<PAGE>
 
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                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C 20549
 
                                   FORM 10-Q
 
                 QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE QUARTERLY PERIOD ENDED JULY 4, 1998
 
                        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,                           02421-7305  
       LEXINGTON, MASSACHUSETTS                       (ZIP CODE)
    (ADDRESS OF PRINCIPAL EXECUTIVE
               OFFICES)
 
                                (781) 861-2069
             (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
  Check Whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act 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 [_]
 
                               ----------------
 
  7,608,421 shares of Common Stock, $.01 par value, were outstanding as of
August 10, 1998.
 
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<PAGE>
 
                           PHOTOELECTRON CORPORATION
 
                         QUARTERLY REPORT ON FORM 10-Q
                       FOR THE PERIOD ENDED JULY 4, 1998
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
 <S>                                                                      <C>
 PART I--FINANCIAL INFORMATION
 Item 1 Consolidated Financial Statements...............................    3
        CONSOLIDATED BALANCE SHEETS AT JULY 4, 1998 AND JANUARY 3,
         1998...........................................................    3
        CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX
         MONTHS ENDED JULY 4, 1998 AND JUNE 28, 1997....................    4
        CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED
         JULY 4, 1998 AND JUNE 28, 1997.................................    5
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS......................    6
 Item 2 Management's Discussion and Analysis of Financial Condition and
         Results of Operations..........................................    7
 PART II--OTHER INFORMATION
 Item 2 Changes in Securities and Use of Proceeds.......................   11
 Item 4 Submission of Matters to a Vote of Security Holders.............   11
 Item 6 Exhibits and Reports on Form 8-K................................   12
</TABLE>
 
                                       2
<PAGE>
 
                         PART I: FINANCIAL INFORMATION
 
ITEM 1: FINANCIAL STATEMENTS
 
                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                 JULY 4, 1998  JANUARY 3, 1998
                                                 ------------  ---------------
                                                 (UNAUDITED)
<S>                                              <C>           <C>
                     ASSETS
CURRENT ASSETS:
  Cash and cash equivalents..................... $    728,823   $  2,286,583
  Inventories...................................    1,122,673        383,051
  Prepaid expenses..............................      382,826        413,707
  Investments held to maturity..................    8,921,256     11,889,356
  Other current assets..........................       55,791         29,111
                                                 ------------   ------------
    Total current assets........................   11,211,369     15,001,808
PROPERTY AND EQUIPMENT:
  Computer Equipment............................      793,158        684,027
  Lab and production equipment..................      865,846        630,472
  Clinical site equipment.......................      795,477        752,952
  Furniture and fixtures........................      156,710        149,513
  Leasehold improvements........................      774,838        758,211
                                                 ------------   ------------
                                                    3,386,029      2,975,175
PROPERTY, PLANT, EQUIPMENT AND LEASEHOLDS,
 LESS--ACCUMULATED DEPRECIATION
 AND AMORTIZATION...............................    2,005,795      1,631,961
                                                 ------------   ------------
                                                    1,380,234      1,343,214
                                                 ------------   ------------
  Other long-term assets........................       80,211         80,211
                                                 ------------   ------------
    Total assets................................ $ 12,671,814   $ 16,425,233
                                                 ============   ============
 LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
  Accounts payable.............................. $    373,250   $    297,514
  Accrued expenses..............................      255,482        398,180
  Accrued payroll and benefits..................       29,560         31,977
                                                 ------------   ------------
    Total current liabilities...................      658,292        727,671
                                                 ------------   ------------
LONG-TERM DEBT:
  Convertible subordinated notes and other
   advances, net of current portion.............    1,733,747      1,685,547
                                                 ------------   ------------
SHAREHOLDERS' EQUITY
  Preferred stock, $0.01 par value--
   Authorized--7,500,000
   Issued and outstanding--none at July 4, 1998
   and January 3, 1998, respectively............          --             --
  Common stock, $0.01 par value--
   Authorized--15,000,000
   Issued and outstanding--7,378,251, and
   7,362,251 at July 4, 1998 and January 3,
   1998, respectively...........................       73,782         73,622
  Capital in excess of par value--common stock..   37,234,884     37,220,144
  Capital in excess of par value--preferred
   stock........................................          --             --
  Deferred Compensation.........................      (17,180)       (17,180)
  Subscription receivable.......................      (11,565)       (25,583)
  Deficit accumulated during development stage..  (27,000,146)   (23,238,988)
                                                 ------------   ------------
    Total shareholders' equity..................   10,279,775     14,012,015
                                                 ------------   ------------
    Total liabilities and shareholders' equity.. $ 12,671,814   $ 16,425,233
                                                 ============   ============
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       3

<PAGE>
 
                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                                 PERIOD FROM
                                                                                  INCEPTION
                               THREE MONTHS ENDED         SIX MONTHS ENDED       (JANUARY 4,
                             ------------------------  ------------------------    1989) TO
                               JULY 4,     JUNE 28,      JULY 4,     JUNE 28,      JULY 4,
                                1998         1997         1998         1997          1998
                             -----------  -----------  -----------  -----------  ------------
                                   (UNAUDITED)               (UNAUDITED)         (UNAUDITED)
<S>                          <C>          <C>          <C>          <C>          <C>
Revenues.................... $       --   $    14,800  $       --   $   377,649  $    725,374
Cost of Goods Sold..........         --         6,836          --       189,735       361,536
                             -----------  -----------  -----------  -----------  ------------
Gross Margin................         --         7,964          --       187,914       363,838
                             -----------  -----------  -----------  -----------  ------------
Operating Expenses
  Research and Development
   expenses................. $ 1,264,044  $ 1,056,757  $ 2,617,769  $ 2,030,150  $ 20,494,427
  Sales, general and
   administrative expenses..     789,970      565,970    1,440,680      985,873     7,370,357
                             -----------  -----------  -----------  -----------  ------------
  Total operating expenses..   2,054,014    1,622,727    4,058,449    3,016,023    27,864,784
                             -----------  -----------  -----------  -----------  ------------
  Operating loss............  (2,054,014)  (1,614,763)  (4,058,449)  (2,828,109)  (27,500,946)
                             -----------  -----------  -----------  -----------  ------------
  Interest income...........     158,303      224,704      345,496      386,670     1,613,309
  Interest expense..........     (24,099)     (28,101)     (48,205)     (58,201)   (1,112,509)
                             -----------  -----------  -----------  -----------  ------------
  Interest income, net......     134,204      196,603      297,291      328,469       500,800
                             -----------  -----------  -----------  -----------  ------------
  Net loss.................. $(1,919,810) $(1,418,160) $(3,761,158) $(2,499,640) $(27,000,146)
                             ===========  ===========  ===========  ===========  ============
  Basic and diluted net loss
   per share................ $     (0.26) $     (0.20) $     (0.51) $     (0.42)
                             ===========  ===========  ===========  ===========
  Weighted average basic and
   diluted shares...........   7,374,262    7,026,778    7,370,221    6,019,585
</TABLE>
 
                                       4
<PAGE>
 
                    PHOTOELECTRON CORPORATION AND SUBSIDIARY
                         (A DEVELOPMENT STAGE COMPANY)
 
                      CONSOLIDATED STATEMENTS OF CASH FLOW
 
<TABLE>
<CAPTION>
                                    SIX MONTHS ENDED
                                 ------------------------       PERIOD FROM
                                   JULY 4,     JUNE 28,    INCEPTION (JANUARY 4,
                                    1998         1997      1989 TO JULY 4, 1998)
                                 -----------  -----------  ---------------------
                                       (UNAUDITED)              (UNAUDITED)
<S>                              <C>          <C>          <C>
Cash flows from operating
 activities:
 Net loss......................  $(3,761,158) $(2,499,640)     $(27,000,146)
 Adjustments to reconcile net
  loss to net cash used in
  operating activities--
 Depreciation and
  amortization.................      373,834      273,783         2,014,387
 Noncash interest converted to
  subordinated notes...........       48,200       58,201         1,025,196
 Noncash salary converted to
  common stock.................          --           --            250,000
 Noncash research and
  development expenses
  converted to subordinated
  notes........................          --           --              9,000
 Noncash salary stock option
  extension....................          --           --          1,134,162
 Changes in current accounts--
  Inventories..................     (739,622)     (52,551)       (1,122,403)
  Prepaid expenses.............       30,881      130,357           (74,626)
  Other current assets.........      (26,680)    (156,562)          (55,791)
  Accounts payable.............       75,736      (64,364)          373,250
  Accrued expenses.............     (145,115)      (6,884)           84,093
                                 -----------  -----------      ------------
   Net cash used in operating
    activities.................   (4,143,924)  (2,317,660)      (23,362,878)
                                 -----------  -----------      ------------
Cash flows from investing
 activities:
 Net Maturities of held to
  maturity investments.........    2,968,100          --         (8,921,256)
 Purchases of equipment and
  leasehold improvements.......     (410,854)    (565,136)       (3,361,183)
 Loan to Officer...............          --           --            (80,211)
 Proceeds from the sale of
  equipment and leasehold
  improvements.................          --           --              9,845
                                 -----------  -----------      ------------
   Net cash provided by (used
    in) investing activities...    2,557,246     (565,136)      (12,352,805)
                                 -----------  -----------      ------------
Cash flows from financing
 activities:
 Proceeds from issuance of
  common stock.................       28,918   17,335,075        18,014,424
 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)
                                 -----------  -----------      ------------
   Net cash provided by
    financing activities.......       28,918   17,335,075        36,444,506
                                 -----------  -----------      ------------
Increase (decrease) in cash and
 cash equivalents..............   (1,557,760)  14,452,279           728,823
Cash and cash equivalents,
 beginning of period...........    2,286,583    2,537,023               --
                                 -----------  -----------      ------------
Cash and cash equivalents, end
 of period.....................  $   728,823  $16,989,302      $    728,823
                                 ===========  ===========      ============
Cash flows from noncash
 financing activities:
 Conversion of salary expense
  to common stock..............  $       --   $       --       $    250,000
                                 ===========  ===========      ============
 Conversion of convertible
  subordinated notes to common
  stock........................  $       --   $   464,231      $  4,491,245
                                 ===========  ===========      ============
 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.
 
                                       5
<PAGE>
 
                           PHOTOELECTRON CORPORATION
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO 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 3, 1998 included in the Company's Form 10-K
filing with the Securities and Exchange Commission.
 
2. NET LOSS PER SHARE
 
  During the second quarter of 1998, basic and diluted net loss per share were
calculated as follows:
 
<TABLE>
<CAPTION>
                                THREE MONTHS ENDED           SIX MONTHS ENDED
                            --------------------------- ---------------------------
                            JULY 4, 1998  JUNE 28, 1997 JULY 4, 1998  JUNE 28, 1997
                            ------------  ------------- ------------  -------------
   <S>                      <C>           <C>           <C>           <C>
   Basic:
     Net loss.............. $(1,919,810)   $(1,418,160) $(3,761,158)   $(2,499,640)
     Weighted average
      shares...............   7,374,262      7,026,778    7,370,221      6,019,585
     Basic net loss per
      share................ $     (0.26)   $     (0.20) $     (0.51)   $     (0.42)
   Diluted:
     Net loss.............. $(1,919,810)   $(1,418,160) $(3,761,158)   $(2,499,640)
     Weighted average
      shares...............   7,374,262      7,026,778    7,370,221      6,019,585
     Diluted net loss per
      share................ $     (0.26)   $     (0.20) $     (0.51)   $     (0.42)
</TABLE>
 
  The computation of diluted earnings per share for July 4, 1998 and June 28,
1997 exclude 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 July 4,
1998, there were 791,292 of such options outstanding, with exercise prices
ranging from $0.40-$9.00 per share.
 
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.
 
                                       6
<PAGE>
 
                         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 in the Company's
Registration Statement on Form S-1 (Reg. No. 333-14541) and in the Company's
Form 10-K for the fiscal year ended January 3, 1998, that could cause actual
future results 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 design, development and commercialization of
the Photon Radiosurgery System ("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 not received any revenue from
the sale of its current PRS model, the PRS400, and does not anticipate
receiving any significant revenue from the sale of its products at least until
late 1998. The Company has an accumulated deficit totaling approximately $27.0
million since its inception and expects to continue to incur losses until such
time as its commercialization efforts yield offsetting revenues. The Company
anticipates that its research and development, sales, general and
administrative and manufacturing expenses will continue to significantly
increase during 1998 as it pursues the commercialization of the PRS400.
 
  The Company received a 510(k) market clearance from the U.S. Food and Drug
Administration ("FDA") in June 1997, to market the PRS Model 3 for the
treatment of intracranial tumors. The Company subsequently submitted to FDA an
application for 510(k) market clearance (Premarket Notification) of the
PRS400, an upgraded version of the PRS Model 3 with similar radiation output
and enhanced safety and user interface systems. In late July 1998, the Company
received 510(k) clearance from the FDA to market the PRS 400 for the treatment
of intercranial tumors. The Company is introducing the PRS400 as its first
commercial product.
 
  Clinical use of the PRS for the treatment of brain tumors continues at
hospitals in the U.S., Europe and Japan, with formal clinical trials leading
toward product approval continuing at sites in Japan.
 
  The Company received authorization from the Medical Devices Agency (MDA) in
the United Kingdom to initiate intraoperative clinical breast tumor trials in
that country using the PRS as an adjunctive treatment with breast surgery.
Those trials have commenced, with the first case having been performed at The
Middlesex Hospital, University College London Hospitals, London, England on
July 2, 1998. The Company has filed an additional notification to the MDA
regarding its intention to begin clinical trials in England using the PRS to
irradiate breast tumors as a potential alternative to surgery. The MDA has
sixty (60) days in which to assess the notification and to issue a decision on
whether they have any objections to the initiation of such clinical trials.
Early results from the above trials, if favorable, will be used to support
applications to begin human clinical trials using the PRS to treat breast
cancer tumors in the U.S. and Germany.
 
  Earlier this year the Company obtained approval from the FDA of an
Investigational Device Exemption for use of the PRS in the treatment of
certain skin cancer tumors (basal cell and squamous cell carcinomas and
Kaposi's sarcomas). Those trials have commenced, with the first two cases
performed on July 17, 1998 at Our Lady of Mercy Medical Center, New York
Medical College, Bronx, New York.
 
  The Company intends to develop methods for use of the PRS in other clinical
applications and to conduct new clinical trials of those additional
applications, contingent upon obtaining all necessary regulatory approvals
prior to the start of a new clinical trial.
 
                                       7
<PAGE>
 
  Before medical devices such as the PRS400 can be marketed in the U.S.,
approval or marketing clearance by the FDA is required. Having obtained all
necessary regulatory approvals for intracranial brain tumors, the Company
intends to begin commercial sale of the PRS400 in the U.S. The Company will
consider use of the PRS400 for other potential applications on an ongoing
basis. In order to support the commercialization of the PRS 400, the Company
will experience significant working capital and financing needs.
 
  As regulatory clearances are obtained, the Company intends to market and
distribute its products through a combination of collaborative relationships
and in-house sales and marketing. The Company has developed and will continue
to develop strategic alliances with companies that have established
distribution channels in domestic and international markets. As part of the
manufacturing process, the Company intends to sub-contract the fabrication of
most of its electrical and mechanical components.
 
  On May 2, 1998, following successful assessment by the British Standards
Institution, the Company was certified as compliant with Annex II of the
European Union Medical Device Directive. The Company may now self-certify and
affix the CE Mark to the Company's products, subject to ongoing compliance
with the Medical Device Directive. On June 24, 1998, the Company passed its
semi-annual audit to maintain its ISO 9001 registration for operating a
quality management system. The Company also expects to demonstrate compliance
to Good Manufacturing Practice standards.
 
  The Company believes that the potential impact of the year 2000 on the
processing of date-sensitive information by the Company's computerized
information systems, and on products sold as well as products purchased by the
Company, will not have a material effect on the Company's business, results of
operations, or financial position, although there can be no assurance that the
Company will not experience unexpected problems or costs.
 
RESULTS OF OPERATIONS
 
 Three Months Ended July 4, 1998 and June 28, 1997
 
  Revenue. The Company had revenue of $0 in the second three months of 1998,
as compared with $14,800 in the second three months of 1997. The Company had
recorded the sale of a small amount of peripheral equipment in the three
months that ended June 28, 1997.
 
  Research and development expenses. The Company's research and development
expenses increased by $207,287 from $1,056,757 in the second three months of
1997 to $1,264,044 in the second three months of 1998. The principal cost in
research and development was continuing development of the PRS400 and
maintaining ISO 9001 registration for operating a quality system.
Additionally, there were significant increases in activity in the Company's
continuing support of clinical trials, satisfying FDA requirements, and
developing protocols to start skin and liver cancer research and development
programs. Other factors contributing to the increase in research and
development expenses were costs incurred in complying with regulatory
requirements and starting breast tumor clinical trials in the United Kingdom.
 
  Selling, general and administrative expenses. The Company's selling, general
and administrative expenses increased by $224,000 from $565,970 in the second
three months of 1997 to $789,970 in the second three months of 1998. The
increase is primarily attributable to the expansion of the Company's Sales and
Marketing department, which has focused on developing and purchasing marketing
material, attending trade shows and hiring new personnel.
 
  Interest income. Interest income decreased by $66,401 from $224,704 in the
second three months of 1997 to $158,303 in the second three months of 1998.
The decrease resulted from the continued expenditure of the proceeds of the
Company's initial public offering.
 
                                       8
<PAGE>
 
 Six Months Ended July 4, 1998 and June 28, 1997
 
  Revenue. The Company had revenues of $0 in the first six months of 1998, as
compared with $377,649 in the first six months of 1997. The 1997 revenue was
the result of the sale of a Model 3 PRS to Toshiba Medical Company for use in
Japanese clinical trials in accordance with the agreements between the Company
and Toshiba. This decrease is a reflection of the Company's plan not to market
the PRS Model 3. It is the Company's intention to market the PRS400 upon
receipt of 510(k) market clearance from the FDA.
 
  Research and development expenses. The Company's research and development
expenses increased by $587,619 from $2,030,150 in the first six months of 1997
to $2,617,769 in the first six months of 1998. The principal cost in research
and development was continuing development of the PRS400 and maintaining ISO
9001 registration for operating a quality management system. Additionally,
there were significant increases in activity in the Company's continued
support of clinical trials, satisfying FDA requirements, and continued efforts
in the Company's breast cancer research and development program. Other factors
contributing to the increase in research and development expenses were costs
incurred in complying with the requirements of regulatory agencies in the
United Kingdom concerning the breast cancer research and trial protocol.
 
  Selling, general and administrative expenses. The Company's selling, general
and administrative expenses increased by $454,807 from $985,873 in the first
six months of 1997 to $1,440,680 in the first six months of 1998. This
increase is primarily attributable to the expansion of the Company's Sales and
Marketing department, which has focused on developing and purchasing marketing
material, attending trade shows and hiring new personnel.
 
  Interest income. Interest income decreased by $41,174 from $386,670 in the
first six months of 1997 to $345,496 in the first six months of 1998. The
decrease resulted from the continued expenditure of the proceeds of the
Company's initial public offering.
 
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. As a result of
the initial public offering, the Company received net proceeds of $16,818,854.
 
  Consolidated working capital was $10.6 million at July 4, 1998, compared
with $14.3 million at January 3, 1998. Included in working capital are cash
and cash equivalents of $0.7 million at July 4, 1998, compared with $2.3
million at January 3, 1998. During the six months ended July 4, 1998, $4.1
million of cash was used for operating activities. The Company anticipates
that it will seek financing in the future to expand its marketing and
manufacturing capabilities, to support the research and development of
additional applications for the PRS400, to fund further clinical trials and to
provide working capital. 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 may occur.
 
  The Company used $410,854 of cash in the six months ended July 4, 1998 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. Prior to commercial sale of its
products, the Company will be required to obtain product liability insurance
covering the commercial use of its products.
 
  In 1995, a physician and his employer made certain claims against the
Company with regard to the Company's planned use of the PRS for treatment of
tumors in body cavities. On April 30, 1998, the dispute was
 
                                       9
<PAGE>
 
settled and the claimants assigned to the Company all of their patent and
other rights to certain disputed technology in exchange for an agreement by
the Company to pay royalties to the claimants on sales derived from such
technology. At the present time, the Company is not utilizing such technology.
The Company's management believes that the settlement of this matter will not
have a material effect on the Company's financial position or results of
operations.
 
  The Company's business plan calls for various applications of the PRS,
including the treatment of metastatic brain tumors, primary brain tumors, and
tumors in the breast, skin, liver and kidney. The Company estimates that the
capital requirements to complete the commercialization of the PRS400 to treat
brain tumors will be approximately $2.0 million. The Company believes that
such an amount will be needed to purchase capital equipment for assembly and
manufacturing of components for the PRS400 and to support sales and marketing.
At this point, the Company is not able to estimate the capital requirements of
commercializing other applications of the PRS.
 
                                      10
<PAGE>
 
                          PART II: OTHER INFORMATION
 
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS.
 
  On February 4, 1997, the Company completed an initial public offering of
2,000,000 shares of its Common Stock at a price of $8.50 per share. Pursuant
to an option to purchase additional shares of Common Stock to cover over-
allotments, Needham & Company, Inc. and Dain Bosworth Incorporated purchased
additional 275,000 shares of Common Stock on March 4, 1997. The shares were
registered with the Securities Exchange Commission pursuant to a registration
statement on Form S-1 (No.333-14541), which was declared effective on January
23, 1997. Syndicate underwriters led by Needham & Company, Inc. and Dain
Bosworth Incorporated underwrote the public offering. After deducting
underwriting discounts and commissions of $1,353,625 and expenses of
$1,165,021 the Company received net proceeds of $16,818,854.
 
  As of July 4, 1998, the Company has used a portion of the net proceeds from
its public offering for the purposes of funding research and development,
sales, general and administrative expenses and fixed assets. Since the
Company's initial public offering, the Company has expensed approximately $7.3
million for research and development, $3.7 million for sales and general and
administrative expenses and capitalized $1.4 million of fixed assets.
 
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  On May 27, 1998 the Company held its annual meeting of stockholders in
Lexington, Massachusetts. The stockholders voted on three matters.
 
  The following votes were cast for the election of directors, and all such
nominees were elected.
 
<TABLE>
<CAPTION>
                                                        VOTES FOR VOTES WITHHELD
                                                        --------- --------------
      <S>                                               <C>       <C>
      Peter M. Nomikos................................. 5,416,847     7,200
      Peter E. Oettinger, Ph.D. ....................... 5,416,847     7,200
      George N. Hatsopoulos Ph.D. ..................... 5,416,847     7,200
      Roger D. Wellington.............................. 5,416,847     7,200
</TABLE>
 
  The votes cast on the approval of the designation of Arthur Andersen LLP to
audit the books; records and accounts of the Company were as follows:
 
      5,255,357 shares voted for approval
        167,950 shares voted against approval
            740 shares abstained from voting
 
  The votes cast to approve the amendment of the Equity Incentive Plan to
increase the number of shares of Common Stock covered by such plan were as
follows:
 
      5,368,447 shares voted for approval
         53,000 shares voted against approval
          2,600 shares abstained from voting
 
                                      11
<PAGE>
 
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K.
 
 (a) Exhibits
 
  Copies of the following Exhibits are furnished with this report. Additional
Exhibits are incorporated herein by reference as reflected in the Exhibit
Index.
 
   NO. DESCRIPTION
   --- -----------
   27. Financial Data Schedule.
 
 (b) Reports on Form 8-K
 
  No reports on Form 8-K have been filed during the quarter for which this
report is filed.
 
  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/ Peter E. Oettinger
                                          By:__________________________________
                                                    Peter E. Oettinger
                                              Vice President, Chief Operating
                                                          Officer
 
                                                    /s/ Gerald J. Bojas
                                          By:__________________________________
                                                      Gerald J. Bojas
                                                  Chief Financial Officer
 
Dated: August 18, 1998
 
                                      12
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 EXHIBIT NO.                         DESCRIPTION                           PAGE
 -----------                         -----------                           ----
 <C>         <S>                                                           <C>
    *3.1     Articles of Organization of the Company, as amended.
    *3.2     Forms of Articles of Amendment of the Company.
   **3.3     By-Laws of the Company, as amended.
    *4.1     Specimen Certificate representing the Company's Common
             Stock.
    *4.2     Subordinated Convertible Note Purchase Agreement among the
             Company, Thermo Electron Corporation and Photoelectron
             Investments Corporation of Liberia dated as of May 22,
             1990, and Exhibits thereto.
    *4.3     Amendment and Waiver of Subordinated Convertible Note
             Purchase Agreement among the Company, Thermo Electron
             Corporation and Photoelectron Investments Corporation of
             Liberia dated as of August 1, 1996, and Exhibits thereto.
    *4.4     Amended and Restated 8% Subordinated Note Due 1997 from the
             Company to ThermoElectron Corporation in the principal
             amount of $125,000 dated as of August 1, 1996.
    *4.5     Amended and Restated 8% Subordinated Note Due 1997 from the
             Company to Peter M. Nomikos in the principal amount of
             $175,000 dated as of August 1, 1996.
    *4.6     Amended and Restated Convertible Note Purchase Agreement
             originally dated as of July 11, 1991, among the Company,
             PYC Corporation (formerly known as Photoelectron
             Investments Corporation of Liberia) and Peter M. Nomikos,
             and Exhibits thereto.
    *4.7     8% Subordinated Convertible Note Due 1998 from the Company
             to Peter M. Nomikos in the principal amount of $500,000
             dated as of August 8, 1996.
    *4.8     Convertible Note and Warrant Purchase Agreement between the
             Company and Peter M. Nomikos dated as of May 13, 1992, and
             Exhibits thereto.
    *4.9     Amendment and Waiver of Convertible Note and Warrant
             Purchase Agreement dated as of May 13, 1992 between the
             Company and Peter M. Nomikos, dated as of August 1, 1996
             and Exhibits thereto.
    *4.10    Amended and Restated 8% Subordinated Convertible Note Due
             on Demand from the Company to Peter M. Nomikos in the
             principal amount of $705,000 dated as of August 1, 1996.
   *10.1     Lease Agreement dated June 12, 1996 between Lexington
             Development Company Trust and the Company.
   *10.2     Cash or Deferred Profit Sharing Plan and Trust dated April
             1, 1995, as amended, of the Company.
   *10.3     Employee Stock Purchase Plan of the Company and form of
             Subscription Agreement.
   *10.4     1989 Employee Stock Option Plan of the Company and forms of
             Stock Option Agreements.
   *10.5     1996 Equity Incentive Plan of the Company.
   *10.6     Form of Stock Purchase Warrant issued to certain security
             holders of the Company and Schedule of Substantially
             Identical Documents from Exhibits.
   *10.7     Stock Option Agreements variously dated between certain
             directors and officers of the Company and the Company.
   *10.8     Form of Subscription Agreement between the Company and
             purchasers of Series B Preferred Stock.
   *10.9     Form of Subscription Agreement between the Company and
             purchasers of Series C Preferred Stock.
</TABLE>
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT NO.                         DESCRIPTION                           PAGE
 -----------                         -----------                           ----
 <C>         <S>                                                           <C>
    *10.10   Series B Subscription Agreement dated 1994 between the
             Company and Thermo Electron Corporation.
    *10.11   Series C Subscription Agreement dated December 16, 1995
             between the Company and Toshiba Medical Systems Co., Ltd.
    *10.12   Form of Registration Rights Agreement between the Company
             and holders of Series C Preferred Stock.
    *10.13   Registration Rights Agreement dated December 22, 1995
             between the Company and Toshiba Medical Systems Co., Ltd.
    *10.14   Technology Cross License Agreement dated as of January 4,
             1989 between the Company and Thermo Electron Corporation.
    *10.15   International Distributor Sales and Service Agreement dated
             December 13, 1995, as amended, between the Company and
             Toshiba Medical Systems Co., Ltd.
    *10.16   Agreement dated as of February 1, 1991, as amended, between
             the Company and the General Hospital Corporation.
    *10.17   Clinical Trial Agreement dated as of August 1, 1992, as
             amended, between the General Hospital Corporation, Nicholas
             T. Zervas, M.D. and the Company.
    *10.18   Investigational Treatment Agreement dated as of September
             1, 1994 between the General Hospital Corporation, Rees G.
             Cosgrove, M.D. and the Company.
    *10.19   Clinical Research Agreement dated as of April 1, 1995, as
             amended, between the Brigham and Women's Hospital
             Corporation, Peter Black, M.D. and the Company.
    *10.20   Clinical Trial Agreement dated as of January 1, 1995
             between the Tokyo Women's Medical College, Kintomo
             Takakura, M.D. and the Company.
    *10.21   Clinical Trial Agreement dated December 13, 1995, as
             amended, between the Company and Toshiba Medical Systems
             Co., Ltd.
    *10.22   Clinical Research Agreement dated as of November 1, 1995
             between The Royal Free Hampstead (NHS), Felix Senanayake,
             M.D. and the Company.
    *10.23   Form of Lock-Up Letter with certain security holders of the
             Company.
    *10.24   Forms of Medical Advisory Board Agreements between the
             Company and members of its Medical Advisory Board.
   **10.25   Letter Agreement between Photoelectron Corporation and
             Peter M. Nomikos dated as of March 29, 1998
   **10.26   Letter Agreement between Photoelectron Corporation and
             Peter M. Nomikos dated as of March 29, 1998
   **10.27   Sub-sublease Agreement between Photoelectron Corporation
             and IPRAX Corporation, dated November 1, 1996
   **10.28   Pledge Agreement dated February 21, 1997 between Peter E.
             Oettinger, Ph.D. and Photoelectron Corporation
   **10.29   Promissory Note of Peter E. Oettinger, Ph.D. in the
             principal amount of $80,211.26 in favor of Photoelectron
             Corporation, dated February 21, 1997
    *21.1    Subsidiaries of the Company.
     27.     Financial Data Schedule.
</TABLE>
--------
*  Filed as same numbered exhibit to the Company's Registration Statement on
   Form S-1 (Reg. No. 333-14541) and incorporated herein by reference.
** Filed as same numbered exhibit to the Company's Annual Report on Form 10-K
   for the period ended January 3, 1998 and incorporated herein by reference.