<PAGE>

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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C 20549

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

                                   FORM 10-Q

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

   For the quarterly period ended October 2, 1999

                                       OR

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

   For the transition period from _______ to _______

                         Commission File number 0-21667

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

                           PHOTOELECTRON CORPORATION
             (Exact Name of Registrant as Specified in its Charter)

             Massachusetts                             04-3035323
    (State or Other Jurisdiction of       (I.R.S. Employer Identification No.)
     Incorporation or Organization)

5 Forbes Road, Lexington, Massachusetts                  02421
    (Address of Principal Executive                    (Zip code)
                Offices)

                                 (781) 861-2069
              (Registrant's Telephone Number, Including Area Code)

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

   Indicate by check mark whether the registrant: (1) has filed all documents
and 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 reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes [X] No [_]

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

   7,762,254 shares of Common Stock, $.01 par value, were outstanding as of
November 9, 1999.

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--------------------------------------------------------------------------------
<PAGE>

                           PHOTOELECTRON CORPORATION

                         QUARTERLY REPORT ON FORM 10-Q
                      FOR THE PERIOD ENDED OCTOBER 2, 1999

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                             Page
                                                                             ----
 <C>       <S>                                                               <C>
 PART I--  FINANCIAL INFORMATION
 Item 1    Consolidated Financial Statements..............................     1
           Consolidated Balance Sheets at October 2, 1999 and January 2,
            1999..........................................................     1
           Consolidated Statements of Operations for the Three and Nine
            Months Ended October 2, 1999 and October 3, 1998..............     2
           Consolidated Statements of Cash Flow for the Nine Months Ended
            October 2, 1999 and October 3, 1998...........................     3
           Notes to Consolidated Financial Statements.....................     4
 Item 2    Management's Discussion and Analysis of Financial Condition and
            Results of Operations.........................................     4
 PART II-- OTHER INFORMATION
 Item 5    Other Information..............................................     9
 Item 6    Exhibits and Reports on Form 8-K...............................    14
</TABLE>
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                           CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
                                                     October 2,    January 2,
                                                        1999          1999
                                                    ------------  ------------
                                                    (Unaudited)
<S>                                                 <C>           <C>
                      ASSETS
Current Assets:
  Cash and cash equivalents........................ $    594,490  $  3,686,457
  Accounts receivable..............................      179,871       260,000
  Inventories......................................    1,882,018     1,454,706
  Prepaid expenses.................................      258,502       336,287
  Investments Held to Maturity.....................          --      1,993,056
  Other current assets.............................       14,452       115,803
                                                    ------------  ------------
    Total current assets...........................    2,929,333     7,846,309
Property and Equipment
  Computer equipment...............................      960,037       899,085
  Lab and production equipment.....................      974,977       926,352
  Clinical site equipment..........................      858,573       720,798
  Sales demo equipment.............................       88,582        81,167
  Furniture and fixtures...........................      177,883       165,898
  Leasehold improvements...........................      805,886       804,263
                                                    ------------  ------------
PROPERTY, PLANT, EQUIPMENT AND LEASEHOLD
 IMPROVEMENT.......................................    3,865,938     3,597,563
                                                    ------------  ------------
LESS ACCUMULATED DEPRECIATION AND AMORTIZATION.....    2,712,027     2,308,683
                                                    ------------  ------------
                                                       1,153,911     1,288,880
                                                    ------------  ------------
    Total assets................................... $  4,083,244  $  9,135,189
                                                    ============  ============
  LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current Liabilities
  Accounts payable................................. $    260,231  $    346,363
  Accrued expenses.................................      344,142       357,650
  Accrued payroll and benefits.....................      106,250        55,409
  Accrued warranty expense.........................      240,000       204,000
  Deferred revenue.................................       87,500           --
  Current portion of convertible subordinated
   notes...........................................      747,670       719,100
                                                    ------------  ------------
    Total current liabilities......................    1,785,793     1,682,522
                                                    ------------  ------------
Shareholders' equity
  Preferred stock, $0.01 par value
    Authorized--7,500,000
    Issued and outstanding--none at October 2, 1999
     and January 2, 1999, respectively.............          --            --
  Common stock, $0.01 par value--
    Authorized--15,000,000
    Issued and outstanding--7,754,254 and 7,704,254
     at October 2, 1999 and January 2, 1999,
     respectively..................................       77,542        77,042
  Capital in excess of par value--preferred stock..          --            --
  Capital in excess of par value--common stock.....   38,575,102    38,324,377
  Deferred compensation............................      (29,913)      (29,913)
  Subscription receivable..........................          --         (5,842)
  Deficit accumulated during development stage.....  (36,325,280)  (30,912,997)
                                                    ------------  ------------
    Total shareholders' equity.....................    2,297,451     7,452,667
                                                    ------------  ------------
    Total liabilities and shareholders' equity..... $  4,083,244  $  9,135,189
                                                    ============  ============
</TABLE>

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

                                       1
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                           Three Months Ended         Nine Months Ended            Period
                         ------------------------  ------------------------    from Inception
                         October 2,   October 3,   October 2,   October 3,    (January 4, 1989
                            1999         1998         1999         1998      to October 2, 1999)
                         -----------  -----------  -----------  -----------  -------------------
                         (Unaudited)  (Unaudited)  (Unaudited)  (Unaudited)
<S>                      <C>          <C>          <C>          <C>          <C>
Revenues................ $   262,500  $       --   $   534,634  $       --      $  1,938,008
Cost of Goods Sold......     142,233          --       266,653          --           906,440
                         -----------  -----------  -----------  -----------     ------------
Gross Margin............     120,267          --       267,981          --         1,031,568
                         -----------  -----------  -----------  -----------     ------------
Operating Expenses
  Research and
   Development
   expenses............. $   768,785  $ 1,289,288  $ 3,006,462  $ 3,907,057     $ 26,316,591
  Sales, general and
   administrative
   expenses.............     724,905      794,864    2,756,885    2,235,544       11,793,608
                         -----------  -----------  -----------  -----------     ------------
    Total operating
     expenses...........   1,493,690    2,084,152    5,763,347    6,142,601       38,110,199
                         -----------  -----------  -----------  -----------     ------------
  Operating loss........  (1,373,423)  (2,084,152)  (5,495,366)  (6,142,601)     (37,078,631)
Interest income.........      16,558      123,288      126,067      468,785        1,944,208
Interest expense........     (14,257)     (17,433)     (42,984)     (65,639)      (1,190,857)
                         -----------  -----------  -----------  -----------     ------------
Interest income, net....       2,301      105,855       83,083      403,146          753,351
                         -----------  -----------  -----------  -----------     ------------
Net loss................ $(1,371,122) $(1,978,297) $(5,412,283) $(5,739,455)    $(36,325,280)
                         ===========  ===========  ===========  ===========     ============
Basic and diluted net
 loss per share......... $     (0.18) $     (0.26) $     (0.70) $     (0.77)
                         ===========  ===========  ===========  ===========
Weighted average basic
 and diluted shares.....   7,754,254    7,542,524    7,744,072    7,427,655
                         ===========  ===========  ===========  ===========
</TABLE>


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

                                       2
<PAGE>

                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)

                      CONSOLIDATED STATEMENTS OF CASH FLOW

<TABLE>
<CAPTION>
                                                                   Period
                                    Nine Months Ended          from Inception
                             -------------------------------  (January 4, 1989
                             October 2, 1999 October 3, 1998 to October 2, 1999)
                             --------------- --------------- -------------------
                               (Unaudited)     (Unaudited)
<S>                          <C>             <C>             <C>
Cash flows from operating
 activities:
 Net loss..................    $(5,412,283)    $(5,739,455)     $(36,325,280)
 Adjustments to reconcile
  net loss to net cash used
  in
 Operating activities--
  Depreciation and
  amortization.............        403,344         526,519         2,720,618
 Noncash interest converted
  to subordinated notes....            --           65,633         1,060,558
 Noncash salary converted
  to common stock..........            --              --            250,000
 Noncash research and
  development expense
  converted to subordinated
  notes....................            --              --              9,000
 Noncash compensation
  expense..................            --              --          1,179,815
 Changes in current
  accounts--
 Inventories...............       (427,312)     (1,170,544)       (1,881,748)
 Accounts receivable.......         80,129             --             80,129
 Prepaid expenses..........         77,785          70,203            49,698
 Other current assets......        101,351        (102,597)         (194,241)
 Accounts payable..........        (86,132)          9,599           260,231
 Accrued expenses..........         73,333          64,446           489,444
 Deferred revenue..........         87,500             --             87,500
                               -----------     -----------      ------------
 Net cash used in operating
  activities...............     (5,102,285)     (6,276,196)      (32,214,276)
                               -----------     -----------      ------------
Cash flows from investing
 activities:
 (Purchases) Maturation of
  held to maturity
  investments..............      1,993,056       8,900,715               --
 Purchases of equipment and
  leasehold improvements...       (268,375)       (511,337)       (3,841,092)
 Loan to officer...........            --              --            (80,211)
 Proceeds from sale of
  equipment and leasehold
  improvements.............            --              --              9,845
                               -----------     -----------      ------------
 Net cash (used in)
  provided by investing
  activities...............      1,724,681       8,389,378        (3,911,458)
                               -----------     -----------      ------------
Cash flows from financing
 activities:
 Proceeds from issuance of
  common stock.............        257,067          73,038        18,523,935
 Proceeds from issuance of
  preferred stock..........            --              --         13,385,370
 Proceeds from issuance of
  subordinated convertible
  notes....................            --              --          5,322,000
 Proceeds from issuance of
  warrants.................            --              --            236,453
 Offering expenses.........            --              --           (473,006)
 Payments under capital
  lease obligations........            --              --            (40,735)
 Payments of subordinated
  notes....................         28,570             --           (233,793)
                               -----------     -----------      ------------
 Net cash provided by (used
  in) financing
  activities...............        285,637          73,038        36,720,224
                               -----------     -----------      ------------
Increase (decrease) in cash
 and cash equivalents......     (3,091,967)      2,186,220           594,490
                               -----------     -----------      ------------
Cash and cash equivalents,
 beginning of period.......      3,686,457       2,286,583               --
                               -----------     -----------      ------------
Cash and cash equivalents,
 end of period.............        594,490       4,472,803           594,490
                               ===========     ===========      ============
Noncash financing
 activities:
 Conversion of salary
  expense to common stock..    $               $                $    250,000
                               ===========     ===========      ============
 Conversion of convertible
  subordinated notes to
  common stock.............    $               $   787,647      $  5,278,892
                               ===========     ===========      ============
 Conversion of common stock
  to preferred stock.......    $               $                $  3,846,015
                               ===========     ===========      ============
 Capital lease obligation
  incurred for equipment...    $               $                $     40,383
                               ===========     ===========      ============
 Conversion of preferred
  stock to common stock....    $               $                $     28,923
                               ===========     ===========      ============
 Conversion of convertible
  subordinated notes to
  warrants.................    $               $                $     47,000
                               ===========     ===========      ============
</TABLE>

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

                                       3
<PAGE>

                           PHOTOELECTRON CORPORATION
                         (A Development Stage Company)

              Notes to Unaudited Consolidated Financial Statements

   1. Unaudited Results--The interim unaudited consolidated financial
statements contained herein have been prepared in accordance with generally
accepted accounting principles for interim financial information. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In
management's opinion, the unaudited information includes all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
the financial position, results of operations, and cash flows for the periods
presented. The results of operations for the interim periods shown on this
report are not necessarily indicative of the results expected for the full
year. The interim financial statements should be read in conjunction with the
financial statements and notes for the year ended January 2, 1999 included in
the Company's Form 10-K filing with the Securities and Exchange Commission.

   2. Net Loss per Share--During the third quarter of 1999 and 1998, basic and
diluted net loss per share were calculated as follows:

<TABLE>
<CAPTION>
                              Three Months Ended         Nine Months Ended
                            ------------------------  ------------------------
                            October 2,   October 3,   October 2,   October 3,
                               1999         1998         1999         1998
                            -----------  -----------  -----------  -----------
   <S>                      <C>          <C>          <C>          <C>
   Basic:
     Net loss.............. $(1,371,122) $(1,978,297) $(5,412,283) $(5,739,455)
     Weighted average
      shares...............   7,754,254    7,542,524    7,744,072    7,427,655
     Basic net loss per
      share................ $     (0.18) $     (0.26) $     (0.70) $     (0.77)
   Diluted:
     Net loss.............. $(1,371,122) $(1,978,297) $(5,412,283) $(5,739,455)
     Weighted average
      shares...............   7,754,254    7,542,524    7,744,072    7,427,655
     Diluted net loss per
      share................ $     (0.18) $     (0.26) $     (0.70) $     (0.77)
</TABLE>

   The computation of diluted earnings per share for October 2, 1999 and
October 3, 1998 excludes the effect of assuming the exercise of certain
outstanding stock options and the conversion of convertible securities because
the effect would be anti-dilutive, due to the Company's net loss during the
year. As of October 2, 1999, there were 896,792 of such options outstanding,
with exercise prices ranging from $0.40--$9.75 per share with expiration dates
ranging from December 11, 1999 to May 10, 2009.

   3. Comprehensive Income--During the first quarter of 1998, the Company
adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income." This pronouncement sets forth requirements for
disclosure of the Company's comprehensive income and accumulated other
comprehensive income. There were no items of other comprehensive income
therefore comprehensive income equals net income.

                         PART I: FINANCIAL INFORMATION

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

Overview

   Certain statements contained in this Quarterly Report on Form 10-Q,
including, without limitation, statements containing the words "expects,"
"anticipates," "believes" and words of similar import, constitute "forward
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. These forward looking statements are subject to various
risks and uncertainties, including those referred to herein in Item 5--Other
Information, under the heading "Risk Factors", that could cause actual future
results

                                       4
<PAGE>

and events to differ materially from those currently anticipated. Readers are
cautioned not to place undue reliance on these forward-looking statements.

   The Company is engaged in the development and commercialization of the
Photon Radiosurgery System (the "PRS"), a proprietary, therapeutic device for
the treatment of cancerous tumors through the application of radiation directly
into a tumor. To date, the Company has received only limited revenue from the
sale of its current PRS400 model.

   The Company has experienced significant operating losses since its
inception, due primarily to substantial research and development expenditures.
As of October 2, 1999, the Company had an accumulated deficit totaling
approximately $36.3 million and expects to continue to incur losses until such
time as its commercialization efforts yield offsetting revenues. There can be
no assurance that the PRS will ever gain acceptance in the marketplace, or that
the Company will ever generate significant revenues or achieve profitability.
The Company's ability to achieve profitable operations will depend in large
part on whether it can successfully commercialize the PRS and make the
transition to a manufacturing and marketing company.

   The Company does not expect to be able to generate sufficient revenue in the
near future for it to continue operations without raising additional capital or
entering into a strategic relationship with another company. The Company
expects that its available cash, including under the $2.25 million line of
credit described under the heading "Subsequent Event", which PYC Corporation
has agreed in principle to provide to the Company, will permit it to continue
operations through April 30, 2000. Should the necessary funds or a strategic
relationship not be available to the Company on acceptable terms, there is
substantial doubt that the Company will be able to continue as a going concern.

   In May 1999, the Company underwent a significant restructuring. There were
three key objectives to this restructuring:

     1. A reduction in operating costs;

     2. A re-focusing of development efforts on key products; and

     3. A remodelling of the Company's approach to sales and marketing.

   The reduction in operating costs was achieved primarily by reducing staff
numbers by 50% and modifying the Company's approach to sales and marketing. In
the second quarter of 1999, the Company laid off approximately twenty-five
employees, including substantially all of its sales and marketing staff, and
now intends to market and distribute its products through collaborative
arrangements with strategic partners that have established distribution
channels in domestic and international markets.

   During the third quarter of 1999, the Company established a strategic
alliance with Carl Zeiss (Oberkochen, Germany). Carl Zeiss will manage the
sales and distribution for a range of the Company's products, including the
PRS. In addition, Carl Zeiss will assist in the service and support of the
Company's products and participate in co-developments. Simultaneously, the
Company joined the Surgical Navigation Network (the "SNN"). The SNN is a
consortium of medical equipment industry leaders including, amongst others,
Carl Zeiss Inc., Philips, Agfa IMPAX, Aesculap and XLTEK. The member companies
use shared, open-standard, image-based software to support their products.

   On September 27, 1999, the Company received permission from the United
States Food and Drug Administration (the "FDA") to proceed in marketing the PRS
for radiation therapy treatments anywhere in the body. Approved use of the
device in the United States was previously limited to the brain, but the FDA's
approval of the Company's 510(k) application lifts that restriction. The 510(k)
approval also permits the Company to market its new system of applicators that
will enable the PRS to be used for intraoperative and intracavity radiation
therapy treatments. With the receipt of the 510(k) approval and the strategic
alliances with Carl Zeiss and the SNN, the Company will begin to address the
global radiation therapy market.

                                       5
<PAGE>

Results of Operations

 Three Months Ended October 2, 1999 and October 3, 1998

   Revenue. The Company had revenue of $262,500 in the third three months of
1999, from the sale of a PRS to the Cleveland Clinic, as compared with $0 in
the third three months of 1998.

   Research and development expenses. The Company's research and development
expenses decreased by $520,503 from $1,289,288 in the third three months of
1998 to $768,785 in the third three months of 1999. The decrease is the result
of the internal restructuring of the Company completed in early May 1999.

   Selling, general and administrative expenses. The Company's selling, general
and administrative expenses decreased by $69,959 from $794,864 in the third
three months of 1998 to $724,905 in the third three months of 1999. The
decrease is primarily attributable to the change in focus of the Company's sale
efforts from a direct sales force to the strategic alliance with Carl Zeiss.

   Interest income. Interest income decreased by $106,730 from $123,288 in the
third three months of 1998 to $16,558 in the third three months of 1999. The
decrease resulted from the Company having to use the entire amount of the
proceeds of the Company's initial public offering by the end of the first three
months of 1999.

 Nine Months Ended October 2, 1999 and October 3, 1998

   Revenue. The Company had revenues of $534,634 in the first nine months of
1999, as compared with $0 in the first nine months of 1998. The 1999 revenue is
primarily the result of one sale of the PRS to Tecnologie Avanzate, Torino,
Italy and one sale of the PRS to the Cleveland Clinic, Cleveland, OH.

   Research and development expenses. The Company's research and development
expenses decreased by $900,595 from $3,907,057 in the first nine months of 1998
to $3,006,462 in the first nine months of 1999. The primary reason for the
decrease in the first nine months of 1999 was the internal restructuring of the
Company completed in early May 1999 and a shift in focus from research and
development to a manufacturing effort for the PRS.

   Selling, general and administrative expenses. The Company's selling, general
and administrative expenses increased by $521,341 from $2,235,544 in the first
nine months of 1998 to $2,756,885 in the first nine months of 1999. This
increase is primarily attributable to costs in the amount $470,672 associated
with the Company's internal restructuring completed in early May 1999, of which
costs of approximately $367,500 are associated with the resignation of the
former Vice-President and Chief Operating Officer of the Company in the first
three months of the year.

   Interest income. Interest income decreased by $342,718 from $468,785 in the
first nine months of 1998 to $126,067 in the first nine months of 1999. The
decrease resulted from the Company having to use the entire amount of the
proceeds of the Company's initial public offering by the end of the first three
months of the 1999.

Liquidity and Capital Resources

   In February 1997, the Company completed an initial public offering of
2,275,000 shares of Common Stock at a price of $8.50 per share. Net proceeds
from the offering to the Company were approximately $16,818,854.

   Consolidated working capital was approximately $1.1 million at October 2,
1999, compared with $6.2 million at January 2, 1999. Included in working
capital are cash and cash equivalents of $0.6 million at October 2, 1999,
compared with $3.7 million at January 2, 1999. During the nine months ended
October 2, 1999, $5.1 million of net cash was used for operating activities.

                                       6
<PAGE>

   The Company used $268,375 of cash in the nine months ended October 2, 1999
for fixed assets and leasehold improvements.

   The Company maintains medical product liability insurance policies with
respect to its clinical trials, which the Company believes, contain reasonable
deductibles and other ordinary and customary provisions. The Company believes
that these policies cover such risks in such amounts as are reasonable and
prudent under the circumstances, and the Company does not anticipate that
claims under these policies, if any, will have a material adverse impact on
the Company's liquidity or capital resources. The Company has obtained product
liability insurance covering the commercial use of its products.

   The Company is in the process of seeking additional debt or equity
financing. There is no assurance that the Company will be able to obtain such
financing on acceptable terms or at all. If the Company raises additional
funds through the issuance of equity securities, dilution to existing
shareholders will occur.

Other Matters--Year 2000 Disclosure:

   The Company addressed the Year 2000 ("Y2K") problem by putting together a
project team and budget to handle the tasks required to ensure that the
Company is Y2K compliant. The project team was headed by the Company's
Information Systems ("IS") department and included members from all functional
departments of the Company. The Company broke the project into five areas of
concern: Internal Information Technology ("IT") systems, internal non-IT
systems (embedded processors), Company products, outside significant third
parties (suppliers, financial institutions, customers, vendors), and
contingency planning.

   The Company devised a six-phase approach to dealing with the five areas of
concern mentioned above. The phases were as follows:

     1) Identification--the Company identified each issue it believed it
  needed to address in accordance with the concerns set forth above.

     2) Detailed Assessment--the Company conducted a detailed assessment of
  the issues identified so it could document all specific areas it needed to
  address.

     3) Corrective Action Plans--the Company defined the proper changes,
  including upgrades, retirements, or new systems.

     4) Testing and Certification--the Company fully tested the proposed
  changes and certified the results.

     5) Implementation--the Company implemented the proper changes that were
  tested and certified.

     6) Contingency Planning--the Company planned to define contingencies for
  all areas of concern.

   The Company defines the phrase--"Y2K compliance" as follows: "That all our
business processes have been tested to our satisfaction so we can state that
the year 2000 date rollover will not affect our ability to manufacture our
products and properly report the financial status of our company". The Company
believes it will be Y2K compliant by December 31, 1999.

   IT systems--100% completed. The Company upgraded its Personal Computers
("PCs") and servers. The Company completed the upgrade project for its
Enterprise Resource Planning (ERP) software at the end of September 1999. The
Company upgraded to compliant versions for most of its desktop applications.

   Non-IT systems--85% completed. The Company identified embedded processors
that are in use around the Company. All the processors that the Company
investigated to date are Y2K compliant. The Company anticipates completing the
analysis of and implementing any necessary changes to its non-IT systems by
mid-December, 1999.

                                       7
<PAGE>

Company Products

   The embedded software in the PRS400 Treatment System is fully Y2K compliant,
as it was a design requirement established during the development of the
software. Additionally, Y2K compliance is formally tested as part of the
software validation testing. The Company completed the validation testing in
November, 1998.

   The software used to run the Company's Water Phantom System is fully Y2K
compliant. The software does not use any dates for calculations or comparisons.
It is written in a Y2K compliant version of Labview. It runs on a PC with the
Windows 3.1 operating system, which is not Y2K compliant. In June 1999, the
Company completed a project to convert the software to run on Windows 95, a Y2K
compliant operating system.

Outside Third Parties

   The Company identified and surveyed outside parties for Y2K compliance. The
Company completed the process of sending its most critical partners a survey by
mail and followed up with them with a phone call or a visit.

Contingency Planning

   The Company did not contemplate a contingency plan as it had intended to do.

   Although the Company dedicated substantial resources towards attaining Y2K
readiness, there is no assurance it was successful in its efforts to identify
and address all Y2K issues. Even if the Company acted in a timely manner to
complete all of its assessments, and identified, developed, and implemented
corrective action plans believed to be adequate, it did not develop contingency
plans and some problems may not have been identified or corrected in time to
prevent material adverse consequences to the Company.

Cost of Compliance

   To date, costs incurred in connection with the Y2K issue have not been
material. The Company does not expect total Y2K remediation costs to be
material, but there can be no assurance that the Company will not encounter
unexpected costs or delays in achieving Y2K compliance.

                                       8
<PAGE>

                          PART II: OTHER INFORMATION

Item 5: Other Information

Risk Factors

   The Company wishes to caution readers that in addition to the important
factors described elsewhere in this Report, the following important factors,
among others, sometimes have affected, and in the future could affect, the
Company's business, financial condition, or operating results. These factors
could cause the Company's future results to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company.

The Company has significant capital needs and may not be able to raise
additional capital that would enable it to continue as a going concern

   The Company has expended, and will continue to expend, substantial funds on
the following:

     - Research and development of the PRS and other potential products;

     - Establishing commercial scale manufacturing in the Company's own
  facilities or in the facilities of others; and

     - Marketing the PRS and any other products.

   The Company's future capital requirements will depend on a variety of
factors, including the following:

     - Market acceptance of the PRS and any of the Company's other products;

     - Expense and results of the Company's continued scientific research and
  development programs;

     - Time and costs expended in filing, prosecuting, and enforcing patent
  claims; and

     - Development of competing technologies.

   The Company does not expect to be able to generate sufficient revenue in
the near future to continue operations without raising additional capital. If
the necessary funds are not available to the Company on acceptable terms, it
is likely that the Company will not be able to continue as a going concern.
The Company estimates that available cash and cash equivalents, together with
revenues from product sales, if any, will allow it to continue operations
through April 30, 2000.

The Company is an early stage company and has a limited operating history

   The Company was incorporated in January of 1989 and has thus had a
relatively short operating history. The Company is still in the process of
developing and commercializing the PRS, the Company's primary product. The
Company may not succeed in commercializing the PRS. The Company is still
waiting for approval from countries outside the United States and the European
Union in which the Company may market the PRS. The Company cannot be sure that
any other countries will grant regulatory approval to market the PRS. In
addition, the Company has only sold four PRS's and may not be able to sell any
more PRS's even if the Company receives all necessary regulatory approvals and
completes the development and commercialization of the PRS.

The Company may not be reimbursed by third party payors

   The Company's ability to be reimbursed for the cost of its products and
related treatments from third party payors will have a significant impact on
the Company's ability to commercialize its products. Such third party payors
include, among others, private insurance companies, self-insured employers,
health maintenance organizations, and federal and state sources of payment
under the Medicare and Medicaid programs. There is

                                       9
<PAGE>

no uniform policy on reimbursement among third party payors, and the PRS or any
of the Company's other products may not qualify for reimbursement. In addition,
foreign countries have their own health care reimbursement systems, and the
Company may not qualify for reimbursement from such foreign third party payors.

   In addition, the continuing efforts of many third party payors to reduce the
costs of health care by decreasing reimbursement rates, or limiting or
prohibiting reimbursement for certain services or devices, may have an adverse
effect on the Company's revenues. Furthermore, legislative proposals to reform
government health care insurance programs, including the Medicare and Medicaid
programs, could have a significant impact the purchase of health care services
and products and could result in lower prices and reduced demand for the
Company's products. The Company is unable to predict whether such proposals
will be enacted or whether other health care legislation or regulation
affecting the Company's business may be proposed in the future.

The Company only markets one product

   The PRS and its related accessories and components are currently the
Company's only product. The Company's ability to sell the PRS and generate
revenue could be adversely affected by problems such as loss of a patent
protection, unexpected side effects, negative publicity, or the introduction of
a new, more effective treatment that would render the PRS obsolete.

The Company has a history of significant operating losses and anticipates
further substantial losses

   The Company has experienced significant operating losses in each year since
its incorporation, primarily due to the cost of substantial research and
development of the PRS. As of October 2, 1999, the Company had an accumulated
deficit of approximately $36.3 million and expects to continue to incur losses
until the Company generates revenues to offset the funds spent on
commercializing the PRS. The Company's ability to achieve profitable operations
will depend, in large part, on whether the Company can successfully develop and
commercialize the PRS and/or any other products, and whether the Company can
effectively make the transition to a manufacturing and marketing company. It is
possible that the PRS will never gain commercial acceptance, and the Company
may never generate significant revenues or achieve profitability. For these
reasons, the Company believes it will continue to incur substantial operating
losses for the foreseeable future, and that these losses may be significantly
higher than the Company's current losses.

The Company is still waiting for certain regulatory clearances in order to
market the PRS in countries outside the U.S. and Europe

   The PRS has not been approved for commercial use in countries outside the
U.S. and Europe, including Japan. The PRS is subject to extensive regulation in
the U.S. by the FDA and, in many instances, by comparable agencies in foreign
countries where the Company plans on manufacturing and/or distributing the PRS.
Sales of medical devices outside the United States are subject to regulatory
requirements that vary widely from country to country. The PRS may not meet the
regulatory standards of countries that have not yet approved the PRS for
commercial use.

   In addition, the length of time the Company will need to wait to obtain
approval for the sale of the PRS in a foreign country may be longer, and the
requirements may be more burdensome or expensive, than that required for FDA
approval. The Company will also need to obtain export licenses from the U.S.
government in order to export its products to certain countries. The U.S.
government may not grant the Company any other export licenses other than those
previously granted for the commercial distribution of the PRS in Europe and
Japan, and the corresponding foreign countries may not grant the Company any
import licenses.

   Furthermore, the Company may not receive any necessary regulatory approvals
if the Company develops any additional products in the future, the length of
time for such approvals may be extensive, and the cost of

                                       10
<PAGE>

attempting to obtain any such approvals may be prohibitive. In addition, the
Company's inability to obtain or maintain requisite governmental approvals
could delay or preclude the Company from further developing and marketing the
PRS and other products. Consequently, such delays could impair the Company's
ability to generate revenues and continue as a going concern.

The PRS is subject to extensive ongoing government regulation

   The FDA has approved the PRS for commercial use in the U.S. for the
treatment of tumors. Because the FDA strictly prohibits the marketing or sale
of approved medical devices for unapproved uses, the Company may only market
and sell the PRS for the approved use. Any possible additional uses of the PRS
may be subject to additional clinical trials and FDA and foreign regulation and
approval. In addition, the FDA imposes strict labeling and training
requirements and may impose other requirements, any of which could limit the
Company's ability to market the PRS.

   The Company may also need to obtain additional approvals from the FDA if the
Company decides to change or modify the PRS. In addition, if the Company fails
to comply with FDA regulatory standards, the FDA could force the Company to
withdraw its products from the market or impose sanctions or fines, each of
which could have a material adverse effect on the Company's business, financial
condition, and results of operations.

   In addition, manufacturers of medical devices are subject to strict federal
regulations regarding quality of manufacturing, including periodic FDA
inspections of manufacturing facilities to determine compliance with FDA
regulations. Such regulations impose certain requirements on, among other
things, the design, testing, production, control, and documentation of
products. The Company may not be able to maintain compliance with cGMP
standards or with ISO Standards. In addition, the Company may not be able to
identify and retain manufacturers on commercially acceptable terms, if at all,
and any manufacturers the Company does retain might not be able to meet all
relevant regulatory requirements. Any problems with the Company's ability to
meet regulatory standards could prevent the Company from marketing the PRS.

Rapid, unpredictable, and significant technological change; highly competitive
industry

   The medical device industry is subject to rapid, unpredictable, and
significant technological change. The Company's business is subject to
competition in the U.S. and abroad from a variety of sources, including
universities, research institutions, and medical device, chemical, and
biotechnology companies. Many of these potential competitors have substantially
greater technical, financial, and regulatory resources than the Company and are
accordingly better equipped to develop, manufacture, and market their products.
If these companies develop and introduce products and processes competitive
with or superior to the Company's products, the Company may not be able to
compete successfully against such competitors.

The Company depends on one product

   The PRS and its related accessories and components are currently the
Company's only product. The Company currently expects that the PRS will be the
primary source of revenue, if any, for the foreseeable future. All additional
potential products using the Company's core technology are in their early
stages of development. Any such additional products in development may not be
safe or effective, approved by regulatory authorities, capable of being
manufactured in commercial quantities at acceptable costs, or introduced into
the market successfully.

The Company has limited marketing experience

   As the Company makes the transition from a company with products in
development but no product sales to a manufacturing and marketing company, the
Company will require significant additional expenditures, management resources,
and time to develop its sales strategy and to make arrangements for the sale or
lease of

                                       11
<PAGE>

its products through third parties. The Company plans to market and distribute
its products primarily through collaborative arrangements with strategic
partners with established distribution channels in domestic and international
markets. The Company may not be able, however, to make adequate third party
arrangements for product marketing and distribution.

Uncertain protection of intellectual property

   The Company's ability to compete effectively in the marketplace will depend,
in part, on the Company's ability to protect its intellectual property rights.
The Company relies on patents, trade secrets, and know-how to establish and
maintain a competitive position in the marketplace. The enforceability of
medical device patents, however, can be highly uncertain. Any limitation or
reduction in the Company's rights to obtain or enforce the Company's patents
could have a material adverse effect on the Company's ability to maintain or
protect its intellectual property rights.

   The Company holds 13 U.S. patents and 4 U.S. patent applications relating to
the PRS. In addition, the Company has filed foreign patent applications in
selected foreign countries, which correspond, to certain of the Company's U.S.
patents and patent applications. Such applications may not result in issued
patents, and the Company cannot be sure that once issued, any issues relating
to the validity and scope of the patents will be resolved in the Company's
favor. In addition, the Company's current or future patents, trade secrets, or
know-how may not protect the Company against competitors with similar
technologies or processes. Also, others may infringe any patents issued to the
Company and other companies may independently develop proprietary technologies
or processes, which are the same as or substantially equivalent to the
Company's proprietary technologies or processes.

   The Company may also become subject to patent infringement claims or
litigation initiated by third parties. The defense and prosecution of such
claims or suits are very costly and time-consuming, and any such proceeding
would result in substantial expense and a significant diversion of effort by
technical and management personnel of the Company. Further, any adverse
determination in such litigation or proceeding could subject the Company to
significant liability and could prevent the Company from manufacturing or
marketing its products.

Peter M. Nomikos has the ability to significantly influence all stockholder
votes

   As of November 9, 1999, Mr. Peter M. Nomikos, Chairman of the Board and
Chief Executive Officer of the Company beneficially owned approximately 45% of
the shares of Common Stock of the Company. If PYC Corporation, of which Mr.
Nomikos is the beneficial owner, were to receive the maximum number of warrants
to which it could be entitled under the line of credit described below, Mr.
Nomikos would beneficially own approximately 48% of the shares of Common Stock
of the Company. As of November 9, 1999, the Company's principal stockholders
and certain affiliates of the Company (including Mr. Nomikos) beneficially
owned in the aggregate approximately 54% of the shares of Common Stock. If PYC
Corporation were to receive the maximum number of warrants to which it could be
entitled under the line of credit described below, the Company's principal
stockholders and certain affiliates of the Company (including Mr. Nomikos)
would beneficially own approximately 57% of the shares of Common Stock of the
Company. Certain principal stockholders serve as directors or have
representatives who serve as directors of the Company. Due to Mr. Nomikos's
ownership of Common Stock coupled with the positions he holds in the Company,
Mr. Nomikos, either alone or with the other principal stockholders, has the
ability to significantly influence all matters requiring approval by the
stockholders of the Company, including the election of all directors,
acquisitions, sales of all or substantially all of the Company's stock or
assets, and other extraordinary transactions.

The Company depends on key personnel

   The Company depends on the continued services and performance of its
scientific personnel and senior management. If the Company loses any key
personnel, it could significantly and adversely impact the

                                       12
<PAGE>

Company's research and development efforts or its strategic objectives. In
addition, competition among medical device companies for highly skilled
scientific and management personnel is increasingly intense. In order to
achieve and maintain the commercialization of the PRS, the Company will need to
attract and retain additional key personnel, and the Company cannot be sure
that it will be able to do so. The Company has no employment agreements with
any of its employees, nor has the Company purchased "key person" life
insurance.

The Company may experience shortages of PRS components; the Company relies on a
small number of suppliers

   The Company manufactures its products based on anticipated product orders.
The different lead times for the supply and delivery of materials and
components can vary significantly, as can the relative availability and cost of
those materials and components. As a result, the Company has built up and
maintains an inventory of certain components for the PRS. The Company also
tries to identify, where feasible, multiple suppliers of materials and
components.

   While the Company sometimes negotiates supply contracts with certain key
suppliers, the Company currently purchases its supplies through open purchase
orders. The Company's vendors may not continue to provide supplies on
acceptable terms, if at all. In addition, if the Company's forecasted product
orders prove to be different than actual product orders, the Company may have
excess or inadequate inventory.

   In addition, the Company may not be able to find alternative suppliers for
the PRS components on a timely basis, if at all, in the event that the Company
needs such alternative suppliers. Any significant delay or interruption in the
Company's ability to acquire product components and materials could have an
adverse effect on the manufacture of the Company's products.

Product liability risks

   The Company will be exposed to the risk of medical product liability claims
if any of its products causes harm or injury. The Company might not have
sufficient resources to satisfy any liability resulting from such claims. The
level or scope of the Company's liability insurance with respect to the PRS may
not be sufficient to cover potential claims. In addition, medical product
liability insurance may not continue to be available at an acceptable cost, if
at all. As a result, a medical product liability claim could cause the Company
significant financial harm.

Anti-takeover provisions; effects of issuance of preferred stock

   Certain provisions of the Company's Articles of Organization and By-Laws are
intended to enhance the likelihood of continuity and stability in the
composition of the Company's Board of Directors and in the policies formulated
by the Board and to delay or prevent a change in control of the Company if the
Board determines that such a change in control is not in the best interest of
the Company. These provisions could have the effect of discouraging certain
attempts to acquire the Company or to remove incumbent management even if some
or even a majority of the Company's stockholders deem such an attempt to be in
the Company's best interest. As a result, the anti-takeover provisions could
limit the price that investors might be willing to pay in the future for shares
of Common Stock, thereby depriving stockholders of certain opportunities to
sell their stock at temporarily higher prices. In addition, the provisions of
Chapter 110F of the Massachusetts General Laws, the Business Combination
Statute, cover the Company. This statute prohibits the Company from engaging in
a merger, stock or asset sale, and other transactions with an "interested
stockholder" that would result in a financial benefit to the interested
stockholder for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a manner set forth in the statute. The application
of this statute could have the effect of delaying or preventing a change of
control of the Company.

   In addition, the Board of Directors is authorized, subject to certain
limitations, to cause the Company to issue one or more series of Preferred
Stock and, to the extent permitted by Massachusetts law, to grant different

                                       13
<PAGE>

classes of stock certain rights and preferences. In the event the Board issues
any Preferred Stock, it could be utilized, under certain circumstances, as a
method of discouraging, delaying, or preventing a change of control of the
Company. The Company currently has no current plans to issue any shares of
Preferred Stock but the Board of Directors may elect do so at some time in the
future.

Year 2000

   As described in this report, the Company is working to address Y2K problems.
If the Company should fail to identify or fix all such problems in the
Company's own operations, or if the Company is affected by the inability of a
supplier to continue operations due to such a problem, it could have a material
adverse effect on the Company's business, financial condition, and results of
operations.

Volatile stock price

   The trading price of the Company's common stock fluctuates significantly.
The Company's stock price may fluctuate as a result of various factors such as
variations in the Company's financial performance, announcements of
technological innovations by competitors or providers of alternative products,
and changes in the economy, the financial markets, or the health care industry.
In addition, stock market have experienced price and volume fluctuations that
have particularly affected medical device companies and has often been
unrelated to such companies' operating performance. Such broad market
fluctuations may adversely affect the market price of the Company's Common
Stock.

Absence of dividends

   The Company has never paid any dividends on its capital stock and does not
anticipate paying any cash dividends to holders of the Company's capital stock
in the foreseeable future.

 Subsequent Event

   On November 10, 1999, the Company entered into an agreement in principle
with PYC Corporation ("PYC"), a corporation controlled and beneficially owned
by Peter Nomikos, the Company's Chief Executive Officer and largest
stockholder. The agreement in principle, which is subject to the execution of
definitive documents, contemplates that PYC will establish a $2,250,000 line of
credit (the "Line of Credit") for the Company payable at the earlier of six
months from the date of the commencement of the Line of Credit, or the
consummation by the Company of a financing of not less than $5,000,000. The
Company will be permitted to draw upon the Line of Credit at a maximum rate of
$400,000 per month from November 1999 through May 2000. Any amounts drawn by
the Company under the Line of Credit will bear interest at an 8% annual rate.
PYC has the option to convert any amounts owed to it by the Company under the
Line of Credit into shares of Common Stock of the Company at a price per share
equal to the market price of the Common Stock at the time of the conversion. In
addition, PYC will receive a warrant for the purchase of one share of Common
Stock for each $5.00 drawn under the Line of Credit. The warrants will be
exercisable for 5 years from the date of issuance at a price equal to the
market price of the Common Stock at the time of the issuance of the warrants.

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

   (a) Exhibits

   Copies of the following Exhibits are furnished with this report.

<TABLE>
<CAPTION>
   No. Description
   --- -----------
   <C> <S>
   27  Financial Data Schedule.
</TABLE>


                                       14
<PAGE>

   (b) Reports on Form 8-K

   The Company filed one report on Form 8-K during the quarter for which this
report is filed. The 8-K was filed on August 24, 1999 in connection with the
Company's announcement that it had entered into a strategic alliance with Carl
Zeiss.

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned
thereunto duly authorized.

                                          PHOTOELECTRON CORPORATION

                                                    /s/ Euan S. Thomson
                                          By: _________________________________
                                                      Euan S. Thomson
                                            President, Chief Operating Officer

                                                    /s/ Gerald J. Bojas
                                          By: _________________________________
                                                      Gerald J. Bojas
                                            Chief Financial Officer, Treasurer

Dated: November 16, 1999

                                       15