FORM 10-KSB/A-4

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

                     For fiscal year ended December 31, 1996
                                                            OR
          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                        For the transition period from to
                         Commission file number: 0-22340
                                [GRAPHIC OMITTED]
                       PALOMAR MEDICAL TECHNOLOGIES, INC.
        -----------------------------------------------------------------
        (Exact name of small business issuer as specified in its charter)
<TABLE>
<S>                                                                                 <C>

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

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

Securities registered pursuant to Section 12 (b) of the Act:

                                                       Name of each exchange on
Title of each class                                         which registered
-------------------                                    ------------------------
  Not Applicable                                             Not Applicable 

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

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

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

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

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

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





<PAGE>


                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL

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

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

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

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

THE COMPANY'S STRATEGIC PLAN

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


                                       1
<PAGE>

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

         The Company has already begun to spin out companies in its  electronics
segment. On April 30, 1997, the Company entered into an agreement to sell its CD
Titles  subsidiary  to the  management  of CD Titles  for a  promissory  note of
$600,000 due April 30, 1999. In addition, the Company also received a warrant to
purchase  750,000  shares of CD Titles common stock at various  exercise  prices
ranging  from  $6.00  to  $10.00  Management  is  currently  evaluating  various
alternatives  and methods for spinning out Dynaco  Corp.  and its  subsidiaries.
Although the Company cannot  guarantee  successful  completion of such spinouts,
the intention is to complete these  transactions  during 1997. In addition,  the
Company's  subsidiary  Nexar  Technologies,  Inc.  completed the initial  public
offering  of its  Common  Stock on  April  14,  1997  (See  "Formation  of Nexar
Technologies, Inc.").

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

         The Company also makes early stage investments in core technologies and
companies that management feels are strategic to the Company's  business or will
yield a higher  than  average  financial  return to support the  Company's  core
business.  Some of these investments are with companies that are related to some
of the  directors  and  officers  of the  Company.  (See  "Item 6.  Management's
Discussion  and Analysis of Financial  Condition  and Results of  Operations  --
Liquidity and Capital Resources" and "Item 12. Certain Relationships and Related
Transactions.")

         RECENT FINANCING OF OPERATIONS AND INVESTMENTS

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

         INCREASE IN OUTSTANDING SHARES

         As a result of financing activities, business developments, mergers and
acquisitions,  issuance of  incentive  stock  options  and  warrants to purchase
common  stock to attract  and retain key  employees,  the  Company's  issued and
outstanding  shares of common stock have increased to 30,596,812 at December 31,
1996.  The Company also had  additional  reserved but unissued  shares of common
stock of  20,467,819  shares at December  31,  1996.  The  Company's  issued and
outstanding shares of common stock increased  subsequent to December 31, 1996 to
30,996,283  shares with additional  reserved but unissued shares of common stock
of 33,083,190  shares as of July 7, 1997. A substantial  number of the Company's
reserved shares are registered and could be resold into the public market.

                                       2
<PAGE>

         RELATED PARTY INVESTMENTS AND TRANSACTIONS

         The Company  has entered  into a number of  transactions  with  related
parties. To date, the Company has an aggregate of $5,584,064 of notes receivable
and investments with related parties. Included in the aggregate amount are loans
to certain officers, directors and key employees of $1,828,499; notes receivable
to related  parties of $464,153;  a loan of  $1,100,000  to a public  company of
which a  former  director  is the  director  and  chief  financial  officer;  an
unsecured note of $604,653 to the Company's underwriter;  and trading securities
of $1,912,614 in a publicly traded company in which a director of the Company is
an approximately 13% owner. See Note 11 in the "Notes to Consolidated  Financial
Statements."

MEDICAL PRODUCTS SEGMENT

BUSINESS DEVELOPMENTS

         ACQUISITION OF STAR MEDICAL TECHNOLOGIES, INC.

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

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

         ACQUISITION OF SPECTRUM MEDICAL TECHNOLOGIES, INC.

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

         FORMATION OF SPECTRUM FINANCIAL SERVICES LLC

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

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

         In August  1995,  the Company  entered  into an  exclusive,  worldwide,
perpetual  license for certain  technology  that applies to a patented method of
delivering  laser energy to treat unwanted hair. The Company also entered into a
four-year agreement with the Massachusetts General Hospital ("MGH"), whereby MGH
agreed   to   conduct   clinical   trials   on  a  laser   treatment   for  hair
removal/reduction  invented  by Dr. R. Rox  Anderson,  Wellman  Laboratories  of
Photomedicine,  MGH. As part of the  agreement,  MGH  provided  the Company with
prior data  already  generated  by Dr.  Anderson  with respect to the ruby laser


                                       3
<PAGE>

device  at MGH.  This  information  was the basis  for an  application  filed on
December 8, 1995 with the FDA for  approval of the  Company's  EpiLaser(TM)  for
treating  unwanted hair. The Company is obligated to fund the clinical  research
in the aggregate amount of approximately  $917,000 over the term of its contract
with MGH.  On August  18,  1995,  the  Company  also  entered  into a  worldwide
exclusive  license  agreement  with MGH.  Upon  completion of a valid product or
service,  or new uses (not related solely to hair removal) based on the findings
of the clinical  studies,  the Company shall be given the right of first refusal
to negotiate an exclusive or non-exclusive  license agreement.  As consideration
for this  license,  the Company is obligated  to pay MGH  royalties of 5% of net
revenue  on  products   covered  by  valid  patents   licensed  to  the  Company
exclusively;  2.5% of net revenues on products covered by valid patents licensed
to the Company  non-exclusively;  no less than 2.5% of net revenues for products
sold for hair removal as well as other uses,  not covered above and a royalty to
be  negotiated  on  services  or  commercial  dispositions  (other  than  sales)
involving products covered by valid patents licensed to the Company,

         ACQUISITION OF TISSUE TECHNOLOGIES, INC.

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

         ACQUISITION OF DERMASCAN, INC.

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

         FORMATION OF  PALOMAR TECHNOLOGIES, LTD.

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

         FORMATION OF PALOMAR MEDICAL PRODUCTS, INC.

         On February 18, 1997,  the Company  formed  Palomar  Medical  Products,
Inc., a wholly-owned subsidiary, for the purpose of consolidating the management
and  operations  of the  medical  products  companies.  Included  in the medical
products  group are the following  companies,  all of which remain  wholly-owned
subsidiaries  of the Company:  Spectrum,  Tissue,  Star  Medical,  Dermascan and
Palomar Technologies, Ltd.

MEDICAL SERVICES SEGMENT

         FORMATION OF COSMETIC TECHNOLOGY INTERNATIONAL, INC.

         On December 20, 1996, Cosmetic Technology  International,  Inc. ("CTI")
was formed as a 100%-owned  subsidiary  of the Company.  As of December 31, 1996
the  Company  had  funded  CTI with  cash of  approximately  $650,000.  CTI is a


                                       4
<PAGE>

         services  company  which  intends to  establish a worldwide  network of
cosmetic  dermatological  laser and medical  device sites with medical  services
partners (both fixed and mobile) in key geographic locations.  Each site will be
provided a turnkey  package of laser and medical device  technology,  equipment,
training and service, operations personnel,  strategic advertising and marketing
programs,  patient financial credit programs and management assistance. In early
1997, a binding letter of intent was completed with Columbia/HCA,  a $20 billion
company  and  one of  the  world's  largest  owners  and  operators  of  medical
facilities,  to  establish  revenue  sharing  sites  throughout  the  country in
existing Columbia/HCA  facilities.  CTI and Columbia/HCA are working together to
determine the location and opening dates of such sites;  to date, none have been
established.  To date,  CTI has  opened  and is  operating  two  sites  that are
wholly-owned  by CTI,  one in Los  Angeles  and  one in  Phoenix.  CTI has  also
established   revenue-sharing  sites  in  St.  Louis,  Missouri;   Chula  Vista,
California  and in  Australia.  During  1996  the  operations  of CTI  were  not
significant.

MEDICAL PRODUCTS AND LASERS IN MEDICINE

         EPILASER PRODUCT FOR LASER HAIR REMOVAL

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

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

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

         THE HAIR-REMOVAL MARKET

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


                                       5
<PAGE>

the  long-term  removal of body hair.  Other  methods  of hair  removal  include
waxing,  depilators,  tweezing,  depilatory creams and shaving, all resulting in
only short-term hair removal.

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

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

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

         COMPETITION

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

         In July 1997, ESC Medical Systems Ltd. received  clearance from the FDA
to market its EpiLight Hair Removal System, a depilation  device based on pulsed
light  technology.  Several  other  companies  have also  indicated  interest in
developing  and/or  introducing hair removal devices in 1997,  making laser hair
removal the most competitive application within the cosmetic laser marketplace.

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


                                       6
<PAGE>

         MARKETING, DISTRIBUTION AND SERVICE FOR THE EPILASER

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

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

         MANUFACTURING AND SUPPLIERS FOR THE EPILASER

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

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

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

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

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

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


                                       7
<PAGE>



         MANUFACTURING AND SUPPLIERS FOR TRU-PULSE LASER

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

         COMPETITION FOR TISSUE'S TRU-PULSE  LASER

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

         RUBY LASER FOR TATTOO REMOVAL

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

         COMPETITION FOR SPECTRUM'S RUBY LASER FOR TATTOO REMOVAL

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

FUTURE PRODUCTS

         RELATIONSHIP WITH WELLMAN LABORATORIES

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


                                       8
<PAGE>

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

         In 1994,  the Company  began a number of studies for the  treatment  of
certain dermatologic  conditions using its diode laser at Wellman Labs. In 1995,
these studies were  expanded to include the  Company's  ruby lasers for cosmetic
procedures.  The data  associated  with  these  treatments  is  currently  being
evaluated by Wellman Labs and the  Company.  Pursuant to its research  agreement
with MGH  (see  "License  and  Research  Agreement  with  Massachusetts  General
Hospital"),  the Company works  closely with Dr. R. Rox  Anderson,  the Research
Director of the MGH Laser  Center and  Associate  Professor  of  Dermatology  at
Harvard Medical School,  who is a recognized expert in laser tissue  interaction
and the inventor of a number of laser  procedures in use today. Dr. Anderson has
authored  over 60 papers in  peer-reviewed  publications  relating to the use of
lasers in dermatology, is the recipient of numerous awards in the field of laser
medicine  and  serves  as the  Chairman  of the Blue  Ribbon-Government  Liaison
Committee of the American  Society for Laser Medicine and Surgery.  Dr. Anderson
holds eight U.S. patents and has pending  applications for an additional eleven.
The Company feels that these types of  relationships  are critical in developing
effective products for widespread use in the market on a timely basis.

         DIODE LASER PRODUCT DEVELOPMENT

         BURN DIAGNOSIS SYSTEM - U.S. AIR FORCE CONTRACT

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

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

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

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

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

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

                                       9
<PAGE>

respectively.  The Company  intends to fund human clinical  studies in this area
over the next twelve-month  period. The Company expects that it may take several
years before a commercial product for tonsillectomy is available.

         DYE LASER PRODUCTS

         U.S. ARMY CONTRACT

         During 1995,  the Company  entered into a two-year  cost plus fixed fee
contract  with  the  U.S.  Army.  The  contract  provides  for  the  Company  to
investigate Compact,  Wavelength Diverse, High Efficiency Solid-State Dye Lasers
and is valued at $3,555,223.  Revenue on the contract is recognized as costs are
incurred. During the fiscal years ended December 31, 1995, and December 31, 1996
the Company  recognized  $1,305,542  and $190,694,  respectively,  of government
contract revenue. The Company does not anticipate this research will result in a
commercial product within the next few years. In April 1997, the Company novated
this  contract  to Physical  Sciences,  Inc.  ("PSI").  Upon  completion  of the
contract,  PSI has agreed to offer the  Company a right of first  refusal  for a
commercial license to sell,  manufacture or otherwise dispose of solid-state dye
laser  technology  as  developed  by PSI under the  contract  for use in medical
products.

         THROMBOLYSIS AGREEMENT

         On September 10, 1993,  the Company  entered into the Baxter  Agreement
with the Edwards LIS  Division of Baxter.  Under the Baxter  Agreement,  the two
companies  intend to develop,  market,  and sell an integrated  system utilizing
lasers and catheters for the removal of blood clots.  Baxter is responsible  for
sales and  marketing  of the  product  after FDA  clearance  and the  Company is
responsible for the  development  and manufacture of the product.  Following FDA
clearance the Company will receive 80% of the net sales for laser  equipment and
50% of the net  sales  for  catheter  and  disposable  components.  Prior to FDA
clearance,  the Company will receive 100% of the revenue received from the laser
and the catheter.  Under the Baxter  Agreement,  Baxter licensed its proprietary
technology  to the Company,  and the Company  cross-licensed  its  technology to
Baxter. The Company also granted to Baxter a license to sell and market products
incorporating  such  technology.  Baxter  agreed to transfer its interest in the
agreement to ACS, a division of Eli Lilly, as part of a purchase by Eli Lilly of
the Baxter LIS division. Eli Lilly subsequently sold ACS to Guidant Corp.

         In January 1997, Palomar became an equity partner in the formation of a
new company, LaTIS, Inc., created to use Palomar's Laser Thrombolysis technology
to develop a pulsed-dye laser system for treating stroke.  With the formation of
this new venture,  Laser  Thrombolysis is no longer part of Palomar's  strategic
agenda,  although the Company can still derive the benefits from its research by
potentially being the laser supplier for this large market.

PATENTS AND LICENSES

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

         In the  medical  products  segment,  the  Company  is aware of  patents
relating to laser technologies used in certain applications. The Company intends
to pursue such laser technologies in the future;  hence, if the patents relating
to those  technologies are valid and  enforceable,  they may be infringed by the
Company.  After  consulting  with outside  counsel to the  Company,  the Company
believes that it is not infringing currently on patents held by others; however,
were the issue ever to be litigated, a court could reach a different opinion.

         In March 1997, Selvac  Acquisitions Corp.  ("Selvac") filed a complaint
in the United  States  District  Court for the District of New Jersey  alleging,
among other  things,  that the EpiLaser  infringes a patent held by Selvac.  The
Company filed an action  against  Selvac's  parent  MEHL/Biophile  in the United
States District Court for the District of Massachusetts in October 1996 seeking,

                                       10
<PAGE>

among other things,  a declaration  that the Company does not infringe  Selvac's
patent and that Selvac's patent is invalid, void and unenforceable. See "Item 3.
Legal  Proceedings."  Other than the Selvac  action,  the  Company  has not been
notified  that it is  currently  infringing  on any  patents nor has it been the
subject of any patent infringement action. Defense of a claim of infringement is
costly and could have a material adverse effect on the Company's business,  even
if the Company were to prevail.

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

GOVERNMENT REGULATION

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

         FDA CLEARANCE STATUS FOR COSMETIC LASER PRODUCTS

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

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

         OTHER GOVERNMENT APPROVALS FOR MEDICAL PRODUCTS

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

                                       11
<PAGE>

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

ELECTRONIC PRODUCTS SEGMENT

BUSINESS DEVELOPMENTS

         ACQUISITION OF DYNACO CORPORATION

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

         FORMATION OF NEXAR TECHNOLOGIES, INC.

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

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

         On April 14,  1997 Nexar  completed  its  initial  public  offering  of
2,500,000 shares of its common stock for its own account, as well as shares held
by Nexar  shareholders.  The price per  share  was  $9.00 and Nexar  raised  net
proceeds of approximately $20.3 million.  Following this offering,  Palomar will
beneficially  own  approximately  67% of Nexar's common stock.  Included in this
percentage is (i) 1,200,000 shares of Nexar's common stock owned by Palomar that
are subject to a contingent  repurchase right by Nexar for an aggregate price of
$12,000 in the event that Nexar does not achieve certain performance  milestones
set forth in an agreement between Nexar and Palomar,  and (ii) 408,000 shares of
Nexar  common  stock which  Palomar may acquire  upon the  conversion  of 45,684
shares of Nexar  Convertible  Preferred  Stock that is also owns.  The 1,200,000
shares of common stock subject to the contingent  repurchase right of Nexar will
be held in escrow and released to Palomar upon Nexar  attaining  certain revenue
levels  ranging from $100 million to $400 million and net income levels  ranging
from $7 million to $28 million over a four year period ending December 31, 2000,


                                       12
<PAGE>

as defined in the agreement between Nexar and the Company. These shares may also
be released  from escrow upon Nexar  attaining a specified  minimum  stock price
ranging  from  $15.75 per share to $29.25  per share over this four year  period
ending  December 31, 2000,  and if the Company  achieves  cumulative  net income
totaling  $70,000,000  through  December  31,  2000.  These  shares will also be
released  if Nexar is party to any  merger or sale of  substantially  all of its
assets.

         Following  the  offering,  Nexar has repaid the  Company  approximately
$7,500,000 from the net proceeds received from the offering.

         FORMATION OF DYNAMEM, INC.

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

         LICENSE AGREEMENT WITH TECHNOVATION COMPUTER LAB, INC.

         Nexar's current PCs are shipped with  motherboards  based on technology
licensed  from  Technovation  Computer  Lab,  Inc.  ("Technovation"),  a  Nevada
corporation which, to the best of the Company's knowledge,  is owned by Babar I.
Hamirani, a former executive officer of Nexar whose employment was terminated on
November 29, 1996.  The Company has  acquired all such  technology  and a patent
application  related  thereto,  and settled all claims between Mr.  Hamirani and
Nexar pursuant to an Asset  Purchase and  Settlement  Agreement by and among Mr.
Hamirani, Technovation, Nexar and the Company dated as of February 28, 1997 (the
"Asset Purchase and Settlement  Agreement").  Pursuant to the Asset Purchase and
Settlement Agreement and a separate asset purchase agreement between the Company
and Nexar, the Company will first acquire the subject technology and then convey
such technology to Nexar.

         FORMATION OF PALOMAR ELECTRONICS CORPORATION

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

         ACQUISITION OF CD TITLES, INC.

         On July 13, 1995, CD Titles,  Inc. ("CD Titles") was incorporated  with
the  Company  owning  substantially  all of CD  Titles'  common  stock.  Certain
minority stockholders of CD Titles loaned CD Titles a total of $600,000. On July
31, 1995, CD Titles purchased certain assets and assumed certain  liabilities of
CDRP,  Inc. The purchase price consisted of $625,000 in cash and a $600,000 note
due  September  30, 1995,  which was  guaranteed  by the  Company.  The notes to
minority  stockholders  and CDRP, Inc. were repaid in December 1995 with 386,144
shares of the Company's  common stock. CD Titles is a CD ROM publishing  company
which  distributes  various  materials  on  CD  ROM  through  personal  computer
wholesale  channels in the United States. On April 30, 1997, the Company entered
into an  agreement  to sell its CD Titles  subsidiary  to the  management  of CD
Titles for a promissory  note of $600,000 due April 30, 1999.  In addition,  the
Company also received a warrant to purchase  750,000  shares of CD Titles common
stock at various exercise prices ranging from $6.00 to $10.00


                                       13
<PAGE>



         ACQUISITION OF COMTEL ELECTRONICS, INC.

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

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

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

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

GENERAL

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

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

         PERSONAL COMPUTER INDUSTRY BACKGROUND

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

                                       14
<PAGE>

manufacturers  have exited the industry for a variety of reasons,  and many more
have reported significant losses.

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

         NEXAR  STRATEGY

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

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

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

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

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

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

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

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


                                       15
<PAGE>

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

         ENGAGE IN PRIVATE LABELING.

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

         EXPLOIT SPECIALIZED GOVERNMENT MARKETS.

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

         COMPETITION

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

         MANUFACTURING AND SUPPLIERS

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


                                       16
<PAGE>



         ENVIRONMENTAL CONTROLS AND GOVERNMENT CERTIFICATIONS

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

         INTELLECTUAL PROPERTY

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

DYNACO CORP. BUSINESS INTRODUCTION

         DYNACO CORP. ("DYNACO")

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

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

         FLEXIBLE INTERCONNECT SUBSTRATE INDUSTRY BACKGROUND

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

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

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

          Flexible   circuits   allow   3-dimensional   interconnect   packaging
          techniques;

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


                                       17
<PAGE>

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

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

        The 3-dimensional  packaging and flexure  characteristics  of multilayer
flexible circuits and multilayer  rigid-flex circuits have made them the fastest
growing  segment of the U.S.  printed  circuit  market.  According to a May 1996
report by TechSearch International,  Inc., a technology licensing and consulting
firm, the world market for flexible printed  circuits in 1995 was  approximately
$1.8 billion to $2.0 billion,  of which the U.S. market was  approximately  $550
million,  an  increase  of  nearly  18% from  $470  million  in  1994.  Japanese
manufacturers  and their affiliated  offshore  operations had  approximately 60%
share of the world  market.  According  to  Flexible  Circuits  Engineering,  an
industry  publication,  sales of flexible  circuits in North  America have grown
from $300 million in 1985 to an estimated $650 million in 1995. The  publication
points out that the market has grown  erratically,  growing  principally  in the
periods from 1985  through 1987 and from 1993 through the present.  According to
Flexible  Circuits  Engineering,  the first growth phase reflected a short-lived
increase in the use of flexible  circuits in missiles,  "black  boxes" and other
defense-related products shortly before the end of the Cold War, and the current
growth  phase  reflects the  increased  use of flexible  circuits in  commercial
markets,  including the personal computer,  automotive,  consumer and instrument
markets.  As a  result  of  these  market  trends,  Dynaco  believes  there is a
significant market opportunity for manufacturers that can timely deliver complex
multilayer  flexible and rigid-flex  circuits to leading suppliers of electronic
equipment.

         DYNACO STRATEGY

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

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

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

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

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

         COMMERCIALIZE THE DYNAFLEX PRODUCTS

         Dynaco  believes that the demand for smaller  electronic  products will
increasingly  cause  commercial  designers to consider  high-density  multilayer
flexible packaging.  Historically,  Dynaco's flexible circuit products have been
too costly to make most commercial  applications  feasible.  Dynaco has recently


                                       18
<PAGE>

developed,  and in June, 1995,  submitted patent  applications  for,  Dynaflex-D
(Dynamic)  and  Dynaflex-S  (Static),  two new flexible  circuit  products  that
utilize less expensive,  commercial-grade substrates. Dynaco believes that these
proposed  products  will permit it to expand  into  commercial  markets.  Dynaco
believes that its proposed Dynaflex-D and Dynaflex-S products will ultimately be
used in commercial  applications such as automotive engine monitoring  controls,
disk  drives,  personal  computers,  workstations,  and  cellular  communication
systems.

         EXPLOIT MANUFACTURING AND MARKETING CAPABILITIES

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

         ACQUIRE, DEVELOP AND MARKET FLEXIBLE CIRCUIT PRODUCTS

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

         COMTEL ELECTRONICS, INC. BUSINESS INTRODUCTION

         COMTEL ELECTRONICS, INC. ("COMTEL")

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

         CONTRACT MANUFACTURING INDUSTRY BACKGROUND

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

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

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


                                       19
<PAGE>

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

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

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

         COMTEL STRATEGY

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

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

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

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

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

         DYNAMEM, INC. BUSINESS INTRODUCTION

         DYNAMEM, INC. ("DYNAMEM")

         Dynamem spent most of 1996 developing the 64MB,  128MB, and 256MB FRAMM
high  density  memory   modules.   These  memory  modules  are  currently  being
technically  evaluated  by a number of  potential  OEM  users.  A memory  module
usually  consists  of various  configurations  of memory  chips or other  memory
devices  mounted on a printed circuit board inserted into a slot on a computer's
motherboard.  Memory  modules  currently in use include  single  in-line  memory
modules  ("SIMMs") and double in-line memory  modules  ("DIMMs"),  both of which
utilize rigid printed  circuit  boards.  Industry  standards limit the number of
memory chips that can be mounted on a rigid printed circuit board within a given
length and height.  Consequently,  a traditional  memory module that has reached
the maximum length and height has also reached maximum memory capacity.  Dynamem


                                       20
<PAGE>

believes its proposed  memory  modules will overcome  this  limitation of memory
capacity by utilizing  the FRAMM  technology  to fit two rigid  printed  circuit
boards in the same slot  arrangement  that  customarily  houses SIMMs and DIMMs.
Dynaco's  proposed memory modules will mount thin,  small outline package memory
chips onto two rigid printed  circuit  boards,  connected by flexible  circuits,
that are folded for insertion into the motherboard.

         HIGH-DENSITY MEMORY MODULES

         A memory module usually  consists of various  configurations  of memory
devices or chips mounted on a printed  circuit  board  inserted into a slot on a
computer's  motherboard.  Dynamem's memory modules consists of two rigid printed
circuit boards connected by flexible circuits that are folded for insertion.  In
recent  years,  the  overall  size of  computers,  especially  that of  portable
computers, has shrunk while the newest program applications, such as Windows 95,
continue to use increasing  amount of random-access  memory ("RAM").  Meanwhile,
computer manufacturers are shipping an increasing number of systems with limited
RAM in order to  maintain  price  competitiveness.  As a result,  end-users  who
desire to run the latest applications must add memory modules or buy new systems
with  greater  memory  capacity.  Dynaco  believes  that these trends will favor
manufacturers  of high density memory modules as  requirements  for RAM increase
from 16MB to 32MB, 64MB, 128MB and beyond.

         DYNAMEM STRATEGY

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

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

         SALES AND DISTRIBUTION

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

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

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

         Dynaco  has  generally  utilized  selected  sources  to  obtain  volume
discounts.


                                       21
<PAGE>

CUSTOMERS

         DYNACO

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

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

         COMTEL

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

COMPETITION

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

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

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

ENVIRONMENTAL CONTROLS AND GOVERNMENT CERTIFICATIONS

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

         Certain  sales of  flexcircuits  are  subject to certain  military  and
government   certifications.   Dynaco  maintains  military   certifications  for
Mil-Q-50884C, Mil-T-55110, Mil-I-45208 and Mil-Std. 2000, and various subsets of
such  certifications.  In January 1996, Dynaco obtained ISO 9001  certification.
Dynaco is further subject to various federal, state and local regulations


                                       22
<PAGE>

regarding environmental protection and hazardous substance controls.  Management
believes  that  its  Dynaco  operations  are  in  compliance  with  governmental
environmental regulations.

MANUFACTURING AND SUPPLIERS

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

PATENTS IN THE ELECTRONIC BUSINESS SEGMENT

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

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

RESEARCH AND DEVELOPMENT

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

EMPLOYEES

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

ITEM 2.  DESCRIPTION OF PROPERTY

         The  Company  currently  leases  approximately  11,500  square  feet of
research  and  development  and office space in Beverly,  Massachusetts  under a
seven year lease,  expiring in June 2000,  for laser  research  and as corporate
headquarters. The Company's Dynaco subsidiary leases approximately 55,000 square
feet in Tempe,  Arizona under a lease from a partnership  consisting of Dynaco's
Chief Executive  Officer and Chief Operating Officer which expires in July 1997.
The Company's Comtel subsidiary leases 65,000 square feet in Tustin, California,
which is used as a  manufacturing  facility under a lease that expires in August


                                       23
<PAGE>

2002. The Company's Star  subsidiary  leases an office and research  facility of
approximately  6,200  square  feet in  Pleasanton,  California  for diode  laser
research and  manufacturing  under a lease expiring in April 1999. The Company's
Spectrum  subsidiary  leases an office,  manufacturing  and research facility of
approximately  25,000  square  feet in  Lexington,  Massachusetts  under a lease
expiring in June 2000. The Company's Tissue  Technologies  subsidiary  leases an
office and  manufacturing  facility of 17,000  square feet in  Albuquerque,  New
Mexico under a lease  expiring in October 1999. The Company's  Nexar  subsidiary
leases an office and telemarketing  facility of approximately  7,000 square feet
in  Westboro,  Massachusetts  under a  lease  expiring  in  August  1998,  and a
manufacturing   facility  of  approximately  100,000  square  feet  in  Haywood,
California  under a  lease  expiring  in  August  2001.  The  Company's  Palomar
Technologies, Ltd. subsidiary owns an office and leases a manufacturing facility
in Hull,  England.  In the opinion of management,  the properties  leased by the
Company and its  subsidiaries  are  currently  suitable  and  adequate for their
intended purposes.

ITEM 3. LEGAL PROCEEDINGS

         On October 7, 1996 the  Company  filed a  declaratory  judgment  action
against  MEHL/Biophile  ("MEHL")  in the United  States  District  Court for the
District of  Massachusetts  seeking (i) a declaration that MEHL is without right
or authority to threaten or maintain  suit against the Company or its  customers
for  alleged  infringement  of the  patent  held  by  MEHL's  subsidiary  Selvac
Acquisitions Corp. ("Selvac" and the "Selvac Patent"), that the Selvac Patent is
invalid,  void and  unenforceable,  and that the Company  does not  infringe the
Selvac patent; (ii) a preliminary and permanent  injunction  enjoining MEHL from
threatening  the  Company  or its  customers  with  infringement  litigation  or
infringement;  and  (iii)  an  award  to the  Company  of  damages  suffered  in
connection with MEHL's conduct.  On March 7, 1997,  Selvac filed a complaint for
injunctive relief and damages for patent infringement and for unfair competition
against the Company,  its Spectrum Medical  Technologies and Spectrum  Financial
Services  subsidiaries,  and a New Jersey  dermatologist,  in the United  States
District Court for the District of New Jersey.  Selvac's  complaint alleges that
the Company's EpiLaser infringes the Selvac Patent and that the Company unfairly
competed by promoting  the EpiLaser for hair removal  before it had received FDA
approval for that  specific  application.  The Company and Selvac have agreed to
dismiss the Massachusetts  litigation without prejudice.  Palomar has brought in
the New Jersey  action its claims that the Selvac  patent is  invalid,  that the
Company has not infringed the Selvac  patent,  that MEHL should be enjoined from
making further assertions  concerning  infringement and unfair competition,  and
that the Company should be awarded attorney fees and other  appropriate  relief.
Thus,  both the  Company's  and MEHL's claims will be tried on the merits in New
Jersey. Automatic discovery will shortly commence. The extent of exposure of the
Company cannot be determined at this time.

         The  Company  is  a  defendant  in  a  lawsuit  filed  by  Commonwealth
Associates  ("Commonwealth")  on March 14,  1996 in the United  States  District
Court for the Southern District of New York. In its suit,  Commonwealth  alleges
that the Company breached a contract with Commonwealth in which Commonwealth was
to  provide  certain   investment   banking   services  in  return  for  certain
compensation. In January 1997, Commonwealth's motion for summary judgment on its
breach of  contract  claim was  granted  and,  after a  damages  trial  before a
magistrate judge, in April 1997 the court awarded  Commonwealth  $2,917,500 (and
interest of  $256,570.56).  The Company  will appeal the matter and believes its
grounds for appeal are meritorious.

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

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


                                       24
<PAGE>


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

                                                Total Votes        Total Votes
                                                     For            Withheld
                                                -----------        -----------

             Steven Georgiev                     25,014,274         348,728

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

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

             Buster Glossen                      25,014,274         348,728


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


                                       25
<PAGE>


                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

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

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

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

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

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

         PRIVATE PLACEMENT OF COMMON STOCK

         Pursuant to Regulation S under the Act, the Company sold 365,533 shares
of common stock and 182,765  warrants to purchase  common stock to a total of 23
overseas  individuals  and  corporations  on February  1, 1996 for an  aggregate
purchase price of  $1,783,800.  The warrants were issued at a price of $5.00 per
share,  are  immediately  exercisable and expire on February 1, 1999. The common
stock, and common stock  underlying the warrants,  were registered on a Form S-3
filed on February 6, 1996.

         Pursuant to  Regulation D and Section 4(2) of the Act, the Company sold
a total of 165,810  shares of common  stock on March 29,  1996 for an  aggregate
purchase price of $1,364,842. 114,810 shares of common stock were sold to Arista
High-Tech Growth Fund, Ltd. for an aggregate purchase price of $936,442;  45,000
shares of common  stock  were sold to Histon  Financial  Services,  Inc.  for an
aggregate  purchase price of $378,000 and 6,000 shares of common stock were sold
to Berkshire  International Finance, Inc. Pension Plan for an aggregate purchase
price of $50,400.  The common stock was  registered  on a Form S-3 filed on June
28, 1996.

         Pursuant to  Regulation D and Section 4(2) of the Act, the Company sold
a total of 44,862 shares of common stock on April 15, 1996 to Egger & Co. for an
aggregate purchase price of $450,000.  The common stock was registered on a Form
S-3 filed on June 28, 1996.


         Pursuant to Section 4(2) of the Act, the Company sold 600,000 shares of
common  stock on  December  27,  1996 to  Finmanagment,  Inc.  for an  aggregate
purchase  price of  $3,150,000.  In addition to the common  stock,  Finmanagment


                                       26
<PAGE>

received  420,000  net  warrants to  purchase  common  stock at $7.50 per share,
300,000 net warrants to purchase common stock at $9.50 per share and 180,000 net
warrants to purchase  common  stock at $11.50 per share.  The net  warrants  are
subject to a cashless exercise for common stock in which the number of shares of
common  stock  issuable  upon such  cashless  exercise  shall be  determined  by
multiplying  (1) the difference  between (a) the closing bid price of the common
stock on the day prior to the date exercised, as reported by NASDAQ, and (b) the
exercise price, by (2) the number of net warrant shares;  divided by the closing
bid price of the common  stock on the day prior to the date  exercised.  The net
warrants are exercisable immediately and expire on February 28, 1997. The common
stock, and common stock  underlying the warrants,  were registered on a Form S-3
filed on February 4, 1997.

         CONVERTIBLE DEBENTURES

         Pursuant to  Regulation  S of the Act,  the Company sold 9,675 units of
convertible debentures to a total of 11 overseas individuals on July 3, 1996 for
an aggregate  purchase price of $7,669,441.  Each unit consists of a convertible
debenture  due July 3, 2003  denominated  in 1,000 Swiss Francs and a warrant to
purchase  24 shares of the  Company's  common  stock at $16.50  per  share.  The
warrants are  immediately  exercisable  and expire on June 27, 2003.  The common
stock  underlying the debentures and warrants was registered on a Form S-3 filed
on March 4, 1997.

         Pursuant  to  Section  4(2) of the  Act,  the  Company  sold a total of
$5,000,000  4.5%  Convertible  Debentures on October 17, 1996 to Cameron Capital
Ltd. and Wood Gundy London Limited. The debentures, due October 17, 2001, may be
converted  at any time after 75 days from  issuance  at the option of the holder
into shares of the Company's common stock at a price equal to 85% of the average
trailing  five day bid  price  from the date of  conversion.  The  common  stock
underlying  the  debentures  was  registered  on a Form S-3 filed on February 4,
1997.

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

         PREFERRED STOCK

         Pursuant to Section  4(2) of the Act,  the Company sold 6,000 shares of
Series D  Convertible  Preferred  Stock on February  14,  1996 to the  Travelers
Insurance  Company for an aggregate  purchase  price of  $6,000,000.  All of the
Series D Convertible  Preferred  Stock was converted  into  1,116,918  shares of
common stock  (including  accrued  dividends of $342,092 and accrued interest of
$9,183) as of December 31,  1996.  In  connection  with the issuance of Series D
Convertible  Preferred  Stock the Company  issued  600,000  warrants to purchase
common  stock at a price of $7.50 per share,  and  200,000  warrants to purchase
common stock at a price of $8.00 per share, both of which expire on February 14,
2001 and are immediately exercisable.  The common stock underlying the Preferred
Stock and the warrants was registered on a Form S-3 filed on June 28, 1996.

         Pursuant to Section 4(2) of the Act, the Company sold 10,000  shares of
Series E Convertible  Preferred  Stock on April 17, 1996 to GFL  Advantage  Fund
Limited for an  aggregate  purchase  price of  $10,000,000.  All of the Series E
Preferred Stock was converted into 1,381,506  shares of common stock  (including
accrued  dividends of $326,174 and accrued interest of $7,536) as of January 28,
1997. In connection with the issuance of Series E Convertible  Preferred  Stock,
the Company issued 304,259  warrants to purchase  common stock at a price of $15
per share, which expire on April 17, 2001 and are immediately  exercisable.  The
common stock underlying the Preferred Stock and the warrants was registered on a
Form S-3 filed on June 28, 1996.

         Pursuant to Section  4(2) of the Act,  the Company sold 6,000 shares of
Series F Convertible Preferred Stock on July 12, 1996 to the Travelers Insurance
Company for an aggregate purchase price of $10,000,000. The Series F Convertible
Preferred  Stock,  together  with  any  accrued  but  unpaid  dividends,  may be
converted  into common stock at 80% of the daily  average  closing  price of the
common stock on the ten trading days preceding such conversion,  but in no event


                                       27
<PAGE>

less than $7.00 or more than $16.00. Series F Preferred stock may be redeemed at
any time,  with no less than 10 days and no more than 30 days notice or when the
stock  price  exceeds  $16.50  per  share,  at an amount  equal to the amount of
liquidation  preference  determined  as of the  applicable  redemption  date. In
connection  with the  issuance  of Series F  Convertible  Preferred  Stock,  the
Company issued 500,000  warrants to purchase  common stock at a price of $11 per
share, which expire on July 12, 2001 and are immediately exercisable. The common
stock  underlying the Preferred  Stock and the warrants was registered on a Form
S-3 filed on August 23, 1996.

         Pursuant to Section 4(2) of the Act, the Company sold 10,000  shares of
Series G  Convertible  Preferred  Stock to Genesee Fund Limited on September 26,
1996 for an  aggregate  purchase  price of  $10,000,000.  Genesee  Fund  Limited
subsequently  transferred 5,000 of its shares of Series G Convertible  Preferred
Stock to GFL Advantage  Fund and the remaining  5,000 shares to GFL  Performance
Fund. The Series G Convertible  Preferred  Stock,  together with any accrued but
unpaid  dividends,  may be  converted  into  common  stock at 85% of the average
closing  bid  price  for  the  three  trading  days  immediately  preceding  the
conversion  date, but in no event at less than $6.00 or more than $11.50 for the
5,000 shares of Series G Convertible  Preferred Stock held by GFL Advantage Fund
and no less  than  $6.00 or more than  $8.00  for the  5,000  shares of Series G
Convertible  Preferred  Stock held by GFL  Performance  Fund.  The  warrants are
immediately  exercisable  and expire on December 31, 2001.  Series G Convertible
Preferred  Stock may be redeemed  at any time,  with no less than 10 days and no
more than 20 days  notice,  at an amount  equal to the sum of (a) the  amount of
liquidation  preference determined as of the applicable redemption date plus (b)
$176.50.  In  connection  with the  issuance of Series G  Convertible  Preferred
Stock,  the Company issued 323,799  warrants to purchase common stock at a price
of $12 per share,  which expire on September  27, 2001,  and 50,000  warrants to
purchase common stock at a price of $6.5625 per share,  which expire on December
31,  2001 and are  immediately  exercisable.  The common  stock  underlying  the
Preferred  Stock and the warrants was registered on a Form S-3 filed on February
4, 1997.

         STOCKHOLDER SERVICES

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

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

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

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

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


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


                                       28
<PAGE>

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

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

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

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


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

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

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

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


                                       29
<PAGE>

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

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

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

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

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

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

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

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

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



                                       30
<PAGE>

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

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

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

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

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

         Some of the  Company's  medical  products  businesses  are still in the
development   stage,  with  significant   research  and  development  costs  and
regulatory constraints that currently limit sales of its medical products. These
activities  are an important  part of the Company's  business  plan.  Due to the
nature of clinical  trials and research and  development  activities,  it is not
possible to predict with any certainty  the  timetable  for  completion of these
research  activities  or the total amount of funding  required to  commercialize
products  developed as a result of such  research and  development.  The rate of
research  and the number of research  projects  underway  are  dependent to some
extent upon external funding. While the Company is regularly reviewing potential
funding  sources in relation to these  ongoing and proposed  research  projects,


                                       31
<PAGE>

there can be no  assurance  that the  current  levels of funding  or  additional
funding  will be  available,  or, if  available,  on terms  satisfactory  to the
Company.

         The Company also makes  investments in core  technologies and companies
that  management  feels are  strategic to the  Company's  business or hopes will
yield a higher  than  average  financial  return to support the  Company's  core
business.  For  example,  the Company has  invested  money in Nexar (see Item 1.
Description of Business -- Formation of Nexar Technologies,  Inc.); the American
Materials &  Technologies  Corporation,  a  manufacturer  of advanced  composite
materials,  of which the Company  owns 13% as of  December  31,  1996;  GreenMan
Technologies,  Inc., a developer and manufacturer of "environmentally  friendly"
plastic and thermoplastic  rubber parts and products that are manufactured using
recycled materials, in which the Company has invested $1,200,000; and HealthCare
2000,  a privately  held  medical  and  cosmetic  services  company in which the
Company has invested  $500,000.  (See Note 11 to Financial  Statements.) Some of
these  investments  are with companies that are related to some of the directors
and officers of the Company. In addition,  the Company has made loans to various
affiliated   parties.   (See  "Item  12.  Certain   Relationships   and  Related
Transactions.") At December 31, 1996, the Company had $1,564,153 of such related
party investments and loans.

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

FACTORS THAT MAY AFFECT FUTURE RESULTS

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

         SUBSTANTIAL AND CONTINUING  LOSSES.  The Company incurred a net loss of
$37,863,792  for the year ended  December 31, 1996 and a net loss of $15,365,145
for the quarter ended March 31, 1997.  Losses of this  magnitude are expected to
continue for the near term,  and there can be no assurance that the Company will
achieve profitable operations or that profitable operations will be sustained if
achieved.   At  December  31,  1996,  the  Company's   accumulated  deficit  was
$64,971,200  and at March  31,  1997,  the  Company's  accumulated  deficit  was
$80,631,341.  Dynaco Corp. ("Dynaco"), Star Medical Technologies, Inc. ("Star"),
CD Titles, Inc. ("CD Titles"),  Dynamem, Inc.  ("Dynamem"),  Comtel Electronics,
Inc. ("Comtel").  Tissue Technologies,  Inc. ("Tissue"),  Spectrum Technologies,
Inc. ("Spectrum") and Nexar Technologies, Inc. ("Nexar") each have had a history
of  losses.  There  can  be no  assurance  that  these  companies  will  achieve
profitable  operations  or  that  profitable  operations  will be  sustained  if
achieved. The Company anticipates incurring substantial research and development
expenses,  which will reduce cash  available  to fund  current  operations.  The
Company must  continue to secure  additional  financing to complete its research
and  development  activities,  commercialize  its current and proposed  cosmetic
laser products, expand its current electronics business, execute its acquisition
business plan and fund ongoing operations.  The Company anticipates that it will
require substantial  additional  financing during the next twelve-month  period.
The  Company  believes  that  the cash  generated  to date  from  its  financing
activities;  amounts  available  under its credit  agreement  and the  Company's
ability to raise  cash in future  financing  activities  will be  sufficient  to
satisfy its working capital  requirements  through the next twelve-month period.
The  Company  bases its belief  that it has the  ability to raise cash in future
financings on its demonstrated historical ability to raise money and its current
and  ongoing  discussions  with  financing  sources.  However,  there  can be no
assurance that this  assumption  will prove to be accurate or that events in the


                                       32
<PAGE>

future will not require the Company to obtain  additional  financing sooner than
presently  anticipated.  The  Company  may also  determine,  depending  upon the
opportunities  available to it, to seek additional  debt or equity  financing to
fund the costs of acquisitions or continuing  expansion.  To the extent that the
Company   finances  an  acquisition  with  a  combination  of  cash  and  equity
securities,  any such issuance of equity  securities could result in dilution to
the interests of the Company's  shareholders.  Additionally,  to the extent that
the Company incurs  indebtedness to fund increased levels of accounts receivable
or to finance the acquisition of capital  equipment or issues debt securities in
connection with any acquisition, the Company will be subject to risks associated
with incurring  substantial  additional  indebtedness,  including the risks that
interest rates may fluctuate and cash flow may be  insufficient to pay principal
and interest on any such  indebtedness.  The Company  continues  to  investigate
several financing  alternatives,  including strategic  partnerships,  additional
bank financing,  private, debt and equity financing and other sources. While the
Company  regularly  reviews potential funding sources in relation to its ongoing
and  proposed  research  projects,  there can be no  assurance  that the current
levels of funding or additional funding will be available,  or if available will
be on terms satisfactory to the Company.  Failure to obtain additional financing
could  have a  material  adverse  effect  on  the  Company,  including  possibly
requiring it to significantly curtail its operations.  (See "Item 1. Description
of  Business"  and  Note  1  to  Financial  Statements,  "Item  6.  Management's
Discussion and Analysis of Financial Condition and Results of Operations"; March
31,  1997 Form 10-Q Part I "Item 2.  Management's  Discussion  and  Analysis  of
Financial Condition and Results of Operations.")

         HOLDING COMPANY  STRUCTURE.  The Company has no significant  operations
other  than  those  incidental  to its  ownership  of the  capital  stock of its
subsidiaries.  As a holding  company,  the Company is  dependent on dividends or
other  intercompany  transfers  of  funds  from  its  subsidiaries  to meet  the
Company's  debt  service  and  other  obligations.  Claims of  creditors  of the
Company's subsidiaries,  including trade creditors, will generally have priority
as to the assets of such  subsidiaries  over the claims of the  Company  and the
holders of the Company's indebtedness.

         LIMITED OPERATING HISTORY;  RECENT ACQUISITIONS.  Many of the Company's
subsidiaries have limited operating  histories and are in the development stage,
and the Company is subject to all of the risks inherent in the  establishment of
a new  business  enterprise.  The  likelihood  of success of the Company must be
considered in light of the problems, expenses,  difficulties,  complications and
delays  frequently  encountered in connection  with the  establishment  of a new
business and development of new  technologies in the cosmetic laser products and
electronic  products  industries.   These  include,  but  are  not  limited  to,
government   regulation,   competition,   the  need  to   expand   manufacturing
capabilities  and  market  expertise,   and  setbacks  in  production,   product
development,  market acceptance and sales and marketing. The Company's prospects
could be  significantly  affected  by its  ability  to  subsequently  manage and
integrate the operations of several distinct  businesses with diverse  products,
services and customer bases in order to achieve cost efficiencies.  There can be
no assurance that the Company will be able to successfully  manage and integrate
the  operations of newly  acquired  businesses  into its  operations or that the
failure to do so will not increase the costs  inherent in the  establishment  of
new business  enterprises.  (See "Item 1. Description of Business" and Note 1 to
Financial Statements.)

         RISKS ASSOCIATED WITH ACQUISITIONS. Since going public, the Company has
acquired  seven  companies.  In the  normal  course  of  business,  the  Company
evaluates potential  acquisitions of businesses,  products and technologies that
would complement or expand the Company's  business.  Promising  acquisitions are
difficult  to  identify  and  complete  for  a  number  of  reasons,   including
competition  among  prospective  buyers and the need for  regulatory  approvals.
Acquisitions  may result in the incurrence of additional  debt, the write-off of
in-process  research and  development or technology  acquisition and development
costs and the  amortization of expenses related to goodwill and other intangible
assets,  any of which  could have a  material  adverse  effect on the  Company's
business, financial condition, results of operations and cash flow. Acquisitions
involve numerous additional risks, including difficulties in the assimilation of
the operations,  services,  products and personnel of the acquired company,  the
diversion of  management's  attention  from other  business  concerns,  entering
markets in which the Company has little or no direct  prior  experience  and the
potential  loss of key  employees of the acquired  company.  In order to finance
acquisitions,  it may be  necessary  for the Company to raise  additional  funds
through public or private financings. Any equity or debt financing, if available
at all, may be on terms which are not  favorable to the Company and, in the case
of equity financing, may result in dilution to the Company's stockholders.  (See
"Item 1. Description of Business" and Note 1 to Financial Statements.)

         NEW VENTURES.  The Company's Cosmetic  Technology  International,  Inc.
("CTI")  subsidiary has entered into several agreements with physician groups to
provide cosmetic laser services at laser treatment  centers,  and plans to enter
into more such  agreements in the future.  While the Company  believes these new
partnerships are strategically  important,  there are substantial  uncertainties
associated with the development of new products,  technologies  and services for


                                       33
<PAGE>

evolving  markets.  The success of these ventures will be determined not only by
the Company's efforts, but also by those of its partners. Initial timetables for
the development and introduction of new  technologies,  products or services may
not be achieved, and price/performance targets may not prove feasible.  External
factors,  such as the  development  of  competitive  alternatives  or government
regulation,  may cause new markets to evolve in unanticipated  directions.  (See
"Highly Competitive Industries," and "Item 1. Description of Business.")

         INVESTMENTS  IN UNRELATED  BUSINESSES.  The Company has  investments in
marketable  and  non-marketable  securities  and loans to related and  unrelated
parties,  including  approximately $8 million  invested in equity  securities of
high-tech companies, both public and privately held. The amount that the Company
may ultimately  realize from these  investments could differ materially from the
value of these investments recorded in the Company's financial  statements,  and
the  ultimate  disposition  of these  investments  could result in a loss to the
Company.  (See  "Item 6.  Management's  Discussion  and  Analysis  of  Financial
Condition  and  Results  of  Operations,"  and  Notes  2  and  11  to  Financial
Statements; "Item 12. Certain Relationships and Related Transactions"; March 31,
1997  Form  10-Q  Notes 3 and 10 to  Financial  Statements  and  Part I "Item 2.
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations.")

         MANAGEMENT OF GROWTH.  In light of management's  views of the potential
for future  growth,  the  Company  has  adopted an  aggressive  growth plan that
includes  substantial  investments  in  its  sales,  marketing,  production  and
distribution  organizations,  the  creation  of  new  research  and  development
programs  and  increased  funding  of  existing  programs,  and  investments  in
corporate  infrastructure  that will be required to support  significant growth.
This  plan  carries  with it a number  of  risks,  including  a higher  level of
operating expenses, the difficulty of attracting and assimilating a large number
of new employees,  and the  complexities  associated  with managing a larger and
faster  growing  organization.  Depending  on the extent of future  growth,  the
Company may  experience a  significant  strain on its  management,  operational,
manufacturing and financial  resources.  The failure of the Company's management
team to  effectively  manage growth,  should it continue to occur,  could have a
material  adverse  effect on the  Company's  financial  condition and results of
operations. (See "Item 1. Description of Business.")

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

         In the electronics  industry,  the Company competes with Packard-Hughes
Interconnect Co., Parlex Corporation, Teledyne Inc., IBM, Apple Computer, Compaq
and Dell Computer, among others. Many, if not most, of the Company's current and
prospective  competitors are substantial in size and have substantial financial,
managerial,  technical,  manufacturing,  marketing and other resources,  and may
introduce additional products that compete with those of the Company.  There can
be no assurance  that the  Company's  products will compete  favorably  with the
products  of its  competitors  or that  the  Company  will  have  the  resources
necessary  to compete  effectively  against such  companies.  As a result of the
intense  competition in the personal  computer market,  the Company expects that
gross margins on sales of its upgradeable  personal  computers will be extremely
narrow and will require the Company to manage  carefully its cost of goods sold.
There can be no  assurance  that the Company  will be able to manage its cost of
goods sold to the degree necessary for sales of upgradeable computer products to
generate  significant gross margins. The Company currently has limited marketing
capabilities   and  expects  to  place   significant   reliance  on  independent
distributors  and resellers for the  distribution and marketing of its products.
The  Company  will be  dependent  upon the  efforts of such third  parties.  The
inability to establish and maintain a network of  independent  distributors  and
resellers,  or a reduction in their sales efforts, could have a material adverse
effect on the  Company's  financial  condition  and  results of  operations.  In
addition,  there can be no assurance as to the viability or financial  stability
of the Company's independent  distributors and resellers.  The computer industry
has  been  characterized  from  time  to  time  by  financial   difficulties  of
distributors  and  resellers;  any such problems could lead to reduced sales and
could have a material  adverse effect on the Company's  financial  condition and


                                       34
<PAGE>

results of  operations.  There can be no assurance  that the Company's  products
will compete  favorably with the products of its competitors or that the Company
will have the resources necessary to compete effectively against such companies.
(See "Item 1. Description of Business.")

         FLUCTUATIONS  IN  QUARTERLY  PERFORMANCE.   The  Company's  results  of
operations have fluctuated substantially and can be expected to continue to vary
significantly.  The Company's  quarterly operating results depend on a number of
factors,  including the timing of the introduction or acceptance of new products
offered by the Company or its  competitors,  changes in the mix of products sold
by the Company,  changes in regulations affecting the cosmetic laser products or
electronics  industry,  changes in the Company's operating  expenses,  personnel
changes and general economic conditions.

         The Company's stock price, like that of other technology companies,  is
subject to significant  volatility.  If revenues or earnings in any quarter fail
to meet the  investment  community's  expectations,  there could be an immediate
impact on the price of the Company's  common  stock.  The price of the Company's
common  stock may also be affected by broader  market  trends  unrelated  to the
Company's  performance.  (See "Volatility of Share Price;" "Item 6. Management's
Discussion and Analysis of Financial Condition and Results of Operations;  March
31, 1997 Form 10-Q "Item 2.  Management's  Discussion  and Analysis of Financial
Condition and Results of Operations.")

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

         GOVERNMENT  REGULATION.  The Company's laser product  business  segment
and,  to a lesser  degree,  its  electronics  business  segment  are  subject to
regulation  in the United States and abroad.  Failure to comply with  applicable
regulatory  requirements can result in fines, denial or suspension of approvals,
seizures  or  recall  of   products,   operating   restrictions   and   criminal
prosecutions,  any or all of which could have a material  adverse  effect on the
Company.  Furthermore,  changes  in  existing  regulations  or  adoption  of new
regulations could prevent the Company from obtaining, or could affect the timing
of,  future  regulatory  approvals.  (See  "Item 1.  Description  of  Business -
Government Regulation.")

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

                  FDA CLEARANCE STATUS FOR COSMETIC LASER PRODUCTS. Three of the
Company's lasers have received clearance from the FDA for certain dermatological
applications:  the Q-switched  Ruby laser,  the Tru-Pulse laser and the Epilaser
system.  The Company's  diode laser has not yet received FDA  clearance,  and is
currently under an Investigative Device Exemption.

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

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

                                       35
<PAGE>

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

                  OTHER   GOVERNMENT   APPROVALS   FOR  LASER   PRODUCTS;   GOOD
MANUFACTURING  PRACTICES.  In order to be sold  outside the United  States,  the
Company's  products are subject to FDA permit  requirements that are conditioned
upon clearance by the importing country's  appropriate  regulatory  authorities.
Many  countries  also require that  imported  products  comply with their own or
international  electrical  and safety  standards.  Additional  approvals  may be
required in other countries.  The Company's  Tru-pulse laser has received the CE
Mark pursuant to the European  Medical Device  Directive which allows that laser
to be sold in all countries that recognize the CE Mark,  including the countries
that comprise the European Community. The Company is currently seeking to obtain
the CE Mark  registration  for its  Epilaser.  The  Company has yet to apply for
international  approval  for its diode  laser for use in  cosmetic  surgery  and
dermatology.

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

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

         Flexible circuit board component sales to the U.S. military are subject
to  certain  military  certifications.   These  certifications  are  based  upon
compliance  with  specification   standards  set  by  the  U.S.  military.   The
certification  for the  Company's  Mil-T-55110  product  expires  in the  fourth
quarter of 1998,  and,  for the  Company's  Mil-Q-50884C  product,  in the first
quarter of 1999.  The Company is subject to periodic  audit and review from U.S.
government  agencies  to ensure  compliance  under  criteria  set forth by these
agencies.  The  Company  has passed all  government  audits.  Failure to meet or
exceed  criteria set forth could result in a suspension or  disqualification  of
certain  certifications.  Such  suspension  or  disqualification  could  have  a
material adverse effect on the Company.

         One customer of Nexar,  Government Technology Services,  Inc. (GTSI), a
leading  supplier  of desktop  systems  to United  States  government  agencies,
accounted for a majority of Nexar's revenues. The Company expects that GTSI will
continue to be an important customer,  and that while Nexar's revenues from GTSI
will  increase,  such  sales as a  percentage  of total  revenues  will  decline
substantially  as Nexar further expands its  distribution  network and increases
its overall  sales.  Nexar has entered into an agreement  with GTSI  pursuant to
which  GTSI  serves as  Nexar's  exclusive  federal  reseller  with  respect  to
Government Services Administration (GSA) scheduled purchases, provided that GTSI
purchases  at least $35 million of Nexar's  products  in 1997.  GTSI is under no
obligation,  however,  to purchase any products of Nexar's.  If GTSI makes fewer
purchases  in 1997 than Nexar  anticipates,  that would have a material  adverse
effect on the Company.

                                       36
<PAGE>

         UNCERTAINTY OF MARKET ACCEPTANCE.  The Company continually develops new
products  intended  for  use in the  cosmetic  laser  products  segment  and the
electronic products segment. As with any new products, there is substantial risk
that the marketplace may not accept or be receptive to the potential benefits of
such products.  Market acceptance of the Company's current and proposed products
will  depend,  in large part,  upon the ability of the Company or any  marketing
partners to  demonstrate  to the  marketplace  the  advantages  of the Company's
products  over  other  types  of  products.  There  can  be  no  assurance  that
applications  or uses for the  Company's  current and proposed  products will be
accepted by the  marketplace  or that any of the  Company's  current or proposed
products  will be able to  compete  effectively.  (See "Item 1.  Description  of
Business.")

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

         DEPENDENCE  ON THIRD PARTY  RESEARCHERS.  The Company is  substantially
dependent upon third party  researchers and others,  over which the Company will
not have absolute control,  to  satisfactorily  conduct and complete research on
behalf of the Company and to grant to the Company favorable  licensing terms for
products  which may be  developed.  The  Company  has  entered  into a number of
research   agreements   with   recognized   research   hospitals   and  clinical
laboratories.  These  research  institutions  include the Oregon  Medical  Laser
Center at the Heart  Institute of St.  Vincent  Hospital  and Medical  Center in
Portland,  Oregon,  the Wellman Labs at  Massachusetts  General Hospital and the
Otolaryngology  Research  Center for  Advanced  Endoscopic  Applications  at New
England Medical Center,  Boston,  Massachusetts.  The Company provides  research
funding, laser technology and optics know-how in return for licensing agreements
with respect to specific medical  applications and patents.  Management believes
that this method of conducting research and development  provides a higher level
of technical  and clinical  expertise  than it could provide on its own and in a
more cost efficient manner.  The Company's success will be highly dependent upon
the results of the research,  and there can be no assurance  that these research
agreements  will provide the Company with  marketable  products in the future or
that any of the products developed under these agreements will be profitable for
the Company.  (See "Item 1.  Description  of  Business"  and Note 6 to Financial
Statements.)

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

         The flexible  circuit board  component,  electronics  interconnect  and
personal computer  industries are characterized by large capital  investments in
new automated processes and state-of-the-art fabrication techniques. In order to
participate  effectively in those industries,  the Company must continue to make
large  capital  investments  in new  automated  processes  and  state-of-the-art
fabrication  techniques.  Development  by  others of new or  improved  products,
processes or technologies may make the Company's  products or proposed  products
obsolete or less  competitive.  The Company will be required to devote continued
efforts and  financial  resources to  enhancement  of its existing  products and
development  of new  products.  There can be no assurance  that the Company will
have the financial resources or the technological  capability necessary to carry
out such product  enhancement  and  development.  Nor can there be any assurance
that any of the products  currently being developed by the Company,  or those to
be developed in the future, will be technologically  feasible or accepted by the
marketplace,  that any such development will be completed in any particular time
frame,  or that the  Company's  products or  proprietary  technologies  will not
become uncompetitive or obsolete. (See "Item 1.
Description of Business.")

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

                                       37
<PAGE>

         The cosmetic laser device market has been  characterized by substantial
litigation  regarding patent and other intellectual  property rights. One of the
Company's  competitors in the cosmetic laser business has filed suit against the
Company alleging patent  infringement,  among other things. In both the cosmetic
laser products and the electronic  products  segments,  litigation,  which could
result in  substantial  cost to and  diversion of effort by the Company,  may be
necessary  to protect  trade  secrets or  know-how  owned by or  licensed to the
Company  or  to  determine  the  enforceability,   scope  and  validity  of  the
proprietary   rights  of  others.   Adverse   determination   in  litigation  or
interference proceedings could subject the Company to significant liabilities to
third parties, require the Company to seek licenses from third parties and could
prevent the Company from  manufacturing  and selling its products,  all of which
could  have a  material  adverse  effect on the  Company's  business,  financial
condition  and  results  of  operations.  (See  "Risk  Associated  with  Pending
Litigation";  "Item 1.  Description of Business";  "Item 3. Legal  Proceedings;"
March 31, 1997 10-Q, Part II "Item 1. Legal Proceedings.")

         POSSIBLE PATENT  INFRINGEMENTS.  In the medical products  segment,  the
Company  is aware of  patents  relating  to laser  technologies  used in certain
applications.  The  Company  intends to pursue  such laser  technologies  in the
future;  hence,  if the  patents  relating to those  technologies  are valid and
enforceable, they may be infringed by the Company. After consulting with outside
counsel to the Company, the Company believes that it is not infringing currently
on patents held by others; however, were the issue ever to be litigated, a court
could reach a different  opinion.  If the Company's current or proposed products
are, in the opinion of patent counsel,  infringing on any of these patents,  the
Company intends to seek non-exclusive,  royalty-bearing licenses to such patents
but  there can be no  assurance  that any such  license  would be  available  on
favorable  terms,  if at all. One of the Company's  competitors  in the cosmetic
laser business has filed suit against the Company alleging patent  infringement,
among other things. In the electronic products segment, the Company has not been
notified  that it is  currently  infringing  on any  patents nor has it been the
subject  of any  patent  infringement  action.  No  assurance  can be given that
infringement  claims will not be made or that the Company  would  prevail in any
legal action with respect thereto.  Defense of a claim of infringement  would be
costly and could have a material adverse effect on the Company's business,  even
if the Company were to prevail.

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

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

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

         The  Company  is  dependent  on  various  sales   representatives   and
distributors  to market and sell its  medical  products.  The  Company is in the
process of  expanding  its direct  sales force to ensure that it  satisfactorily
masters and controls  the expected  growth of its medical  product  sales.  (See
"Item 1. Description of Business.")

         ISSUANCE OF  PREFERRED  STOCK AND  DEBENTURES  COULD  AFFECT  RIGHTS OF
COMMON  SHAREHOLDERS.  The Company is authorized to issue up to 5 million shares
of Preferred Stock,  $.01 par value. The Preferred Stock may be issued in one or
more series, the terms of which may be determined at the time of issuance by the
Board of Directors,  without  further  action by  shareholders,  and may include
voting rights  (including the right to vote as a series on particular  matters),
preferences as to dividends and  liquidation,  conversion and redemption  rights
and sinking fund  provisions.  In July 1996,  the Company issued 6,000 shares of
Series F  Convertible  Preferred  Stock  at a price  of  $1,000  per  share.  In


                                       38
<PAGE>

September  1996, the Company issued 10,000 shares of Series G Preferred Stock at
a price of $1,000 per share.  As of July 8, 1997,  2,316  shares were  converted
into 362,824  shares of common stock.  In March 1997,  the Company  issued 6,000
shares of Series H Convertible  Preferred  Stock at a price of $1,000 per share.
In May 1997, the Company issued 10,000 shares of Series H Convertible  Preferred
Stock at a price of $1,000 per share.  In July 1996,  the Company  issued  9,675
units in a convertible debenture financing. Each unit consisted of a convertible
debenture  denominated in 1,000 Swiss Francs and a warrant to purchase 24 shares
of the Company's  common stock at $16.50 per share.  In February 1997, 300 units
were  redeemed by the Company for an  aggregate  price of  $195,044.  In October
1996, the Company issued $5,000,000 in 4.5% Convertible  Subordinated Promissory
Notes.  As of July 8,  1997,  $3,900,000  principal  amount was  converted  into
896,657  shares of common stock.  In December 1996 and January 1997, the Company
issued a total of $6,000,000 in 5% Convertible Debentures.  Also, In March 1997,
the Company issued $5,500,000 in 5% Convertible  Debentures.  In March 1997, the
Company issued $500,000 in 6% Convertible  Debentures.  The issuance of any such
additional  Preferred Stock or Debentures could affect the rights of the holders
of Shares,  and could  reduce the market  price of the  Shares.  In  particular,
specific rights granted to future holders of Preferred Stock or Debentures could
be used to restrict the Company's  ability to merge with or sell its assets to a
third party,  thereby  preserving control of the Company by the existing control
group.  (See "Item 1.  Description  of Business," and "Item 5. Market for Common
Equity and Related Stockholder  Matters," Notes 4 and 5 to Financial Statements;
March 31, 1997 Form 10-Q, Part II, "Item 2. Changes in Securities" and Note 9 to
Financial Statements.)


         ISSUANCE OF RESERVED SHARES;  REGISTRATION  RIGHTS. As of July 8, 1997,
the Company had 33,123,190 Shares of Common Stock  outstanding.  The Company has
reserved an additional  31,371,850 Shares for issuance as follows: (1) 3,872,500
Shares for  issuance to key  employees,  officers,  directors,  consultants  and
advisors  pursuant to the Company's  Stock Option Plans;  (2) 212,690 Shares for
issuance to employees,  officers and directors  pursuant to the Company's 401(k)
Plan; (3) 997,586 Shares for issuance  pursuant to the Company's  Employee Stock
Purchase Plan; (4) 9,577,940 Shares for issuance upon exercise of three-,  four-
five- and seven-year Warrants issued to certain lenders, investors, consultants,
directors  and officers (a portion of which are subject to certain  antidilutive
adjustments);  (5) 600,000  Shares for  issuance  upon  conversion  of the 6,000
shares of Series F Preferred  Stock;  (6)  1,337,176  Shares for  issuance  upon
conversion of the 7,684 shares of Series G Preferred Stock (7) 1,275,000  Shares
for   issuance   upon   conversion   of  the   debentures   sold  in  the  Swiss
Franc-Denominated  Offering;  (8) 403,503 Shares for issuance upon conversion of
$1,500,000 principal amount of a 4.5% Convertible  Subordinated Promissory Note;
(9) 2,300,000 Shares for issuance upon conversion of $6,000,000 principal amount
of  a 5%  Convertible  Debentures;  (10)  2,750,000  Shares  for  issuance  upon
conversion of $5,500,000  principal amount of a 5% Convertible  Debenture;  (11)
45,455 Shares for issuance upon conversion of $500,000 6% Convertible Debentures
and (12) 8,000,000  Shares for issuance upon  conversion of the 16,000 shares of
Series H Preferred.  All of the  foregoing  reserved  Shares are, or the Company
intends for them shortly to be,  registered  with the  Commission  and therefore
freely salable on Nasdaq or elsewhere.

         PRODUCT  LIABILITY  EXPOSURE.  Cosmetic laser product companies face an
inherent business risk of financial  exposure to product liability claims in the
event that the use of their products results in personal  injury.  The Company's
products are and will continue to be designed with numerous safety features, but
it is possible  that patients  could be adversely  affected by use of one of the
Company's products or that deaths could occur. Further, in the event that any of
the Company's  products  prove to be  defective,  the Company may be required to
recall and redesign such products.  Although the Company has not experienced any
material  losses  due to  product  liability  claims  to date,  there  can be no
assurance  that it will not  experience  such losses in the future.  The Company
maintains general liability insurance in the amount of $1,000,000 per occurrence
and $2,000,000 in the aggregate and maintains umbrella coverage in the aggregate
amount of  $25,000,000;  however,  there can be no assurance  that such coverage
will  continue to be available on terms  acceptable  to the Company or that such
coverage will be adequate for liabilities  actually  incurred.  In the event the
Company  is found  liable for  damages in excess of the limits of its  insurance
coverage,  or if any claim or  product  recall  results in  significant  adverse
publicity against the Company,  the Company's business,  financial condition and
results of operations could be materially and adversely  affected.  In addition,
although the  Company's  products  have been and will continue to be designed to
operate in a safe manner,  and although the Company  attempts to educate medical
personnel  with  respect  to  the  proper  use of its  products,  misuse  of the
Company's  products  by medical  personnel  over whom the Company  cannot  exert
control  may  result in the filing of product  liability  claims or  significant
adverse publicity against the Company.

         RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. As part of its business
strategy,  the Company intends to seek  opportunities  to expand its product and
service  offerings  into  international  markets.  In marketing its products and
services  internationally,  the Company will likely face new competitors.  There
can be no  assurance  that  the  Company  will be  successful  in  marketing  or
distributing  products and services in these  markets or that its  international
revenue will be adequate to offset the expense of  establishing  and maintaining
international operations.  The Company's international business may be adversely
affected by changing economic  conditions in foreign countries.  The majority of
the Company's sales are currently  denominated in U.S. dollars, but there can be
no  assurance  that a  significantly  higher  level of future  sales will not be


                                       39
<PAGE>

denominated  in  foreign  currencies.  To the  extent the  Company  makes  sales
denominated  in  currencies  other  than U.S.  dollars,  gains and losses on the
conversion of those sales to U.S.  dollars may contribute to fluctuations in the
Company's business,  financial condition and results of operations. In addition,
fluctuations  in exchange  rates could affect demand for the Company's  products
and services.  Conducting an international business inherently involves a number
of other  difficulties and risks, such as export  restrictions,  export controls
relating  to  technology,  compliance  with  existing  and  changing  regulatory
requirements,  tariffs and other trade  barriers,  difficulties  in staffing and
managing international operations, longer payment cycles, problems in collecting
accounts  receivable,  political  instability,  seasonal  reductions in business
activity  in Europe  and  certain  other  parts of the world  during  the summer
months, and potentially adverse tax consequences. There can be no assurance that
one or more of these  factors  will not have a  material  adverse  effect on any
international  operations established by the Company and,  consequently,  on the
Company's business, financial condition and results of operations.

         The Company plans to expand its business into international markets and
has set up a manufacturing and distribution  center in Hull,  England.  To date,
the Company has minimal  experience in marketing and  distributing  its products
internationally  and plans to  establish  alliances  with  sales  representative
organizations and resellers with particular experience in international markets.
Accordingly,   the   Company's   success  in   international   markets  will  be
substantially  dependent  upon the skill  and  expertise  of such  international
participants in marketing the Company's products. There can be no assurance that
the Company will be able to successfully  market,  sell and deliver its products
in these  markets.  In  addition,  there are  certain  risks  inherent  in doing
business in  international  markets,  such as  unexpected  changes in regulatory
requirements,   export   restrictions,   tariffs  and  other   trade   barriers,
difficulties in staffing and managing foreign  operations,  management's lack of
international  expertise,  political  instability  and  fluctuations in currency
exchange rates and potentially  adverse tax consequences,  which could adversely
impact the success of the Company's  international  operations.  There can be no
assurance  that one or more of such  factors  will not have a  material  adverse
effect on the Company's future international  operations and,  consequently,  on
the company's business,  financial condition or operating results. (See "Item 1.
Description of Business.")

         NEED FOR CONTINUED PRODUCT  DEVELOPMENT.  Although the Company received
FDA clearance in February 1997 to commercially market its Tru-Pulse(R) laser for
wrinkle treatment, and in March 1997 to commercially market its Epilaser(TM) for
hair removal,  the Company is continuing its  development of both products.  The
Company is continuing to study both laser  systems to optimize  performance  and
treatment parameters.

         DEPENDENCE ON SOLE SUPPLIERS.  The Company relies on outside  suppliers
for  substantially  all of its  manufacturing  supplies,  parts and  components.
Pyralux(R),  an integral  component of most of the  Company's  flexible  circuit
products,  is  manufactured  exclusively  by E.I. du Pont de Nemours and Company
("DuPont"). Although the Company has a written agreement with DuPont under which
DuPont will supply the Company with all of its requirements  for Pyralux,  there
can be no assurance that the Company will be able to obtain a sufficient  supply
of Pyralux to fulfill orders for its products in a timely manner, if at all.

         In  addition,  CO2 laser  tubes,  an  integral  component  of  Tissue's
Tru-Pulse  Laser system,  are  manufactured  exclusively by Pulse Systems,  Inc.
There can be no  assurance  that the Company  will be able to obtain  sufficient
supply of CO2 laser tubes to fulfill orders for its products in a timely manner,
if at all. Furthermore,  several other component parts of the Company's cosmetic
laser products and electronic  segment products are manufactured  exclusively by
one supplier.  There can be no assurance that the Company will be able to obtain
a sufficient  supply of such components at commercially  reasonable prices or at
all. A shortage  of  necessary  parts and  components  or the  inability  of the
Company to obtain such parts and components would have a material adverse effect
on the Company's business,  financial condition and results of operations.  (See
"Item 1. Description of Business.")

         DEPENDENCE ON  SUBSTANTIAL  CUSTOMERS.  In the year ended  December 31,
1996, one customer of Nexar,  Government  Technology  Services,  Inc. ("GTSI), a
leading  supplier  of desktop  systems  to United  States  government  agencies,
accounted  for  17.5% of the  Company's  revenues  and  23.2%  of the  Company's
accounts receivable balance. In the quarter ended March 31, 1997, GTSI accounted
for 9.0% of the Company's revenues and 9.4% of the Company's accounts receivable
balance.  The  Company  expects  that  GTSI  will  continue  to be an  important
customer,  and that, while Nexar's revenues from GTSI will increase,  such sales
as a  percentage  of total  revenue will  decline  substantially  as the Company
further expands its distribution  network and increases its overall sales. Nexar
has entered  into an  agreement  with GTSI  pursuant to which GTSI serves as the
Company's  exclusive  federal  reseller  with  respect  to  Government  Services
Administration (GSA) scheduled purchases,  provided that GTSI purchases at least
$35 million of Nexar's  products in 1997. GTSI is under no obligation,  however,
to purchase  any products of Nexar.  If GTSI makes fewer  purchases in 1997 than
the  Company  anticipates,  that  would have a  material  adverse  effect on the
Company.

                                       40
<PAGE>

         In the year ended December 31, 1996, one customer of Comtel, New Media,
Inc.  ("New  Media"),  a related  party,  accounted  for 22.3% of the  Company's
revenues and 26.7% of the Company's accounts  receivable balance. In the quarter
ended March 31, 1997,  New Media  accounted for 11.6% of the Company's  revenues
and 18.3% of the Company's accounts receivable balance.  Comtel has entered into
a five (5) year  agreement  with New Media whereby New Media,  subcontracted  to
Comtel all of its manufacturing and assembly business over the contract term. On
April 5, 1996,  Palomar  invested  $2,345,000 in New Media  preferred and common
stock and loaned New Media an  additional  $1,000,000.  Palomar also  received a
warrant to  purchase  200,000  shares of common  stock in New Media at $1.20 per
share.  In February 1997, the note  receivable was converted into equity and the
Company invested an additional $1,200,000 in New Media. The Company expects that
New Media  will  continue  to be an  important  customer,  but that sales to New
Media,  Inc. as a percentage of total revenue will decline  substantially as the
Company  further  expands its  distribution  network and  increases  its overall
sales. New Media has had a history of losses. There can be no assurance that New
Media will achieve profitable  operations or that profitable  operations will be
sustained if achieved.

         A loss from either  customer  could have a material,  adverse effect on
the Company's business in the short term. (See "Item 1. Description of Business"
and Note 2 to Financial Statements.)

         HAZARDOUS SUBSTANCE AND ENVIRONMENTAL  CONCERNS;  LACK OF ENVIRONMENTAL
IMPAIRMENT  INSURANCE.   The  manufacture  of  substrate  interconnect  products
involves  numerous  chemical  solvents and other solid,  chemical and  hazardous
wastes and  materials.  Dynaco is subject  to a variety  of  environmental  laws
relating to the generation,  storage,  handling,  use,  emission,  discharge and
disposal of these substances and potentially  significant risks of statutory and
common law liability for environmental  damage and personal injury. The Company,
and in certain  circumstances,  its officers,  directors and  employees,  may be
subject to claims arising from the Company's manufacturing activities, including
the  improper  release,   spillage,   misuse  or  mishandling  of  hazardous  or
non-hazardous  substances  or material.  The Company may be strictly  liable for
damages,  regardless  of whether it  exercised  due care and  complied  with all
relevant  laws  and  regulations.   The  Company  does  not  currently  maintain
environmental  impairment insurance.  There can be no assurance that the Company
will not face claims resulting in substantial liability for which the Company is
uninsured  or that  hazardous  substances  are not or will not be present at the
Company's  facilities.   The  Company  believes  that  it  operates  its  Dynaco
facilities  in  substantial  compliance  with  existing  environmental  laws and
regulations. In June 1989 and April 1994, Dynaco conducted environmental studies
of its Tempe, Arizona substrate  manufacturing facility and did not discover any
contamination  requiring  remediation.  Failure to comply with proper  hazardous
substance handling procedures or violation of environmental laws and regulations
would have a material  adverse effect on the Company.  (See "Item 1. Description
of Business.")

         SIGNIFICANT OUTSTANDING INDEBTEDNESS;  SUBORDINATION OF DEBENTURES. The
Company has incurred substantial  indebtedness in relation to its equity capital
and will be subject to all of the risks  associated with  substantial  leverage,
including  the risk that  available  cash may not be adequate  to make  required
payments to the holders of the Company's  debentures.  The Company's  ability to
satisfy its  obligations  under the debentures  from cash flow will be dependent
upon the Company's future performance and will be subject to financial, business
and other factors  affecting the operation of the Company,  many of which may be
beyond the Company's control.  In the event the Company does not have sufficient
cash resources to satisfy quarterly  interest or other repayment  obligations to
the  holders  of the  debentures,  the  Company  will be in  default  under  the
debentures,  which would have a material  adverse effect on the Company.  To the
extent that the Company is required to use cash  resources  to satisfy  interest
payments to the holders of the debentures, it will have less resources available
for other  purposes.  Inability  of the  Company  to repay the  debentures  upon
maturity would have a material adverse effect on the Company, which could result
in a reduction of the price of the  Company's  Shares.  The  debentures  will be
unsecured and subordinate in right of payment to all senior  indebtedness of the
Company.  The  debentures  do  not  restrict  the  Company's  ability  to  incur
additional senior indebtedness and most other indebtedness.  The terms of senior
indebtedness  now existing or incurred in the future could affect the  Company's
ability  to make  payments  of  principal  and/or  interest  to the  holders  of
debentures.  (See  "Item 5.  Market for Common  Equity and  Related  Shareholder
Matters";  March 31, 1997 Form 10-Q, Part II "Item 2. Changes in Securities" and
Note 8 to Financial Statements.

         POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS. The Company is subject to
the anti-takeover  provisions of Section 203 of the Delaware General Corporation
Law, which prohibit the Company from engaging in a "business  combination"  with
an  "interested  stockholder"  for a period of three years after the date of the
transaction  in which the person becomes an interested  stockholder,  unless the
business  combination  is approved in a prescribed  manner.  The  application of
Section 203 could have the effect of delaying or  preventing a change of control


                                       41
<PAGE>

of the Company.  The  Company's  stock option  grants  generally  provide for an
exercise of some or all of the optioned stock, including non-vested shares, upon
a change of control or similar  event.  The Board of Directors  has authority to
issue  up to  5,000,000  shares  of  Preferred  Stock  and  to fix  the  rights,
preference,  privileges and  restrictions,  including  voting  rights,  of these
shares without any further vote or action by the stockholders. The rights of the
holders of the Common  Stock will be subject to, and may be  adversely  affected
by, the rights of the holders of any  Preferred  Stock that may be issued in the
future. The issuance of Preferred Stock, while providing  desirable  flexibility
in connection with possible  acquisitions  and other corporate  purposes,  could
have the  effect of  making it more  difficult  for a third  party to  acquire a
majority of the  outstanding  voting  stock of the  Company,  thereby  delaying,
deferring or  preventing a change in control of the Company.  Furthermore,  such
Preferred Stock may have other rights,  including  economic rights senior to the
Common Stock, and, as a result,  the issuance of such Preferred Stock could have
a  material  adverse  effect  on the  market  value of the  Common  Stock.  (See
"Issuance  of  Preferred  Stock and  Debentures  Could  Affect  Rights of Common
Shareholders.")

         RISKS  ASSOCIATED  WITH  PENDING   LITIGATION.   The  Company  and  its
subsidiaries  are involved in disputes  with third  parties.  Such disputes have
resulted  in  litigation  with such  parties  and,  although  the  Company  is a
plaintiff in several matters, the Company is subject to claims and counterclaims
for damages and has 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 the  Company.  The Company is unable to
determine  the total expense or possible  loss,  if any, that may  ultimately be
incurred in the  resolution  of these  proceedings.  These matters may result in
diversion of  management  time and effort from the  operations  of the business.
After  consideration of the nature of the claims and the facts relating to these
proceedings,  the Company believes that the resolution of these proceedings will
not have a material effect on the Company's  business,  financial  condition and
results of operations; however, the results of these proceedings,  including any
potential  settlements,  are  uncertain  and there can be no  assurance  to that
effect.

         On October 7, 1996 the  Company  filed a  declaratory  judgment  action
against  MEHL/Biophile  ("MEHL")  in the  United  States  District  Court of the
District of  Massachusetts  seeking (i) a declaration that MEHL is without right
or authority to threaten or maintain  suit against the Company or its  customers
for  alleged  infringement  of the  patent  held  by  MEHL's  subsidiary  Selvac
Acquisitions Corp. ("Selvac" and the "Selvac Patent"), that the Selvac Patent is
invalid,  void and  unenforceable,  and that the Company  does not  infringe the
Selvac patent; (ii) a preliminary and permanent  injunction  enjoining MEHL from
threatening  the  Company  or its  customers  with  infringement  litigation  or
infringement;  and  (iii)  an  award  to the  Company  of  damages  suffered  in
connection with MEHL's conduct.  On March 7, 1997,  Selvac filed a complaint for
injunctive relief and damages for patent infringement and for unfair competition
against the Company,  its Spectrum Medical  Technologies and Spectrum  Financial
Services  subsidiaries,  and a New Jersey  dermatologist,  in the United  States
District Court for the District of New Jersey.  Selvac's  complaint alleges that
the Company's EpiLaser infringes the Selvac Patent and that the Company unfairly
competed by promoting  the  EpiLaser or hair removal  before it had received FDA
approval for that  specific  application.  The Company and Selvac have agreed to
dismiss the Massachusetts  litigation without prejudice.  Palomar has brought in
the New Jersey  action its claims that the Selvac  patent is  invalid,  that the
Company has not infringed the Selvac  patent,  that MEHL should be enjoined from
making further assertions  concerning  infringement and unfair competition,  and
that the Company should be awarded attorney fees and other  appropriate  relief.
Thus,  both the  Company's  and MEHL's claims will be tried on the merits in New
Jersey. Automatic discovery will commence shortly. The extent of exposure of the
Company cannot be determined at this time.

         The  Company  is  a  defendant  in  a  lawsuit  filed  by  Commonwealth
Associates  ("Commonwealth")  on March 14,  1996 in the United  States  District
Court for the Southern District of New York. In its suit,  Commonwealth  alleges
that the Company breached a contract with Commonwealth in which Commonwealth was
to  provide  certain   investment   banking   services  in  return  for  certain
compensation. In January 1997, Commonwealth's motion for summary judgment on its
breach of  contract  claim was  granted,  and,  after a damages  trial  before a
magistrate judge in April 1997, the court awarded  Commonwealth  $2,917,500 (and
interest of  $256,570.56).  The Company  will appeal the matter and believes its
grounds for appeal are meritorious. (See March 31, 1997 Form 10-Q "Part II, Item
1. Legal Proceedings.")





                      This space intentionally left blank]


                                       42
<PAGE>


ITEM 7. FINANCIAL STATEMENTS




                       PALOMAR MEDICAL TECHNOLOGIES, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<S>                                                                                              <C>

Report of Independent Public Accountants                                                         F-2

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

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

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

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

Notes to Consolidated Financial Statements                                                       F-10

</TABLE>


                                      F-1
<PAGE>


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To Palomar Medical Technologies, Inc. and Subsidiaries:

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

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

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







                                                             ARTHUR ANDERSEN LLP



Boston,  Massachusetts,  
March  7,  1997  (Except  with  respect
to the  matter discussed in Note15(a) as 
to which the date is March 31, 1997)



                                       F-2
<PAGE>


              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES


                          CONSOLIDATED BALANCE SHEETS

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

                                                                                 December 31,         December 31,
                                                                                     1995                1996
ASSETS

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

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

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

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:

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

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

Commitments and Contingencies (Note 13)

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

</TABLE>

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

                                      F-3

<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF OPERATIONS






                                                    Year ended December 31,
                                                         1995            1996

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

Cost of evenues                                       17,192,470     63,177,555
                                                     -----------    -----------
      Gross profit                                     4,714,034      6,920,888
                                                     -----------    -----------

Operating Expenses

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

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

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

Interest Income                                          913,050      1,586,620

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

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

Other Income (Expense)                                   102,305     (4,245,642)
                                                     -----------    -----------
      Net loss                                      $(12,620,768)  $(37,863,792)
                                                     ===========   ============

Net Loss Per Common Share                              $(0.89)        $(1.49)
                                                     ==========    ============

Weighted Average Number of
    Common Shares Outstanding                        14,164,901      26,166,538
                                                     ==========    ============

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

                                       F-4
<PAGE>

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES


                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


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


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

Balance, December 31, 1994                                       --            $--     9,464,963  $94,649          --        $--

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

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





                                                          Additional                 Unrealized                          Total
                                                           Paid-in    Accumulated       Loss On        Subscriptions  Stockholders'
                                                           Capital     Deficit   Marketable Securities   Receivable      Equity
                                                         --------------------------------------------------------------------------

Balance, December 31, 1994                                   $15,773,109 $(13,119,279)       $--            $--         $2,748,479

   Sale of common stock pursuant to warrants and options       7,588,888      --              --    (4,633,975)          2,984,164
   Sale of common stock                                        2,935,921      --              --             --          2,952,144
   Payments received on subscriptions receivable                  --          --              --     3,694,840           3,694,840
   Issuance of preferred stock, including common stock 
          issued as as a placement fee, net of 
          issuance costs                                      19,382,750      --              --              --        19,385,963
   Purchase of treasury stock                                     --          --              --              --        (1,211,757)
   Issuance of common stock in lieu of payment of notes 
     payable                                                   1,873,611      --              --              --        1,879,932
   Repayment of convertible debentures                          (321,533)     --              --              --         (321,533)
   Conversion of convertible debentures                        3,071,302      --              --              --        3,090,740
   Value ascribed to convertible debentures                      899,813      --              --              --          899,813
   Value ascribed to warrant in exchange for license technolo    100,000      --              --              --          100,000
   Issuance of common stock for technology                       292,605      --              --              --          300,000
   Conversion of preferred stock                                  68,377      --              --              --           86,060
   Exercise of underwriter's warrants                          1,049,574      --              --        (1,049,574)         2,000
   Issuance of common stock for Spectrum Medical Tech., Inc.     996,358      --              --               --       1,000,000
   Issuance of common stock for investment banking and merger
             and acquisition consulting services                 416,823      --              --               --         418,500
   Amortization of deferred financing costs                      (70,583)     --              --               --         (70,583)
   Compensation expense related to warrants issued to
             consultants and investment bankers                   95,370      --              --               --          95,370
   Preferred stock dividends                                      --         (124,610)        --               --        (124,610)
   Net loss                                                       --      (12,620,768)        --               --     (12,620,768)
                                                            ----------------------------------------------------------------------
Balance, December 31, 1995                                   $54,152,385 $(25,864,657)       $--       $(1,988,709)   $25,288,754
                                                            =======================================================================
</TABLE>

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


                                       F-5
<PAGE>


              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                  (continued)

<TABLE>


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

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

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

</TABLE>


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

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

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

</TABLE>


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

                                       F-6
<PAGE>
                                    


PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS

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

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

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


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

                                       F-7
<PAGE>
                                     

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (continued)

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

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

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

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

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

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

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

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

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

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

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

                                       F-8
<PAGE>
                                    

              PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (continued)


<TABLE>

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

Supplemental Disclosure of Noncash Financing and Investing Activities

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

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

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

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

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

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

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

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

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

                                      F-9

<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)  ORGANIZATION AND OPERATIONS

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

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

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

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

MEDICAL SEGMENT BUSINESS DEVELOPMENTS

STAR MEDICAL TECHNOLOGIES, INC.

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

SPECTRUM MEDICAL TECHNOLOGIES, INC.

         On April 5, 1995, the Company  acquired all of the  outstanding  common
stock of Spectrum Medical Technologies,  Inc.  ("Spectrum").  The purchase price
consisted  of $300,000 in cash, a $700,000  two-year  promissory  note,  364,178
shares of the  Company's  common  stock with an  aggregate  fair market value of
$1,000,000,  acquisition  costs of  $161,138  and assumed  liabilities  totaling


                                       F-10
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  (CONTINUED)

$1,128,139.  In addition, the purchase price includes a 20% contingency payment,
payable  in  the  Company's  common  stock,   based  upon  the  future  earnings
performance of Spectrum over a three to five-year period, which will be recorded
as additional  goodwill if earned.  Spectrum develops,  manufactures,  sells and
services  ruby  lasers  throughout  the  world for  dermatological  applications
including the recently (March 1997) FDA approved  EpiLaser.  The acquisition has
been accounted for as a purchase in accordance with Accounting  Principles Board
("APB") Opinion No. 16.

SPECTRUM FINANCIAL SERVICES LLC

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

TISSUE TECHNOLOGIES, INC.

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

DERMASCAN, INC.

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

PALOMAR TECHNOLOGIES, LTD.

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

PALOMAR MEDICAL PRODUCTS, INC.

         In February 1997,  Palomar Medical  Products,  Inc.  ("Palomar  Medical
Products")  was formed  with the purpose of  consolidating  the  management  and
operations of the medical products companies. In January 1997, the Company named
an outside party as the President and CEO of Palomar Medical Products to oversee
and  manage the  operations.  Included  in the  medical  products  group are the
following companies; Spectrum, Tissue, Star, Dermascan and Palomar Technologies,
Ltd.


                                       F-11
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  (CONTINUED)

COSMETIC TECHNOLOGY INTERNATIONAL, INC.

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

NEXAR TECHNOLOGIES, INC.

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

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

         On April 14,  1997 Nexar  completed  its  initial  public  offering  of
2,500,000 shares of its common stock for its own account, as well as shares held
by Nexar  shareholders.  The price per  share  was $9.00 and Nexar  raiseed  net
proceeds of approximately $20.3 million.  Following this offering,  Palomar will
beneficially  own  approximately  67% of Nexar's common stock.  Included in this
percentage is (i) 1,200,000 shares of Nexar's common stock owned by Palomar that
are subject to a contingent  repurchase right by Nexar for an aggregate price of
$12,000 in the event that Nexar does not achieve certain performance  milestones
set forth in an agreement between Nexar and Palomar,  and (ii) 408,000 shares of
Nexar  common  stock which  Palomar may acquire  upon the  conversion  of 45,684
shares of Nexar  Convertible  Preferred  Stock that it also owns.  The 1,200,000
shares of common stock subject to the contingent  repurchase right of Nexar will
be held in escrow and released to Palomar upon Nexar  attaining  certain revenue
levels  ranging from $100 million to $400 million and net income levels  ranging
from $7 million to $28 million over a four year period ending December 31, 2000,
as defined in the agreement between Nexar and the Company. These shares may also
be released  from escrow upon Nexar  attaining a specified  minimum  stock price
ranging  from  $15.75 per share to $29.25  per share over this four year  period
ending  December 31, 2000,  and if the Company  achieves  cumulative  net income
totaling  $70,000,000  through  December  31,  2000.  These  shares will also be
released  if Nexar is party to any  merger or sale of  substantially  all of its
assets.

         Upon  completion  of  the  offering,   Nexar  will  repay  the  Company
approximately $8,200,000 from the net proceeds received from this offering.

CD TITLES, INC.

         On July 13, 1995, CD Titles,  Inc. ("CD Titles") was incorporated.  The
Company owns substantially all of CD Titles'  outstanding  common stock.  During
July 1995,  certain minority  stockholders of CD Titles loaned CD Titles a total
of $600,000.  On July 31, 1995, CD Titles  purchased  certain assets and assumed
certain  liabilities  of CD  Titles  totaling  $1,271,345.  The  purchase  price
consisted  of $625,000 in cash and a $600,000  note  payable due  September  30,
1995,  which was  guaranteed  by the Company.  CD Titles is a CD ROM  publishing
company that distributes  various  materials on CD ROM through personal computer


                                       F-12
<PAGE>
               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  (CONTINUED)

wholesale  channels in the United States. The acquisition has been accounted for
as a purchase in accordance with the APB No. 16.

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

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

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

PALOMAR ELECTRONICS CORPORATION

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

COMTEL ELECTRONICS, INC.

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

                                       F-13
<PAGE>
               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  (CONTINUED)

PRO FORMA INFORMATION

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

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

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

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


                                       F-14
<PAGE>
               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  (CONTINUED)

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


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

         Separate  and combined  results of the Company and Tissue  Technologies
preceding the merger were as follows:
<TABLE>
<S>     <C>                                                 <C>                <C>               <C>

                                                              Tissue            Palomar          Combined

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

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

(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

(A)  PRINCIPLES OF CONSOLIDATION

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

(B)  MANAGEMENT ESTIMATES

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

(C)  INVESTMENTS

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


                                       F-15
<PAGE>

evaluate  whether a  permanent  impairment  has  occurred.  The amount  that the
Company  realizes  from  these  investments  may differ  significantly  from the
amounts recorded in the accompanying consolidated financial statements.

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

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

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

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


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

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

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

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

</TABLE>


(D)  INVENTORIES

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

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


                                 F-16
<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
               ------------------------------------            -----------------
               Equipment under capital leases                      Term of Lease
               Machinery and Equipment                               5-8 Years
               Furniture and Fixtures                                 5 Years
               Leasehold improvements                              Term of Lease

        Property and Equipment consist of the following:

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

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

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


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

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

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


                                       f-17
<PAGE>

estimated  future cash flows to be  generated  by such  assets.  The Company had
write-offs totaling  approximately  $1,032,000 associated with the realizability
of certain  licenses  and  goodwill.  This  amount is  included  in general  and
administrative expenses in the accompanying consolidated statement of operations
for the year ended December 31, 1996.

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

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

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

(G)  DEFERRED COSTS

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

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

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

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

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


                                       F-18
<PAGE>

(H)  REVENUE RECOGNITION

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

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

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

(I)   SIGNIFICANT CUSTOMERS

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

(J)  RESEARCH AND DEVELOPMENT EXPENSES

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

(K)  NET LOSS PER COMMON SHARE

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

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

(L)  CONCENTRATION OF CREDIT RISK

         SFAS No. 105,  DISCLOSURE OF INFORMATION  ABOUT  FINANCIAL  INSTRUMENTS
WITH  OFF-BALANCE-SHEET  RISK AND FINANCIAL  INSTRUMENTS  WITH  CONCENTRATION OF
CREDIT RISK,  requires  disclosures  of any  significant  off-balance-sheet  and
credit risk  concentrations.  Financial  instruments that subject the company to
credit risk consist primarily of cash and trade accounts receivable. The Company
places its cash in highly  rated  financial  institutions.  The Company also has
convertible debentures denominated in Swiss francs of $7,222,846 at December 31,


                                       F-19
<PAGE>

1996 (see Note 4(c)).  The Company  currently  does not have a foreign  currency
hedging  arrangement  and plans to hedge this amount in 1997. The Company has no
other significant off-balance-sheet concentration of credit risk such as foreign
exchange contracts, options contracts or other foreign hedging arrangements.  To
reduce  its  accounts  receivable  risk,  the  Company  routinely  assesses  the
financial  strength of its customers  and, as a  consequence,  believes that its
accounts  receivable  credit risk exposure is limited.  The Company maintains an
allowance for potential credit losses. The Company's accounts  receivable credit
risk is not within any  geographic  area.  The Company has issued notes and made
investments to various  related  parties  totaling  $5,076,751as of December 31,
1996 (see Note 11).  Included in this amount are unsecured  loans of $604,653 to
and for the benefit of a director of the Company's  underwriter.  As of December
31, 1996, the Company also made strategic equity investments totaling $2,587,500
in four technology companies.  Subsequent to year-end,  the Company loaned money
to, prepaid fees for,  purchased  inventory on behalf of and made investments in
certain related entities totaling $3,060,000.

  (M)  DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

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

(N)  RECLASSIFICATIONS

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

(3)  INCOME TAXES

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


                                       F-20
<PAGE>

(4)  LONG-TERM DEBT

  (A)  NOTES PAYABLE

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

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

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

  (B)  DOLLAR DENOMINATED CONVERTIBLE DEBENTURES

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

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


                                       F-21
<PAGE>

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

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

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

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

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

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

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

(C) SWISS FRANC DENOMINATED CONVERTIBLE DEBENTURES

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


                                       F-22
<PAGE>

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

(D)  FUTURE MATURITIES OF LONG-TERM DEBT OBLIGATIONS

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

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

(5)  STOCKHOLDERS' EQUITY

    (A)  COMMON STOCK OUTSTANDING

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

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


                                       F-23
<PAGE>

  (B)  PREFERRED STOCK

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

       As of December 31, 1995 and 1996, preferred stock authorized,  issued and
outstanding consists of the following:
<TABLE>
<S>    <C>                                                                                         <C>             <C>    

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

           Total preferred stock                                                                    $139              $182
                                                                                                    ====              ====

</TABLE>


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

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

         In July 1996,  the Company  issued  6,000 shares of Series F redeemable
convertible  preferred  stock at a price  of  $1,000  per  share.  The  Series F
redeemable  convertible  preferred  stock,  together with any accrued but unpaid
dividends,  may be  converted  into shares at 80% of the daily  average  closing
price of the shares on the ten trading days preceding such conversion, but in no

                                       F-24
<PAGE>

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

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

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

  (C) STOCK OPTION PLANS AND WARRANTS

     (I)     STOCK OPTIONS

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

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


                                       F-25
<PAGE>

         The  following  table  summarizes  all stock  option  activity  for the
Company:

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

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

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

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

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

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

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

                                       F-26
<PAGE>

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

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

     The following table summarizes stock option activity for Nexar:
<TABLE>
<S>                                                         <C>                      <C>                 

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

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

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

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

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

                                       F-27
<PAGE>

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

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

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


                                                                 1995                         1996
                                                        ------------------------     -----------------------

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

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

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

                                                                     1995                    1996
                                                              --------------------    -------------------

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

</TABLE>

                                       F-28
<PAGE>

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

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

                                                                 1995                         1996
                                                        ------------------------     -----------------------

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

         (II)  WARRANTS

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

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

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

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


                                       F-29
<PAGE>

Company issued 1,978,058 warrants during 1996 in connection with preferred stock
for a total  Black  Scholes  value of  $13,325,477.  The Company  issued  36,553
warrants  during 1996 in investment  banking fees in connection  with financings
for a total Black Scholes  value of $119,894.  The Company has not reflected the
value   attributable  to  these  warrants  in  the  consolidated   statement  of
stockholders'  equity due to the fact that the issuance of these  warrants  were
directly  associated  with the issuance of  convertible  debentures,  common and
preferred  stock and the  Company  believes  it is the  intent of the  debenture
holders to convert  their  debentures  into common stock on a short-term  basis.
Accordingly,  the value of those  warrants  would  both  increase  and  decrease
additional paid-in capital.

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

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

         The following table summarizes all warrant activity for the Company:

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

</TABLE>




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

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

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


                                       F-30
<PAGE>

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

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

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

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

                                                                     1995                    1996
                                                              --------------------    -------------------

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


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

         (III)   PRO FORMA DISCLOSURE

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

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

                                       F-31
<PAGE>

(D)  RESERVED SHARES

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


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

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

  (E)  COMMON STOCK ISSUED IN LIEU OF PAYMENT

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

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

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

(F)  EMPLOYEE STOCK PURCHASE PLAN

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

(6)  RESEARCH & PRODUCT DEVELOPMENT AGREEMENTS

         The  Company  has an  agreement  with the New  England  Medical  Center
("NEMC") and Dr.  Stanley M. Shapshay to provide a research grant and to sponsor


                                       F-32
<PAGE>

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

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

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

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


                                       F-33
<PAGE>

(7)  SEGMENT INFORMATION

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

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

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

(8)  ACCRUED EXPENSES

         Accrued expenses consist of the following:
<TABLE>
<S>                       <C>                                       <C>                   <C>            

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

(9)  OTHER INCOME (EXPENSE)

         Other Income (Expense) consist of the following:
<TABLE>
<S>                       <C>                                      <C>                  <C>              

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


                                       F-34
<PAGE>


(10)  REVOLVING LINES OF CREDIT

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

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

(11) RELATED PARTY TRANSACTIONS

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

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

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

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

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

         A former  director of Palomar is also a director  of a publicly  traded
company.  The Company  loaned  $1,700,000  during 1996 to this  publicly  traded


                                       F-35
<PAGE>

company,  of which $500,000 was paid back as of December 31, 1996. The remaining
balance  outstanding of $1,200,000 is a note receivable which is  collateralized
by a security agreement for manufacturing equipment owned by the publicly traded
company.  The note is also  convertible to common stock at the discretion of the
Company at a  conversion  price of $1.00 per share,  subject  to  adjustment  as
defined.  The  Company  also has three  warrants  to purchase a total of 300,000
shares of common stock at a price of $1.13.

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

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

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

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

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

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


                                       F-36
<PAGE>

(12)  401(K) PROFIT SHARING PLAN

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

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

 (13)  COMMITMENTS AND CONTINGENCIES

(A) OPERATING LEASES

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

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

                December 31,
                   1997                                            $2,151,000
                   1998                                             1,983,000
                   1999                                             1,692,000
                   2000                                             1,350,000
                   2001                                               940,000
                   Thereafter                                       1,002,000
                                                                 -------------
                                                                   $9,118,000
                                                                 =============

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

  (B) ROYALTIES

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

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

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


                                       F-37
<PAGE>

shareholder  of Dynamem,  equal to 2% of net sales  proceeds,  as defined in the
license agreement.  The license agreement expires upon expiration of the patent,
and royalties are  guaranteed by Dynaco.  For the years ended  December 31, 1995
and 1996, amounts incurred under this agreement were immaterial.

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

(C) CONSULTING AGREEMENTS

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

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

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

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

  (D) GOVERNMENT CONTRACTS

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


                                       F-38
<PAGE>


(E)  CONTINGENCIES

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

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

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

  (F) LETTERS OF CREDIT

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

  (G) CORPORATE GUARANTEES

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

  (H)  LITIGATION

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

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

                                       F-39
<PAGE>

(14)  EMPLOYMENT AGREEMENTS

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

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

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

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

(15)  SUBSEQUENT EVENTS

(A) EQUITY AND FINANCING TRANSACTIONS

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

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

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

                                       F-40
<PAGE>

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

(B) LEGAL SETTLEMENTS

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

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

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

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

(C)  COMMITMENTS AND CONTINGENCIES

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


                                       F-41
<PAGE>

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

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


                                       43
<PAGE>


                                    PART III

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

         The following  table sets forth  certain  information  concerning  each
director and nominee for election as a director  and each  executive  officer of
the Company.
<TABLE>
<S>     <C>                                  <C>     <C>   

         Name                                Age     Position
         Louis P. Valente                    66      Chief Executive Officer, President and Director

         Michael H. Smotrich (1)             64      Secretary, Chief Technical Officer and Vice Chairman of the Board
         Steven Georgiev(1)                  62      Chairman of the Board
         Buster C. Glosson                   54      Director
         John M. Deutch                      58      Director
         A. Neil Pappalardo                  55      Director
         James G. Martin                     61      Director
         Joseph P. Caruso                    37      Treasurer, Vice President and Chief Financial Officer
</TABLE>


         (1)  Each of those  persons may be deemed a parent  and/or  promoter of
              the   Company  as  these  terms  are  defined  in  the  Rules  and
              Regulations  promulgated  under  the  Securities  Act of 1933,  as
              amended.

        Shortly  after year end, Mr. Joseph  Levangie  resigned as a director of
the Company and was replaced by Mr. Deutch; Mr. Valente also joined the Board at
that time. Messrs.  Pappalardo and Martin joined the Board in June of this year.
Messrs.  Georgiev and Smotrich will not run for  re-election as directors of the
Company at the Company's 1997 Annual Meeting of Stockholders.

The background of each  director,  officer and key employee of the Company is as
follows:


        LOUIS P.  VALENTE.  Mr.  Valente  became a  director  of the  Company on
February  1, 1997;  on May 14,  1997,  he became  Chief  Executive  Officer  and
President of the Company.  From 1968 to 1995 Mr. Valente held numerous positions
at EG&G, Inc., a diversified  technology company which provides  optoelectronic,
mechanical and electromechanical components and instruments to manufacturers and
end-user  customers  in  varied  markets  that  include  aerospace,  automotive,
transportation,  chemical,  petrochemical,  environmental,  industrial, medical,
photography,  security and other global  arenas.  In 1968 he began his career at
EG&G,  Inc. as an Assistant  Controller and held executive  positions  including
Assistant  Treasurer  and  Corporate  Treasurer  before  becoming a Senior  Vice
President  of EG&G,  Inc.  In this  position  he  presided  over and  negotiated
acquisitions, mergers and investments. Since his retirement in 1995, Mr. Valente
has served in a similar  role on a  consulting  basis.  Currently,  Mr.  Valente
serves as a  director  in Micrion  Corporation,  a publicly  held  company.  Mr.
Valente is a Certified Public Accountant and a graduate of Bentley College.

        MICHAEL H.  SMOTRICH.  Dr.  Smotrich is the  Company's  Chief  Technical
Officer and,  since May 14, 1997,  Vice Chairman of the Board of Directors.  Dr.
Smotrich  was a  consultant  to Dymed from May 1992  until its  merger  with the
Company in September 1992, at which time he became the Company's  Executive Vice
President,  Chief Operating Officer,  Secretary and a director.  In August 1994,
Dr. Smotrich became the Company's President, a position in which he served until
May 14, 1997.  From July 1988 until May 1991,  Dr.  Smotrich was an  independent
consultant  specializing  in the  development  and  manufacture  of laser  based
medical products. Dr. Smotrich was Vice President of Operations at Candela Laser
Corp.  from June 1987 to June 1988,  where he was  responsible for medical laser
production  and product  development.  From July 1984 to June 1987, as Corporate
Vice President of Research and Development, Dr. Smotrich was responsible for the
design and  development of surgical  laser  products at Merrimack  Laboratories,
Inc.,  which was acquired by the  LaserSonics  division of Cooper  Laboratories,
Inc.  From  1972 to 1984,  Dr.  Smotrich  was Vice  President  in  charge of the
Electro-Optics Group at Avco Everett Research  Laboratory,  Inc., working in the
laser technology  field.  Dr. Smotrich  received a certificate from the Advanced


                                       44
<PAGE>

Management Program at Harvard Graduate School of Business Administration and has
a B.S. in Physics from the Massachusetts Institute of Technology and an M.S. and
Ph.D. in Physics from Columbia University.

        STEVEN  GEORGIEV.  Mr.  Georgiev is Chairman of the  Company's  Board of
Directors. Mr. Georgiev served as Chief Executive Officer of the Company between
November  12,  1993 and May 14,  1997,  and became a full time  employee  of the
Company on January 1, 1995.  Mr.  Georgiev was a  consultant  to Dymed from June
1991 until its September  1991 merger with the Company,  at which time he became
the Chairman of the Company's  Board of Directors.  Mr.  Georgiev is a financial
and business  consultant to a variety of emerging,  high growth  companies.  Mr.
Georgiev  has been a director  of Excel  Technology,  Inc.  since  1992,  and of
Dynagen, Inc. since 1996. Mr. Georgiev was Chairman of the Board of Directors of
Dynatrend,  Inc., a publicly-traded  consulting firm that he co-founded in 1972,
until February 1989. Mr. Georgiev has a B.S. in Engineering Physics from Cornell
University  and an M.S.  in  Management  from  the  Massachusetts  Institute  of
Technology (Sloan Fellow).

         BUSTER  GLOSSON.  Mr.  Glosson has been a director of the Company since
September  1, 1996.  From 1965 until June 1994,  he was an officer in the United
States Air Force (USAF).  Most recently,  he served as a Lieutenant  General and
Deputy Chief of Staff for plans and operations,  Headquarters USAF,  Washington,
D.C. Mr. Glosson is a veteran of combat missions in Vietnam and, during the Gulf
War, he commanded  the 14th Air Force  Division and was the director of campaign
plans for the United States Central Command Air Forces, Riyadh, Saudi Arabia. In
1994 he founded and has since  served as  President  of Eagle Ltd., a consulting
firm   concentrating   on   international    business   opportunities   in   the
high-technology arena. He is also Chairman and CEO of Alliance Partners Inc., an
investment  holding  company  with a focus on  international  business.  He also
serves as a director of The American Materials and Technologies Corporation, and
Skysat Communication Network Corporation, both publicly held companies.

        JOHN M. DEUTCH.  Dr. Deutch became a director of the Company on February
1, 1997. In May 1995 he was sworn in as Director of Central  Intelligence  (DCI)
following a unanimous vote in the Senate, and served as DCI until December 1996.
In  this  position  he was  head  of the  Intelligence  Community  (all  foreign
intelligence   agencies  of  the  United   States)  and   directed  the  Central
Intelligence  Agency.  From  March  1994 to May  1995 he  served  as the  Deputy
Secretary of Defense.  From March 1993 to March 1994, Dr. Deutch served as Under
Secretary of Defense for  Acquisitions  and  Technology.  Dr.  Deutch has been a
member of the faculty of the Massachusetts Institute of Technology (M.I.T.) from
1970 to the  present,  where he was an  associate  professor  and  professor  of
chemistry, Chairman of the Department of Chemistry, Dean of Science and Provost.
Currently,  Dr. Deutch is an MIT Institute  Professor and serves as director for
the following  publicly held  companies:  Ariad  Pharmaceutical,  Citicorp,  CMS
Energy and Schlinberger Ltd. Dr. Deutch has a B.A. in history and economics from
Amherst College and both a B.S. in chemical  engineering and a Ph.D. in physical
chemistry  from M.I.T.  He holds  honorary  degrees  from Amherst  College,  the
University of Lowell and Northeastern University.

        A. NEIL PAPPALARDO.  Mr.  Pappalardo became a director of the Company on
June 2, 1997.  Mr.  Pappalardo is the founder and serves as the Chairman and CEO
of Medical Information  Technology,  Inc.  ("Meditech"),  a provider of software
systems to hospitals in the United  States,  Canada and the United  Kingdom with
over 2,000 employees. Mr. Pappalardo received his B.S. in electrical engineering
from M.I.T. in 1964. Mr.  Pappalardo  serves on the Executive as well as various
other operational and academic committees at M.I.T., and is a trustee of the New
England Aquarium and serves on its Board of Governors.

        JAMES G. MARTIN.  Dr. Martin became a director of the Company on June 2,
1997. From 1995 through the present, Dr. Martin has served as the Vice President
of Research at the Carolinas  Medical  Center.  He has also been the Chairman of
the Research  Development  Board of the Carolinas Medical Center since 1993. Dr.
Martin was the Governor of North  Carolina from 1985 to 1993.  Prior to that, he
served as a United States  Congressman  from North Carolina for six terms,  from
1973 to 1984.  Dr.  Martin  currently  serves as a  director  for the  following
publicly held companies:  Duke Power Company and Family Dollar,  Inc. Dr. Martin
has a B.S. in chemistry  from  Davidson  College and a Ph.D.  in chemistry  from
Princeton University.

        JOSEPH P.  CARUSO.  Mr.  Caruso  joined  the  Company  in March  1992 as
Controller in a part-time  capacity and became a full-time  employee on June 15,
1992.  Effective  January 1, 1993,  Mr. Caruso  became Vice  President and Chief
Financial  Officer.  From  October 1989 to June 1992,  Mr.  Caruso was the Chief
Financial  Officer  of  Massachusetts  Electrical  Manufacturing  Co.,  Inc.,  a


                                       45
<PAGE>

privately held manufacturer of power distribution equipment. From September 1987
to October 1989,  Mr.  Caruso was a manager with Robert Half,  an  international
consulting  firm. From December 1982 to September 1987, Mr. Caruso was a manager
with Pannell Kerr Forster,  an international  public accounting firm. Mr. Caruso
became a Certified  Public  Accountant in 1984 and has a B.S. in accounting from
Merrimack College.

         Section 16(a) of the  Securities  and Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than 10% of
the Company's Common Stock ("10% Stockholders"), to file with the Securities and
Exchange  Commission  (the "SEC") initial  reports of ownership of the Company's
Common  Stock and other  equity  securities  on Form 3 and reports of changes in
such  ownership on Form 4 and Form 5. Officers,  directors and 10%  Stockholders
are  required  by SEC  regulations  to furnish  the  Company  with copies of all
Section 16(a) forms they file.

         To the  Company's  knowledge,  based  solely on review of the copies of
such  reports  furnished  to the Company  during,  and with respect to, its most
recent fiscal year, or written representations that Form 5 was not required, the
Company  believes that all Section 16(a) filing  requirements  applicable to its
officers, directors and 10% Stockholders were fulfilled in a timely manner.

ITEM 10.  EXECUTIVE COMPENSATION.

         The  following  table sets forth  certain  information  concerning  the
compensation  for  services  rendered in all  capacities  to the Company for the
fiscal years ended December 31, 1995 and 1996 of (i) the Chief Executive Officer
of the Company during 1996 and (ii) the other executive  officers of the Company
serving on December 31, 1996 whose salary and bonuses for 1996 exceeded $100,000
(the "Named Executive Officers"):

                              SUMMARY COMPENSATION TABLE

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

                                                                                          Long-Term
                                                                                        Compensation
                                                                                           Awards
                                                                                       ----------------

                                                                                         Securities                 All
                                                                                         Underlying                Other
Name and                            Fiscal           Salary            Bonus             Options(1)            Compensation
Principal Position                  Year              ($)               ($)                 (#)                    ($)
                                --------------    ------------    ----------------    ----------------    -----------------------

Steven Georgiev                    12/31/96       $ 275,000       $305,000                  800,000                $    --
     Chief Executive Officer       12/31/95       $ 161,800       $ 50,000                  450,000                $    --
                                   12/31/94       $    --         $    --                       --                 $  80,000(2)

Michael H. Smotrich                12/31/96       $214,000        $  50,000                 300,000                $    --
     President, Chief              12/31/95       $149,400        $  50,000                 250,000                $    --
     Operating Officer,            12/31/94       $ 92,000        $  20,000                 170,000                $    --
     Secretary

Joseph P. Caruso                   12/31/96       $180,000        $  64,000                 450,000                $    --
     Vice President and  Chief     12/31/95       $109,600        $  75,000                 250,000                $    --
     Financial Officer             12/31/94       $ 70,400        $  20,000                 170,000                $    --
</TABLE>

         (1) During  fiscal 1996 and fiscal 1995,  the Company did not grant any
restricted  stock  awards or stock  appreciation  rights  or make any  long-term
incentive plan payouts to any of the Named Executive Officers.

         (2) Represents  monies paid by the Company to Mr.  Georgiev  during the
year ended  December 31, 1994 pursuant to a consulting  arrangement  between the
Company and Mr. Georgiev.


                                       46
<PAGE>


OPTION GRANTS IN LAST FISCAL YEAR

         The following  table sets forth  certain  information  regarding  stock
options and warrants  granted during 1996 by the Company to the Named  Executive
Officers:
<TABLE>
<S>                                <C>                 <C>               <C>                 <C>           

                                              OPTION GRANTS
-----------------------------------------------------------------------------------------------------------
                                   Number of Shares       Percent of
                                      Underlying        Total Options
                                       Options             Granted        Exercise Price
Name and                               Granted           to Employee        Per Share        Expiration
Principal Position                       (#)            in Fiscal Year        ($/Sh)            Date
-----------------------------------------------------------------------------------------------------------

Steven Georgiev
     Chief Executive Officer             300,000(1)          5.87%              6.75            2/5/01
     Chairman of the Board               200,000(1)          3.91%              6.00          12/18/01
                                         300,000(1)          5.87%              8.00           8/26/01

Michael H. Smotrich
     President, Chief                    250,000(2)          4.89%              6.75            2/5/01
     Operating Officer,                   50,000(2)           .98%              6.00          12/18/01
     Secretary

Joseph P. Caruso
     Vice President and Chief            200,000(3)          3.91%               8.00          8/26/01
      Financial Officer                  150,000(3)          2.94%               6.75           2/5/01
                                         100,000(3)          1.96%               6.00         12/18/01

-----------------------------------------------------------------------------------------------------------
</TABLE>

(1)     On February 5, 1996, the Company granted Mr. Georgiev  300,000 shares of
        Common  Stock,  issuable  upon  exercise  of a five year  warrant  at an
        exercise price of $6.75 per share,  all of which vests  immediately.  On
        December 19, 1996, the Company  granted Mr.  Georgiev  200,000 shares of
        Common  Stock,  issuable  upon  exercise  of a five year  warrant  at an
        exercise  price  of  $6.00  per  share,  of  which  66,666  shares  vest
        immediately,  66,667  shares  vest a year  from  issuance  and the final
        66,667  shares vest two years from  issuance.  On August 27,  1996,  the
        Company  granted Mr.  Georgiev  300,000  shares of Common Stock issuable
        upon exercise of a five year stock option at an exercise  price of $8.00
        per share, of which 100,000 shares vest immediately, 100,000 shares vest
        one year from issuance and the final 100,000  shares vest two years from
        issuance.

(2)     On February 5, 1996, the Company granted Dr. Smotrich  250,000 shares of
        Common  Stock,  issuable  upon  exercise  of a five year  warrant  at an
        exercise price of $6.75 per share,  all of which vests  immediately.  On
        December 19, 1996,  the Company  granted Dr.  Smotrich  50,000 shares of
        Common  Stock,  issuable  upon  exercise  of a five year  warrant  at an
        exercise  price  of  $6.00  per  share,  of  which  16,666  shares  vest
        immediately,  16,667  shares  vest a year  from  issuance  and the final
        16,667 shares vest two years from issuance.

(3)     On February 5, 1996,  the Company  granted Mr. Caruso  150,000 shares of
        Common  Stock,  issuable  upon  exercise  of a five year  warrant  at an
        exercise price of $6.75 per share,  all of which vests  immediately.  On
        December 19, 1996,  the Company  granted Mr.  Caruso  100,000  shares of
        Common  Stock,  issuable  upon  exercise  of a five year  warrant  at an
        exercise  price  of  $6.00  per  share,  of  which  33,333  shares  vest
        immediately,  33,333  shares  vest a year  from  issuance  and the final
        33,334  shares vest two years from  issuance.  On August 27,  1996,  the
        Company  granted Mr. Caruso 200,000 shares of Common Stock issuable upon
        exercise of a five year stock  option at an exercise  price of $8.00 per
        share, of which 66,666 shares vest  immediately,  66,667 shares vest one
        year from  issuance  and the final  66,667  shares  vest two years  from
        issuance.


                                       47
<PAGE>

AGGREGATED OPTION EXERCISES IN LAST YEAR AND FISCAL YEAR-END; OPTION/SAR VALUES

         The  following  table sets forth  information  on an  aggregated  basis
regarding the exercise of stock options during the last completed fiscal year by
each of the Named  Executive  Officers and the value of  unexercised  options at
December 31, 1996:
<TABLE>
<S>                                <C>                <C>             <C>                       <C>                     
-------------------------------------------------------------------------------------------------------------------------
                                                                          Number of
                                                                          Securities                 Value of
                                                                          Underlying               Unexercised
                                                                         Unexercised               in-the-Money
                                      Shares                             Options/SARs              Options/SARs
                                     Acquired            Value          at FY-End (#)            at FY-End ($)(1)
Name and                            on Exercise        Realized          Exercisable/              Exercisable/
Principal Position                      (#)               ($)           Unexercisable             Unexercisable
-------------------------------------------------------------------------------------------------------------------------
Steven Georgiev
     Chief Executive Officer          260,000           426,200        703,666/333,334(2)         1,115,750/100,000

Michael H. Smotrich
     President, Chief                   --                --            686,666/33,334(3)         1,881,249/25,000
     Operating Officer,
     Secretary

Joseph P. Caruso
     Vice President and Chief           --                --           699,999/200,001(4)         2,041,250/50,000
     Financial Officer

-------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Value is based on the December  31, 1996  closing  price on the Nasdaq Small
Cap Market of $6.75 per share.  Actual gains, if any, on exercise will depend on
the value of the Common Stock on the date of the sale of the shares.

(2) Includes  warrants to purchase  Common Stock and stock options with exercise
prices ranging from  $2.00-$8.00,  all of which expire on or before December 18,
2001.

(3) Includes  warrants to purchase  Common Stock and stock options with exercise
prices ranging from $2.125-$6.75,  all of which expire on or before December 18,
2001.

(4) Includes  warrants to purchase  Common Stock and stock options with exercise
prices ranging from  $2.00-$8.00,  all of which expire on or before December 18,
2001.

(5)  Consists of a warrant to purchase  Common Stock at an exercise  price of
     $6.00 per share expiring on December 19, 2001.

        Between the time they joined the Board and June 2, 1997, Mr. Glosson and
Dr.  Deutch were paid $30,000 for their  services as director.  Mr.  Valente was
paid  $17,500 for his  services as a director  until he became  Chief  Executive
Officer and  President of the Company on May 14, 1997.  Effective  June 2, 1997,
outside  directors will receive $30,000 per year for their services as director,
and  $5,000  per year,  per  committee,  for their  services  as  members of any
committee of the Board of Directors. For his services as a director, Mr. Glosson
received a warrant to  purchase  100,000  shares of Common  Stock at an exercise
price of $8.00 per share.  This  warrant  vests over a period of three years and
expires on August 26, 2001. For his services as a director,  Dr. Deutch received
a warrant to purchase  50,000  shares of Common  Stock at an  exercise  price of
$6.75 per share.  This  warrant  vests  immediately  and expires on December 27,
2001.  In  accordance  with Company  policy,  directors who are employees of the
Company serve as directors without compensation.  (Upon becoming Chief Executive
Officer and President of the Company,  Mr. Valente  relinquished  the warrant to
purchase  50,000 shares of Common Stock that he had received for his services as
an outside director.) Directors are also reimbursed for reasonable out-of-pocket
expenses incurred in attending Board of Directors meetings.

                                       48
<PAGE>

EMPLOYMENT AGREEMENTS

        Effective  January 1, 1997,  the Company  entered  into  three-year  key
employment agreements with Mr. Georgiev,  Dr. Smotrich and Mr. Caruso.  Pursuant
to these  agreements,  Dr.  Smotrich  served as  President  and Chief  Operating
Officer at a base salary of $250,000 and Mr.  Georgiev served as Chief Executive
Officer at a base salary of $350,000 until their respective  resignations on May
14, 1997. Mr. Caruso serves as Chief Financial Officer, at an annual base salary
of $200,000.  The  agreements  provide for bonuses as determined by the Board of
Directors or Executive  Committee,  and employee benefits,  including  vacation,
sick pay and insurance, in accordance with the Company's policies.

         The  agreements  provide that, in the event of  termination  (i) by the
Company  without  cause,  as defined,  or by the executive  for good reason,  as
defined,  other than within one year of a change in control,  the Company  shall
pay the executive four times the executive's  annual base salary then in effect,
and continue the  executive's  employee  benefits for the remaining  term of the
agreement; (ii) within one year following a change in control, the Company shall
pay the executive eight times the executive's annual  compensation,  as defined,
and continue the  executive's  employee  benefits for the remaining  term of the
agreement;  and (iii) by the executive for good reason within one year following
an approved change in control,  as defined,  the Company shall pay the executive
eight  times the  executive's  annual  base  salary then in effect and any bonus
compensation  to which the executive would have been entitled if he had remained
as an employee  under the agreement to the end of the fiscal year,  and continue
the executive's  employee  benefits for the remaining term of the agreement.  In
the event of resignation,  the agreements provide that the Company shall pay the
executive any base salary or other  compensation  earned (and a pro rata portion
of any bonus payable with respect to the year in which resignation occurred) but
not paid to the executive prior to the effective date of such resignation.

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

        The following table sets forth, as of July 7, 1997, the number of shares
of the Company's Common Stock owned by each director, by the Company's Principal
Executive  Officer  and  each of the  other  Named  Executive  Officers,  by all
directors and executive  officers as a group, and by any persons  (including any
"group" as used in Section  13(d)(3) of the  Securities  Exchange  Act of 1934),
known by the Company to own  beneficially 5% or more of the  outstanding  Common
Stock. Except as otherwise indicated, the stockholders listed in the table below
have sole voting and investment power with respect to the shares indicated.

<TABLE>
<S>                                                         <C>                               <C>        
                                                                                              Percentage
                                                             Number of Shares                  of Class
Name and Address of Beneficial Owner                        Beneficially Owned                   (1)
------------------------------------                        ------------------                ----------
Louis P. Valente(2)                                                404,000                      1.22
66 Cherry Hill Drive
Beverly, MA  01915

Joseph P. Caruso(3)                                                901,590                      2.72%
66 Cherry Hill Drive
Beverly, MA  01915

Michael H. Smotrich(4)                                           1,214,256                      3.67%
66 Cherry Hill Drive
Beverly, MA  01915

Steven Georgiev(5)                                               1,272,871                      3.84%
66 Cherry Hill Drive
Beverly, MA  01915

Buster C. Glosson(6)                                               119,999                        *
66 Cherry Hill Drive
Beverly, MA  01915

John M. Deutch(7)                                                   50,000                        *
66 Cherry Hill Drive
Beverly, MA  01915


                                       49
<PAGE>

A. Neil Pappalardo(8 )                                              50,000                        *
66 Cherry Hill Drive
Beverly, MA  01915

James G. Martin( 8)                                                 50,000                        *
66 Cherry Hill Drive
Beverly, MA  01915

All Directors and Executive Officers as a Group                  4,062,716                      12.28%
(8 persons)(9)
</TABLE>

*     Less than one percent.

(1)  Pursuant to the rules of the Securities and Exchange Commission,  shares of
     Common Stock which an individual or group has a right to acquire  within 60
     days  pursuant to the  exercise of options  and  warrants  are deemed to be
     outstanding  for the purpose of computing the percentage  ownership of such
     individual or group,  but are not deemed to be outstanding  for the purpose
     of  computing  the  percentage  ownership  of any other person shown in the
     table.  Percentage  ownership is based on 33,083,190 shares of Common Stock
     outstanding.

(2)  Includes  400,000 shares of Common Stock which Mr. Valente has the right to
     acquire within 60 days pursuant to the exercise of warrants.

(3)  Includes  833,332  shares of Common Stock which Mr. Caruso has the right to
     acquire  within 60 days  pursuant to the exercise of options and  warrants,
     and 1,432 shares held in the Company 401(k) Plan.

(4)  Includes 686,666 shares of Common Stock which Mr. Smotrich has the right to
     acquire  within 60 days  pursuant to the exercise of options and  warrants,
     and 8,000 shares of Common Stock owned by family members.

(5)  Includes 903,666 shares of Common Stock which Mr. Georgiev has the right to
     acquire  within 60 days  pursuant to the exercise of options and  warrants,
     40,000 shares of Common Stock held by family  members and 2,051 shares held
     in the Company 401(k) Plan.

(6)  Includes  119,999 shares of Common Stock which Mr. Glosson has the right to
     acquire within 60 days pursuant to the exercise of options and warrants.

(7)  Includes  50,000  shares of Common Stock which Mr.  Deutch has the right to
     acquire within 60 days pursuant to the exercise of warrants.

(8)  Includes 50,000 shares of Common Stock which Messrs.  Martin and Pappalardo
     have the  right to  acquire  within 60 days  pursuant  to the  exercise  of
     warrants.

(9)  Total  issued and  outstanding  shares  includes an  aggregate of 2,406,997
     shares  issuable  pursuant to options and  warrants  exercisable  within 60
     days.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

       From January 1996 to March 1997 the Company has advanced varying amounts
to Steven Georgiev,  the Company's  Chairman of the Board; the total outstanding
indebtedness, with interest, at June 5, 1997 was $985,872.99. These advances are
evidenced  by demand  promissory  notes which bear  interest at 7% and are fully
collateralized  by stock in the Company and  American  Materials &  Technologies
Corporation ("AM&T).

                                       50
<PAGE>

        From  January  1996 to February  1997 the Company has  advanced  varying
amounts to Michael H. Smotrich, the Company's Chief Technical Officer; the total
outstanding indebtedness,  with interest, at June 5, 1997 was $508,314.48. These
advances are evidenced by demand  promissory notes which bear interest at 7% and
are collateralized by stock in the Company at a 90% loan to value ratio.

        At December 31, 1995,  the Company had notes  receivable  for $3,150,000
from AM&T evidenced by a $3,000,000  promissory  note and a $150,000  promissory
note,  both  with  interest  at the rate of 10% per  annum.  Steve  Georgiev  is
Chairman of the Board of AM&T and owns 13% of AM&T's  outstanding  common stock.
On March 29, 1996, the Company  assigned a portion of its notes  receivable at a
face value of $1,500,000 to a  non-affiliated  individual  for  $1,500,000.  The
remaining  outstanding  portions of the notes was paid off in 1996.  The Company
owns a total of 463,664  shares of AM&T's common stock at March 31, 1997.  These
shares were purchased at a cost of $375,000 and have a market value at March 31,
1997 of $2,781,984.

        In 1996 the  Company  had loans  outstanding  at various  points in time
totaling $5,800,000 to Alliance Partners, Inc. Buster Glosson, a director of the
Company,  is Chairman and Chief  Executive  Officer of Alliance  Partners,  Inc.
These loans accrued interest at a rate of 10% per annum.

        In 1996 the Company made consulting  payments totaling $109,000 to Eagle
Limited. Buster Glosson is President of Eagle Limited.

        On December 18, 1996,  Steven Georgiev pledged 77,000 shares of his AM&T
common  stock in favor of the Company to secure a loan of  $500,000  made by the
Company to Trani,  Inc.; on April 16, 1997, Mr. Georgiev increased the number of
pledged AM&T shares to 100,000.

        On March 31, 1997,  Steven  Georgiev  pledged 112,000 shares of his AM&T
common  stock in favor of the Company to secure a loan of  $500,000  made by the
Company to JCV Capital  Corp.;  on April 16, 1997,  Mr.  Georgiev  decreased the
number of AM&T shares pledged to 100,000

        (See also "Employment Agreements.")

        The Company  believes the foregoing  transactions  were on terms no less
favorable to the Company than could be obtained from unaffiliated third parties.
The Company's policy, as adopted by its Board of Directors on December 16, 1996,
is that, in order to reduce the risks of self-dealing or a breach of the duty of
loyalty to the  Company,  all  transactions  between  the Company and any of its
officers,  directors or principal  stockholders  must be for bona fide purposes,
will be subject to approval by a majority  of the  disinterested  members of the
Board of Directors of the Company, and must be on terms no less favorable to the
Company than could be obtained from unaffiliated  parties.  On May 13, 1997, the
Board of  Directors  unanimously  adopted a resolution  prohibiting  any further
loans to officers, directors or stockholders of the Company.


                                       51
<PAGE>



                                     PART IV

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

  (A)  EXHIBITS

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

Exhibit
   No.                                                    Title

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

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

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

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

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

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

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

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

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

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

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

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

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


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

                                       52
<PAGE>

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

###3.4            Certificate of Designation of Series H Convertible Preferred Stock as filed with the Delaware Secretary
                  of State on March 26, 1997.

3.5               Bylaws, as amended

4.1               Form of Common Stock Certificate.

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

**10.2            1991 Stock Option Plan, as amended.

#10.3             1993 Stock Option Plan.

####10.4          1995 Stock Option Plan.

----10.5          1996 Stock Option Plan

----10.6          1996 Employee Stock Purchase Plan

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

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

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

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

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

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

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

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

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

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

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

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

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

                                       53
<PAGE>

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

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

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

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

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

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

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

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

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

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

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

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

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

###10.33          Common Stock Purchase Warrant dated December 31, 1996.

###10.34          Form of Net Warrant to Purchase Common Stock.

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

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

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

###10.38          Warrant dated as of April 16, 1996.

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

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

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

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

                                       54
<PAGE>

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

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

###10.45          6% Convertible Debenture due March 13, 2002.

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

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

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

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

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

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

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

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

&&&&&10.54        Form of Promissory Note dated October 17, 1996.

&&&&&10.55        Form of Subscription Agreement dated October 16, 1996.

10.56             Supplement to Securities Purchase Agreement dated May 5, 1997.

10.57             Supplement to Registration Rights Agreement dated May 5, 1997.

10.58             Supplement to Securities Purchase Agreement dated May 23, 1997.

10.59             Supplement to Registration Rights Agreement dated May 23, 1997.

23                Consent of Arthur Andersen LLP.

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

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

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

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

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

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

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

###               Previously  filed as an exhibit to the Company's Annual Report
                  on Form  10-KSB  for the year ended  December  31,  1996,  and
                  incorporated herein by reference.

                                       55
<PAGE>

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

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

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

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

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

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

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

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

&&&&&             Previously filed as an exhibit to Form S-3 Registration Statement No. 333-28251 filed on May 30, 1997
                  and incorporated herein by reference.

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

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

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

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

  (B)  REPORTS ON FORM 8-K

            None


                                       56
<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 Beverly in the
Commonwealth of Massachusetts on July 28Ma, 1997.


                                              PALOMAR MEDICAL TECHNOLOGIES, INC.





                                              By:  /s/ Louis P. Valente
                                                 -------------------------------
                                                   Louis P. Valente
                                                   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>                                            <C>           

                          Name                                   Capacity                             Date

            /s/ Louis P. Valente                 President, Chief Executive                      July 11, 1997
            ---------------------------------
            Louis P. Valente                     Officer and Director

            /s/ Joseph P. Caruso                 Chief Financial Officer and Treasurer           July 11, 1997
            ---------------------------------
            Joseph P. Caruso                     ( Principal Financial Officer and
                                                 Principal Accounting Officer)

            /s/ Dr. Michael H. Smotrich          Chief Technical Officer,                        July 11, 1997
            ---------------------------------
            Dr. Michael H. Smotrich              and Director

            /s/ Steven Georgiev                  Chairman of the Board                           July 11, 1997
            ---------------------------------
            Steven Georgiev

            /s/ Buster C. Glosson                Director                                        July 11, 1997
            ---------------------------------
            Buster C. Glosson

            /s/ John M. Deutch                   Director                                        July 11, 1997
            ---------------------------------
            John M. Deutch

            /s/ James G. Martin                  Director                                        July 11, 1997
            ---------------------------------
            James G. Martin

            /s/ A. Neil Pappalardo               Director                                        July 11, 1997
            ---------------------------------
            A. Neil Pappalardo

</TABLE>