FORM 10-K/A-1
    

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

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

                     For fiscal year ended December 31, 1998

                         Commission file number: 0-22340
                                [OBJECT OMITTED]

                        PALOMAR MEDICAL TECHNOLOGIES, INC.
                        ----------------------------------
             (Exact name of registrant as specified in its charter)

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

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

               45 Hartwell Avenue, Lexington, Massachusetts 02173
               --------------------------------------------------
                    (Address of principal executive offices)
                                 (781) 676-7300
                                 --------------
                (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-K  contained  in  this  form,  and no  disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information  statements  incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]

     As of March 2, 1999,  72,145,509  shares of Common Stock were  outstanding.
The  aggregate  market value of the voting  shares (based upon the closing price
reported by Nasdaq on March 20,  1998) of Palomar  Medical  Technologies,  Inc.,
held by nonaffiliates was $$43,549,606.  For purposes of this disclosure, shares
of Common  Stock held by entities who own 5% or more of the  outstanding  Common
Stock,  as reported in  Amendment  No. 4 to a Schedule  13G filed on January 22,
1999 and  Amendment  No. 3 to a Schedule  13D filed on February  16,  1999,  and
shares of common stock held by each officer and director  have been  excluded in
that such persons may be deemed to be "affiliates" as that term is defined under
the  Rules  and  Regulations  of  the  Securities  Exchange  Act of  1934.  This
determination of affiliate status is not necessarily conclusive.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive  proxy  statement to be filed prior to April 30,
1998,  pursuant to  Regulation  14A of the  Securities  Exchange Act of 1934 are
incorporated by reference into Part III of this Form 10-K

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



<PAGE>


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

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

PART II

      Item 8.  Financial Statements............................................................................1

         Reports of Independent Public Accountants.............................................................1
         Consolidated Balance Sheets as of December 31, 1997 and 1998..........................................3
         Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998............4
         Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
              December 31, 1996, 1997 and 1998.................................................................5
         Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998............8
         Notes to Consolidated Financial Statements...........................................................10

SIGNATURES....................................................................................................36
</TABLE>


                                       -i-


<PAGE>

                                     PART II

Item 8.  Financial Statements



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To Palomar Medical Technologies, Inc:

     We have audited the  accompanying  consolidated  balance  sheets of Palomar
Medical  Technologies,  Inc. (a Delaware  corporation)  and  subsidiaries  as of
December  31,  1997  and  1998,  and  the  related  consolidated  statements  of
operations,  stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1998. These financial  statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion  on these  financial  statements  based on our  audits.  The  summarized
financial  data  for  Nexar  Technologies,  Inc.  as of and for the  year  ended
December 31, 1997  contained in Note 2 are based on the financial  statements of
Nexar Technologies,  Inc. which were audited by other auditors. Their report has
been furnished to us and our opinion,  insofar as it relates to the data in Note
2, is based solely on the report of the other auditors.

     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,  based on our audits and the report of other auditors,  the
financial statements referred to above present fairly, in all material respects,
the financial position of Palomar Medical Technologies, Inc. and subsidiaries as
of December  31, 1997 and 1998,  and the results of their  operations  and their
cash flows for each of the three years in the period ended  December 31, 1998 in
conformity with generally accepted accounting principles.



                                                            ARTHUR ANDERSEN LLP



Boston, Massachusetts
February 11, 1999 (except for the
matters discussed in Notes 1 and
12(c) as to which the dates are
April 27, 1999 and March 17, 1999),
respectively.

                                       -1-
<PAGE>

              REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

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

We  have  audited  the   accompanying   consolidated   balance  sheet  of  Nexar
Technologies,  Inc. and  subsidiary  as of December  31,  1997,  and the related
consolidated  statements of operations,  stockholders' equity (deficit) and cash
flows for the year then ended.  These financial  statements (which are not shown
separately  herein) are the  responsibility  of the  Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audit. The consolidated financial statements of Nexar Technologies, Inc. and
subsidiary as of December 31, 1996 and for the periods  ended  December 31, 1995
and 1996 (not shown  separately  herein),  were audited by other  auditors whose
report dated January 24, 1997 (except with respect to the  purchased  technology
matter discussed in Note 2 as to which the date is February 28, 1997), expressed
an unqualified opinion on those statements.

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

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


                                                  /s/ BDO Seidman, LLP
                                                  ----------------------------
                                                  BDO Seidman, LLP


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


                                       -2-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

<TABLE>

                                                                                            December 31,          December 31,
                                                                                                1997                  1998
                                                                                           ----------------      ----------------
<S>                                                                                             <C>                   <C>       
ASSETS

CURRENT ASSETS:
       Cash and cash equivalents                                                                $3,003,300            $1,874,718
       Marketable securities                                                                     1,449,326                     -
       Accounts receivable, net of allowance for doubtful accounts of
            approximately $746,000 and $364,000 in 1997 and 1998, respectively                   2,248,680             9,938,121
       Inventories                                                                               4,711,474             5,416,342
       Other current assets                                                                      2,153,941             1,056,388
                                                                                           ----------------      ----------------
            Total current assets                                                                13,566,721            18,285,569
                                                                                           ----------------      ----------------

NET ASSETS OF DISCONTINUED OPERATIONS (NOTE 2)                                                   5,825,602                     -
                                                                                           ----------------      ----------------

PROPERTY AND EQUIPMENT, NET                                                                      6,455,586             3,314,087
                                                                                           ----------------      ----------------

OTHER ASSETS:
       Cost in excess of net assets acquired, net of accumulated amortization of
            approximately $1,280,000 and $1,882,000 in 1997 and 1998, respectively               2,302,348             1,699,983
       Deferred financing costs                                                                    591,609                58,923
       Other non-current assets                                                                    225,706               167,352
                                                                                           ----------------      ----------------
            Total other assets                                                                   3,119,663             1,926,258
                                                                                           ----------------      ----------------

                                                                                               $28,967,572           $23,525,914
                                                                                           ================      ================

LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES:

       Current portion of long-term debt                                                        $1,640,465            $6,290,041
       Accounts payable                                                                          4,150,982             6,553,745
       Accrued liabilities                                                                      13,759,854            10,301,624
       Current portion of deferred revenue                                                       1,284,395             1,143,796
                                                                                           ----------------      ----------------
            Total current liabilities                                                           20,835,696            24,289,206
                                                                                           ----------------      ----------------

NET LIABILITIES OF DISCONTINUED OPERATIONS                                                               -             1,680,171
                                                                                           ----------------      ----------------

LONG-TERM DEBT, NET OF CURRENT PORTION                                                          12,445,563             3,150,000
                                                                                           ----------------      ----------------

DEFERRED REVENUE, NET OF CURRENT PORTION                                                         1,870,000               870,000
                                                                                           ----------------      ----------------

COMMITMENTS AND CONTINGENCIES (NOTE 12)

STOCKHOLDERS' DEFICIT:
       Preferred stock, $.01 par value-
            Authorized - 5,000,000 shares
            Issued and outstanding -
            16,397 shares and 6,993 shares
            at December 31, 1997 and 1998, respectively
            (Liquidation preference of $8,228,082 as of December 31, 1998)                             164                       69
       Common stock, $.01 par value-
            Authorized - 120,000,000 shares
            Issued - 45,792,585 shares and 70,524,027 shares
            at December 31, 1997 and 1998, respectively                                            457,926                  705,240
       Additional paid-in capital                                                              147,356,579              160,733,433
       Accumulated deficit                                                                    (152,359,497)            (166,263,346)
       Less: Treasury stock - (345,000 shares at cost)                                          (1,638,859)              (1,638,859)
                                                                                           ----------------         ----------------
            Total stockholders' deficit                                                         (6,183,687)              (6,463,463)

                                                                                           ----------------         ----------------
                                                                                               $28,967,572              $23,525,914
                                                                                           ================         ================

</TABLE>

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



                                      -3-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>

                                                                                 Years Ended December 31,
                                                                       1996                 1997               1998
                                                                 ------------------   -----------------   ----------------

<S>                                                                    <C>                 <C>                <C>        
REVENUES                                                               $17,606,871         $20,994,546        $44,514,057

COST OF REVENUES                                                        14,169,471          20,055,963         23,050,834
                                                                 ------------------   -----------------   ----------------

         Gross profit                                                    3,437,400             938,583         21,463,223
                                                                 ------------------   -----------------   ----------------

OPERATING EXPENSES:

         Research and development                                        6,297,477          11,990,332          7,029,348
         Sales and marketing                                             5,076,941           6,959,750         15,132,595
         General and administrative                                      9,752,922          15,332,241          8,866,530
         Business development
              and other financing costs                                  2,879,603           2,060,852                  -
         Restructuring and asset write-off (Note 4)                      1,660,808           3,325,000            (131,310)
         Settlement and litigation costs                                   880,000           3,199,000                  -
                                                                 ------------------   -----------------   ----------------

                 Total operating expenses                               26,547,751          42,867,175         30,897,163
                                                                 ------------------   -----------------   ----------------

                 Loss from operations                                  (23,110,351)        (41,928,592)        (9,433,940)

INTEREST EXPENSE                                                          (271,619)         (6,993,898)        (1,290,905)

INTEREST INCOME                                                          1,355,488             456,945             33,080

NET GAIN (LOSS) ON TRADING SECURITIES                                    2,033,371             (52,272)           703,211

ASSET WRITE-OFF (NOTE 4)                                                (1,397,000)         (9,658,000)                 -

OTHER INCOME (EXPENSE)                                                     591,853            (193,262)            21,311
                                                                 ------------------   -----------------   ----------------

         NET LOSS FROM CONTINUING OPERATIONS                           (20,798,258)        (58,369,079)        (9,967,243)
                                                                 ------------------   -----------------   ----------------

LOSS FROM DISCONTINUED OPERATIONS (NOTE 2):

         Loss from operations                                          (20,895,534)        (29,508,755)        (1,090,885)
         Gain (Loss) on dispositions, net                                3,830,000           2,073,943         (1,533,295)
                                                                 ------------------   -----------------   ----------------

         NET LOSS FROM DISCONTINUED OPERATIONS                         (17,065,534)        (27,434,812)        (2,624,180)
                                                                 ------------------   -----------------   ----------------

                 NET LOSS                                            $ (37,863,792)      $ (85,803,891)      $(12,591,423)
                                                                 ==================   =================   ================

BASIC AND DILUTED NET LOSS PER COMMON SHARE:

         Continuing operations                                              $(0.84)             $(1.79)            $(0.18)
         Discontinued operations                                             (0.65)              (0.78)             (0.04)
                                                                 ------------------   -----------------   ----------------

                 TOTAL LOSS PER COMMON SHARE                                $(1.49)             $(2.57)            $(0.22)
                                                                 ==================   =================   ================

WEIGHTED AVERAGE NUMBER OF
    COMMON SHARES OUTSTANDING                                           26,166,538          35,105,272         62,868,696
                                                                 ==================   =================   ================
                                                                 
</TABLE>

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



                                      -4-
<PAGE>




               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)


<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, 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>
<S>                                                              <C>           <C>              <C>            <C>




                                                                 Additional                     Unrealized
                                                                 Paid-in        Accumulated   (Loss) Gain on   Subscriptions 
                                                                 Capital         Deficit        Marketable      Receivable         
                                                                                Securities                  
                                                                 ------------------------------------------------------------
BALANCE, DECEMBER 31, 1995                                        $54,152,385  $(25,864,657)      $--          $(1,988,709)

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

BALANCE, DECEMBER 31, 1996                                       $104,900,551 $(64,971,200) $(342,500)           $(604,653)
                                                                 ============================================================
</TABLE>



<TABLE>
<S>                                                             <C>




                                                                      Total 
                                                                   Stockholders
                                                                 Equity (Deficit)
                                                                -------------------
BALANCE, DECEMBER 31, 1995                                         25,288,754 

    Sale of common stock pursuant to warrants and
     options                                                        7,598,907 
    Sale of common stock                                            6,061,380 
    Payments received on subscriptions receivable                   2,441,556 
    Issuance of preferred stock, including common stock issued 
     as a placement fee, net of issuance costs                     30,823,147 
    Issuance of common stock for 1995 employer 401(k) 
     matching contribution                                            160,598 
    Conversion of preferred stock, including accrued 
     dividends and interest of $782,602                               788,687 
    Conversion of convertible debentures                              145,606 
    Redemption of convertible debentures                              (41,530)
    Value ascribed to convertible debentures                        2,757,860 
    Redemption of preferred stock                                  (3,123,152)
    Exercise of underwriter's warrants                                  5,000 
    Exercise of stock options in majority controlled
     subsidiary                                                        50,000 
    Issuance of common stock for conversion of debentures at
     Tissue Technologies, Inc.                                      1,027,156 
    Issuance of common stock for minority interest in
     Star Medical subsidiary                                        1,749,723 
    Issuance of common stock in exchange for license 
     rights                                                           370,143 
    Issuance of common stock for acquisition of
     Dermascan, Inc.                                                  490,000 
    Issuance of common stock for investment banking and merger 
     and acquisition consulting services                              476,724 
    Compensation expense related to warrants issued to 
     non-employees under SFAS No. 123                                 532,758 
    Return of escrowed shares                                              -- 
    Amortization of deferred financing costs                          (77,683)
    Unrealized loss on marketable securities                         (342,500)
    Preferred stock dividends                                      (1,242,751)
    Net loss                                                      (37,863,792)
                                                                 ------------

BALANCE, DECEMBER 31, 1996                                       $ 38,076,591
                  === ====                                       ============

</TABLE>

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



                                       -5-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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

<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, 1996                                   18,151       $182    30,596,812  $305,968     (200,000)  $(1,211,757) 

    Sale of common stock pursuant to warrants,
     options and Employee Stock Purchase Plan                    --         --       815,101     8,151           --            -- 
    Reduction in subscriptions receivable                        --         --            --        --           --            -- 
    Sale of preferred stock, net of issuance costs of
     approximately $1,000,000                                16,000        160            --        --           --            -- 
    Issuance of common stock for 1996 employer 401(k)
     matching contribution                                       --         --        87,441       874           --            -- 
    Conversion and redemption of preferred stock            (17,754)      (178)    6,139,841    61,399           --            -- 
    Conversion of convertible debentures and issuance
     of common stock to an investor                              --         --     7,464,961    74,650           --            -- 
    Issuance of common stock for investment banking, merger
     and acquisition and consulting services                     --         --        20,000       200           --            -- 
    Value ascribed to the discount feature of
     convertible debentures issued                               --         --       413,109     4,131           --            -- 
    Unrealized gain on marketable securities                     --         --            --        --           --            -- 
    Preferred stock dividends                                    --         --            --        --           --            -- 
    Guaranteed value of common stock associated with
     Dermascan acquisition                                       --         --            --        --           --            -- 
    Issuance of common stock for technology                      --         --       255,320     2,553           --            -- 
    Purchase of stock for treasury                               --         --            --        --     (145,000)     (427,102)
    Gain related to the issuance of common stock by
     Nexar Technologies, Inc.                                    --         --            --        --           --            -- 
    Value ascribed to warrant to purchase common
     stock issued to Coherent, Inc.                              --         --            --        --           --            -- 
    Net loss                                                     --         --            --        --           --            -- 
                                                            ----------------------------------------------------------------------

BALANCE, DECEMBER 31, 1997                                   16,397       $164    45,792,585  $457,926     (345,000)  $(1,638,859)
                                                            ======================================================================

</TABLE>




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



                                                             Additional                  Unrealized (Loss)                   
                                                             Paid-in      Accumulated    Gain on Marketable    Subscriptions 
                                                             Capital       Deficit         Securities         Receivable     
                                                             ----------------------------------------------------------------
BALANCE, DECEMBER 31, 1996                                   $104,900,551  $(64,971,200)      $(342,500)     $(604,653)

    Sale of common stock pursuant to warrants, 
     options and Employee Stock Purchase Plan                   1,606,083            --              --             -- 
    Reduction in subscriptions receivable                              --            --              --        604,653 
    Sale of preferred stock, net of issuance costs of 
     approximately $1,000,000                                  14,999,840            --              --             -- 
    Issuance of common stock for 1996 employer 401(k) 
     matching contribution                                        317,280            --              --             -- 
    Conversion and redemption of preferred stock               (3,926,317)           --              --             -- 
    Conversion of convertible debentures and issuance 
     of common stock to an investor                            16,935,713            --              --             -- 
    Issuance of common stock for investment banking, merger 
     and acquisition and consulting services                       52,925            --              --             -- 
    Value ascribed to the discount feature of
     convertible debentures issued                              3,750,812            --              --             -- 
    Unrealized gain on marketable securities                           --            --         342,500             -- 
    Preferred stock dividends                                          --    (1,584,406)             --             -- 
    Guaranteed value of common stock associated with 
     Dermascan acquisition                                       (216,562)           --              --             -- 
    Issuance of common stock for technology                     1,146,388            --              --             -- 
    Purchase of stock for treasury                                     --            --              --             -- 
    Gain related to the issuance of common stock by 
     Nexar Technologies, Inc.                                   7,409,866            --              --             -- 
    Value ascribed to warrant to purchase common 
     stock issued to Coherent, Inc.                               380,000            --              --             -- 
    Net loss                                                           --   (85,803,891)             --             -- 
                                                             ----------------------------------------------------------
BALANCE, DECEMBER 31, 1997                                   $147,356,579  $(152,359,497)    $       --      $      -- 
                                                             ==========================================================

</TABLE>


                                                                Total     
                                                             Stockholder
                                                           Equity (Deficit)
                                                           ----------------

BALANCE, DECEMBER 31, 1996                                   $38,076,591  

    Sale of common stock pursuant to warrants,                            
     options and Employee Stock Purchase Plan                  1,614,234  
    Reduction in subscriptions receivable                        604,653  
    Sale of preferred stock, net of issuance costs of                     
     approximately $1,000,000                                  15,000,000 
    Issuance of common stock for 1996 employer 401(k)                     
     matching contribution                                        318,154 
    Conversion and redemption of preferred stock               (3,865,096)
    Conversion of convertible debentures and issuance 
     of common stock to an investor                            17,010,363 
    Issuance of common stock for investment banking, merger
     and acquisition and consulting services                       53,125 
    Value ascribed to the discount feature of
     convertible debentures issued                              3,754,943 
    Unrealized gain on marketable securities                      342,500 
    Preferred stock dividends                                  (1,584,406)
    Guaranteed value of common stock associated with 
     Dermascan acquisition                                       (216,562)
    Issuance of common stock for technology                     1,148,941 
    Purchase of stock for treasury                               (427,102)
    Gain related to the issuance of common stock by 
     Nexar Technologies, Inc.                                   7,409,866 
    Value ascribed to warrant to purchase common 
     stock issued to Coherent, Inc.                               380,000 
    Net loss                                                  (85,803,891)
                                                             ------------ 
BALANCE, DECEMBER 31, 1997                                   $(6,183,687) 
                  === ====                                   ============  
                                                              

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

                                       -6-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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

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

                                                                                        Preferred Stock              Common Stock  
                                                                                    -----------------------------------------------
                                                                                          Number        $0.01            Number    
                                                                                         of Shares       Par Value      of Shares  
                                                                                     ----------------------------------------------
BALANCE, DECEMBER 31, 1997                                                                  16,397   $         164      45,792,585

  Sale of common stock pursuant to warrants, options and Employee 
   Stock Purchase Plan                                                                          --              --         192,211
  Issuance of common stock for 1997 employer 401(k) matching contribution                       --              --         311,887
  Conversion of preferred stock                                                             (5,888)            (59)      6,891,682
  Conversion of convertible debentures                                                          --              --       7,035,662
  Issuance of common stock net of investment banking fees                                       --              --      10,200,000
  Redemption of preferred stock                                                             (3,516)            (36)             --
  Value ascribed to warrants issued to investment banker                                        --              --              --
  Common stock issued for advisory services                                                     --              --         100,000
  Costs incurred related to the issuance of common stock                                        --              --              --
  Preferred stock dividends and penalties                                                       --              --              --
  Net loss                                                                                      --              --              --

                                                                                     -------------   -------------     -----------
BALANCE, DECEMBER 31, 1998                                                                   6,993   $          69      70,524,027
                                                                                     =============   =============     ===========
</TABLE>
<TABLE>
<S>                                                                                  <C>             <C>             <C>           


                                                                                    Common Stock                Treasury Stock     
                                                                               ----------------------------------------------------
                                                                                        $0.01            Number
                                                                                        Par Value       of Shares          Cost
                                                                               ----------------------------------------------------
BALANCE, DECEMBER 31, 1997                                                           $     457,926       (345,000)  ($  1,638,859)

  Sale of common stock pursuant to warrants, options and Employee 
   Stock Purchase Plan                                                                       1,923             --               -- 
  Issuance of common stock for 1997 employer 401(k) matching contribution                    3,118             --  
  Conversion of preferred stock                                                             68,917             --  
  Conversion of convertible debentures                                                      70,356             --               -- 
  Issuance of common stock net of investment banking fees                                  102,000             --               -- 
  Redemption of preferred stock                                                                 --             --               -- 
  Value ascribed to warrants issued to investment banker                                        --             --               -- 
  Common stock issued for advisory services                                                  1,000             --               -- 
  Costs incurred related to the issuance of common stock                                        --             --               -- 
  Preferred stock dividends and penalties                                                       --             --               -- 
  Net loss                                                                                      --             --               -- 

                                                                                     -------------   -------------   ------------- 
BALANCE, DECEMBER 31, 1998                                                           $     705,240        (345,000)  ($  1,638,859)
                                                                                     =============   =============   ============= 
</TABLE>

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


                                                                                  Additional                              Total
                                                                                  Paid-in           Accumulated       Stockholders'
                                                                                  Capital             Deficit       Equity (Deficit)
                                                                                ---------------------------------------------------
BALANCE, DECEMBER 31, 1997                                                           $ 147,356,579   ($152,359,497)  ($  6,183,687)

  Sale of common stock pursuant to warrants, options and Employee 
   Stock Purchase Plan                                                                      64,208              --          66,131
  Issuance of common stock for 1997 employer 401(k) matching contribution                  251,163              --         254,281
  Conversion of preferred stock                                                            583,310              --         652,168
  Conversion of convertible debentures                                                   6,368,820              --       6,439,176
  Issuance of common stock net of investment banking fees                                9,738,000              --       9,840,000
  Redemption of preferred stock                                                        (3,615,522)              --      (3,615,558)
  Value ascribed to warrants issued to investment banker                                  171,000               --         171,000
  Common stock issued for advisory services                                                99,000               --         100,000
  Costs incurred related to the issuance of common stock                                 (283,125)              --        (283,125)
  Preferred stock dividends and penalties                                                      --       (1,312,426)     (1,312,426)
  Net loss                                                                                     --      (12,591,423)    (12,591,423)
                                                                                    -------------    -------------   ------------- 
BALANCE, DECEMBER 31, 1998                                                          $ 160,733,433    ($166,263,346)  ($  6,463,463)
                                                                                    =============    =============   ============= 
</TABLE>



                                       -7-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>

<CAPTION>

                                                                                               Years Ended December 31,
                                                                                        1996            1997              1998
                                                                                --------------------------------------------------
<S>                                                                                <C>              <C>              <C>          
CASH FLOWS FROM OPERATING ACTIVITIES
       Net Loss                                                                    $(37,863,792)    $(85,803,891)    $(12,591,423)
            Less: Net Loss from Discontinued Operations                             (17,065,534)     (27,434,812)      (2,624,180)
                                                                                   ------------     ------------     ------------ 
       Net Loss from Continuing Operations                                          (20,798,258)     (58,369,079)      (9,967,243)
                                                                                   ------------     ------------     ------------ 

       Adjustments to reconcile net loss from continuing operations to net cash
            used in operating activities-
            Depreciation and amortization                                             2,343,013        2,246,412        2,676,651
            Restructuring and asset write-off costs                                   3,057,808       12,983,000         (131,310)
            Write-off of in-process research and development                             57,212               --               --
            Write-off of intangible assets                                              631,702               --               --
            Loss on sale of wholly-owned subsidiary                                          --          165,845               --
            Write-off of deferred financing costs associated with                            --               --               --
                 redemption of convertible debentures                                   201,500           27,554               --
            Valuation allowances for notes and investments                                   --        1,035,912               --
            Accrued interest receivable on note                                              --               --               --
                 and subscription receivable                                           (568,917)              --               --
            Foreign currency exchange gain                                             (446,596)        (651,970)              --
            Non-cash interest expense related to debt                                   163,680        5,473,077           63,652
            Non-cash compensation related to common stock and warrants                  836,982          205,238          171,000
            Realized gain on marketable securities                                     (835,197)        (577,969)              --
            Unrealized (gain) loss on marketable securities                          (1,198,174)         669,293         (703,211)
            Changes in assets and liabilities,
                 Purchases of marketable securities                                 (10,355,055)        (152,938)              --
                 Net sale of marketable securities                                   10,244,044        2,234,436        2,152,537
                 Accounts receivable                                                    (82,025)      (1,809,371)      (7,689,441)
                 Inventories                                                         (4,661,443)      (3,390,396)        (704,868)
                 Other current assets                                                (1,514,858)      (1,005,781)       1,097,553
                 Accounts payable                                                     1,243,161        1,378,637        2,402,763
                 Accrued liabilities                                                  4,727,008        3,546,543          639,934
                 Deferred revenue                                                        35,773        2,948,247       (1,140,599)
                                                                                   ------------     ------------     ------------ 
                          Net cash used in operating activities                     (16,918,640)     (33,043,310)     (11,132,582)
                                                                                   ------------     ------------     ------------ 
CASH FLOWS FROM INVESTING ACTIVITIES
       Purchases of property and equipment                                           (3,180,112)      (5,777,446)        (403,189)
       Increase in other assets                                                      (1,176,527)         (95,830)         (19,628)
       Loans to related parties                                                      (7,338,625)      (1,250,000)              --
       Loans to unrelated parties                                                    (2,236,531)              --               --
       Payments received on loans to related parties                                  9,322,284          941,288               --
       Guaranteed value associated with Dermascan acquisition                                --         (216,562)              --
       Net proceeds from notes receivable                                                    --               --               --
       Investment in nonmarketable securities                                        (2,077,054)      (1,057,631)              --
                                                                                   ------------     ------------     ------------ 
                          Net cash used in investing activities                      (6,686,565)      (7,456,181)        (422,817)
                                                                                   ------------     ------------     ------------ 
</TABLE>

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

                                       

                                       -8-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Continued)

<TABLE>
<CAPTION>


                                                                                         Years Ended December 31,
                                                                                   1996               1997              1998
                                                                               ----------------------------------------------------
<S>                                                                             <C>              <C>                     <C> 
CASH FLOWS FROM FINANCING ACTIVITIES
       Proceeds from issuance of convertible debentures                           14,169,441       16,715,169               --
       Proceeds from notes payable                                                        --        3,500,000               --
       Deferred financing costs incurred related to convertible debentures        (1,365,217)            --                 --
       Redemption of convertible debentures                                         (930,000)        (196,000)      (2,196,667)
       Proceeds from (payments of) notes payable and capital lease obligations      (260,224)      (4,856,479)       3,010,817
       Proceeds from issuance of common stock                                     13,715,287        1,462,121        9,840,000
       Proceeds from exercise of warrants, stock options
            and Employee Stock Purchase Plan                                              --               --           66,131
       Issuance of preferred stock                                                30,823,147       15,000,000               --
       Purchase of treasury stock                                                         --         (427,102)              --
       Payment of contingent note payable                                           (500,000)              --               --
       Cost incurred in connection with the issuance of common stock                      --               --         (283,125)
       Redemption of preferred stock, including accrued dividends of $71,223
            and $771,876 in 1996 and 1998, respectively                           (3,194,375)              --       (4,387,434)
       Proceeds from line of credit                                                       --               --        1,000,000
       Payments received on subscription receivable                                2,009,592               --               --
       Deferred costs                                                               (932,661)              --               --
                                                                                ============    =============     ============
                          Net cash provided by financing activities               53,534,990       31,197,709        7,049,722
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                              29,929,785       (9,301,782)      (4,505,677)
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS                           (30,073,633)          12,676        3,377,095
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD                                12,436,254       12,292,406        3,003,300
                                                                                ------------     ------------     ------------
CASH AND CASH EQUIVALENTS, END OF THE PERIOD                                    $ 12,292,406     $  3,003,300     $  1,874,718
                                                                                ============     ============     ============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
       Cash paid for interest                                                   $    280,659     $    534,037     $  1,094,759
                                                                                ============     ============     ============

SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
       Conversion of convertible debentures and related accrued
            interest, net of financing fees                                     $  1,172,762     $ 17,010,363     $  6,439,176
                                                                                ============     ============     ============
       Subscription received in connection with warrant
            exercises                                                           $  1,057,500     $         --     $         --
                                                                                ============     ============     ============

       Conversion of preferred stock                                            $    788,687     $    414,904     $    652,168
                                                                                ============     ============     ============

       Issuance of common stock for purchase of technology
            related to discontinued operations                                  $         --     $  1,148,941     $         --
                                                                                ============     ============     ============
       Exchange of preferred stock for investment in a
            discontinued operation                                              $         --     $ (4,280,000)    $         --
                                                                                ============     ============     ============
       Investment banking and consulting fees for services related
            to the issuance of common stock and convertible debentures          $    709,224     $     53,125     $         --
                                                                                ============     ============     ============
       Issuance of common stock for employer 401(k)
            matching contribution                                               $    160,598     $    318,154     $    254,281
                                                                                ============     ============     ============
       Issuance of common stock for minority interest
            in Star Medical Technologies subsidiary                             $  1,749,723     $         --     $         --
                                                                                ============     ============     ============
      Issuance of common stock for advisory services performed
            in 1997                                                             $         --     $         --     $    100,000

                                                                                ============     ============     ============
</TABLE>

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

                                       -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")  are engaged in the commercial  sale and  development of cosmetic and
medical laser systems and services. During the year ended December 31, 1997, the
Company  formed and began  execution  of a plan to  dispose  of its  electronics
segment  (see Note 2).  The  Company  substantially  completed  the  divestiture
program in May of 1998.

         Some of the Company's  medical laser  products are in various stages of
development;  and, accordingly, the success of future operations is subject to a
number of risks  similar to those of other  companies  with  products in similar
stages  of   development.   Principal  among  these  risks  are  the  successful
development  and  marketing  of the  Company's  products,  obtaining  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.

   
         On December 7, 1998,  the Company  entered into a Agreement and Plan of
Reorganization  (the  "Agreement")  with  Coherent to sell all of the issued and
outstanding  common  stock of Star,  its 99.96%  majority-owned  subsidiary,  to
Coherent.  The  Company  currently  owns  substantially  all of the  issued  and
outstanding  common  shares of Star.  However,  options  outstanding  granted to
Palomar and  employees of Star to purchase  shares of Star's common stock remain
outstanding  prior to the consummation of this sale. When all of the outstanding
options under Star's Stock Option Plan have been exercised, the Company will own
82.46% of Star's common stock and the employees  will  collectively  own 17.54%.
See Note 7. This sale was approved by a majority of the  stockholders of Palomar
on April 21, 1999 and on April 27, 1999,  the Company completed the sale of Star
to Coherent  and  received  gross  proceeds of  approximately  $49  million.  In
addition,  under the terms of the  Agreement the Company will receive an ongoing
royalty of 7.5% from  Coherent on the sale of any products by Coherent  that use
certain  patents  currently  licensed by the Company on an exclusive  basis from
Massachusetts  General  Hospital.  See Note  12(b).  
    

         The  Agreement  may only be  terminated  by (i)  mutual  consent of the
Company,  Star and Coherent, or (ii) Coherent, if Palomar's Board of the Company
approves a superior  proposal to sell Star to a different party, or (iii) either
party after May 1, 1999.  The Company  anticipates  that this sale will close by
May 1, 1999, so long as the Company obtains stockholder approval.

(2)      DISCONTINUED OPERATIONS

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

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

         During the fourth quarter of 1997, the Company reduced its ownership in
Nexar  through the sale of common  stock to private  investors.  At December 31,
1997, the Company  beneficially  owned 3,746,343 shares of Nexar's common stock,
representing  approximately a 36% ownership. As of December 31, 1998 the Company
beneficially  owned  2,406,080  shares of  Nexar's  common  stock,  representing
approximately a 19% ownership 

                                       -10-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

interest and had no other significant  obligations  related to Nexar, other than
the guaranty to GFL Advantage Fund Limited ("GFL")  discussed below. The Company
has been  actively  trying to sell its  remaining  shares of Nexar common stock;
however,  the  Company  may not be  successful  since  Nexar filed in the United
States Bankruptcy Court a petition for reorganization  under Chapter 11 of Title
11 of the United States Code on December 17, 1998.  Furthermore,  Nexar has been
delisted from The Nasdaq Stock Market due to Nexar's  failure to satisfy  Nasdaq
minimum listing requirements.

         The Company has accounted for its investment in Nexar as a discontinued
operation using the equity method. During 1998, the Company recorded a charge to
discontinued  operations of $1,524,966 as a result of  management's  decision to
write-down the carrying value of its investment in Nexar. During the years ended
December 31, 1996 and 1997, the Company  recognized  gains on the disposition of
shares of Nexar common stock of $3,830,000 and $6,221,689,  respectively.  These
amounts are included in "Gain (Loss) on  Dispositions,  net" in the Consolidated
Statements of Operations.

         The following is the summarized financial information for Nexar:
<TABLE>
<CAPTION>

                                                                  December 31,
                                                        1996                        1997
                                              -------------------------    ------------------------
             <S>                                           <C>                         <C>
             Current Assets                                $16,966,851                 $17,810,564
             Non-Current Assets                              2,622,270                   2,098,495
             Current Liabilities                             6,542,296                   7,886,594
             Non-Current Liabilities                        22,817,998                     883,613

                                                             Year Ended December 31,
                                                        1996                        1997
                                              -------------------------    ------------------------

             Net Revenues                                  $18,695,364                 $33,608,063
             Gross Profit                                    2,302,881                     740,151
             Net Loss                                       (7,510,139)                (13,346,380)

</TABLE>



         On December 31, 1997 the Company entered into an Exchange Agreement and
sold 500,000  shares of Nexar's  common stock to GFL for  $2,000,000.  Under the
terms of the Exchange Agreement,  Palomar guaranteed GFL a minimum selling price
of $5.00 per share with respect to 400,000 shares of Nexar's common stock over a
two-year time period. The Company is obligated to pay GFL on January 1, 2000 the
difference  between $5.00 and the price at which GFL sells the shares of Nexar's
common stock.  As of December 31, 1998, the deferred  liability  related to this
transaction  totaled $1,680,171 and represents the total amount due to GFL after
GFL sold their 400,000 common shares of Nexar stock.


         The other  entities  that were  included  in the  electronics  business
segment are Dynaco  Corp.  ("Dynaco")  and Dynaco's  wholly  owned  subsidiaries
Comtel Electronics,  Inc. ("Comtel") and Dynamem, Inc. ("Dynamem").  On December
9, 1997,  the Company  entered into a two-phase  stock  purchase  agreement with
Biometric  Technologies  Corporation ("BTC"). BTC was formed jointly by Dynaco's
President  and its  Chairman of the Board.  The first phase was  consummated  on
December 9, 1997 and consisted of the sale of all of the issued and  outstanding
common  stock of Comtel and Dynamem in exchange  for  $3,654,000  payable in two
installments.  The first  installment was a $850,000  unsecured  promissory note
that was due on February 15,  1998.  The second  installment  was a $2.8 million
unsecured  promissory note due in forty-eight  monthly  installments,  beginning
February 1, 1999.  This promissory note was fully reserved by the Company during
1997, as its ultimate  collectibility was believed to be uncertain.  BTC did not
make the  first  installment  on  February  1, 1998 and on  October  7, 1998 the
Company and BTC agreed to reduce the principal balances of the $850,000 note and
the $2.8 million note to a total of  $1,000,000.  

                                      -11-

<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


BTC paid $500,000  during 1998 and the balance is due April 5, 1999. The amended
note is guaranteed by the principal shareholders of BTC.

         As part of phase I, the Company  entered  into a Loan and  Subscription
Agreement  with a  creditor  of Comtel  for  $3,233,000.  This  promissory  note
represents  the settlement of amounts owed the creditor by Comtel and guaranteed
by Palomar.  Principal  and interest  payments  are being made over  twenty-four
months, beginning December 31, 1997 and interest will accrue at the bank's prime
rate (7.75% at December  31,  1998) plus 2.25%.  This  promissory  note has been
collateralized  by 3,250,000  shares of the Company's common stock that are held
in escrow,  are not  entitled to vote and are not  considered  outstanding.  The
Company  also  guaranteed  up to  $2,500,000  of Comtel's  borrowings  from this
creditor  until  November  30, 1999.  The  stockholders  of BTC have  personally
guaranteed to the Company  payment for any amounts  borrowed  under this line of
credit in excess of  approximately  $1,500,000  in the event that the Company is
obligated to honor this guarantee.

         In  connection  with  the  disposition  of  Comtel,  the  Company  also
restructured  all assets and  investments  related to a significant  customer of
Comtel into a $4,000,000 note receivable.  This receivable was fully reserved by
the Company during 1997, as its ultimate  collectibility is uncertain.  To date,
no amounts have been received under this  restructured  note receivable from the
customer,  nor does the Company anticipate  receiving any amounts from this note
receivable in the foreseeable future.

         In phase II, BTC agreed to purchase  all of the issued and  outstanding
stock of Dynaco. The phase II purchase price was $5,346,000, of which $2,673,000
was to be paid in cash  and  $2,673,000  was to be paid in BTC  common  stock of
equal value.  Alternatively,  the Company  could have elected to have the entire
phase II purchase paid in cash at a value of $3,500,000. During phase II BTC had
the option of selling  Dynaco to a third  party if agreed to by the  Company and
BTC. Phase II was required to be completed by June 30, 1998. Consistent with the
terms of the  agreement  with BTC,  the Company  entered  into a Stock  Purchase
Agreement  with Quick Turn  Circuits,  Inc.  ("QTC") on May 26, 1998 pursuant to
which QTC purchased 100% of the issued and outstanding shares of common stock of
Dynaco for $3,200,000.

         As of December 31, 1997, the Company recognized a loss of approximately
$4,148,000 related to the phase I and phase II dispositions.  These charges have
been  netted  in  "Gain  (Loss)  on  Dispositions,   net"  in  the  accompanying
Consolidated  Statements  of  Operations.  As of December 31, 1997,  the Company
accrued for the estimate of Dynaco's 1998  operating  loss through June 30, 1998
of  approximately  $850,000.  Through  the date of  disposition  of Dynaco,  the
Company recognized additional operating losses totaling $1,090,885. During 1998,
the Company  recorded a loss on  disposition  of $8,329  related to the ultimate
sale of Dynaco to QTC.

         Pursuant  to  Accounting  Principles  Board  ("APB")  Opinion  No.  30,
REPORTING  THE  RESULTS OF  OPERATIONS  REPORTING  THE  EFFECTS OF DISPOSAL OF A
SEGMENT OF A BUSINESS,  AND  EXTRAORDINARY,  UNUSUAL AND INFREQUENTLY  OCCURRING
EVENTS AND TRANSACTIONS, ("APB No. 30") the consolidated financial statements of
the  Company  have  been   reclassified  to  reflect  the  dispositions  of  the
aforementioned subsidiaries that comprise the electronics segment.  Accordingly,
the  assets  and  liabilities,  revenues  and  expenses,  and cash  flows of the
electronics  segment  have been  excluded  from the  respective  captions in the
Consolidated   Balance  Sheets,   Consolidated   Statements  of  Operations  and
Consolidated  Statements of Cash Flows.  The net assets  (liabilities)  of these
entities  have  been  reported  as "Net  Assets  (Liabilities)  of  Discontinued
Operations" in the accompanying  Consolidated  Balance Sheets; the net operating
losses of these  entities  have  been  reported  as "Net Loss from  Discontinued
Operations" in the accompanying  Consolidated Statements of Operations;  the net
cash flows of these  entities have been reported as "Net Cash (Used in) Provided
by Discontinued Operations" in the accompanying  Consolidated Statements of Cash
Flows.

                                      -12-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

     Summarized  financial  information for the discontinued  operations were as
follows:
<TABLE>
<CAPTION>

                                                                        December 31,
                                                                  1997                1998
                                                              --------------      --------------
              <S>                                               <C>                <C>
              Current Assets                                     $5,683,694       $         -
              Total Assets                                       11,506,145                 -

              Current Liabilities                                 5,375,353                 -
              Total Liabilities                                   5,680,543        (1,680,171)

                                                              --------------      --------------
              Net Assets (Liabilities) of Discontinued
                   Operations                                    $5,825,602       $(1,680,171)
                                                              ==============      ==============
 
</TABLE>

         The  assets  and  liabilities  of  the  discontinued  operations  as of
December 31, 1997  represent the financial  position of Dynaco and the Company's
liability  associated  with  the  sale of Nexar  common  stock  to GFL.  The net
liability as of December 31, 1998 represents the Company's liability  associated
with the sale of Nexar common stock to GFL.
<TABLE> 
<CAPTION>


                                                              Year Ended December 31,             Period Ended May 26,
                                                              1996              1997                   1998

                                                         ----------------  ----------------   ------------------------
              <S>                                          <C>               <C>                        <C>         
              Revenues                                       $52,491,572       $57,663,080                 $6,471,701

              Net Loss from Discontinued Operations        $(17,065,534)     $(27,434,812)               $(2,624,180)

</TABLE>


         The loss from  operations for all of the  discontinued  operations from
the  measurement  date,  October 1, 1997,  through the date of  disposition  for
Comtel  and  Dynamem  or  December  31,  1997 for  Dynaco,  total  approximately
$3,405,000.  Dynaco's loss from operations for the period  beginning  January 1,
1998 and ending May 26, 1998, the date of disposition, totaled $1,940,885.


(3)  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  including Star, a
99.96% majority owned subsidiary as of December 31, 1998.  Nexar, a discontinued
entity,  has been  accounted  for in  consolidation  under the equity  method in
accordance  with APB No. 30 as  described in Note 2. 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.

                                      -13-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         (C)      INVESTMENTS

         The Company  accounts for  marketable  securities  in  accordance  with
Statement of Financial  Accounting  Standards  ("SFAS") No. 115,  ACCOUNTING FOR
CERTAIN  INVESTMENTS  IN  DEBT  AND  EQUITY  SECURITIES.  Under  SFAS  No.  115,
securities  that the  Company  has the  positive  intent and  ability to hold to
maturity are  reported at amortized  cost and  classified  as  held-to-maturity.
There were no  held-to-maturity  securities  as of  December  31, 1997 and 1998.
Securities  purchased to be held for indefinite periods of time and not intended
at the time of purchase to be held until  maturity  are  reported at fair market
value and  classified as  available-for-sale  securities.  Unrealized  gains and
losses  related to  available-for-sale  securities  are  included  as a separate
component of stockholders' equity. There were no  available-for-sale  securities
as of  December  31,  1997  and  1998.  Securities  that  are  bought  and  held
principally  for the  purpose of selling  them in the near term are  reported at
fair market value and classified as trading securities.  Realized and unrealized
gains and losses related to trading  securities are included in the Consolidated
Statements  of  Operations.  As of  December  31,  1997,  marketable  securities
consisted  of American  Material &  Technologies  Corporation,  held for trading
purposes.  As of December 31, 1998, the Company did not have any  investments in
marketable securities.

         (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, 1997 and 1998,  inventories
consist of the following:

<TABLE>
<CAPTION>

                                                                               December 31,
                                                                         1997               1998
                                                                    ---------------    ----------------
                            <S>                                         <C>                 <C>
                            Raw materials                               $2,928,350          $2,478,289
                            Work-in-process                                727,284           1,330,822
                            Finished goods                               1,055,840           1,607,231
                                                                    ---------------    ----------------
                                                                        $4,711,474          $5,416,342
                                                                    ===============    ================
</TABLE>


         Included  in  finished   goods   inventory  at  December  31,  1998  is
approximately  $938,000  of  service  inventory  and  finished  good test  units
currently being evaluated by medical professionals.

                                      -14-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         (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:
<TABLE>
<CAPTION>

                                                                                  Estimated
                                   Asset Classification                          Useful Life
                            ------------------------------------            ----------------------
                            <S>                                                 <C>
                            Machinery and equipment                               3-8 Years
                            Furniture and fixtures                                 5 Years
                            Leasehold improvements                              Term of Lease
</TABLE>


         At December 31, 1997 and 1998,  property and  equipment  consist of the
following:

<TABLE>
<CAPTION>

                                                                               December 31,
                                                                         1997                1998
                                                                    ----------------    ----------------
                             <S>                                         <C>                 <C>
                             Machinery and equipment                     $6,328,442          $6,022,320
                             Furniture and fixtures                       1,018,931           1,120,450
                             Leasehold improvements                         480,453             567,216
                                                                    ----------------    ----------------
                                                                          7,827,826           7,709,986
                             Less:  Accumulated depreciation
                                        and amortization                  1,372,240           4,395,899
                                                                    ----------------    ----------------
                                                                         $6,455,586          $3,314,087
                                                                    ================    ================
</TABLE>

         Included in machinery and equipment as of December 31, 1997 and 1998 is
approximately $3,470,000 and $2,726,000, respectively, of equipment manufactured
by the Company and used in its service business.

         (F)      COST IN EXCESS OF NET ASSETS ACQUIRED

         The costs in excess of net assets  for  acquired  businesses  are being
amortized on a straight-line basis over 5 to 7 years.  Amortization  expense for
the years ended  December 31, 1996,  1997,  and 1998  amounted to  approximately
$536,000,  $554,000  and $602,000  respectively,  and is included in general and
administrative expenses in the Consolidated Statements of Operations.

         The Company accounts for long-lived  assets in accordance with SFAS No.
121,  ACCOUNTING  FOR THE  IMPAIRMENT  OF LONG-LIVED  ASSETS AND FOR  LONG-LIVED
ASSETS TO BE DISPOSED  OF. Under SFAS No. 121, the Company is required to assess
the valuation of its long-lived  assets,  including cost in excess of net assets
acquired,  based on the  estimated  future  cash flows to be  generated  by such
assets.  The Company has assessed the  realizability of its long-lived assets as
of December 31, 1998 and believes them to be realizable.

         (G)      DEFERRED FINANCING COSTS

         During the year ended December 31, 1996, the Company incurred financing
costs related to several issuances of convertible debentures. Deferred financing
costs are  amortized  by a charge to interest  expense  over the period that the
debt is outstanding (see Note 6).

                                      -15-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         (H)      REVENUE RECOGNITION

         The Company  recognizes  product  revenue upon shipment.  The Company's
sales of its product do not include any rights of return. Provisions are made at
the time of revenue recognition for any applicable warranty costs expected to be
incurred.  Revenues from services,  which have not been significant to date, are
recognized as the services are provided.

         (I)      SIGNIFICANT CUSTOMERS

         For the years ended  December 31, 1997 and 1998,  Coherent acted as the
sales agent for products sold to the Company's  customers that  represented  11%
and  89% of  revenues  and 51% and  89% of  accounts  receivable,  respectively.
Coherent is the  Company's  worldwide  distributor  of laser  systems  (see Note
12(d)).  International  sales  (including sales for which Coherent was the sales
agent) for the years ended December 31, 1996,  1997 and 1998 were  approximately
22%, 24% and 39% respectively, of total revenue.

         (J)      RESEARCH AND DEVELOPMENT EXPENSES

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

         (K)      NET LOSS PER COMMON SHARE

         Basic net loss per share was  determined  by  dividing  net loss by the
weighted average shares of common stock outstanding during the year. Diluted net
loss per  share  is the same as basic  loss  per  share  because  the  Company's
potentially dilutive securities,  primarily stock options, warrants,  redeemable
preferred stock and convertible debentures are antidilutive.  The calculation of
the Company's net loss per common share from continuing operations for the years
ended December 31, 1996, 1997 and 1998 are as follows:

<TABLE>
<CAPTION>


                                                                   Year Ended December 31,
                                                        1996                1997                1998
                                                   ----------------    ---------------     ----------------
   <S>                                               <C>                <C>                   <C>
   Net loss from continuing operations               $(20,798,258)      $(58,369,079)         $(9,967,243)
   Preferred stock dividends                           (1,242,751)        (1,584,406)          (1,312,426)
   Amortization of value ascribed to preferred
   stock conversion discount                             ---              (2,823,529)            ---
                                                   ----------------    ---------------     ----------------
   Adjusted net loss from continuing  operations     $(22,041,009)      $(62,777,014)        $(11,279,669)
                                                   ================    ===============     ================

   Basic and diluted net loss per common share
   from continuing operations                              $(0.84)            $(1.79)              $(0.18)
                                                   ================    ===============     ================

   Weighted average number of common shares
   outstanding                                         26,166,538         35,105,272           62,868,696
                                                   ================    ===============     ================
</TABLE>


         Net loss from  discontinued  operations per common share is computed by
dividing  the net loss from  discontinued  operations  by the  weighted  average
number of common shares outstanding for the period.

         In 1996, 1997 and 1998, 16,140,688,  32,358,446 and 28,451,024 weighted
average common equivalent shares, respectively, were not included in the diluted
weighted average shares outstanding, as they were antidilutive.

                                      -16-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         (L)      CONCENTRATION OF CREDIT RISK

         SFAS No. 105,  DISCLOSURE OF INFORMATION  ABOUT  FINANCIAL  INSTRUMENTS
WITH  OFF-BALANCE-SHEET  RISK AND FINANCIAL  INSTRUMENTS WITH  CONCENTRATIONS OF
CREDIT RISK, requires disclosure of any significant off-balance-sheet and credit
risk  concentrations.  Financial  instruments that subject the Company to credit
risk consist primarily of cash and trade accounts receivable. The Company places
its cash in established financial  institutions.  The Company has no significant
off-balance-sheet   concentration  of  credit  risk  such  as  foreign  exchange
contracts,  options contracts or other foreign hedging  arrangements.  To reduce
its accounts receivable risk, the Company relies on its worldwide distributor to
assess the  financial  strength  of its end  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 concentrated  within any one geographic
area. The Company has not experienced  significant losses related to receivables
from any individual customers or groups of customers in any specific industry or
by geographic  area.  Due to these  factors,  no  additional  credit risk beyond
amounts provided for collection  losses is believed by management to be inherent
in the Company's accounts receivable.

         (M)      DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

         SFAS No. 107,  DISCLOSURE  ABOUT FAIR VALUE OF  FINANCIAL  INSTRUMENTS,
requires  disclosure  of an  estimate  of the fair  value of  certain  financial
instruments.  At December  31, 1997 and 1998,  financial  instruments  consisted
principally of convertible  debentures and preferred stock financings.  The fair
value of  financial  instruments  pursuant  to SFAS No. 107  approximated  their
carrying  values at December 31, 1997 and 1998. Fair values have been determined
through information obtained from market sources and management estimates.

         (N)      COMPREHENSIVE INCOME

         The Company  adopted  SFAS No.  130,  REPORTING  COMPREHENSIVE  INCOME,
effective January 1, 1998. SFAS No. 130 establishes  standards for reporting and
presentation  of  comprehensive  income/loss and its components in the financial
statements. The components of the Company's comprehensive loss are as follows:

<TABLE>
<CAPTION>

                                                                        December 31,
                                                        1996                1997                1998
                                                   ----------------    ---------------     ----------------
   <S>                                               <C>                <C>                   <C>
   Net loss from continuing operations               $(20,798,258)      $(58,369,079)         $(9,967,243)
   Unrealized (loss) gain on marketable securities       (342,500)           342,500                  ---
                                                   ----------------    ---------------     ----------------
   Comprehensive loss from continuing  operations    $(21,140,758)      $(58,026,579)         $(9,967,243)
                                                   ================    ===============     ================
</TABLE>

         (O)      RECLASSIFICATIONS

         Certain   reclassifications  have  been  made  to  the  1996  and  1997
consolidated   financial   statements   to  conform  with  the  current   year's
presentation.

                                       -17-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


(4)      ASSET WRITE-OFF AND RESTRUCTURING

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

                                         Description                                 Carrying Amount
                                         -----------                                 ---------------
                 <S>                                                                 <C>
                 Notes Receivable                                                       $ 2,250,000
                 Investments in Non-Core Businesses                                       8,033,000
                                                                                        -----------

                                                                                        $10,283,000
                                                                                        -----------
                                                                                        -----------
</TABLE>


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

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

         All expenses accounted for as restructuring  charges were in accordance
with the  criteria  set forth in  EMERGING  TASK  FORCE  ISSUE  94-3,  LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY  (INCLUDING  CERTAIN  COSTS  INCURRED  IN  A  RESTRUCTURING),  and  are
exclusive of the charges  related to  discontinued  operations,  as disclosed in
Note 2. Through  December 31, 1998, the Company paid out $2,289,690 of severance
costs and has a remaining  liability of $279,000 to two individuals that will be
paid out in 1999 resulting in total  restructuring costs incurred of $2,568,690.
Accordingly,  the Company reversed the balance of this restructuring  accrual of
$131,310 in its consolidated  statement of operations  during the fourth quarter
of fiscal 1998.

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

         (A)      TISSUE TECHNOLOGIES, INC.

         On December 16, 1997,  the Company sold assets and certain  liabilities
of Tissue  Technologies,  Inc.  ("Tissue  Technologies"),  a  manufacturer  of a
dermatological  laser product for the  treatment of wrinkles,  to a newly formed
medical laser manufacturer. This medical laser manufacturer was formed by former
executives of Tissue Technologies.  In exchange, the Company received a $500,000
note  receivable  due in  monthly  installments  over the 

                                       -18-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (Continued)

next year,  royalties ranging from 2% to 5% on product revenue over the next ten
years,  a 15%  equity  position  in the newly  formed  company  and a warrant to
purchase 10% of the common stock of the newly formed  company at $.50 per share.
The  Company  placed  zero  value on the  equity  position  in the newly  formed
company.

         (B)      PALOMAR TECHNOLOGIES, LTD.

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

(5)      INCOME TAXES

         The Company  provides  for income taxes under the  liability  method in
accordance with the provisions of SFAS No. 109,  ACCOUNTING FOR INCOME TAXES. At
December 31,  1998,  the Company had  available,  subject to review and possible
adjustment  by the  Internal  Revenue  Service,  a federal  net  operating  loss
carryforward of  approximately  $101,000,000 to be used to offset future taxable
income,  if any. This net operating  loss  carryforward  will begin to expire in
2003. The Internal Revenue Code contains provisions that limit the net operating
loss  carryforwards  due to changes  in  ownership,  as defined by the  Internal
Revenue Code.  The Company  believes that its net operating  loss  carryforwards
will  be  limited  due  to its  reorganization  in  1991  and  subsequent  stock
offerings.  The Company has completed an analysis of its availability to utilize
its operating loss in connection with the  anticipated  sale of Star to Coherent
(See  Note 1).  The  Company  estimates  that its has net  operating  losses  of
approximately  $75,000,000 that are not subject to limitation under the Internal
Revenue  Code.  The  Company  has a net  deferred  tax  asset  of  approximately
$40,400,000,  comprised mainly of the net operating tax carryforwards  discussed
above,  and the tax  effect of  certain  expenses  and  reserves  not  currently
deductible.  However,  the Company has placed a full valuation allowance against
the deferred tax asset, due to uncertainty  relating to the Company's ability to
realize the asset.

(6)      LONG-TERM DEBT

         At  December  31,  1997  and  1998,  long-term  debt  consisted  of the
following:

<TABLE><CAPTION>

                                                                                          December 31,
                                                                                      1997             1998
                                                                                 ---------------  ---------------
<S>                                                                                <C>               <C>
Convertible debentures                                                              $10,683,440       $2,150,000
Revolving line of credit with a bank                                                         --        1,000,000
Note payable in connection with guarantee on behalf of discontinued
    subsidiary (See Note 2)                                                           3,233,000        2,290,041
Short-term notes payable to Coherent                                                         --        4,000,000
Other notes payable                                                                     169,588               --
                                                                                 ---------------  ---------------
                                                                                    $14,086,028       $9,440,041
Less - current maturities                                                           (1,640,465)       (6,290,041)
                                                                                 ---------------  ---------------
                                                                                    $12,445,563       $3,150,000
                                                                                 ===============  ===============

</TABLE>

                                       -19-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         (A)      CONVERTIBLE DEBENTURES

         The  following  table  summarizes  the issuance and  conversion  of the
convertible debentures for the years ended December 31, 1997 and 1998.
<TABLE>
<CAPTION>

                                                                                                                Common Shares
                                                             Initial            Amount Outstanding              Issued Upon
                                                              Face                 December 31,                  Conversion
                                                                           ----------------------------- --------------------------
   Series                                                     Value            1997            1998          1997          1998
   ----------------------------------------------------  --------------   --------------  ------------- ---------------- ----------
   <S>                                                      <C>              <C>            <C>              <C>          <C>
   4.5% Series due October 21, 1999, 2000, 2001              $5,000,000         $100,000       $--           1,381,264       60,809
   5% Series due December 31, 2001                            5,000,000          923,439        --           2,074,992    1,160,999
   5% Series due January 13, 2002                             1,000,000        1,000,000        --            --            924,029
   5% Series due March 10, 2002                               5,500,000        1,160,001        --           2,794,677    1,561,064
   6% Series due March 13, 2002                                 500,000          500,000        500,000       --            --
   6%, 7% and 8% Series due September 30, 2002                7,000,000        7,000,000      1,650,000       --          3,328,761
   4.5% Series denominated in Swiss francs
        due July 3, 2003                                      7,669,442         --              --             914,028      --
                                                          --------------   --------------  ------------- --------------- ----------

                                                            $31,669,442      $10,683,440     $2,150,000      7,164,961    7,035,662
                                                          ==============   ==============  ============= =============== ==========

</TABLE>



         It is the Company's policy to discount convertible  debentures based on
the discount  conversion  price and amortize the discount to operations over the
expected life of the  convertible  debentures,  which in most cases is less than
the term of the debentures.  Accordingly, the Company credits the ascribed value
for the discount features  described above to additional  paid-in capital.  This
ascribed  amount is  amortized  over a period to the earliest  conversion  date,
which is six months for the convertible debentures outstanding in 1997 and 1998.

         During 1996 and 1997, the Company  recorded  approximately  $77,000 and
$5,444,000, respectively, of interest expense related to the amortization of the
discount of convertible debentures. There was no amortization of the discount of
convertible debentures in 1998.

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

         On September 30, 1997,  the Company  issued  $7,000,000 of  convertible
debentures due September 30, 2002. The debentures  bear interest at a rate of 6%
for  the  first  179  days,  7%  for  days  180-269  and  8%   thereafter.   The
debentureholders were also issued 413,109 shares of common stock related to this
financing.  The fair market  value of the common stock was  $1,050,000  and this
amount is being treated as debt discount and amortized to interest expense.  The
convertible  debentures have a conversion price of 100% of the Company's average
stock price, as defined.  In addition,  the  debentureholder may convert no more
than 33% of their debentures in any thirty-day  period (or 34% of the debentures
in the last thirty-day  period).  The Company also has redemption rights related
to this financing.  During the year ended December 31, 1998 the Company redeemed
$2,196,667  of  these  convertible  debentures.  This  amount  includes  accrued
interest of $196,667.

         On July 3, 1996, the Company raised  approximately  $7,669,000  through
the issuance of 9,675 units in a convertible  debenture  financing.  These units
are  traded on the  Luxembourg  Stock  Exchange  and  consist  of a  convertible
debenture,  due July 3, 2002, denominated in 1,000 Swiss francs and a warrant to
purchase  24 shares of the  Company's  common  stock at $16.50  per  share.  The
warrants are  non-detachable and may be exercised only if the related debentures
are simultaneously converted, redeemed or purchased. Interest on the convertible
debentures  accrued  at a rate of 4.5% per annum and was  payable  quarterly  in
Swiss francs. The convertible  debentures were convertible by the holder, or the
Company,  commencing October 1, 1996 at a conversion price equal to from 100% 

                                      -20-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

to 77.5% of the applicable conversion price,  calculated as defined. The Company
ascribed  a value  of  $1,917,360  to the  discount  conversion  feature  of the
convertible debenture.  This amount was being amortized to interest expense over
the life of the Swiss franc  convertible  debenture.  During  1997,  the Company
redeemed 300 units of this convertible debenture financing for $195,044.

         On October 16, 1997, the Company brought a declaratory  judgment action
in  the  United  States  District  Court  against  certain  of the  Swiss  franc
debentureholders.  Prior to this suit, those  debentureholders  had alleged that
the Company  was in breach of certain  protective  covenants  and on October 22,
1997, they brought suit based on these claims. On November 13, 1997, the Company
exercised its right to convert  9,375 units into 914,028  shares of common stock
and  cash  of  approximately   $36,000.   The  unamortized   discount   totaling
approximately $1,784,000 was amortized to interest expense upon conversion.  The
Company has  accounted  for these  debentures  as converted in the  accompanying
financial  statements.  The ongoing  litigation will be accounted for under SFAS
No. 5, ACCOUNTING FOR CONTINGENCIES (see Note 12(c)).

         The  Company  incurred   deferred   financing  costs  of  approximately
$2,038,000  and  $769,000  relating to the  issuance of  convertible  debentures
during the years ended December 31, 1996 and 1997, respectively. These costs are
reflected as deferred financing costs in the accompanying  consolidated  balance
sheets and are being amortized to interest  expense over the term of the related
convertible debentures. During the years ended December 31, 1996, 1997 and 1998,
the Company amortized  approximately  $78,000,  $276,000 and $64,000 to interest
expense,  respectively.  Any remaining  unamortized deferred financing costs are
charged to additional  paid-in capital upon  conversion.  During the years ended
December 31, 1996,  1997 and 1998, the Company  charged  approximately  $41,000,
$1,820,000 and $374,000,  respectively,  of unamortized deferred financing costs
to additional paid-in-capital.

         (B)      REVOLVING LINE OF CREDIT WITH A BANK

         The Company  has a  $10,000,000  revolving  line of credit with a bank.
This line of credit  will  mature on March 31,  2000 and bears  interest  at the
bank's prime rate (7.75% at December 31,  1998).  Borrowings  under this line of
credit are secured by substantially all assets of the Company and are limited to
80% of qualified accounts receivables.  A director of Palomar has guaranteed all
borrowings  under this line of credit.  In  connection  with this  guarantee the
Company issued this director 200,000 warrants with a three-year term to purchase
the  Company's  common stock at $1.50 per share.  These  warrants were valued at
approximately  $69,000.  This amount is being amortized to interest expense over
the term of the revolving line of credit.

         (C)      BRIDGE LOAN

         On March 27, 1998, the Company borrowed  $2,000,000 from an individual.
The Company subsequently repaid this note during 1998. Interest on this note was
in the form of a warrant to purchase 125,000 shares of common stock for $.01 per
share exercisable over five years. This warrant was valued at $171,000 using the
Black-Scholes  option pricing model. The Company accounted for this warrant as a
discount  to the note  through  additional  paid-in  capital and  amortized  the
discount to interest expense over the period that the note was outstanding.

         (D)      NOTES PAYABLE TO COHERENT

         On May 22 and  June 22,  1998,  the  Company  borrowed  $3,000,000  and
$1,000,000,  respectively,  from the Company's worldwide distributor,  Coherent.
These notes accrue  interest at 8.5% per annum.  The notes are secured by all of
the inventory owned by the Company's Star subsidiary.

                                      -21-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         Under the terms of the Loan Agreement between Coherent and the Company,
in the event that sale of Star to Coherent is not  completed,  the $4,000,000 of
funds  borrowed by the Company  from  Coherent  are due 90 days from the date of
termination of the Agreement to sell Star to Coherent as discussed in Note (1).

         (E)      FUTURE MATURITIES OF LONG-TERM DEBT

         Future maturities of notes payable and convertible debentures reflected
at face value as of December 31, 1998 are as follows:

<TABLE>
<CAPTION>
                                         <S>                                <C>
                                         1999                               $6,290,041

                                         2000                                1,000,000
                                         2001                                       --
                                         2002                                2,150,000
                                                                          -------------
                                                                            $9,440,041
                                                                          =============
</TABLE>

(7)  STOCKHOLDERS' EQUITY

         (A)      COMMON STOCK

         During 1998,  the Company sold  10,200,000  shares of common stock to a
group of investors for  $10,200,000.  In addition,  the Company issued  callable
warrants with a three-year term to these investors to purchase 10,200,000 shares
of common stock at an exercise price of $3.00 per share.  The callable  warrants
are not  exercisable  for the first six months after issuance and thereafter are
callable by the  Company if the  closing  price of the  Company's  common  stock
equals or exceeds $5.00 for ten  consecutive  trading  days.  Under the terms of
this private  placement,  the Company is obligated to pay the investors a fee of
5% per annum (payable  quarterly) of the dollar value invested in the Company as
long as the  investors  continue to hold their common stock in their name at the
Company's transfer agent. During 1998, the Company paid $283,125 related to this
fee. This amount has been charged to  additional  paid-in  capital.  The Company
also paid $360,000 for investment  banking fees related to the issuance of these
common shares.  The Company  netted this amount  against the proceeds  through a
reduction in additional paid-in capital.

         On February  28,  1997,  the Company  and Nexar  entered  into an Asset
Purchase  and  Settlement  agreement  with  a  former  executive  of  Nexar  and
Technovation Computer Labs, Inc. ("Licensor").  The Licensor was affiliated with
a former officer of Nexar. Under the terms of this agreement, the Company agreed
to pay this former  executive and certain of his  affiliates  $1,250,000 in cash
and deliver $1,500,000 worth of Palomar's common stock. In exchange, the Company
and Nexar received the rights to certain technology previously licensed to Nexar
and a  complete  release  and  settlement  of all  claims  between  this  former
executive and Nexar.

         The Company  assigned to Nexar all of its rights to the  technology and
charged  Nexar for the cost  associated  with this claim and the purchase of the
technology.  Nexar recorded $1,375,000 of the consideration to settle this claim
as a  litigation  expense  in its  statement  of  operations  for the year ended
December 31, 1996. The remaining  consideration totaling $1,375,000 was recorded
as purchased  technology and was being amortized by Nexar 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.

                                       -22-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         (B)      PREFERRED STOCK

         The Company is authorized to issue up to 5 million  shares of preferred
stock,  $.01 par  value.  As of  December  31,  1997 and 1998,  preferred  stock
authorized, issued and outstanding consist of the following:
<TABLE>
<CAPTION>

                                                                                                  1997             1998
                                                                                                  ----             ----
       <S>                                                                                         <C>              <C>
       Redeemable convertible preferred stock, Series F, $.01 par value per
         share Authorized, issued and outstanding - 6,000 shares
         (liquidation preference of $7,072,917 at December 31, 1998)                               $60              $60

       Redeemable  convertible  preferred  stock,  Series  G, $.01 par value per
         share  Authorized - 10,000 shares Issued and outstanding - 2,684 shares
         and 743 shares in 1997 and 1998, respectively,
                                 (liquidation preference of $874,603 at December 31, 1998)          27                7

       Redeemable  convertible  preferred  stock,  Series  H, $.01 par value per
         share  Authorized - 16,000 shares Issued and outstanding - 7,690 shares
         and 250 shares in 1997 and 1998, respectively,
                                 (liquidation preference of $280,562 at December 31, 1998)          77                2


                                 Total preferred stock                                            $164            $  69
                                                                                                  ====            =====
</TABLE>


         The  Series  F  redeemable   convertible  preferred  stock  ("Series  F
Preferred"),  together with any accrued but unpaid  dividends,  may be converted
into common  stock at 80% of the  average  closing bid price for the ten trading
days preceding the conversion date, but in no event less than $3.00 or more than
$16.00. This conversion floor was decreased by the two parties from the original
price to $7.00. The Series F Preferred may be redeemed at the Company's  option,
with no less than 10 days'  and no more  than 30 days'  notice or when the stock
price exceeds $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.

         The  Series  G  redeemable   convertible  preferred  stock  ("Series  G
Preferred"),  together with any accrued but unpaid  dividends,  may be converted
into common  stock at 85% of the average  closing bid price for the five trading
days preceding the conversion  date, but in no event less than $.01. On December
31, 1997,  the Company and the holder of the remaining  2,684 shares of Series G
Preferred entered into an Exchange Agreement. The conversion floor was decreased
by the two parties from the original floor to $6.00.  In addition,  beginning on
March 1, 1998,  for any  thirty-day  period,  the holder may  exchange a limited
amount of the Series G Preferred  ("exchangeability amount") and any accrued but
unpaid  dividends  for common stock at 85% of the average  closing bid price for
the five trading days  preceding the  conversion  date  ("exchange  date").  The
exchangeability   amount   increases  as  the  exchange  rate   increases.   The
exchangeability amount ranges from 268 shares of preferred stock for an exchange
rate below $2.00 to 1,072  shares of  preferred  stock for an  exchange  rate in
excess of $4.00.  The Series G Preferred may be redeemed at the Company's option
at any time, with no less than 15 days' and no more than 20 days' notice,  at an
amount equal to the sum of (a) the amount of liquidation  preference  determined
as of the  applicable  redemption  date plus (b) $176.50.  Dividends are payable
quarterly  at 7% per annum in arrears on January 1, April 1, July 1 and  October
1.  Dividends not paid on the payment date,  whether or not such  dividends have
been declared, will bear interest at the rate of 12% per annum until paid.

         The conversion price for the Series F and G Preferred is adjustable for
certain  dilutive  events,  as  defined.  The  Series F and G  Preferred  have a
liquidation preference equal to $1,000 per share of redeemable convertible

                                       -23-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

preferred  stock,  plus  accrued  but unpaid  dividends  and  accrued but unpaid
interest.  The  Series F and G  Preferred  stockholders  do not have any  voting
rights except on matters affecting the Series F and G Preferred.

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

         During  the year ended  December  31,  1997,  the  following  shares of
preferred stock,  accrued premium,  dividends,  interest and other related costs
were converted into shares of common stock as follows: 
<TABLE> 
<CAPTION>

                 Number of                              Additional Dollar Amount
  Preferred      Preferred      Dollar Amount of      Converted, Including Accrued                           Number of Common
Stock Series      Shares        Preferred Stock       Premium, Dividends, Interest        Total Dollar       Shares Converted
                 Converted         Converted            and Other Related Costs         Amount Converted           Into
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------
      <S>           <C>             <C>                          <C>                        <C>                   <C>     
      E             2,128           $2,128,000                   $126,366                   $2,254,366            332,859
      G             7,316            7,316,000                    438,234                    7,754,234            602,824
      H             8,310            8,310,000                    228,411                    8,538,411          5,204,158
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------

                   17,754          $17,754,000                   $793,011                  $18,547,011          6,139,841

</TABLE>

     In addition to the 602,824  shares of common  stock  issued  related to the
Series G  Preferred  conversion,  the  Company  issued to the Series G Preferred
stockholder  $47,731 in cash  dividends and 956,388 shares of Nexar common stock
valued at  $4,671,597.  The  reduction to  stockholder's  equity  (deficit) as a
result of this transaction was as follows: 
<TABLE> 
<CAPTION>
             <S>                                                                   <C>
             Value of Nexar Common Stock                                          $4,671,597
             Accrued Interest and Dividend                                          (391,597)
                                                                                  -----------
                                                                                  $4,280,000
                                                                                  ===========
</TABLE>


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

                 Number of                              Additional Dollar Amount
  Preferred      Preferred      Dollar Amount of      Converted, Including Accrued                           Number of Common
Stock Series      Shares        Preferred Stock       Premium, Dividends, Interest        Total Dollar       Shares Converted
                 Converted         Converted            and Other Related Costs         Amount Converted           Into
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------
      <S>           <C>             <C>                          <C>                        <C>                 <C>            
      G             1,941           $1,941,000                   $268,245                   $2,209,245          2,703,032
      H             3,947            3,946,700                    383,923                    4,330,623          4,188,650
-------------- -------------- --------------------- --------------------------------- --------------------- -------------------

                    5,888           $5,887,700                   $652,168                   $6,539,868          6,891,682
</TABLE>

                                       -24-
<PAGE>

          PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         In addition to the 4,188,650  shares of common stock issued  related to
the Series H Preferred conversion, the Company redeemed 3,516 shares of Series H
Preferred for $4,387,434.  This amount includes  accrued  dividends and interest
totaling $771,876.

         (C)      STOCK OPTION PLANS AND WARRANTS

                  (I)      STOCK OPTIONS

         The Company has several  Stock Option Plans (the  "Plans") that provide
for the issuance of a maximum of 7,350,000 shares of common stock,  which may be
issued as incentive stock options  ("ISOs") or nonqualified  options.  Under the
terms of the Plans,  ISOs may not be granted at less than the fair market  value
on the date of grant (and in no event less than par  value);  in  addition,  ISO
grants to holders of 10% of the combined  voting power of all classes of Company
stock  must be granted  at an  exercise  price of not less than 110% of the fair
market  value  at the  date  of  grant.  Pursuant  to  the  Plans,  options  are
exercisable at varying dates, as determined by the Board of Directors,  and have
terms not to exceed 10 years (five years for 10% or greater  stockholders).  The
Board of Directors,  at its  discretion,  may convert the  optionee's  ISOs into
nonqualified options at any time prior to the expiration of such ISOs.

         The following table summarizes all stock option activity of the Company
for the years ended December 31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>

                                                                 Number of           Exercise           Weighted Average
                                                                   Shares              Price             Exercise Price
                                                                -------------     ----------------    ----------------------
<S>                                                               <C>               <C>                      <C>              
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
            Granted                                                1,747,345            0.01-6.50             2.53
            Exercised                                              (214,845)            0.01-3.00             1.62
            Canceled                                             (1,206,100)          2.375-10.50             6.23
                                                                -------------     ----------------    ----------------------
Outstanding, December 31, 1997                                     2,982,400          $1.50-$8.00            $3.33
            Granted                                                2,294,900                 1.50             1.50
            Canceled                                             (2,924,400)           1.50-8.125             3.38
                                                                -------------     ----------------    ----------------------
Outstanding, December 31, 1998                                     2,352,900          $1.50-$2.50             $1.51
                                                                =============     ================    ======================
Exercisable, December 31, 1998                                     1,851,371          $1.50-$2.50             $1.51
                                                                =============     ================    ======================
Available for future issuances under the Plans                                
            as of December 31, 1998                                4,354,755
                                                                =============
</TABLE>


                                       -25-
<PAGE>



               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         The exercise prices for options  outstanding and options exercisable at
December 31, 1998 are as follows:
<TABLE>
<CAPTION>

                                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
--------------------- ---------------- ---------------------- -----------------------    --------------- ----------------------
       <S>                  <C>             <C>                       <C>                     <C>                <C>          
       $1.50                2,327,900       2.88 years                $1.50                   1,834,705          $1.50
       $2.50                   25,000       2.96 years                 2.50                      16,666           2.50
                      ================ ====================== =======================    =============== ======================
                            2,352,900       2.88 years                $1.51                   1,851,371          $1.51
                      ================ ====================== =======================    =============== ======================
</TABLE>

         The Company accounts for its stock-based  compensation  plans under APB
Opinion No. 25,  ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.  In October 1995, the
FASB issued SFAS No. 123,  ACCOUNTING  FOR  STOCK-BASED  Compensation,  which is
effective  for fiscal years  beginning  after  December  15, 1995.  SFAS No. 123
established a fair-value-based method of accounting for stock-based compensation
plans. The Company has adopted the  disclosure-only  alternative  under SFAS No.
123 which requires  disclosure of the pro forma effects on earnings per share as
if SFAS No. 123 had been  adopted,  as well as certain  other  information.  The
Company  accounts for equity  instruments  issued to non-employees in accordance
with EITF 96-18 by valuing the instrument using the Black-Scholes pricing model,
as prescribed  by SFAS No. 123, and  recording a charge to operations  for their
fair value. The Company has issued options and warrants to purchase common stock
to certain  financial  intermediaries  in connection with various  financings at
below the fair market value of the underlying  stock.  The costs associated with
these  issuances  are  accounted  for as a cost of  raising  capital  and netted
against the proceeds from these issuances.

         During the year ended  December 31, 1997 and 1998, a total of 1,005,000
and 2,184,900  options to purchase  common stock were repriced to above the fair
market  value of the  underlying  common  stock to $2.50 and  $1.50  per  share,
respectively.  The majority of the remainder of the options  canceled during the
years  ended  December  31,  1996,  1997 and 1998 were the  result  of  employee
terminations.

         The Company has computed the pro forma disclosures  required under SFAS
No. 123 for all stock  options  granted to employees of the Company in the years
ended December 31, 1996,  1997 and 1998 using the  Black-Scholes  option pricing
model prescribed by SFAS No. 123.

         The assumptions used to calculate the SFAS No. 123 pro forma disclosure
for the years  ended  December  31,  1996,  1997 and 1998 for the Company are as
follows:
<TABLE>
<CAPTION>



                                                                               December 31,
                                                             1996                  1997                  1998
                                                       ------------------    ------------------    ------------------
     <S>                                                   <C>                  <C>                   <C>
     Risk-free interest rate                                 6.37%                 6.09%                 5.60%
     Expected dividend yield                                   -                     -                     -
     Expected lives                                        4.4 years            3.69 years            2.94 years
     Expected volatility                                      79%                   79%                   93%
     Grant date fair value of options granted during
           the period                                        $4.57                 $2.06                 $0.64
</TABLE>

                                       -26-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         The weighted average  fair-value and weighted average exercise price of
options  granted by the Company for the years ended December 31, 1996,  1997 and
1998 are as follows:
<TABLE>
<CAPTION>



                                                                                 December 31,
                                                                1996                1997                 1998
                                                            -------------     -----------------    -----------------
<S>                                                            <C>                 <C>                  <C>
Weighted average exercise price for options:
     Whose  exercise  price  exceeded fair market value at
      the date of grant                                        $10.00              $2.53                $1.50
     Whose  exercise  price was equal to fair value at the
      date of grant                                            $6.875                $-                   $-
Weighted average fair market value for options:
     Whose  exercise  price  exceeded fair market value at
      the date of grant                                        $8.875              $2.06                $0.64
     Whose  exercise  price was equal to fair market value
      at the date of grant                                     $6.875                $-                   $-

</TABLE>

     The  Company's  majority  owned  Star  subsidiary,  a  manufacturer  of the
Company's  diode laser,  also has  established a stock option plan that provides
for the issuance of a maximum of 650,000  shares of common  stock,  which may be
issued as  nonqualified  options and ISOs.  The following  table  summarizes the
employee stock option activity for Star:

<TABLE>
<CAPTION>

                                                                                                       Weighted
                                                                                                       Average
                                                                Number of Shares  Exercise Price    Exercise Price
                                                                ----------------  --------------    --------------
                  <S>                                                   <C>        <C>                  <C>
                  Outstanding, December 31, 1995                         95,000   $2.50 - $5.00         $3.68
                           Granted                                      150,000    6.00 - 19.00          6.27
                           Exercised                                    (20,000)       2.50              2.50
                           Canceled                                     (10,000)       6.00              6.00
                                                                ----------------- --------------- -----------------
                  Outstanding, December 31, 1996                        215,000   2.50 - 19.00           5.44
                           Granted                                       40,500        19.00            19.00
                           Canceled                                      (1,917)       19.00            19.00
                                                                ----------------- --------------- -----------------
                  Outstanding, December 31, 1997                        253,583    $2.50-$19.00         $8.04
                           Exercised                                     (6,300)     2.50-5.00           4.21
                                                                ----------------- --------------- -----------------
                  Outstanding, December 31, 1998                        247,283    $2.50-$19.00         $8.13
                                                                ================= =============== =================
                                                                ================= =============== =================
                  Exercisable, December 31, 1998                        218,870    $2.50-$19.00         $7.22
                                                                ================= =============== =================
                                                                ================= =============== =================
                  Available  for  future  issuances  under the                                                      
                    Plan as of December 31, 1998                         24,493                                     
                                                                =================
</TABLE>

                                       -27-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         The exercise prices for options  outstanding and options exercisable at
December 31, 1998 for Star are as follows:
<TABLE>
<CAPTION>

                                    OPTIONS OUTSTANDING                                   OPTIONS EXERCISABLE
                               ------------------------------------------------     ------------------------------
                                                  Weighted
                                                  Average           Weighted                           Weighted
                                 Options         Remaining          Average           Options          Average
           Exercise Prices     Outstanding    Contractual Life   Exercise Price     Exercisable     Exercise Price
                <S>                  <C>         <C>                     <C>              <C>               <C>
                 $2.50                28,000     5.45 years     $         2.50             28,000  $         2.50
                 $5.00                40,700     5.43 years               5.00             40,700            5.00
                 $6.00               120,000     7.13 years               6.00            113,332            6.00
                 $9.50                10,000     7.63 years               9.50              7,777            9.50
                $19.00                48,583     8.20 years              19.00             29,061           19.00
                             ---------------     ----------     --------------    ---------------  --------------

                                     247,283     6.89 years     $         8.13            218,870  $         7.22
                             ===============     ==========     ==============    ===============  ==============
</TABLE>


         During 1998,  Star also issued  options to purchase  378,224  shares of
common stock of Star to Palomar at $19.00 per share.

                  (II)     WARRANTS

         The following table  summarizes all warrant activity of the Company for
the years ended December 31, 1996, 1997 and 1998:

<TABLE>
<CAPTION>

                                                                                                  Weighted
                                                            Number of          Exercise           Average
                                                              Shares            Price          Exercise Price
                                                          ---------------  ----------------- -------------------
<S>                                                          <C>               <C>                 <C>
Outstanding, December 31, 1995                                 6,549,924       $0.01-$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
              Granted                                          2,793,187         2.50-8.875         4.29
              Exercised                                        (584,879)          0.60-7.50         2.10
              Canceled                                       (2,186,517)         1.00-16.50         6.65
                                                          ---------------  ----------------- -------------------
Outstanding, December 31, 1997                                 9,998,030       $2.00-$15.00        $6.65
              Granted                                         12,585,000          0.01-3.00         2.75
              Exercised                                        (125,000)               0.01         0.01
              Canceled                                       (2,878,452)          2.25-6.75         4.13
                                                          ---------------  ----------------- -------------------
Outstanding, December 31, 1998                                19,579,578       $1.50-$15.00        $4.38
                                                          ===============  ================= ===================
Exercisable, December 31, 1998                                19,359,578       $1.50-$15.00        $4.37
                                                          ===============  ================= ===================
</TABLE>


         During the years ended December 31, 1997 and 1998, a total of 1,240,000
and 1,300,000  warrants to purchase common stock were repriced to above the then
current  fair market  values of the  underlying  common  stock.  These  repriced
exercise  prices  ranged  from $2.50 to $4.00 per share in 1997 and ranged  from
$1.50 to $2.00 per share in 1998.  The majority of the remainder of the canceled
warrants  during the years ended  December  31, 1997 and 1998 were the result of
employee  terminations.  During 1998,  the Company  also issued  warrants for an
aggregate  of 250,000  shares of common stock to various  parties in  connection
with certain financing arrangements. 

                                      -28-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

The Company  valued these  warrants using the  Black-Scholes  pricing model,  as
prescribed by SFAS No.123,  and recorded a charge to  operations  for their fair
value for approximately $47,000.

         The range of exercise  prices for warrants  outstanding and exercisable
at December 31, 1998 are as follows:
<TABLE>
<CAPTION>

                                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
--------------------- ---------------- ---------------------- -----------------------    --------------- ----------------------
     <S>                   <C>              <C>                         <C>                  <C>                 <C>
      $1.50 - $2.125        2,739,500       2.44 years                  $1.71                 2,619,500          $1.72
       $3.00 - $3.00       10,560,000       4.26 years                   3.00                10,560,000           3.00
       $3.25 - $9.50        5,102,020       2.07 years                   6.45                 5,002,020           6.39
     $10.38 - $15.00        1,178,058       2.07 years                  13.98                 1,178,058           13.98
                      ---------------- ---------------------- -----------------------    --------------- ----------------------
                           19,579,578       3.30 years                  $4.38                19,359,578          $4.37
                      ================ ====================== =======================    =============== ======================
</TABLE>


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

     The weighted-average assumptions used to calculate the SFAS No. 123 pro
forma disclosure for the years ended December 31, 1996, 1997 and 1998 for the
Company are as follows:
<TABLE>
<CAPTION>

                                                                               December 31,
                                                            1996                  1997                  1998
                                                       ----------------     ------------------    ------------------
<S>                                                       <C>                  <C>                   <C>
Risk-free interest rate                                      5.93%                6.13%                 5.44%
Expected dividend yield                                       -                     -                     -
Expected lives                                            5.9 years            4.44 years            2.58 years
Expected volatility                                          79%                   79%                   93%
Grant date fair value of warrants granted during
     the period                                             $5.39                 $2.17                 $0.76
</TABLE>

                                       -29-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)



         The weighted  average fair value and weighted average exercise price of
warrants  granted by the Company for the years ended December 31, 1996, 1997 and
1998 are as follows:
<TABLE> 
<CAPTION>

                                                                                   December 31,
                                                                     1996               1997                1998
                                                               -----------------    --------------    -----------------
<S>                                                                 <C>                 <C>                <C>
Weighted average exercise price for warrants:
     Whose  exercise price exceeded fair market value at date
       of grant                                                     $11.76              $4.30               $2.78
     Whose  exercise price was less than fair market value at
       date of grant                                                 $7.07              $7.50               $0.01
     Whose  exercise  price was equal to fair market value at
       date of grant                                                 $6.67              $3.25               $-
Weighted average fair value for warrants:
     Whose  exercise price exceeded fair market value at date
       of grant                                                      $9.34              $1.10               $0.76
     Whose  exercise price was less than fair market value at
       date of grant                                                 $8.82              $0.62               $1.24
     Whose  exercise  price was equal to fair market value at
       date of grant                                                 $6.67              $2.18               $-

</TABLE>


                  (III)    PRO FORMA DISCLOSURE

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

<TABLE>
<CAPTION>

                                  December 31,
                                                                 1996                      1997                    1998
                                                          -------------------      ----------------------    -----------------
<S>                                                         <C>                        <C>                    <C>
Pro forma net loss from continuing operations               $(48,292,780)              $(62,020,782)          $(23,169,514)
Pro forma basic and dilutive net loss per share from
    continuing operations                                      $(1.89)                    $(1.89)                $(0.39)
</TABLE>

         (D)      RESERVED SHARES

         At December  31, 1998,  the Company has  reserved  shares of its common
stock for the following:
<TABLE>
<CAPTION>

              <S>                                                               <C>
              Warrants                                                          19,579,578
              Stock option plans                                                 6,707,655
              Convertible debentures                                             3,216,694
              Preferred stock                                                    3,328,894
              Employee stock purchase plan                                         419,412
              Employee 401(k) plan                                                 554,787
                                                                            ---------------
                                   Total                                        33,807,020
                                                                            ===============
</TABLE>

         (E)      EMPLOYEE STOCK PURCHASE PLAN

     In June  1996,  the Board of  Directors  established  the  Palomar  Medical
Technologies,  Inc. 1996 Employee  Stock  Purchase Plan (the  "Purchase  Plan").
Under the Purchase Plan,  all employees,  are eligible to purchase the Company's
common  stock at an exercise  price equal to 85% of the fair market value of the
common  stock with a 

                                       -30-
<PAGE>
           PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

lookback  provision of three months.  The Purchase Plan provides for issuance of
up to 500,000 shares under the Purchase Plan. During the year ended December 31,
1997 and 1998,  employees  purchased  15,377 and 65,211  shares of the Company's
common stock for approximately  $40,000 and $50,000,  respectively,  pursuant to
the Purchase Plan.

(8)      RESEARCH AND PRODUCT DEVELOPMENT AGREEMENTS

         During  1995,  the Company  entered into a  multi-year  agreement  with
Massachusetts  General Hospital ("MGH"),  whereby MGH agreed to conduct clinical
trials on a laser treatment for hair removal.  MGH will provide the Company with
data previously  generated by Dr. Anderson and 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  agreed 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 paid 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 up to 5% on
net revenues as defined (See Note 12 (b)). In March 1997, the U.S. Patent Office
issued a patent covering the laser-based hair removal technology developed by at
MGH, for which Palomar is the exclusive worldwide licensee.

(9)      ACCRUED LIABILITIES

         At  December  31,  1997 and 1998,  accrued  liabilities  consist of the
following:
<TABLE>
<CAPTION>

                                                                                December 31,
                                                                         1997                  1998
                                                                    ----------------      ---------------
                          <S>                                           <C>                  <C>
                          Payroll and consulting costs                   $1,535,013           $1,148,898
                          Royalties                                         853,808            1,106,352
                          Settlement costs                                1,457,020                   --
                          Warranty                                        2,583,677            2,798,836
                          Restructuring                                   1,981,907              279,000
                          Interest and preferred stock dividends          1,659,709            1,550,662
                          Other                                           3,688,720            3,417,876
                                                                    ----------------      ---------------
                              Total                                     $13,759,854          $10,301,624
                                                                    ================      ===============
</TABLE>

(10)     RELATED PARTY TRANSACTION

         At December 31, 1997,  approximately  $478,000 of loans receivable with
interest at the rate of 7% per annum were  outstanding from the Company's former
President.  In the first quarter of 1998,  the Company's  former  President paid
back his outstanding loan.

(11)     401(K) PROFIT SHARING PLAN

         The Company  has a 401(k)  profit  sharing  plan (the  "Profit  Sharing
Plan") which covers  substantially all employees who have attained the age of 18
and are  employed  at  year-end.  Employees  may  contribute  up to 15% of their
salary,  as defined,  subject to  restrictions  defined by the Internal  Revenue
Service. The Company is obligated to make a matching  contribution,  in the form
of the Company's  common stock, of 50% of all employee  contributions  effective
January 1, 1995. The Company  contributions  vest over a three-year  period. The
Company  has  reserved  554,787  shares  of its  common  stock for  issuance  in
connection with the Profit Sharing Plan.

                                      -31-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

         During 1997 and 1998,  the Company  issued 87,441 and 311,887 shares of
its common stock to the Profit Sharing Plan in  satisfaction of its $318,154 and
$254,281   employer  match  for  the  1996  and  1997  employee   contributions,
respectively.  For the year ended  December  31,  1998,  the Company has accrued
$206,000  for the 1998 match.  The  Company  contributed  227,930  shares of its
common stock for this match in February of 1999.

(12)     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 $34,000,  adjusted annually
for  certain  other costs such as  inflation,  taxes and  utilities,  and expire
through July 2003. The Company guarantees Star's facility operating lease

         Future  minimum  payments  under  the  Company's  operating  leases  at
December 31, 1998 are approximately as follows:
<TABLE>
<CAPTION>

                             December 31,
                             <S>                                             <C>
                             1999                                              $548,000
                             2000                                               264,000
                             2001                                                96,000
                             2002                                               101,000
                             2003                                                60,000
                                                                           -------------
                                                                             $1,069,000
                                                                           =============
</TABLE>

         (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 8). For the
years ended December 31, 1996, 1997 and 1998,  approximately $175,000,  $854,000
and  $1,332,000  of  royalty  expense,  respectively,  was  incurred  under this
agreement.  These  amounts  are  included  in cost of sales in the  accompanying
consolidated statements of operations.

         A  former   employee  and  previous  owner  of  one  of  the  Company's
subsidiaries is paid a 1% commission on the net sales of certain ruby lasers and
diode lasers, as defined.  These commissions will be paid through March 31, 2000
and are to be no less than $450,000. In accordance with the settlement agreement
with  this  individual,  the  Company  paid  advances  on  commissions  totaling
$450,000: $200,000 in 1997 and $250,000 in January 1998.

         (C)      LITIGATION

         The Company was a defendant in a lawsuit filed on March 14, 1996 in the
United  States  District  Court  for  the  Southern  District  of  New  York  by
Commonwealth Associates ("Commonwealth"). In its suit, Commonwealth alleged that
the Company had 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 in April 1997 the  District  Court
awarded  Commonwealth  $3,174,070  in damages.  That  judgment  was  appealed by
Palomar and on August 18, 1997 the case was settled for $1.875  million.  During
the year ended  December  31,  1997,  the  Company  incurred  $1.875  million in
settlement  costs related to the above matter and another $1.324 million related
to several other claims and associated litigation costs.

         On March 7, 1997, Selvac Acquisition Corp. ("Selvac"),  a subsidiary of
Mehl Biophile  International,  Inc.  ("Mehl"),  filed a complaint for injunctive
relief and damages for patent  infringement  and for unfair  competition  in 

                                      -32-
<PAGE>

               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (Continued)

the United  States  District  Court for the  District of New Jersey  against the
Company,  two of  its  subsidiaries  and a New  Jersey  dermatologist.  Selvac's
complaint alleged that the Company's EpiLaser(R)- ruby laser hair removal system
infringed a patent licensed to Selvac (the "Selvac Patent") and that the Company
unfairly  competed by promoting the EpiLaser(R)-  ruby laser hair removal system
for  hair  removal  before  it had  received  FDA  approval  for  that  specific
application.  On May 18, 1998 the court granted the Company's motion for partial
summary  judgment on the ground that the Selvac patent is invalid  because prior
art   anticipated   it.  The  court  has  since  denied   Selvac's   motion  for
reconsideration of the summary judgment ruling. On September 25, 1998, the court
denied Selvac's motion for reconsideration of its prior order dismissing so much
of Selvac's unfair  competition  claim as relied on interpreting  the Food, Drug
and Cosmetics Act or FDA regulations,  and dismissed without prejudice the state
law remainder of Selvac's unfair  competition claim. On October 26, 1998, Selvac
filed its  notice of appeal to the Court of  Appeals  for the  Federal  Circuit.
Selvac subsequently filed its opening brief on appeal; the Company's  opposition
was filed in March,  1999. The Company is unable to express an opinion as to the
likely  outcome  of  Selvac's  appeal,  or as to the  range  of loss  if  Selvac
ultimately prevailed at trial.

         On October 16, 1997, the Company brought a declaratory  judgment action
in U.S. District Court for the District of Massachusetts against the holders and
the indenture trustee of the Company's 4.5% Subordinated  Convertible Debentures
due 2003, denominated in Swiss francs (the "Swiss Franc Debentures"). Just prior
to this suit,  certain of the debenture  holders (the  "Asserting  Holders") had
alleged that the Company was in breach of certain protective covenants under the
indenture,  and on  October  22,  1997  they  sued  the  Company  and all of its
principal  subsidiaries  in the same court;  the October 16 and October 22 cases
have been  assigned to the same judge,  and the  dispute  between the  Asserting
Holders and the Company is proceeding  under the October 22 case.  The Asserting
Holders  claim  that the  Company  has  breached  certain  protective  indenture
covenants  and that the Asserting  Holders are entitled to immediate  payment of
their   indebtedness   under  the  Swiss  Franc  Debentures  (which  amounts  to
approximately  US$5,600,000 at December 31, 1998 exchange rates). As of November
13, 1997,  acting under  applicable  provisions  of the  indenture,  the Company
notified  the  holders of the Swiss  Franc  Debentures  that it is  causing  the
conversion  of all of the Swiss Franc  Debentures  into an  aggregate of 914,028
shares of the  Company's  common  stock.  The Company  believes  that it has not
breached any of the protective  covenants under this indenture and that the debt
cannot  properly  be  accelerated,  and  intends  to  contest  the claims of the
Asserting  Holders  vigorously.  Nonetheless,  an  adverse  result  could have a
material adverse effect on the Company in the range of $5,600,000 to $7,000,000.
By mutual  agreement,  the Asserting  Holders and the Company requested that the
case be removed from the Court's trial calendar. The parties have discussed ways
to resolve their dispute,  including the  restructuring  of the debentures,  but
there can be no absolute assurance that all of the  debentureholders,  including
the Asserting Holders, and the Company will complete a proposed settlement.

         On March 17,  1999,  the company and a former and current  officer were
added as defendants in the class action of VARLJEN V. H.J.  MEYERS,  INC. ET AL.
pending in the United  States  District  Court of the  Southern  District of New
York. The Company is unable to estimate any possible outcome or range of loss in
this  matter at this time.  An adverse  result in the VARLJEN  action,  however,
could  have a  materially  adverse  effect  upon the  financial  statements  and
operations of the Company.

         The  Company is also aware of a claim  alleging  that the  Company  had
previously  committed to make an additional  capital  contribution to Nexar. The
Company believes that this claim is without merit.

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

                                      -33-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         (D)      DISTRIBUTION AGREEMENT

         On  November   17,  1997,   the  Company   entered  into  an  exclusive
distribution,  sales  and  service  agreement  with  Coherent,  an  established,
worldwide laser company. Under this agreement,  Coherent has the exclusive right
to sell the EpiLaser(R) and  LightSheer(TM)  laser systems and future generation
products  worldwide.  The Company pays Coherent a per unit commission,  adjusted
for certain  events as  defined.  During  1997 and 1998,  the  Company  incurred
approximately  $800,000 and  $14,108,000,  respectively,  of commission  expense
related to this  agreement  which is included in sales and marketing  expense in
the accompanying  consolidated  statement of operations.  Upon execution of this
agreement, Coherent made a lump sum payment of $3,500,000 and received a warrant
to purchase one million shares of the Company's common stock at a share price of
$5.25. The valuation of the warrant using the Black-Scholes option pricing model
was approximately $380,000. The value was credited to additional paid-in capital
during the year ended  December 31, 1997.  The remaining  amount of  $3,120,000,
included in deferred revenue,  is being amortized to revenue over the three year
life of the agreement.  If the Company completes its anticipated sale of Star to
Coherent  as  discussed  in Note 1,  the  current  distribution  agreement  with
Coherent  will  be  terminated  and  replaced  with  a  one  year  non-exclusive
distribution   agreement  that  will  enable  Coherent  to  sell  the  Company's
ruby-based  laser  products.  The Company will  amortize  the  deferred  revenue
related to Coherent over this one year non-exclusive period.

         In exchange  for the payment at closing of $2,740 per day from  January
20, 1999 until  Palomar  shareholder  approval of the  Agreement,  Coherent  has
agreed to waive its exclusive rights under the distribution  agreement to market
and sell our  ruby  laser  products,  so that we may  begin to sell the  Palomar
E2000(TM)  immediately through other channels without the obligation of paying a
commission  to Coherent or waiting for the  distribution  agreement to terminate
upon the closing of the sale of Star to Coherent.

         (E)      EMPLOYMENT AGREEMENTS

         The  Company  and its  subsidiaries  have  employment  agreements  with
certain  executive  officers that provide for annual bonuses to the officers and
expire on various dates through 2001. Each of these  agreements  provides for 12
months severance upon termination of employment.

(13)     SEGMENT AND GEOGRAPHIC INFORMATION

         The Company has adopted SFAS No. 131,  DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE  AND RELATED  Information in the fiscal year ended December 31, 1998.
SFAS 131 establishes  standards for reporting  information  regarding  operating
segments in annual financial  statements and requires  selected  information for
those  segments  to  be  presented  in  interim   financial  reports  issued  to
stockholders.  SFAS 131 also establishes standards for related disclosures about
products and services and geographic areas. Operating segments are identified as
components of an enterprise about which separate discrete financial  information
is available for evaluation by the chief  operating  decision maker, or decision
making  group,  in  making  decisions  how  to  allocate  resources  and  assess
performance. The Company's chief decision-maker, as defined under SFAS 131, is a
combination of the Chief Executive Officer and the Chief Financial  Officer.  To
date,  the  Company  has viewed its  operations  and  manages  its  business  as
principally  one  segment,  cosmetic  laser sales.  Associated  services are not
significant.  As a result, the financial information disclosed herein represents
all of the material  financial  information  related to the Company's  principal
operating segment.

         Product revenues from international  sources were  approximately  $3.87
million, $5.03 million and $17.36 million in 1996, 1997 and 1998,  respectively.
The Company's revenues from international  sources were primarily generated from
customers located in Europe, Canada, Latin America and Asia/Pacific.  All of the
Company's  product  sales for the years ended  December 31, 1996,  1997 and 1998
were shipped from its facilities located in the United States.

                                       -34-
<PAGE>


               PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


         The  following  table  represents  percentage  of  product  revenue  by
geographic region from customers for 1996, 1997 and 1998:
<TABLE>
<CAPTION>

                                                                          Year ended December 31,
                                                             1996                    1997                   1998
                                                             ----                    ----                   ----
                          <S>                                <C>                     <C>                    <C>
                          United States                       78%                     76%                    61%
                          Europe                               3                       6                     17
                          Asia/Pacific                        10                       6                     13
                          Canada                               9                       4                      3
                          Latin America                       --                       8                      6
                                                             ----                    ----                   ----
                                   Total                     100%                    100%                   100%
                                                             ====                    ====                   ====
</TABLE>

                                       -35-
<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 Lexington in the
Commonwealth of Massachusetts on May 3, 1999.


                                              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>

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

/s/ Louis P. Valente                     President, Chief Executive                           May 3, 1999
--------------------------------------   Officer and Director
Louis P. Valente                       

                                          
/s/ Joseph P. Caruso                      Chief Financial Officer and Treasurer               May 3, 1999
--------------------------------------    (Principal Financial Officer and
Joseph P. Caruso                          Principal Accounting Officer)
                                      


/s/ Nicholas P. Economou                  Director                                            May 3, 1999
--------------------------------------
Nicholas P. Economou


/s/ A. Neil Pappalardo                    Director                                            May 3, 1999
--------------------------------------
A. Neil Pappalardo


/s/ James G. Martin                        Director                                           May 3, 1999
--------------------------------------
James G. Martin
</TABLE>


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