       Issuance of common stock for 1997 employer
          401(k) matching contribution                            253,835                 -               254,281
       Conversion of preferred stock                              642,382                 -               652,168
       Conversion of convertible debentures                    6 ,429,125                 -             6,439,176
       Issuance of common stock, net of investment
          banking fees                                          9,825,429                 -             9,840,000
       Redemption of preferred stock                           (3,615,522)                -            (3,615,558)
       Value ascribed to warrants issued to
          investment banker                                       171,000                 -               171,000
       Common stock issued for advisory services                   99,857                 -               100,000
       Costs incurred related to the issuance of
          common stock                                           (283,125)                -              (283,125)
       Preferred stock dividends and penalties                          -        (1,312,426)           (1,312,426)
       Net loss                                                         -       (12,591,423)          (12,591,423)
                                                       --------------------------------------------------------------------
Balance, December 31, 1998                                   $161,337,926     $(166,263,346)        $  (6,463,463)
                                                       ====================================================================
</TABLE>




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


                                       25
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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


<TABLE>
<S>     <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, 1998                              6,993         $69       10,074,864     $100,747      (49,285) $(1,638,859)

       Issuance of common stock for  Employee
          Stock Purchase Plan                               -           -           10,118          103        4,081       15,344
       Issuance of common stock for 1998
          employer 401(k) matching
          contribution                                      -           -           32,561          326            -            -
       Conversion of preferred stock                     (340)         (3)          74,905          749            -            -
       Conversion of convertible debentures                 -           -          377,760        3,778            -            -
       Redemption of preferred stock                     (653)         (6)               -            -            -            -
       Redemption of common stock related to
          Swiss franc convertible debentures                -           -                -            -     (130,576)    (575,348)
       Purchase of stock for treasury                       -           -                -            -     (362,550)  (1,471,893)
       Issuance of escrow shares to treasury                -           -          464,285        4,642     (464,285)      (4,642)
       Costs incurred related to the issuance
          of common stock                                   -           -                -            -            -            -
       Unrealized loss on available-for-sale
          investments                                       -           -                -            -            -            -
       Preferred stock dividends                            -           -                -            -            -            -
       Net  income                                          -           -                -            -            -            -
                                                 ----------------------------------------------------------------------------------
Balance, December 31, 1999                              6,000         $60       11,034,493     $110,345   (1,002,615)  $(3,675,398)
                                                 ==================================================================================
</TABLE>


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

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

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

       Issuance of common stock for  Employee
          Stock Purchase Plan                          30,824                   -                    -                  46,271
       Issuance of common stock for 1998
          employer 401(k) matching
          contribution                                206,333                   -                    -                 206,659
       Conversion of preferred stock                   62,665                   -                    -                  63,411
       Conversion of convertible debentures         1,802,296                   -                    -               1,806,074
       Redemption of preferred stock                 (781,381)                  -                    -                (781,387)
       Redemption of common stock related to
          Swiss franc convertible debentures                -                   -                    -                (575,348)
       Purchase of stock for treasury                       -                   -                    -              (1,471,893)
       Issuance of escrow shares to treasury                -                   -                    -                       -
       Costs incurred related to the issuance
          of common stock                            (383,050)                  -                    -                (383,050)
       Unrealized loss on available-for-sale
          investments                                       -                   -              (67,943)                (67,943)
       Preferred stock dividends                            -            (352,584)                   -                (352,584)
       Net  income                                          -          25,065,890                    -              25,065,890
                                                 ----------------------------------------------------------------------------------
Balance, December 31, 1999                        162,275,613        (141,550,040)       $     (67,943)          $  17,092,637
                                                 ==================================================================================
</TABLE>

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

                                       26
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S>    <C>                                                              <C>               <C>             <C>

                                                                                    Years Ended December 31,
                                                                            1997              1998            1999
                                                                        --------------    -------------   --------------
Cash Flows from Operating Activities:
       Net income (loss)                                                $(85,803,891)     $(12,591,423)    $ 25,065,890
            Less: net loss from discontinued operations                  (27,434,812)       (2,624,180)        (435,000)
                                                                        --------------    -------------   --------------
       Net income (loss) from continuing operations                      (58,369,079)       (9,967,243)      25,500,890
                                                                        --------------    -------------   --------------

       Adjustments to reconcile net income (loss) from
          continuing operations to net cash
          used in operating activities-
             Depreciation and amortization                                 2,246,412         2,676,651        1,191,810
             Restructuring and asset write-off costs                      12,983,000          (131,310)               -
             Loss (gain) on sale of subsidiary                               165,845                 -      (47,090,877)
             Write off of deferred financing costs associated with
                redemption of convertible debentures                          27,554                 -                -
             Valuation allowances for notes and investments                1,035,912                 -                -
             Foreign currency exchange gain                                 (651,970)                -                -
             Noncash interest expense related to debt                      5,473,077            63,652                -
             Noncash compensation related to common stock and
                warrants                                                     205,238           171,000                -
             Realized gain on marketable securities                         (577,969)                -                -
             Unrealized loss (gain) on marketable securities                 669,293          (703,211)               -
             Unrealized foreign currency exchange loss on foreign debt             -                 -         (130,943)
             Redemption of common stock held by Swiss franc debenture
                holders                                                            -                 -        6,167,369
             Changes in assets and liabilities, net of effects from
                 sale of subsidiary:
                 Purchases of marketable securities                         (152,938)                -                -
                 Net sale of marketable trading securities                 2,234,436         2,152,537                -
                 Accounts receivable                                      (1,809,371)       (7,689,441)       2,843,509
                 Inventories                                              (3,390,396)         (704,868)       1,010,751
                 Other current assets                                     (1,005,781)        1,097,553          313,495
                 Accounts payable                                          1,378,637         2,402,763       (4,041,465)
                 Accrued liabilities                                       3,546,543           639,934       (1,336,081)
                 Accrued income taxes                                              -                 -        2,500,000
                 Deferred revenue                                          2,948,247        (1,140,599)      (1,095,154)
                                                                        --------------    -------------   --------------
                     Net cash used in operating activities
                                                                         (33,043,310)      (11,132,582)     (14,166,696)
                                                                        --------------    -------------   --------------

Cash Flows from Investing Activities:
       Purchases of property and equipment                                (5,777,446)         (403,189)        (398,037)
       Purchases of available-for-sale investments                                  -                -      (22,786,767)
       Proceeds from sale of subsidiary                                             -                -       49,448,023
       Proceeds from sale of building                                               -                -          424,676
       Loans to related parties                                           (1,250,000)                -                -
       Payments received on loans to related parties                         941,288                 -                -
       Guaranteed value associated with Dermascan acquisition               (216,562)                -                -
       Investment in nonmarketable securities                             (1,057,631)                -                -
       Decrease (increase) in other assets                                   (95,830)          (19,628)           2,884
                                                                        --------------    -------------   --------------
                     Net cash provided by (used in) investing
                          activities                                      (7,456,181)         (422,817)      26,690,779
                                                                        --------------    -------------   --------------
</TABLE>

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

                                       27
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S>    <C>                                                              <C>               <C>             <C>
                                                                                    Years Ended December 31,
                                                                            1997               1998            1999
                                                                        --------------    -------------   --------------
Cash Flows from Financing Activities:
       Proceeds from issuance of convertible debentures                  16,715,169                 -                -
       Proceeds from notes payable                                        3,500,000                 -                -
       Redemption of convertible debentures                                (196,000)       (2,196,667)               -
       Proceeds from (payments of) notes payable and advances from
          distributor                                                    (4,856,479)        3,010,817          750,000
       Proceeds from issuance of common stock                             1,462,121         9,840,000                -
       Proceeds from exercise of warrants, stock options
            and Employee Stock Purchase Plan                                      -            66,131           46,271
       Costs incurred related to issuance of common stock                         -          (283,125)        (383,050)
       Proceeds from line of credit                                               -         1,000,000          500,000
       Payments on line of credit                                                 -                 -       (1,500,000)
       Payment on Swiss franc convertible debentures                              -                 -       (4,441,064)
       Issuance of preferred stock                                       15,000,000                 -                -
       Purchase of stock for treasury                                      (427,102)                -       (1,471,893)
       Payment on note payable                                                    -                 -       (2,290,041)
       Redemption of preferred stock                                              -        (4,387,434)        (781,387)
                                                                        ---------------   -------------   --------------
                          Net cash provided by (used in) financing
                          activities                                      31,197,709        7,049,722       (9,571,164)
                                                                        ---------------   -------------   --------------
Net increase (decrease) in cash and cash equivalents                      (9,301,782)      (4,505,677)       2,952,919
Net cash provided by (used in) discontinued operations                        12,676        3,377,095       (2,115,171)
Cash and cash equivalents, beginning of the period                        12,292,406        3,003,300        1,874,718
                                                                        ---------------   -------------   --------------
Cash and cash equivalents, end of the period                             $ 3,003,300       $1,874,718       $2,712,466
                                                                        ===============   =============   ==============

Supplemental Disclosure of Cash Flow Information:
       Cash paid for interest                                            $   534,037       $1,094,759       $  389,637
                                                                        ===============   =============   ==============
       Cash paid for income taxes                                        $        -        $        -       $        -
                                                                        ===============   =============   ==============

Supplemental Disclosure of Noncash Financing and Investing Activities:
        Conversion of convertible debentures and related accrued
             interest, net of financing fees                             $17,010,363        $6,439,176      $ 1,806,074
                                                                        ===============   =============   ==============

        Conversion of preferred stock                                    $   414,904        $  652,168      $    63,411
                                                                        ===============   =============   ==============

        Issuance of common stock for 1996, 1997 and 1998 employer
           401(k) matching contribution                                  $   318,154        $  254,281      $   206,659
                                                                        ===============   =============   ==============

        Unrealized loss on available-for-sale investments                $         -        $        -      $    67,943
                                                                        ===============   =============   ==============

        Issuance of common stock for advisory services performed
           in  1997                                                      $         -        $  100,000      $         -
                                                                        ===============   =============   ==============

       Issuance of common stock for purchase of technology
            related to discontinued operations                           $ 1,148,941        $        -      $         -
                                                                        ===============   =============   ==============

       Exchange of preferred stock for investment in a discontinued
       operation                                                         $(4,280,000)       $        -      $         -
                                                                        ===============   =============   ==============

       Investment banking and consulting fees for services related
            to the issuance of common stock and convertible
            debentures                                                   $    53,125        $        -      $         -
                                                                        ===============   =============   ==============

       Accrued dividends and interest on preferred stock                 $ 1,584,406        $1,312,426      $   352,584
                                                                        ===============   =============   ==============
</TABLE>

                                       28

<PAGE>
               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


(1)      Organization and Operations

         Palomar Medical Technologies,  Inc. and subsidiaries are engaged in the
commercial  sale and  development  of  cosmetic  and medical  laser  systems and
services.  During the year ended December 31, 1997, the Company began  execution
of a plan to dispose  of its  electronics  segment  (see Note 12).  The  Company
substantially completed the divestiture program in May of 1998.

         The  Company's   medical  laser  products  are  in  various  stages  of
development;  accordingly,  the  success  of future  operations  is subject to a
number of risks  similar to those of other  companies  with  products in similar
stages of  development.  Principal among these risks are the need for successful
development  and marketing of the Company's  products,  the need for  regulatory
approval, the need to achieve profitable operations, competition from substitute
products  and  larger  companies,  the need for  successful  funding  of  future
operations, and dependence on key individuals.

         On December 7, 1998, the Company  entered into an Agreement and Plan of
Reorganization  (the  "Agreement")  with  Coherent to sell all of the issued and
outstanding  common  stock  of Star,  Palomar's  majority-owned  subsidiary,  to
Coherent.  The Company  owned  substantially  all of the issued and  outstanding
common  shares of Star.  However,  options  outstanding  granted to Palomar  and
employees of Star to purchase shares of Star's common stock remained outstanding
prior to the  consummation  of this sale.  When all of the  outstanding  options
under  Star's  Stock  Option Plan were  exercised,  the Company  owned 82.46% of
Star's  common  stock and the  employees  collectively  owned  17.54%.  See Note
11(c)(i). This sale was approved by a majority of the stockholders of Palomar on
April 21, 1999.  On April 27, 1999,  the Company  completed  the sale of Star to
Coherent and received net proceeds of $49,736,023.  Additionally,  $3,254,907 is
being held in escrow  until  April 27,  2000 as  security  for any claims  which
Coherent may have under the Agreement,  resulting in a gain of $47,090,877.  The
Company has deferred  gain  recognition  of $3,139,556 of the proceeds from this
sale pending the  resolution in 2000 of certain  commitments  and  contingencies
related to the sale.

         The gain on the sale of Star is calculated as follows:

<TABLE>
<S>                                                                                                   <C>

Cash Received, Net of $965,000 of Bonuses Due to Star Employees                                       $48,771,023
Plus:  Net Amount Held in Escrow Pending Final Asset Valuation                                          3,254,907
Less:  Net Assets Divested                                                                             (1,165,482)
                                                                                       -----------------------------
Gain on Sale Before Expenses                                                                           50,860,448
Less:  Expenses                                                                                         3,769,571
                                                                                       -----------------------------
Net Gain on Sale of Subsidiary                                                                        $47,090,877
                                                                                       =============================
</TABLE>

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

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

(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.



                                       29
<PAGE>



         (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 investments of
which the Company owns less than 20% of the common stock are accounted for using
the  cost  method.  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.

         (c)      Investments

         The Company  accounts for  marketable  securities  in  accordance  with
Statement of Financial  Accounting  Standards  ("SFAS") No. 115,  Accounting for
Certain  Investments  in Debt and Equity  Securities.  The Company's  marketable
equity   securities  with  maturities   greater  than  90  days  are  considered
available-for-sale investments in the accompanying balance sheet and are carried
at market  value,  with the  difference  between cost and market  value,  net of
related tax effects,  recorded as a separate  component of stockholders'  equity
(deficit).  As of December 31, 1998, the Company did not have any investments in
marketable  securities.  For the year ended  December  31, 1999,  the  aggregate
market value,  cost basis,  and gross  unrealized  losses of  available-for-sale
investments are as follows:
<TABLE>
<S>     <C>                                            <C>               <C>            <C>

                                                         Market             Cost              Gross
                                                          Value             Basis       Unrealized Loss

         Available-for-sale securities:

         Corporate and municipal debt securities       $22,505,996       $22,573,939         $67,943
                                                       ===========       ===========         =======
</TABLE>

         Available-for-sale  investments  in the  accompanying  balance sheet at
December  31, 1999 include  debt  securities  of  $22,505,996  with  contractual
maturities of one year or less.  Actual  maturities may differ from  contractual
maturities as a result of the Company's intent to sell these securities prior to
maturity and as a result of call features of the  securities  that enable either
the Company,  the issuer or both to redeem these  securities at an earlier date.
Unrealized  holding losses totaling $67,943 on such debt securities are included
as a component of deducted  from  stockholders'  equity  (deficit)  for the year
ended December 31, 1999.

         (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, 1998 and 1999,  inventories
consist of the following:

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

                                                                December 31,
                                                         1998                1999
                                                    ----------------    ----------------
           Raw materials                                 $2,478,289          $1,403,001
           Work-in-process                                1,330,822             496,590
           Finished goods                                 1,607,231                   -
                                                    ----------------    ----------------
                                                         $5,416,342          $1,899,591
                                                    ================    ================
</TABLE>

                                       30
<PAGE>

         (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
          --------------------------------------            -------------------
          Machinery and equipment                                3-8 years
          Furniture and fixtures                                  5 years
          Leasehold improvements                               Term of Lease

         At December 31, 1998 and 1999,  property and  equipment  consist of the
following:
<TABLE>
<S>       <C>                                      <C>                <C>

                                                                December 31,
                                                          1998                1999
                                                   ----------------   -----------------
          Machinery and equipment                       $6,022,320          $1,062,774
          Furniture and fixtures                         1,120,450           1,006,125
          Leasehold improvements                           567,216             139,046
                                                   ----------------   -----------------
                                                         7,709,986           2,207,945
          Less:  Accumulated depreciation
                     and amortization                    4,395,899           1,216,513
                                                   ----------------   -----------------
                                                        $3,314,087            $991,432
                                                   ================   =================
</TABLE>

         (f)      Cost in Excess of Net Assets Acquired

         The costs in excess of net assets  for  acquired  businesses  are being
amortized  on a  straight-line  basis  over  five to seven  years.  Amortization
expense  for the years ended  December  31,  1997,  1998,  and 1999  amounted to
approximately $554,000,  $602,000 and $252,000 respectively,  and is included in
general  and   administrative   expenses  in  the  consolidated   statements  of
operations.

         The Company accounts for long-lived  assets in accordance with SFAS No.
121,  Accounting  for the  Impairment  of Long-Lived  Assets and for  Long-Lived
Assets to Be Disposed  Of. 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 has assessed the  realizability of its long-lived assets as
of December 31, 1999 and believes them to be realizable.

         (g)      Deferred Financing Costs

         The Company  incurred  financing costs related to several  issuances of
convertible  debentures.  Deferred  financing costs are amortized by a charge to
interest expense over the period that the debt is outstanding (see Note 9(a)).

         (h)      Revenue Recognition

         The Company  recognizes  product  revenue upon shipment and acceptance.
The  Company's  sales of its  product  do not  include  any  rights  of  return.
Provisions  are  made at the  time of  revenue  recognition  for any  applicable
warranty costs expected to be incurred. Revenues from services are recognized in
the period the services are provided.

                                       31
<PAGE>

         (i)      Significant Sales Agent

         For the years ended December 31, 1997, 1998 and 1999, Coherent acted as
the sales agent for products sold to the Company's  customers  that  represented
11%,  89% and 60% of product  revenues,  respectively.  At December 31, 1998 and
1999, Coherent accounted for 89% and 60% of accounts  receivable,  respectively.
Coherent was the  Company's  exclusive  worldwide  distributor  of laser systems
until the sale of Star in April 1999.  International  sales (including sales for
which Coherent was the sales agent) for the years ended December 31, 1997,  1998
and 1999 were approximately 24%, 39% and 35%, respectively, of total revenue.

         (j)      Research and Development Expenses

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

         (k)      Net Income (Loss) per Common Share

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

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

                                                                    Years Ended December 31,
                                                         1997                 1998                 1999
                                                   ------------------   -----------------    -----------------
Basic weighted average common
   shares outstanding                                      5,015,039           8,981,242           10,152,763

Potential common shares pursuant to:
   Stock options and warrants                                      -                   -               69,219
   Convertible preferred stock                                     -                   -              402,006
   Convertible debentures                                          -                   -              151,684
                                                   ------------------   -----------------    -----------------
Diluted weighted average common
  shares outstanding                                       5,015,039           8,981,242           10,775,672
                                                   ==================   =================    =================

</TABLE>

                                       32
<PAGE>

         The  Company's  basic  net  income  (loss)  per share  from  continuing
operations for the years ended 1997, 1998 and 1999 is as follows:
<TABLE>
<S>                                                <C>    <C>           <C>    <C>            <C>    <C>

                                                                    Years Ended December 31,
                                                         1997                 1998                 1999

                                                   ------------------   -----------------    -----------------
Net income (loss) from
   continuing operations                               $(58,369,079)        $(9,967,243)         $ 25,500,890
Preferred stock dividends                                (1,584,406)         (1,312,426)             (352,584)
Amortization of value ascribed to preferred
   stock conversion discount                             (2,823,529)                  -                     -
                                                   ------------------   -----------------    -----------------
Adjusted net income (loss) from
   continuing operations                               $(62,777,014)       $(11,279,669)          $25,148,306
                                                   ==================   =================    =================
Basic net income (loss) per common share
   from continuing operations                             $  (12.52)          $   (1.26)             $   2.48
                                                   ==================   =================    =================
Basic weighted average number of shares
   outstanding                                             5,015,039           8,981,242           10,152,763
                                                   ==================   =================    =================
Diluted net income (loss) per common
   share from continuing operations                        $ (12.52)            $ (1.26)              $  2.39
                                                   ==================   =================    =================
Diluted weighted average number of
   shares outstanding                                      5,015,039           8,981,242           10,775,672
                                                    =================   =================    =================

</TABLE>

         For the years  ended  1997,  1998 and  1999,  potential  common  shares
related to  4,622,635,  4,064,432 and 3,687,262 of  outstanding  stock  options,
stock warrants and convertible  securities,  respectively,  were not included in
diluted weighted average shares outstanding as they were antidilutive.

         (l)      Concentration of Credit Risk

         SFAS No. 105,  Disclosure of Information  about  Financial  Instruments
with  Off-Balance-Sheet  Risk and Financial  Instruments with  Concentrations of
Credit Risk, requires disclosure of any significant off-balance-sheet and credit
risk  concentrations.  Financial  instruments that subject the Company to credit
risk  consist  primarily of cash,  short-term  investments,  and trade  accounts
receivable.   The  Company  places  its  cash  and  short-term   investments  in
established   financial   institutions.   The   Company   has   no   significant
off-balance-sheet  concentration  of  credit  risk,  such  as  foreign  exchange
contracts, options contracts or other foreign hedging arrangements.  The Company
maintains an allowance  for potential  credit  losses.  The  Company's  accounts
receivable  credit risk is not concentrated  within any one geographic area. The
Company has not experienced  significant  losses related to receivables from any
individual  customers  or groups of  customers  in any  specific  industry or by
geographic area. Due to these factors,  no additional credit risk beyond amounts
provided for  collection  losses is believed by management to be inherent in the
Company's accounts receivable.

         (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.  At December  31, 1998 and 1999,  financial  instruments  consisted
principally of convertible  debentures  and preferred  stock.  The fair value of
financial  instruments  pursuant  to SFAS No. 107  approximated  their  carrying
values at December 31, 1998 and 1999. Fair values have been  determined  through
information obtained from market sources and management estimates.

                                       33
<PAGE>


         (n)      Comprehensive Income (Loss)

         The Company  adopted  SFAS No.  130,  Reporting  Comprehensive  Income,
effective January 1, 1998. SFAS No. 130 establishes  standards for reporting and
presentation of comprehensive  income (loss) and its components in the financial
statements. The components of the Company's comprehensive loss are as follows:
<TABLE>
<S>                                              <C>    <C>          <C>    <C>           <C>    <C>

                                                                      December 31,
                                                       1997                 1998                1999

                                                 ----------------    -----------------    ---------------
Net income (loss) from continuing operations        $(58,369,079)         $(9,967,243)       $25,500,890

Unrealized gain (loss) on available-for-sale
   investments                                           342,500                    -            (67,943)
                                                  ----------------    -----------------    ---------------
Comprehensive income (loss) from
   continuing operations                            $(58,026,579)         $(9,967,243)       $25,432,947
                                                  ================    =================    ===============
</TABLE>


         (o)      Reclassifications

        Certain   reclassifications   have  been  made  to  the  1997  and  1998
consolidated   financial   statements   to  conform  with  the  current   year's
presentation.

         (p)      Recent Accounting Pronouncements

         In June 1998, the Financial  Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This
statement   establishes   accounting  and  reporting  standards  for  derivative
instruments,  including derivative instruments embedded in other contracts,  and
for hedging  activities.  SFAS No. 133, as amended by SFAS No. 137, is effective
for all fiscal  quarters of fiscal years beginning after June 15, 2000. SFAS No.
133 is not  expected  to have a material  impact on the  Company's  consolidated
financial statements.

(3)      Segment and Geographic Information

         The Company has adopted SFAS No. 131,  Disclosures about Segments of an
Enterprise  and Related  Information.  SFAS No. 131  establishes  standards  for
reporting   information   regarding   operating  segments  in  annual  financial
statements and requires selected  information for those segments to be presented
in  interim  financial  reports  issued  to  stockholders.  SFAS  No.  131  also
establishes  standards for related  disclosures  about products and services and
geographic  areas.  Operating  segments  are  identified  as  components  of  an
enterprise about which separate discrete financial  information is available for
evaluation by the chief  operating  decision maker, or decision making group, in
making decisions how to allocate resources and assess performance. The Company's
chief  decision-maker,  as defined under SFAS No. 131, is a  combination  of the
Chief Executive  Officer and the Chief Financial  Officer.  To date, the Company
has viewed its operations  and manages its business as principally  one segment,
cosmetic laser sales. Associated services are not significant.  As a result, the
financial  information disclosed herein represents all of the material financial
information related to the Company's principal operating segment.

         Product revenues from international  sources were  approximately  $5.03
million, $17.36 million and $8.44 million in 1997, 1998 and 1999,  respectively.
The Company's revenues from international  sources were primarily generated from
customers located in Europe, Canada, Latin America and Asia/Pacific.  All of the
Company's  product  sales for the years ended  December 31, 1997,  1998 and 1999
were shipped from its facilities located in the United States.

                                       34
<PAGE>

         The  following  table  represents  percentage  of  product  revenue  by
geographic region from customers for 1997, 1998 and 1999:

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

                                                               Years Ended December 31,
                                                  1997                   1998                   1999
                                            -----------------     -------------------     ------------------

         United States                            76%                    61%                     57%
         Europe                                    6                      17                     19
         Asia/Pacific                              3                      2                       4
         Japan                                     3                      11                     17
         Canada                                    4                      3                       1
         Latin America                             8                      6                       2

                                            -----------------     -------------------     ------------------

                       Total                      100%                   100%                   100%
                                            =================     ===================     ==================
</TABLE>

(4)      Research and Development

         In August 1995, the Company  entered into an agreement with MGH whereby
MGH  agreed  to  conduct   clinical   trials  on  a  laser  treatment  for  hair
removal/reduction  developed at MGH's  Wellman  Laboratories  of  Photomedicine.
Effective  February 14, 1997,  the Company  amended the 1995 agreement with MGH.
Under the terms of this  amendment,  the  Company  agreed to provide  MGH with a
grant of approximately  $204,000 to perform research and evaluation in the field
of hair removal.  In July 1999,  the Company  entered an amendment to extend its
exclusive  research agreement for an additional five years. In addition to laser
hair  removal,   the  agreement  has  been  expanded  to  include  research  and
development  in the fields of fat  removal and acne  treatment.  Palomar has the
right to exclusively license, on royalty terms to be negotiated,  Palomar-funded
inventions  in the  relevant  fields.  Under  the terms of this  agreement,  the
Company will pay MGH $475,000 on an annual basis for clinical  research  through
August 2004.

(5)      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,  1999,  the Company had  available,  subject to review and possible
adjustment  by the  Internal  Revenue  Service,  a federal  net  operating  loss
carryforward of approximately  $59.2 million to be used to offset future taxable
income,  if any. This net operating  loss  carryforward  will begin to expire in
2012. 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 completed an analysis of its availability to utilize
its operating loss in connection with the sale of Star to Coherent (see Note 1).
The Company  estimates that its has net operating losses of approximately  $37.9
million that are not subject to limitation  under the Internal Revenue Code. The
Company has a net deferred tax asset of approximately  $40.4 million,  comprised
mainly of the net  operating  tax  carryforwards  discussed  above,  and the tax
effort of certain expenses and reserves not currently  deductible.  However, the
Company has placed a full  valuation  allowance  against the deferred tax asset,
due to uncertainty relating to the Company's ability to realize the asset.


                                       35
<PAGE>

         A  reconciliation  of the  federal  statutory  rate  to  the  Company's
effective tax rate is as follows:
<TABLE>
<S>                                                      <C>                <C>                  <C>

                                                                             December 31,
                                                              1997                1998                 1999
                                                         ----------------    ----------------     ---------------

Income tax provision at federal statutory rate                     34.0%               34.0%               34.0%
Decrease in tax resulting from-
     Net operating loss utilization                                   -                  -                (25.1)
     Increase in valuation allowance                              (34.0)              (34.0)                   -
                                                         ----------------    ----------------     ---------------
Provision for income taxes                                          0.0%                0.0%                8.9%
                                                         ================    ================     ===============
</TABLE>


(6)      401(k) Profit Sharing Plan

         The Company  has a 401(k)  profit  sharing  plan (the  "Profit  Sharing
Plan"), which covers substantially all employees who 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. As of
December 31, 1999,  the Company has reserved  114,292 shares of its common stock
for issuance in connection with the Profit Sharing Plan.

         During 1998 and 1999,  the Company  issued 44,555 and 326 shares of its
common  stock to the Profit  Sharing  Plan in  satisfaction  of its $254,281 and
$206,659   employer  match  for  the  1997  and  1998  employee   contributions,
respectively.  For the year ended  December  31,  1999,  the Company has accrued
$123,564 for the 1999 match.

(7)      Quarterly Results of Operations (Unaudited)

         The following table presents a condensed  summary of quarterly  results
of  operations  for the years ended  December  31, 1998 and 1999 (in  thousands,
except per share data).

<TABLE>
<S>                                       <C>               <C>               <C>               <C>
                                                         Years Ended December 31, 1999
                                          ------------------------------------------------------------------
                                             First            Second             Third            Fourth
                                            Quarter           Quarter           Quarter           Quarter
                                          ------------      ------------      ------------      ------------

       Total revenues                        $ 13,479           $ 5,529           $ 2,923           $ 2,320
       Gross profit                             8,509             1,292               396            (1,456)
       Income (loss) from
         continuing operations                    469            33,198            (2,598)           (5,568)
       Net income (loss) per
         share from continuing
         operations:
            Basic                                0.04              3.22             (0.27)             (.56)
            Diluted                              0.04              3.02             (0.27)             (.55)
</TABLE>

                                       36
<PAGE>
<TABLE>
<S>                                       <C>               <C>               <C>               <C>>

                                                         Years Ended December 31, 1998
                                          ------------------------------------------------------------------
                                             First            Second             Third            Fourth
                                            Quarter           Quarter           Quarter           Quarter
                                          ------------      ------------      ------------      ------------

       Total revenues                         $ 7,067           $ 9,090          $ 13,810          $ 14,547
       Gross profit                               731             4,278             8,088             8,366
       Income (loss) from
         continuing operations                 (6,839)           (3,968)              540               300
       Net income (loss) per
         share from continuing
         operations:
            Basic                              $(1.02)            (0.48)              0.07              0.03
            Diluted                            $(1.02)            (0.48)              0.07              0.03
</TABLE>

(8)      Accrued Liabilities

         At December  31, 1998 and 1999,  accrued  liabilities  consisted of the
following:
<TABLE>

<S>                                                      <C>                   <C>
                                                                     December 31,
                                                              1998                  1999
                                                         ----------------      ---------------
              Payroll and consulting costs                    $1,148,898             $782,912
              Royalties                                        1,106,352            1,265,825
              Settlement costs                                        --            2,500,000
              Warranty                                         2,798,836              711,606
              Restructuring                                      279,000                   --
              Other                                            3,716,152            1,111,210

                                                         ----------------      ---------------
                  Total                                       $9,049,238           $6,371,553
                                                         ================      ===============
</TABLE>

(9)      Long-Term Debt

         (a) At December  31, 1998 and 1999,  long-term  debt  consisted  of the
following:
<TABLE>
<S>                                                                              <C>              <C>

                                                                                          December 31,
                                                                                      1998             1999
                                                                                 ---------------  ---------------
Dollar-denominated convertible debentures                                           $2,150,000         $500,000
Revolving line of credit with a bank                                                 1,000,000               --
Note payable in connection with guarantee on behalf of discontinued
    subsidiary (See Note 12)                                                         2,290,041               --
Short-term notes payable to Coherent                                                 4,000,000               --
Swiss franc-denominated convertible debentures                                              --        2,244,016
                                                                                 ---------------  ---------------
                                                                                     9,440,041        2,744,016
Less - Current maturities                                                           (6,290,041)      (1,122,008)
                                                                                 ---------------  ---------------
                                                                                    $3,150,000       $1,622,008
                                                                                 ===============  ===============
</TABLE>

                                       37
<PAGE>

         (a)      Convertible Debentures

         The  following  table  summarizes  the issuance and  conversion  of the
convertible debentures for the years ended December 31, 1998 and 1999.
<TABLE>
<S>                                                  <C>               <C>            <C>          <C>             <C>
                                                                                                          Common Shares
                                                         Initial           Amount Outstanding              Issued Upon
                                                           Face               December 31,                 Conversion
                                                                       --------------------------- ----------------------------
Series                                                    Value            1998          1999          1998           1999
---------------------------------------------------- ----------------- -------------- ------------ --------------  ------------
4.5% Series due October 21, 1999, 2000 and 2001            $5,000,000            $--      $--              8,687       --
5% Series due December 31, 2001                             5,000,000             --      --             165,857       --
5% Series due January 13, 2002                              1,000,000             --      --             132,004       --
5% Series due March 10, 2002                                5,500,000             --      --             223,009       --
6% Series due March 13, 2002                                  500,000        500,000      500,000       --             --
6%, 7% and 8% Series due September 30, 2002                 7,000,000      1,650,000      --             475,537       377,760
4.5% Series denominated in Swiss francs
     due July 3, 2003                                       7,669,442       --         2,244,016              --       --
                                                     ----------------- -------------- ------------ --------------  ------------
                                                          $31,669,442     $2,150,000   $2,744,016      1,005,094       377,760
                                                     ================= ============== ============ ==============  ============
</TABLE>

         It is the Company's policy to discount convertible  debentures based on
the discount  conversion  price and amortize the discount to operations over the
expected life of the  convertible  debentures,  which in most cases is less than
the term of the debentures.  Accordingly, the Company credits the ascribed value
for the discount features  described above to additional  paid-in capital.  This
ascribed  amount is  amortized  over a period to the earliest  conversion  date,
which is six months for the convertible debentures outstanding in 1998 and 1999.

         During 1997, the Company recorded approximately  $5,444,000 of interest
expense related to the  amortization of the discount of convertible  debentures.
There was no amortization  of the discount of convertible  debentures in 1998 or
1999.

         On March 13,  1997,  the  Company  issued  $500,000  of 6%  convertible
debentures  due March 13, 2002.  The  convertible  debentures  have a conversion
price of $11.00. The  debentureholder  may convert no more than one-third of the
debenture in any 30 day period.  The Company has accounted for these  debentures
at face value.

         On September  30, 1997,  the Company  issued $7 million of  convertible
debentures due September 30, 2002. The debentures  bear interest at a rate of 6%
for the first 179  days,  7% for days 180  through  269 and 8%  thereafter.  The
debentureholders  were also issued 59,015 shares of common stock related to this
financing.  The fair market value of the common stock was $1.05 million and this
amount is being treated as debt discount and amortized to interest expense.  The
convertible  debentures have a conversion price of 100% of the Company's average
stock price, as defined.  In addition,  the  debentureholder may convert no more
than 33% of their debentures in any thirty-day  period (or 34% of the debentures
in the last 30 day period).  The Company also has  redemption  rights related to
this  financing.  During the year ended December 31, 1998, the Company  redeemed
$2,196,667  of these  convertible  debentures,  including  accrued  interest  of
$196,667.  During  the  year  ended  December  31,  1999,  the  debentureholders
converted  the  remaining  $1,650,000  of  principal  plus  $176,483  of accrued
interest,  into 377,760 shares of the Company's common stock. As of December 31,
1999, all of these debentures have been redeemed or converted.

         On July 3, 1996, the Company raised  approximately  $7,669,000  through
the issuance of 9,675 units in a convertible  debenture  financing.  These units
are  traded on the  Luxembourg  Stock  Exchange  and  consist  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  non-detachable and may be exercised only if

                                       38
<PAGE>

the related  debentures  are  simultaneously  converted,  redeemed or purchased.
Interest on the convertible  debentures  accrued at a rate of 4.5% per annum and
was  payable  quarterly  in  Swiss  francs.  The  convertible   debentures  were
convertible  by the  holder,  or the  Company,  commencing  October 1, 1996 at a
conversion  price  equal to 100% to 77.5% of the  applicable  conversion  price,
calculated  as  defined.  The  Company  ascribed  a value of  $1,917,360  to the
discount conversion feature of the convertible debenture.  This amount was being
amortized  to  interest  expense  over the life of the Swiss  franc  convertible
debenture.  During  1997,  the Company  redeemed  300 units of this  convertible
debenture financing for $195,044.

         On October 16, 1997, the Company brought a declaratory  judgment action
in the United States District Court against certain of the Swiss franc debenture
holders.  Prior to this suit,  those  debenture  holders  had  alleged  that the
Company was in breach of certain protective  covenants and, on October 22, 1997,
they brought  suit based on these  claims.  On November  13,  1997,  the Company
exercised its right to convert  9,375 units into 130,576  shares of common stock
and  cash  of  approximately   $36,000.   The  unamortized   discount   totaling
approximately $1,784,000 was amortized to interest expense upon conversion.  The
Company  accounted  for  these  debentures  as  converted  in  the  accompanying
financial statements as of December 31, 1998.

         During  the year  ended  December  31,  1999,  the  Company  recorded a
redemption  expense of $6,167,369 as a result of a compromise  agreement between
Palomar and  certain  European  banks that had held the Swiss franc  debentures.
Under the terms of this  April 21,  1999  agreement,  which  resolved a lawsuit,
Palomar agreed to rescind its conversion  notices issued in November 1997. Under
the terms of the agreement,  the Company agreed to pay a total of  approximately
$6,742,717  to the  European  banks,  of which  $4,433,355  had been  paid as of
December 31,  1999.  The  remaining  amounts due under this  obligation  are due
through  2001.  Accordingly,  the Company has recorded a charge to operations of
$6,167,369.  This amount  represents  the total amount due to the European banks
less the fair market value of the  redemption  of the common  shares  ($575,348)
previously considered outstanding by the Company.

         The Company incurred deferred financing costs of approximately $769,000
relating  to the  issuance  of  convertible  debentures  during  the year  ended
December 31, 1997. These costs are reflected as deferred  financing costs in the
accompanying  consolidated  balance  sheets and are being  amortized to interest
expense over the term of the related  convertible  debentures.  During the years
ended  December 31, 1997,  1998 and 1999,  the Company  amortized  approximately
$276,000, $64,000 and $39,000 to interest expense,  respectively.  Any remaining
unamortized  deferred  financing costs are charged to additional paid-in capital
upon  conversion.  During the years ended December 31, 1997,  1998 and 1999, the
Company charged approximately $1,820,000, $374,000 and $20,000, respectively, of
unamortized deferred financing costs to additional paid-in-capital.

         (b)      Revolving Line of Credit with a Bank

         The  Company had a $10  million  revolving  line of credit with a bank.
This line of credit  was to mature on March 31,  2000 and bore  interest  at the
bank's  prime  rate.  Borrowings  under  this line of  credit  were  secured  by
substantially  all assets of the  Company and were  limited to 80% of  qualified
accounts receivables.  A director of Palomar had guaranteed all borrowings under
this line of credit. In connection with this guarantee,  the Company issued this
director warrants to purchase 28,571 shares of common stock at $10.50 per share.
These warrants were valued at approximately  $69,000.  This amount was amortized
to interest  expense over the term of the revolving line of credit.  The Company
repaid all amounts  outstanding under this line of credit on April 27, 1999, and
cancelled the line of credit.

         (c)      Bridge Loan

         On March 27, 1998, the Company  borrowed $2 million from an individual.
The Company subsequently repaid this note during 1998. Interest on this note was
in the form of a warrant to purchase  17,857 shares of common stock for $.07 per
share exercisable over five years. This warrant was valued at $171,000 using the


                                       39
<PAGE>

Black-Scholes  option pricing model. The Company accounted for this warrant as a
discount  to the note  through  additional  paid-in  capital and  amortized  the
discount to interest expense over the period that the note was outstanding.

         (d)      Notes Payable to Coherent

         In  May  and  June  1998  and  February  1999,  the  Company   borrowed
$3,000,000,  $1,000,000  and $750,000,  respectively,  from the  Company's  then
worldwide distributor,  Coherent. These notes accrued interest at 8.5% per annum
and were  collateralized  by Star's  inventory.  Coherent  assumed  this debt in
connection with its purchase of all of the issued and  outstanding  common stock
of Star on April 27, 1999.

         (e)      Future Maturities of Long-Term Debt

         Future maturities of convertible  debentures reflected at face value as
of December 31, 1999 are as follows:

                         2000             $1,122,008
                         2001              1,122,008
                         2002                500,000
                                        -------------
                                          $2,744,016
                                        =============

(10)     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  rent ranging from  approximately  $4,000 to $81,000,  which is adjusted
annually for certain other costs,  such as inflation,  taxes and utilities,  and
expire through August 2009.

         Future  minimum  payments  under  the  Company's  operating  leases  at
December 31, 1999 are approximately as follows:

                           Year Ended
                          December 31,
                   ----------------------------
                              2000                      $939,000
                              2001                       941,000
                              2002                       889,000
                              2003                       889,000
                              2004                       911,000
                           Thereafter                  4,562,000
                                                     -------------
                                                      $9,131,000
                                                     =============

         (b)      Royalties

         The Company is required to pay a royalty under a license agreement with
MGH (see  Note 4).  For the  years  ended  December  31,  1997,  1998 and  1999,
approximately   $854,000,   $1,332,000  and   $2,085,000  of  royalty   expense,
respectively,  was incurred under this agreement.  These amounts are included in
cost of sales in the accompanying consolidated statements of operations.

         A  former   employee  and  previous  owner  of  one  of  the  Company's
subsidiaries  is paid a 1%  commission  on the net sales of certain  lasers,  as
defined in his severance agreement. These commissions will be paid through March
31, 2000 and are to be no less than $450,000.  In accordance with the settlement
agreement  with this  individual,  the



                                       40
<PAGE>

Company paid advances on commissions  totaling $450,000 as follows:  $200,000 in
1997 and $250,000 in January 1998.  During 1999, the Company paid commissions of
approximately $218,000.

         (c)      Litigation

         The  Company  was  a  defendant  in a  lawsuit  filed  by  Commonwealth
Associates ("Commonwealth"). In 1997, Commonwealth's motion for summary judgment
was granted and the District Court awarded  Commonwealth  $3,174,070 in damages.
That  judgment  was  appealed  by Palomar  and the case was  settled  for $1.875
million.  During the year ended December 31, 1997, the Company  incurred  $1.875
million in  settlement  costs  related to the above  matter and  another  $1.324
million related to several other claims and associated litigation costs.

         In 1997, the Company brought a declaratory  judgment action against the
holders and the indenture trustee of the Company's 4.5% Subordinated Convertible
Debentures due 2003, denominated in Swiss francs (the "Swiss Franc Debentures").
Just  prior to this suit,  certain  of the  debenture  holders  (the  "Asserting
Holders")  had filed suit against the Company  alleging  that the Company was in
breach of  certain  protective  covenants  under the  indenture.  The  Asserting
Holders  claimed  that the Company had  breached  certain  protective  indenture
covenants and that the Asserting  Holders were entitled to immediate  payment of
their  indebtedness  under the Swiss Franc Debentures.  As of November 13, 1997,
the  Company  notified  the holders of the Swiss  Franc  Debentures  that it had
caused  conversion  of all of the Swiss Franc  Debentures  into an  aggregate of
130,576 shares of the Company's  common stock.  Since the  conversion  date, the
Company  had  treated  these  shares as issued  and  outstanding.  In July 1999,
Palomar and certain European banks entered into a settlement  agreement  whereby
Palomar agreed to rescind its conversion  notices issued in November 1997. Under
the terms of this compromise, the Company agreed to pay a total of approximately
$6.7  million to the European  banks,  of which $4.5 million has been paid as of
December 31, 1999.  The balance of $2.2 million is due through 2001. The Company
recorded a charge to operations of approximately  $6.2 million  representing the
total  amount  due to the  European  banks  less  the fair  market  value of the
redemption  of  the  common  shares  previously  considered  outstanding  by the
Company.

         On March 17,  1999,  the Company and a former and current  officer were
added as defendants in the class action of Varljen v. H.J. Meyers,  Inc., et al.
In February  2000,  Palomar and the Varljen  plaintiffs  reached an agreement in
principle  pursuant  to  which  Palomar  and its  insurance  carrier  would  pay
plaintiffs $5 million in settlement of all their claims. Of this amount, Palomar
would  contribute up to $1 million in stock and $1.375  million in cash, and its
insurance  carrier would  contribute the remaining  $2.625 million in cash. This
settlement agreement must be approved by the court. There can be no assurance of
such court  approval;  however,  management  believes that the court approval is
probable and accrued for its estimated loss at December 31, 1999.

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

         (d)      Distribution Agreement

         On  November   17,  1997,   the  Company   entered  into  an  exclusive
distribution,  sales  and  service  agreement  with  Coherent,  an  established,
worldwide laser company. Under this agreement,  Coherent had the exclusive right
to sell the  EpiLaser(R)  and the  LightSheer(TM)  diode laser system and future
generation products worldwide.  The Company paid Coherent a per unit commission,
adjusted for certain events, as defined.  During 1997,1998 and 1999, the Company
incurred approximately $800,000,  $14,108,000 and $4,702,000,  respectively,  of
commission  expense  related to this  agreement,  which is included in sales and
marketing expense in the accompanying consolidated statement of operations. Upon
execution of this  agreement,  Coherent  made a lump sum payment of $3.5 million
and received a warrant to purchase  142,857 shares of the Company's common stock
at a share price of $36.75. The valuation of the warrant using the Black-Scholes
option  pricing  model was  approximately  $380,000.  The value was  credited to
additional  paid-in  capital  during  the year  ended  December  31,  1997.  The
remaining  amount of

                                       41
<PAGE>

$3,120,000,  included in deferred revenue,  was originally  amortized to revenue
over the three year life of the agreement. On April 27, 1999, in connection with
the Company's  completion of the sale of Star to Coherent,  as discussed in Note
1, the  distribution  agreement  was  terminated  and  replaced  with a one year
non-exclusive distribution agreement that enabled Coherent to sell the Company's
ruby-based  laser  products.  The Company is  amortizing  the  deferred  revenue
related to Coherent  over this  one-year  non-exclusive  period ending April 27,
2000.

         (e)      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  provides for 12
months severance upon termination of employment and change of control.

(11)     Stockholders' Equity

         (a)      Common Stock

         During  1998,  the Company sold  1,457,142  shares of common stock to a
group of investors for  $10,200,000.  In addition,  the Company issued  callable
warrants with a three-year term to these investors to purchase  1,457,142 shares
of common stock at an exercise price of $21.00 per share. The callable  warrants
are not  exercisable  for the first six months after issuance and thereafter are
callable by the  Company if the  closing  price of the  Company's  common  stock
equals or exceeds  $35.00 for 10  consecutive  trading days.  Under the terms of
this private  placement,  the Company is obligated to pay the investors a fee of
5% per annum (payable  quarterly) of the dollar value invested in the Company as
long as the  investors  continue to hold their common stock in their name at the
Company's  transfer  agent.  During 1998 and 1999, the Company paid $283,125 and
$383,050,  respectively,  related to this fee.  This amount has been  charged to
additional  paid-in  capital.  During 1998,  the Company also paid  $360,000 for
investment  banking fees related to the  issuance of these  common  shares.  The
Company  netted  this  amount  against  the  proceeds  through  a  reduction  in
additional paid-in capital.

         (b)      Preferred Stock

         The Company is authorized to issue up to 1,500,000  shares of preferred
stock,  $.01 par  value.  As of  December  31,  1998 and 1999,  preferred  stock
authorized, issued and outstanding consists of the following:
<TABLE>
<S>    <C>                                                                                        <C>              <C>

                                                                                                  1998             1999
                                                                                                  ----             ----
       Redeemable  convertible  preferred  stock,  Series  F, $.01 par value per
         share Authorized, issued and outstanding - 6,000 shares
         (liquidation preference of $7,417,183 at December 31, 1999)                                 $60            $60

       Redeemable  convertible  preferred  stock,  Series  G, $.01 par value per
         share Authorized - 10,000 shares
         Issued and outstanding - 743 shares in 1998                                                  7              --

       Redeemable  convertible  preferred  stock,  Series  H, $.01 par value per
         share Authorized - 16,000 shares
         Issued and outstanding - 250 shares 1998                                                     2              --
                                                                                                   -----           -----
                                 Total preferred stock                                             $ 69            $ 60
                                                                                                   =====           =====
</TABLE>

         The  Series  F  redeemable   convertible  preferred  stock  ("Series  F
Preferred"),  together with any accrued but unpaid  dividends,  may be converted
into  common  stock at 80% of the  average  closing bid price for the 10 trading
days

                                       42
<PAGE>

preceding  the  conversion  date,  but in no event less than $21.00 or more than
$112.00.  This  conversion  floor  was  decreased  by the two  parties  from the
original  price  to  $49.00.  The  Series F  Preferred  may be  redeemed  at the
Company's option, with no less than 10 days' and no more than 30 days' notice or
when the stock price exceeds $117.60 per share for 60 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.

         The  conversion  price for the Series F  Preferred  is  adjustable  for
certain  dilutive events,  as defined.  The Series F Preferred has 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
Preferred stockholders do not have any voting rights except on matters affecting
the Series F Preferred.

         The  Series  G  redeemable   convertible  preferred  stock  ("Series  G
Preferred"),  together with any accrued but unpaid  dividends,  may be converted
into common  stock at 85% of the average  closing bid price for the five trading
days preceding the conversion date, but in no event less than $.07. The Series G
Preferred may be redeemed at the Company's option 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, bear interest at
the rate of 12% per annum until paid.  During 1999,  the Company  converted  340
shares of Series G Preferred and accrued  dividends and interest of $63,411 into
74,905  shares of the  Company's  common  stock.  During 1999,  the Company also
redeemed  403  shares of  Series G  Preferred  for  $557,635.  Included  in this
redemption was $73,346 of accrued  dividends and $10,363 of accrued  interest on
dividends.  As of December  31,  1999,  all of the Series G  Preferred  had been
redeemed or converted.

         During the first and second quarters of 1997, the Company issued 16,000
shares of Series H redeemable convertible preferred stock ("Series H Preferred")
for $16 million,  less associated  financing  costs of $1 million.  The Series H
Preferred  accrued  dividends  at  rates  varying  from 6% to 8% per  annum,  as
defined. The Series H Preferred, including any accrued but unpaid dividends, may
be converted  into common stock at 100% of the average stock price for the first
179 days from the closing date, 90% of the average stock price, as defined,  for
the  following  90  days  and  85% of  the  average  stock  price,  as  defined,
thereafter. The conversion price was adjustable for certain dilutive events. The
holders were  restricted  for the first 209 days  following  the closing date to
converting  no more than 33% of the Series H Preferred  in any 30 day period (or
34% in the last 30 day period).  Under certain  conditions,  the Company had the
right to redeem the Series H  Preferred.  The  Company  had  ascribed a value of
$2,823,529 to the discount  conversion feature of the Series H Preferred,  which
was amortized as an adjustment to earnings available to common stockholders over
the most favorable  conversion  period  attainable to the holders (270 days from
the date of issuance).  During 1999, the Company redeemed 250 shares of Series H
Preferred for $344,761.  This redemption  included $37,301 of accrued dividends.
As of December  31,  1999,  all of the Series H Preferred  had been  redeemed or
converted.

                                       43
<PAGE>

         During  the year ended  December  31,  1998,  the  following  shares of
preferred stock, accrued premiums, dividends,  interest, and other related costs
were converted into shares of common stock as follows:
<TABLE>
<S>            <C>            <C>                   <C>                               <C>                   <C>

                 Number of                              Additional Dollar Amount
  Preferred      Preferred      Dollar Amount of      Converted, Including Accrued                           Number of Common
Stock Series      Shares        Preferred Stock       Premium, Dividends, Interest        Total Dollar       Shares Converted
                 Converted         Converted            and Other Related Costs         Amount Converted           Into
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------

      G             1,941           $1,941,000                   $268,245                   $2,209,245            386,147
      H             3,947            3,946,700                    383,923                    4,330,623            598,378
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------
                    5,888           $5,887,700                   $652,168                   $6,539,868            984,525
</TABLE>

         In addition to the 598,378 shares of common stock issued related to the
Series H Preferred  conversion,  the Company  redeemed  3,516 shares of Series H
Preferred for $4,387,434 in 1998.  This amount  includes  accrued  dividends and
interest totaling $771,876.

         During  the year ended  December  31,  1999,  the  following  shares of
preferred stock,  accrued premium,  dividends,  interest and other related costs
were converted into shares of common stock as follows:
<TABLE>
<S>            <C>            <C>                   <C>                               <C>                   <C>

                 Number of                              Additional Dollar Amount
  Preferred      Preferred      Dollar Amount of      Converted, Including Accrued                           Number of Common
Stock Series      Shares        Preferred Stock       Premium, Dividends, Interest        Total Dollar       Shares Converted
                 Converted         Converted            and Other Related Costs         Amount Converted           Into
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------

      G               340             $340,000                    $63,411                     $403,411             74,905
</TABLE>

         In addition to the 74,905 shares of common stock issued  related to the
Series G  Preferred  conversion,  the  Company  redeemed  403 shares of Series G
Preferred and 250 shares of Series H Preferred  for $902,396 in 1999,  including
related accrued dividends and interest of $121,009.

         (c)      Stock Option Plans and Warrants

                  (i)      Stock Options

         The Company has several  Stock Option Plans (the  "Plans") that provide
for the issuance of a maximum of 4,778,571 shares of common stock,  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);  in  addition,  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 its  discretion,  may convert the  optionee's  ISOs into
nonqualified options at any time prior to the expiration of such ISOs.

                                       44

<PAGE>

         The following table summarizes all stock option activity of the Company
for the years ended December 31, 1997, 1998 and 1999:
<TABLE>
<S>                                                             <C>              <C>                  <C>

                                                                 Number of           Exercise           Weighted Average
                                                                   Shares             Price              Exercise Price
                                                                -------------    -----------------    ----------------------
Outstanding, December 31, 1996                                       379,428       $14.00-$73.50              $35.21
            Granted                                                  249,621         0.07-45.50                17.17
            Exercised                                                (30,692)        0.07-21.00                11.34
            Canceled                                                (172,300)       16.63-73.50                43.61
                                                                -------------    -----------------    ----------------------
Outstanding, December 31, 1997                                       426,057        10.50-56.00                23.31
            Granted                                                  327,760           10.50                   10.50
            Canceled                                                (417,771)       10.50-56.88                23.66
                                                                -------------    -----------------    ----------------------
Outstanding, December 31, 1998                                       336,046        10.50-17.50                10.57
            Granted                                                1,039,327         1.63-10.50                 3.10
            Canceled                                                (140,385)        3.19-10.50                 8.24
                                                                -------------    -----------------   ----------------------
Outstanding, December 31, 1999                                     1,234,988        $1.63-$17.50               $4.55
                                                                =============    =================   ======================
Exercisable, December 31, 1999                                       796,487        $3.19-$17.50               $5.21
                                                                =============    =================    ======================
Available for future issuances under the Plans
            as of December 31, 1999                                3,451,840
                                                                =============
</TABLE>

         The range of  exercise  prices  for  options  outstanding  and  options
exercisable at December 31, 1999 is as follows:
<TABLE>
<S>                   <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
--------------------- ---------------- ---------------------- -----------------------    --------------- ----------------------
       $1.63                   75,000       9.83 years                $1.63                           -            $-
    3.19 - 3.75               917,560       9.42 years                 3.19                     579,520          3.19
       10.50                  238,857       2.21 years                10.50                     213,396          10.50
       17.50                    3,571       1.96 years                17.50                       3,571          17.50
                      ---------------- ---------------------- -----------------------    --------------- ----------------------
$1.63 - $17.50              1,234,988       8.03 years                $4.55                     796,487          $5.21
                      ================ ====================== =======================    =============== ======================
</TABLE>

         The Company accounts for its stock-based  compensation  plans under APB
Opinion No. 25,  Accounting for Stock Issued to Employees.  In October 1995, the
FASB 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  accounts for equity  instruments  issued to non-employees in accordance
with EITF 96-18 by valuing the instrument using the Black-Scholes option pricing
model,  as prescribed by SFAS No. 123, and recording a charge to operations  for
their fair value over the vesting  period.  The  Company has issued  options and
warrants  to  purchase  common  stock to  certain  financial  intermediaries  in
connection  with  various  financings  at  below  the fair  market  value of the
underlying stock. The costs associated with these issuances are accounted for as
a cost of raising capital and netted against the proceeds from these issuances.


                                       45
<PAGE>

         During the years ended  December  31, 1997 and 1998, a total of 143,571
and 312,128  options to purchase  common  stock were  repriced to above the fair
market  value of the  underlying  common  stock to $17.50  and $10.50 per share,
respectively.  The majority of the remainder of the options  canceled during the
years  ended  December  31,  1997,  1998,  and 1999 were the result of  employee
terminations.

         The Company has computed the pro forma disclosures  required under SFAS
No. 123 for all stock  options  granted to employees of the Company in the years
ended December 31, 1997,  1998 and 1999 using the  Black-Scholes  option pricing
model prescribed by SFAS No. 123.

         The assumptions used to calculate the SFAS No. 123 pro forma disclosure
for the years  ended  December  31,  1997,  1998 and 1999 for the Company are as
follows:
<TABLE>
<S>                                                    <C>                   <C>                   <C>
                                                                               December 31,
                                                             1997                  1998                  1999
                                                       ------------------    ------------------    ------------------

     Risk-free interest rate                                 6.09%                 5.60%                 5.81%
     Expected dividend yield                                   -                     -                     -
     Expected lives                                       3.69 years            2.94 years            3.65 years
     Expected volatility                                      79%                   93%                   94%
     Grant date fair value of options granted during
        the period                                          $14.42                 $4.48                 $2.04
</TABLE>

         The weighted average  fair-value and weighted average exercise price of
options  granted by the Company for the years ended December 31, 1997,  1998 and
1999 are as follows:
<TABLE>
<S>                                                         <C>               <C>                  <C>

                                                                                 December 31,
                                                                1997                1998                 1999
                                                            -------------     -----------------    -----------------

Weighted average exercise price for options:
     Whose  exercise  price  exceeded fair market value at
      the date of grant                                        $17.71              $10.50               $5.05
     Whose  exercise  price was equal to fair value at the
      date of grant                                                $-                $-                 $3.08
Weighted average fair market value for options:
     Whose  exercise  price  exceeded fair market value at
      the date of grant                                        $14.42              $4.48                $1.93
     Whose  exercise  price was equal to fair market value
      at the date of grant                                         $-                $-                 $2.04
</TABLE>

                                       46
<PAGE>

         The Company sold its majority-owned subsidiary, Star, a manufacturer of
the  Company's  diode laser,  on April 27, 1999.  Star had  established  a stock
option plan that  provided  for the  issuance of a maximum of 650,000  shares of
common stock,  which may have been issued as nonqualified  options and ISOs. The
following table summarizes employee stock option activity for Star:
<TABLE>
<S>               <C>                                           <C>               <C>               <C>

                                                                                                       Weighted
                                                                                                       Average
                                                                Number of Shares  Exercise Price    Exercise Price
                                                                ----------------  --------------    --------------

                  Outstanding, December 31, 1996                        215,000   $2.50 - $19.00        $5.44
                           Granted                                       40,500        19.00            19.00
                           Canceled                                      (1,917)       19.00            19.00
                                                                ----------------  --------------    --------------
                  Outstanding, December 31, 1997                        253,583     2.50-19.00           8.04
                           Exercised                                     (6,300)     2.50-5.00           4.21
                                                                ----------------  --------------    --------------
                  Outstanding, December 31, 1998                        247,283     2.50-19.00           8.13
                           Exercised                                   (247,283)    2.50-19.00           8.13
                                                                ----------------  --------------    --------------
                  Outstanding, December 31, 1999                             --         $--              $--
                                                                ================  ==============    ==============
</TABLE>

                  (ii)     Warrants

         The following table  summarizes all warrant activity of the Company for
the years ended December 31, 1997, 1998 and 1999:
<TABLE>
<S>                                                       <C>             <C>                   <C>>

                                                                                                    Weighted
                                                            Number of           Exercise             Average
                                                             Shares              Price           Exercise Price
                                                          --------------  --------------------  -----------------
Outstanding, December 31, 1996                                1,425,177      $4.20-$115.50           $49.14
              Granted                                           399,026      17.50-62.13              30.03
              Exercised                                         (83,554)      4.20-52.50              14.70
              Canceled                                         (312,359)      7.00-115.50             46.55
                                                          --------------  --------------------  -----------------
Outstanding, December 31, 1997                                1,428,290      14.00-105.00             46.55
              Granted                                         1,797,792       0.07-21.00              19.25
              Exercised                                         (17,857)         0.07                  0.07
              Canceled                                         (411,207)     15.75-47.25              28.91
                                                          --------------  --------------------  -----------------
Outstanding, December 31, 1998                                2,797,018      10.50-105.00             30.66
              Granted                                           113,000          3.19                  3.19
              Canceled                                         (260,327)     14.00-72.63              32.53
                                                          --------------  --------------------  -----------------
Outstanding, December 31, 1999                                2,649,691     $3.19 - $105.00          $29.51
                                                          ==============  ====================  =================
Exercisable, December 31, 1999                                2,649,691     $3.19 - $105.00          $29.51
                                                          ==============  ====================  =================
</TABLE>

         During  years ended  December 31, 1997 and 1998, a total of 177,143 and
185,714 warrants,  respectively, to purchase common stock were repriced to above
the then  current  fair market  values of the  underlying  common  stock.  These
repriced  option  exercise prices ranged from $17.50 to $28.00 per share in 1997
and  ranged  from  $10.50  to  $14.00  per share in 1998.  The  majority  of the
remainder of the  canceled  warrants  during the years ended  December 31, 1997,
1998 and 1999 were the result of employee terminations.

                                       47
<PAGE>

         The range of exercise  prices for warrants  outstanding and exercisable
at December 31, 1999 are as follows:
<TABLE>
<S>                    <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
---------------------- --------------- ---------------------- -----------------------    --------------- ----------------------

        $3.19                 113,000       9.06 years                $3.19                     113,000          $3.19
    10.50 - 14.88             319,559       1.61 years                11.49                     319,559          11.49
    21.00 - 22.75           1,544,264       3.23 years                21.04                   1,544,264          21.04
    35.00 - 66.50             511,719       1.26 years                50.24                     511,719          50.24
   84.00 - 105.00             161,149       1.16 years                98.97                     161,149          98.97
---------------------  --------------- ---------------------- -----------------------    --------------- ----------------------
=====================  =============== ====================== =======================    =============== ======================
$3.19 - $105.00             2,649,691       2.78 years                $29.51                  2,649,691         $29.51
=====================  =============== ====================== =======================    =============== ======================
</TABLE>

         The Company has computed the pro forma disclosures  required under SFAS
No. 123 for all warrants  granted in the years ended December 31, 1997, 1998 and
1999 using the Black-Scholes option pricing model prescribed by SFAS No. 123.

         The weighted-average assumptions used to calculate the SFAS No. 123 pro
forma  disclosure for the years ended  December 31, 1997,  1998 and 1999 for the
Company are as follows:
<TABLE>
<S>                                                    <C>                  <C>                   <C>

                                                                               December 31,
                                                            1997                  1998                  1999
                                                       ----------------     ------------------    ------------------
Risk-free interest rate                                     6.13%                 5.44%                 5.81%
Expected dividend yield                                       -                     -                     -
Expected lives                                           4.44 years            2.58 years            4.00 years
Expected volatility                                          79%                   93%                   94%
Grant date fair value of warrants granted during
     the period                                            $15.19                 $5.32                 $2.20
</TABLE>

                                       48
<PAGE>


         The weighted  average fair value and weighted average exercise price of
warrants  granted by the Company for the years ended December 31, 1997, 1998 and
1999 are as follows:
<TABLE>
<S>                                                            <C>                  <C>               <C>

                                                                                    December 31,
                                                                     1997               1998                1999
                                                               -----------------    --------------    -----------------

Weighted average exercise price for warrants:
     Whose  exercise price exceeded fair market value at date
       of grant                                                     $30.10             $19.46                   $-
     Whose  exercise price was less than fair market value at
       date of grant                                                $52.50              $0.07                   $-
     Whose  exercise  price was equal to fair market value at
       date of grant                                                $22.75                 $-                $3.19
Weighted average fair value for warrants:
     Whose  exercise price exceeded fair market value at date
       of grant                                                      $7.70              $5.32                   $-
     Whose  exercise price was less than fair market value at
       date of grant                                                 $4.34              $8.68                   $-
     Whose  exercise  price was equal to fair market value at
       date of grant                                                $15.26                 $-                $2.20
</TABLE>

                  (iii)    Pro Forma Disclosure

         The pro forma  effect on the Company of  applying  SFAS No. 123 for all
options  and  warrants  to  purchase  common  stock of the  Company  would be as
follows:
<TABLE>
<S>                                                               <C>                 <C>                <C>>

                                                                                       December 31,
                                                                       1997                1998              1999
                                                                  ----------------    ----------------   --------------

Pro forma basic net income (loss) from continuing operations        $(62,020,782)       $(23,169,514)      $23,289,114
Pro forma basic net income (loss) per share from
     continuing operations                                            $   (12.37)          $   (2.58)         $   2.29

Pro forma diluted net income (loss) from continuing operations      $(62,020,782)       $(23,169,514)      $23,885,314
Pro forma diluted net income (loss) per share from
     continuing operations                                            $   (12.37)          $   (2.58)         $   2.22
</TABLE>

         (d)      Reserved Shares

         At December  31, 1999,  the Company has  reserved  shares of its common
stock for the following:

<TABLE>
<S>           <C>                                                            <C>
              Warrants                                                           2,649,691
              Stock option plans                                                 4,686,828
              Convertible debentures                                               188,635
              Convertible preferred stock                                           85,714
              Employee stock purchase plan                                         114,292
              Employee 401(k) plan                                                 203,840
                                                                            ---------------
                                   Total                                         7,929,000
                                                                            ===============
</TABLE>
                                       49

<PAGE>

         (e)      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 are eligible to purchase the Company's
common  stock at an exercise  price equal to 85% of the fair market value of the
common  stock with a lookback  provision  of three  months.  The  Purchase  Plan
provides for issuance of up to  approximately  140,000 shares.  During the years
ended December 31, 1998 and 1999, employees purchased 9,315 and 14,199 shares of
the Company's common stock for approximately $50,000 and $46,000,  respectively,
pursuant to the Purchase Plan.

(12)     Discontinued Operations

         During the fourth  quarter of 1997,  the  Company's  Board of Directors
approved a plan to dispose of the Company's  electronics  business segment.  The
electronics segment consisted of the manufacture and sale of personal computers,
high-density  flexible  electronics  circuitry and memory  modules.  The Company
substantially completed this plan in May 1998.

         Nexar  Technologies,  Inc.  ("Nexar")  was included in the  electronics
business segment.  Nexar was an early-stage company that manufactured,  marketed
and sold  personal  computers.  On April 14,  1997,  Nexar  completed an initial
public  offering of  2,500,000  shares at $9.00 per share,  for net  proceeds of
approximately  $19,593,000.  The Company  recorded an increase in  stockholders'
equity of $7,409,866,  in accordance with Staff Accounting  Bulletin ("SAB") No.
51 as a result of Nexar's  initial  public  offering.  The Company's  accounting
policy for gains  arising  under SAB No. 51 is to  recognize  these gains in its
consolidated  statement  of  operations  to  the  extent  that  such  gains  are
realizable at the date of each transaction.

         During  1997 and 1998,  the  Company  reduced  its  ownership  in Nexar
through the sale of common stock to private investors. At December 31, 1997, the
Company   beneficially   owned   3,746,343   shares  of  Nexar's  common  stock,
representing  approximately 36% ownership.  As of December 31, 1998, the Company
beneficially  owned  2,406,080  shares of  Nexar's  common  stock,  representing
approximately 19% ownership  interest and had no other  significant  obligations
related to Nexar,  other than the guaranty to GFL Advantage Fund Limited ("GFL")
discussed below.

         During 1998, the Company  recorded a charge to discontinued  operations
of $1,524,966 as a result of  management's  decision to write-down  the carrying
value of its  investment in Nexar.  During the year ended December 31, 1997, the
Company  recognized a gain on the disposition of shares of Nexar common stock of
$6,221,689. This amount is included in "Gain (Loss) on dispositions, net" in the
accompanying consolidated statements of operations.

         The following is the summarized financial information for Nexar:

                                                              Year Ended
                                                          December 31, 1997
                                                    ---------------------------

               Net Revenues                                    $33,608,063
               Gross Profit                                       $740,151
               Net Loss                                       $(13,346,380)

         On December 31, 1997 the Company entered into an Exchange Agreement and
sold 500,000  shares of Nexar's  common  stock to GFL for $2 million.  Under the
terms of the Exchange Agreement,  Palomar guaranteed GFL a minimum selling price
of $5.00 per share with respect to 400,000 shares of Nexar's common stock over a
two-year time period. As of December 31, 1998, the deferred liability related to
this transaction  totaled  $1,680,171

                                       50
<PAGE>

and represents the total amount due to GFL
after GFL sold its 400,000  common shares of Nexar stock.  The Company paid this
deferred obligation on May 3, 1999.

         The other  entities  that were  included  in the  electronics  business
segment are Dynaco  Corp.  ("Dynaco")  and Dynaco's  wholly  owned  subsidiaries
Comtel Electronics,  Inc. ("Comtel") and Dynamem, Inc. ("Dynamem").  On December
9, 1997,  the Company  entered into a two-phase  stock  purchase  agreement with
Biometric  Technologies  Corporation ("BTC"). BTC was formed jointly by Dynaco's
President  and its  Chairman of the Board.  The first phase was  consummated  on
December 9, 1997 and consisted of the sale of all of the issued and  outstanding
common  stock of Comtel and Dynamem in exchange for  $3,654,000,  payable in two
installments.  The first  installment was a $850,000  unsecured  promissory note
that was due on February 15,  1998.  The second  installment  was a $2.8 million
unsecured promissory note due in 48 monthly installments,  beginning February 1,
1999. This promissory note was fully reserved by the Company during 1997, as its
ultimate  collectibility was believed to be uncertain.  As of December 31, 1999,
the Company has not received any amounts due on these notes.

         As part  of the  first  phase,  the  Company  entered  into a Loan  and
Subscription  Agreement with a creditor of Comtel,  Coast Business  Credit,  for
$3,233,000.  This promissory note represented the settlement of amounts owed the
creditor by Comtel and  guaranteed by Palomar.  Principal and interest  payments
were  being made over 24 months,  beginning  December  31,  1997,  and  interest
accrued  at the bank's  prime rate plus  2.25%.  This  promissory  note had been
collateralized by 464,285 shares of the Company's common stock that were held in
escrow.  The Company also  guaranteed up to $2.5 million of Comtel's  borrowings
from  this  creditor  until  November  30,  1999.  The  stockholders  of BTC had
personally guaranteed to the Company payment for any amounts borrowed under this
line of credit in excess of  approximately  $1.5  million  in the event that the
Company would have been obligated to honor this guarantee.

         BTC did not make the first  installment  on  February  1, 1998,  and on
October 7, 1998 the Company and BTC agreed to reduce the  principal  balances of
the $850,000  note and the $2.8 million note to a total of $1 million.  BTC paid
$500,000  during 1998,  with the balance due April 5, 1999. BTC did not make its
final  principal  payment on April 5, 1999,  and on April 16,  1999  amended the
agreement,  resulting  in payment  of  $100,000,  a release of Palomar  from its
obligation to Coast  Business  Credit and a promissory  note for $400,000 due on
March 31, 2001. The amended note is guaranteed by the principal  stockholders of
BTC.

         In  connection  with  the  disposition  of  Comtel,  the  Company  also
restructured  all assets and  investments  related to a significant  customer of
Comtel into a $4 million note receivable.  This receivable was fully reserved by
the Company during 1997, as its ultimate  collectibility is uncertain.  To date,
no amounts have been received under this  restructured  note receivable from the
customer,  nor does the Company anticipate  receiving any amounts from this note
receivable in the foreseeable future.

         In the  second  phase,  BTC  agreed to  purchase  all of the issued and
outstanding  stock of Dynaco.  During  phase two,  BTC had the option of selling
Dynaco to a third party if agreed to by the Company and BTC. Consistent with the
terms of the  agreement  with BTC,  the Company  entered  into a Stock  Purchase
Agreement  with Quick Turn  Circuits,  Inc.  ("QTC") on May 26, 1998 pursuant to
which QTC purchased 100% of the issued and outstanding shares of common stock of
Dynaco for $3.2 million.

         As of December 31, 1997, the Company recognized a loss of approximately
$4,148,000  related to the phase one and phase two  dispositions.  These charges
have been  netted  in "Gain  (Loss) on  dispositions,  net" in the  accompanying
consolidated  statements  of  operations.  As of December 31, 1997,  the Company
accrued for the estimate of Dynaco's 1998 operating loss through the anticipated
disposition date of approximately  $850,000.  Through the date of disposition of
Dynaco, the Company recognized  additional operating losses totaling $1,090,885.
During 1998, the Company recorded a loss on disposition of $8,329 related to the
ultimate sale of Dynaco to QTC.

         Pursuant  to  Accounting  Principles  Board  ("APB")  Opinion  No.  30,
Reporting  the Results of  Operations  - Reporting  the Effects of Disposal of a
Segment of a Business,  and  Extraordinary,  Unusual and Infrequently

                                       51
<PAGE>

Occurring Events and  Transactions,  ("APB No. 30") the  consolidated  financial
statements of the Company have been presented to reflect the dispositions of the
aforementioned  subsidiaries that comprise the electronics segment in accordance
with APB 30. Accordingly,  revenues, expenses, and cash flows of the electronics
segment have been  excluded  from the  respective  captions in the  accompanying
consolidated statements of operations and consolidated statements of cash flows.
The net  liabilities  of these  entities have been reported as  "Liabilities  of
Discontinued  Operations" in the accompanying  consolidated  balance sheets; the
net  operating  losses of these  entities  have been  reported as "Net Loss from
Discontinued   Operations"  in  the  accompanying   consolidated  statements  of
operations;  and the net cash flows of these entities have been reported as "Net
Cash  Provided  by  (Used  in)  Discontinued  Operations"  in  the  accompanying
consolidated statements of cash flows.

         The  liability of  $1,680,171  as of December 31, 1998  represents  the
Company's deferred  liability  associated with the sale of Nexar common stock to
GFL. The Company paid its obligation  related to this deferred  liability on May
3, 1999. The following summarizes the results of the discontinued operations:
<TABLE>
<S>       <C>                                       <C>                <C>                  <C>

                                                       Year Ended          Period Ended           Year Ended
                                                      December 31,           May 26,             December 31,
                                                          1997               1998                  1999
                                                    -----------------  -------------------  ---------------------
          Revenues                                      $57,663,080           $6,471,701                    $--

          Net loss from discontinued operations        $(27,434,812)         $(2,624,180)             $(435,000)
</TABLE>

         The loss from  operations for all of the  discontinued  operations from
the measurement date, October 1, 1997 (or December 31, 1997 for Dynaco), through
the date of disposition for Comtel and Dynamem total  approximately  $3,405,000.
Dynaco's  loss from  operations  for the  period  beginning  January 1, 1998 and
ending May 26, 1998, the date of disposition,  totaled $1,940,885.  During 1999,
the Company paid and settled a lawsuit  related to the  operations of Dynaco for
$435,000.

(13)     Restructuring And Asset Write-off

         The Company,  in  accordance  with  applicable  accounting  principles,
determined during the third quarter of 1997 that certain  investments' and notes
receivables' carrying values would not be realizable due to the Company's change
in  strategy  to  divest  of  its  investments  in  non-core  businesses.  These
investments did not qualify for  discontinued  operations in accordance with APB
No. 30.  During  1997,  the  Company  fully  reserved  for all such  investments
resulting in a charge of approximately  $10,283,000 to continuing operations, as
follows:

                        Description                             Carrying Amount
                        -----------                             ---------------

                 Notes receivable                                  $2,250,000
                 Investments in non-core businesses                 8,033,000
                                                                ---------------
                                                                  $10,283,000
                                                                ===============

         The  write-offs of the notes  receivable and  investments  related to a
number of strategic  investments  and loans in non-medical  businesses  that the
Company  made  during  1996 and 1997.  The  notes  receivable  were  principally
mezzanine  investments  whereby  the  Company  loaned  money and, in some cases,
received  equity in early stage  companies as a condition to making these loans.
During  1996 and  1997,  the  Company  also made  other  equity  investments  in
companies  that at the time  were  believed  to be  strategic  to the  Company's
business or had the potential to yield a higher than average  financial  return.
During 1997,  based on a number of factors,  including the  Company's  change in
strategy, the book value of these companies and their poor financial performance
to date, it became apparent to management that there was significant uncertainty
as to the ultimate  realizability  of these

                                       52
<PAGE>

investments  and notes  receivable.  Accordingly,  the  Company  wrote off these
investments and notes receivable in 1997.

         In the third quarter of 1997,  the Company  recognized a  restructuring
charge of  $2,700,000  based on the  decision  to  discontinue  certain  medical
product and service business units and consolidate others. The majority of these
amounts relate to severance benefits for significant  reductions in staffing for
all areas of the Company,  including the  elimination of essentially  all of the
sales and marketing function as a result of the Coherent Distribution  Agreement
(Note 10(d)).  Management's plan  specifically  identified 33 employees who were
targeted  for   termination,   almost   exclusively  in  selling,   general  and
administrative  functions.  Actual  employees  terminated  as a  result  of this
restructuring totaled 45.

         All expenses accounted for as restructuring  charges were in accordance
with the  criteria  set forth in  Emerging  Task  Force  Issue  94-3,  Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity  (Including  Certain  Costs  Incurred  in  a  Restructuring),  and  are
exclusive of the charges  related to  discontinued  operations,  as disclosed in
Note 12. Through December 31, 1998, the Company paid out $2,289,690 of severance
costs.  Through December 31, 1999, the remaining  liability of $279,000 was paid
resulting in total restructuring costs incurred of $2,568,690.

         As part of this  restructuring,  the Company  disposed of the following
medical businesses:

         (a)      Tissue Technologies, Inc.

         On December 16, 1997,  the Company sold assets and certain  liabilities
of Tissue  Technologies,  Inc.  ("Tissue  Technologies"),  a  manufacturer  of a
dermatological  laser product for the  treatment of wrinkles,  to a newly formed
medical  laser  manufacturer  (the  "Newco").  The  Newco  was  formed by former
executives of Tissue Technologies.  In exchange, the Company received a $500,000
note  receivable  due in  monthly  installments  over the next  year,  royalties
ranging from 2% to 5% on product  revenue  over the next 10 years,  a 15% equity
position in the Newco and a warrant to purchase  10% of the common  stock of the
Newco at $.50 per share.  As of December 31, 1999,  no payments had been secured
from the  Newco  and the  Company  continued  to place  zero  value on the note,
royalty and equity position in the newly formed company.

         (b)      Palomar Technologies, Ltd.

         On January 1, 1998, the Company sold  substantially all of the business
assets and liabilities of Palomar Technologies, Ltd., a foreign manufacturer, to
a publicly traded company.  The Company received cash of approximately  $200,000
and was relieved of obligations related to the building lease and all employment
agreements.  This  transaction  did not have a material  effect on the Company's
operations for the year ended December 31, 1997.


                                       53
<PAGE>

ITEM 9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
              FINANCIAL DISCLOSURES.
              ----------------------------------------------------------------

              Not applicable.

                                       54
<PAGE>



                                    PART III

ITEM 10.      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
              ---------------------------------------------------

         The  information  concerning  directors  required  under  this  item is
incorporated  herein by reference from the material  contained under the heading
"Election of Directors" in the  Registrant's  definitive  proxy  statement to be
filed with the Securities and Exchange  Commission  pursuant to Regulation  14A,
not later  than 120 days  after the close of the fiscal  year.  The  information
concerning  delinquent  filers  pursuant  to  Item  405  of  Regulation  S-K  is
incorporated  herein by reference from the material  contained under the heading
"Section 16(a) Beneficial  Ownership  Reporting  Compliance" in the Registrant's
definitive  proxy  statement  to be  filed  with  the  Securities  and  Exchange
Commission  pursuant to Regulation  14A, not later than 120 days after the close
of the fiscal year.

ITEM 11.      EXECUTIVE COMPENSATION.
              -----------------------

         The  information  required  under this item is  incorporated  herein by
reference from the material contained under the heading "Executive Compensation"
in the  Registrant's  definitive proxy statement to be filed with the Securities
and  Exchange  Commission  pursuant to  Regulation  14A, not later than 120 days
after the close of the fiscal year.

ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
              ---------------------------------------------------------------

         The  information  required  under this item is  incorporated  herein by
reference from the material contained under the heading "Stock Ownership" in the
Registrant's  definitive  proxy  statement to be filed with the  Securities  and
Exchange  Commission  pursuant to Regulation  14A, not later than 120 days after
the close of the fiscal year.

ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
              -----------------------------------------------

         The  information  required  under this item is  incorporated  herein by
reference  from the  material  contained  under the heading  "Relationship  with
Affiliates" in the Registrant's  definitive proxy statement to be filed with the
Securities and Exchange  Commission  pursuant to Regulation  14A, not later than
120 days after the close of the fiscal year.

                                       55
<PAGE>

                                     PART IV

ITEM 14.       EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
               ---------------------------------------------------------------
<TABLE>
<S>     <C>       <C>                                                                                          <C>

(a)      1.       Index to Consolidated Financial Statements.                                                  Page
                  ------------------------------------------                                                   ----

         The following  Consolidated Financial Statements of the Company and its
         subsidiaries are filed as part of this report on Form 10-K:

                  Reports of Independent Public Accountants                                                     20

                  Consolidated  Balance  Sheets - December 31, 1999 and
                  December 31, 1998                                                                             22

                  Consolidated Statements of Operations -
                  Years ended December 31, 1999, December 31, 1998 and December 31, 1997                        23

                  Consolidated  Statements of  Stockholders'  Equity (Deficit) -
                  Years ended December 31, 1999,  December 31, 1998 and
                  December 31, 1997                                                                             24

                  Consolidated  Statements of Cash Flows - Years ended
                  December 31, 1999, December 31, 1998 and December 31, 1997                                    27

                  Notes to Consolidated Financial Statements                                                    29
</TABLE>

         2.       Consolidated Financial Statement Schedules

                  Report of Independent Public Accountants on Schedule II

                  Schedule II - Valuation and Qualifying Accounts

                  Schedules  not listed  above  have been  omitted  because  the
                  matter  or  conditions  are  not  present  or the  information
                  required   to  be  set  forth   therein  is  included  in  the
                  Consolidated Financial Statements hereto.

(b)      Reports on Form 8-K.

                  Form 8-K  filed  April  21,  1999  (announcing  the  Company's
                  adoption of a shareholder rights plan).

                  Form  8-K  filed  May 10,  1999  (announcing  the sale of Star
                  Medical Technologies, Inc. to Coherent, Inc.).

                  Form 8-K  filed  June 29,  1999  (announcing  the  preliminary
                  report of  independent  inspector of  elections in  connection
                  with the Company's annual meeting)..

                  Form 8-K filed July 1, 1999 (announcing the Company's  victory
                  in proxy contest).

                  Form 8-K filed December 16, 1999  (announcing  the adoption of
                  the Company's amended and restated Bylaws).

                                       56
<PAGE>

(c)      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.

Exhibit
No.               Title
--------          -----

 ^^^3(i).1        Certificate  of  Designation,   as  filed  with  the  Delaware
                  Secretary of State on April 21, 1999.

   ^3(i).2        Second Restated  Certificate of  Incorporation,  as filed with
                  the Delaware Secretary of State on January 8, 1999.

  ^^^^3(ii)       Bylaws, as amended.

      ^4.1        Common Stock Certificate.

     ^^4.2.       Rights Agreement  Between Palomar Medical  Technologies,  Inc.
                  and American Stock Transfer & Trust Company, dated as of April
                  20, 1999

     ##4.3        Form of  4.5%  Convertible  Debenture  (denominated  in  Swiss
                  Francs) due July 3, 2003.

       4.4        First Allonge and Amendment to 4.5%  Subordinated  Convertible
                  Debenture

     ##4.5        Form of 6% Convertible Debenture due March 13, 2002.

      <4.6        Second Amended 1991 Stock Option Plan.

      <4.7        Second Amended 1993 Stock Option Plan.

      <4.8        Second Amended 1995 Stock Option Plan.

      <4.9        Second Amended 1996 Stock Option Plan.

     <4.10        Third Amended 1996 Employee Stock Purchase Plan.

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

    ##4.12        Form of Stock Option  Agreement  under the 1996 Amended  Stock
                  Option Plan.

     #4.13        Form of Company Warrant to Purchase Common Stock.

   ###10.1        Employment  Agreement,  dated as of May 15, 1997,  between the
                  Company and Louis P. Valente.

     <10.2        Amendment  No.  1 to  Key  Employment  Agreement  between  the
                  Company and Louis P. Valente dated May 15, 1999.

      10.3        Amendment  No.  2 to  Key  Employment  Agreement  between  the
                  Company and Louis P. Valente dated February 1, 2000

     <10.4        Amended and Restated Employment  Agreement between the Company
                  and Joseph P. Caruso dated June 30, 1999.

      10.5        Amendment No. 1 to Amended and Restated  Employment  Agreement
                  between the Company and Joseph P.
                  Caruso, dated February 1, 2000.

                                       57
<PAGE>

     <10.6        Lease  for  premises  at  82  Cambridge  Street,   Burlington,
                  Massachusetts, dated June 17, 1999.

   ###10.7        License   Agreement  between  the  Company  and  Massachusetts
                  General Hospital, dated August 18, 1995.

   ###10.8        First Amendment to License  Agreement  between the Company and
                  Massachusetts General Hospital, dated August 18, 1995.

   ###10.9        Second Amendment to License  Agreement between the Company and
                  Massachusetts General Hospital, dated August 18, 1995.

    -10.10       The Company's 401(k) Plan.

   **10.11        Agreement and Plan of  Reorganization  by and among  Coherent,
                  Inc., Medical Technologies, Acquisition, Inc., Palomar Medical
                  Technologies, Inc., Star Medical Technologies, Inc., Robert E.
                  Grove,  James Z.  Holtz  and David C.  Mundinger,  dated as of
                  December 7, 1998.

       21         List of Subsidiaries.

       23         Consent of Arthur Andersen LLP.

       27         Financial  Data  Schedule  for the Period  Ended  December 31,
                  1999.


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

       ^^         Previously  filed as an  exhibit  to Form 10-K for the  period
                  ended  December  31,  1998,   filed  on  March  30,  1999  and
                  incorporated herein by reference.

       ^^^        Previously  filed as an  exhibit  to Form 10-Q for the  period
                  ended March 31, 1999,  filed on May 17, 1999 and  incorporated
                  herein by reference.

      ^^^^        Previously  filed as an exhibit to Form 8-K, filed on December
                  16, 1999 and incorporated herein by reference.

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

        **        Previously  filed as an  exhibit to the  Company's  Definitive
                  Proxy  Statement for the period ended  December 31, 1998 filed
                  on March 12, 1999, 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 Company's Annual Report
                  on Form  10-KSB  for the year ended  December  31,  1996,  and
                  incorporated herein by reference.

       ###        Previously  filed as an exhibit to the Company's Annual Report
                  on Form  10-K  for the  year  ended  December  31,  1998,  and
                  incorporated herein by reference.

                                       58
<PAGE>
         -        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 Form 10-Q for the period ended
                  June 30, 1999, and incorporated herein by reference.

                                       59
<PAGE>
             REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE II

To Palomar Medical Technologies, Inc.:

         We  have  audited,  in  accordance  with  generally  accepted  auditing
standards,   the   consolidated   financial   statements   of  Palomar   Medical
Technologies,  Inc. and subsidiaries  included in this Form 10-K and have issued
our report thereon dated February 1, 2000. Our audit was made for the purpose of
forming an  opinion  on the basic  financial  statements  taken as a whole.  The
schedule  listed in Item  14(2)  above is the  responsibility  of the  Company's
management  and is presented for purposes of complying  with the  Securities and
Exchange  Commission's rules and is not part of the basic financial  statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic  financial  statements and, in our opinion,  fairly states,  in all
material  respects,  the  financial  data required to be set forth  therein,  in
relation to the basic financial statements taken as a whole.

                                                             Arthur Andersen LLP


Boston, Massachusetts
February 1, 2000

                                       60
<PAGE>



                                   SCHEDULE II

                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                        Valuation and Qualifying Accounts

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

                                               Balance,
                                             Beginning of                                                  Balance, End of
                                                Period             Increases            Deductions              Period

Allowance for Doubtful Accounts:

December 31, 1997                                $1,129,000             $933,000         $(1,316,000)              $746,000
                                           =================    =================     ================     =================

December 31, 1998                                  $746,000             $183,000           $(565,000)              $364,000
                                           =================    =================     ================     =================
December 31, 1999                                  $364,000                  $--           $(157,000)              $207,000
                                           =================    =================     ================     =================


                                               Balance,
                                             Beginning of                                                  Balance, End of
                                                Period             Increases            Deductions              Period

Restructuring Accrual:

December 31, 1997                                       $--           $2,700,000           $(718,000)            $1,982,000
                                           =================    =================     ================    =================

December 31, 1998                                $1,982,000                  $--         $(1,703,000)              $279,000
                                           =================    =================     ================     =================

December 31, 1999                                  $279,000                  $--           $(279,000)                   $--
                                           =================    =================     ================     =================

</TABLE>

                                       61
<PAGE>

                                   SIGNATURES

         Pursuant  to the  requirements  of the  Securities  Act  of  1934,  the
Registrant  certifies  that it has caused this Report to be signed on its behalf
by the undersigned,  thereunto duly authorized, in the Town of Burlington in the
Commonwealth of Massachusetts on March 27, 2000.


                                             PALOMAR MEDICAL TECHNOLOGIES, INC.



                                             By:  /s/ LOUIS P. VALENTE
                                                -------------------------------
                                                      Louis P. Valent
                                                      President and
                                                      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>
<S>                                       <C>                                                <C>

                Name                                      Capacity                                Date
                ----                                      --------                                ----


/S/ LOUIS P. VALENTE                      President, Chief Executive                         March 27, 2000
--------------------------------------    Officer and Director
Louis P. Valente


/S/ JOSEPH P. CARUSO                      Chief Financial Officer                            March 27, 2000
--------------------------------------   (Principal Financial Officer and
Joseph P. Caruso                          Principal Accounting Officer)


/S/ NICHOLAS P. ECONOMOU                  Director                                           March 27, 2000
--------------------------------------
Nicholas P. Economou

/S/ A. NEIL PAPPALARDO                    Director                                           March 27, 2000
--------------------------------------
A. Neil Pappalardo


/S/ JAMES G. MARTIN                       Director                                           March 27, 2000
--------------------------------------
James G. Martin

                                       62

</TABLE>